Business Associations Outline Fall Semester 2008 Afra Afsharipour § General Overview: Economic and Legal Aspects of the

Firm • General Overview o The “Firm”

Old view  owner and employees • Excludes: suppliers, customers, creditors

New view  firm as a Nexus of Contracts • Owners + all involved parties connected by contract o Everything affected by the market. Firm as crossroads where all contracts intersect.

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Role of the Corporate Lawyer  Lawyers as value-creating “transaction cost engineers” • •  How: identify and plan for transaction costs Why: the legal background matters

Making the Investment Decision • Risk-return calculation o • How do we quantify risk?

Probability x risk

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Transaction Cost Factors & Choice of Organizational Form  Bounded rationality •  No one can make a fully rational decision because no one has perfect information.

Opportunism • Decisions made because of secret information not know by the other party

Team-specific investment • The more team-specific the investment is, the more unsatisfactory a loose relationship will be.

Discrete  contracting  Relational

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Single transaction Long-term contract Corporation

Form divides between • • Internal relationships between partners External relationships with everyone else

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State-Provided Governance Structures (why join?)   Efficiency, off-the-rack forms, rules established, don’t know any better. Default vs. Immutable rules • Default Rules: o o Off-the-rack rules; generally “enabling.” Provide parties w/ default rules that govern the relationship if the parties do not provide otherwise (subject to modification).

Immutable Rules: mandatory rules o Certain mandatory rules exist to protect firm members or negative effects of allowing firms to adopt different rules.

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Tailored, Majoritarian and Penalty Default Rules

Agency Law o Background Rules  Agent owes duties to Principal • • •  Fiduciary duty; duty of loyalty; duty of care A is put in a position of trust; must put Ps interest first Specific duties depend on the agency context

Agent has power to bind (create legal obligations for) the Principal • Subject to limitations, eg where A has gone so far “off the leash”

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Terminology

Agency Law: set of standard form rules that provide backdrop for Ks or market transactions among team members; govern relations b/w team members in firm & relations b/w firm and outsiders Agency Cost: cost of doing business is possible that agent may slack off, backstab, etc.

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Agent: Someone who works for somebody else. • BUT, if S/J are partners, they are each the agent and they are each the principal.


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Principle: s/he to whom the agent answers

When does agency exist?

Def  Agency exist where (1) one person (the Principle) consents that another (the Agent) shall act on P’s behalf and subject to P’s control and (2) A consents so to act

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Agent’s Fiduciary Duty (FD)  Key Concept of Agency


Duty of Loyalty: employee has to put his employer interest first. Default rule so that agents and principles know what to expect from each others.

CCS v. Reilly (1963) (while working for P, D solicits P’s clients, and then steels those clients when he quits a few months later. Court held that D was working fm himself, when he should have been working for D, and finds a breach of the duty of loyalty.

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Rule  A agent has a “fiduciary duty” to his/her principe.

Hamburger v. Hamburger (1995) (D-employee makes arrangments to start a company which will compete with his current employer; D takes out loan and rents office space. Court doesn’t find breach of fiduciary duty.

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Rule  Employees are free to make logistically arrangements, like taking loans and leasing space, in contemplation of leaving current job. Rule  Because D was intimately familiar with the pricing and clients list, he is free to use his general knowledge, experience, and memory, “including remembered information" after he leaves o Can’t steal proprietary information considered to be company IP, but can take general knowledge.

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Employment-at-all

Def: At-will → termination at any time for any lawful reason • Right to discharge somewhat limited by deterrent factors/costs to ERs incl. lost reputation, subsequent service by less skilled / diligent work force.

Foley v. Interactive Date Corp. (1988) (P claims wrongfully discharged in contra to an implied K in fact. D argues at-will EE.)

Rule  court will look at the entire relationship between parties and allows pleading of implied employment agreement

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Facts tended to show Witter knew that he was a risk.• •  Rule  Where no employment agreement is found. Rodman & Renshaw (P is defrauded by the son of a partner in the D-firm. Facts tend to show that P didn’t rely on upon agency. Court holds Witter liable under theory that advisor was an agent acting with apparent authority. does Agent have authority to bind Principle • Actual Authority: when P manifests consent directly to A o Express or Implied  Implied authority is highly contextual. Victims no savvy investers. (3) discharges in violation of a covenant of good faith and fair dealing. employment is generally at-will. most efficient mean to protect customers is to hold principle liable for acts of agent. (This had not been adopted. P also didn’t have clean hands in the transaction.  Blackburn v. P also a savvy investor. Witter (renegade Dean Witter investment adviser uses his position to defraud unknowing innocent clients into investing in non-existent stocks. Court finds no agency/liability for firm.) § General Partnerships and Other Non-corporate Business Associations • Partnerships o Partnerships are governed by both statute and common law 4 . but P manifests consent directly to third party who is dealing with A o Express or Implied • Inherent Authority (not in restatements) o A gap-filler when the equities are in favor of holding the principle liable for the agents action even though it is near clear that the agent has neither apparent or actual authority. Three (3) possible exceptions to at-will doctrine • • • (1) Discharges in violation of public policy (2) Discharges in violation of employee handbooks (unilateral contract). Sennot v.) o Manifestations of Consent/Authority in Agency Relations  Generally. Rule  Principle doesn’t owe FD to agent. often depending on prior practices or industry customs • Apparent Authority: when A is without actual authority.) •  Rule  companies in better position to realize risk.

