TEMPLATES

Table of Contents
AGENCY............................................................................................................................................................................................. 2
BREACH OF FIDUCIARY DUTY OF MAJORITY AGAINST MINORITY [PUBLIC CORPORATION]................................4
BREACH OF FIDUCIARY DUTY OF MAJORITY AGAINST MINORITY [CLOSE CORPORATION]..................................5
CONFLICT OF INTEREST (DERIVATIVE SUIT)....................................................................................................................... 6
BREACH OF DUTY OF CARE (DERIVATIVE)............................................................................................................................ 8
COMPETING WITH THE CORPORATION............................................................................................................................... 10
CORPORATE OPPORTUNITY DOCTRINE (DERIVATIVE)................................................................................................. 11
LEVERAGE AND COMPENSATION (CONFLICT OF INTEREST ISSUE)............................................................................ 13
SHAREHOLDER REMEDIES:...................................................................................................................................................... 14
PREEMPTIVE RIGHTS (DIRECT)............................................................................................................................................. 16
SALE OF CONTROL...................................................................................................................................................................... 18
REPURCHASE OF SHARES......................................................................................................................................................... 19
SHARES........................................................................................................................................................................................... 21
DIVIDEND POLICY (DERIVATIVE SUIT)................................................................................................................................ 22
RULE 10B-5 (DERIVATIVE)...................................................................................................................................................... 24
DERIVATIVE SUITS..................................................................................................................................................................... 28
INDEMNIFICATION..................................................................................................................................................................... 30
THE SPECIAL LITIGATION COMMITTEE............................................................................................................................... 31
ORGANIC CHANGES..................................................................................................................................................................... 33
TYPES OF ORGANIC CHANGES................................................................................................................................................. 36
BOARD OF DIRECTORS.............................................................................................................................................................. 40
PIERCING THE CORPORATE ENTITY VEIL........................................................................................................................... 43
SHAREHOLDERS.......................................................................................................................................................................... 45
SQUEEZE OUTS AND FREEZE OUTS (DIRECT)..................................................................................................................... 48

1
 AGENCY

ISSUE: Whether an agency relationship exists.

RULE: Agency is the consensual, fiduciary relationship that arises when one person (a principal) manifests assent to
another person (an agent) that the agent shall at on the principal’s behalf and subject to the principal’s control and the
agent manifests assent or otherwise consents so to act. In order to create an agency, there must be some form of agreement
or understanding, but not necessarily a contract, between the parties.

ANALYSIS:

1) Did the Principal give authority to the Agent? YES (P liable); NO (P not liable).
a. ACTUAL  Actual authority exists when the principal communicates to the agent about the activities in
which the agent may engage and the obligation the agent may undertake. Actual authority exists from the
standpoint of the agent.
i. EXPRESS  Express authority exists when a principal directs an agent to do a particular thing
and involves examining the principal’s explicit instructions.
ii. IMPLIED  Implied authority exists when there are no words or documents granting authority,
but the situation makes it clear that the principal intended the agent to have authority to do
something for him. 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.
b. APPARENT  Apparent authority is created when a person (principal or apparent principal) creates
appearances (a manifestation) that another person (the apparent agent) has the authority to act on behalf
of that apparent principal, which would reasonably lead a third party to believe the apparent agent is
authorized. Apparent authority exists from the standpoint of the third party.
i. Did the Principal make appearances? The principal must make some appearance, which to a
third party, creates the impression the principal is holding another person out to be an agent.
ii. Did the third party reasonably rely? The third party’s assumption that the principal has given
some authority to the agent must be reasonable.
c. IF NOT, did Principal ratify the contract? YES (P liable); NO (P not liable).
i. Ratification is authority that is 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). Affirmation may be express or implied. Once an agreement or transaction has been
ratified, the law treats it as if the agent originally did it with actual authority. Both parties to the
agreement are bound. Ratification is based on the idea that one should not be permitted to obtain
the benefits of an act done on his account unless he is made responsible for the means by which
they have been obtained.
ii. Do any exceptions apply? YES (P not liable); NO (P liable).
1. Didn’t know all the facts?
2. Partial ratification?
3. Unfair result to third party?
d. Does estoppel apply? YES (P cannot deny); NO (P can deny).
i. Estoppel is an equitable doctrine, which prevents the principal from denying an agency
relationship exists and is based on the idea that one should be bound by what he manifests,
irrespective of fault. The recovery is limited only to the damage actually incurred.
ii. Did the Principal do something wrong, or fail to do something, that created an impression
with the third party?
iii. Did the third party rely and later his or her position to his or her detriment?
2) Was the Principal disclosed, partially disclosed, or undisclosed?
a. DISCLOSED  When the Principal is fully disclosed, the Principal is liable for all acts of the Agent,
with some exceptions (e.g., breach of fiduciary duty, scope).
b. UNDISCLOSED

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 i. PARTIALLY DISCLOSED  A partially disclosed principal exists when an agent tells the third
party the agent is acting on behalf of a principal, but the identity of the principal is not disclosed.
Since a partially disclosed principal may not enter into a contract, the agent is usually treated as a
party to and bound by the agreement. The undisclosed principal is also liable because it was his
transaction.
ii. FULLY UNDISCLOSED An undisclosed principal exists when an agent is acting on behalf of
a principal, but the agent does not tell the third party (and the third party does not know) the agent
is acting on behalf of a principal. Since the third party thinks it is entering into an agreement with
the agent and no other person is disclosed, the agent is presumed to be a party to the agreement
and is bound by the agreement. The undisclosed principal is also liable because it was his
transaction.
iii. Did the third party make a “detrimental change in position”?
iv. Did Principal have notice of Agent’s conduct and that said conduct might induce the third
party to change his or her position?
v. Did the Principal take reasonable steps to notify the third party?
3) Any other issues?
a. Imputed Knowledge - The law presumes agents communicate information to their principals. This
irrefutable presumption exists because people should not be better off just because they use an agent. A
principal may not insulate himself from liability based on knowledge by picking an agent who will not
communicate with them. However, the agent must have an opportunity to communicate and a need to
communicate.
i. Adverse Agent Exception – Knowledge is not imputed when the agent is working adversely to
the principal. The exception applies whenever an agent acts in his own or another’s interest and
adversely to his principal.
1. Sole Actor Exception - Even if an agent’s actions are totally adverse to the principal, if
the agent is the sole agent, the agent’s knowledge and conduct will be nevertheless
imputed to the principal. Moreover, this rule only applies to a person attempting to retain
the benefit of the transaction.
b. Independent Contractor - In a situation with an independent contractor, there is no agency relationship;
the independent contractor is hired to do some service but is not controlled by his client in performance of
that service. The distinction between employee and independent contractors is important because
employees and independent contracts create different potential liabilities for their principals (e.g.,
respondeat superior).

CONCLUSION: An agency relationship does/does not exist.

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 BREACH OF FIDUCIARY DUTY OF MAJORITY AGAINST MINORITY [PUBLIC CORPORATION]

ISSUE: Whether the majority shareholders breached their fiduciary duty to minority shareholders.
 When issue arises:
o Issuance of dividends
o Issuance of shares
o Transactions between parent and subsidiary at the expense of the minority shareholders (Sinclair Oil case)
o Usurpation of corporate opportunities
o Exclusion of shareholders from transaction
o Preemptive rights

RULE: Controlling shareholders owe a fiduciary duty to minority shareholders. A majority shareholder may not use the
control to their own advantage to the disadvantage of the minority. This duty encompasses loyalty, good faith, and fair
dealing.

NOTE: In Illinois, shareholders owe a fiduciary duty to each other.

ANALYSIS: To determine if there has been a breach, courts will scrutinize the agreements to determine 1) whether the
action was taken for a business purpose and 2) whether the minority shareholder was treated fairly.

 Valid business purpose – Some courts require the majority to state a valid business purpose as justification for a
transaction, which affects shares. Even if offered, the minority shareholder may still suggest less restrictive
means. Even after applying this test, there is little substantive protection for minority shareholders.
 Fairness (tie in to conflict of interest analysis) –
 NOTE:
o Parent and subsidiary company: In Sinclair Oil Corp v Levien the court held that a parent subsidiary
owes a fiduciary duty to its subsidiary where there are parent subsidiary dealings. This standard will be
applied when the fiduciary duty is accompanied by self dealing (meaning that the parent is on both sides
of the transaction with its subsidiary), in which the parent causes the subsidiary to act in such a way that
the parent gets the benefit and this amounts to inherent unfairness.

CONCLUSION: There was/was not a breach of fiduciary duty, and thus (explain what the remedy would be).

REMEDIES: § 12.55(b) and (c) set forth possible remedies:

1) Appointment of a custodian to manage the business and affairs of the corporation to serve for a time and under the
conditions prescribed by the court;
2) Appointment of a provisional director to serve for the term and under the conditions prescribed by the court; or
3) Dissolution of the corporation.
Additionally, the court, at any time during the pendency of the action and upon the motion of the complaining
shareholder, may order the corporation to purchase the shares of the petitioning shareholder at a fair price determined by
the court, with or without the assistance of appraisers, and payable in cash or in installments and with or without such
security other than personal commitments of other shareholders as the court may direct.

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 BREACH OF FIDUCIARY DUTY OF MAJORITY AGAINST MINORITY [CLOSE CORPORATION]

ISSUE: Whether the majority shareholders breached their fiduciary duty to minority shareholders.
 When issue arises:
o Issuance of dividends
o Issuance of shares
o Transactions between parent and subsidiary at the expense of the minority shareholders (Sinclair Oil case)
o Usurpation of corporate opportunities
o Exclusion of shareholders from transaction
o Preemptive rights

RULE: As noted in Donahue v. Rodd Electrotype Company of New England, stockholders in a close corporation owe
one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another, that
of utmost good faith and loyalty. This is one of the only causes of action in which the π can receive employment and/or
financial distributions, rather than liquidity as a remedy.

NOTE: In Illinois, shareholders owe a fiduciary duty to each other.

ANALYSIS: As established in Wilkes v. Springside Nursing Home, Inc., to determine if there has been a breach, courts
will scrutinize the agreements under the balancing test by considering: 1) whether the majority can demonstrate a
legitimate business purpose for its actions and 2) whether the minority can show the same legitimate objective could have
been achieved through an alternative course of action less harmful to the minority’s interest. Thereafter, the court will
balance the legitimate objective against the practicality of the alternative.

 Legitimate Business Purpose

o The majority must have a large measure of discretion in:
1) Declaring or withholding dividends;
2) Deciding whether to merge or consolidate;
3) Establishing the salaries of corporate officers;
4) Dismissing directors with or without cause; and
5) Hiring and firing corporate employee.
 Alternative Course of Action

CONCLUSION: There was/was not a breach of fiduciary duty, and thus (explain what the remedy would be).

REMEDIES: § 12.56. The court in Donahue compelled the majority to provide the minority πs an opportunity to redeem
their stock on the same terms that had been made available to a controlling shareholder. As a remedy, the court allowed
the πs to choose between rescinding the challenged redemption or participating on the same terms.

See also OPPRESSIVE CONDUCT UNDER SHAREHOLDER REMEDIES.

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 CONFLICT OF INTEREST (derivative suit)

ISSUE: Whether the ∆ breached their duty of loyalty, through a conflict of interest, when (explain relevant actions).

RULE: The duty of loyalty requires that fiduciaries put the interests of the corporation ahead of their own interests and is
implicated when a director is involved in a situation where there is a conflict of interest, meaning that there is some aspect
of the situation that creates a personal benefit for the fiduciary. A conflict of interest exists when the director knows that,
at the time he is asked to take action with regard to a potential transaction, he or a person related to him (1) is a party to
the transaction or (2) has a beneficial interest in the transaction; and then exercises his influence to the detriment of the
corporation. In Illinois, section 8.60 governs conflict of interest problems. This section provides that the fact that a
director has conflict of interest is ground neither for invalidating the transaction nor for negating the director’s vote.
However, this section provides that for a transaction to be upheld, the director has the burden of showing: 1) that the
transaction was fair OR 2) that after full disclosure of the director’s interest and also of the material information that the
transaction was approved by disinterested directors, even if they constituted less than a quorum, or other shareholders,
who are not interested directors.

ANALYSIS:

ONE: Is there a conflict of interest? YES (issue); NO (no issue).

 Self-dealing – Self-dealing arises when a fiduciary for the corporation enters into a transaction with himself or
herself or with an entity in which he or she (or a family member) has a substantial financial interest.
 Taking a “corporate opportunity” – A fiduciary “takes a corporate opportunity” when he or she
misappropriates an opportunity which belongs to the corporation.
 Stealing – Stealing arises when a fiduciary of the corporation takes something of value such as money/assets from
the corporation for himself or herself.
 Executive Compensation – Executive compensation is a conflict of interest when the executives whose
compensation is at issue are also on the BOD that votes to determine their compensation.
 The evaluation by the BOD of whether, and how much information to disclose to shareholders (particularly when
the nature of the disclosure might impact the liability of all or some of the BOD).
 Entrenchment – Entrenchment arises when directors take steps to prevent others from removing them from their
positions with the company for any reason.
 Situations in which a key player’s personal financial interests are, at least potentially, in conflict with the financial
interests of the corporation.

