Kamar - Corporations Outline - Spring 2007 | Law Of Agency | Partnership

Kamer, Corporations, Fall 2006 Grade: A INTRO TO CORPORATIONS Goals of corporate law  to facilitate the creation and governance

of private legal entities that are the principle economic actors in the modern world  reduce all forms of agency costs,  establish standard contracting terms with business organizations  establish internal governance structures  create and transfer property right and partition assets Problems addressed by corporate law  Erects corporate form and legitimates property rights  Facilitates relationships among co-owners, corporations, and management (horizontal agency problem)  Facilitates the relationship between shareholder & management of corporation (vertical agency problem)  Facilitates contracting between shareholders and other stakeholders (creditors, etc.). Best to align the incentives of the firm and its agents. Need to align incentives of • managers vs. investors/owners • minority vs. minority shareholders • firm vs. external parties What is efficient? o Pareto Efficiency/Optimality: something, or some change in the law, is efficient when that change makes at least someone better off and no one is worse off o Kaldor-Hicks efficiency: when there is a net utility gain, the law is desirable  When all parties affected experience a net gain in utility If human nature is to not work as hard for someone else as you would for yourself, why not just do it yourself? o Specialization o Size – sometimes you can do something better by doing it on a larger scale (economies of scale) Coase, The Nature of the Firm: it’s a matter of transaction costs o If you do every single transaction yourself it can get too much o Cost reducing relationships Agency costs: o monitoring (watching what the agent is doing), o bonding (giving people incentives to do the right thing for you even when you aren’t watching, ex: designing compensation),







Kamer, Corporations, Fall 2006 Grade: A o residual costs (whatever is left after you’ve done the other two and agents still aren’t acting exactly as you want the to) Duties an Agent owes to the Principal: o Fiduciary o Disclosure o Governance: sum allocation of powers between the principal and the agent, maybe some key decisions you want the principal to make instead of entrusting it to the agent Two types of Agency o independent contractor (agent decides how to perform the job), o employer-employee (principal tells agent exactly how to perform the service) Justifications for Agencies o Economies of scale o Focus expertise o Specialization  The bigger you are the more you need to specialize Formation o Res. Agency §1: Agency is the fiduciary relation that results from o Manifestation of consent by P to A that the other shall act on his behalf and subject to his control and o Consent by the other to so act o Types of Agency Relationships: o Special agent: agency limited to single act / transaction o General agent: series of transactions / acts o Disclosed agent: 3rd party knows agent acting for principal o Undisclosed agent: 3rd party unaware of principal and believes agent is principle. The 3rd Party is contractually bound to undisclosed principal o Partially disclosed: 3rd party knows that the negotiating party is an agent, but does not know identity of principal Jenson Farms v. Cargill (p. 18, 1981)  Parties Conception does not control/ Implied Agency • Jenson Farms v. Cargill, (Minn. 1981) p. 16 o Facts: Warren Seed Co. and Cargill enter into a security arrangement. Warren’s indebtedness





Kamer, Corporations, Fall 2006 Grade: A exceeds its credit line. Cargill learns that Warren has falsified records. Cargill refuses additional funding. Warren defaults and breaches its contract with the farmers. The farmers sue Cargill stating that it is jointly and severally liable. o Issue: Can the courts infer a principal/agent relationship? o Holding: Yes, there was a principal/agent relationship. Cargill exercised sufficient control over Warren to create such a relationship. Cargill manifested consent to be agent; Many factors show control beyond normal debtor-creditor relation. Control indicates consent to agency relationship. Thus liability attaches if creditor has too much control. (banks beware!) o Didn’t matter to the court what the contract was, but as a practical matter what the actual relationship was like  essence of their relationship was that of principal-agent o If you have a principal agent relationship, and the agent incurs some debt to a third party, the third party can sue the principal to recover (principal is liable) Liability in Contract o Agreements within the scope of A’s authority: What a reasonable person in A’s position would infer from P’s conduct  Actual/express authority: What a reasonable person in A’s position would infer from P’s conduct  Incidental/Implied - authority for steps ordinarily done in connection w/ authorized activity  Apparent authority – what a reasonable 3rd party would infer from A’s actions even if A doesn’t have authority and was specifically precluded • 3rd party has a right of action against P, who can sue A • Equitable remedy to prevent fraud / unfairness to 3rd party  Inherent authority (conferred by law) – general agent may bind P to unauthorized K as long as a general agent would ordinarily have power to enter such a K & 3rd party doesn’t know that matters differ in this case (RST § 161, 194) • Thus P bound by A’s contract • Burden falls to P if there is ambiguity; protects against undisclosed P  Ratification: actual authority after the fact Think about Best Cost Avoider in Principle-Agent relationships White v. Thomas (Ark., 1991, p. 22)


Corporations. not implied that she could sell the land and definitely not express o Apparent authority: principal never led π to believe that agent had authority to sell the property. π. only the agent’s word suggested she had authority  Who is in the best position to avoid this misunderstanding? Here. and those are different enough that authority to sell not inherent in authority to buy (not necessary for completion of her job)  Same logic for implied authority. it is fair that a lower-level employee would assume this person had the authority to offer him a raise Gallant Insurance v. but agent does anyway - - .000 o Principal returns and refuses to honor the contract to sell part of the land to π o Π sues for breach of contract. not to sell. her authority was to buy. the court says that if the principal never communicated with the third party.Kamer. Fall 2006 Grade: A o White authorizes his assistant to go to an auction and bid up to $250. principal counters that she was not authorized to sell anything o Inherent authority must be incidental. Schenley (3d Cir. how can the principal be the least cost avoider  The third party here is the person who turned a blind eye – in a large real estate deal should have followed up and ensured that agent actually had authority she was asserting Caveat: some cases have gone differently o Lind v. she accidentally bids above that amount (another couple. bought attached land with home on it) o Assistant agrees to sell part of that land she bid on π in order to lower the total price to $250.000 to a tract of land. 1960)  When you call someone executive vice president. Fenwick (KB)(1892) Situation where 3rd party doesn’t realize he’s not principal Alehouse not with owners name on it but with Bartender’s name on it Principal told agent not to buy a certain type of drink. Issac (2000)(pg 26) Issac tries to change the insurance policy with the insurance broker during the temporary coverage period Insurance company says that all the paperwork has to be faxed and payment made before insurance kicks in Issue of insurance broker says Discussion You could take every part where Court says inherent authority and replace with apparent authority Kamar thinks this case really shows how courts mistake stake apparent authority Kamar says you do need some action on behalf of principal (or some clear inaction) Watteau v.

1949. Humble claims operated by independent contractor so no liability o Issue: Who is the principal in this relationship? o Holding: Court finds that there existed a masterservant relationship. p. Sun Oil. o Types of relationships:  Franchisee relationship: bundled services. Fall 2006 Grade: A Then doesn’t pay.Kamer. 1949) p. profit-sharing. 20 Car at gas station rolls out and his Martin Fault of gas station attendant They go after the oil company themselves instead of gas station operator. brand name. so 3rd party go after them for money No apparent authority because 3rd party didn’t know principal existed No actual authority because guy is clear don’t buy it Inherent authority with Apparent authority Kamar says he doesn’t see what principal did wrong here Humble Oil v. p. lease termination Things Sunaco did that substitute for monitoring o Incentives o Longer selection process • Humble Oil v. cigarette causes fire and there is damage Sues Sun Oil Sun not liable Rent is somewhat dependant on sale paid to Sun Oil from people o But minimum and maximum o So Sun Oil not bearing part of risk Humble and Hoover show how risk is key. so who will lose what when Other differences: weekly reports. 25 o Facts: Car rolls out of a gas station and hits the Martins. Martin. (Tex. Corporations. not Schneider – the operator Question: Is Schneider an employee of Humble Oil Answer: Yes Humble has decision-making power here. 32 Station attendant Smilick smokes cigarette. mgr must periodically report to Humble & has very - - . 1965. Humble liable for the negligent employee. eager to mask other parts of independent contractor relationship – much harder to mask risk follow the money. day-to-day control and o Key: gets a percentage of sales o So assumes part of risk Hoover v. Martin.

Hoover is seriously burned.Annually Overall P & . Humble pays utilities (biggest expense). not the profits. Sun Oil Co ( Del. Barone. it used Sunoco ads and uniforms. out of gross Profit and Loss ownership: proxy for the control relationship  Commission sales agreement: Schneider is paid out of the gross revenue. o payments out of profit vs.Sunoco operator (Schneider) (Barone) Hrs of op control .~N .N . the station assumed overall risk of profit/loss. is not a partner. 27 o Facts: Sunoco Attendant lights a cigarette while filling a gas tank. the station and equipment were owned by Sunoco.Y products Took title to . Comparison of two cases: . the station owner. and had title to products. Fall 2006 Grade: A little business discretion. Barone exercises greater control. gets his gas from Sunoco. Humble gives location & equip & ads  “Commission Sales Agreement”: manager paid from gross revs. Though the station sold mainly Sunoco products. had a terminable lease.Y Sell non-P . not net profits→ good proxy for control because company eats operating costs • Hoover v.~Y ownership Control on-site .Kamer.N . Humble Oil pays all of Schneider’s bills to run the station. and he is paid out of the net. Schneider does not share in profits. Therefore.  Barone does share in the profits of the corporation.At will . o Issue: Is Sunoco liable for the fire as a principle? o Holding: No. and Sunoco gave weekly rebates on gas. Corporations. Humble Oil exercises a lot of control.Y products sold Lease termination . strict control & supervision.Humble manager . still there was no obligation to Sunoco because there was no reporting requirement.Y employees - . 1965) p.Y .N .

finding conflict of interest much easier to show) – much more difficult to show that breach of duty (negligence) breach of duty instead of just misfortune o Care is easier to see. also whether P depends on A’s advice Duty of Care o Don’t be negligent o Incentives are aligned for agent and principal here mostly Duty of Loyalty more effective as legal tool than Duty of Care o Easier to prove for judges. 36) o Principal hires agent to investigate route of jukeboxes that wants to buy. whether or not the persons intend to form a partnership UPA §15: Partners are Jointly liable for Torts and J&S liable for Contracts vs.Kamer.  Acting as an Adverse Party: o §389: Acting as Adverse Party w/o P’s Consent – duty not to deal w/ P as adverse party in agency transaction w/o P’s knowledge o §390: Acting as Adverse Party w/ P’s Consent – must deal fairly w/ P and disclose all relevant facts fully. o §388: Duty to Account for Profits Arising out of Employment. p. Market price discrepancy is evidence that transaction unfair. avoid conflicts of interest o Incentives different for agent and principal o §387: General Principle: A should act solely for benefit of P win all matters connected with his agency. etc.PARTNERSHIPS  RUPA §202(a) – A partnership is the association of two or more persons to carry on as co-owners a business for profit forms a partnership. Fall 2006 Grade: A Payment paid out of gross Paid out of profits - - Fiduciary Duties Duty of Loyalty o Gain should be for Principal. but once you find loyalty it is easier to prove Tarnowski v. then sues agent for amount of kickback o Right to recover profits made by the agent in the course of the agency not affected by fact that principal already recovered what he lost from third party o Loyalty and care - . RUPA §306: Partners are J&S liable for Torts and  . Corporations. principal buys route based on investigation o Principal successfully sues sellers and recovers all his expenses. agent gets kickback from sellers to do superficial investigation and falsify reports to make look better. Cannot use confidential information against P. Resop (Minn 1952.

but RUPA §307(d): must exhaust business assets before pursuing personal assets. unsupported by authority. Issue: Is Sweet a partner by inference? Holding: Yes. 47 Facts: Vohland (the elder) gives Sweet. V alone took up loans. money paid Sweet was listed as “commissions” in V’s income tax return. Unless Sweet were a co-owner. and (2) bare assertion. he would have a perverse incentive to keep inventory low so as to keep his profits higher. 1982) p. subsequent borrowers want higher level of interest because first lender (Walter) claim is senior to theirs So say to abe and Bill. Sweet (Ind. that neither of alleged partners in nursery had any interest whatever in nursery stock planted on leased land did not comply with appellate rule requiring citation of authority and cogent argument. 20% of net returns (no explicit agreement) of nursery business. sell assets and distribute proceeds). unanimity required if matters unusual - - - - . a partnership may be implied. I can’t afford and Walter doesn’t like either o So become partners – if I am profitable you make a lot No clear answer to when you want to borrow and when to make someone equity holder o Depends on risks involved Formed by agreement o Just like agency though. Rules controlling a partnership Control (§401) – majority decides ordinary matters (body not share). Sweet tries to dissolve partnership and get his share of business (wind-up. App. thus waiving such issue. they’re partners Vohland v. the nursery man. S managed the physical aspects of the nursery. Note: The more inventory Sweet provides. Corporations. The Court of Appeals held that: (1) evidence that plaintiff received a 20% share of nursery's profits presents a prima facie case (UPA §7(4)) to support a finding that a partnership existed and that plaintiff had a 20% interest in inventory of the nursery. not required that partnership law has to be written as governing affairs o If they act like partners. Sweet believed he had a stake in the business Note 2: If Vohland had faced bankruptcy. Vohland (the younger) takes over. Fall 2006 Grade: A Contract. you won’t get fixed interest. even by contribution of sweat equity. but were silent on what they actually are. When V dies. Pamela example Pamela needs more money. Thus. court likely would not have found that Vohland sincerely believed that Sweet was a partner. but already has borrowed money.Kamer. the less he gets paid. V handled all financial books and made most of the sales. Sweet’s income tax stated he was a selfemployed salesman at the nursery.

Artis promise half his share of the profits to Mayer - . this action is against Peter and he’s no longer liable • RUPA §603: Effect of Partner’s Dissociation Problem 3. Bob takes on the duties of the old contract under a new contract with the Munn’s. Terms were changed to pre-pay and over-pay Bob. More liability is incurred. but have been sharing profits equally among the three of them o Mayer provided cash. so the Munns sue Pete by suing the original partnership. but the Munns renegotiated the terms of performance by offering advance payment. • Issue: Is Pete liable for the losses from the partnership where his brother and the Munn’s consented to release him from future liability? • Holding: Pete is not liable under § 36(3). all knew about it.Kamer. Munns contract with Bob to complete their house. Scalera (Conn. Bob is judgment proof. so the material alternation in the extent of exposure makes it such that Pete is off the hook.3. Fall 2006 Grade: A Agency (§301) – each partner is an agent to all other partners. Pete and Bob dissolve their partnership when the house is half built. 51 • Facts: Pete and Bob contract to build Munn’s house. whichever higher. Gratia and Artis form and operate a business. all agency obligations carry over (disclosure) Liability (§306) – each partner fully liable for debts incurred by partnership if partnership assets insufficient o explicit agreement to release partner from liability o somehow modify the relationship between the partners and a third-party that removes the departing partner from liability Idea of if law just let partners get out and get rid of liability – then the richest partners will leave first Idea of buying more time in reorganizing a debt with a third-party more time now accrue additional liabilities in this extra time Third Party Claims against Partners: Munn v. Munns agree to be a surety for the materials that Bob needs to purchase. Here there was no creditor who extended more credit. Corporations. Munns had knowledge of this material change and consented to it. but unbeknownst to the other partners.1 o Ars. Ars gets $5k or one third of profits. 1980) p.

but not new ones incurred afterwards o Can have agreement. could maybe get him through principal-agent relationship o Low. but counter argument is that in good year gets 1/3 of profits. is he liable in contract case and/or tort case? • Mayer is liable in first case. Ars uncle. which sounds like wages. whether or not there was a reliance on the part of the suppliers/bank  partner by estoppel • Low will argue he is just a lender. but is he a partner in another way? • Might have two partnerships going on.Kamer. or the remaining partners and creditors can agree to release him from the terms of the agreement  Partners’ Liability provisions: • RUPA §306. he is liable in tort and contract  Mayer? • Not a partner in the business (Argar). to release him of liability. Fall 2006 Grade: A o (a) Customer is injured because of Artis’ negligence (also contract case caused by Gratia)  Is Ars liable? • In a bad year he gets $5k. and then one between Artis and Mayer • If yes. Corporations. loaned business $50k for ten years. even if implied. because he has a partnership with Artis and Artis has a tort claim against him • But much harder to find liability in contract case because he is not a partner of Gratia • If Mayer had loaned Artis 100% of the money. UPA §13: Partners are liable in tort for the acts or omissions of co-partners the course of ordinary business even if the action is unlawful - . but counter argument is that had control over actions like in Cargill • Also argument that he is partner is interest tied to share of profits What happens when a partner leaves the firm o Remains liable for debts/responsibilities incurred before left. for 25% of profits and veto of certain expenditures  Is Low liable to bank or other suppliers? • Has a lot of control for just a lender  like Cargill case  became more of a principal-agent relationship than just a creditor-debtor • Really going to be a factual question. one between the three of Argar. and in last few years that’s what he’s gotten (doesn’t matter that didn’t contribute capital because contributes labor)  so sounds like partnership • If he is a partner.

Kamer, Corporations, Fall 2006 Grade: A • • • • • • RUPA §306; UPA §17: New partners are not liable for the acts of the firm prior to their involvement. RUPA §401(f): Partners have equal rights in management and conduct RUPA §401 (i): Person can become a partner only with the consent of the other partners RUPA §404: Partners owe one another a duty of care and a duty of loyalty Creditors who exert too much control can be considered partners by control or by estoppel. (Cargill). RUPA §703; UPA § 36: A dissociated partner maintains liability for the firm’s actions during the time the partner was active unless there is a waiver by partnership or 3rd parties.



Conflict between Personal Creditors and Partnership Creditors. Two solutions: (1) UPA §40(h) and (i): Jingle Rule: Which Creditors Get Dibs on What o (A) Partnership creditors get first dibs on partnership assets o (B) Individual creditors get first dibs on individual assets  Both are second in line for the other type of assets. (2) 1978 Bankruptcy Act §723(c) & RUPA §807(a): Which Creditors Get Dibs on What o Partnership creditors get first dibs on partnership assets o Equal Footing for Individual Assets: Neither partnership nor individual creditors get first dibs on individual assets Nabisco v. Stroud (1959) p. 58 Facts: Stroud and Freeman are partners in Stroud’s food. Stroud tells Nabisco that he personally would not be responsible for bread deliveries. Nabisco still delivers bread at Freemans’ request. Partnership dissolves, Stroud doesn’t want to pay for bread. Issue: Can Stroud be held liable for the actions of Freeman? Holding: In a two person partnership, a majority is greater than one. Stroud is liable. Bodies count more than contribution of capital. Note: Preserves value of ongoing business – opposite rule would allow minority partners to hold up the business BALANCE SHEET ISSUES Termination of a partnership: Greatest Doctrinal divergence between UPA and RUPA Default Rules of Partnership Dissolution UPA 29, 30, 37 & 38 If partnership for a term, no partnership has right to dissolve before term expires



Kamer, Corporations, Fall 2006 Grade: A o You have the power to dissolve but then you’ll be in breech of the partnership agreement If at-will then you can dissolve it whenever you want Winding-up the partnership, terminating partnership You can contract around default rules though  UPA: • Dissolution § 29: Any change of partnership relations, e.g. exit of a partner, entry, etc. • Winding up § 38: Orderly liquidation and settlement of partnership affairs • Termination § 30: Partnership ceases entirely at the end of winding up • Improper disassociation: doesn’t get any claim to goodwill of the business—can’t get going concern value. No right to windup. Just pro-rata liquidation value minus damages  RUPA: lowers the barrier to enter into/exit partnerships • Disassociation § 601: a partner leaves but the partnership continues, e.g., pursuant to agreement. • RUPA § 801: the onset of liquidating of partnership assets and winding up its affairs • Improper disassociation: pro-rata claim on going concern, minus damages. Going concern value is the cash flow you expect in the future discounted by the time value of money. Adams v. Jarvis (Wis. 1964) p. 62 Facts: Dr. Adams withdraws from a partnership. He requests a wind-up and dissolution. Agreement: The withdrawal of a partner will not terminate the partnership. Instead, Adams should get his share (1/3) of the year’s profits for the time that he worked (5 mos.) Trial court finds that the withdrawal works as a statutory dissolution. Issue: Should the statute trump the partnership agreement? Holding: Dr. Adams loses. The partnership is not wound-up, but he does get his portion of the profits. Agreement trumps the statute because the statute is just a default rule. Note: Why does Dr. Jarvis care about the accounts receivable? Why isn’t value of accounts receivable fully reflected in the income statement? Answer: Hospital is using a cash accounting system, so the books only reflect the money that has been paid. Dreifuerst (Wis. 1979) p. 66 Facts: Winding-up of an at-will partnership amongst three brothers to run two feed mills. There is no partnership agreement, so this is a partnership at will. Trial court divides the assets, giving one mill to one brother and the other mill to





Kamer, Corporations, Fall 2006 Grade: A the other brothers. UPA S38(1): “When dissolution is caused in any way, except in contravention of the partnership agreement, each partners, as against his copartners . . ., unless otherwise agreed, may have the partnership property applied to discharge its liability, and the surplus applied to pay in cash the net amount owing to the respective partners.” Issue: How should the court divide the assets of an at-will partnership? Holding: The trial court did not have the right to divide the assets in this way. In a partnership at-will, all partners have the right to request liquidation. Rule: An exiting partner has the right to insist on sale of the assets and allocation. Asset market is the most efficient and fair allocation of funds and best protects creditors. The market decides the worth of the business. RUPA §§ 402, 801, 802 and 804 codify the holding in this case. Question: Why would the brothers want to separate the mills in-kind? They may want to continue running the business or they may think that the court gave them the greater valued mill. There may also be tax reasons to avoid selling the business. ABA proposal: have a judicial valuation and appraisal of assets, then let the partners who want to continue to work pay off the exiting at-will partner. Exiting partner has appraisal rights, not a right to apportion the assets. (potential transaction costs associated with actual sale v. appraisal) Dissolution of Partnership Partnership-at-term: can convince a court to dissolve it for you, hard but can be done Default rule: Dreifuerst, codified in UPA If partners think default rule is going to be very expensive because of taxes or transaction costs, can negotiate in the shadow of this rule, can even negotiate after the fact Ars, Artis and Gratia Artis wants to leave the partnership, they want to replace him and bring someone else in as partner and do the work Artis was doing If Ars is your client, what contract provisions does he want to protect him? o Concerned about (§ 36.3?) so he wants to make an agreement with the new partner coming in o Want some sort of indemnification/reimbursement to protect him from liabilities incurred before he left o If he just wants to leave, suppose the value of the business is $700k, worth $500k if you sell it to someone else as a whole, and $400k if you sell it in pieces  By default, if partnership at will, Artis can force a sale, which could net as little as 400k and as much as 500k  partners have an incentive to negotiate because if keep business intact and keep running it, it’s worth 700k  RPU § 701: The remaining partners will have to pay him the upper of the liquidation value minus the value of Ars’ presence






better to be in a partnership for a term. The younger Page claims that the elder is trying to take an opportunity. the elder Page seeks to dissolve the partnership. RUPA §701(b): a disassociating partner who doesn’t insist on wind-up gets: a higher of: (1) liquidation or (2) going concern value. so the value would be less  § 38. breach of the partnership agreement which means they can force him out. Issue: Was this a partnership at-will? Holding: UPA S 31 says that a partner may wind-up a partnership at any point if the partnership is at-will. and may be worth more as going concern than as individual assets. Page (Cal. not at will. because Elder page will be the only buyer of the assets. (This is the pro-rata ownership of the business) Limited Partnership General Partner plus limited partners Limited partners have limited liability Used to be the case that to retain limited partnership position couldn’t exercise any control o However that’s really not the case anymore PE funds are often like this Limited duration - - - - . minus damages and excluding good will (the difference between the asset value and the __?___)  Under new version getting paid the value of the business as a going concern. 70 Facts: Oral partnership agreement between two brothers to run a laundry. Fall 2006 Grade: A o Say he was caught getting kickbacks. minus whatever damage he caused with his behavior First look to their agreement.2(c): going to be paid the value of the partnership interest. he would breach his fiduciary duty. Young Page is not protected. and he was being asked to leave by the partners. There is a concern that the older brother will use his superior capital to purchase the business and run it at a profit. The trial court finds that the partnership is for a term. Passive/Active partners don’t generally enter into partnerships at-will.Kamer.. 1961) p. Corporations. Just when the business starts to make money. Implicit assumption that market inefficient – because if market was efficient the value would be easy to determine Reasons for Cash Payout: o (1) Market Test of Value: sale allows better determination of real market value o (2) Protects Creditor’s Rights: easier to pay debt if there is cash. Salmon. otherwise look to default provisions in statutes UPA § 701: greater of liquidation of assets or what business is worth as going concern without him Page v. If Older brother seeks to purchase business. Notes: This is like the inverse of Meinhard v.

but only from specific liabilities listed in the statute Also LLLP.CORPORATIONS Everyone has limited liability Can sell shares Centralized management o Board of Directors elected by majority of shareholders o Much more streamlined. Can do this without paying tax If corporation buys an LLC there will be tax on the sale. how far can you contract around fiduciary duties? Subchapter S-Corp Corp but get pass-through taxation Have to have less than 75 live human shareholders Limited liability like corporations If one corporations buy S-Corp. can’t be contradicted by by-laws - .Kamer. than partnership o Easier for third-parties to deal with business  Know that the board can do everything Charter o In order to make changes in the charter you need joint action of Board of Directors and shareholders o Higher than by-laws. limited liability. liability partnerships LLC (Limited Liability Company) Limited liability like corporation But pass-through taxation o Originally had to have no more than 3 of the following 4 to still have passthrough taxation  Centralized management  Unlimited duration  Transferability of shares  Limited liability But then in 1987 IRS said okay you can have pass-through taxation as long as you don’t have publicly traded shares Hugely popular these days Still some doubt about how Courts are going to treat LLCs? o For example. but if buy an S Corporation can buy it as a tax free reorganization Can only have one class of stock Best if you think you might be acquired some time soon - . Fall 2006 Grade: A LLP (Limited Liability Partnership) for law and accounting partners Helps limit liability for other partners torts Good for helping as malpractice Everyone is limited. less risk for impasse. Corporations.