If money left over settled to partners account.) (e) a payment or advance made by a P which gives rise to partnership obligation constitutes a loan which accurse interest **(f) each P has equal rights in the management and conduct of the partnership of the business (h) a partner is not entitled to remuneration for services performed for the partnership o default rule.. partner’s adaptability to changed circums favored over firm’s cont / adaptability Formation  UPA § 202 (a) the association of two or more persons to carry on as co-owners a business for profit forms partnership. etc. Vietri  key inquiry is whether the parties intend to be joint owners. Partners are liable for shortfall or losses in proportion to their share.  UPA § 807 (a)&(b) – settlement of accounts (1) creditors then (2) partner accounts. Court will look at behavior and deduce from of organization. (expenses. 5 . An act outside ordinary course of business or amendment to partnership agreement needs the consent of all the partners. pension. whether or not the persons intend to form a partnership. o Ownership  UPA § 401 – Partnership Rights and Duties • (a) Each partner is deemed to have an account that is: (b) each P is entitled to an equal share of profits and is chargeable w/a share of the partnership losses proportional to the P’s share of the profits o presumption is equal share of both profits and losses • • • • • (c) partnership shall reimburse a P for payments made in the ordinary course of business. (default presumption) Byker v. service.  Hynanbsky v. or co-owners of business for profit.  • Under § 202 (a) if parties carry on as “co-owners” they from a partnership. rent. Mannes  P &D had a number business together which they split profits and shared management. unless received for repayment of debt. o Indiv. can K around • **(j) difference arising in ordinary course of business may be decided by majority vote. §202(c)(3) presumes a person who receives share of profits is a partner.

 Kovacic v.  If in the Partnership   6 . after full disclosure of all material facts. not liable to K for money losses K incurred through the partnership. only receive share or profits after capital accounts settled. where (1) has express authority or where he is acting with apparent authority (unless not authorize and 3rd knows or has reason to know). only where authorized to bind. Partners free to contract around this so that labor could be consider cash deficit in their account.Fiduciary duties rules are immutable and cannot be waived rule. Ladd  court holds that services given to the partnership are not capital contributions. unless the partners contract around default rules 401(h). o Withdrawal  • UPA § 601. Disputes resolved by majority rule. if not manifestly unreasonable or o (ii)…the partners…may authorize or ratify. Cobalt v. • (a) Except as otherwise provided in subsection (b). Parties who invest labor. a specific act or transaction that otherwise would violate the duty of loyalty. On equities  court holds that you only loss what you put in w/r/t to other partners. Can’t eliminate 404(b) loyalty or 603(b)(3) loyalty during winding up.Provides easy exit default rules Fiduciary Duties of Partners o Basic statutes  UPA § 301 – Each partner is an agent to the other. who contributed only labor to partnership. § 401(f). 801 . Reed  court holders that parties have contracted around default rules of § 807. and (2) where not apparently carrying out ordinary business. and can bind other in for ordinary course of partnership business. Shamloo v. R. If deadlock. but: o (i)…[it] may identify specific types or categories of activities that do not violate the duty of loyalty. dissenters can move to dissolve. UPA § 306 – partners are joint and severely liable for obligations of partnership undertaken while they are partners UPA § 103 . relations among the Ps and b/w the Ps and the pship are governed by the pship agreement • (b) The pship agreement may not: • (3) eliminate the duty of loyalty (404(b))…. High  dispute between the parties about an aspect of their business   • Rule  each partner has equal right to manager partnership. Parties who invest cash will be settled first.