TWO: Is the transaction fair? The burden of showing fairness is on the interested director, unless the decision was
approved by disinterested shareholders/directors. Courts scrutinizing fairness often look at two factors: reasonableness of
the terms and value to the corporation. The Illinois court in Romanik v. Lurie Home Supply Center, Inc., set forth several
factors, which the court has considered in determining whether a transaction was fair. Of these factors, the following are
most relevant (choose the relevant factors):
 Whether the transaction was at market price;
 The corporation’s need for the property;
 Whether the corporation could have obtained a better bargain in dealing with others;
 The possibility of corporate gain being diverted by the director; and
 Whether full disclosure was made to the other directors and shareholders (note that disclosure cannot transform an
unfair deal into a fair one)
 NOTE: If fair, approval by the disinterested directors or shareholders is NOT necessary
 Disinterested director’s or shareholder’s approval:
o Material facts AND directors’ interest and relationship to transaction were disclosed?
o To BOD or committee thereof;
o The transaction was approved or ratified by affirmative votes of a majority of disinterested directors OR
o Note: OK that majority is less than a quorum
o Shareholders entitled to vote authorized, less the votes of any shareholder who is an interested director.
o Material: information, which would have made a difference in the approval.
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  § 8.60 is not a safe harbor provision meaning the benefit of the disinterested director or shareholder action is to
change the burden of proof, not to foreclose judicial scrutiny. Even if disinterested directors or shareholders
approve the transaction, the court may still scrutinize it if it is unfair.
 Derivative suit will be brought (see derivative suit analysis)

CONCLUSION: Therefore, the transaction will/will not be upheld. The normal remedy is to rescind or cancel the
transaction, in lieu of rescission, and damages may also be awarded.

7
 BREACH OF DUTY OF CARE (derivative)

ISSUE: Whether ∆s breached their duty of care.

 When issue arises? Anytime a business or management decision is made

RULE: As noted in Smith v. Van Gorkom, directors have a fiduciary obligation to the corporation to exercise the care of
an ordinary prudent and diligent person in a like position under similar circumstances. When a director is sued upon the
claim that he or she violated the duty of care, that director is often entitled to the protection of the business judgment rule.
The business judgment rule provides protection for directors from lawsuits, which might seek to challenges the business
judgment of those directors. However, this presumption can be overcome and the burden of proof is on π show either:
fraud, illegality, conflict of interest, bad faith, waste, an egregious or irrational decision, no decision, or an uninformed
decision.
 Exculpate duty of care: Section 2.10(b) provides that a director can be exculpated(not guilty) of his duty of care
but only if he is acting in good faith.

ANALYSIS:

Business Judgment Rule

 Procedural – The BJR protects directors when they make an informed decision. There is no BJR protection when
a Board does not “act” to make a decision or when it makes an uninformed decision.
 Substantive -
o Lack of good faith
o Fraud / Illegality – Fraud and illegality cause loss of the business judgment presumption and potentially
the possibility of proving the transaction was fair.
o Conflict of Interest – Where the BOD, with a conflict of interest, takes actions, the business rule is
effectively reversed and it is the directors themselves who must prove the fairness and rationality of the
transaction (See Conflict of Interest).
o Waste / Rational Business Purpose – If no rational business purpose exists, from the vantage point of
the BOD, can be found for action or inaction taken by the BOD, then the transaction may not be insulated
by the business judgment rule. It is important to note this analysis cannot be performed with hindsight; it
must be looked at through the eyes of the directors at the time they made their decision.
o Gross Negligence (Van Gorkom) - Gross negligence of a corporation may overcome the shield of the
business judgment rule. It is very rare, however, that a breach of duty of care is found; there may be other
elements at work, or the case may be particularly egregious.
Breach of Duty of Care – Whether because of substantive violation or procedural defects, if the BJR does not apply, in
order for π to successfully argue that a fiduciary duty was violated, π must also show a violation of the underlying duty of
care.
 Informed and Deliberate Decision Making - A director is expected to make informed and deliberate decisions.
A director is entitled to rely on information, opinions, reports or statements prepared by officers, employees, legal
counsel, public accountants, and a committee of the BOD of which he is not a member, if the director reasonably
believes them to be competent.
o An important distinction may be made between inside directors who might have a reason to know the
BOD is being misinformed and outside directors who are not in a position to know about false
information given to the BOD by insiders and officers.
 Inattention
o To Mismanagement – Courts have been reluctant to hold directors liable for inattention to
mismanagement. In Barnes v. Andrews, the court concluded a passive director, though he had technically
breached his duty of care, could not be liable because nothing indicated he could have prevented the
business failure.
o To Management Abuse – Courts have been less forgiving when a director fails to supervise management
defalcations and deceit. In Francis v. United Jersey Bank, although a rare case, the court found a breach
of fiduciary duty because a director’s laxity proximately caused the losses to the corporation.

8
 o To Monitor Illegality - Directors have oversight and monitoring responsibilities over the persons to
whom they delegate power to conduct the day-to-day business of the corporation. This remains a difficult
case to make, however, because typically π will have to prove (1) directors would have discovered the
problems had they been more involved, and (2) they could have done something to avoid the problem had
they possessed the knowledge.

Affirmative Defenses (∆): A violation might not result in liability if the BOD can show that the transaction was:
1) Beneficial to the corporation;
2) “Fair”; OR – courts will typically look at substantive or intrinsic fairness. Entire fairness involves both
procedural fairness by which the judgment was made and the substantive result (was it a good deal?). If both of
the conditions are met, the decision is protected.
3) There were no damages.

Other Considerations:
1) Expert? If the board hired or consulted an expert, regarding certain matters, the board’s decisions and actions
with regard to those matters will later be protected under the BJR as “informed” decisions provided the decision
does not violate another requirement of the BJR. There is a duty of care in hiring the expert (duty of inquiry as
part of the duty of care), and the board should be clear on what is beyond the scope of the expert’s competence. In
order to have a decision by an expert protected, the expert’s opinions must be relied on. Also, reliance on an
expert must reasonable. A BOD may not rely on an expert when the directors know, or should know, that the
expert is wrong.
2) Failure to Act? When a board or director on the board did not make a decision or did not act, it is important note
the BJR protects decisions, not the people who are charged with making them. The BJR requires the director to
actually make judgments. If the director fails to make a decision, there is no BJR protection because there has
been no “judgment.”

CONCLUSION: The π did/did not overcome the business judgment rule. If they did, any director who participated in the
decision is jointly and severally liable for breaching a duty of care. As long as proximate cause is shown, there will be
liability for damages.
 See Barnes v. Andrews, where proximate cause easily in oversight cases and disregard for management abuse.
Not so easy when directors are inattentive to mere mismanagement.

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 COMPETING WITH THE CORPORATION

ISSUE: Whether director has breached fiduciary duty of loyalty by competing with the corporation.

RULE: A director or officer of a corporation has a duty not to be involved with a competing business, and to do so
amounts to a breach of his duty of loyalty because it would be a usurpation of a corporate opportunity, but also a director
cannot faithfully serve two masters. This duty applies unless there is no foreseeable harm caused by the competition or
disinterested directors or shareholders have authorized it. The πs carry the burden of proof in showing the director
“competed with the corporation.”

APPLICATION: Generally, directors are allowed to engage in preliminary or planning activities, but a showing that the
director used the corporate facilities, employees, or funds to start the competing business serves as a showing that the
director/officer has breached his fiduciary duty.
 Pre-termination: Permissible preliminary activities: organization of new corporation, purchasing machinery for
new corporation, obtaining financing for new company, designing a production plant.
 Post termination: Generally the fiduciary duty not to compete terminates when the fiduciary relationship
ends due to termination or resignation. Nonetheless, some courts will not sever liability for transactions completed
after termination of the party’s association if the transactions began during the existence of the relationship or
were founded on information acquired during the relationship.

REMEDY: If the director is found to have competed with the corporation, court may impose 1) injunction 2) covenant
not to compete 2) damages for the lost profits 3) court may order no misappropriation of trade secrets

CONCLUSION: The π did/did not breach his fiduciary duty of loyalty by competing with the corporation.

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 CORPORATE OPPORTUNITY DOCTRINE (derivative)

ISSUE: Whether the director has usurped the corporation of a corporate opportunity thereby breaching his duty of loyalty.

RULE: The corporate opportunity doctrine stands for the principal that a fiduciary of a corporation may not take, for
personal gain, a corporate opportunity, in which the firm has a property right, and use it for his or her own advantage
without first offering it to the corporation. Under the corporate opportunity doctrine, a corporate manager, director, or
executive cannot usurp corporate opportunities for his own benefit unless the corporation has rejected the opportunity.
The π has the burden of proving the existence of a corporate opportunity.

ANALYSIS:

ONE: Is this a corporate opportunity? (burden of proof on π) Three instances where it is:
1) Acquisition of property: Courts generally find that a director has usurped a corporate opportunity when a
director takes property that would be useful or needed by the corporation, and the director only discovered the
property while looking for it for the corporation.
2) Acquisition of a business
3) Acquisition of the corporation’s own shares
Also ask:
1) Has the corporation been seeking the opportunity?
2) Would the corporation have sought it if it knew of it? Same line of business as the one the corporation engages in?
3) Have corporation funds or facilities been used in finding or developing the opportunity?

TWO: Affirmative Defenses (burden of proof on ∆)

1) Incapacity - ∆ would plead an incapacity affirmative defense because he believed the corporation would not be
able to take advantage of the opportunity. Where a business opportunity is presented to an officer in his individual
capacity, rather than in his official capacity as an officer or director, AND the opportunity is NOT essential to the
corporation NOR one in which the corporation has an interest or expectancy, opportunity is officer’s and not the
corporation’s (Paulman v Kritzer).
2) Source - ∆ would plead a source affirmative defense because he believed the opportunity was presented to him
personally, not because of his corporate position, but because of his personal skills, knowledge, and expertise. The
doctrine does not apply and the opportunity is that of the officer and not the corporation IF 1) the opportunity is
presented to an officer in his individual capacity, not his official capacity as an officer of the corporation AND 2)
the opportunity is NOT essential to the corporation NOR one in which the corporation has an interest or
expectancy (Paulman v. Kritzer).

THREE: Did the officer present the opportunity to the corporation? YES (no breach); NO (breach)
1) Rule Any time a corporate opportunity exists, ∆ must fully disclose the opportunity and his or her interests in the
opportunity to the corporation. The corporation has, what amounts to a right of first refusal on the opportunity. In
doing so, the ∆ should demonstrate good faith and candor (Kerrigan v Unity Savings).

FOUR: Has the corporation declined the offer? YES (if pursued, no breach); NO (if pursued, breach)
1) Rule However, if a director of a corporation informed the corporation of a business opportunity, which the
corporation declines, the director may then be free to pursue the opportunity himself.  The burden of proof shifts
to ∆ to prove the corporation declined the offer.  
2) The degree of disclosure made to the corporation
a. If directors have effective control on the board of directors, tender to the board of directors would still be
ineffectual. In such a case, the offer would have to be tendered to the shareholders, because to do otherwise
would be a conflict of interest.
3) The action taken by the corporation within reference of the disclosure.

CONCLUSION: The director did/did not usurp the corporation of a corporate opportunity and therefore, did/did not
breach his duty of loyalty

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REMEDY: What is remedy for corporate opportunity?
1) Courts have consistently recognized that the proper remedy is a constructive trust or money, however, any
violation may also be subject to damages.
2) When tangible property is involved and the property is still be held by ∆, the court determines the price paid by ∆
plus any necessary expenditure made by ∆ and orders ∆ to convey the property to π upon tender by π.

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 LEVERAGE and COMPENSATION (conflict of interest issue)

ISSUE: Whether there was a conflict of interest in determining the reasonable compensation of all directors for services
to the corporation as directors, officers, or otherwise, and thus a breach of the duty of loyalty.

RULE: Salary and compensation issues falls within self-dealing. Salaries are subject to challenge unless disinterested
shareholders review the salaries OR fairness is proven. IBCA § 8.05(c) provides that unless the articles of incorporation
of the by-laws provide otherwise, the board of directors by an affirmative majority vote, irrespective of any personal
interest of any of its members, have authority to establish reasonable compensation of all directors for services to the
corporation as directors, officers or otherwise, but this must be considered in relation to section 8.60 which governs
conflict of interest situations. The burden of proof is on the defendant to prove his or her compensation was reasonable.
o Compensation: can take the form of bonuses, salaries profit sharing, pension plans, stock options, expense
accounts, severance pay, etc.

ANALYSIS:

 Whether the compensation was fair? Go through § 8.60 analysis.

o RULE: As discussed in The Disney Litigation, the test is whether the compensation was excessive,
unreasonable or out of proportion to the value of the services rendered. Courts scrutinizing fairness often
look at two factors: reasonableness of terms and value to the corporation (i.e., no waste of corporate
funds). ∆ has the burden of proving fairness of the transaction, unless it was approved by disinterested
shareholders/directors.
o In Illinois, section § 8.60 governs conflict of interest problems. This section provides that the fact that a
director has conflict of interest is ground neither for invalidating the transaction nor for negating the
director’s vote. However, this section provides that for a transaction to be upheld, the director has the
burden of showing: 1) the fairness and/or reasonableness of the compensation OR 2) that after full
disclosure of the director’s interest and also of the material information that the transaction was approved
by disinterested directors, even if they constituted less than a quorum, or other shareholders, who are not
interested directors.
 Alternatively, in a case of a close corporation, where a stockholder ratifies the actions of the board, a claim can
be brought under § 12.56 for waste of corporate assets, stating that the compensation was given for an improper
or unnecessary purpose.
o Although directors are given wide latitude in making business judgments, they are bound to act out of
fidelity and honesty in their roles as fiduciaries. Thus, they may not use their position to grant themselves
excessive compensation at the expense of ousting a minority of a fair return on their investment.