Fall 2006 Grade: A o Only subject to statutes o Governed by DGCL 102 o Some things that have to be there  Name of corporation.By-laws o Usually either Board or shareholders can do this unilaterally o Governed by DGCL 109 .Benefits o Eliminates problem of personal liability: creditors can only use corporate assets o Investors can enter and exit by buying and selling shares  Transferability o Prevents minority investors from holding up the firm by threatening dissolution o Can incorporate in any state – state of incorporation dictates which state laws will control the management of your corp. 92 • Reduces need to monitor agents • Reduces need to monitor other shareholders • Makes shares fungible  facilitates takeovers • makes it possible for market prices to impound additional info about value of firms (w/o LL.Key benefits of the corporate form: (3) Centralized management • all corps need central coordinator to oversee exercise of managerial power • Management is appointed by elected board of directors .  Capital structure • Total number of shares of stock that can be issued • Classes and types of stock . Corporations.Key benefits of the corporate form: (2) Transferability of shares  no concern over dissolution or reformation (problem for partnerships)  good check on management  encourages the development of an active stock market. which facilitates diversification of investments  Provides liquidity . o Centralized management o Considered to be a person in the eyes of the law o A corporation does not cease to exist when shareholders exit o Take on riskier ventures! o Prods creditors to monitor management Easterbrook & Fischel p. etc. could not have 1 market price for all shares of corp) • allows investors to accept risky ventures • Facilitates diversification • Enlists creditors in monitoring managers • Full information about the value of stocks? .Kamer.

typically common stock and these shares have voting rights and can elect the board of directors o Can also have other classes of stock and set out in charter what rights these different classes of stock have Board of Directors – how elected. authority. Historically charters came with monopoly rights. how often board meets. later there was increasing pressure on legislatures to adopt general corporation laws to allow anyone to incorporate and get a charter. § 109 (bylaws)  very important. why Delaware wins because it is the worst law possible  Because you are playing to managers. CEO’s authority. etc. it is more difficult for shareholders to monitor management.Kamer. how notice is given. • Separation of powers: board approves business decisions and managers execute business decisions (necessary transaction cost) Mechanics of Creation Have to file a certificate of corporation with secretary of state (articles of incorporation) Corporate charter – constitution of the corporation – usually more high level and general Create bylaws – usually more specific Main differences are how you change and adopt the charter and bylaws o To change or adopt charter need joint agreement between board and shareholders o Usually one group or the other (or both) can on its own change/adopt the bylaws Charter is only subject to the state statute Bylaws are subject to the charter and the law DGCL § 102 (charters). yes states are competing to offer law corporate decision makers want - - - - . Corporations. Fall 2006 Grade: A • Separation of board and managers allows distinction between the approval of business decisions and their executions • As firms increase in size. read these Need to include in charter the capital structure  number of shares of stock the corporation can issue. now anyone who qualifies and files the correct forms can get a charter Corporate Law Literature Cary’s article in Yale Law Journal in 1936 o Race to the bottom. while corporate law is supposed to protect shareholders Winter’s article in 1978 o Says Cary is wrong. what classes of stock and what types of stock going to issue o If one class of stock.

Fall 2006 Grade: A o But that’s good. don’t know where race is to DGCL 141 is key for Powers of the board - - - - - . just no market discipline on doing this Kamar and Kahan (2001) o Expensive to compete with Delaware  Court of Chancellery without a jury • Often have to change state constitution  Other states aren’t really competing with Delaware Dane: the market values DE companies higher Argument that Delaware is overseen o Feds will federalize parts that go out of the box too far with things like Sarbanes-Oxley Empirically back to square one here.Kamer. so lawyers in Delaware benefit o Law goes that way because Delaware lawyers a very powerful interest group in the state Bebhcuk (1992) o Race is to the top in areas of states offering protection to shareholders o Except in areas where redistributive between shareholders and managers and managers can get a lot of money incentives out of it  Delaware is highly distributive in this way • Low protections under duty of loyalty • Duty of care will be fine though Klausner (UVA sometimes recent) o Law is language o Value of law is higher when most people use it  (Similar software packages become more valuable when more people use it) o Use of case law makes the law clear – more predictable  Corporations love predictability o If another state could offer Delaware comparable law  Problem is Delaware judges gives laws meeting  Also incentive for Delaware to gives law hard to copy • Delaware does that by making application of law dependant on Delaware court distribution o Maybe not on purpose. manages don’t want to offer law that’s bad for shareholders because otherwise shareholders wouldn’t invest in their companies Romano (1980s) o States get more corporate franchise tax revenue when more responsive to demands of corporate power Macey & Miller (1987) o Delaware lawyers benefit from Delaware law o The law invites litigation. Corporations.

then shareholder approval. have to pay dividends for each year) • Rights always set out in the charter • Voting stock  Preferred stock • Usually get guaranteed dividends (ex: every year 5%. Corporations. etc.) • Usually no voting rights • This is not a statutory provision  statute just says you can design stock anyway you want • This is industry practice not statutory • DE code: you can leave the rights of the stockholders open in the charter o Ex: rights of preferred stockholders will be determined when the board issues them o Board can slice the stock into different series and decide the rights of the stock as you issue them  Blank check preferred - . Fall 2006 Grade: A DGCL 271 Sale of all or substantially all assets of corporation needs initial approval from board. o Same for  charter amendments  mergers  dissolutions Corporation has two ways of financing business activity o Debt  Secure debt  Unsecure debt  Public debt • Bonds .Kamer.long-term debt secured by assets • Debentures Long-term debt not secured by assets • Notes Short term debt not secured by assets • Subordinated notes – unsecured and subordinate to other notes  Private debt • Credit from banks and suppliers  Creditors deserve to get interest payments every year o Equity (Ownership)  Common stock • Right to get dividends when board decides to give them – many don’t pay dividends for many years • Paying dividends in arrears – have to pay dividends for every year don’t pay it (so if wait five years between payments.

The two valuations were based on different information. Fall 2006 Grade: A  Discount Rate: PV = FV/(1 + r)t Risk Premium Risk Adjusted Discount Rate Diversification investing in things that move in opposite directions o Betting on two different sides of the same sporting event systematic risk v. unsystematic risk o systematic is risk that is inherent to the system  Hard to get away through diversification o unsystematic is extra risk on top of that  Should be able to diversify away o Risk companies risk is correlated with market is its “beta”  How many companies stock moves when market moves If market moves 10% and company moves 15%. Holding: Court determines that proper value was $38. Small Firm/small stock premium DE law: market price should be considered in appraisal. prior to the deal. Corporations.95/share.Kamer. Information available to insiders re: June projections that were not shared with the market.05/share. Defendants: company is worth $10. Ch. Plaintiffs: company is worth $44. the shares were trading at $7/share.38/share. company has a beta of 1.CREDITORS Creditors can minimize costs: o Take security interests in particular assets o Negotiate specific covenants that give them early warnings of credit problems o Usually too costly for small creditors Corporate law: 3 protections o Impose mandatory disclosure duty on corporate debtors o Promulgate (usually de minimis) rules regulating amount and disposition of corporate capital o Impose duties to safeguard creditors on corporate participants - . 2004) Supp Facts: Attorney and I-banker are held liable for recommending a low value. Huge difference in valuation between the Professor and the Investment Banker. Deal price was at $10.5 In re Emerging Communications (Del. There was reason to believe under these facts that the market price was not reliable.25. the market price of shares is not always indicative of fair value Articles of incorporation left it open for the board decide later - - - .

70% of 4 = 2.5.8 EV .5% of 0 = 0 EV .5 14.8 EV .5 .5 mil .Expected Value of Company’s Assets Appeal .8 .25%of51 = .70% x 4 = 2.1 EV 5% of 0 = 0 EV Total EV = 3 Mil 3 3 - - - - - - .5% x 0 = 0 2. Corporations.70% of 4 = .5 .5 .75EV 9. Fall 2006 Grade: A Credit Lyones Example 12.Total EV = 15. and can saddle the creditors with the risk Solvent Company (debt of 3 million) .Expected .5 .5 Mil Settlement I .12 Crux of Problem  Cannot identify group of people whose duties run with interests of assets Plus in real life these numbers are almost all estimates So Courts usually give the board discretion here So we see here how Shareholders prefer risk as opposed to Creditors.12.5% x 0 = 0 EV 9.0. EV of 15.Total EV = .12.5mil Corporate example – you remember this from the reading Company is 12 million in debt Kamar defines best interests of the company as the choice that maximizes the Net Present Value of the company Settlement offer I = 12.17.5 Insolvent Company (debt = 60 million) Expected Value of Shareholder’ s Claims 25%of 48 = 12 EV 70% of 4 = 0 5% of 0 = 0 EV Total EV = 12 Mil 9.25% x 12 = 12.25%of51 = 12.8 mil 15.5 mil.5 Settlement II .Total EV = .Expect .5 Expected Value of Creditor’s Claims 25%of 3 = 1 EV 70% of 3 = 2.75EV .75 .5% of 0 = 0 .75 3 .Expected Value of Value Value of Company’s Shareholders Creditor’s Assets ’ Claims Claims Appeal .5 Mil Settlement I .Kamer.17.12 Settlement II .5 mil Settlement offer II = 17.Total EV = 5.70% x 0 = 0 .25% x 39 = .

5 17. Corporations. or o Assets are less than liabilities plus the preferential claims of preferred shareholders If corporations assets are worth more in economic value than as reflected on books.75EV 70% of 4 = 2. or out of assets as long as those assets remain at least 1.75EV 70% of 4 = 2. causes increase in capital surplus account  reevaluation surplus Only real protection creditors have is under fraudulent transfers act Protection from other Creditors  DOCTRINE OF FRAUDULENT CONVEYANCE .25 times greater than liabilities. Fall 2006 Grade: A Expected Value of Company’s Assets 25%of51 = 12.5 Mil 12.5 - Appeal - - - - Settlement I Settlement II - - 0 0 - - - - - - - How to use balance sheet in capital regulation and protection of creditors? Represent particular fund on balance sheet as “permanent capital” that could not be paid out to shareholders and upon which creditors could rely when extending credit o Legal or stated capital account Capital surplus test (NY § 510): bars distribution that would render corporation insolvent (unable to pay its immediate obligations as they come due)  dividends may only be paid out of surplus and not out of stated capital o But board of directors is entitled to shift any portion of capital account to surplus account if authorized to do so by shareholders Nimble dividend test (DE § 170): Pay dividends out of capital surplus.8 EV 5% of 0 = 0 EV Total EV = 15. and current assets at least equal current liabilities RMBCA § 6.5 17.40: Corporations cannot pay dividends if: o Wouldn’t be able to pay debts as they come due. free to change assets column to reflect this o Since no corresponding liability.5 Mil 12.5 Expected Value of Shareholder’ s Claims 25% x 0 = 0 70% x 0 = 0 5% x 0 = 0 Total EV = 0 Expected Value of Creditor’s Claims 25%of51 = 12. out of net profits in the current or preceding fiscal year o Can freely transfer state capital stock associated with no par stock into surplus account on its own Modified Retained Earnings Test (CA): two-part distribution test  pay dividends either out of retained earnings.8 EV 5% of 0 = 0 EV Total EV = 15. or if no capital surplus.Kamer.

Minimum Capital and Capital Maintenance Requirements In US.Kamer. and - - - - - .2.  one last gasp for air by company spin-off o paying a dividend in kind. statutory minimum capital requirements are either truly minimal or nonexistent EU: minimal capital requirements more like de minimis screening than meaningful creditor protection o Traditionally adopted capital maintenance rules w/ main characteristic to accelerate point at which failing corporations must file for insolvency No capital maintenance requirements in US Equitable Subordination: Courts of equity use this doctrine to recharacterize debts owed to controlling shareholders as equity rather than debt—this protects unaffiliated creditors by giving them rights superior to creditors who are also controlling shareholders (i. buying a company for cash with borrowed money o Leveraged a company up  Change the ratio of debt to equity  Can pre-pay the company’s debt with new debt if they want  So now when have an investment company that wants to buy a company.3. giving stock? o What if you put a lot of assets there and spin-off? o Could mean bad news for creditors – clean parents company and subsidiary with few assets bearing all the debt o Creditors could say fraudulent conveyance o (Kamar’s example that often stock goes up but bonds drop. Corporations. company’s debt de facto accelerated. and typically an officer of the company as well. Generally only invoked in bankruptcy and only when two requirements are met: o (1) the creditor is also a shareholder. and need money now. Fall 2006 Grade: A o Protection of creditors from other creditors o If transfer assets of failing company to single creditor. other creditors can set aside conveyance or hold creditor responsible for company’s debt  Creditors that get the assets tend to be insiders  Concern that shareholders will now wear the hat of creditors and transfer assets to themselves o Why would a company favor an outside creditor?  Have a company bleeding cash. LBO.e. etc. subordinates claims of creditor shareholders). and investment company will pay off all the company’s debt when buy out 6. so do whatever it takes to get cash infusion into the company o Might be third creditor will lend the money for certain assets.

000 in the corporate fund. only deals with debt that has not yet been paid by the company o Here would have to use fraudulent transfer to undo Piercing the Corporate Veil for contract creditors: this is the equitable power of the court to set aside the entity status of the corporation and impose tort or contract liability directly on the shareholders. Holding: Inequitable shareholder-creditor claims against a bankrupt corporation may be subordinated to general creditors. The partners took advantage of their fiduciary position. to their own benefit but to the detriment of the corporation. could you have gotten the money out of him? o Not with equitable subordination. Costello v. Partners keep the business alive so that they can turn over their creditors. and defaults. However. A claim that is not within the bounds of reason and fairness. because done with contemplation of incorporation Wasn’t fraud. This is corporate law. 1958) p. Now the partnership creditors are paid off. Fall 2006 Grade: A o (2) the inside creditor has behaved unfairly or wrongly toward corporation / outside creditors. the corporation is then totally under-funded. 142 Facts: Originally organized as a partnership. Generally consists of two components: - - - - - . Immaterial that withdrawel happened before incorporation. o Partners loans are automatically subordinated o Corporate loans from controlling shareholder . or that does not carry the earmarks of an arm’s length transaction. but had effects of fraud How could this have been different under the Fraudulent Transfer Act? Future creditors are not protected under constructive fraud  in Costello we are dealing with future creditors. and both past and future creditors protected from actual fraud If the company had already paid Ambrose (inside creditor). not partnership law. Fazio and Ambrose are now unsecured debt holders. This firm was undercapitalized and there was action for the partners’ personal or private benefit. Corporations. is inequitable. Difference between partnership and corporate context: automatic vs. this just means kicked back to the end of the line.not automatic – because controlling shareholder has the best information. and they have a new set of corporate creditors. Fazio (9th Cir. these claims should be subordinated to general creditors. so might not be protected under the act Only past creditors protected from constructive fraud.Kamer. Partners trade debt capital for equity capital. but still don’t get paid first Constructive fraud – not intent to fraud. Where the partners’ claims left the business seriously undercapitalized. Copartners are now in the same class as unsecured creditors. nonautomatic subordination. best position and so don’t want to totally discourage it. but partners then incorporate and Fazio and Ambrose pull out most of their money so that each partner only has $2.

and finds that Pepper Source has dissolved without any assets. o (2) Circumstances such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. but is insufficient to prove intent.  Four factors are relevant to the first requirement: (1) failure to maintain adequate corporate records or comply with corporate formalities. Sea-land Services v. who has a stable of companies that have limited funds.  Cases where there is generally not piercing: against public corporation. Van Dorn Test (7th Circuit – applied in Sea Land): o (1) such unity of interest and ownership that separate personalities of the corporation and the individual [other than the corporation] no longer exist. The lower court granted summary judgment in favor of Sea-Land Holding: Court applies the Van Dorn test and remands. against passive shareholders. Polan) (1) unity of interest and ownership such that the separate personalities of the corporation and the individual shareholder no longer exist. District Court finds actual fraud and tax fraud. minority shareholders.  Remedy: go beyond corporate assets and get assets of shareholders. “Tinkerbell test” – to be protected. stealing. (NOTE: PROBLEMATIC TEST: either real fraud or “injustice. o (2) unfair or inequitable conduct (lying. This is the wildcard in veil-piercing cases). (3) undercapitalization. cheating. Corporations.Kamer. v. Laya test (Applied in Kinney Shoe Corp. Sea-Land then tries to sue Marchese. shareholder must believe in the separation).”)  Promotion of injustice requires showing a “wrong” beyond merely that creditor would be unable to collect. The Pepper Source (7th Cir. Fall 2006 Grade: A o (1) evidence of lack of separateness (shareholder domination. Sea-Land tries to pierce through to Marchese and reverse pierce to the other corporations. implicit or explicit misrepresentation. (2) commingling of funds or assets. if all formalities are observed and nothing “funny” with the accounts. The injustice prong seems to apply to strategic behavior which results in disappointing legitimate creditor expectations. 148 Facts: Sea-Land is a creditor that gets stiffed on the freight bill from Pepper Source. 1991) p. and (2) would an inequitable result occur if the acts were treated as those of the corporation alone. and (4) one corporation treating the assets of another as its own. (Note similarity to norms underlying fraudulent conveyance law— unfairly shifting assets. BUT: even if these 2 - - . Sea-Land tries to collect a judgment on Pepper Source.  Real proof of fraud in these cases would be unreasonably difficult. thin capitalization. no formalities / co-mingling of assets.) Note: the lower court circumvented the “injustice” issue of Van Dorn by finding actual fraud. colorable business purpose is always present.

protects his business assets. Corporations. Polan has two corporations: Polan Industries and Industrial. it is not mandatory and doesn’t apply here 7th Cir. An Kinney was desperate – shouldn’t they have investigated and protected themselves 7th circuit would have required the injustice element not necessary here Would fraudulent transfer have helped here? o When you use fraudulent conveyance. they are not in a position to rely on the firm’s creditworthiness when they put themselves in a position of risk and then suffer loss. protects his personal assets and the second corp. Fall 2006 Grade: A prongs are satisfied. Carlton (N. and then realizes that it cannot make it in WVA. Polan uses two corporations so that the first corp. introduce third prong o If creditor had reason to know the corporation was undercapitalized then the re is no veil piercing o But this prong wasn’t applicable here o Even if prong three applied here. o Second.Y. In many cases tort creditor may be unaware of tortfeasor. you don’t know what was given to whom when. Both of Polan’s corporations go bankrupt. not mandatory.Kamer. 1966) p. which has assets. Walkovszky v. Kinney then seeks to pierce the corporate veil and hold Polan personally liable. Kinney then subleases the building to Industrial. but Industrial subleases 50% of its sublease to Polan Industries. 157 - - - - - - . Facts: Kinney shoe is given a deal to invest in WVA. still potential “third prong” – Defendant might still prevail by showing assumption of risk. Industrial has no assets. 2 prong test more important/prevelant Study on 160 in 92% of the cases Court finds some sort of “injustice” Most cases stem from contractual liability Veil Piercing on Behalf of Involuntary Creditors (tort) Difference from contract creditors: o First. and maybe all these assets are dissipated across dozens of people and not all in Polan’s hands o With veil piercing don’t need to trace specific assets Found that first two prongs satisfy. they cannot negotiate with the firm ex ante for contractual protections from risk. Holding: Court applies Laya test and holds that there was a: o Unity of interest and ownership such that the separate personalities of the corporation and the individual shareholders no longer exist o and to rule otherwise would be inequitable o No discussion of assumption of risk prong because this is discretionary. you have to trace the assets o When company doesn’t keep clear books. Kinney takes a lease in WVA.