or a knowing violation of law.” [note] – dissent believe parties where in JV and therefore the withheld deal outside scope of the JV. liable for breach. thought duty not explicit in their agreement. o (2) to refrain from dealing w/ the p-ship as a party having an interest adverse to the partnership (Storch). incl…a partnership opportunity (Meinhard). P uses for distribution of his share of partnership. give accounting. • • • • “The punctilio of an honor most sensitive. • (5) eliminate the obligation of good faith and fair dealing…but the pship agreement may prescribe the standards by which the performance of the obligation is to be measured UPA 103b(4)• Cant Unreasonably reduce the duty of care o Duty is already so low. UPA § 404 – duties owned to partners duty of loyalty and care (default pretty much same as case law).  7 . not compete Vigneau v.   (4) unreasonably reduce the duty of care under Section 404(c) …. • o FD – Duty Loyalty  §404 Definition– Fiduciary may not engage in self-dealing. Issue – was the withheld deal close enough to the partnership’s ordinary course of business. intentional misconduct.” “Only through disclosure could opportunity be equalized. Partner show failed to disclose information. Salmon  court finds duty of loyalty exist between partners. D refuses to pay him his partnership interest b/c of breach of duty of loyalty/disclose. and o (3) to refrain from competing w/ the p-ship…  Violation of the duty of loyalty cannot result in divestment of the P’s original capitol investment • (c) A partner’s duty of care…is limited to refraining from engaging in grossly negligent or reckless conduct. • (a) The only fiduciary duties a P owes to the p-ship and the other Ps are the duty of loyalty and the duty of care… • (b) A partner’s duty of loyalty…is limited to the following: o (1) to account to the p-ship…for…any…benefit derived by the P [from]…the p-ship business or…p-ship property.” “Thought of self was to be renounced. Storch Engineers  P self deals and resigns. and take advantage of business deal withheld from partnership. (Ferguson) • (d) A partner shall discharge the duties…and exercise any rights consistently w/…good faith and fair dealing Meinhard v. however hard the abnegation. disclose. P is obligated to render true accounts. Yes.

o Rule  Capital contribution not a form liquidated damages for breach of loyalty. •  • Rule  the common law care required is minimal. there is still an implied covenant of good faith and fair dealing.allowing P’s to determine payouts so each would get something different. reckless. “the beginning of the end”  Termination: the end of a pship  Process • Elect to Dissolve  Windup business  lastly Termination 8 . In this case there was a K around loyalty. Williams  Williams alleges Ferguson violated duty of care. Fordham  Law firm partner leaves firm. Ferguson v. Bad decisions aren’t enough. and have breached duty of loyalty. evidence shows that Ferguson was a bad business person.  Dissolution: process of ending a pship. Court uses gross recklessness standard. So while loyalty was K around. Would have been the same under § 404. Remaining partners give him a much smaller share then he deserved. and finds no breach. BUT COURT finds that the payout here was too low. and expections of the parties. • Note  court ruled on basis of equities. • Can’t unreasonably limit the duty of good faith even if limit loyalty o Duty of care    §404 Definition : breached where conduct is grossly negligent. intentional misconduct. o Rule  Partnership can only seek damages equal to profits earned from the activities constituting breach of loyalty. They court holds they are self-dealing to increase their takes. fairness.  Starr v. • •   EACH PARTNER IS TO BE TREATED FAIRLY AND WITH CANDOR AND NO ACTION IS TO BE DONE FOR SELFDEALING. But would have been the same under § 404 duty of loyalty.Unreasonable K around Duty of Loyalty is still subject to judicial oversight. or unlawful. Dissolution and Dissociation o Dissolution Formal Winding Up Process o General  Dissociation: partner no longer part of partnership• By own choice  then dissolution • Wrongful dissociation  triggers byout.

UPA § 601 – Event’s causing dissociation • • • • (1) Partnership having notice of partners’ express will to withdraw (2) agreement event in partnership agreement (3) partner’s expulsion pursuant to partnership agreement (4) partner’s expulsion by unanimous vote if o o (i) unlawful to carry on business with that partner (ii) transfer of substantially all of partnership interest. or by court charging interest (iii) 90 days after charter revoke. other than for security reasons. filed for dissolution or equivalent (iv) partnership has been dissolved / wound up. o 601(1). 9 .  UPA § 701 – Purchase of dissociated partner’s interest • Sets out rules for determining and performing a purchase of a dissociated partner’s shares.o Analysis & Framework of Statutes  Analysis for Dissolution upon Dissociation • § 601  defines dissociation.  transfer of interest § 802 (add 802)  partnership continues through winding up. kicked out.Winding up of partnership • § 603 / 801 o If at-will dissociation under §601 (1)  then § 801(1)  At will dissociation  company dissolves o If dissociation under § 601 (2)-(10)  § 701  •  Death. etc.Partner gives notice he wants to leave (Partnership at will) o So we go to article 8. o o • (5) by judicial determination b/c o o (i) partner engaged in wrongful conduct adversely/materially affect business (ii) partner willfully breached duty owed to partnership or partners.