CONCLUSION: Therefore, there was/was not a conflict of interest in determining the reasonable compensation of all
directors for services to the corporation as directors, officers, or otherwise, and accordingly, a/no breach of the duty of
loyalty

REMEDIES: Generally, courts have offered rescission and re-negotiation of the terms of the compensation as remedies.

13
 SHAREHOLDER REMEDIES:
Shareholder or director’s deadlock, waste of corporate assets, oppression

NOTE: § 12.55 governs shareholder remedies for a public corporation and § 12.56 governs for close corporations.

RULE:

§ 12.55 provides that shareholders of a public corporation may petition the court to order a remedy offered in 12.55(b) if
one of the following situations exist: 1) directors are deadlocked and either irreparable injury to the corporation is thereby
caused or threated or the business of the corporation can no longer be conducted to the general advantage of the
shareholders; 2) director or those in control of the corporation are acting in a fraudulent, illegal, or oppressive manner
with respect to the petitioning shareholder; OR 3) the corporation’s assets are being misapplied or wasted.

§ 12.56 provides that shareholders of a non-public (closely held) corporation may petition the court to order a remedy
offered in 12.56(b) if one of the following situations exist: 1) the directors or shareholders are deadlocked and either
irreparable injury to the corporation is thereby caused or threated to the business of the corporation can no longer be
conducted to the general advantage of the shareholders; 2) director or those in control of the corporation are acting in a
fraudulent, illegal, or oppressive manner with respect to the petitioning shareholder; OR 3) the corporation’s assets are
being misapplied or wasted.

ANALYSIS: choose the one that applies

Director’s deadlock:
To petition the court for a remedy under § 12.55/§ 12.56, the director must show that 1) the directors are deadlocked,
either because of even division or greater than majority voting requirements, in the management of the corporate affairs 2)
the shareholders are unable to break the deadlock 3) either irreparable injury to the corporation is thereby caused or
threatened or 4) the business of the corporation can no longer be conducted to the general advantage of the shareholders.

Shareholder’s deadlock:
§ 12.55 does not provide for a remedy for shareholder deadlock.

To petition the court for a remedy under § 12.56, the shareholder must show that 1) the shareholders are deadlocked in
voting and 2) have failed for a period of at least 2 consecutive annual meeting dates to elect successors to directors whose
terms have expired and 3) either irreparable injury to the corporation is thereby caused or threatened or 4) the business of
the corporation can no longer be conducted to the general advantage of the shareholders.

Oppression: Oppression is conduct that can be characterized as heavy-handed or overbearing and excludes minority
participation. In Illinois, the courts have adopted the standard for oppressive conduct from White v. Perkins, which is a
lack of probity and fair dealing in the affairs of the company to the prejudice of some of its members. Oppression should
be deemed to arise only when the majority’s conduct substantially defeats expectations, that objectively viewed, were
both reasonable under the circumstances and were central to the decision to join the venture.

Waste of corporate assets: Although the board of directors is protected via the business judgment rule for making
legitimate business decisions, this is overruled in a case where the board has a conflicting interest or corporate assets are
spent for improper or unnecessary purposes. If this is found, the court can order one of the following remedies in
12.55(b)/12.56(b) being (see below).

 REMEDIES § 12.55(b):
o Appointment of a custodian to manage the business and affairs of the corporate to serve for the
term and under the conditions proscribed by law;
o Appointment of a provisional director to serve for the term and under the conditions prescribed
by the court; OR
o The dissolution of the corporation.
 REMEDIES § 12.56(b):
14
 o Appointment of a provisional director
o The setting aside of any action of the corporation or its shareholders, directors, or officers or any
other party in the proceedings
o Appointment of a custodian
o Cancellation or alteration of any provision in the corporation’s articles of incorporation or bylaws
o Removal from office of any director or officer
o An accounting
o Payment of dividends
o Award of damages to an aggrieved party
o Submission of the dispute to mediation or other forms of non-binding alternative dispute
resolution
o Dissolution
o Reasonable expectations- §12.56(d) provides that a court can consider the reasonable
expectations of a shareholder when making a remedy determination.

Asserting a Cause of Action:

1) When a minority shareholder seeks relief from [insert] conduct for available remedies, the shareholder must
establish that majority shareholders engaged in alleged statutory misconduct, but need not prove that wrongdoing
was so severe that it would justify dissolving the corporation;
2) Once a predicate conduct has been established, the court may, in its discretion, determine which, if any, remedy is
available and appropriate.
a. Reasonable Expectations - § 12.56(d) provides that a court can consider the reasonable expectations of a
shareholder when making a remedy determination.
b. RULE: Court-ordered dissolution is an extreme action, which courts are reluctant to order.
c. For example, a court can order that corporation pay the minority shareholder for his shares, without also
ordering dissolution of the corporation.

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 PREEMPTIVE RIGHTS (direct)

ISSUE: Whether shareholder has preemptive right to the shares.

RULE: A preemptive right is a right sometimes given to a corporation’s existing shareholders to protect the proportionate
interests of a shareholder in a corporation. The requirement is essentially that, when a new (subsequent) issue of shares is
to be made, existing shareholders will have the right to subscribe to that number of the new shares as the number of
shares, which are presently held by such shareholder bears to the total number of shares then issued by the corporation.
Likewise, preemptive rights do NOT exist where the stock about to be issued is part of the original issue. The burden of
proof is on the directors to establish fairness.

ANALYSIS:

1) Is the corporation public or private?

a. PUBLIC  There should be no preemptive rights for publicly held companies b/c they are not a big deal.
b. PRIVATE  There should always be preemptive rights in a private corporations b/c they are a big deal.
2) Was the corporation established before January 1, 1982? § 6.50 provides that the 1981 amendment to the 1933 act
reversed the policy of Illinois with respect to preemptive rights. Thus, this section provides that shareholders of a
corporation organized after Jan. 1, 1982, shall have no preemptive rights UNLESS such rights are affirmatively
provided for in the articles of incorporation.
a. YES  preemptive rights are the default provision
b. NO  NO preemptive rights is the default provision
3) Is this a new offering? Assuming the articles do affirmatively provide for preemptive rights, the issue becomes
whether or not the new issue of shares represented a new offering, because shareholders only preemptive rights in
the case of a new offering. YES (preemptive rights); NO (no preemptive rights).
a. RULE: The question is often whether the old issue has come to rest, which is a question of fact. As the
court discussed in Ross Transport v. Crothers, this may be determined by the number of shares the BOD
planned to sell for an issue and whether more capital was needed under that issue or not. Evidence that
they had enough capital, were making money, etc., are indications that the old issue was over and the new
stock is part of a new offering and hence, preemptive rights apply.
b. Considerations:
i. Was the corporation preeminently successful? YES (rights); NO (consider more).
ii. Passage of Time / Efforts - What happened between the time of the first and second issuances?
1. SOMETHING  needed $$ - consider more.
2. NOTHING  did not need $$ (Ross Transport v. Crothers) / not trying to issue.
a. Did they start issuing again?
iii.
Optional:
 New offering: If the corporation had more capital than was needed when shares were issued, then more than
likely, the new issuance of shares represents a new offering.
 Preemptive rights DO NOT apply if: 1) if shares are sold for a purpose other than to get money (i.e. property) 2)
the holder of the shares is only entitled to preferred or limited shares to collect dividends or assets 3) holder of
common stock is not entitled to shares that are preferred 4) holder of common stock shares with no voting power
is not entitled to shares of common stock with voting power

OTHER COA
 Breach of fiduciary duty: As noted in Ross Transport v Crothers, even if there are no preemptive rights
the court may provide remedy to the petitioning shareholder under the theory of breach of fiduciary duty
of majority against minority, because majority shareholders owe a fiduciary duty of loyalty, good faith
and fair dealing.
o The argument would be that the new issue is arbitrary of unnecessary
 Conflict of interest
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  10b5
 Oppression
 Waste of corporate assets

CONCLUSION: The shareholder does/does not have preemptive rights.

REMEDY: See § 12.55(b) and § 12.56(b).

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 SALE OF CONTROL

ISSUE: Whether the sale of control was appropriate.

RULE: A controlling shareholder usually may sell his control block for a premium (above market price not
available to other shareholders) and keep the premium for himself UNLESS the purpose of selling is to:

ANALYSIS:

1) Sale of Office:
RULE: It is illegal to sell corporate office or management control by itself (that is, accompanied by
no stock or insufficient stock to carry voting control). Persons holding management control hold it on
behalf of the stockholders and it is not personal property. As the court held in Perlman v. Feldmann,
∆ sinned when he sold control and took the profit himself instead of giving it to the company. The
main idea behind the sin is that the public should have shared in this; ∆ should have told offeror to
buy a portion from him and a portion from the public.
2) Sale to looters:
RULE: A controlling shareholder may not sell control if the seller has reason to suspect the buyer
will use the control to harm the corporation. Signals of a looter, which require the seller to investigate
the buyer’s intentions, include a price that is too good, a buy cannot afford the company, a dishonest
or hurried buyer and a buyer with a bad business reputation.
3) Usurpation of corporate opportunity:
RULE: A controlling shareholder cannot convert an offer made to the corporation into one for the
shareholder. If the buyer offers to purchase all shares on an equal basis, such as a merger proposition
or asset acquisition, the controlling shareholder cannot divert the offer to himself.

CONCLUSION: The sale of control was/was not appropriate.

REMEDIES: Court may allow 1) the corporation to recover OR 2) plaintiff may award a pro rata recovery under
which the seller repays to the minority shareholders the pro rata part of the benefit.

OTHER COA:
 Conflict of interest
 Oppression
 10b5

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 REPURCHASE OF SHARES

ISSUE: Whether the repurchase of shares was appropriate.

RULE: The 1983 IBCA act is very permissive with respect to the repurchases and other distributions. Today a repurchase
can be made out of paid-in capital. The repurchase of shares by a corporation may have many different purposes, all of
which in some way might involve fiduciary duties.  A repurchase may be made out of paid-in capital. 
In a challenge to a repurchase of shares, inside directors have their own interest at stake and thus have a higher burden of
proof than outside directors. The burden on inside directors is to prove the repurchase of shares transaction was fair under
IBCA §8.60 analysis.  

ANALYSIS:

ONE: What is it that the shareholder is objecting to in the repurchase of shares?

1) Corporation has paid too high a price; OR
2) Corporation has refused to give all shareholders equal opportunity to have their shares purchased; OR
3) Repurchasing would render the corporation insolvent.

TWO: What was the purpose/instance of repurchasing shares?

1. Proper Purposes
a. There may be a number of proper reasons for repurchase: elimination of preferred stock, which pays a
higher dividend, a justified defensive tactic to a takeover bid, or capital reorganization.
2. Repurchase from Controlling Shareholder
a. Even if it can be proven that the distribution is a fair price there is the additional problem that the
repurchase may be viewed as a selective distribution.
b. This purchasing or issuance of shares becomes a conflict of interest problem because whenever the BOD
is buying back shares to maintain control, they are not allowing an increase of capital to the corporation
so the burden is on the directors.
3. Repurchase as a Defensive Tactic (see Unocal/Revlon below)
a. All directors have fiduciary duty implications for repurchase to maintain control as all directors have an
interest in their control. The actions must be reasonable in relation to the threat posed.
b. When a BOD addresses a pending takeover bid, it has an obligation to determine whether the offer is in
the best interest of the corporation and its shareholders. In that respect, a BOD’s duty is no different form
any other responsibility and its decisions should be entitled to the respect they otherwise receive in the
realm of business judgment (see below).
4. Market Manipulation
a. Stock may be repurchased to manipulate share prices.  Officially this practice is prohibited, but there have
been very little successful attacks.

THREE: Should the corporation overturn the corporation’s repurchase of shares?

Courts will usually NOT overturn a corporation’s repurchase of shares if the:
1) The corporation has a proper purpose for repurchasing the shares;
a. If not proper, like to maintain control, see Business Judgment (below).
2) The corporate behaves with reasonable care; AND
3) The corporation does not violate its duty of loyalty (there is no potential conflict of interest).

19
Note: But if shares are issued for less than par value, creditors will often be allowed to recover against the shareholders
who received the “cheap” stock.

Business judgment rule: The business judgment rule erects a rebuttable presumption that corporation business decisions
are made by disinterested and independent directors (so that there is no breach of the duty of loyalty), acting with due care
(i.e., on an informed basis), in the good faith belief that the decisions are in the best interests of the corporation and its
shareholders, with no abuse of directorial discretion. This presumption is rebutted when there is a conflict of interest, and
thus § 8.60 applies in that the directors must show fairness (See conflict of interest template).
 There is a conflict of interest problem because on the one hand, the controlling shareholder is selling their shares to
the corporation, while on the other hand, they are authorizing the transaction on behalf of the corporation and
determining how much they will be paid, so effectively, they are dealing with themselves.
 There may also be a breach of fiduciary duty to the minority shareholders because similar to the
circumstance in Donahue v. Electrotype, because in authorizing the transaction, the majority has made a market for
themselves while excluding the minority shareholders from said market. Effectively, the majority shareholders are
making preferential distributions of the corporate assets to themselves.