each owning only a few cabs that were part of overall fleet. followed corporate formalities. then he should be liable for the corporation’s acts. p. They carry the statutory minimum for liability insurance and have no other assets. etc. operated by another. However. when an individual defendant uses the corporation to further his own rather than the firm’s interests. 170) Especially want to pierce veil for tort creditors and involuntary creditors. Specifically. Enterprise liability – piercing liability across all corporations.Kamer. 166) Here liability is to the state for criminally polluting the environment Is there a different standard for veil piercing under this federal act than veilpiercing for creditors? Seems to be yes  sufficiently capitalized. they actually get less protection than contract creditors Don’t want to encourage investment in businesses that are too risky Solution: pro rata limited liability o Liability proportionate to shares held in company Why assume limited liability for torts anyway? Might be doable. 2001. Corporations. because most exposed to hazards of limited liability But because of court focus on fraud. court willing to do this o But Court won’t actually to the guy himself Carter-Jones Lumber v. but not the law today - - - - - . thin capitalization alone is insufficient to pierce the corporate veil for tort liability. The plaintiff is really trying to allege fraud in the complaint but the companies in this case complied with the law. Incentive to engage in overly risky behavior since can shield assets from risky business activity by holding multiple corporations Holding: The plaintiff has not produced sufficient evidence that the individual defendant was operating the various companies in his individual capacity. Fall 2006 Grade: A Facts: Plaintiff severely injured when run down by taxicab owned by one defendant. NY rule on veil-piercing: Courts will pierce the corporate veil whenever necessary to prevent fraud or to achieve equity. Also sued defendant Carlton who was stockholder of 10 corporations. etc. Assets of companies are worthless – cabs are mortgaged and medallions are judgment-proof. LTV Steel (6th Cir. and still found liable for pollution Based on Supreme Court decision in Best Foods o But this seems to give the same standard for veil-piercing under CERCLA as for creditors o Just in this case found someone at parent company of wholly owned subsidiary that broke CERCLA also Hansmaan and Kraakman article (p.

yes unless it’s classified o DGCL 141. she’ll only get 2/3 per year. can buy even more time than just each measure alone o Instead of Kagan taking control of one third of the board each year. all of your votes go to that person (each person you vote for gets all 100 of your votes) If combine cumulative voting with classified board. by-laws Mergers (DGCL 251) Sale (DGCL 271) Dissolutions Resolutions (creature of federal law) o Standard rule about proxies being revocable (although can be irrevocable) Board decides about a “record date” for who can vote as of a certain day Removing a director with cause takes a lot – they have to be a real villain according to Kamar. and will take the full three years for her to gain a majority Suppose Kagan can petition the court to call a special shareholder meeting o Articles incorporation = charter - - - - . 141(K) The Unfireable CEO Problem (p.have as many votes as shares times positions voting for (ex: have 100 shares and there are 3 seats up for election. 3 elected per year) Kagan buys 51% o f shares (R has 25%) Delay tactic  take three years of voting to remove the board (staggered). want to control company Revesz.Kamer. Corporations. get 300 votes that he can split up as he likes  can give all 300 to one person.CHAPTER 7 . Fall 2006 Grade: A . amendments to bylaws classifies the board R: o Amends charter so that only board can amend bylaws o Enacts cumulative voting o Staggered (classified) board (9 members. just bad management isn’t enough Can I just remove them because I own them? o Well . or split among the three seats) o Regular voting: choose one person per seat. 182) Revesz  CEO and substantial shareholder w/ 25% of stock of Village Kagan  takeover artist.NORMAL GOVERNANCE: THE VOTING SYSTEM What Shareholders Can Vote On Elections Charter. or two years to gain majority Also changes charter to cumulative voting .

not the shareholders (though must be signed off on by the shareholders Can she amend the bylaws (§ 109) o No – only the board can amend the bylaws (see R’s charter amendment) o But if she could amend the bylaws o Can she increase the size of the board by amending the bylaws? As long as the charter allows a maximum above what is currently in place  If bylaws says 9 members. so she needs to amend the bylaws  If she changes the board to 27. he’ll get four more (in addition to the 9 he already has) for 13 total. o Companies with staggered boards much less likely to cave in during hostile takeover (Bebchuck study) Staggered boards are bad for shareholders in other ways: - - - . you need both shareholders and must be initiated by the board § 275 Charters are stronger than bylaws. so the board cannot restagger itself Could she dissolve the company? No. she’ll be able to swamp the board with her people and she’ll get the majority § 216 DCL – company can have in the bylaws a provision that says a majority must elect the board of directors even if no one runs against them Can she destagger the board? Yes. and not addressed in the charter – will this help her?  Now there will be a bunch of vacancies – who gets to fill them?  § 223(a)(1) – vacancies filled by directors unless otherwise directed by bylaws. Corporations. so she’ll have a majority  To figure out how many directors someone will get with cumulative voting: (new directors + 1)(Opposing party votes – 1)/(votes cast) • Round down  As long as she expands the board enough. since she’ll have the majority because then. she can remove the directors without cause o Can’t dismiss without cause if board is staggered or cumulative voting § 141(d): can stagger the board in the initial bylaws or in the bylaws adopted by shareholders.Kamer. so if want to erect your defenses against corporate contests. with cumulative voting. and she’ll get 14. when the board isn’t staggered. do it in the charters o Charter requires board initiation to change. Fall 2006 Grade: A o Can she get rid of the cumulative voting by amending the charter? o § 242(b)(1) & (2) – charter amendments must be initiated by the board. and then shareholder vote o Amending bylaws is easier because shareholders can initiate on their own Nowadays you have to work really hard to convince shareholders to go to staggered boards  need shareholder support because has to be either in the bylaws or the charters Today a lot of pressure on companies to destagger their boards Staggered Boards The most powerful defense a board has against takeover is a classified board.

incumbents spent $106. Issue: Should both sides of a proxy contest be reimbursed? Holding (Froessel rule): Board is allowed to reimburse all reasonable costs incurred in a proxy contest supporting its own candidates (it’s about policies.000 and reimbursed themselves from company treasury. Corporations. Insurgent reimbursed incumbents $28. not persons!).000 for which they were not reimbursed b/c they were voted out. Insurgents reimbursed only if they are successful and have shareholder ratification. and then can place them for whatever director you’d like It’s basically proportional representation Used to be used for minority representation on the board of directors Now it is used to further entrench boards Formula for how many directors you can get: o (New directors +1)(vote – 1)/(vote cast) Shareholder access initiative: proposal to allow shareholders to nominate minority candidates in company’s proxy statements  under certain circumstances the shareholders will be able to demand that included in the company’s proxy statement a certain number of candidates representing the shareholders to run against the incumbent board members Idea of you have liability risk in a proxy statement Costly to prepare Costly to circulate Liability in it So overall pretty deterring Rosenfeld v. 183 Facts: During proxy context. Note: the Froessel rule serves as a screen to insurgents because they have no guarantee of being reimbursed unless they have a reasonable chance at prevailing. Fairchild Engine and Airplane (NY 1955) p.Kamer. Fall 2006 Grade: A o 2005 study: Companies without staggered boards valued higher than companies with staggered shares in market o CEO turnover and compensation less sensitive to company performance o Likelihood company will adopt proposals by shareholders is lower o Board less likely to be challenged in proxy fights o More insulated from market control Delaware limited to up to three classes for a board o NY limits you to four classes Cumulative Voting You get your number of votes times the number of directors being elected. Spent $28.000 and reimbursed themselves. Makes an area where it would be efficient to takeover but not worth the proxy cost risk Class Voting: - - - - . Shareholders ratified insurgents’ reimbursement.

but there can be more protections in the charter or by other contract Shareholder Information Rights § 220 DGCL Access under DGCL § 219 or 220? o Under § 219  Can see list. if the amendment would o Increase or decrease aggregate number of authorized shares of such class o Increase or decrease par value of the shares of such class or o Alter or change powers. so can get access to records  as long as have proper purpose courts will compel inspection of stock list State corporate law in the US leaves function of informing shareholders largely to the market. federal securities law and SEC rules mandate extensive disclosure for publicly traded securities Common law (codified in Delaware statute) grants shareholders two rights: request “stock list” and inspect “books and records” if you have an appropriate purpose Stock list: discloses identity. Note that the statute provides the minimum protections for senior class. their brokers are. ownership interest. By contrast. without contact information. NY: Delaware law requires a class vote if the rights of the securities are changed 242(b)(2). individuals typically are not registered. but it does not make reference to the effect or issuance of a new class of stock. preferences or special rights of the shares of such class to affect them adversely Voting regimes present risk that majority blocks will advance own interests – minority needs protection Under NY Law: Section 804(3): if a new class of shares is issued that is superior to the rights of the existing stock. and this list may also be disclosed) o easy to get access to o allows insurgents to initiate proxy fights Inspection of books and records: o Far more expensive than stock list and can jeopardize proprietary or sensitive information o Much harder to get access to  companies will typically litigate to protect - - - . (Remember. there is a class vote to decide whether to create this stock. DE v. Corporations. whether or not entitled to vote thereon by the certification of incorporation. for 10 days before meeting (so too late) o Under § 220: Have proper purpose. but individuals are NOBOs (nonbeneficial stock owners). Fall 2006 Grade: A a majority (or such higher proportion as may be fixed) of the votes in every class that is entitled to a separate class vote must approve the transaction for it to be authorized DGCL §242(b)(2) – holders of outstanding shares of a class shall be entitled to vote as a class upon a proposed amendment. and address of each registered stock owner.Kamer.

essentially won’t have the stock tomorrow but has the voting rights in the meantime - - - - . Carney (Del. p. also held warrants With a little money could convert warrants and avoid tax liability. shareholder opposed it b/c of expensive tax liability. NY law: statutory right to inspect key financial statements. placing bets on how the company will do Can buy a pull option. Tally Industries DE § 220 (state supp p. what matters is that has shown proper purpose and so is entitled to production of stockholder list Vote Buying Schreiber v. so company made a loan to company so it could do so Independent committee negotiated terms and submitted for approval to shareholders. 1982. for the rest courts reserve common law power to compel inspection in proper cases General Time Corp v. required majority of shareholder votes other than the 30% owner Court: no harm no foul. would have lost money when company value depreciated o So just buy votes so can destroy company  don’t lose from stock cash flow rights. 203) Shareholder held 35% of voting rights. balance sheet. Ch. and retained pull option. only illegal if trying to defraud or disenfranchise other shareholders Ichan blurb (p. 201) Burden on corporation to show stockholder requesting list for improper purpose General Time: noticed in Tally’s president’s deposition statements which caused ∆ to believe π attempting to obtain list to acquire General Time stock for illegal purposes Tally has primary purpose that is legitimate (solicitation of proxies to run opposition candidates for director) Court: any secondary purpose is irrelevant. 207) Today have very sophisticated corporate technology – there are much more elegant ways of vote buying today which don’t directly fit into Schreiber case Ex: buy derivite securities o Right to buy the stock at a certain price – call option o Right to sell the stock at a certain price – pull option Hedge funds: new breed of aggressive investors. Fall 2006 Grade: A o Burden is on the shareholder to establish a proper purpose to inspect books and records. company needed those votes for merger.Kamer. and income statements. and then you buy voting rights and gain from its losing value o If had bought stock. and make a killing off the put option Ichen: so sold call option. which will make you rich if the company loses value. Corporations.

Kamer. of company that owns 51% of another company. Fall 2006 Grade: A So combination of pull options and call options will essentially separate the cash flow rights from the voting rights Borrowing stock Vibrant market in borrowing stock Borrow stock. and it loans it out to make money) So hedge funds borrow stock for that one critical day to get voting rights (b/c board has to announce in advance what day will determine voting rights  record date) So borrow stock for one day. why would you lend your stock to someone who is planning to destroy the company. Corporations. but also market might fix itself Stock Pyramids If want to have disproportionate voting power. very quickly becomes less profitable Only way to get exemption from tax is to get 80% in the company. and if they can do it by rental they should o Kamar: probably won’t last for long.5% of cost of lower company to control it Doesn’t happen much in this country because of tax consequences When company pays shareholder dividends. but then might as well get 100% and make it a private company Tax law adopted this way precisely to discourage this form of ownership structure - - . that owns 51% of another company. have to pay taxes on it. Effectively gives control of the all the companies in the chain So only costs you approximately 12. rent it for a couple days  buy the stock with right to sell back at certain date Institutional investors tend to rent the stock (just like when you put your money in the bank. buy 51% of stock. either regulators will get involved or institutions will wise up o Going to see increasingly more and more shareholder involvement in the voting mechanism o But if voting mechanism is rotten because the people who are voting aren’t really the people you think are voting. etc. vote it. then return it to the lender But don’t care what happens to this company after the vote. then really just polishing a rotten apple o Might be regulation. or who doesn’t have the companies best interest in mind o So don’t you think institutional investors would raise the rent? Turns out they don’t o Argue that have fiduciary duty to make money for the holders. there are taxes on it So each time the money moves up a level in the pyramid. so the sale will go through and you make a ton of money off of that But if you’re an institutional investor. could be for a number of reasons that want to vote even if don’t have stock in that company o Ex: want to vote so company buys another company you have a stock in.

but struck down because SEC doesn’t have the right to deal with corporate governance. Fall 2006 Grade: A The farther you get away from the original company. and institutional investors figured it out and refused to vote in favor of this recapitalization (takes a charter amendment so shareholders had to sign off) Rule: Still ok to go public for the first time with dual class capitalization. but no one cared at that point because hostile takeovers had subsided and had alternative anti-takeover remedies. then hold the super-voting stock. ten votes per share and other class get one vote per share) Founders. and Dual Class Equity (p. Triantis. act more like an owner and interests more aligned with company  Value of company increases when ownership of management when management owns more than 25% o Dual class  Companies with a greater wedge have less value  So greater separation of voting rights from cash flow rights decrease companies value because don’t have that alignment check Bebchuk. the stock with the super voting power is not traded o On average higher voting stock holders have 40% of the cash flow rights and 60% of the voting rights Ex: NY Times o Publishing industry lends itself well to control o Psychic control o Still controlled by founding family Companies with founders name in company name are more likely to have dual class capitalization How does this affect shareholder value? o With single stock  More entrenched. that is for the states SEC strong-armed exchanges to adopt this rule on their own. Stock Pyramids. Kraakman. so less market influence on controlling party  But also. and then sell the other class to others SEC tried passing rule that said can’t recapitalize single class company into a dual class company. etc. and can spin off companies with dual class stock 85% of dual class firms. Cross-Ownership. because listing exchanges have their own listing rules So all the listing exchanges adopted the rule that had been struck down. when have so much stock.Kamer. Corporations. 209) -Dual class share structures: single firm issuing two or more classes of stock with differential voting rights - - - . the less cash flow you get but still retain conrol Dual class capitalization Have at least two classes of common stock. and give one class more voting rights than the other (example.

213) Voting rarely any function except in extremis No vote expects vote to decide the contest  no/diminshed incentive to study firm’s affairs and vote intelligently Today voters not fungible  those with more shares do not face collective action problem to same extent o Investment companies. Corporations. pension trusts. helping to overcome class agency problem publicly held corporations Incentives to monitor: o Incentivized to maximize returns to fund investors b/c of fee structure - - - - . Voting in Corporate Law (p. keep in mind that they have their own agency costs o Institutional investors are just people working for the big company. Fall 2006 Grade: A o Planner can attach all voting rights to fraction of shares assigned to controller and no voting rights to remaining shares offered to public o Most common form in US Pyramid structure o Most common world-wide o Minority shareholder holds a controlling stake in an holding company.Kamer. and they're not getting paid to incentivize them to do best things for the firms Kahan & Rock. mutual funds: legal limits on ability to hold large percentage stakes Uncertain law  legal risk. Hedge Funds in Corporate Governance and Corporate Control (p. 216) Hedge funds emerging as shareholder activists. institutions would do more monitoring Pozen. Next Steps in Proxy Reform Legal rules limit oversight of corporations and the size of financial institutions in US Banks. some insiders Collective action problem may be overcome by aggregating shares Black. discouraging oversight by institutional fiduciaries Institutions own half the equity in American public companies If law changed. Institutional Investors: The Reluctant Activists (p. 216) Robert Pozen o Before you celebrate institutional investors as cure for collective action problem. insurers. which owns a controlling stake in an operating company Cross-ownership structure o Horizontal cross holding of shares that reinforce and entrench power of central controllers o Make control over company less transparent Latter two are unpopular in US because of tax penalties for pyramid structures and stringent regulatory and reporting requirements Easterbrook & Fischel.

to solicit any proxy to vote any security under § 12. Regulation 14A contains the implementing rules. Corporations. as we saw yesterday. • Regulation 14A: substantive regulation of the process of soliciting proxies and communication among shareholders • Schedule 14A: What you need to disclose in a full-dress registration statement • 1992 Amendments: Changed rule that shareholders couldn’t speak to one another about the company through proxies w/o approval from the SEC of their proxy statement  Four Major Elements of Proxy Rules • Disclosure requirements and a mandatory vetting regime • Substantive regulation of the process of soliciting proxies • A “town meeting provision” 14(a)(8) that permits shareholders to gain access to corporate proxy materials at a low-cost. value to themselves may not be the same as value for everybody else  They may destroy company to increase value for themselves o The Federal Proxy Rules: the rules of voting in a public company  Proxy solicitation: Any solicitation reasonably expected to result in the procurement of a proxy §14(a)(1)(L)(iii)  Background: • Rules are promulgated after the Great Depression • Securities Act of 1933 (“33 Act”) deals with disclosure procedures that companies must follow when selling securities on public markets.Kamer. in contravention of any rule the commission may adopt. Fall 2006 Grade: A o Often manager invested significant portion of own personal wealth in fund o Benefit directly from achieving high absolute returns Hedge funds may be the solution! o They're like institutional investors (they have a lot of money) and their compensation (much higher fees) gives them incentive to try to generate more value  Problem is. All public companies are subject to proxy regulation under Section 14(a) of the Act. Covers initial offering of securities when you first go public • Securities Act of 1934 (“34 Act”) establishes (among other things) disclosure requirements for corporations after they have gone public. (Cheaper for investors to get things on the company proxy) • General anti-fraud rule 14(a)(9) allowing courts to imply a private SH remedy for false or misleading proxy materials  Section 14(a) of 1934 Securities & Exchange Act makes it illegal. - .

o Had the unintended consequence of actively discouraging proxy fights. in some circumstances. those opposing mergers.Kamer. Fall 2006 Grade: A The basic scheme of the Regulation is to state with great detail the types of information that any person must provide when seeking a proxy to vote a covered security. from requirement to file a disclosure form before they could communicate with other shareholders about a corporation Rules 14a-1 through 14a-7: Disclosure and Shareholder Communication • Rule 14a-1: defines proxy as any solicitation or consent whatsoever. and beneficial owners cannot be exempt. o 1992 Amendments released institutional shareholders. etc. o The breadth of these terms protected management from shareholder attack because of the expenses of o 1992 Amendment provided exemption of solicitations that  do not seek to act as a proxy  are disinterested in the subject matter of the vote and  own less than $5 million in stock or  are managers paying for the solicitation at their own expense • Rule 14a-2: Most proxy solicitations are subject to regulations. o Solicited by less than 10 shareholders o Shareholders who wish to communicate but don’t seek to act as proxies • Rule 14a-3: Information to be Furnished to Security Holders o Central regulatory requirement of the proxy rules o No one may be solicited for a proxy unless they are or have been furnished with a proxy statement o When the solicitation is made on behalf of the company itself and relates to an annual meeting for the election of directors. Corporations. it must include considerable info about the company •  .. Exceptions for: o Solicitations by registrants. • These rules apply not only to an issuing corporation but also to a third party who might seek to oust incumbent management by proxy fight.

Corporations. • Rule 14a-6 and 14a-12: formal filing requirements o File 5 copies must be sent 10 calendar days before the statements are mailed to shareholders o Still have to file (though not full proxy statement) if acted under 14(a)(2)(b) and own 1% of stock or $5 million • Rule 14a-7: List-or-mail rule o Management must either provide a dissident shareholder with a list of shareholders or mail the dissident’s proxy statement for her. Fall 2006 Grade: A o Solicitors who are not part of management must disclose their identity. and the financing of their proxy campaign.000 or 1% of the corporation’s stock for 1 year • Must file with management 120 days before management plans to release its proxy statement • Proposal limited to 500 words • Proposal must not run afoul of subject matter restriction • Management can ask to exclude shareholder information in the corporation’s proxy materials if that information o Would impede state law o Is a proposal related to ordinary business (BJR) o Relates to a matter <5% of business o Relates to the election of directors o Conflicts with company’s proposal o Burden is on the company to demonstrate grounds for exclusion  . o Shareholders vote individually on each proposal. their holdings. o Short slate rule: The 1992 amendment required that the form of the proxy provide for a separate vote on each matter presented. o 1992 rule made it so that 14a-3 could be delivered through alternative media..Kamer. dissident can also solicit votes for some but not all of management’s candidates for the board. Rule 14a-8: Shareholder Proposals (Town Meeting rule) • Shareholders can include some of their proposals in the corporation’s proxy materials • Shareholders must hold $2. • Rules 14a-4 and Rule 14a-5: The Form of the proxy o Procedural rules as to what must be contained in the proxy. proxy must instruct SHs that they can withhold support for a director by crossing through the name. Thus.g. E. reducing transaction costs.

though it is an element of fraud in common law o Remedies: Injunctive relief. (1976) and Blue Chip Stamps). However. • Preference for precatory resolutions: shareholders sidestep questions on the scope of shareholder authority under state law Rule 14a-9: The Anti-Fraud Rule • Broad-range rules that let shareholders bring suits in federal courts attacking disclosures made to them by managers • Proscribes false or misleading statements that are MATERIAL (likely to influence how reasonable shareholder votes). so there is no private right to action Concurrence/Dissent: There is no authority to limit § 14(a) to protecting only those minority shareholders whose numerical strength could permit them to vote down a proposal. No predictions.229 Facts: “Freeze-out” merger of Bank into VBI – public shareholders get $42 per share cash on the recommendation of an outside banker. jury awards $18 additional per share. can demonstrate compensable damages required for a private action under § 14(a) if the proxy solicitation was an essential link in the accomplishment of the transaction. In this case. 227 • Elements of Private Right of Action for Fraud under §14a-9 o False or misleading statement that’s material (it influenced the Reasonable SH to vote) o Level of culpability (negligence or scienter) o Causation – Fraud must be an essential link to the challenged transaction (no reliance necessary) o Reliance NOT necessary in 14a-9 actions. Failure to follow proxy form • SCOTUS recognizes a private right of action under §14a9 (JI Case v.Kamer. and 4th Circuit affirms. Statements are actionable under Rule 14a-9 if (i) there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote and (ii) the statements are with respect to material facts (based TSC Industries. Nothing that impugns the character of associates without factual foundation. such as poison pills or structural reforms of the board. no state-law claim was lost. In this case. or general social responsibility. minority shareholders. Fall 2006 Grade: A Mostly relate to corporate governance. Corporations. the conclusion that no state-law remedy was . such environmental or personnel practices. whose vote was not required for approval of a transaction. Inc. rescission or monetary damages (Mills) •  - - - Virginia Bankshares v. Shareholders bring suit alleging a violation of 14a-9. Borak) p. Issue: Are false statements on a proxy solicitation actionable? Holding: Judgment for Defendant. Bank urges the vote for the plan and states that the $42 is a “high” and “fair” price. Sandberg (1990) p.