o Not wrongful if another partner had left within 90 days • • If wrongful  no dissolution.§ 807  On dissolution. If dissociating partner has only been partner for a few weeks w/established business o Wrongful Dissociation  A partner. even through remaining partners want to keep business operation.  • o Can withhold his payment until term is completed • (c) partner who wrongful dissociates is liable for damages cause by dissociation in addition to any other obligations to the partnership or partners. goto 701. and if the partnership is for term. must wait until the end of term to receive their buyout price. dissolution mandatory unless parties K around. cannot build for control of the company. UPA § 801 – Events cause dissolutions and winding up. who is wrongful dissociated. Prof notes that one can always that equities of dissolution are unfair. Brevig  court forces dissolution because of dissociating partner. They cannot order dissolution. • • • • • (1) partner dissociates by will. § 602  wrongful dissociations • (b)(1) if in violation of the agreement (b)(2) if partnership of term. § 701 (c)  provides for damages against wrongful dissociated partner. under 601(1) (2) term of partnership ends (3) occurrence of event in defined in partnership agreement (4) partnership becomes unlawful (5) partners requests judicial determination (6) transfer of interest request judicial determination •  McCormick v. if before term completes. o Dissolution Payouts / Process . assets sold and the payout in order: • • •  (1) creditors (2) partnership accounts (3) profits/losses distributed or shared by partners. If at-will dissociation. 10 .

Per agreement can expel a partner.• § 701 (h) if a partnership for a term. dissociated partner can show that early buyout would not cause undue hardship to the partnership. But must be reasonable • • Bohatch Cannot expel a partner absent an agreement. P tries to aruge that Duty of loyalty extends to a duty to report partners who are overbilling. court holds it is at-will (not for term. Butler and Binon where partnership agreements creates a procedure for expulsion. [Note] that a wrongfully dissociate partner can still use § 801 (5) to can seek judicial dissolution Impracticable to carry on. 11 . o Contracting to Prevent Opportunistic Withdrawal  General – partner leaves. Unless. Brevig •  Family farm Drashner- • o Alcoholic partner can be wrongfully disassociated Fiduciary Limits on Expulsion of Unwanted Partners  § 601(3).  § 601(5) a partner can be dissociated on application by the partnership or another partner. court allows any fundamental schism that sharers mutual trust to be valid reason. the buyout price based on value at time of dissociation 701(b). Court disagrees and finds no duty to remain partners with a whistle blower. taking clients. (ii) willful or persistent material breach of agreement or of duty owed to partners (iii) conduct relating to biz that makes it not reasonably practicable to carry partnership  Bohatch v. the partner’s expulsion by judicial determination because • • • (i) wrongful conduct that adversely/materially affected biz. •   Page v. Would require judicial determination. unless specifically K’ed for). partnership agreements can define acceptable protocol. or contrary conduct by another partner. but it is not payable until the expiration of the term. Page  in an unclear partnership agreement. McCormick v. economic purpose unreasonably frustrate.

o General Law of Agency (w/r/t to partners)  P may be liable to 3d party on transaction conducted by A if A was actually or apparently authorized to enter into transaction o UPA § 301 . Inc v. Jones  LLP partnership tries to escape liability for malpractice resulting from a case tried by one it’s ex-partners after the partnership received a cert of dissolution. Pship for a particular purpose. eg looking for office space. Meehan v. Lundy .Defines extent of liability of a company for actions of its partners  (1) Each partner is an agent of the partnership for the purpose of its business. Shaughnessy  partner leaves taking clients. This is especially true that A can bind B where B would receive up side of the deal. (individuals may not be liable but the Business is bound by the acts of a partner)  • Rule  Other Non-Corporate Business Associations o Joint Venture: Sub-category of general partnership. Act of a partner for apparently in the ordinary course the partnership binds the partnership. A only needs to apparent authority. etc. B. Court finds damages (unfairly stealing clients). trial conducted while winding up.  Line between venture and a simple general partnership and JV is very thin/dull  so care is needed to distinguish. Moss. • Partners as Agents – Allocating the Risk of Loss in Transactions w/ 3rd parties. 12 . and asking who is in the best position to bear the burden of risk.??? need rule/summary o Dow v. etc. A can bind B to agreements with 3rd parties w/o B’s knowledge or consent of actual authority.  Prof note  professor very concerned with the equities. still liable.S. LLP obligated to complete work already in process at time of election to dissolve. Dissocation at-will OK under agreement.  party A and B in form JV. • Violations: handling cases so collection would come later. failure to fully disclose info to clients. Explicit agreement is best. but breach of FD. firm wants damages. o Haymond v. • Acceptable Preparation: logistics. unless the partner had no authority to act for the partnership in the particular matter and the person the partner was dealing knew or had received a notification that the partner lacked authority (2) Where no apparent authority partner can only bind partnership through acts explicated authorized  o PA Proporties. Court: YES. misrepresenting intention to leave. Partnership still liable for work of its partners will winding up.