Additionally, as noted in Unocal Corp v. Mesa Petroleum, the BOD is entitled to the protection of the business judgment
rule with regard to its decision in defensive conduct only after the BOD has proved 1) they reasonably believed the hostile
takeover bid posed a threat to corporation policy, AND 2) the BOD’s defensive conduct was reasonable relation to the
threat posed. The court relied on the decision from Cheff v. Mattes in determining that showing good faith and a
reasonable investigation would satisfy the burden for the first prong. Such proof is further materially enhanced by the
approval of a board comprised of a majority of outside independent directors who acted in accordance with the forgoing
standards. With respect to the second prong, the court briefly stated the defensive conduct could not be draconian.

Furthermore, in Revlon v. MacAndrews Forbes, the Delaware Supreme Court said, once the board has accepted that the
break up or sale of the corporation is desirable or inevitable, the nature of the directors’ duty to shareholders necessarily
changes. The directors’ duty is no longer involved in managing the company and benefitting shareholders in the long
term; rather, the directors become auctioneers and their role is to (1) make active and reasonable efforts to become
informed of the alternative options, and (2) maximize shareholder value by getting the best price available.
When is a break up or sale inevitable? When do we apply this standard?
1) When the corporation itself initiates an “active bidding process” and is seeking to sell or to effect a business
organization re: the break up of the company (BOD affirmatively solicits offers).
2) Where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative
transaction involve the break up of the company (what happened in Revlon).
3) When the board’s approval of a transaction will result in a “sale or change of control” (for example, corporation
goes from no controlling shareholder to one controlling shareholder).

TREASURY SHARES: Issued but not outstanding shares: Treasury shares are outstanding shares bought back by the
corporation. After the buy back, the stock cannot vote and does not have any dividend. Treasury shares can be cancelled
and can be issued again subject to provisions of the articles of incorporation, which may state that certain preferred stock
can be reissued after cancellation.

CONCLUSION: The repurchase of shares was/was not appropriate.

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 SHARES

WATERED, BONUS AND DISCOUNT SHARES

RULE: Prior to the elimination of par value, a frequent subject of litigation was the difference between par value and
consideration actually paid. Shares issued at a price lower than fair value or for less than fair consideration can have the
effect of dilution of the interest of minority shareholders. Thus, if the corporation sells shares for less than par value the
purchasing shareholders may be liable to the corporation or its creditors.

Watered stock (par value): The consideration received (usually property or services) usually because of
overvaluation is less than full consideration.

No par value: With abolition of the legal importance of the par value, the focus is directly upon the price the
board of directors establishes. Absent a showing of bad faith, no par value stock may be sold at whatever price is
determined reasonable by the board of directors and the petitioner would not be able to recover anything.

COAS: conflict of interest, 10b5, breach of fid duty, preemptive rights

AUTHORIZED SHARES

RULE: The articles of incorporation authorize certain number of stock, including the characteristics of the shares such as
class designation, preferences, qualifications, restrictions, or special relative rights and voting rights. The board can vote
to issue those shares, which are authorized and outstanding. However, the board may not issue more shares than
authorized. To do so necessitates an amendment to the articles of incorporation, which requires a majority shareholder
vote.

 Recapitalization (§ 10.20): Often involves the issuance of more shares and/or the cancellation of certain
classes. Changes to the characteristics of any class of stock require a class vote from the affected class.
Authorization of new share requires an amendment to the articles. Requires a 2/3 vote from the shareholders
because this is an organic change.

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 DIVIDEND POLICY (derivative suit)

ISSUE: Whether the court can compel payment of dividends

RULE: Generally, the decision of whether or not to declare a dividend is within the business judgment of the board and
courts are reluctant to interfere with business judgment of directors. § 9.10 provides that the board may make distributions
to its shareholders UNLESS 1) there are restrictions in the articles of incorporation OR 2) if after giving the distribution a)
the corporation would be insolvent OR b) the net assets of the corporation would be less than zero or less than the
maximum amount payable ay the time of distribution to shareholders having preferential rights in liquidation if the
corporation were then liquidated. Thus, distributions can be made so long as such distributions would not make the
liabilities exceed the assets. The burden of proof rests with the plaintiff to disprove the presumption of the BJR.
 In Reilly v Segert, the court determined that shareholders could be liable to creditors when the distribution
was made in insolvency.

ANALYSIS:

ONE: Will the distribution of dividends render the corporation insolvent or is the corporation already insolvent?
 As noted in Miller v Magline, the court may require a dividend to be declared where there is enough liquidity in
the corporation based on the theories of breach of fiduciary duty of majority against minority shareholders and
also oppression.
 YES  NO dividends
 NO  consider more.
TWO: Can the court compel the distribution of dividends?
 Is there a violation of the business judgment rule? (See Overcoming Business Judgment Rule)
o NO  cannot compel
o YES  consider more
 Does the corporation’s failure to issue constitute a breach of good faith?
 Miller v Magline approach: A dividend may be compelled when the board’s refusal to
declare one would constitute a breach of that good faith which they are bound to exercise
toward the stockholders. This is particularly important is a close corporation where it is
impossible for the majority to impartially decide if dividends should be paid.
 The corporation made distributions through salaries and bonuses only; dividends
were never declared. As a result, plaintiffs could never share in the profits of their
investment once they were no longer officers.
 Is the corporation immensely profitable?
 Dodge v Ford Motor Co: The court ordered dividends because of the immense
profitability of the company finding that powers of the directors are to be employed for
the benefit of the shareholders, and not society. Moreover, the powers of the directors are
to be employed for the benefit of the shareholders.

CONCLUSION: The court can/cannot compel payment of dividends.

REMEDIES
 A director who is found liable is entitled to contribution.
 A director who is found not liable may be entitled to indemnification.
 § 8.65(a)(1) provides that any director who votes for, or assents to any distribution prohibited by §
9.10 are jointly and severally liable to the corporation UNLESS the director acted in good faith and
relied on the balance sheet and profit and loss statement presented to him by the president or officer
of the corporation or any other individual with authority to have charge over the account. A director
can also shield himself from liability by dissenting on the record and voting against the action at the
meeting to approve the action.

22
23
 RULE 10b-5 (derivative)

ISSUE: Whether there was a violation of Rule 10b-5.

RULE: Rule 10b-5 allows for civil liability as well as criminal liability. Pursuant to SEC Regulation 17 C.F.R. 240.10.b-
5, 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 any facility of any national exchange
a) To employ any device, scheme or artifice to defraud
b) To make any untrue statement of material fact or to 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
c) To engage in any practice, or course of business which operates or would operate as fraud or deceit upon any
person in connection with the purchase or sale of securities.

ANALYSIS: A cause of action under rule 10b5 requires a showing of 1) interstate nexus 2) standing 3) in connection
with a purchase or sale of securities 4) material misinformation 5) scienter 6) reliance, and 7) causation (both actual and
proximate cause). This cause of action is brought derivatively and the burden of proof rests with π.

1) Interstate Nexus
a) RULE: Rule 10b-5 applies only to interstate transactions. This is broad because it can include use of mail
or telephone.
2) Standing
a) RULE: In order to bring a Rule 10b-5 cause of action, one must have standing. In Blue Chips Stamps, the
court deferred to the Birnbaum Rule, which says, in order to have standing, one must have been a
purchaser or sell of the securities at issue. A person does not have standing if a false of misleading
statement leads a person not to buy or sell a security.
b) Optional: In the absence of the Birnbaum doctrine, bystanders to the securities marketing process could
await developments on the sidelines without risk, claiming that inaccuracies in disclosure causes non-
selling in a falling market and that unduly pessimistic predictions by the issuer followed by a rising market
caused them to allow retrospectively olden opportunities to pass.
3) In Connection With The Purchase or Sale of Securities
a) RULE: The fraud must be in connection with a sale or trade of securities. There is no privity requirement
but πs must have been purchasers or sellers in order to seek damages. π must at least satisfy the “touch
test,” as SCOTUS created in Superintendent of Insurance of NY v. Bankers Life.
b) Optional: Corporate misstatements in situations when the corporation itself is not trading are actionable
provided it is foreseeable the misstatements will affect securities transactions.
c) “Touch Test” – In Superintendent of Insurance of NY v. Bankers Life, SCOTUS created the “touch test,”
whereby πs were deemed to have suffered an injury as a result of deceptive practices touching its sale of
securities, thereby giving a very broad gloss to the “in connection with” language. The touch test
seemingly allowed any fraudulent corporate act to be the focus of a Rule 10b-5 violation if somewhere
along the line, there was a purchase or sale of securities.
d) Insider Trading (direct) - In US v. O’Hagan, SCOTUS put to rest any argument that insider trading was
“in connection with” the purchase or sale of a security. The court took the position that the fiduciary’s
fraud occurred when he used the information to purchase or sell securities without disclosure to his
principal, not when he obtained the information. This is so even though the person or entity defrauded is
not the other party to the trade, but instead, is the source of the nonpublic information.
1. Majority Rule – The majority rule, as set forth in Goodwin v. Agassiz, takes the position that
officers and directors of a corporation may trade in the corporation’s stock, with disclosing
material information. The rule is premised on the idea that directors of a corporation stand in a
relation of trust to the corporation and are bound to exercise the strictest good faith in respect to a
corporation’s property and business.
2. Special Circumstances Rule – The special circumstances rule, as set forth in Strong v. Repide,
makes certain exceptions to the majority rule, taking the position that a corporation’s officers and
directors have a duty to disclose information before they trade with shareholders of the corporation
when certain special circumstances are present.
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 3. Minority Rule – The minority rule, as set forth in Oliver v. Oliver, takes the position that the
corporation’s officer and directors do have a duty to disclose material information whenever buying
from a shareholder.
e) Three Potential πs (SCOTUS):
1. Potential purchaser, either in the distribution or the trading markets, who allege they did not
purchase due to gloomy representations
2. Shareholders who allege they decided not to sell because of unduly optimistic representations
3. Shareholders, creditors and others related to the issuer who suffered loss as a result of insider
activities in connection with the purchase or sale of securities.
4) Material Misinformation
a) RULE: ∆ must have 1) affirmatively misrepresented a material fact, 2) failed to state a material fact that
made his statement misleading, OR 3) remained silent in the face of a fiduciary duty to disclose a material
fact. Misinformation includes half-truths or omissions of information. Moreover, ∆s must have engaged in
actual fraudulent behavior, not the collateral assistance of an officer, director or accountant.
b) Material - Additionally, as the court determined in Basic, Inc. v. Levinson, the misinformation must be
material, such that there is a reasonable likelihood a reasonable investor would consider the information
important in deciding to buy or sell. OPTIONAL: The court based its decision of the materiality of a
contingent event on two things: 1) the contingent event must have a highly significant impact on the
company, if it occurs, and 2) the contingent event must have a high probability of occurring.
c) Deception – In Santa Fe v. Green, SCOTUS held that Rule 10b-5 only regulates deception, not unfair
corporate practices or breaches of fiduciary duty. Initially, this holding would cause a negative reaction
from liberals, but after thinking it through, this makes a lot of sense and in fact, harmonizes state and
federal law. Effectively, the court in Santa Fe outlined fraud/deception: in order for liability to result, the
disclosure must have been misleading. Specifically, In Santa Fe, the court determined an unfairly low price
per share the parent corporation offered did not amount to fraud.
 Misappropriation – See Misappropriation.
 Duty to Abstain/Disclose – See Insider Trading.
d) Safe Harbor - Statements are protected by the safe harbor if they are identified as forward-looking and
accompanied by “meaningful cautionary statements identifying important factors that could cause actual
results to differ materially form those projected in the forward-looking statement.”
e) Aiding and Abetting – There is no aiding and abetting liability for the express private causes of action,
however, there is express aiding and abetting liability for criminal actions that are brought based on section
10(b). The Metge court identified three generally recognized elements, which are necessary to establish
aiding and abetting liability: (1) the existence of a securities law violation by the primary party; (2)
“knowledge” of a violation on the part of the aider and abettor; and (3) “substantial assistance” by the aider
and abettor in the achievement of the primary violation. These elements have been accepted, with certain
variations, by all courts considering the issue. Although the decision in Central Bank of Denver v. First
Interstate Bank of Denver eliminated aiding and abetting liability for those who provide services to
participants in the securities business, not long thereafter, a cause of action was upheld shortly after against
PwC, as a primary violator, in a 10b-5 case.
5) Scienter
a) RULE: Next, π must plead and prove ∆’s scienter. According to the court in Ernst & Ernst v. Hochfelder
(excellent judicial work), π must show that ∆ either knew or was deliberately reckless in not knowing of
the misrepresentation and intended π to rely on the misinformation. The Supreme Court appeared to favor
actual intent to defraud but later court interpretations have included recklessness. In any event, negligence
will not suffice.
b) PLEADING: In Tellabs Inc. v. Makor Issues & Rights Ltd., the court said, to plead scienter, a complaint
must state with particularity facts giving rise to a strong inference that ∆ acted with the required state of
mind. Moreover, a comparison of plausible inferences (of both non-culpability and fraudulent intent) is
necessary, and the inference of scienter must be “at least as likely as” any plausible opposing inference.
SCOTUS thus concluded that pleading facts that create “cogent and compelling” inferences of scienter
could satisfy this standard, provided these inferences are at least as strong as inferences of non-culpability.
6) Reliance
a) RULE: Next, it must be shown that a reasonable investor would have relied on the misrepresentation. In
10b-5 cases involving a duty to speak, courts dispense with reliance if the undisclosed information was

25
 material. In 10b-5 cases involving transactions on impersonal trading markets, courts infer reliance from
the dissemination of misinformation in the trading market.
b) Affirmative Misrepresentation: The burden rests with π to prove reliance in cases of affirmative
misrepresentations.
c) Nondisclosure: As noted in Affiliated Ute Citizens, when ∆ fails in a duty to speak, whether in a face-to-
face transaction or an anonymous trading market, courts dispense with the proof of reliance if the
undisclosed facts were material. The policy behind this is to require proof of reliance in a case of
nondisclosure would impose a nearly insuperable burden on a π to prove reliance on something not said.
d) Omitted Information: Courts are divided as to whether reliance must be shown in cases of omitted
information.
e) Fraud on the Market: As noted in Basic, Inc. v. Levinson, courts have created a rebuttable presumption
of reliance in cases of false or misleading representations on a public trading market, otherwise known as
the “fraud on the market” theory. The theory rests on the principle that the market price of a security,
traded on an open and developed market, reflects all publicly available information regarding the issuer of
the security. Accordingly, investors implicitly rely on the integrity of the market price as being reflective
of the value of the security. The court in Basic also explained ∆ can rebut the presumption by showing (1)
the trading market was not efficient, such as by showing that the challenged misrepresentation did not in
fact affect the stock’s price, or (2) the particular π would have traded regardless of the misrepresentation.
7) Causation
a) RULE: Subsequently, as the court noted in Diamond v. Oreamuno, π must be shown π suffered actual
losses proximately caused by the misrepresentation. Specifically, π must prove two kinds of causation:
actual cause (but for ∆’s fraud, π would not have entered the transaction or would have entered the
transaction under different terms) and proximate cause (the fraud foreseeably or proximately produced the
claims loss to π).
b) Economic Loss: Moreover, with proximate cause, SCOTUS has held π cannot simply allege losses caused
by an artificially inflated price due to “fraud on the market,” but must allege and prove the alleged
misrepresentations proximately caused economic loss.