224) Is this a major proposal? o Rather than responding to shareholders. Π has lost her state-law remedy. there should be no change in level of support that these kinds of proposals get o Counter-argument = if you make it easier to have shareholder proposals. Otherwise.Kamer. so drop in support • --> finds that what caused the drop in approval rate of proposals was increase in public interest proposals Majority voting vs. looking at shareholder proposals before and after rules reform Hypothesis o That more insider ownership would mean less likely to get shareholder proposals His study confirmed this o Post-reform. Fall 2006 Grade: A deprived rests on the assumption that Virginia uses the same standard of “materiality” as federal proxy rules. plurality voting (p. Study by Steve Choi from NYU in 2000. there will be less support  Study showed drop in support  Choi explained this by saying maybe there was change types of proposals being offered • Types of shareholder proposals: (1) governance and (2) public interest • Governance proposals are often settled outside voting setting • Public interest proposals are not usually settled and go to votes. company sends "no action letter" to SEC asking to have proposal excluded  Argued that proposal was not going to make a substantial difference b/c company had already adopted it in substantially the same way: o Proposal wants to have bylaw rule that you can only win board election w/majority votes Company has policy that's slightly different o SEC says company has to include proposal cause it's different than company policy  So company includes proposal in statement and also explains why management doesn't like it  Proposed 14(a)(11): Shareholder Proxy Access Rule • Long-term shareholders will have the power to place their own nominees on a public company’s proxy materials under limited circumstances: - - . Corporations.

• Partial rationale for the Malone exemption is that the shareholders held their shares (rather than selling) and were therefore not covered by Rule 10b-5 (anti-fraud) o Proxy Rules decision tree  Is it a proxy that is governed by the rules? §14(a)(1) & (2)?  Is it a regulated solicitation that requires filing of proxy statement? §14(a)(2)? . the courts became more involved in regulating proxy solicitations. or  Successful resolution brought by 1% of SHs requesting nomination rights during prior meeting Requires a 2 year process (1st year to get the trigger.  Delaware Approach: Duty of Candor: Delaware law has focused on governance rather than market disclosure and has been careful to avoid potential conflicts with federal proxy law by limiting state regulation to situations where shareholders are being asked to take some action. • As the substantive protections in state corporate law decreased and the importance of fiduciary duties increased. • However.Kamer. This principle has been extended to directors and to proxy solicitations. (Del. 2nd year for the vote to occur). Corporations. Vickers Energy Corp. 1998) the court reversed course and applied a duty of candor to all communications by directors to shareholders. in Malone v. either indirectly or directly. or 3 directors to run against specified management directors on the company’s proxy upon the occurrence of either:  35% of shareholders withheld vote on board nominee during prior annual meeting. would potentially shift a lot of power to institutional shareholders. 2. Brincourt (Del.  Fiduciary Duty: In 1976 the Delaware Supreme Court held that a controlling shareholder making a cash tender offer for stock held by minority shareholders has a fiduciary duty to make full disclosure of all germane facts (Lynch v. 1977)). • o State Disclosure Law: Fiduciary Duty of Candor:  History: • State law usually did not regulate proxy solicitation outside of common law fraud claims. Fall 2006 Grade: A o A 5% group of people who have held shares for two years can nominate a short slate of 1.

Trifoods International.Kamer. Shareholders shouldn’t want directors to be risk averse.3rd Party Coverage Expenses Condition Good Mandatory? No - - (a) . there can be no liability for corporate loss. Fall 2006 Grade: A    Do they still have to file under 14(a)(6)(g) b/c they own 1% or $5 million? If they must file. did they enclose critical information with the proxy materials? Were they justified in waiting until they send out the cards to give it to SEC and shareholder under §14(a)(12)? - FIDICIARY DUTIES Three ways to protect shareholders Voting Lawsuit after you get swindled Selling your stock Entire Fairness Test (DE Law) What will happen to you if it had been shown that you breached duty of loyalty or duty of care? o You have to actually show that the transaction was entirely fair to shareholders So breach of fiduciary duty doesn’t mean you lose. “The [business judgment] ‘rule’ in effect provides that where a director is independent and disinterested. Corporations. 241 Facts: Shareholders sue directors of TriFoods for mismanagement Issue: What must a shareholder plead to state a claim of mismanagement? Holding: Officers are not liable for decisions made in good faith. unless the facts are such that no person could possibly authorize such a transaction if he or she were attempting in good faith to meet their duty. Inc. (Del. Ch. 1996) p.” DGCL §145 . just that you have to prove it’s fair (which means you’re probably on your way to losing) Burden varies for plaintiff or defendants having to produce fairness Limitations on fiduciary duty liability Three sources o Business judgment rule  If you don’t have any reason to believe board messed up.Plaintiff . court will defer to board’s business judgment because courts don’t want to make business judgment second guessing Insurance and indemnification Exculpation Gagliardi v.

Holding: Waltuch prevails because he “succeeded” on the merits by not having been found personally liable. Corporations. Cir. but this is not done in practice. Fall 2006 Grade: A liability settlemen t Expenses faith Good faith and not adjudged to be liable Successful Repay if not entitled Not in contravent ion of other parts of §145 No - (b ) - Corporation - - (c) (e) (f) - Any Any Any - Expenses Expense advance ment Any - - Yes No No - - Waltuch v.Kamer. he got the benefit of having his charges dropped because Conti settled the case. Conticommodity Services. 243 Facts: Waltuch seeks indemnification for his legal expenses under DGCL 145(c) because he is dismissed from the lawsuit. both officers and shareholder benefit from firm-sponsored D&O insurance. Inc. (2d. Company had provision in laws (article nine) that doesn’t seem to require good faith for indemnification Holding o Court says (f) cannot be applied to counteract (a) o So article nine isn’t legal under DGCL o But gets indemnified under another provision (c) Directors and Officers Insurance (D&O) DGCL § 145 (g): A corporation may purchase liability insurance on behalf of a director. Conti says that Waltuch was not successful.57: A corporation may purchase and maintain insurance for directors or officers of the corporation. and this is another means to hide the total amount of management compensation - . 1996) p. officer. Could a board raise the salaries for directors and officers and allow them to bear their own risk? Perhaps. employee or agent of the corporation RMBCA § 8. likely because it is cheaper for a firm to negotiate the rate of D&O insurance rather than an individual.

but does not give them an agenda in advance. Fall 2006 Grade: A American Express Case American Express buys stock in DLJ and then stock price drops and they have to get rid of it. they could either o Sell the stock and get a nice big capital gains loss o Give the stock as a dividend to all their stockholders.Kamer. (Stock is selling for $35/share). compensation related to earnings per share. had a conflict of interest But approval of other 16 of 20 directors cleanses it because its approval by a neutral decision-maker Holding: Decision to pay a dividend is protected under the business judgment rule. BJR does not protect grossly negligent actions. by doing it through dividends they didn’t have to show this loss for accounting purposes o So they give it as a dividend (makes them look better to Wall Street) Court says they don’t agree with business rationale but its not up to them Plaintiff says but personal gain of 4 directors on board. its for not getting the capital gains write-off by doing it through dividends and costing money Reason company did it was because it would have changed their income statement. Holding: (3-2) The managers were “grossly negligent” in failing to carefully consider the offer. Corporations. Van Gorkom Facts: Trans Union Corp. is a publicly held company with unused net operating losses and a CEO who is looking to retire. but then they don’t get to deduct capital gains on it (costs them about 8 million dollars in capital gains tax they probably have to pay because they can’t offset the tax) Lawsuit isn’t for acquiring the stock. Pritzker wants a decision in 48 hours. - - - - . and the case is remanded for damages. which is what they do. A class of shareholders sue and claim a breach of the duty of care because the board did not act in an informed manner. Business Judgment Rule Wanting decision to be based on law rather than fact so judges and not the Jury would decide it Desire for a good process DGCL §145(g) Insurance You can pretty much buy insurance for anyone you want We don’t have the same circumscribing of buying insurance for directors But if you think about it the insurance company is going to apply some constraints Smith v. Board approves the merger after a 2 hour meeting. Mere errors of judgments are not sufficient grounds to interfere in the decisions of management. so CEO calls a special meeting of the board. CEO arranges a sale to Pritzker at $55/share.

or knowing violation of the law • Unlawful payment of a dividend or stock purchase (under § 174) • Transactions where the officer received an improper personal benefit • 102(b)(7) eliminates damages. 1995) p. 262 (The Technicolor Dialogue) Facts: Technicolor CEO negotiates to sell the company to Perelman for $23/share. Inc. Issue: What happens when BJR doesn’t apply because there is gross negligence? Holding: The sale was entirely fair. Van Gorkom: Rise in D&O premia Delaware legislature enacts Section 102(b)(7) which validates charter amendments that provide that a corporate director has no liability for losses caused by transactions in which the director had no conflicting financial interest or otherwise was alleged to violate a duty of loyalty.Kamer. involving intentional misconduct. Chancery Court (Allen): “Absent proof of self-interest that casts upon the director the burden to prove the entire fairness of an interested transaction. (CEDE III) (Del. Disinterest board is very casual (as in Van Gorkom). Inc v. but not with insurance o In fact if a company has insurance. 155 Stat. Lawsuit still painful to directors have to go be deposed and testify miss work time on front page of wall street journal This is all avoided if you have exculpatory provision. DGCL: o Higher burden of proof – clear and convincing evidence o Higher scienter requirement – deliberate intent to cause injury to the corporation Cinerama.60/share. but doesn’t eliminate plaintiff’s other remedies (injunctive relief). DGCL § 102(b)(7) (p. Fall 2006 Grade: A Aftermarth of Smith v. a - - - - .): Contracting around the duty of care o (b): The certificate of incorporation may also contain…  (7): a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. and the company is not shopped to other potential buyers. less economic incentives for company to fight as hard Ohio General Corporation Law vs. Corporations. provided that such provision shall not eliminate or limit the liability of a director for • Any breach of the director’s duty of loyalty • Acts or omissions not in good faith. Technicolor. It gets no credible valuation. In appraisal proceedings. Disinterested shareholders still bring suit. and approves the transaction. This is 100% premium over pre-bid share price. Supp. Technicolor is valued at $21.

” Kraakman’s note: Note that the courts have circumvented Section 102(b)(7) by not dismissing “duty of care” cases at the outset for failures to state a claim. but a minority shareholder alleges that the deal is unfair. and requires the directors to prove that the transaction was entirely fair.Kamer.” Del. CEO/controlling shareholder of May. Emerald Partners v. Hall goes bankrupt.” Del. May’s independent directors approve. As a realist point. Corporations. o BUT: gross negligence doesn’t necessarily mean that the substance was unfair – you can have gross negligence and the transaction can still be entirely fair (Cede III). Berlin (Del.” Chancery Court (Allen): “I find myself unable to conclude that [this was not] a completely fair transaction. injury or damages becomes a proper focus only after a transaction is determined not to be entirely fair. Chancery Court dismisses the complaint without an “entire fairness” analysis because only duty of care claims remain. Fall 2006 Grade: A shareholder-plaintiff must prove by a preponderance of the evidence that director negligence did cause some injury and must introduce sufficient evidence from which a responsible estimation of resulting damage can be made. Orman v. . 264 Facts: Hall. o Gross negligence with respect to process is sufficient to put burden on directors to show entire fairness (Cede II). 2002) Can only dismiss under 102(b)(7) if you have a very clear case of duty of care (and not duty of loyalty) (But Kamar doesn’t know how actually useful this is for you today in reality) Disney Complete disregard of duties is bad faith. without any requirement of proof of injury. Technicolor Takeaways: o Duty of care does not require P to show injury (Cede II). Supreme Court (Holland): Affirmed. proposes a roll up to acquire 13 companies. . so remand and court of chancery has to hear the case Chancery court said not enough evidence to show bad faith Left us with a standard of good faith as well as duty of care and duty of loyalty - - - - - - . and shareholders try to continue suit against directors. is sufficient to rebut the business judgment rule. Holding: Supreme Court reverses: “where entire fairness is the applicable standard of judicial review. . 2001) p. Cullman (Chancery. which may waived under Section 102(b)(7). Section 102(b)(7) becomes a proper focus of judicial scrutiny after the directors’ potential personal liability has been established. A breach of either the duty of loyalty or the duty of care rebuts the presumption that directors have acted in the best interests of the shareholders. Supreme Court (Horsey): “[B]reach of the duty of care. these suits will likely settle.

Derivative Litigation (Del. a large provider of specialized patient care. Shareholders bring a derivative suit against directors to recover fines on behalf of the corporation. 271 Facts: Allis-Chalmers is a large. In 1937. In addition. there is lower level violation of the anti-referral payments law.Kamer. Corporations. 276 Facts: Caremark. Court: not the same rule as Allis-Chambers. Allis-Chalmers Manufacturing Co. PWC gave Caremark a clean bill of health. directors have no duty to always be suspicious of their management. Allen takes this opinion to announce a change in Delaware law to increase the duty of management after AllisChalmers. Caremark has an ethics guidebook. However. In the late 50s. and a toll-free confidential ethics hotline. Plaintiffs allege that the directors breached their duty of care in failing to install internal controls to prevent violations Derivative suit: Suits shareholders bring on behalf of the company against the directors to recuperate losses sustained by the company. an internal audit plan. 1996) p. Directors did not have duty to investigate managerial abuse before their regular monitoring suggested anything was even wrong Directors are entitled to rely on honesty and integrity of subordinate directors until something occurs to put them on suspicion that something is wrong Absent such cause. Note: BJR only applies to acts. Fall 2006 Grade: A Graham v. However. (Del. always have these monitoring obligations Nowadays can lose a lot of money by not having a monitoring system in place Here company had everything in place you could imagine to prevent this. 1963) p. no duty to install and operate corporate system of espionage to ferret out wrongdoing Board has the duty to monitor when there is a red flag Martha Stewart Case Weren’t supposed to actually sneak after her to see what she was doing Might have made company personally liable to Stewart Marchese Case Guy was outside director and went ahead and blew whistle to SEC that there was accounting fraud He was found liable for signing fraudulent statements before he left firm Bottom line  outside director must make sure that financial statement is at least accurate In re Caremark International Inc. four mid-level managers plead guilty. not omissions. don’t need the red flag. it enters into a consent decree with the FTC to stop price fixing. Holding: No liability. is subject to the Anti-Referral Payments Law: it must not pay MDs to refer patients funded by Medicare or Medicaid. decentralized company that made electrical equipment. so no - - . Directors are allowed to delegate management. The parties seek to settle. and they only have a duty to install internal controls. Holding: The settlement is fair. Ch.

Shareholders are within the class that the law is designed to protect. Court held he could only seek to maximize shareholder benefit). Holding: Intentional violation of the law cannot be protected under the BJR even if claimed to be in best interests of corporation. disregard. have to show that action was in bad faith – says that in Disney that this meant careless. Ritter Court says Caremark is the law in DE But to find breach of monitoring obligations. Shareholders sue. DUTY OF LOYALTY Dodge v. saying that this is a violation of the federal election laws and corporate waste. Cir. Lower court dismisses the case as protected under BJR for failure to state a claim. If you’re generous. can be illegal under federal law Have to have all these control systems in place o Have to verify they are effective o Have to get an outside auditor to sign off on them Miller v. Sarbanes-Oxley Kamar doesn’t like how the casebook deals with this o It’s only making sure that the financial statements are accurate. be generous at your own expense Can’t not pay dividends and use price to lower costs even if it’s a good thing for business Note: this is an old case. 282 Facts: AT&T refuses to collect money from the DNC.Kamer. - - - . Ford Motor Co. recklessness – in any case serious dereliction of duty Puzzling part: Court says it knows that there has been some discussion on whether duty to act in good faith is third fiduciary duty o Court says this is not an independent duty. and it is one the few that advocates shareholder primacy as a rule of law probably because Ford expressly stated that he was acting in the interest of non-shareholders. Corporations. not dealing with other stuff Whether or not you violated your duty of care. 1974) p. (Henry Ford explained that he eliminated dividends in order to give price reductions to the public. Any breach for duty of bad faith is really a duty of loyalty claim  But notes there can be breach of duty of loyalty even in good faith but Caremark really about duty of care Possible huge expansion of duty of loyalty! o Which wouldn’t be covered by indemnities etc. Fall 2006 Grade: A liability Always put a system in place Stone v. AT&T (3d.

p. Barlow (N.” Donations.Kamer. 126) Conflict of interest transaction (related-party transaction) Controlling shareholder decided to cash out minority shareholders (went private)  this can be done by against wishes of minority shareholders by merging two companies together both controlled by same shareholder  subject to judicial review Board signed off on this.P. Shareholder Litigation (2004. Corporations. have a long term corporate benefits.. Holding: Court holds that charitable notion acceptable as being in pursuit of the corporation’s long-term interests. Allis-Chalmers case Company involved in anti-trust violations n 1930s and 50s Lawsuit against several. 288 Facts: Shareholders sue a corporation for making a charitable donation to Princeton University. even though he didn’t actively do anything wrong This is the law today  you can draw distinction between directors and hold some liable and others not Breach of loyalty  examine each director’s interest individually Casebook divides into three categories Self-dealing/conflict of interest generally Executive Compensation Corporate Opportunity - - - - . Smith v. particularly to prestigious universities. shareholder lawsuit against directors Obviously controlling shareholder knew that price not right (because he set it) but what about the rest of the board One of the directors had a substantial amount of market and financial experience  he should have known the price wasn’t right.J. Contribution is permissible. but not all members of board o How did they choose them?  They were the ones who knew about this history of the 30s Two reasons to hold disinterested directors liable for breach of care o Knowledge and expertise Update: In Re Emerging Communications Inc. so he was held responsible even though the rest of the board without that kind of experience weren’t held responsible DE Supreme Court justice sitting as trial judge. Fall 2006 Grade: A Some states have constituency statutes DE does not A. 1953) p. comports with NJ statute which explicitly allows up to 1% of capital and surplus to be used for charity as directors “deem expedient. so instead of appeal case settled So here special knowledge was enough to hold director liable.

61(b)(3) – states that conflicted transactions are ok if they are “established to have been fair to the corporation.” But this likely would lead to the same outcome as Hayes Oyster – disclosure is necessary for fairness. and the deal was substantively fair. next part of the inquiry is: what standard of review will the court apply? DGCL §144(a) (common/self-interested director count towards quorum) - - - - - - . Even if there is disclosure. DGCL §144 – a conflicted transaction requires disclosure of all facts material to the transaction or that the transaction be fair. in which he is a 25% equity-holder. RMBCA § 8. and the law will not permit the agent to put himself in a situation where he may be tempted by his private interest. and 23% shareholder of Coast Oyster. 1964) p. but does this mean you have to state the best price you’ll accept? Some Del. CEO. Verne doesn’t disclose. some independent body signed off The law has moved from never allowing self-dealing transactions to now sometimes offering them: Sometimes it’s a benefit to the company for there to be a self-dealing transaction Small. Fall 2006 Grade: A Three important concepts: Identify duty of loyalty situation Find element of disclosure If you want to show that.e. Holding: Nondisclosure itself is per se unfair. unless there’s a very good reason for not disclosing. Keypoint (Wash. gets 50% of Keypoint’s equity). Verne’s argument: Entire fairness should be applied. Corporations. but a Delaware court would still likely come down with Hayes Oyster in requiring disclosure as an element of fairness. Actual injury is not the principle upon which the duty of loyalty law proceeds in condemning this contract. and Coast sues for the “secret profits” (i. How much needs to be disclosed? Delaware says all “material” facts. 294 Facts: Hayes is director. Verne enters into an agreement with a Coast employee to form Keypoint to buy the beds (Verne’s family corporation.Kamer. closely held companies o CEO knowing more about his own company  Has confidence in his ability o Less analysts tracking the company Service industry. but before shareholders approve.. based on disclosure. v. often harder to value because of their business o Expect greater divergence between outsiders values and insiders values Hayes Oyster Co. Fidelity in the agent is what is aimed at. Hayes Oyster’s 50% interest in Keypoint). After this. He convinces the board to sell two oyster beds. courts have suggested that it doesn’t go that far.

difficult to persuade court of fair dealing when there is failure to disclose an interest in the transaction More you replicate a true arms-length process. Code § 310.61(b)(3): fairness requires disclosure  if director doesn’t comply can get equitable relief.Kamer. Nakash (535 A. Corporations. going to be easier to be able to play some cards close to your chest  if you don’t. not about disclosing before the transaction Safe Harbor Statutes: conflicted transactions can be approved or ratified by disinterested parties. UOP (p. you must disclose it. if have interest that exceeds 10% in entity that deals with the company. Fall 2006 Grade: A (1) Disclosed or known. and if do get caught. p. - - - . court is going to expect you to be very honest about everything Marciano v. 498): (federal law) o 8(a): even if have only indirect interest. if less than 10% maybe important. if don’t have punitive damages insider has no incentive to disclose (otherwise either don’t get caught and so keep money. maybe not o in excess of $60. NYBCL § 713. so didn’t matter because wouldn’t have helped the transaction o But very special case  by and large need disclosure MBCA § 8. 499) Test of entire fairness: two prongs o Fair dealing o Fair price Not a bifurcated test.000 o over 5% of voting securities o maybe of immediate family o For Publicly traded companies o Make disclosure in SK. damages and/or sanctions Deterrence point: difficult to learn about self-dealing transaction. Examples: DGCL § 144. DE 1987) o Two factions in closely-held company  disclosure would not have helped to get any approval from the other side o Technical oversight to fail to disclose interest. Corp. Cal. financial report due at end of fiscal year. Most jurisdictions have adopted such statutes in order to make sure conflicted transactions aren’t always voidable by the corporation. just give it back) Item 404 (supp. or shareholders How would the statute be interpreted in DE? § 144(a)(3): so it is ok if entirely fair  but don’t want to get to this test Answer in Weinburger v. good faith authorization by a majority of disinterested directors (2) Disclosed or known to shareholders and they specifically approve in good faith (3) It’s fair at the time it’s authorized by board. 2d 400. a committee. must be examined as a whole Bottom line: fair dealing is important.

or it is fair. the success of the company leads the court to believe that the deals were fair. 322 - - - - . RMBCA § 8. In this case. 1995) p. and even with the fairness review this transaction was fair Dissent: Fairness cannot be established without inquiry into the fair market price. 316 If the interested transaction is between a corporation and a director. always requires entire fairness (pro-plaintiff). or if it is fair.Kamer. but doesn’t have to. and a “majority of the minority” approves. Fall 2006 Grade: A o Possible interpretations:  A transaction isn’t voidable solely because it is interested. • However. or must there also be a showing of fairness? Holding: Directors who engage in self-dealing also have to establish fairness. Herrig enters into self-dealing contracts with Cookies. all of which are successful for the corporation. Issue: Is it enough to satisfy one of the three prongs of the safe harbor statutes. by disinterested parties). and he becomes the controlling shareholder and a director. if have disinterested decision making body without majority shareholder.61 – stronger safe harbor statute (pro-majority): takes review down to the business judgment rule.  Broader plausible reading: A transaction is never voidable if it is fully disclosed and approved. virtually in business judgment territory which means plaintiff loses Lewis v.e. Shareholder Approval: In re Wheelabrator (Del Ch. the same standard will apply Most DE cases point in same direction. the company doesn’t pay dividends. If the interested transaction is with a controlling shareholder. 303 Facts: Herrig is distributor of Cookies’ BBQ sauce. Other interpretation of what constitutes “full disclosure”: Delaware – Chancery Court retains power to look at fairness. BJR applies. Vogelstein (Del. however. Two circumstances: o Controlling shareholder o Don’t have controlling shareholder. 1997) p. Lakes Warehouse (Iowa 1988) p. and shareholders approve. Corporations. as long as it is adequately disclosed and approved (i. The transactions were approved by disinterested shareholders. but still have self-dealing transactions (ex: director) In both cases have disinterested entity approve it Whenever you have a conflict of interest decision. ALI § 5. Ch.02 – other extreme. Courts have resisted this broader reading Cookies Food Products v. fairness review remains but the burden shifts to the plaintiff.