o o o Limited Partnership: Limiter partners are passive owners. Directors and Officers. 301-303. but do share in the profits Can own shares.the named individuals can amend the bylaws As soon as a shareholders buy stock they have the right to amend. 601. 110. w/ limited exposure to liability. 404. lawyers. not allowed to incorporate § The Corporate Form and the Specialized Roles of Shareholders. which are often. 107. Officers.Power to manage company. 603. 401-404. ULPA §§102(9). Get paid. • General / Introduction / Incorporation Process o o Directors. 1001.  Uniform Limited Pship Act (2001) §§102(8)-(13). 701. elected by plurality (see below). General partners actively participate in business and have full liability. unless otherwise stated in the certificate of incorporation o • • • Default rule  Decisions made by the board are made by majority vote Nominated by sitting board. can’t actively participate in the business w/o sacrificing limited liability status. repeal and make bylaws •  Divest named individuals In the articles of incorporation the power to amend. doctors. 203. 303. accountants. 404(c)  Designed especially for professional partnership. 604  Defining Characteristics • Separation of ownership and management functions • Firm’s continuity / adaptability to changed circum’s favored > ind’s adaptability Limited Liability Company  ULLCA §§202. repeal and make bylaws can be given to the directors but will not divest the shareholders o § 141(a)  Directors • § 141 . or be officers (inside directors) 13 . 801  Defining Characteristics • Partnership-like or centralized management • Limited liability • Adaptability to changed circumstances Limited Liability Partnership  RUPA §§306. Also limited power / involvement. Shareholders § 109  When Articles are filed.

Officers titles and duties are specified in bylaws. this rule is effectively immutable. but management power still with Directors unless otherwise or provided in the articles of incorporation. but not • Can call meetings and vote to make recommendations. Statutes relativity silent on the duty of officers Sarbanes-Oxley requires CEO/CFO to certify financial reports. sell and sue Risk bears and residual claimants No liability to corp / no FD to Shares fungible Rule  All statute hold that shareholder receive voting power. request. can have up to 3 classes of directors.Power to amend and repeal bylaws • • o § 142  Officers  DGCL § 142 • • § 142 . • • • Officers are agents of the corporation. Directors can initiate an amendment to the articles of incorporation. 14 . with a fiduciary duty.Hired by directors to oversee day-to-day § 142 . that must be done through the articles of in corp. Since Directors won’t move to curtail their own power. only one of which is up for election each year. or bylaw passed by shareholders. can be in Articles. o Shareholders normally: assent. • o Rule  The MBCA and Delaware default rules are that only o Rule  Shareholders can initiate changes to the bylaws. o Except. all need a “corporate secretary” for keeping and verifying corporate records. to add control of ordinary biz decisions.o • • Outside directors are not shareholders Individual directors have fiduciary duty to shareholders and corporation Usually held to a “business judgment rule” standard § 141(d) – staggered boards. or recommend. may also be tied to classes of shares. § 109.  Shareholders  those who own an interest in the corporation • • • • They vote.

can call special meeting.Before Share sold. and cannot restrict directors full power to exercise their fiduciary duty. If the company is authorized for 5 million shares. by majority of incorporators. § 242 -. amend.•  109(a) can modify. give notice and explanation of shareholders. longs list. directors propose amendment. Rule  under 102(b) and 109(b) bylaws can only give process oriented restraints on management of the company. The charter must specify the amount. the more fees •  Outstanding Shares • • The number of shares the corporation has sold and not repurchased. and you only issue 10K shares. needs majority of outstanding stock. Delaware charges a fee per share. Authorized but unissued shares are shares that are authorized by the charter but which have been sold by the firm  Types • Common Stock – combine residual claimant status and voting rights 15 . AFSCME Employee Pension Plan • Court holds that a proposed bylaw requiring and specifying the conditions under which the directors must reimburse shareholders for the expense of nominating directors is invalid because it restricts the directors from exercising their fiduciary duties. More shares. substantial room for signification dilution Administrative different. or director’s if elected.After Shares issued. Amending • • § 241 -. • o Certificate of Incorporation  General •  § 102 – Contents of Certificate. or revise bylaws CA. §242(b) – only the board can initiate amendment of process for Certificate • o Shares  Authorized Shares • • Number of shares the company is permitted to issue. The numbers affect will affect the value in relation to the shares issued. or majority of outstanding stock of each class of stock entitled to vote. Inc v. or wait until annual meeting.