REMEDIES: Courts use a variety of theories to measure damages under Rule 10b-5. Unlike common law insider trading,
rule 10b-5 does not make punitive damages available. Courts have traditionally imposed liability on a joint and several
basis, such that each culpable ∆ becomes liable for the entire damages award. The court’s intent is to deter securities fraud
and assure compensation for its victims.
Damages in a 10b-5 action may take the form of:
 Rescission – allows the defrauded π to cancel the transaction.
 Recessionary damages – if rescission is not possible because the stock has been resold, recessionary
damages replicate a cancellation of the transaction (defrauded seller recovers purchaser’s profits or
defrauded purchaser recovers his losses).
 Cover damages – Assumed π mitigates her losses by selling or reinvesting (difference between the price at
which π transacted and the price at which π could have transacted once the fraud was revealed).
 Out-of-Pocket damages (most common) – π recovers the difference between the purchase price and the true
value of the stock at the time of purchase.
 Contract damages – compensation π for the loss of the benefit of the bargain (difference between the value
received and the value promised).
Limitations:
 π’s recovery cannot exceed actual damages (implying the goal of liability is compensation and
effectively precluding punitive damages).
 Damages are capped at the difference between the transacted price and the average of the daily prices
during the 90-day period after corrective disclosure.
MOST FREQUENTLY LITIGATED SITUATIONS
 Management acting as adverse agents defrauded the corporation in securities transactions (Pappas).
 Corporation and management defrauding the investing public – should have abstained from buying stock until
disclosed information (Texas Gulf Sulphur).
 A buyer or seller of securities who is controlling shareholder defrauding another party in a face-to-face transaction.
(Kardon).
 Insider trading by the management (Fridrich).
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 Insider trading by nontraditional insiders (Dirks).

27
 DERIVATIVE SUITS

ISSUE: Whether the suit should be brought directly or indirectly.

RULE: Two litigation techniques are available to shareholders to vindicate their interests in the corporation. Shareholders
can sue in their own capacity to enforce their rights as shareholders (a direct action) or they can sue on behalf of the
corporation to enforce corporate rights that affect them only indirectly (a derivative action). The distinction is premised on
the idea that a shareholder of a corporation may be hurt in either of two ways: (1) directly through an injury which affects
him or her individually as a shareholder OR (2) indirectly through an injury to the corporation which has the
consequential effect of reducing the value of the shares which the shareholder owns.

ANALYSIS:

1) Who is injured?
a. SHAREHOLDER  In a direct action, the shareholder makes a claim in his own name against the
corporation or against a director or officer of the corporation for a wrong that was done directly to him. In
other words, the wrong must have impacted the shareholder directly. Any remedy or recovery goes to the
shareholder.
EX: voting, dividends, anti-takeover defense, inspection, protection of minority shareholder
b. CORPORATION  A shareholder may bring a derivative suit when the corporation has been injured. In
effect, the shareholder is suing on behalf of himself and all shareholders for the corporation as a
representative of the corporation against those who injured the corporation. Pursuant to IBCA § 7.80, a
derivative proceeding may not be discontinued or settled without the court’s approval. If the court
determined that a proposed discontinuance or settlement would substantially affect the interest of the
corporation’s shareholders or a class or shareholders, the court may direct that notice be given the
shareholders affected.
2) Procedure for DERIVATIVE SUITS:
a. Standing – First, shareholders need standing to bring derivative suits. Pursuant to § 7.80(a), only those
persons who were shareholders at the time of the injury and at the time the suit is brought may participate
in a derivative action.
b. Demand – Second, the general rule under § 7.80(b) is shareholders are required to make demand upon the
BOD before they can commence a derivative suit in the name of the corporation. Under the prevailing
judicial approach, the BOD can decide the fate of derivative litigation if a pre-suit demand on the BOD is
required. If the BOD receives a demand and refuses to take or settle the charges, tis response (or
nonresponse) receives deferential review under the business judgment rule. A shareholder-π must show
the board’s response to the demand was self-interested, dishonest, illegal, or insufficiently informed.
Usually, a demand-required claim is a lost claim.
c. Demand Excused/Futile - However, demand is excused if it would be futile to bring the matter to the
BOD. As the Supreme Court of Delaware held in Aronson v. Lewis, demand is excused if the
shareholder-π can allege with particularity facts that create a reasonable doubt on either of two scores: 1)
doubt that a majority of the current directors on whom demand would have been made are disinterested
and independent, or 2) doubt that the challenged transaction was protected by the business judgment rule
–by showing a conflict of interest, bad faith, grossly uninformed decision making, or a significant failure
of oversight. As applied in Brehm v. Eisner, the Aronson test places a heavy burden on derivative πs
seeking review of board operational decisions. When demand is excused, the directors cannot block a
derivative suit.
d. No demand – If no demand is made, the court may grant the ∆’s motion to dismiss.
e. SPECIAL LITIGATION COMMITTEE?

CONCLUSION: The suit should/should not be brought directly/indirectly.

REMEDIES: In general, the recovery in a derivative suit is to be paid to the corporation because it derivative litigation
enforces corporate rights.  The shareholder will recover only indirectly when the value of his shares increase because of
the corporate recovery.  However, even in derivative suits for public corporations, there have been judicial decisions in
28
which the judgment was awarded to the plaintiffs individually since otherwise the wrongdoers would participate in the
judgment. 
 For example, in Perlman v. Feldman and Donohue v. Rodd, shareholders were allowed to recover directly in
proportion to their holdings because the corporation is no longer in existence or recovery would produce a
windfall of new owners.  
 Attorney’s fee: Typically, the corporation will pay the plaintiff for attorneys’ fees for a successful derivative suit. 
IL courts in particular have generally recognized that a party who has conferred a benefit upon another through
litigation may obtain a share of the attorney fee from those who benefit.

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 INDEMNIFICATION

ISSUE: Whether an officer or director is entitled to indemnification.

RULE: Corporate indemnification is the corporation’s reimbursement of litigation expenses and personal liability of a
director sued because he or she is or was a director. In general, pursuant to § 8.75, indemnification applies when a director
is or was (or is threated with being made) a ∆ in any civil, criminal, administrative, or investigative proceeding. Moreover,
§ 8.75(c) provides an officer or director is entitled to indemnification as a matter of right if the person was [wholly]
successful on the merits or otherwise. A director’s indemnification rights continue even after she has left the corporation.

ANALYSIS:

1) Did ∆ lose the suit?

a. NO [MANDATORY] – If a director is used because of her corporation position and he or she defends
successfully, the corporation is obligated, under all state statutes, to indemnify the director for litigation
expenses, including attorney fees. The right of the successful director to claim repayment of expenses is
available whether the suit was brought on behalf of the corporation or by an outside party. The right
protects a director from the corporation’s faithless refusal to indemnify a director who successfully
defends a suit arising from her corporate position.
i. Corporate statutes uniformly require indemnification when ∆ is successful on the merits (§ 8.75).
ii. Some statutes require indemnification “to the extent” ∆ is successful, compelling the corporation
to reimburse a partially successful director’s litigation expenses related to those claims or charges
she defends successfully. In Merritt-Chapman & Scott Corp. v. Wolfson, the DE Supreme Court
interpreted a statute as requiring indemnification for partial success and held that ∆ was entitled
to indemnification as a matter of right for the litigation expenses related to the dropped charges.
b. YES [PERMISSIVE] – Indemnification is not automatic when a director becomes liable because of his
corporate role. Instead, corporate indemnification of an unsuccessful director’s litigation expenses and
liability is discretionary. The corporation may indemnify an unsuccessful director only if certain
corporate actors or a court, under specified criteria, approves indemnification. Under modern statutes, the
ability of the corporation to indemnify depends on whether the action was brought by a third a party or
was brought on behalf of the corporation.
2) Were they suing the third party or the corporation?
a. CORPORATION – Most statutes do not allow the corporation to indemnify a director “adjudged liable”
to the corporation if the action is brought by the corporation itself or by shareholders in a derivative
action on behalf of the corporation. Nonetheless, the corporation can indemnify a director who settles a
suit brought against her or by or on behalf of the corporation for her litigation expenses if the director
meets the standard of conduct. In addition, a court can order indemnification of litigation expenses, if fair
and reasonable, even though the director is found liable in a derivative action.
b. THIRD PARTY – In an action brought by a third party, the unsuccessful director must deserve to be
entitled to indemnification. A director sued by a third party action may be indemnified for reasonable
litigation expenses and any personal liability arising from a court judgment, an out-of-court settlement, or
the imposition of penalties or fines.
3) Does ∆ meet the 3-prong test (below) for eligibility?

Generally, according to § 8.75, a director must meet a 3-prong test to be eligible for indemnification against both
derivative suits and third party claims.
1) The amounts must be reasonably incurred in connection with litigation;
2) The person must have acted in good faith; AND
3) The person must have acted in a manner, which he or she reasonably believed to be in, or not opposed to, the best
interests of the corporation.

CONCLUSION: The officer or director likely is/is not entitled to indemnification.

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REMEDIES: Pursuant to § 8.75(a), the scope of indemnification is very broad since it includes expenses, including
attorneys’ fees, judgments, fines, and amounts paid in settlement. Think: contribution.

THE SPECIAL LITIGATION COMMITTEE

ISSUE: Whether the use of the special litigation committee was appropriate.

RULE: During the 1980s, special litigation committees developed to investigate derivative actions and recommended
continuance of the suit or dismissal (in reality, almost always a dismissal because litigation is rarely even in the best
interests of the corporation). The board of directors can develop of special litigation committee comprised of disinterested
directors to investigate the merits of the shareholder’s derivative suit and determine whether such suit should be
dismissed. In the case where a special litigation committee is appointed, the question becomes: 1) what weight should be
accorded to the recommendation of the committee and 2) what should be the standard for judicial review of the
committee’s decision. In a special litigation committee case, ∆ carries the burden of proof.

ANALYSIS: Over time, two major approaches have developed, namely the test from Auerbach and the test from Zapata.
1) Is this a close corporation?
a. YES  To recognize the efficacy of a special litigation committee in the context of a closely held
corporation, where the board of directors is rarely a functioning entity, is to praise form over substance.
The issue raised in litigation involving closely held corporations often is whether the majority
shareholder has appropriated property in which the minority shareholder has an interest-either the
profits of the business through salaries or other diversions, or business opportunities. This is an issue for
judges to decide, not laymen who are picked by the defendant.
b. NO  see below.
2) AUERBACH (duty of care) – Under the Auerbach test, the business judgment rule’s presumption of propriety
applies to the SLC and the shareholder-π has the burden of disproving either the good faith and the
disinterestedness/independence of the SLC members or the reasonableness and adequacy of their investigation.
Moreover, unless the shareholder-π meets the burden of proof, the court is precluded from second-guessing the
merits of the SLC’s decision. If a disinterested/independent SLC conducts a reasonable and adequate investigation
and recommends a dismissal, the court must dismiss. With the Auerbach test, Courts examine 1) whether there
were disinterested directors, 2) whether the investigation was reasonable, and 3) whether the investigation was
conducted in good faith. The court will not attempt to make an independent determination of whether the
committee was correct, merely whether there is independence (disinterestedness), a good faith investigation, and
appropriate techniques (reasonable investigation).
a. Were the directors disinterested? The directors will almost always be independent because the
corporation will not assigned just anyone (especially someone involved in the corporation, a crook).
b. Was the investigation was reasonable? There will almost always be an independent investigation because
the corporation is the one that must pay for the reasonable investigation and they will hire the best firm
they can find, presumably Schiff Hardin, since the expenditure benefits those in control.
c. Was the investigation conducted in good faith?
d. The court will NOT attempt o make an independent investigation of whether the committee was correct.
3) ZAPATA (duty of loyalty) - In DE, the corporation has the burden of showing the Auerbach elements as well as
the basis upon which the committee made its determination. This test only applies to demand futile cases and
overlays on the Auerbach rule. Specifically, under Zapata, there is no presumption of propriety and the
corporation/SLC has the burden of proving the good faith and disinterestedness/independence of the SLC
members, as well as the reasonableness and adequacy of their investigation. Moreover, even if the
corporation/SLC meets its burden, the court may, at its discretion, exercise its own business judgment.
a. The Illinois courts are more likely to adopt the Zapata approach in determining whether the
recommendation of the special litigation committee is sufficient to dismiss the shareholder’s derivative
suit in a duty of care case because the Auerbach approach in the duty of loyalty area directly conflicts
with § 8.60 since this statute provides that the approval by a committee of disinterested directors does not
foreclose judicial review but rather changes only the burden of proof.
b. The analysis for whether the directors were disinterested is discussed above.
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 c. The analysis for whether the investigation conducted in good faith is discussed above.
d. The analysis for whether the investigative procedure is appropriate is discussed above.
e. Ultimately, the court applies its own business judgment analysis through a cost benefit analysis,
examining negative publicity costs and future benefits, to determine if suit should be allowed.