Standards in case law: o In same line of business o Company has interest or expense in it o How you came to know of it  Did you use company assets to discover it o Is taking the opportunity going to put you in conflict with the company Holding: Applied to the facts: No corporate opportunity here – it was the line of business. so it misuses a corporate opportunity to help eBay higher ups by giving them allocations of IPO stock (very lucrative. Broz. Note: If this had been a corporate opportunity. Fall 2006 Grade: A Facts: Shareholders approved a compensation plan drawn up by a self-interested board comprising a large one-time option grant. Cellular Information Systems (Del. bids on a license for his other company RFBC. In re eBay Shareholders Litigation (Del. 332 Facts: CIS is in financial difficulty. including an outside director o Difficult because you want outside directors with experience in the industry 122-17 DGCL o company can opt out of corporate opportunity doctrine Broz v. Ch. a CIS director. 74 Supp Facts: Goldman wants eBay’s business. and eBay would have enjoyed this opportunity if it had not gone to the top management. and Broz took care not to usurp corporate opportunities. Corporations. Broz doesn’t present the opportunity to the board. Holding: Even though the waste standard applies. but is told by two officers that CIS isn’t interested. Holding: Court finds this a clear corporate opportunity: investing in these sorts of securities is within eBay’s line of business. 2004) p. PriCellular sues Broz for taking a corporate opportunity. PriCellular buys CIS. Opinion: Chancellor Allen reviews the existing Delaware standard.Kamer. notes that courts are not good at evaluating compensation decisions. It is not enough to informally go to directors. but no financial ability to take it. the stock “pops” after going public and makes a lot of money). and concludes that it is the normal standard for waste. and had no expectancy or interest (at the time it was divesting itself of similar holdings). PriCellular is negotiating to buy CIS. Corporate Opportunity Doctrine not supposed to compete with a company if you’re a fiduciary. wasn’t inimical to corp’s interests. 1996) p. CIS is in bad financial shape. Broz buys the license. Allen forces a trial since this option grant is sufficiently unusual. - - - - - . Broz should’ve presented to the board. eBay had the financial wherewithal to pursue the investment. and that institutional shareholders will likely do a better job at monitoring.

o usually brought as class actions (See F. but best to do with shareholder approval because otherwise might bring lawsuit claiming breach of loyalty by opting out. charging them with improperly failing to sue on the existing corporate claim • The underlying claim of the corporation itself (that the corporate directors have failed to bring)  Directors owe their loyalty to the corporation itself. Agent is responsible for profits earned in connection with performing her duties for the principal. Fall 2006 Grade: A Alternative holding – also a violation of fiduciary duty under agency principles. shouldn’t have been kept by directors  should have been given to all shareholders Kamar: this is a stretch to use the corporate opportunity doctrine Telxon v. Corporations. which is why alleged breaches of obligations by directors and officers most often arise in the context of derivative suits. . COMPARING/CONTRASTING DIRECT AND DERIVATIVE CLAIMS: The derivative suit advances a corporate claim whereas the direct suit alleges harm to the shareholders. it’s not enough How do you reconcile with Broz? o No conflict.Kamer.Shareholder Lawsuit Background: Derivative and Direct Claims Derivative suits o An assertion of a corporate claim against an officer or director (or third party). If the officers breach their duty to the corporation. which charges them with a wrong to the corporation  Said to represent 2 suits in one • Against the directors. because in Broz not a corporate opportunity If corporate opportunity must get permission DGCL § 217: company can opt out of this corporate opportunity doctrine by putting it in charter or board action. P. 23 ) under federal securities laws o To recover damages suffered by individuals directly (or to prevent injury to these individuals) because they are shareholders  Plaintiffs may bring suits for both types of harm. damages should go back to the corporation. DE SC 2002) If you have corporate opportunity and get permission from the CEO. Direct actions. Civ. R. Essentially taking bribe from investment company Getting this freebie was corporate opportunity of ebay. Meyerson (802 A. - - . 2d 257.

won’t have any shareholders because all the shareholders are gone  have to turn to class action o Demand requirement FRCP 23.contemporaneous ownership – must own stock at time damage was cause and lawsuit brought In what case will you find no shareholder to bring a lawsuit? o Acquisition – shareholders cashed out and want to sue board for breach of duty. Donaldson (Del. which blurs the line between the two suits  However. Corporations. p. 372) Breach of fiduciary duty by delaying date of closing for merger Shareholders brought suit for time value of the lost time Court: o Who suffered the alleged harm? o Who’s going to receive the benefit of cover? No claim because shareholders had no individual right to have to merger at all  cannot be direct/class action suit No damage to company either – how can the company suffer loss from changing hands tomorrow instead of today? Had there been a breach of fiduciary duty it would have been a direct claim - - - - . Civ. 23. Fall 2006 Grade: A o Sometimes (but rarely) courts approve direct payment to minority shareholders in derivative litigation.Kamer.1: first must go to the board and tell board to bring a lawsuit before you can bring your own  Can get around it by showing board’s bias and that demand was futile  Don’t have to do this for class action because suing on behalf of yourself and not the company • Class action just need to have owned when the harm was done o § 145: Indemnification changes depending on whether or not suit brought on behalf of the company Tooley v. 2004. this offends the formal character of corporate law and may be unfair to corporate creditors  Derivative suits have procedural hurdles designed to protect the board of directors’ role as the primary guardian of corporate interests. See F.1 (derivative actions). P. Both suits provide for: o Settlement and release only after notice o Opportunity to be heard o Judicial determination of fairness of the settlement o Successful plaintiffs are customarily compensated o Can get nonmonetary relief in both types of suits o Attorney’s fees  In practice.R. treated similarly o Standing issues Derivative .

g. and mostly derivative suits when other stuff Solving a Collective Action Problem: Attorneys’ Fees and the Incentive to Sue Plaintiffs’ attorneys have an interest in bringing either type of suit o Plaintiffs’ attorneys get fees if they are part of litigation that creates a common fund to benefit all shareholders  Many shareholder suits against the directors and officers of public companies are initiated by the plaintiffs’ bar • In form. diluted both voting and economic power of minority shareholders. so really didn’t want this to be a derivative suit  wanted it to be direct suit With overpayment claims. if there is a controlling shareholder. these attorneys are the economic agents of their shareholder clients • In substance. it will be a direct harm to the minority shareholders By giving him so much more stock. to sweeten the conversion rate (he get more common stock for his debt) Company sold to third party (another company) which filed for bankruptcy Once sold. and can’t sue new bankrupt owner. Corporations.Kamer. and minority shareholders. depositions. risk of personal liability) but they do not bear the cost of settling • Awarding attorneys a % of the recovery may encourage premature settlement - - . 2006) Controlling shareholder also CEO. which was a direct claim People mostly bring class action when its acquisition related. shareholders had been cashed out. after the fact. Fall 2006 Grade: A Gentile v. even though normally appears as harm to company only. Rossette (Del. company issued him convertible debt (could convert to common stock) Got board. they are legal entrepreneurs motivated by the prospect of attorneys’ fees When a derivative suit succeeds on the merits or settles (usual outcome) o The corporation is said to benefit from any monetary recovery or governance change o The corporation and its insurer also generally bear the bulk of litigation costs on both sides  The company is likely to have advanced the cost of defense to its managers and it must usually pay the Π a sum for “costs” The role of lawyer as bounty hunter creates its own agency problem o Perverse incentives:  Plaintiffs’ lawyers can initiate “strike suits” – suits without merit – simply to extract a settlement by exploiting the nuisance value of litigation and the personal fears of liability • Corporate defendants may be too eager to settle because they bear at least some of the costs of litigation personally (e.

A. Corporations. but haven’t seen state cases auctioned yet Federal Private Securities Litigation Reform Act of 1995 o Designed to discourage non-meritorious suits o Number of class actions has not decreased Fletcher v. instead of law firm getting everything. 1968) p. Fall 2006 Grade: A o Lodestar formula: alternative fee rule  Pays attorneys a base hourly fee for the reasonable time expended on a case. but plaintiffs’ attorneys applied for fees anyway.J. (Cal App.Kamer. Industries bring a derivative suit against the company and its directors alleging domination by Ver Halen and excessive salary to Malone that resulted in damage to the corporation. inflated by a multiplier to compensate for unusual difficulty or risk  But this rule creates the opposite incentive to spend too much time litigating Some courts have experimented with auctioning the rights to represent the corporation (or class) to the law firm that makes the best bid “security for expenses” statutes: permit corporate defendants to require plaintiffs (or their attorneys) to post a bond to secure coverage of the company’s anticipated expenses in the litigation o See e. Settlement specified that plaintiffs’ attorneys could only be awarded fees if the corporation revived a monetary award in the arbitration proceedings. NYBCL § 627. Corp.000) because “substantial benefits had been conferred” upon the corporation by the settlement - - - . Code § 800  Started in the 1940s o Seems to have failed in practice: Π s are rarely forced to post bonds and are almost never charged with the litigation costs of corporate defendants o What about auctioning the right to be the lead attorney?  5 law firms want to be the lead attorneys – want not sell the lawsuit to the firms?  Maybe sometimes better to get structural changes to company than cash. Inc.352 Facts: Shareholders of A.g. and these firms won’t care about that (when derivative lawsuit)  Might affect the way court treats the case when plaintiff and sole benefactor is lawyer instead of shareholders  What law firm has enough money to put up all this money off front?  Or. The trial court granted plaintiff’s attorneys’ fees and costs (totaling $67. J. Industries. Cal. can bid competitively  which firm will do it for the smallest percentage • No control for quality • No single best solution o Federal securities cases auctioned.

- - - - . “Substantial benefits” accrue if the court finds that the results of the action: o “maintain the health of the corporation and raise the standards of ‘fiduciary relationships and of other economic behavior. Compensation should not be limited only to cases that produce monetary recovery – non-pecuniary benefits are very real. ex ante the settlement is not necessarily a benefit if settlements incentivize plaintiffs’ attorneys to bring suits. Issue: What is the substantial benefit? Holding: Appellate court affirms lower court finding of substantial benefit. o Double agency problem: π attorney thinks about himself (better to settle than lose).Kamer. However. cost born by insurance company Problem: encourages frivolous lawsuits b/c know will settle. not final judgment. and (c) referred all monetary claims to arbitration.” Dissent: This is a slippery slope! Note: Ex post the settlement is a real economic benefit because the litigation has already been commenced. (b) removed Malone as director and corporate treasurer. saw increase in the number of cases where public pension funds took the lead role in lawsuits. ∆ also have agency costs because if settle they aren’t going to have to change much. Corporations.’” or o “prevent an abuse which would be prejudicial to the rights and interests of the corporation or affect the enjoyment or protection of an essential right to the stockholder’s interest. Derivative suits are an effective means of policing management. but don’t want to scare away meritorious suits Choi. meritorious suits settle too soon How do you calculate the fees? o Court estimates the benefit and does some calculation when there are structural changes o Done in the shadow of going through lawsuit and winning some cash o At trial gets percentage What are the right incentives? Is there anything percentage of the recovery leaves out? o Any cost to the company not captured in the recovery?  Reputational damage  Managerial time  Insurance premiums will go up  All these costs are ignored by lawyer focused on the recovery o What are some benefits not taken into account when only looking at cash recovery? o One option is to delay recovery until suit passes benchmark of motion to dismiss. Fall 2006 Grade: A Settlement: Plaintiffs negotiate to (a) reduced Ver Halen’s influence over the board. Fisch & Pritchard After law (Private Securities Litigation Reform Act 1) was enacted. and it is not significant that the benefits accrued from settlement.

arguing that demand would have been futile. notes. Fall 2006 Grade: A but private investment companies didn’t Attorney’s fees smaller when public pension funds take over the case But can’t conclude from this that law works Standing Matters when shareholders first learn about the claim So if harm occurred in 1988. made by the plaintiff to obtain the action he desires from the directors or comparable authority .” Fed. P. and 4) can “fairly and adequately” represent the interests of shareholders.41: Plaintiff must have been a shareholder at the time of the alleged wrongful act or omission and must be able to “fairly and adequately” represent the interests of shareholders. A three-person committee and the full (22-person) board approve the deal. meaning in practice that there are no obvious conflicts of interest o ALI § 7.Kamer. 23. 1991) p. claiming breach of fiduciary duty. Civ.1  Plaintiff must be a shareholder for the duration of the lawsuit.02: Plaintiff must 1) have held the security before or because of the allegedly wrongful conduct. Smith (Del. 364 Facts: In 1984. The Demand Requirement: A derivative complaint must “allege with particularity the efforts. • Demand requirement (see below) • Demand excused cases (see below) o RMBCA § 7. Shareholders bring a derivative action. Perot starts criticizing GM publicly. 23. 3) comply with the demand requirement or be excused. This rule has bite chiefly in the context of corporate mergers and dissolutions. R.1 (Delaware has the identical rule) Baseline rule is that the plaintiff must make a demand – this balances the board’s business judgment with the plaintiff’s interest in review. Levine v. Code Com. Corporations. need contemporaneous ownership in 1996 Standing Requirements o Standing requirements for a derivative suit are established both by statute and court rule (10 Del. or the grounds for not making the effort. and an agreement not to wage a proxy contest or to publicly criticize GM’s management. Civ. . GM buys EDS from Ross Perot in a stock transaction that makes Perot GM’s largest shareholder (with 0. . but find out about it in 1996. Lower court: The Chancery Court rejects the demand futility claim because (a) plaintiffs did not plead particularized facts sufficient to create a reasonable doubt - - - . 2) continue to hold the equity during the course of the lawsuits. and GM pays Perot $742 million in exchange for: his GM stock. R. § 327 and F.8% of GM’s stock) and puts Perot on GM’s board. if any. P.

1993) p. not conjunctive. The court says that the independent directors are under the thumb of the Rales brothers. Holding: Affirmed. so there is no review for valid BJ. Court on certification from the District Court. and (b) did not rebut the presumption that the decision was an exercise of valid business judgment. The suit alleges a breach of the duty of loyalty – the investment is the quid pro quo for Drexel’s past favors for the Rales brothers personally. but they instead invest the proceeds in Drexel junk bonds a t a time when Drexel (owned by Milkin) is on its last legs and the DOJ is hot on Michael Milkin’s trail. - - - - . Corporations. The decisions made by the Rales brothers on the old board infect the new board because the Rales brothers are still board members. officially to finance investments. After the deal but before the shareholder suit. a company that is controlled and managed by the Rales brothers. as the original test implied. Fall 2006 Grade: A as to the independence of the GM board. but is instead a shareholder of Danaher. along with six others. Kraakman: Though the court says it only applies the first prong. but it does not extend to future board members who should have greater objectivity. so there is a transitive business judgment duty. 368 Facts: Shareholder/plaintiff Blasband owns stock in Easco. it looks like they are also applying the second prong. When suit is brought.) Holding: Demand is excused: This suit does not require application of the second prong of the Aronson test (valid BJ). Blasband (Del. Are they objective? Are the conflicted – this can be measure directly or indirectly o Can’t expect people who think they will be held liable to bring a lawsuit against themselves or their peers To get around demand requirement must either show: o Too interested o Particularized facts creating a reasonable doubt as to the soundness of the challenged transaction Rales v. The current Board was not involved in the challenged transaction. but they just sit on the board. Court applies the Aronson Demand Futility Test: in Levine: A demand is futile if a reasonable doubt is created that Test: must show that directors either not independent/objective/neutral or decision not covered by business judgment rule to avoid demand requirement Note: the test that the courts apply is disjunctive. so plaintiffs cannot attack the competency of the new board that didn’t make the contested decision. the Rales brothers merge Easco into a subsidiary of Danaher. which they also control. the shareholder/plaintiff is no longer a shareholder of Easco.Kamer. Issue: Is Demand excused under the substantive law of Delaware? (This case was in Del. Inference: second prong of test protects acting board members. in helping them finance their earlier takeovers with junk bonds. This case satisfies the first prong because there is reasonable doubt that the independent directors act independently. Rales brothers do a public debt offering of $100 million in notes. The Rales brothers own 44% of Danaher.

etc)  why do it twice?  Weeding out process  dress rehearsal for actual trial  Like having trial but without depositions. Shareholder of a new company (Danaher) brings suit against another company (Easco) to bring a suit against the Rales brothers. so no one brings demands anymore o Courts are now the ones evaluating these suits o But doesn’t the Court already have to find these facts later (that not covered by business judgment rule. witnesses and testimonies  All the court has before it is the complaint  assume all facts in plaintiff’s favor and decide whether or not have a case  Defendant’s usually wait until after this motion to dismiss decided Don’t always have to rush to the courts. 375 - - - - . business judgment rule applies Zapata Corp v. but making a demand doesn’t prevent you from then bringing a lawsuit Special Litigation Committees (Derivative Lawsuits) Can you get the lawsuit dismissed after survived demand requirement – Maybe Board appoints committee of directors who are “above reproach” o Usually add new board members to be in committee o Choose new outside law firm o Investigate the company and suit. Demand requirement treated as substantive and not merely procedural Two points You must pay attention to the language of the cases. Maldonado (Del. determine whether or not should continue the suit Background: two schools of thought re: deference to a SC: o Zapata Corp v. you will have a difficult time bringing suit. because by bringing demand you are saying you don’t think the board is conflicted. Code Section 220 as an information-gathering tool to gain information to strengthen the pleadings. under ALI principals of corporate governance opposite rule (look at MBCA b/c followed in many states) o Always have to go make a demand. and the practice of the cases o If make demand of the board and board rejects it. Corporations. Note 2: footnote 10 of the opinion says that the plaintiffs could use Del. 1981) p.Kamer. Fall 2006 Grade: A Note: This case is a double derivative suit.) gives the court the authority to review the independence of the SC o New York courts say that mere existence of an SC entitles corporation to BJ deference without judicial second-guessing  NY: business judgment rule  once establish that committee is independent and acting in good faith. Maldonado (Del.

there may be an over-deterring effect because of the costs incurred to get to the second stage of review (SLC review) Plaintiff has original burden of proof (under demand requirement) to show board is biased  now moved into second phase. the SLC then decides to dismiss. even if the corporation does not want to. when appropriate. and the court may agree. give special consideration to matters of law and public policy in addition to the corporation’s best interest. The SLC investigates the action – and. The burden is on the moving party to demonstrate that the action is more likely than not to be against the interests of the corporation. The Court has greater competence/independence is making this sort of review. 381 (Applying Zapata) Winter: Winter goes through a cost/benefit analysis and exercises his business judgment. and four years into the litigation. Fall 2006 Grade: A Facts: Plaintiff files a derivative suit in Delaware.  How compelling is the corporate interest?  Matters of law and public policy Note: the court applies its own business judgment at the SC stage. The court is not in a good position to make this judgment. individual right to continue a derivative suit for breaches of fiduciary duty. recommends that the court dismiss the suit. the Zapata board appoints two new independent directors who serve as a Special Litigation Committee (SLC).Kamer. but it doesn’t apply the same standard at the demand stage. Inefficiency: A court may allow a non-beneficial suit to go forward at the demand stage. and the burden is on the board/special committee to show reliable Many states have adopted this two prong test (or similar) Joy v. like virtually all SLCs. Holding: judicial scrutiny of special litigation committee recommendations should be limited to a comparison of the direct costs imposed upon the corporation by the litigation with the potential benefits Dissent: The majority has gone beyond Zapata by saying that the court must apply its own business judgment rule.” - - - - - . Corporations. COMPETING APPROACHES TO THE COURT’S EXERCISE OF BUSINESS JUDGMENT Zapata (Delaware approach): “The Court of Chancery should. but shareholders do not need to comply with the SLC’s recommendation. However. Chancery court rules that shareholders have an independent. Two step test: to apply when SLC recommends dismissal o Court should inquire into the independence and good faith of the committee o Court should apply its own business judgment to establish if the committee made a good faith decision. Winter also notes that the court’s function here is not unlike a lawyer’s determination of what a case is worth for purposes of settlement. North (2d Cir. 1982) p. demand is excused. Holding: Defendants have a right to form SLC committees.

direct family interest In re Oracle Corp. for any substantial reason.” Difference between Joy and Zapata. Derivative Litigation (Del. Beatrice - - - . balance of the factors indicates not a corporate opportunity. o Was Stewart placed in a position inimical to the interests of MSO? No. p. TLC Beatrice International Holdings. 412) Power to appoint SLC based on § 141(a)  means all committee members must be directors Carlton Investments v. (Del. o No expectancy or interest. Holding: Court comes to the intuitively right conclusion that it is not a corporate opportunity – couldn’t be that every time a director sold stock in the company she was appropriating a corporate opportunity. North: “The court’s function is thus not unlike a lawyer’s determining what a case is ‘worth’ for purposes of settlement. o Not within the line of business. Inc. not stock. Fall 2006 Grade: A Joy v. Corporations. Π – demand excused b/c Martha Stewart had 94% of votes (de facto controlling shareholder) Directors in company. 1997) p. when it comes to application. All together. they are not independent b/c either get their salary from Martha Stewart Living or good buddies of hers Court: personal friendship is not enough to taint director to render director too interested o Court very formalistic: no financial interest. 2003.Kamer. 386 Facts: Reginald Lewis (HLS ‘68) does an LBO of Beatrice Foods with the help of some banks. Company sells homemaking advice. 402) Independence test: whether director is. no evidence of bad faith. Ch. 78 Supp. though no personal interest in her insider trading. Lewis ends up with 45% of Beatrice and banks get 20%. 2003) p. No showing that MSO was in need of additional capital. and it had available a ready liquid market. incapable of making decision with only the best interests of the corporation in mind Two committee members tenured professors at Stanford (no fund-raising duties) Defendants had substantial ties to Stanford through activities and donations SLC bears burden of proving independence  failed here b/c not just matter of economic independence (must also consider human nature) Notes (p. Martha Stewart (Del. probably not that big Beam v. Facts: Martha Stewart found an opportunity to sell lar ge blocks of stock in MSO to a ready buyer. More difficult was fitting the obvious answer into the 4-part test: o Financial ability to exploit was present. Ch.