o Voting Rights  Default Rules . •  Shareholders are residual claimants. Using Preferred stock is the best means to adjust the value of the shares with a liquidation preference. usually have limited or no voting rights. one vote. in all matters. which are entitled to vote on mater (3) Directors – plurality of those entitled to vote (4) Where a separate vote by class is require majority of share of that class = quorum.  Classes • Shares can be divided in to different class with different voting rights. For example. need a majority affirmative vote by those present. • • With common stock. per director Each director is separate item to vote .” Needs to be in Article of Incorporation. or whatever is in the bank account. or might have 5 votes per share  “dual class common.• Preferred Stock – given to different investors with different incentives like dividends or liquation status.DGCL § 216 • (1) Majority of shareholders entitled to vote = quorum o • Unless AOI say otherwise/Can never be less than 1/3 of shareholders entitled to vote (2) Decision other than election of directors need affirmative vote of a majority of shares present or in proxy. Proxies are allowed o o Proxy must be granted authority in writing  Variations on the Default Rules • Cumulative Voting 16 . • •  RULE 212 Straight voting – default rule • • • • One share. the majority holders can liquidate and take the initial investment. A can cast 15 votes for each director up for election. A has 15 shares. except election of directors. a certain class might have the board to elect 25% of the directors. One person with 51% of share can then elect all of the directors.

(b) if not written consent in lieu of meeting. Protects from hostile proxy fights. Example.  o Equation to determine the number of shares required to elect X number of directors: SX / (D +1) . written consent to elect directors must be unanimous. 3 directors up.  By concentrating their votes. but most stock holders activists. directors can call the time and place of meeting. A has 100 shares. A can vote 300 shares in total. If less than unanimous directorships must be vacant at time of election.§ 141(d) o o Only some directors are elected per. can be done without a meeting. and vote them for one or more directs. dislike as they protected from accountability. TSI  DGCL § 228 – allows that unless otherwise stated in the certification of incorporation. minority shareholders have an increased likelihood of electing their director to the board. by written consent of a majority shareholders or quorum as designated in the AOI • Most public companies opt out of this provision 17 . any action required to be done in meeting.o Shareholder can vote: shares X directors  can concentrate on one or more directors. +1 Staggered Boards .    S= number of shares voting X= number of desired directors D = number directors up for election Example. (a)(2) Directors can authorize in their sole direction that shareholders may participate via remote commutation. [gets around Hoschett v. an annual meeting shall be held to elect the directors. • Dual Class Common Stock o Different number of votes for different class of stock (Google) o Annual Meetings  DGCL 211 – • • • (a)(1) unless otherwise stated in the Articles or Bylaws. to elect 2 directors where 100 shares are voting for 5 directors  • • 100 x 2 / (5+1) = you need 33 shares.

if less than the entire board is to be removed. P has no notice of substance of meeting  as controlling shareholder.  Murray v Conseco. no director may be removed without cause if the votes cast against such director's removal would be sufficient to elect such director if then cumulatively voted at an election of the entire board of directors. in the case of a corporation whose board is staggered. Inc. if there be classes of directors. with or without cause. had right to know substance of meeting before hand. P in dual role. or o Cumulative voting  (2) In the case of a corporation having cumulative voting. Some companies keep. Alderstein v. Board calls meeting. 228 allows the election of directors by consent but does negate the meeting requirement.Directors may be removed. Current law  Section 211 (b) revises this.  • Court  reverse vote on general farness. o As controlling stockholder. exceptions o Staggered board  (1) Unless the certificate of incorporation otherwise provides. the board must notify him. removed by Board. • Policy: meetings are an important means for shareholders to keep the directors and management accountable. by holders of a majority of the shares then entitled to vote at an election of directors. a way to for shareholders to voice their concern. or. TSI – Rule . Wertheimer (DE): P controls 75% of stock and is on board. so that they can cut down on the costs of meetings. Many public companies opt of this. under certain circumstances. Rule  removal rules modified by fairness consideration and FD. A vote to elect directors by written consent does not satisfy the annual meeting requirement in DGCL. but springs a vote on him to kick P off board and issue new shares to 3rd effective wrestling control of company of P. and allows voting and election of directors in lieu of a an annual meeting. Hoschett v. Argument: can only SHs remove him? Held: Board w/in authority in removing Murray. • 18 . Board has FD to shareholders. • • • o Removal of Directors  DGCL § 141 (k) -. A written consent provision does not negate the requirement of having annual meeting. he could have kicked all other board members off he know. The court orders a meeting. (Indiana): Articles of incorp don’t have provisions re removal of Ds. at an election of the class of directors of which such director is a part. shareholders may remove only for cause (if not up for election). Murray elected to Board.

investment k. debenture. or any instrument known security • Look to see whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others. directors Current financial statements o Basically info to lead to sound investments o Exemptions from Registration  Intrastate Exemption • Sales by a local company to local investors for local use  Regulation D: provides three exemptions • • Rule 504.) 19 .• Initial Issuance of Securities o Securities Act of 1933  o Regulates offering and sale of new securities THE SEC Created in 1934 Act    Independent Agency Created to enforce securities law Creates rules and regs to make securities law more effective o Security  Any note. o Registration of Securities   Securities Act 1933 requires that all securities for sale must be registered with the SEC or meet an exemption Registration • • • • Description of Business Description of security to b offered to sale Info about the company’s management. bond.Exemptions for some firms who sell up to $1million of their securities in a 12 month period Rule 505 o o Offer up to $5 million dollars in any 12 month period Only to accredited investors (banks etc. stock.