CONCLUSION: The use of the special litigation committee is/is not appropriate.

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 ORGANIC CHANGES

ISSUE: Whether the organic change was appropriate.

RULE: Organic changes affect the basic structure of the corporation. In order for an organic change to be effectuated: 1)
§ 11.05 provides that the board of directors of each corporation must adopt the resolution by a majority vote approving the
merger or share exchange and direct that it be submitted to a vote at a meeting of shareholders, which may be an annual or
special meeting and 2) §§ 11.15 and 11.20 provide that shareholders must receive notice of the meeting 20-60 days before
this notice must state that the purpose of the meeting is to effectuate an organic change. Pursuant to § 10.20, organic
changes to the corporation via an amendment to the articles of corporation, require the AFFIRMATIVE vote of 2/3 of
shareholders UNLESS the articles alter this provision (but cannot be less than a majority). However, shareholders of the
unaffected corporation may not need to vote on a merger or exchange.

ANALYSIS:

1. First, the board adopts a resolution.

a. BOD of each corporation, by a majority vote of the entire board, must pass a resolution approving the
merger or share exchange (§ 11.05).
2. Second, the board presents the opportunity to the shareholders.
a. Shareholder must receive notice of a matter (20-60 days before) and a summary of the plan.
b. Shareholders must approve the plan by a 2/3 vote (or some other number not less than a majority) (§§
11.15 and 11.20).
c. Conversely, shareholders of the unaffected corporation may not need to vote on the merger or exchange.

CONCLUSION: The organic change was/was not appropriate.

ISSUE: A minority shareholder disagrees with the proposed action. Has the minority shareholder appropriately exercised
their dissenters’ rights?

RULE: Pursuant to §§ 11.65 and 11.70, dissenters rights exists for all: mergers, consolidations, share exchanges, sales of
substantially all the assets of a corporation, OR amendments to the articles that materially affect the dissenter’s shares. If
shareholder has received material information regarding the transaction prior to the vote to determine whether to exercise
dissenters’ rights, then shareholder may assert dissenters’ rights only if, prior to the vote, the shareholder gives the
corporation a written demand for payment for his/her shares if the proposed action is taken and shareholder votes against
proposed action.

ANALYSIS:

1. Does the shareholder have dissenters’ rights?

a. YES  if it was a merger, consolidation, share exchange, sale of substantially all the assets of the
corporation, or amendments to the articles that materially affect the dissenters’ share.
i. Merger: A shareholder involved in a merger has appraisal rights if he or she had the right to vote
on the merger.
ii. Asset Sales: Shareholders of a corporation that is selling substantially all of its assets may get
appraisal rights.
iii. Triangular Merger: The Acquirer’s shareholders do NOT get appraisal rights, whereas the
Target’s shareholders do.
iv. Reverse Triangular Merger: The Acquirer’s shareholders do NOT get appraisal rights, whereas
the Target’s shareholders might.
v. Share Exchange: Buying corporation’s shareholders do NOT get appraisal rights, whereas the
selling corporation’s shareholders do. (§ 11.10)
b. NO  anything else not listed above.

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 c. Note: In a merger, shareholders of both corporations have dissenter’s rights whereas in a sale of
substantially all the assets only shareholders from selling corporation have dissenters’ rights.
2. Did the shareholder receive material information re: dissenters’ rights in transaction prior to vote?
a. YES  consider more.
b. NO  inappropriate.
3. Did shareholder give written demand for payment of his or her shares?
a. YES  consider more.
b. NO  inappropriate.
4. Did shareholder vote against the merger?
a. YES  good to go.
b. NO  inappropriate.

CONCLUSION: The minority shareholder did/did not appropriately exercise their dissenters’ rights.

REMEDIES: Shareholder entitled to dissent may only receive payment for his/her shares unless the corporate action was
fraudulent with respect to the shareholder or corporation or constitutes a breach of a fiduciary duty to the shareholder (e.g.
self-dealing).

ISSUE: Whether the shareholder is warranted appraisal rights. How will the court evaluate the payment to the
shareholder?

RULE: § 11.65 provides that shareholders that vote against a major organic change and exercise dissenters’ rights may
petition a court for a valuation if the shareholder and corporation cannot agree on the fair value of the shares. Essentially,
§ 11.65 gives the dissatisfied shareholder, through appraisal rights, a way to be cashed out of his investment at a price the
court determines to be fair.

In Sterling v. Mayflower Hotel Corp, the DE Supreme Court set forth a “block approach,” whereby an appraise assigns an
arbitrary weight to three values (market, earnings, and asset) and adds them to get a weighted value.
1) Market Value – Market value is the price at which the corporation’s shares were traded (if a market existed) or at
which they could been sold to a willing buyer. Less weight is given to the market price in the case of thinly traded
shares, although unusual trading in a deep market before the transaction could justify discounting this fact.
2) Earnings Value – Earnings value seeks to measure the earning capacity of the corporation based on its past
earnings record. Average annual earnings are computed and then capitalized by applying a multiplier, which is
determined according to the business conditions and types of business involves.
3) Net Asset Value – Net asset value can be determined using the firm’s “book value” (the excess of historical-
valued assets over liabilities on the firm’s accounting balance sheet). Book value does not reflect the ongoing
earnings from the business. Asset value can also be determining using the firm’s liquidation value (the amount for
which the firm’s marketable assets could be sold for cash). It may fail to take into account the firm’s value as an
ongoing business.

However, courts have mostly abandoned the “block method,” since it fails to recognize that shares, like any other
investment, are valuable because they represent a promise of future income. In Weinberger v. UOP, the DE Supreme
Court abandoned the “block method” and called on the appraiser to look to elements of future value, provided they are
susceptible of proof. The most widely used method of valuation in the financial community is discounted cash flow.
Under this method, the PV of expected future cash flows is calculated using a discount rate to take into account the time
value of money and the risks of those future flows.

ANALYSIS:

1. Did the shareholder properly exercise his or her dissenters’ rights?

a. YES  consider more.
b. NO  inappropriate.
2. Can the corporation and shareholder agree on a FMV of shares?
a. YES  Shareholder can cash out at the agreed amount.

34
 b. NO  The court will appoint an appraiser to determine the FMV of the shares.
3. IF NO, there are two approaches. First, there was the original “block method” from Sterling v. Mayflower Hotel
Corp.. However, courts have mostly abandoned the “block method,” since it fails to recognize that shares, like
any other investment, are valuable because they represent a promise of future income and in Weinberger v. UOP,
the court adopted a more modern method.

In Sterling, the DE Supreme Court set forth a “block approach,” whereby an appraise assigns an arbitrary weight to three
values (market, earnings, and asset) and adds them to get a weighted value.
1. Market Value – Market value is the price at which the corporation’s shares were traded (if a market existed) or at
which they could been sold to a willing buyer.
2. Earnings Value – Earnings value seeks to measure the earning capacity of the corporation based on its past
earnings record.
3. Net Asset Value – Net asset value can be determined using the firm’s “book value” (the excess of historical-
valued assets over liabilities on the firm’s accounting balance sheet). However, book value does not reflect the
ongoing earnings from the business. Asset value can also be determining using the firm’s liquidation value (the
amount for which the firm’s marketable assets could be sold for cash). It may fail to take into account the firm’s
value as an ongoing business.

In Weinberger, the DE Supreme Court abandoned the “block method” and called on the appraiser to look to elements of
future value, provided they are susceptible of proof.

Optional: The most widely used method of valuation in the financial community is discounted cash flow. Under this
method, the PV of expected future cash flows is calculated using a discount rate to take into account the time value of
money and the risks of those future flows.

CONCLUSION: The shareholder is/is not warranted appraisal rights.

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 TYPES OF ORGANIC CHANGES

TRADITIONAL MERGER – The parties include the target corporation, the acquiring corporation, and their respective
shareholders. The target corporation merges into the acquiring corporation and the acquiring corporation acquires the
assets and liabilities of both corporations (§ 11.50). Thereafter, the parties are a single corporation. The BOD, by
resolution adopted by a majority vote of the members of each corporation, approve a plan of merger or consolidation and
authorize the transaction (§§ 11.05, 11.15). Consideration to the target corporation’s shareholders can be stock (might be
tax free) in the acquiring corporation, or cash (taxable). Moreover, the consideration is determined in accordance with the
relative percentage ownership each respective company’s shareholders will hold in the new firm, as negotiated by the two
companies. Furthermore, the consideration passes to the target corporation’s shareholders, provided they are not
dissenting and opting to exercise their appraisal rights (§ 11.05).
State Filing Requirements - The corporations must file the Articles of Merger with Secretary of State, containing the
plan of merger and statement that requisite shareholder approval has been obtained (§ 11.25). The merger is effective
upon filing unless a date, not more than 30 days, is specified (§ 11.40). The Articles of Merger must be filed in the
office of the recorder where the registered agent of each merging corporation is located (§ 11.45).

TRIANGULAR MERGER – The parties include the target corporation, the acquiring corporation, the shareholders of
the target corporation, and a subsidiary of the acquiring corporation. The target corporation merges into a subsidiary of
the acquiring corporation and the target corporation dissolves. The acquiring company is not responsible for the
liabilities of the subsidiary but has acquired all their assets. The subsidiary was essentially created as a “vehicle” for this
transaction and has no assets, except a share of stock in its parent corporation. The BOD, by resolution adopted by a
majority vote of the members of each corporation, approve a plan of merger or consolidation and authorize the transaction
(§§ 11.05, 11.15). Consideration to the target corporation’s shareholders can be stock (might be tax free) in the acquiring
corporation, or cash (taxable). Moreover, the consideration is determined in accordance with the relative percentage
ownership each respective company’s shareholders will hold in the new firm, as negotiated by the two companies.
Furthermore, the consideration passes to the target corporation’s shareholders, provided they are not dissenting and opting
to exercise their appraisal rights (§ 11.05).

36
REVERSE TRIANGULAR MERGER – The parties include the target corporation, the acquiring corporation, the
shareholders of the target corporation, and a subsidiary of the acquiring corporation. The acquiring corporation’s
subsidiary merges into the target corporation and the acquiring corporation’s subsidiary dissolves. The target
corporation is the surviving corporation. The target shareholders give up their stock and the acquiring corporation does
not assume all the liabilities of the target corporation. A reverse triangular merger is necessary so as to maintain the
intellectual property rights that only the target corporation can hold. Consideration to the target corporation’s
shareholders can be stock (might be tax free) in the acquiring corporation, or cash (taxable). Moreover, the consideration
is determined in accordance with the relative percentage ownership each respective company’s shareholders will hold in
the new firm, as negotiated by the two companies. Furthermore, the consideration passes to the target corporation’s
shareholders, provided they are not dissenting and opting to exercise their appraisal rights (§ 11.05). The acquiring
company’s shareholders do not have to approve, but the target corporation’s shareholders must approve by a 2/3 vote.

SHARE EXCHANGE – The parties include the target corporation, the acquiring corporation, and the shareholders of the
target corporation. In a share exchange, the acquiring corporation acquires all of the issued or outstanding stock of one
or more classes of another corporation, only if the shareholders in the target corporation are willing to sell. Essentially, a
share exchange accomplishes the result of a triangular merger without the need for the acquiring corporation to create a
subsidiary. If a majority or more of the shares are sold, the acquiring corporation will, in effect, have acquired
corporation. However, the minority can re removed and cashed out. For a share exchange to happen, the board of
directors of each corporation must by resolution adopt by a majority vote the plan of exchange. The shareholders must
vote 2/3 majority in order for the exchange to be effectuated (§ 11.10). The liabilities remain in the target corporation and
dissenters’ rights arise, but the dissenter must still go through with the exchange. Consideration to the target corporation’s
shareholders can be stock (might be tax free) in the acquiring corporation, or cash (taxable) (§ 11.05).
Note: Delaware does not have a share exchange provision; Illinois does (§ 11.10).

RECAPITALIZATION – Recapitalization often involves the issuance of more shares and/or the cancellation of certain
classes of shares. A class vote from the affected class is required for all changes to the characteristics of any class of
stock. Authorization of the new share requires an amendment to the articles of incorporation. In order to amend the
articles, the BOD shall adopt a resolution setting forth the proposed amendment and submit said proposal for a vote at an
annual or special meeting of shareholders (§ 10.20(a)). The shareholders must receive written notice setting forth the
proposed amendment or a summary of the changes to be effected thereby 20-60 days before said meeting (§ 10.20(b)). An
affirmative 2/3 shareholder vote of all shares entitled to vote on such amendment is required (§ 10.20(c)), however the
articles of incorporation may superseded the 2/3 vote requirement by specifying anything not less than a majority of the
votes of shares entitled to vote (§ 10.20(d)).