Settlement is better than court’s BJ - . proposed settlement falls within range of reasonable solutions to problem presented Holding: In applying Zapata. The company appoints an SLC.5 million in compensation payment just before he dies. court accepts the parties’ settlement as one reasonable compromise to the suit. and 10% shareholders) must file public reports of any transactions in the corporation’s securities within two days of the trade (under Sarbanes Oxley Section 403). Fall 2006 Grade: A pays Lewis $19. meant to deter  Profit disgorgement: insiders must disgorge corp of any profits made on shore-term turnovers in the issuer’s shares (purchases and sales w/in 6 month periods) § 16(a)(2)(C): Reporting - - . filing must happen within 2 days of trade. It’s rarely granted extensions. alleging self-dealing and waste. corporation can sue you to recover this benefit. Corporations.SECURITIES TRADING Hard to find fiduciary duty not to insider trade under state law o Except in CA Mostly done federally Exchange Act §16(b) and Rule 16 Section 16(a): Statutory insiders (directors. § 16(b): cannot benefit from short-swing transactions  purchase and sell within 6 months while insider. unless SEC grants extension. Note: Court doesn’t want to apply its own BJR. “Officer” status is defined as access to non-pubic information in the course of employment. insiders could report: • Up to ten days after end of a month in which they traded. Plaintiff objects to the settlement and brings suit in the Delaware Chancery Court. and six months in the future from reportable event. This is left to shareholder groups.Kamer. officers.  Strict liability rule. Independent and good faith by SLC committee. • Up to 45 days after the end of the fiscal year o §403 of Sarbanes-Oxley: now. o Until recently. and sold. One of the big bank shareholders brings derivative suit. Match any transaction that produces a profit o Only case where shareholder can bring derivative suit under federal law o SEC does not have the power to enforce Section 16(b). shareholder can sue you derivatively on behalf of corporation o look six months into past. which eventually negotiates a settlement for Lewis’s estate to pay Beatrice $14.9 million plus interest in installment payments over seven years. Match them together to determine the profit realized. Count number of shares purchased. and it allows the parties to contract around court-imposed BJ.

filed 45 days after calendar year) o Does it matter?  Not about short-swing transactions  Before you could choose a date for your options when stock price was low So if today stock price is 30. Corporations. and whenever you change your beneficial ownership of the corporation (Form 4. of 365 days somehow picked the day the stock price the lowest  SEC started investigating Harron and Lie. because then the option has to be expensed right away Rule 16 2002 Sorbannes Oxley Act – amended period for filing form 4 (disclosing change in official ownership) to w/in 2 days of transaction (formerly 10 days after month ended) o SEC rule implementing act Another change: form 4 must now include option grants o Options used to not be considered change in beneficial ownership – would only report them in form 5 (catchall annual disclosure. must be filed within 2 days of transaction) o Form 5  annual report for everything not reported in form 4 during the year (filed 45 days before end of calendar year) o Changed by Sorbannes-Oxley Act Transactions occurring within 6 months after cease to be an officer or director. went and checked all the company stock prices with option grant.Kamer. 83 JFE 271 (2007) o Since new section went into place. significant drop in option back-dating (or at least drop in suspicious option dates) - - - - . subject to § 16 You have plaintiff have prerogative to match anyway you want. Fall 2006 Grade: A o Must report when become statutory insider (Form 3). date options back to day 6 months ago so doesn’t have to go on balance sheet Wall Street Journal article one year ago. as long as have enough shares within period to match Option Backdating A lot of the directors get paid in options  stock based compensation o For tax purposes cheaper for the company o Don’t have to expense the option for financial statement purposes until they are exercise (makes earnings per share look higher) Value of option depends on the difference between the exercise price and the current stock price Executives want exercise price to be as low as possible Strong disincentive for companies to issue options to executives below the current stock price. and 6 months ago it was 20.

seemed like small step at the time. then backdate option Jesse Fried proposal o Executives can trades stocks till their hearts are content - - - - . or artifice to defraud. or • To engage in any part. Corporations. or course of business which operates or would operate as fraud or deceit upon any person in connection with any purchase or sale of any security. Elements of a 10b-5 Claim o General Fraud Elements  False or misleading statement • Of material fact that is o Made with intent to deceive another  Upon which that person • Reasonably relies. o Section 10b: “It shall be unlawful to use or employ. let stock price go up. any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may proscribe as necessary or appropriate in the public interest or for the protection of investors. • To make any untrue statement of material fact or omit to state a material fact necessary in order to make the statements made. practice. not misleading. in the light of the circumstances in which they were made. Fall 2006 Grade: A o Not everyone complies and some companies still wait before reporting option grant  SEC hasn’t been enforcing strictly EXCHANGE ACT §10(B) AND RULE 10B-5 1934 Act §10: granted broad power for SEC to promulgate rules regulating securities on national exchanges. Additionally: o Elements specific to 10b-5  Person relying must be a buyer/seller of stock  Harm must be to trader  Misleading statement must be made in connection with purchase/sale. in connection with the purchase or sale of any security registered. Kardon v.  10b-5: It shall be unlawful: • To employ any device. • Rule gives rise to implied private right of action.Kamer. National Gypsum. Written on a napkin by Milton Freeman. Evolution of Private Right of Action Under §10 o Rule 10b-5: most important rule in §10. Eric Lie on options pricing o Wait after good news is released. scheme.

including TGS employees and directors. 1968) Chiarella (1980) Dirks (1983) Chestman (1991) O’Hagan (1997) SEC v. This test identifies who is an insider. No one has the right to trade on information that is not available to all traders.” Three theories about why insider trading is illegal: .) must abstain from trading in or recommending the securities concerned while information remains undisclosed .Fiduciary Duty Theory: In order to establish that an insider violates 10b-5 by breaching a duty to disclose or abstain to an uninformed trader you have to show that there was a pre-existing legal duty.Equal Access Theory: All traders owe a duty to the market to disclose or refrain from trading on non-public corporate information . . TGS president Stephens instructs them not to tell anyone. In addition. etc. Corporations. SEC brings a 10(b) action against everybody. TGS issues a misleading press statement. all of them who at least know something about the new discovery.Facts: In Oct. 1963. TGS issues stock options (“calls”) to its top executives. information trickles through the company and everyone starts trading. 1968) p. 592 . Texas Gulf Sulphur (2nd Cir. and second.Holding: The court establishes a broad theory of liability/equal access. In April. the inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing. Texas Gulf Sulphur geologists make a valuable discovery of copper/zinc deposit. This means that the court must establish an affirmative legal duty whose breach would constitute fraud.Misappropriation theory: Insider information is the property of the corporation. Cir. . Fall 2006 Grade: A  BUT gives investors a few days heads up that they are trading Cady Roberts: Disclose or Abstain Rule: “Analytically the obligation rests on two principal elements: first the existence of a relationship giving access to information intended to be available only for a corporate purpose and note for the personal benefit of anyone.Dicta: there is a broad duty of fairness . More like corporate opportunity doctrine. or if cannot (corporate confidentiality. Series of cases developing this doctrine: TGS (2d. .Kamer.Anyone in possession of material information must either disclose it to the investing public. and so it doesn’t matter who is defrauded but that information that belongs to the company is appropriated for personal use. but the doctrinal problem is that this test doesn’t identify the nature of the fraud required for the 10(b)(5).

SEC: (1983) p. He receives this information from Secrist. Dirks. Though company heads deny that there is any wrongdoing. openly discusses this information with his clients and investors. the jury instructions assert the equal opportunity rule. but he might have violated the misappropriation duty. There was no special relationship between he and the company. Fall 2006 Grade: A Chiarella v. . Over 14 months he realizes a gain of $30. and censures him a 10b-5 violation. The court does not discuss whether violation of the misappropriation duty would be sufficient to violate 10b-5. so no 10b-5 violation.SEC had another theory  not an insider. no duty is breached  this will be a caseby-case inquiry • reaffirms Chiarella – “no duty to disclose where person who traded on inside information was not the corporation’s agent. SEC brings suit against Dirks.Issue: Did the insider’s tip constitute a breach of the insider’s fiduciary duty? .Facts: Chiarella is a printer who is able to figure out the identity of a target corporation from the code names in merger documents. there was no RETAC presented at trial. some company insiders tell him that there was fraud.Kamer.Court: he lacked duty to shareholders of the companies he’s trading in (got information from bidder companies). not the acquiring corporation duty rule. that Equity has overstated its assets. SEC begins investigating his activities and Chiarella eventually enters into a consent decree to disgorge his profits. and so he owed no duty to the sellers.Holding: Chiarella is of the hook. a former officer of Equity Funding. • Absent personal gain. who did not own stock in the fund nor did his firm. rejects equal access theory . not the sellers.000. Chiarella buys the target’s stock before the deal is announced and sells immediately afterwards. Jury finds Chiarella guilty. However. 612 . Dirks also urged the WSJ to publish an article on fraud allegations. . He has no contractual relationship to the shareholders of the target firm. was .Holding: Conviction is overturned o There was no relationship between Dirks and the firm (he was not its agent or fiduciary). Corporations.Facts: Dirks is an investment advisor who wants to investigate allegations that Equity Funding’s stock is overstated.Note: Chiarella gets off because the theory of harm to the target wasn’t presented to the jury. . but had a duty to the acquiring company but court rejects that because that company (shareholders) not harmed o Early strings of misappropriation theory Dirks v. • Tippers did not violate their duty – they wanted to expose fraud (whistleblowing) and did not personally benefit from the information • Don’t want an overarching rule banning analysts from ferreting out market inaccuracies. therefore. . Price of stock begins falling. 608 . Chiarella pieces his information together from information from the buyers. United States (1980) p.

Duty (RETAC) exists between family members. This test will allow insiders to use external agents to disseminate information to clients. etc.Kamer. Fall 2006 Grade: A not a fiduciary. Chestman . or was not a person in whom sellers of securities placed trust” • Secrist owed a duty of trust and confidence if he had traded. United States v. child. 619 .If disclosure unintentional: must make public disclosure promptly. 1983: bunch of neighbors at a BBQ told by drunk Michael Milken that advancing a tender for Revlon § 14e-3: equal access doctrine for tender offers Suppose merger and so § 14e-3 doesn’t apply Are these neighbors insiders? Temporary insiders? What about with RegFD? o Doesn’t cover Michael Milken because isn’t a company spokesperson (doesn’t work for Revlon) and neighbors not the specific people covered by FD (stock analysts. .) o If unintential/unplanned.) United States v. but he did not benefit from the transaction. Whenever there is asymmetry of information. 1991) p. sibling.If disclosure intentional: must make public disclosure simultaneously. • Tippee liability is like aider/abettor/accessory liability Dissent: Personal gain is not an element of the duty. history or practice of sharing confidences. Regulation FD (“Fair Disclosure”): new regime for selective disclosure of corp info (to brokers. analysts. Different Now Regulation Fair Disclosure o Changed policy o Now. must promptly release same information to entire market o This is a change  the behavior protected by the Court in Dirk’s is no longer legal - - Rule 14e-3: imposes a duty on any person who obtains inside information about a tender offer that originates with either the offeror or the target to disclose or abstain from trading. Chestman (2d cir. Includes: agreement to maintain confidence. Corporations. if disclosure is planned it must be made simultaneously to the entire market (press release.10b5-2: defines “Duties of Trust and Confidence” (like RETAC). Therefore. parent. realm of corp takeovers. . But only some of these harms can be legally pursued. any person who discloses information about the company. etc. the uninformed shareholder will be harmed.Reintroduces equal access theory in small. journalists). but important. receiving nonpublic info from spouse. Dirks is not liable. .

O’Hagan (1997) p. Chestman argues that he purchased this stock based on his own info.Breach of duty owed to source  law firm and client defrauded .3 million. Today. and his other clients. . who is the nephew-in-law of Waldbaum. this case would have been decided differently: SEC 10b5-2: Information obtained from a spouse gives rise to fiduciary duty of confidentiality. Loeb. The SEC brings suit and the lower court convicts.Fraud consummated at sale or purchase  so related to sale or purchase of securities . O’Hagan was an insider of Grand Met. However. Note: Keith has no direct contact with Waldbaum. through the numerous family connections. . and sells his stock at a profit of $4. 624 .Holding: Conviction reinstated – the misappropriation theory is a valid. Chestman is not the tippee of a misappropriator. Loeb receives information from his wife who gets it through her mother who hears it from her brother Ira. though tenuous. but the court doesn’t find that he has acquired the duty. but his purchase of Pillsbury was still a misappropriation of info obtained from his law firm. and 14e3 is within SEC’s rule promulgating power to regulate tender offers. 10b-5 is overturned. that Waldbaum stock is going up. There is no proof that Loeb owed a duty to his uncle-in-law.Facts: O’Hagan is a partner in the law firm of Dorsey & Whitney that is representing Grand Met in its tender offer for Pillsbury.Kamer. and then he buys 2500 call options in Pillsbury stock (or 250. Fall 2006 Grade: A Facts: Chestman is the broker for Keith Loeb. O’Hagan learns of this information from his work. the Eighth Circuit reversed the lower court’s conviction.Issue: Is the misappropriation theory valid under 10b-5? . Issue: Can Chestman be held liable if it is not proven that Loeb breached a duty not to misappropriate data? Holding: 14e3 conviction is maintained. O’Hagan controls more stock than anyone else in Pillsbury. Misappropriation fails because Loeb has no fiduciary duty to his wife or the Waldbaum family. Chestman purchases Waldbaum stock for himself. so the 14e3 conviction is reinstated. so there is no misappropriation. The SEC has the power to promulgate 14e3 to move beyond common law fraud. Loeb calls Chestman and asks him for his advice on what to do with the stock. SEC didn’t like the outcome o 10b5-2(b)(3): lists circumstances under which relationship of trust and confidence o Rebuttable presumption of relationship of trust and confidence between family members o So under this Loeb probably would have been found to have fiduciary duty and been in breach - - - United States v.000 shares). Corporations. .Note: O’Hagan was on the PLI circuit lecturing on insider trading when he committed this crime. who agrees to sell his company to Great Atlantic and Pacific Tea Company (A&P).

Sandberg (cannot mislead shareholders when soliciting proxies) o Rule 10b-5 – illegal to defraud investors Two applications: • Company must be honest when communicating with investors and the market (other than in the context of proxy solicitation) • Insider trading o Who cannot trade on inside information? o Fraudulently misleading omission (this is how the law tends to catch insiders trading on nonpublic information. Fall 2006 Grade: A Not every use of information is misappropriation. Empirical Studies after Reg FD Results have been helpful – there is now more information in market rather than less Anti-fraud rules (prohibition against misleading investors) arise in many different situations o Proxy solicitation § 14 SEA. .Facts: WSJ columnist regularly disclosed contents of the column to his friends before publication. Rule 14(a)(9) – Virginia Bankshares v. Columnists’ friends made a lot of money. Corporations. o Today. but upheld the mail and wirefraud charge. United States (early SC case) . lawyer would have to prove that the journal and readers had a proprietary interest in the column’s information. and the columnist violated his duty to the readers. This column was so influential that it always affected share prices. to convict under the misappropriation theory. should abstain from trading until information public) o Misappropriation theory Components of insider trading violations Fraudulently misleading information Materiality Scienter (mental state) Standing Reliance/causation Damages Applicable to both forms of 10b-5 violations .Court splits 4-4 on whether 10b-5 applies because it has not yet adopted the misappropriation theory.Kamer. must be some element of deception o Need relationship of trust and confidence with source of information Carpenter v.

finding that otherwise immaterial merger discussions becomes material when Basic denied their existence. The harm may actually be felt by the takeover artist who wants to protect his deal.Basic Inc v. Probability x magnitude test o Corporation could still remain silent (say “no comment”) o Note: other courts had decided otherwise that merger discussions were not material. 62 o Facts: Basic and Combustion are in merger talks for two years. This is possible. Nelson & Preacher. Do the Merits Matter More? Accounting variables and abnormal insider sales are predictors of these lawsuits . Plaintiffs sell stock based on the press releases. and shareholder may lose out on valuable deals. and then sue when the merger is announced. Materiality must be determined on a case-by-case basis. Lying about talks is a way to protect a deal. o Holding: Reasonable investor test: information regarding a merger discussion is significant to the reasonable trader’s decision to sell. Plaintiffs appeal the district court’s ruling of summary judgment saying that the press statements were a material breach. must allege specific facts Two studies o Johnson. Corporations. Fall 2006 Grade: A Materiality Not illegal to trade on inside information. and only a closing of a transaction will be sufficient to render merger discussions material. Levinson (1988) p.Kamer. just not bombshell information (material enough) Insiders systematically do better than the market when they trade (16b – 6 month limitation) Information that would be viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available Material: what would a reasonable shareholder consider . It is likely that the court wanted to protect the merger negotiations and allow denials of talks as proper business judgment. but the board should encourage competition. must having something like intent to defraud (negligence is not enough) Half the circuits infer scienter from behavior o If you have acted in way so reckless that can infer acted with scienter that is enough (especially at the pleading stage) 1995: Public Securities Litigation Reform Act o Must plead specific facts to give strong inference of scienter o Not enough to just assert acted with scienter. but Basic makes press statements denying this. can trade on soft information (not material enough). Sixth circuit reverses. o Endorses a net present value calculation Scienter Not enough to defraud investors.

just incidence of litigation Steve Choi Before PSLRA you could get real settlement value out of cases with no clear indicia of fraud Now. etc. Fall 2006 Grade: A Aggressive use of accounting on balance sheet  predictor of incidence of lawsuit and size of outcome Insider trades show no affect on outcome. o o Rule 10b5-1 Escape hatch for insiders who want to trade but don’t want to be charged with 10b-5 violations If have an automatic trading system. cannot be sued for insider trading Safe harbor A lot of executives use 10b5-1  have individuals who trade for them.Kamer. but also blocking meritorious claims which lack hard evidence. objective measure of the strength of the lawsuit. Corporations. don’t communicate with them directly about specific stocks Article: o Individuals who have this kind of trading programs make more money than those who don’t So those who use safe harbor and have broker do all their trades for them making more money than other insiders and the market o Nothing in the rules says anything about when you end your trading program o People who make abnormal returns mysteriously end trading program just before something big happens  SEC threatens that will lose safe harbor if do that. or hands off approach. how the size of the settlement indicia of how serious the case was Many serious cases that were possible beforehand are no longer possible Yes getting rid of some frivolous lawsuits. so mixed bag Kamar Problematic to measure value of case by size of settlement because product of the legal rules already in place Before PSLRA could get a serious settlement by scaring defendant’s and under new rules can’t get a settlement Seems that size of settlement not an independent. but people still do . it’s the strength of the lawsuit under the existing legal rules So not surprising that under new rules have lower settlements when don’t have hard evidence of aggressive accounting. etc.

just the law doesn’t protect you unless you were a trader Reliance/Causation In common law fraud must show reliance In 10b-5 have reverse presumption Basic: rebuttable presumption that everyone in class relied on the false statements o Fraud-on-the-market: Enough that those who heard misleading information traded on that information. then stock price dropped after disappointing earning results Then later FDA didn’t approve inhaler.What is the appropriate measure of damages? o Traditional out-of-pocket measure – difference between market price and sale price . Fall 2006 Grade: A o Walking fine line in trading on news that probably would be material under 10b-5 Standing . then the share drops to $46 at the announcement.Facts: Liggett & Myers tells certain analysts about a negative earnings announcement to be disclosed the next day. . 640 . Broudo (US 2005. then a few days later it recovers Clear lie about FDA approval (or statement at least reckless) Court: News wasn’t all about inhaler. Analysts’ clients sell shares at $55. because when they traded on it the market was affected. Cir.However. 699) Issued upbeat statements about asthma inhaler being approved by FDA. others who did not hear the information relied indirectly on it because of this change in the market price o Efficient capital market hypothesis: stock prices at any given point in time reflect publicly available information about the company. can bring a suit under 14e3 even if you don’t buy or sell because this is a broad rule for tender offers Blue Chips Π chose not to purchase stock because of material false statement In order to have standing must be a trader during the relevant period Not to say that couldn’t have lost money. but not private (insider) information (semi-strong version of hypothesis) Some argue that stock prices already reflect value of the insider information (harder case to make) Dura Pharmaceuticals v. Liggett & Myers (2d.must be a purchase or seller of securities .Kamer. stock price drops 5% on one day. market barely reacted Commentators: creates incentive to release good and bad news together because then creates a wash Elkind v. Corporations. 1980) p. p.

want to follow the one that does well Replacing bad management team o Through hostile deals o Friendly deals with a golden parachute - . o Note: it does not make sense to pursue tippee’s gains because these are generally minimal.Kamer. $50$48 * shares Disgorgement measure: recover post-purchase decline in market price. suits are generally brought for out-of-pocket damages. but limit it to the amount earned by the tippee. Holding: Third option provides optimal deterrence. Fall 2006 Grade: A Equation: Price paid minus true value when bought Here plaintiff can recover $48-$40 * shares o Causation-in-fact measure or loss from the erosion of the market price – recover the loss in value that was caused by tippee’s trading. – perhaps too late in the game/doesn’t consider changes in value before when he should have disclosed • Equation: Price decline by D’s wrongful trading. don’t need to get funds to invest. capped at gain by tippee = disgorgement measure capped at gain to the tippee. Corporations. o Equation: Post-purchase decline due to the disclosure. • - - Academic Debate Today there is a consensus that insider trading should be prohibited Most insider trading by executives is to sell before bad news o Cheaper. just sell before bad news materializes (perverse incentives) Allows executives to bribe block holders Better information to market Mergers & Acquisitions Good Motivation for Deals Economies of scale Economies of scope Vertical integration o Fitting your product to their line and then getting them involved in opportunistic behavior Tax (NoL distribution) o Kamar doesn’t think this actually works Agency Costs Diversification o Smoothing earnings by diversifying business projects o Kamar argument that shareholders would want you to just do one thing well  Managers would want to make their job more stable Undiversifying companies o If you invest in multiple start-up technologies.