still can’t beat the market • Institutional Investors • Proxy Voting o “Proxy”  Legal relationship under which 1 party is given power to vote the shares of another  Person or entity given the power to vote  Tangible document that evidences the relationship Federal Disclosure Rules (SEC) o  o [missed class / no notes] Proxy Solicitation in Process and Shareholder Voting  Proxy • • Either given the shareholder instruction or absolute discretion Is given the power to vote so the shareholder does not need to attend the meeting 20 . stock is “liquid”  Valuation: you get what stock is worth.• Rule 506 o “safe harbor” under section 4(2) of the 1933 Act o o Raise unlimited amount of capital To accredited investors and 35 others  o 35 others must be Sophisticated investors Must give non-accredited investors disclosure documents  • Financial Statements Governance in Publicly Held Corporations o General/Introduction [missed class / no notes]  Unique Characteristics of “Publicly Held” Corporations • National Market System and EMH o Nat’l Market System: virtual location where anyone can buy/sell shares  IPO: initial public offer. according to market  Monitoring: people pay only what stock is worth  Different Forms • Semi-Strong: you cannot d1 `evelop a trading strategy that will beat the market by using publicly available info • Strong Form: even if strategy is based on nonpublic info. when initial SHs can sell their shares o Efficient Market Hypothesis (EMH)  Liquidity: where people are buying/selling.

and have proxies solicited in favor of them in the company’s proxy statement.•  Can be used to pool votes especially for institutional investors Concern about Activist Shareholders • Hedge funds have been pursuing managers to make changes in how they operate the corporation o Marty Lipton: “Today shareholder activism is ripping through the boardrooms of public corporations and threatening the future of American Business.  Sec Proxy Rules • Shareholder access to effective means of communication w/other shareholders Rule 14a-7  Solicitation Assistance to Shareholder o Requires a corporation that itself is solicit shareholders in connection with an annual meeting to provide specified proxy assistance to requesting shareholders Corporation must either   1. Directly mail the requesting shareholders proxy material to shareholders and financial intermediaries • o • Rule 14a-8  Shareholder Proposals placed with Corp. 21 . Provide shareholders a list of shareholders 2. Proxy Statement o o Allowing qualifying shareholders to put a proposal before their fellow shareholders And have proxies solicited in favor of them in the company’s proxy statement.  Company responses to proposals • Attempt to exclude on procedural or substantive grounds o • • Must have specific reasons to exclude that is valid under Rule 14a-8 Include with opposing statement Negotiate with proponent o o Wide range of possible comprises If the proposer is powerful (Calpers) the board will just negotiate s solution rather than put it to vote. private equity firms have been acquiring a larger number of public corporations. • But.

but o 14a(8)(g) burden on company to show it should be exclude o 14a(8)(h) must send representative to meeting for vote. then a reasonable time before meeting. •  Oftern Proponets send out a press release to shareholders SEC Response • Staff level action o o o Staff determines can be excluded. special interest  5) Relevance. issues a no-action letter Staffer determines should be included. no previous yearly meeting. • Substantive exclusions: o Rule 14a-8(i): Grounds for mgmt to refuse to include SH proposal in the corporate proxy  1) Not a proper subject of SH action under state law. o ** 14a(8)(f) if fail to comply.  3) Violates SEC proxy rules. issuer must provide proponent with opportunity to cure most errors within 14 days after submission. incl 14a-9.. or 1% of the companies securities continuously for 1 year. can be exclude with notice. Otherwise 120 days before date of the last published proxy in the previous year. Process for Excluding a Proposals • Management files a notes of intent to exclude o o Accompanied by an opinion of counsel if any of the state reasons rely on legal issues Under rule 14a-(8)f. Relates to <5% of assets and of earnings and is “not otherwise significantly related to the company’s business” (Iroquois).  2) Would cause corp to violate law. prohibiting false or misleading stmts  4) Personal grievance. notify the issues Intermediary options … notices of deficiency  Procedural Exclusions • Proponent does not meet ownership/format guidelines o 14a(8)(b) Must holds $2000. 22 . management must notify the shareholderproponent of remediable deficiencies in the proposal and provide an opportunity for them to be cured. o 14a(8)(c) One per meeting o 14a(8)(d) Can only 500 words o 14a(8)(e) if special meeting. or date more 30 days from previous year.•  Adopt proposals as submitted.