37
ASSET ACQUISITION / SALE OF ASSETS – The parties include the target corporation, the acquiring corporation,
and their respective shareholders. The acquiring corporation purchases all, or substantially all, the assets and sometimes,
the liabilities of the target corporation. The target corporation is the “holding company” and is dissolved and liquidated
by shareholder vote (§ 12.15) and only the acquiring corporation remains. A sale of substantially all the assets of a
corporation outside the ordinary course of business requires shareholder approval and gives rise to dissenters’ rights (§§
11.60 and 11.65). The target corporation’s assets are transferred by documents of conveyance per contract and generally,
the liabilities are assumed per contract. Typically, the liabilities assumed are “stated” and the goal is to avoid contingent
liabilities (§ 11.60). There is the possibility for liabilities to be assumed by operation of law, however, Illinois does follow
such methods. The consideration is the assumption of the selling corporation’s liabilities and shares of the acquiring
corporation, which are subsequently distributed to the acquiring corporation’s shareholders. The BOD authorizes a sale of
assets is authorized at an annual or special meeting (§ 11.60). Shareholders must receive written notice stating the purpose
of the meeting and their right to dissent between 20 to 60 days before (§ 11.60(b)). Such authorization requires the
affirmative vote of the holders of at least 2/3 of the outstanding shares entitled to vote on such matter (§ 11.60(c)).

DE FACTO MERGER – Under the de facto merger doctrine, if the asset sale has the effect of a merger,
shareholders receiver merger-type voting and appraisal rights. In Farris v. Glen Alden Corp., to protect the Glen
Alden shareholders’ expectation of “membership in the original corporation,” the court recast the asset acquisition
as a merger and enjoined the transaction for failing to give the Glen Alden shareholders the voting and appraisal
rights they would have had in a statutory merger. Conversely, many courts have rejected the de facto merger
doctrine and have refused to imply merger-type protection for shareholders when the statute does not provide for
it (Hariton v. Arco Electronics).
Likewise, creditors may be able to claim a de facto merger in an asset sale if the acquiring corporation did not
assume the liabilities.

STOCK ACQUISITION – The parties include the acquiring corporation, the target corporation, and their respective
shareholders. In a stock acquisition, the acquiring corporation purchases the stock of the target corporation; dependent
on whether the target corporation’s shareholders are willing to sell. In effect, the acquiring corporation makes the target
corporation a subsidiary. The advantage is the acquiring corporation does not assume the liabilities of the acquired
corporation. No shareholder approval is necessary. If shares are consideration for the stock acquisition (might be tax
free), the target corporation becomes a subsidiary of the acquiring corporation and there will be a minority interest in the
subsidiary, whereby the acquiring corporation will owe a fiduciary duty to the minority shareholders. Since a stock
acquisition involves individual decisions on the part of the shareholders of the target corporation, there is no need for
statutory protection in the form of dissenters’ rights.

OVERHEAD TENDER OFFER – In a tender offer, the offeror makes a bid to buy stock at a certain price that is open
to all shareholders for at least a 20-day period. The offeror’s bid contains a certain amount of consideration.
Subsequently, the shareholders tender their shares. If shareholders tender a greater number of shares than the bidder
38
agreed to buy, the shares must be purchased on a pro rata basis from each shareholders and increases in price must be paid
to all shareholders who tender stock. In a tender offer, there is no approval necessary by the target corporation’s BOD
because the acquiring corporation is working directly with the shareholders of the target corporation.

39
 BOARD OF DIRECTORS

 How is a board member selected, removed, replaced:

o Number, election, and resignation of directors IBCA 8.10: The board of directors MUST consist of
ONE or MORE members. The number of directors shall be fixed by the bylaws, EXCEPT that the
number of initial directors must be fixed by the incorporators in the articles of incorporation OR at the
organizational meeting. If no bylaws fixing the number of board members then the number is the same as
in the articles of incorporation OR organizational meeting. The number of directors may be increased
or decreased from time to time by amendment to the bylaws.
o Vacancy of a board member: IBCA 8.30 provides that any vacancy occurring in the board of directors
and any directorship to be filled by reason of an increase in the number of directors may be filled by
election at an annual meeting or at a special meeting of shareholder.
o Removal of director: The 1983 Business Corporation Act authorizes removal of directors with or
without cause, but sets forth limitations on the power of shareholders to remove a director.
 By shareholder with or without cause: IBCA 8.35 provides that one or more of the directors
may be removed, with OR without cause, at a meeting of shareholders by the affirmative vote of
the holders of a majority of the outstanding shares EXCEPT:
 A director cannot be removed unless the notice of meeting states that the purpose is to
vote upon a removal of one or more directors and only a director or directors named in
the notice may be removed at such a meeting.
 If a director is elected by a class or series of shares, he or she may be removed only by
the shareholders of that class or series.
 Cumulative voting: In the case of a corporation that has cumulative voting, a director
cannot be removed if the votes cast against her removal would have been sufficient to
elect her.
 Director removed for cause: When a corporation's shareholders attempt to remove a director for
cause, there must be the service of specific charges, adequate notice and full opportunity of
meeting the accusation. The power of removal cannot be exercised in an arbitrary manner. The
accused director is entitled to be heard in his own defense.  Campbell v Loews
 Removal only for cause: The 1983 Act permits the articles to provide that directors may only be
removed for cause, provided that the board is classified.
 By the court: A court may remove a director for cause.
 MANAGEMENT ROLE OF BOARD OF DIRECTORS
o RULE: The board of directors is where the management of a corporation is usually centered. IBCA 8.05
Directors must approve all transactions or authorize officers to undertake the transaction. IBCA 8.05,
11.55
 EXCEPTION: Extraordinary activities need shareholders’ approval as well as directors’
approval
 Organic changes (see section in shareholders section).
o Unless, the articles of incorporation pr by laws prescribe, a director is not required to be a resident of
Illinois or a shareholder of the corporation.

o What is the responsibility of the board of directors? Board of directors make many business decisions
in the course of managing a business corporation like:
 whether to issue shares of stock
 whether to borrow money
 what products to manufacture
 what properties to buy or sell
 whether to declare dividends;
 what form those dividends should take, etc.
 Compensation: Unless otherwise provided, the board of directors may by 1) affirmative vote of a
MAJORITY of the directors in office AND 2) irrespective of any personal interest of any of the
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 members, establish reasonable compensation of all directors for services to the corporation as
directors, officers, or otherwise despite the provisions in 8.60.

 DIRECTORS’ MEETINGS
o General rule: There is no statutory minimum period for calling a director’s meeting. Notice must be
given and failure to give notice may void the actions taken by the directors at the purported meeting. The
notice given for a meeting should be reasonable. However, typical notice for a special meeting is 2 days.
This is not unreasonable because directors, who under the statute direct or manage the company, should
be accessible to meet the needs of the corporation. The purpose of neither regular or special meetings of
the directors need be specified UNLESS required by the bylaws. EXCEPTION: The board can take
informal action and not conduct a meeting if this is 1) expressed in writing 2) all directors or committee
members entitled to vote on subject matter consent
 Rationale: The rationale is that directors regularly attend meetings, are informed, and need no
such protection
 Closely held corporation: In a closely held corporation, it is important to consider fairness.
 Waiver: Attendance at the meeting constitutes a waiver of notice
 The lack of proper notice cannot be asserted against a third party who dealt with the corporation
in good faith
 However, if the third party were aware that the meeting was not validly called, she cannot
rely upon actions taken by the board at the purported meeting
 Special meetings: In addition to regular meetings, typically, bylaws provide that special
meetings may be called by the President or chairman of the board, or at the request of any 2
directors
o Voting at the meeting: Quorum: A majority of the directors constitutes a quorum, UNLESS otherwise
provided by the by-laws
 RULE: IBCA 8.15 provides that a quorum of directors is necessary to approve a business
transaction UNLESS a greater number is specified by the articles of incorporation or the by laws.
 A quorum represents a majority of the number of directors fixed by the by-laws, OR if
not stated in the by laws, the number stated in the articles of incorporation OR named by
the incorporators
o Informal action by directors IBCA 8.45: Unless specifically prohibited by the articles of incorporation
or bylaws, any action required by this act to be taken at a meeting of the board or directors or a committee
thereof, may be taken without a meeting if:
 The action is expressed in writing; AND
 ALL directors OR members of the committee entitled to vote on the action/subject matter grant
their consent
 The consent shall be evidenced by one or more written approvals so long as all directors or
committee give authorization
 APPOINTMENT OF A COMMITTEE
o RULE: Committee creation: IBCA 8.40 provides that if provided in the articles of incorporation or the
bylaws, a majority of the directors may create one or more committees, each to have one or more
members, and appoint members on the board to serve on the committee or committees. A quorum of
committee must be present at meeting and a quorum at meeting is needed to pass action. However, the
action can be passed in an informal manner, without a meeting, if there is unanimous consent subject to
the bylaws or action by the board. The committee is authorized to the rights of the board in section 8.05
with a number of limited exceptions. The committee may not:
 Authorize distributions, except for dividends to be paid with respect to shares of any
preferred or special classes or any series thereof
 Approve or recommend to shareholders any act this act requires to be approved by
shareholders
 Fill vacancies on the board of its on committees
 Elect or remove officers or fix compensation of any member of the committee
 Adopt, amend, or repeal the bylaws
 approve a plan of merger

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  authorize or approve reacquisition of shares
 authorize or approve the issuance or sale, or contract for sale of shares
 amend, alter, repeal or take action inconsistent with any resolution or action of the board
of directors when the resolution or action so provides
 Quorum: Unless the appointment of the board requires a greater number, a majority of any
committee shall constitute a quorum, and a majority of a quorum is necessary for committee
action.
 Committee may act informally without a meeting: A committee may act by unanimous
consent without a meeting, subject to the provisions of the bylaws or action by the board of
directors
 The committee by majority vote of its members shall determine the time and place of meetings
and notice required thereof
 FIDUCIARY DUTIES OF DIRECTORS (See sections below)
o Duty of care
o Duty of loyalty
 Conflict of interest
 Corporate opportunity
 Competing with the corporation
o No insider trading
 Rule 10(b)(5)

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 PIERCING THE CORPORATE ENTITY VEIL

ISSUE: Whether the court is likely to pierce the corporate veil.

RULE: One of the principle features of a corporation is owners are insulated from liability incurred by the corporation.
Assuming a corporation is properly formed, § 6.40 of the IBCA provides that a shareholder is under no obligation to the
corporation or its creditors with respect to such shares, other than the obligation to pay to the corporation the full
consideration for which the shares were issued or to be issued. The choice of limited liability is a policy choice, which
seeks to foster business and reward people for going into business. However, as noted in Gallagher v. Reconco Builders,
this shield is not complete in limited cases, courts recognize that injustice requires piercing this corporate formality.
Hence, some or all of the shareholders can be held personally liable for a corporation’s debts upon a showing of: (1) unity
of interest and ownership, and (2) injustice. The easiest way to avoid piercing the corporate veil is to have adequate
insurance.

ANALYSIS:

1) Unity of Interest and Ownership – To determine whether there is a unity of interest and ownership, courts look
to whether there is such a unity of interest and ownership that separate personalities of the corporation and
individual no longer exist. As noted in Gallagher v. Reconco Builders, courts often consider a showing of (1)
inadequate capitalization, (2) commingling of funds, (3) failure to comply with corporate formalities, and (4) use
of corporate assets as one’s own as a basis for determining whether shareholder liability should be imposed.
a. Inadequate Capitalization – The corporation should have adequate capital to deal with its day-to-day
business, determined at the time of the formation, however, losses are not an adequate basis for piercing the
corporate veil. Inadequate capitalization makes the corporation appear to be a mere formality. Additionally,
inadequate capitalization may be indicative of a choice of a corporate owner to place the risk of injury on
prospective πs. In Gallagher, the court noted a corporation’s capitalization is a major consideration in
determining whether a legitimate separate corporate entity was maintained. In Minton v. Cavaney, one
extreme example, the court decided to pierce the corporate veil because there was no attempt to provide
adequate capitalization and the corporation never had any substantial assets.
b. Commingling of Funds – The corporation must maintain separate accounts from owners or other
corporations. One cannot pay corporation accounts with personal money, nor can one pay personal accounts
with corporate money. The best way to protect against this is for a corporation to have insurance to cover
liabilities.
c. Corporate Formalities – As noted in Gallagher, failure to observe corporate formalities, such as directors’
and shareholders’ meetings, is strong evidence for piercing the corporate veil. This factor may not be as
important for a close corporation. Moreover, this is the least important factor because it is easy to prove a
lack of corporate rituals.
d. Use of Corporate Assets as One’s Own – One should not treat corporate assets as one’s own and a parent
corporation should not treat a subsidiary as a department of the parent corporation.
2) Injustice – Next, to satisfy the second prong of injustice, courts will look to see if circumstances exist such that
adherence to the fiction of a separate corporate existence would sanction a fraud or promote injustice.
a. Behavior, which improperly thwarts or undermines the legal rights of others, such as “unfair” business
practices;
b. Intentional misrepresentations, deception, or other fraud-like conduct;
c. Actions, which might incur criminal or civil penalties;
d. The creation of a corporation structure solely in an attempt to eliminate liability and lacking a true “business
operation” or purpose (this element would be similar to showing undercapitalization above if the purpose of
the undercapitalization were to avoid liability);
e. Unjust enrichment (this behavior might involve looting the corporation at the expense of potential or actual
creditors. The idea here is that “undercapitalization” takes place when setting up the corporation and “unjust
enrichment” involves removing assets from an existing corporation in bad faith, leaving the business
undercapitalized); OR
f. Fraud – if one can demonstrate that some sort of fraud occurred (e.g., false claims about corporate assets,
etc.), that showing would suffice. Fraud is, of course a separate cause of action. If the owners of a
43
 corporation engage in fraud, they have already exposed themselves to personal liability. However, actual
fraud is often very difficult to prove (which is why fraud is not necessary to prove in a case for piercing the
corporate veil).