Kamer.Mistake mergers .Managers who just want more power o Kamar thinks there are a lot of these deals.” .  The surviving corporation’s common stock will not be increased by more than 20%. their approval is required in all cases. Corporations.Squeeze-Out merger . Fall 2006 Grade: A Bad Motivation for Deals .1970s o Lots of diversifying mergers  Like GE .1990s o Lots of stock deals  Buying another public company with your stock  This worked because stock prices were very high • Internet boom  Lots of golden parachutes • (Traditionally three times annual salary plus bonus) o (If its more than that feds will charge excise tax • Accelerates stock options o Because mergers are usually at a premium these options are very valuable Mergers: legally collapse one corporation into another.e.  The security held by the surviving corporation’s shareholders will not be exchanged or modified. . especially the bad deals  “Empire Building” History of deals .1980s o Lots of deals undoing the diversification of the 1970s  Turns out these conglomerates weren’t doing that well o Deregulation offered a lot of opportunities o Development of leveraged buyouts o Acceptability of hostile takeovers .Rights of the parties and effect of the merger: o Target Voting Rights: The voting common stock of the target always has voting rights. and the remaining entity is the “surviving corporation.Market power o Reduce competition o Possibly monopolistic behavior . o Surviving Shareholder Voting Rights: The common stock of the surviving corporation is generally required to vote on mergers also. The exception is when the following three conditions are met:  The surviving corporation’s charter is not modified. i.

Kamer, Corporations, Fall 2006 Grade: A Statutory Merger: DGCL §251(f); RMBCA §12.03. (Long-form merger) o A(cquiror) & T(arget) boards negotiate the merger o Proxy materials are distributed to shareholders as needed o T shareholders always vote (§251(c)); A shareholder vote if outstanding stock of A increases by > 20% (§251(f)). o If majority of shares outstanding approves, T assets merge into A, T shareholders get back A stock. Certificate of merger is filed with the secretary of state.  Dissenters who had a right to vote have appraisal rights.  Preferred stock holders don’t get a special class vote Rules governing mergers: o DGCL §212(a): All classes of common stock vote, unless a stock is designated as nonvoting. o DGCL §203: The ban on merging with an interested shareholder for 3 years after the shareholder became interested unless conditions are met. Likely passed to ensure that the interested shareholder is not forcing the company into a bad merger.


Structuring the M&A Transaction - The weight of different variables will determine which merger form the companies follow. - Merger contract protections o “Lock-Up” Provisions: Designed to protect friendly deals from hostile interlopers. o “Fiduciary Out” Provisions (See Chapter 13)  Standstill Agreements: Bars hostile activity prior to closing on the merger agreement.  Confidentiality Provisions: parties must remain mum.  Timing: In a dynamic market, the conditions that made an acquisition or merger desirable may change. Different agreement structures can affect the speed of the transaction. - All-cash, multi-step acquisition: Typically the fastest way to lock up a target and assure its complete acquisition. May be consummated 20 business days after commencement under the Williams Act, whereas a merger will require a shareholder vote at least by target shareholders, which will in turn require SEC clearance of proxy materials and solicitation of proxies. o If stock is part of the deal consideration, then stock must be registered with the SEC, which takes time. - Regulatory Approvals, Consents, and Title Transfers o Reverse triangular mergers are the cheapest method of transfer because they leave both pre-existing corporations intact, i.e. the target and the subsidiary. o Avoiding regulatory approval speeds up process

Kamer, Corporations, Fall 2006 Grade: A Planning Around Voting and Appraisal Rights – don’t want shareholders involved; if they are involved, want to be able to give them an ex post remedy (appraisal) so that deal still goes through Due Diligence, Representations and Warranties, Covenants, and Indemnification o Much easier to acquire this information for public companies. o When deal is friendly, ask the target for warranties o When the deal is hostile, target has no duty to warrant Deal Protection and Termination Fees: terms in merger agreements designed to protect friendly deals from interference by hostile bidders. Accounting Treatment: survivor records the FMV of the target’s assets. The purchase price – asset value = goodwill. Goodwill is an intangible asset that goes on the asset side of the balance sheet and can depreciate.


DGCL §251(b): Mergers require shareholder vote by shareholders of target and acquirer, except the acquirer’s shareholders do not vote when the acquirer is much larger than target. - Then file with Secretary of State DGCL §271: Sales of substantially all assets require shareholder vote, but purchases of assets do not require vote. General Concept: The transactions that require shareholder vote are those which cause the most dramatic alteration of a board’s relationship to its shareholders. Change in management accountability, not the size of transaction, is the underlying concern. Statutory merger Used to need a unanimous shareholder vote, but today just need a majority (or some variation on that, depending on statute) o DE requires 50% of votes outstanding  means need a lot of people have to cast vote, because will have a quorum requirement (usually 50%) and need to get 50% of all outstanding votes Once approved, all assets and all liabilities transfer from target to acquiring company (agreement will specify which is which) Triangular (Subsidiary) Merger Triangular Mergers: protects the acquirer from acquiring the liabilities of the target. The Mechanics of the Triangular Merger The acquirer (A) forms a wholly owned subsidiary (sub-A). o (A) transfers the merger consideration to (sub-A) in exchange for all of (sub-A)’s stock. Target and (sub-A) merge. Target shareholders get the merger consideration from (sub-A), and all Target shares are cancelled. A now owns all the stock of (sub-A), and (sub-A) owns all of Target’s assets and liabilities.

Kamer, Corporations, Fall 2006 Grade: A Forward Triangular Merger: (sub-A) survives the merger as the new company Reverse triangular merger: Target survives the merger as the new company. DGCL § 251(b) o Could pay with stock of acquiring company, cash, debt securities (essentially borrowing from target and saying pay you later), o Can also pay with securities/shares of another company Can’t pay with stock of subsidiary, because then trading public stock (which is liquid) with private stock (of the subsidiary, which is not liquid)  shareholders would never go for that This provision allows subsidiary and target to merge, with payment in form of shares in the parent company Insulates the parent company from the liabilities of the target  courts so far have declined to pierce the corporate veil (when company’s careful) Vote o Shareholders of the constituent companies have to vote  target and subsidiary o Parent is the sole shareholder of the subsidiary, so board of directors and not shareholders of parent company vote (because parent company not merging with anyone) Possible agency problem – maybe thought shareholders wouldn’t approve deal Expensive to hold vote, so avoiding vote of parent company shareholders holds expenses down If target company is privately held, and only parent company board votes, can close deal before even announcing it (private companies sometimes have only one or a handful of shareholders) o Time – deal based on current market conditions o If deal is pending for 5 months, employees will be in state of flux because often job loss after mergers (restructuring) Especially a bad thing if deal doesn’t go well and doesn’t close, and then have lost employees Used to think that most mergers triangular, but not actually true o Lots of banking deals lately, and those have been primarily statutory mergers o Why? Tax reasons (for banks) Regulation Y Banking subsidiaries don’t have limited liability Forward triangular merger Reverse triangular merger o If deal is taxable, disaster to do forward triangular merger Reasons for a Speedy Merger - Possible change in market conditions

and shareholders individually choose whether or not to sell o So once get large block go to merger o But why the two steps? o Hostile takeover can only be done as a tender offer followed by a merger Must have an agreement between the two companies. T mergers with S2 . Fall 2006 Grade: A o People driving up the price o Especially if word leaks  So want to go fast so word doesn’t leak Effects on employees o Lots of employees will leave now - Double Dummy merger aka Holding Company Merger aka Spaceship .Acquiring (A) company sets up Holding company which has two subsidiaries (S1 and S2) . §351 is more liberal with how big the stock component has to be) o Allows you to reincorporate in a completely new place o Must be big stock component in consideration  40% or more (IRS rule)  So if have deal with at least 40% stock.Two Reasons o Tax  In order to qualify for tax free treatment you have to satisfy certain requirements  One is continuity of interests.Now H owns both A and T . Corporations. considered tax free restructure Stock Purchase When you buy all the stock What company can you not buy in a stock purchase? o Contract between the seller and the buyer – so with publicly-traded companies cannot get 100% of the stock because would need to make a contract with every single shareholder Hybrid between merger and stock buy allows stock purchase of publicly traded company o Public tender offer – literally advertise publicly that want to buy stock for a certain price. surprise. then shareholder vote o With a majority of the stock can replace the board (this is why you do the tender offer) and then follow with merger (because. more reorganization than sale • If shareholders are still shareholders of something • Have to show big stock component in the transaction • Allows you to use different section (§351 instead of §368 for triangles. the new board loves the deal and is willing to propose it) . then board approval.A mergers with S1.Kamer.

Kamer. surely they must have done due diligence and believe stock is worth its price or worth more than cash .Federal Law with environmental hazard liabilities also Downside is tons of very specific paperwork o Have to specify everything you are buying Can be a public target o But if you get substantially all have to have a shareholder vote Stock Exchange Rules .If you issue less than 20% of stock you can speed up things . get at least 90%.You know there’s not agency costs for a private company and that they did their due diligence . agreed to take stock of the public buyer.If you issue more than 20% of your stock.lots of arm-twisting in the dark Why you pay stock instead of cash in a certain deal (why your stock is good) . then do short-form merger (in jurisdictions that allow.HUGE DIFFERENCE BETWEEN CASH AND STOCK o TAX . Corporations.Public target company is offering liquidity to private company o When public companies announce big stock deal their stock price drops  Can drop because a lousy deal  Could be negative signal to market .Divestitures usually lead to a really good price . if have 90% of stock can do automatic buyout of remaining shareholders) Asset purchase Sale of substantially all assets is fundamental transaction for selling company and requires shareholder approval Can specify which liabilities you want to assume Successor liability issues though .You believe your stock is fully-valued .Stock price of acquirer appreciates when it announces stock deal with private target (as opposed to public target) o Positive signal to market  Not a company with collective action problem or agency costs. Fall 2006 Grade: A o Tender offer under federal law must be open for 20 days – if price is high enough will get enough shares that will end up with more than majority of stock Or could make tender offer for target company stock. the major exchanges say you have to win a vote of all the votes cast (as opposed to statutorily required all the votes outstanding) Interesting thing about some deals that are “friendly” are really done in the shadow of a hostile deal .

because many friendly deals are done under threat of hostile takeover.Representations and Warranties . friendly deals Not always obvious. 2004. Fall 2006 Grade: A o Kamar says the vast majority of deals with a stock component are tax-free Issue with lower earnings per share when you use stock in these deals o Market wants deals that will be accreditive at least a year after closing o Cash doesn’t increase earnings per share! o So it’s just an accounting concept.Set range for sock price of acquirer . public target Acquisitions v. 466) Sale of newspaper groups 56% of value NOT constitutionally all of company’s assets Substantially all = essentially everything Taxonomy o Can categorize deals in different ways Hostile v. decide to close the deal and go ahead and sue “Collar” . sometimes only becomes friendly when goes public Private v. Ch.Kamer.Egyptians . longing funds of the target - - Hollinger v. purchase with securities/bonds Tax free v taxable Requires continuity of interest to be tax free Non-stock component of tax free deals is still taxable. but if have taxable transaction the entire thing is taxable (including stock) o o o o How do you deal with information asymmetry inherent to deals? . cash purchase. divestitures Stock purchase.Travoltas . but it matters in the real world Flow-back o Cross-border deals o Investors don’t like stock in foreign markets  Many have restrictions of how much stock they will have in foreign markets so they will dump their stock right away Price Pressure o Hedgefunds and arbiters  Shorting funds of acquirer. Corporations. Hollinger (Del. p.Due Diligence “Sandbagging” .Knew something was wrong.

Kamer. but not when it’s a publicly traded company If find some breach after signing and before closing. its an insurance policy b/c if disclose it can’t be used against you later . don’t have to register the stock (don’t have to file with SEC) Tender offer must be open for 20 days by law (added in Williams Act) How do you save time if you have to do the backend merger anyway? • If get more than 90% do short-form merger  don’t need a shareholder meeting. 476 Merger Agreement o Three parties – parent. no one can take it from you • Speed – typically see tender offers for cash o Article III – Representations and Warranties Can sue for breach when it’s a privately held company. and then just the details change P. all you have to do is file a tender offer If doing it as a cash deal. Corporations. who can sue the shareholder afterwards From perspective of seller. subsidiary (acquisition vehicle) and target Parent is buying the target. can do it all in one afternoon • Afraid of interlopers  don’t want a second person to come and snatch target from your hands • Once have your tender offer and get a majority of stock. target merging into subsidiary Triangular merger o Offer With initial cash tender offers speed Don’t have to file proxy statement.For example pension funds get tax preferential treatment . Fall 2006 Grade: A o These look like the dances Some investors and much more tax sensitive than others . you can rescind the deal contractually or try and renegotiate If it is a closely owned company.And long-term v short-term capital gains o Did they buy the stock in the last year Structure Will generally have several components typical to each transaction.Matters for stock basis .

Fall 2006 Grade: A Acquiror also usually makes a few reps and warranties – typically dealing with financing if cash. it will happen.Kamer.  And then all the stock will be acquired anyway o So you will FOLLOW YOUR PREFERENCE o Problem of not offers costing more  But what you can do is three things • Partners • Just buy smaller companies • Borrow from Investment Banks for more money o Idea of adding option that minority shareholders could retain their stock on this tender offer system  Rule in London • Offerror is compelled to offer the same terms on the backend as on the front-end o Once you make an offer for 30% you have to offer the rest o Nice thing about this solution is that now you don’t need the courts . Article V – Conditions to closing Most sensitive part of agreement Three parts: conditions pertaining to both parties. it doesn’t happen o If you don’t like it and other people like it. etc.Idea of one tier of offer where buyers have to buy the whole thing o Will tender freely (no pressure) against a normal tender 50% offer o So if you like you do it o If you don’t like and other people don’t like it. anything that would deplete its cash. just to acquiror. and if it does the board can’t interfere: o So no two tier offers .Well you could have a rule that the offer has to fit a certain shape. care a lot and have more extensive reps when stock deal Article IV – Covenants What parties must do between signing and closing Ex: • Best effort clause: make best effort to ensure deal comes to fruition • Target not supposed to do anything out of the ordinary. and just to target Article VI – Termination When either party can terminate the deal Article VII – Misc Where all the good stuff is hidden o o o o Other Countries Rules: How else could you do it? What other legal systems could you create? . Corporations.

Greenmailing o Buying the stock and pressuring board. do a merger instead So typically you will see o Termination rights Acquiror - - . the defenses break apart if the tender offer hits a certain point o Seems like only Italy will opt in to this rule  Traditional European defenses • Dual class capitalization o Superior stock voting class  Vandenburg’s in Sweden  Shareholders know what they’re get when they’re buying the stock in this case • Tender voting o In order for shares to have voting power have to hold it for at least a year Don’t have two-tier tender hostile offers anymore because then it gives the Board an excuse to fight you .That’s why other bidders bid after someone starts bidding . there’s a gem there that no one knows until someone discovers it. not always just looking for a deal breaker or bad guy o So if find contract with third party that says can’t divest assets without permission. Corporations. If a company has defenses.But then original person can sell and that first person makes money . but deal only happens if shareholders tender while saying we like this offer o This is also the law in England! o But Scandinavia and Germany derailed it from all of Europe  Worry about foreigners taking companies  Worry about their jobs  Legislation was modified and became optional • One optional component was no anti-takeover tactic could have been made without shareholder vote o Some like England kept it but others don’t • Second optional component: breakthrough rule. Fall 2006 Grade: A Another Solution: Shareholders can tender. then the board buys back the stock at a premium for that person Information Reps and warranties Due diligence o Want to deal with issues early on.you do see tender offers in friendly deals Sometimes people are sleepy. .Kamer.

. worried stock price will drop o Pricing Flowing exchange rate  pricing – formula for price for amount of money that is going to be paid that is not fixed and depends on value of stock getting If cash deal. can walk After closing – cause of action Parties will specify what can be sued for Often set minimum – can’t sue unless.. fixed amount When stock deal (options) • Fixed exchange ratio o Value of consideration is going to rise or drop with value of stock of acquiror • Fixed value – get as many shares as it takes to keep dollar value the same • Collars – within range either a fixed value.  establishes threshold Basket – cannot sue for first 10m dollars. but must be correct as of day of closing – if not. Fall 2006 Grade: A • Reps and warranties must be true as a condition to closing – usually with materiality qualifiers • Correct in all material respects taken as a whole • Break down – not only are reps and warranties accurate as of day of sign. but can sue for loss above that (like a deductible) Time limits – can only sue for a year after closing Limit for indemnification (ex: up to 10% acquisition price) Put money in escrow to ensure recovery Can you sue them for misrepresentations that you knew were in there?  Sandbagging (knew something was wrong. and outside the range fixed exchange ratio (Travolta). chose to close the deal anyway and then sue) • Benefit of the bargain – don’t want to argue forever after closing about whether knew about misrepresentation • Generally find one of three – anti-sandbagging clause. Corporations..Kamer. or vice versa (Egyptian) (rare) o Doesn’t have to be symmetrical o Walk away right – if stock drops below certain point can walk o Can also have mixed cash and stock deal . contract is silent o Things that can go wrong in the future If target getting stock of acquiror. allow sandbagging.

so change from 5050 stock and cash to 40-60 or something like that • Why do companies worry about issuing stock? o When stock dilutes it drops earning per share • To qualify for tax free transaction. often in separate transaction do a repurchase of own stock What happens if after closing the target doesn’t perform well? When value of company depends on employees (service industry) rather than something fixed (real estate transaction) especially when employees are former shareholders. can equalize the components and everyone who gets cash will get a little less cash. can pro rate it so everyone also gets some cash • Some investors are more tax sensitive than others – ex: pension funds get more tax benefits so less sensitive to tax incentives o Investors might have different basis. might not have as much incentive • Ex: accounting firm. Fall 2006 Grade: A Value of cash component will stay the same.) So can include an earn-out clause • Pay half price now. but stock component might drop Usually have an election clause which lets shareholders choose what they want • If not enough stock for everyone who wanted stock. especially private company (because no audited financials. etc. must have at least 40% (in certain types of transactions) stock exchanged o What happens if drops and now drop below 40% stock – this will give target a walk away o So beef up stock – to prevent dilution. Corporations. car dealership o Incentive problem Sometimes can’t ascertain value of company until you acquire it.Kamer. and people who get stock (whose value has gone down) will get a little more stock  Drop whole number of shares being replaced by stock. half over the next three years after closing depending on how well company does o Fixes incentive problems o . thereofore differing tax incentives even for people who have same risk o If stock price change.

acquiror can walk away Tender Offer Tender deal doesn’t go through board. it goes straight to the shareholders. shareholders get their shares back If friendly deal do it the same way. this offer has the blessing of your board Hostile Deals Why would target shareholders ever sell stock to you in tender offer? o Free rider problem . Corporations. but if someone surfaces with a superior offer. buyer can walk away Can put in anything you want (negotiated) and also put in what exceptions you want (carve-outs) Tyson Foods: Court: long term point of view is appropriate  MAC contemplates development that is consequential to a company’s earning power over a commercially reasonable period (usually years. worried about negative effects by acquiror.Kamer. etc. not months) o Fairness opinion bring down (clause that says condition to closing says this opinion is reaffirmed by opinion of bank as of day of closing) Bank must give opinion that fair deal for target’s shareholders If bank withdraws opinion  walk away right for target o Financing condition Walk away right for acquiror If target want to check lending documents to make sure MAC clause not worse for you than negotiated MAC clause in merger agreement If lose financing. we’ll have to talk to them if its our fiduciary duty • Can start a bidding war o Material Adverse Change (MAC) clause If something really horrible happened to target between signing and closing. then they have 20 days (minimum) to sell their shares Sale generally contingent on offeror getting certain number of shares  if don’t reach minimum number. o As a practical matter can be fraught with difficulties Fiduciary out • Target might want out o Shareholders don’t want deal anymore o Higher bidder comes along • Promise not to talk to 3rd parties. Fall 2006 Grade: A o But now if seller. but allows you to say.

(Del 1985) .Mesa buys 13% of stock o Cheaper to buy when no one knows someone is going for control  But 25% of stock triggers a 13(b) filing within 10 days . Mesa Petroleum Co. and if like deal and others don’t the deal won’t happen but won’t hurt me because get stock back English rule – nice thing is that you don’t need the courts Trying to create a rule where shareholders will only tender their stock if they like the offer. but the deal will go through only if shareholders tender while saying. so offer to buy stock at more than current market price ($11) and then I keep difference as profit But shareholder might think that if I think I’m so smart and am going to raise the price of the company. worth $10 per share today and has $100 shares. Fall 2006 Grade: A If I want to buy a company. decreasing value of company shares o If two tier tender offer people more likely to rush and sell to make sure get front-end instead of back-end offer o Prisoner’s dilemma How can we deal with the Prisoner’s Dilemma? Maybe say that if bidder makes two-tier offer. without regard to what other shareholders do Shareholders can tender. Corporations. if the shareholders know this they will tender freely. should demand higher or stick around Free rider because depending on new person to create value for you. and depending on other shareholders to sell o In reality see people tender stock in tender offers quite happily If company is worth $1500 per share. board can do whatever it wants to counter if believes it is inadequate What if we had a rule saying the buyer could only complete the tender offer if he receives 100%.Kamer. I might not see $15 per share Difference between the company value and the share value Controlling shareholder might appropriate to himself the private benefits of control. because if they don’t like the deal it won’t happen. we like this offer  so when tender can tender in protest (check a box on the paper sent in) o So then the deal goes through only if a majority of the shareholders tender while supporting the deal  replicating a vote on the deal o This is also the law in England – they have both protections “Tenure” voting  don’t have voting power until held stock for one year Unocal Corp v. I think I can do better because management sucks If I think I can make the company worth $1500.

then its decision will be insulted under BJR. if successful in the first stage tender offer. Changes post-Unocal (concern that this was overly defensive) - - - - - . The back-end sellers will get junk bonds (main threat). and tender for remaining 20% also at $72/share in debt securities if Mesa gains 50%. Fall 2006 Grade: A • So everyone knows o Called a “toehold” Makes a tender offer for the next 37% of stock for $54 a share o Says there will be a backend of $54 a share buy in junk bonds Has a board of 8 outsiders and 6 insiders o Debate for nine hours and have Goldman Sachs advise them Board is going to make going to make tender offer o After Pickens makes front-end tender offer. etc.  Week later have another meeting. Mesa brings suit to enjoin the defensive measures. improper defensive measure or a proper exercise of business judgment. make it unconditional Facts: Unocal stock is trading at $33/share. Rule of defensive measures: Does corporation face a reasonable threat? o Structural coercion: the risk that disparate treatment of non-tendering shareholders might distort shareholders’ tender decisions o Opportunity loss: a hostile offer might deprive target shareholders of the opportunity to select a superior alternative offered by management o Substantive coercion: the risk that shareholders will mistakenly accept an under-priced offer because they disbelieve management’s representations of intrinsic value Was the corporation’s response proportional to that threat? o Response may not be preclusive. Mesa is excluded from the offer. which would then allow the hostile tender offer to proceed. If the board of directors is disinterested. Unocal board reviews offer.” this was a proper defensive measure because the board acted to protect shareholders who would be coerced to sell on the front end. Issue: is this an interested. and so the shareholders will always choose to sell to Pickens. with due care. the back-end by the board is at $72. Corporations. we’re going to take care of the remaining shareholders than a back-end tender offer  Thing is Picken’s tender is at $54. acts in good faith. Board decides to undergo defensive recapitalization by making a self-tender for 30% of the shares at $72/share in debt securities. makes a response that is reasonable and proportional to the threat. and Goldman Sachs reports that the minimum cash value in a liquidation should be $60. Holding: Applying “enhanced business judgment review.Kamer. then makes a tender offer for another 37% at $54/share. so everyone is going to wait for $72 and will depress the price • But worried about Court implications. Mesa buys 13% of stock. Mesa discloses its plan to freeze-out the remaining 50% for junk bonds worth $45.share. Goldman advises instead of making it conditional on Pickens completing tender offer.

o Flip-in Pill: Corporation can dilute the potential ownership interest of the hostile interloper by giving the corporation a right to issue and the existing shareholders a right to buy more stock in the company if a triggering event occurs. Example of triggering event: third party acquires >10% of stock without board approval. then pill not redeemable and rights become exercisable. Must be pursuant to a charter amendment that allows rights plans. o Can be implemented at any time. o Validated by DE Supreme Court in Moran v. No shareholder vote necessary. Pillsbury. Target’s board must put terms into the merger to force acquirer to recognize these rights.Types of pills o Flip-over Pill: Gives existing shareholders of the target the right to buy discounted stock of the acquirer.  How it Works • Board adopts “rights plan” (poison pill). . . However.” Very effective defensive measures against hostile takeover attempts.14(D)(10) o Even third parties can’t make discriminatory tender offers  Headache for friendly deals because trying to get management to stay with employment deals and then you start violating 14(D)(10) with your employment agreements Private Law Innovation: The Poison Pill . Grand Metropolitan v. could force corp to redeem the poison pill. • Rights distributed to shares (through dividend). Fall 2006 Grade: A o SEC passes rules 13(e)(4) and 14(e)(10)  No more selective tender offer (greenmail) After this case SEC said companies cannot make self-tender offers that are discriminatory . Corporations.  If not proportional.Poison pill: also known as “shareholder rights plan.  Redemption clause: allows the board to withdraw pill and allow a sale of control/stock/assets (aka “Board Out clause”). Household International. decision to use it (turning it on) subject to Unocal test:  look at the hostile party’s offer and decide if defense is proportional. remain imbedded there. court almost never does. Adoption of the pill (putting it into bylaws) subject to BJR.14(E)(3) . • If “triggering event” occurs (it never does).Kamer.

so no pill) .Court says okay you can go do it o (But here’s the thing. • After the pill (1985-present): board control is a prerequisite to buying a majority of the shares: o Bidder launches a proxy contest to replace the target’s board over one (no SB) or two (SB) annual elections. can adopt the pill in the last minute •   Moran . thus clearing the way for the hostile bidder to proceed with its bid.Kamer. (Shades of Unocal. o Once in office. unequal treatment) • Effect: acquirer is diluted out Benefits: • Efficiency: no restructuring required to protect incumbents. Fall 2006 Grade: A All rights holders allowed to buy shares at half price.Would the court in Moran have come to the same conclusion if it was a flip-in pill? Kamar doesn’t know . can buy the company and then just not backend. diluting controller’s stake. o But then point about how you don’t need the pill in advance – but instead the pill can be adopted at the last minute.  If directors stay they will be voted out over one (no SB) or two (SB) annual elections. perhaps even in response  So just adopt the pill after you have the tender offer  So any Del. the acquirer doesn’t get this right. the new directors redeem the pill. Corporations. Such restructurings are often costly and wasteful. • Doesn’t trigger SEC rules • No shareholder vote required The Effect of the pill • Before the pill (1970s-1985): board control is an inevitable consequence of buying a majority of the shares: o Bidder makes a tender offer and gains a majority of the shares  Board will almost certainly resign because independence is doomed. Corp. However.So Court in Moran says Pill doesn’t seem that bad o (But pill designers got fancy and had the pills flip-in much earlier) .Pill with a flip-over component .

Described in casebook.Uniciper(sp?) . gets an “asset lockup.Schnel . A lock-up is not per-se illegal. Mac-Andrews and Forbes Holdings (Del.Holding: This was violation of board’s fiduciary duty to corporation. Chancery Court rules for Perelman and enjoins the asset lockup. and a breakup fee. no-shop provision.” a “noshop” provision. with the promise of even more if Revlon redeems its pill. which in turn makes an LBO more difficult. will give some background in class State Takeover Statute . but this lock-up was geared to thwart Perelman without any benefit to the shareholders. The recapitalization permits Revlon to subject itself to specialized debt covenants that restrict the sale of assets. 520 . Perelman increases his offer to $58. Offer would break up the company. Revlon board adopts a poison pill and tenders for 20% of its own shares with notes.50 per share when the stock is trading at $25. Revlon is now between two potential offers that would both break up the company. all-cash tender offer for Revlon at $47. When bidders make relatively similar offers or . Perelman raises his offer to $50.(MM +Liquid Audio) Poison Pill . . and finally to $56. Corporations. $53.25. Forstmann enters as a “white knight” and eventually agrees to pay $57. Fall 2006 Grade: A Cases Unocal Revlon Barkan Pennance Netsmart Paramount QVC Santa Fe Pacific Lukens Anti-takeover statutes . 1986) p.CA Revlon v.Kamer. in exchange for supporting the par value of the Notes which had faltered in the market.25 per share.Facts: Perelman makes a hostile.slow-hand . it was to protect the shareholders . and breakup fee. and brings suit to enjoin the defensive tactics and deal protection devices that Revlon used to preserve its deal with Forstmann.dead-hand .Job of the board is not to protect the noteholders.Blasicis .

. as long as cost is justified by value to shareholders. Pulling Together Unocal and Revlon o Lockup Post-Revlon  Still allowed. if agreement lacks such a provision. At this point. must focus on the interest of shareholders. community. . it is invalid (Omnicare) o Post-Revlon Cases Clarifying Revlon Duties (Barkan)  Multiple bidders: Level Playing Field Among bidders “When several suitors are actively bidding for control of a corporation. creditors in deploying defensive tactics. Fall 2006 Grade: A dissolution of the company becomes inevitable. The directors’ role remains an active one. Once a company - - - . . Corporations. o Revlon: board should maximize shareholder profit when the company is being dismantled or sold. Kraakman’s synthesis: o Unocal: board should consider the interest of employees. Exemption allowed in very limited circumstances. • For example: could be used to ensure highest price for corp • Court will likely reject deal protection measures if they’re too large (like Paramount v. the directors may not use defensive tactics that destroy the auction process….” (emphasis added) o Deal protections  Asset lockup: right to purchase T’s (Target’s) assets if someone else wins bidding war  No-shop rule: Target not allowed to negotiate with other companies  Termination fee: if company is outbid. who are the last to receive compensation.” “the directors’ role [is] changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.Kamer. When multiple bidders are competing for control … fairness forbids directors from using defensive mechanisms to thwart an auction or to favor one bidder over another. Board must let market forces operate freely to bring target’s The Revlon duty: When a “sale” or “breakup” of the company becomes “inevitable. Target must pay a price for ending negotiation. QVC) o Friendly deals must give the Target Board a fiduciary out such that they can abandon the deal protection if they’re advised by counsel that they’re going to violate fiduciary duties. Unocal was trying to prevent against being sold. changed only in the respect that they are charged with the duty of selling the company at the highest price attainable for the stockholders’ benefit.  Market check requirement: “When the board is considering a single offer and has no reliable grounds upon which to judge its adequacy … fairness demands a canvass of the marketplace to determine if higher bids may be elicited 1.

But that is the easiest way to prove to court Financial buyer – someone in the business of buying and selling companies Strategic buyer – someone in same industry. expanding own business. Revlon is triggered on the sale of a company.Time and Warner restructure so Time is making a friendly cash offer with a back end stock trade o Because Tender offer is full cash there is not going to be a vote  If you issues more than 20% of stock. and knew it was the best value. the only party that you can protect is the shareholders because the creditors are now at the whim of the purchasing party. 12% . Fall 2006 Grade: A is being sold. no because the shareholders are the last to get compensated.  Can a board legitimately favor other interested parties at the expense of shareholders? • Kraakman: when the company is being sold.Lawsuit o DE Sup. Corporations. 1989. Court says this is closer to Unoco more than Revlon o But doctrine diff than Chancery  Chancery – diffusely held company before merger. can favor other parties.Kamer. but if you find new buyer go ahead and just give us a couple days to match Court didn’t like the go-shop provision either.Warner getting a premium.Paramount comes in and bids . Amsted Industries (Del.Time buying Warner . have to vote. Barkan v. When the company is not being sold. diffusely held company after merger – so not really selling the company . so the board should do its best to protect them.But now it goes up so Time is worth more . 558) Don’t have to hold an auction If you can prove to the court that you got the best value. not really making an effort Paramount . found in violation of Revlon Selling to financial buyer usually means management stays on Comfort – not going to seriously consider other deals Market checks after offers by financial buyers less (successful) b/c management is comfortable with deal. p. Netsmart Sign deal first. you don’t have to hold an auction.Time stock goes up . . etc. etc. but don’t need to vote if its cash. business who buys company b/c think can run it better.

. There are deal protection devices. Fall 2006 Grade: A Supreme Court – same result.” or o where in response to a bidders’ offer. Time’s board rejects the offer based on (revised) fairness opinion from Wasserstein Perella. the reason is because there is no break-up in this case . this deal is closer to Unocal than Revlon o Court of Chancery: before merger Time company owned by diverse group of shareholders.Facts: Time and Warner agree to a stock-for-stock dealer in which Warner shareholders get 62% of the surviving corporation. 1989) p. and will have diverse group of shareholders afterwards  not a sale of control o SC: no. .” . Shareholders might have voted for Paramount in ignorance or mistaken belief about the value being conferred. Concerned about its shareholder vote.Holding: The deal is approved as a proper exercise of business judgment. 530 . 1994) p.Kamer.Two important factors for Time board o Distinguished board with clear majority of independent directors o Time actually considered and negotiated transformative transaction for years before deal occurred . 524 . but is Unoco. including “cross-options” to deter third-party bidders. then upped to $200. which values the Time shares for as much as $250. Time will also inherit the combined entity after 5 years when Warner’s CEO steps down. Corporations.Even if there is a great imbalance between two companies its Warner and not Revlon Paramount Communications v. o this decision sounds like a “just say no” BJR. first at $174. The court rules that Time specifically sought out Warner for business reasons/fit reasons. Time’s action was reasonable with relation to the threat posed (Unocal). a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of a company. No Revlon duties because there is no change of control.  Santa Fe Pacific .Court: if anything. but rational that company wasn’t sold Paramount Communications v. Time (Del. Paramount makes an all-cash hostile bid for 100% of Time shares. QVC (Del. Time shareholders join suit and also assert a Revlon claim. Time restructures its deal with Warner so that Time borrows $10 billion and uses it to make a cash tender offer to Warner. Time has no duty to maximize shareholder value in the short-term. Paramount brings suit to enjoin Time’s defensive tactics under Unocal.Unocal elucidated: o board’s decision to pull a pill is strictly within its own BJ.Revlon elucidated o “When a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company.

Corporations. The board had a duty to explore the QVC offer. who is Viacom’s majority shareholder. the purchase of 51% creates a controlling shareholders out of Redstone. QVC jumps the deal with an offer to acquire Paramount for $80 in cash and then stock. no appraisal rights and no Revlon duties Contractual argument: Contracts to keep deal protections that go against fiduciary duties are invalid and unenforceable. no asset lock-ups.  Note: The nature of Consideration Matters: • If there is cash. with a planned back-end squeeze-out for $80 in QVC stock. Paramount rejects the offer as “excessively conditional. but leaves the deal protection unchanged except for a new “fiduciary out. there was no controlling shareholder (widely held company). o When there is a sale of control. Sometimes it is more profitable to lose the auction and get the termination fee. 62% cash) Chancery Court: had to decide whether Revlon applied o Suit said board breached fiduciary duty b/c failed to max. Chancery agrees and strikes down impediments to the QVC offer Holding: Revlon duties are trigged. and then raises its price to $85 in cash and stock. QVC brings suit claiming that Paramount was in Revlon-mode. The deal gives substantial deal protection measures to Viacom. appraisal right AND Revlon duties • If a stock merger. for Viacom stock and cash worth ~$70. Fall 2006 Grade: A Facts: Paramount agrees to be acquired by Viacom. only stock lock-ups - - - In Re: Luckens (Not in casebook)(1999) Deal of mixed cash and stock (38% stock. Revlon further elucidated o sale of control with a cash-out merger requires board to apply Revlon duties. the minority shareholders should get a control premium. this would still be a Revlon transaction if there were a cash-out  If Viacom were widely held.  An enhanced business judgment test  Even if Viacom were widely held. QVC makes a hostile $80 cash tender offer for 51% of Paramount.Kamer. controlled by Redstone.” but makes no effort to explore the conditions or negotiate with QVC. but this was a stock consideration. Pre-offer. o Argument that these are not very effective because there is an opportunity cost. o After Revlon. Lock-up options: will the bidder with a lock-up option generally get the deal? o Termination fees can be held to be invalid if the transaction turns into a Revlon deal. Viacom matches QVC at $80. Deal protections are struck down. when negotiations stall. value in sale o Can breach Revlon duties (failure to get top price) by breaching duty of care or duty of loyalty . no Revlon duties.” QVC goes to $90.

like Time-Warner. but amount they will make is fixed today by the exchange ratio Should expect future case law to change the doctrine a bit because it isn’t solid Kamar Prediction – in 10 yrs distinction between Unoco and Revlon will evaporate Omnicare v. might some day be able to sell at a premium if company is acquired. NCS Healthcare (Del. even if decided not to recommend it) In NCS combined § 251(c) with fact that had controlling shareholders who committed to voting shares in favor of the deal o Chairman and President/CEO Court: lock-up too extreme  can’t seal the deal entirely o But company had been shopping for buyer for two years o This was a surprise decision  providing lock-up was the only way to get G to buy the company o If majority of shareholders are willing to commit. Fall 2006 Grade: A o Calling it a Revlon case won’t tell you whether breached loyalty or care o This was a Revlon case because so much of the consideration was in cash. but widely circulated) Summary: Sale of company or change in control  obligation to get best price you can Always have obligation to get best value for shareholders  but can be long-term interest if no change control/sale If have two companies of a similar size. Corporations. why can’t they? o Strong dissent by the two corporate experts on the Court Cash lockups No Shops o Cannot solicit bids or negotiate with alternative buyers o Not allowed to put a provision in your contract that says you can’t negotiate with third parties unless include a fiduciary out . 2003) Shareholder lock-up – can only be done if target has controlling shareholder (or significant shareholders DGCL § 251(c) – can have force the vote provision in merger agreement (board commits to submitting offer to shareholders. which meant that most of the stockholders would be cashed out o If 60% cash or above going to treat it as a Revlon case (footnote in case.Kamer.

and 50% of outstanding shares). o Control share statute: require disinterested shareholders to approve the purchase of shares by any person crossing certain levels of share ownership that constitute “acquisition of control” (usually 20%. . unless: board approves. the more powerful a vocal minority becomes (b/c you need 66% of their approval. Dynamics Corp of America) p. acquirer owns 85%. NCS . required disclosure • 37 states followed suit. Ex: DGCL §203.2d 95. . approved by 66% of shareholders.  Effect: bans immediate liquidation of acquired corp.THIRD-GENERATION ANTITAKEOVER STATUTES (1987-2000) o “Business combination statutes:” prohibits corp from engaging in “business combination” w/in set time period after shareholder acquires share threshold.  DGCL §203: No “business combination” (merger) for three years after passing threshold. • Effect: acquirers must try for 85% in one fell swoop.Kamer. the more you buy. including Illinois • Illinois Act: Struck down by Supreme Court as preempted by the Williams Act. Upheld by CTS Corp v. short of 85% ownership). NYBCL §912.3%. but allows takeovers where acquirer will continue to operate business of target. 549: . Fall 2006 Grade: A If board determine would breach fiduciary duties not to negotiate with alternative buyer. then can negotiate with them without breaching the contract .First Generation: address disclosure and fairness concerns o Williams Act (1968) o First anti-takeover laws (trying to limit hostile takeovers)  Created auction period. Capital Reinsurance (747 A. unless fair price rule included). Corporations. 33.ACE v. Requires that minority shareholders frozen out in the second step of two-tier takeovers get same price as those in first step. (Today’s version: require supermajority of shareholders to approve two-tier takeover.Second Generation o Fair price statute: meant to deter coercive two-tier takeovers. • Interesting side effect: if you’re short of 85%. 1999) Omnicare v.Background o Asset lockups – gone o Stock lockups – on the way out Cash lockups State Anti-takeover Statutes .

creditors. • NYBCL version bans both mergers and sales of assets. Classified Board Statutes (MA and MD) provide classified boards for all companies incorporated in the state (with opt-out possible) • - - Modern Techniques for Challenging Corporate Control Combination proxy fights and tender offers Makes proxy more credible when increasing own risk levels by investing in company Partially to pressure the board. and if win to redeem the pill See courts protecting free election of board of directors in a much more powerful way Schnell v. Allow broader justifications for defenses. “Business disgorgement statute:” mandatory disgorgement of profits when bidder sells stock/assets within set period after becoming controlling shareholder. other factors. “Constituency statute:” allow or require boards to consider additional constituencies when deciding how to respond to a hostile takeover offer. Petitioning shareholders get fair price + pro rata share of control premium. Adopted in Pennsylvania. Fall 2006 Grade: A DGCL: bans mergers for 3 years.Kamer. made it more difficult for dissident campaign to get ready Court: the fact that the board has the power to change the meeting date doesn’t mean the board has the right to move the date o This was not in good faith  breach of fiduciary duty o Board may be allowed to move the meeting. but it can’t do so to entrench itself. (Do shareholders still own the corp? Yes. “Redemptive rights statute:” appraisal rights not just for freeze-outs. Ohio. communities. Chris-Craft Industries (Del. Corporations. Says board may consider shareholders. does not ban sale of assets. the board moves it up and to an obscure town Board moved up annual shareholder meeting. p. o Ex: Indiana Code §23-1-35-1. 613) Facts: With only a couple of months left before the meeting. but board amends its bylaws to create 2 new seats and fill them with friendly directors to preclude the takeover of a majority of the board . suppliers. Applies only to transactions between target and bidder. but when acquirer passes 30% stock ownership (“controlling share acquisition”). because they elect the directors). 1971. A fiduciary may not use legal power in a way that is intended to treat a beneficiary of the duty unfairly Blasius Facts: Large shareholder intends to solicit to increase the size of the board and to fill the new seats with friendly directors.

not a business judgment standard the board can’t use defensive measures that entail removing shareholders right to vote. when there is a conflict between the board and a shareholder majority. etc? o Blasius is much harder to get around and convince court what you were doing is ok o Standard of review  if you do mess with the voting mechanism. but rejected increasing size of the board DESC o Blasius applies and they failed Blasius o The board did this to make it more difficult for dissidents to challenge them. and to nominate two new directors (out of 5. these only ones up for election this year) and shareholder proposal to increase size of board by four Board: signed stock merger agreement with white knight. Almost reverse of BJR: disenfranchisement is presumptively inequitable. Fall 2006 Grade: A Holding: Even if the board was acting in good faith. Revlon. This is a strict standard. can’t block voter franchise to do that o Where is the line drawn between Blasius. and filled with own supporters Chancery: o This is different from Blasius o Key is that in Blasius no matter what shareholders did the board would have majority o Here board has 5. postponed the upcoming shareholder meeting Board increased its size by two spots so have 7.Kamer. so even if shareholders passed all the proposals (elect two dissidents and add four new ones) the dissidents would get the majority o So despite board actions. added 2 to give them seven. dissidents can still get everything they want Shareholders ultimately rejected proposal to increase size of board. board classified. Liquid Audio Sent letter of intent to buy the company. Corporations. you must show compelling reasons o Yet to see a case where Blasius applies and management won o Question: why do we want to push all shareholder decisions to voting? Why are proxy fights preferable to tender offers? Easy to create formal boundary (one is voting one is tendering stock) but why treat voting as so special Van Gorkom – only case where directors held liable for agreeing to a transaction . applies even when directors act in good faith. unless the board’s interest is compelling.

then release written opinion later Why do people buy companies? Banks  increasingly need to get larger and extend reach Line extensions – when company looks around at competitors and realizes wants to expand into some area or expand and acquire smaller competitor Putting money to work o Private equity. Corporations. Fall 2006 Grade: A Procedural context – no witnesses. say 20%.Kamer. usually with limited percentage of total contract amount. never hear live testimony. hedge funds  businesses organized for purpose of investing money to make a return for investors Lots of these investors are pension funds Private equity: contract with investor to have call for a certain amount of money over a certain amount of time • Call capital – over certain period investor will make available to equity fund certain amount of money to invest in deals that firm finds. so if haven’t called the capital yet the commitment expires Firms make a lot of money off of fees and carry – so important for them to pick good deals because the more money they make and the easier it is for them to raise their next fund Agendas – can’t underestimate someone’s personal agenda Reasons for Sales Always an exit strategy in a private equity transaction Non-core business (acquired when building conglomerate and then that goes out of fashion so trying to get rid of some parts of business that not part of main business) Over-leverages (particularly in bankruptcy) Personal agendas Participants Target Buyer . to be invested in each company) “Carry” – if deal is successful they get more than their pro rata share when they exit the deal (sell) (so not long term investors) Can only call capital within fixed period of time. all firm needs to do is find a deal and then give investor notice and investor will give them the money (up to contract price. just affidavits written by lawyers DE Courts prided themselves on speed – can get a chancellery decision within a day or two DE SC would announce judgment same day as arguments.

and Suppliers SEC Commission. Corporations.Kamer. regulators Regulation FD – in public companies can’t selectively release information only to certain people . Fall 2006 Grade: A Senior management In-house counsel Boards of directors Financial advisors Outside counsel Accountants Local counsel Regualtory counsel Stockholders Bondholders Employees. Customers.

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