Types of corporate veil piercing:

1) Vertical (most common; only available for close corporations) – used to enforce a judgment against the owners of
a corporation.
2) Horizontal “Enterprise Liability” – There is enterprise liability when the sister corporation transgresses the
corporation-corporation boundary.
a. Sometimes a judgment might be forced against affiliate corporations. This was attempted in Walkovsky
v. Carlton, where the owner of a taxi company created a corporation for each taxi, thereby insulating the
entire operation form liability. There, the court determined π could not hold the multiple corporations’
stockholders liable to him based on a fraud allegation. In other words, π could not horizontally pierce the
corporate veil.
b. Are two or more nominally separate sister corporations, really acting as a single enterprise?
c. Are the corporations operated as separate entities with separate accounts, books, and records?
d. Are the respective corporation’s assets intermingled for use toward a common business purpose?
3) Parent-Subsidiary – A creditor may look to the parent corporation upon a showing of the fact that the parent and
the subsidiary were a single economic unit. In determined whether the pierce in a parent-subsidiary situation,
courts look to whether:
a. Parent corporation owns all or most of the capital stock of the subsidiary;
b. Parent and subsidiary corporations have common directors or officers;
c. Parent corporation finances the subsidiary;
d. Parent corporation subscribes to all the capital stock of the subsidiary or otherwise causes its
incorporation;
e. Subsidiary has grossly inadequate capital. (BIG one);
f. Parent corporation pays the salaries and other expenses or losses of the subsidiary (BIG one);
g. Subsidiary has substantially no business except with the parent corporation or no assets except those the
parent corporation conveyed to it;
h. In the papers of the parent corporation or in the statements of its officers, the subsidiary is
described as a department or division of the parent corporation, or its business or financial
responsibility is referred to as the parent corporation’s own (BIG one);
i. Parent corporation uses the property of the subsidiary as its own (BIG one);
j. The directors or executives of the subsidiary do not act independently in the interest of the
subsidiary but take their orders from the parent corporation in the latter’s interest (BIG one); OR
k. Formal legal requirements of the subsidiary are not observed.

CONCLUSION: Thus, the court is likely/not likely to pierce the corporate veil.

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 SHAREHOLDERS

Shareholders Role:
1. Election and Removal of Directors [See below]
2. Approval of Board-Initiated Transactions
a. Fundamental Corporate Changes [See Organic Changes] [2/3 all shareholders]
b. “Dilutive” Issuance of Shares [See generally Watered, Bonus, Discount Shares; Mergers]
c. Conflicting Interest Transactions [See Conflict of Interest]
3. Shareholder-Initiated Changes
a. Amendment of Bylaws - Unless the power to make, alter, amend or repeal the by-laws is reserved to the
shareholders by the articles of incorporation, the by-laws may be made, altered or amended by the
shareholders or the BOD. Additionally, any by-law passed by the shareholders cannot be amended,
altered or repealed by the BOD if the by-law so provides (§ 2.25).
i. Note: Under the old statute, only directors had power to amend the by-laws. Under the new
statute, either the directors or the shareholders have the power to amend the by-laws. If there ever
is ambiguity, think: whose company is it? It is ALWAYS a shareholders’ company.
b. Amendment of Articles [2/3 all shareholders] - The BOD adopts a resolution and submits vote to
shareholders. § 10.15 allows minor amendments by only the directors. Notice must be given to the
shareholders. 2/3 vote of the outstanding shares is necessary (or 2/3 class). The articles may specify the
vote necessary to amend the articles as long as it is greater than a majority.
b. Nonbinding recommendations - Auer v. Dressel [1928] … πs submitted written requests to the president
for a special meeting of stockholders. The president failed to call the meeting and petitioners brought suit.
The court held there is no discretion is a corporate officer as to whether or not to abide by the
corporation’s by-laws.

Shareholders’ Meetings: § 7.05

1. Annual and Special Meetings – Shareholder meetings are generally held annually but special meetings may
also be called for matters requiring shareholder voting (§ 7.05).
2. Notice – shareholders must receive notice of shareholders meeting not less than 10 days, but not more than
60 days, before the meeting (§ 7.05).
3. Quorum – Unless the articles specify otherwise, a quorum is a majority of the outstanding shares entitled to
vote. However, a quorum can never be less than 1/3 of the shares entitled to vote (§ 7.60).
4. Proxy - In a publicly traded corporation, most shareholders vote by proxy. This means that they authorize certain
shareholders (either management or possibly an opposition group) to vote their shares. By voting proxy, they are
in effect creating an agency relationship (§ 7.50(g)).
a. Detail - Proxies expire within 11 months unless otherwise provided in the proxy. Proxies may be revoked
prior to the vote by the person executing it; such revocation is performed by said person either (i) writing
to the corporation to state that the proxy is revoked, (ii) executing a subsequent proxy, or (iii) attending
the meeting and voting in person. The dates contained in the proxy forms always control (§ 7.50(b)).
b. Revocability - An appointment of a proxy is revocable by the shareholder unless the appointment form
conspicuously states that this is irrevocable, and the appointment is coupled with an interest in the share
or in the corporation generally. A proxy is coupled with an interest when the proxy appointed is one of
the following examples (not exhaustive): a pledgee, a person who has purchased or has agreed to
purchase the shares, a creditor of the corporation who has extended it credit under terms requiring
appointment, an employee or the corporation whose employment contract requires appointment, or a
party to a voting agreement created under (§§ 7.70, 7.50(c)).
c. Process - Proxy voting takes place after management and auditors have prepared financial statements.
BOD sets a date for annual meeting and then selects “record date” used to identify which shareholders
will be given notice and will vote at the meeting. There are Record Owners (only ones that vote) and
Beneficial Owners (give voting instructions to those who hold shares in the company’s record). Most
public shareholders are beneficial owners.
5. Voting at Shareholders’ Meetings - In corporations incorporated before the Illinois Constitution was revised in
1971, all stock was entitled to vote and vote cumulatively. Stock in post-revision corporations may be classified
as non-voting provided the articles of incorporated are amended to do so.
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 a. Voting Non-Stock - Shares, which are allowed to vote, but have no other incidents of ownership (e.g. no
right to dividends). This type is employed when a group wishes to gain control with a large number of
shares; they sell for a nominal price so they may be purchased in large quantities. Though shady, this type
is legal in Illinois.
b. Non-Voting Stock - Shares issued with no voting rights but with all other incidents of ownership (e.g.
there is a right to dividends). These shares may even be limited to voting only on certain matters. This
pleases management because they want to sell some stock to employees while maintaining control. This
is still somewhat advantageous for shareholders because it gives him a stake in the company (policy
standpoint).

Election of Directors:
1. Number of Directors – It is established in the articles of incorporation or the by-laws and can be amended.
2. Voting Methods
a. Straight Voting - In most situations, action is authorized by a mere majority of votes cast by outstanding
shares eligible to vote. Each shareholder has one vote per share, per issue being voted on (default for
other matters).
b. Cumulative Voting - In the election of directors, cumulative voting allows shareholders “to vote the
number of shares owned by such shareholder for as many persons as there are candidates to be elected, or
to cumulate such votes and give on candidate as many votes as shall equal the number of directors
multiplied by the number of such shares or to distribute such cumulative votes in any proportion among
any number of candidates” (§ 7.40(a)). For corporations incorporated before 1971, all stock is entitled to
vote cumulatively, regardless of when the shares of that corporation were purchased. Stockholders of
those corporations may waive their right to cumulative voting through unanimous consent. Shares in
corporations incorporated in 1971 and thereafter vote based on the current Illinois Constitution, the
IBCA, and the articles of incorporation. While the IBCA makes cumulative voting the default provision,
corporations may change this to straight voting or class voting. The purpose of cumulative voting is to
strengthen minority representation on the BOD through a semi-proportional system of voting for directors
(default for election of directors).
i. Calculation - To determine the total number of shares needed to elect one director, you take the
total number of voting shares (Y) over the number of directors to be elected (N) plus one, and add
one to the total.
c. Class Voting – When the holders of outstanding shares of a class are entitled to vote as a class upon an
amendment that affects their class. Imagine a three-shareholder corporation, where one person has 80% of
the stock but is willing to give up control. You could divide the stock into Class A and Class B, where
Class A elects one director and Class B elects two directors. Hence, if 80% of shareholders get Class A
stock and the other 20% get Class B shares, power is shared. Class voting is authorized under IBCA (§
10.25).
i. Shareholder Agreements: Typically in close corporations, methods for shareholders to pool
votes to bring about desired result
ii. Pooling Arrangements - Pooling arrangements in which shareholders agree to vote their shares
in concert are valid. Occasionally, a problem may exist with the enforcement of such agreements,
but the IBCA allows for their specific enforcement. This is the most useful in electing directors (§
7.70(b)). Enforce PA by Voting Trusts
iii. Voting Trusts - A voting trust is an agreement by which the parties transfer the legal title to their
shares to a trustee. However, other attributes of ownership (e.g., rights to dividends) remain with
the former shareholders. The agreement is enforceable because the trustee must vote according to
the agreement, and the shareholder still receives the benefit of their shares. A valid voting trust
must meet the FOUR requirements of § 7.65, unless otherwise provided:
1. There must be a written agreement specifying the terms and conditions of the trust.
2. The shares must actually be transferred to the trustee.
3. The trust agreement must be deposited with the corporation.
4. The trust may last no longer than 10 years, if not otherwise specified.
d. Removal of Directors - A majority of those entitled to vote can remove directors, with or without cause, at
a meeting of the shareholders (§ 8.35).

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47
 SQUEEZE OUTS AND FREEZE OUTS (direct)

ISSUE: Whether the squeeze/freeze out breached a fiduciary duty or violated Rule 10b-5.

RULE: A squeeze out is when the majority attempts to purchase minority shareholders’ shares and remove the minority
from the business. In a squeeze out merger, stockholders of the target receive cash rather than shares of the acquirer. Such
action is authorized by § 11.30 but may be scrutinized under fiduciary duty principles and Rule 10b-5.

A freeze out occurs when the majority shareholder or block of shareholders earns a return at the expense of the other
shareholders, often channeling corporate funds to the controlling shareholder block and depriving other shareholders of
the opportunity to share in funds paid out by the company. A freeze out involves a situation in which the majority blocks a
minority shareholder from holding a paid position with the corporation.
1) The corporation does not pay dividends so that none of the corporation’s profits are distributed to its shareholders;
2) The only corporate funds paid out are paid in the form of salary to those shareholders who are employees;
3) The “frozen out” shareholder is prevented form holding a paying position; then
4) As a result, the minority shareholder(s) do not receive any of these corporate funds, distributed as “salary” and are
unable to profit in any way from their investment in the corporation.
The burden of proof is on π to show a breach of duty and that the majority group is diverting the profits of the corporation
to themselves to the exclusion of the frozen out shareholder and, therefore, depriving the frozen out shareholder of his or
her rightful return on investment.

ANALYSIS:

There are generally three different approaches to determining whether a squeeze/freeze out is unlawful.

ONE: In Illinois, under § 11.30(b)(2), the acquiring corporation may pay shareholders of the target corporation cash
rather than shares of the acquiring corporation, provided there is no fraud, breach of fiduciary duty, or unfairness of price.
1) Was the payment in cash? YES (ok); NO (not ok).
2) Is there fraud? YES (not ok); NO (ok).
3) Is there a breach of fiduciary duty? YES (not ok); NO (ok).
4) Is the price unfair? YES (not ok); NO (ok).

TWO: In Berkowitz v. Power/Mate Corp., the court invoked the business purpose doctrine. Under the business purpose
doctrine, the parent corporation must have some business purpose for the merger other than eliminating the minority.
1) Does the corporation have some business purpose?
a. YES  OK
b. NO  not OK

THREE: In Weinberger v. UOP, the court noted two aspects of fairness: fair dealing and fair price.
1) Fair Dealing – when the transaction was timed, how the transaction was initiated, structured, negotiated, disclosed
to directors, how approvals or directors and stockholders were obtained.
2) Fair Price – relates to economic and financial considerations of the proposed merger, such as the assets, market
value, earnings, and future prospects.

ASK [Freeze]: Did directors act with intent to deprive π of his rightful ROI while distributing that return to themselves?

CONCLUSION: The squeeze/freeze out was/was not a breach of fiduciary duty and did/did not violate Rule 10b-5.

REMEDIES:
Squeeze Outs - Usually, the minority can seek fair value of the shares if dissenter’s rights exist by way of an appraisal.
The minority may also seek to enjoin the transaction if no dissenter’s rights are available or in addition to dissenter’s
rights if such rights exist.
Freeze Outs - Allege deadlock or oppression and seek dissolution or an alternative remedy such as an appointment of a
provisional director/custodian or a judicial buy out.
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