” including amending Articles. • 23 .P wants company to studio force feeding of geese.> SEC refused to issue no action letter. The proposal only asked for a study. Function of management  8) Relates to the election of Ds  9) substantially implemented. notify the issuers Intermediary options … notices of deficiency  Lovenheim v. 6) Would be beyond mgmt’s power. Iroquois’s . Goeverance Related Shareholder Proposals  Governance-Related Proposals • US Bancorp. issues a “no-action letter” meaning the SEC won’t take object to taking the action (exlusion). which can only be down by a vote the shares (DE law doesn’t allow board to charge Articles) o Holding -.” • Holding ”otherwise significantly related” includes ethical and/or social significance. management must notify the shareholderproponent of remediable deficiencies in the proposal and provide an opportunity for them to be cured.  +more see statute. D defends on basis of relevance. 7) Relates to “ordinary business”. Process for Excluding a Proposals   • Management files a notice of intent to exclude o o Accompanied by an opinion of counsel if any of the state reasons rely on legal issues Under rule 14a-(8)f. doesn’t interfere with management. o o Staffer determines should be included. o Rule shareholders can bring up issue by using nonbinding language (no management interference under 14a-8(i)(7)) and defend relevance w/ “significantly related to business” under Rule 14a-8(i) (5). proposal passed for Board to take “all action. Board requested “no action” letter under 14a8(i)(6) no basis that such change would require amending the Article. Request for “No Action” Letter: SHs requested Board to take “all steps necessary to cause annual elections” for all Ds (current system w/ staggered groups). •  Often Proponents send out a press release to shareholders SEC Response • Staff level action o Staff determines whether can be excluded. less the 5% of companies revenue Rule 14a-8(i)(5). P argues rule allows for proposals that “significantly relataed to business.

]  Conservative Caucus v Chevron Corp. shall. (DE): P-Corp wants SH list to communicate w/ other SHs re risks of involvement in Angola. and its other books and records.o Communications and Access to Corporate Information  Missed class / no notes  DGCL §220 Inspection of books and records. shareholder can as court to force access • (d) directors entitle to records that reasonable relate director’s position  “Proper Purpose”: purpose reasonably related to such person’s interest as a stockholder  SEC Act §14a-7 • Shareholder desiring to make proxy solicitation may ask corp for “14a7 assistance”  corp then w/ choice b/w mailing proxy material for SH (at SH expense). Errors need to rise negligence to be actionable 24 . • RULE  Burden on corporation to show lack of proper purpose. Held: P entitled to list. Shareholder Litigation. § Fiduciary Duty. have the right during the usual hours for business to inspect for any proper purpose. The corporation has actual p ossession and control of such records of such subsidiary. or providing SH w/ list of SHs • [usually choose directing mailng. or the extent the corporation can control the subsidiary (might be illegal) • (c) if corp refuse. there may be market consequences for Ds/Os that fail to make SHs rich • FIDUCIARY DUTY – Duty to the Corporation • Officers are the ones that really run corps. other improper purposes irrelevant if proper purpose exists. in person or by attorney or other agent. upon written demand under oath stating the purpose thereof. more control of time. Business Judgment Rule  Duties of Fiduciaries • Directors are supposed to run the corporation for the benefit of shareholders o No actionable duty of Ds to make most money possible for SHs o BUT. and to make copies and extracts from: o (1) The corporation's stock ledger. Ds delegate their duties to Os • Methods of Enforcement o Action brought by corporation at behest / under direction of directors o “Derivative” action brought on behalf of corp by 1+ shareholders  Business Judgment Rule • General: Director/officer have discretion to make business decisions relating the management of the company. a list of its stockholders. o Bad decisions not enough  shareholders have taken the risk the company may make mistakes. to the extent that:  a. bad decision. • (b) Any stockholder. and o (2) A subsidiary's books and records. and the Business Judgment Rule • Role of Fudiciary Duty and The Business Judgment Rule o Duties of Corporate Fiduciaries.

unlawful fraud. loyalty. and continuing revenue.: SH suing D for bad decisions of upgrading facilities and lowering price of cars rather than distributing dividends to SHs. you can ask the Board for permission. Held: Ford could pursue upgrading facility. not checklist. good procedure will thwart any evaluation of the substance (i. conflict. deference to Court.. Fiduciary Duty of Loyalty.Interested Directors o A transactions shall not be voided even if an interested director or officer is involved. or make a decision.e. except as may be otherwise provided in this chapter or in its certificates of incorporation DGCL 144. but analysis of equities.Suit against Wrigley (as director) for negligence / mismanagement. self-dealing. o Note: his would never happen today. and good faith o Held to an abuse of discretion standard o Shareholders have burden to show enough evidence to overcome presumption Shlensky v Wrigley: Bad business decision does not constitute negligence. o Usurping of Corporate Opportunity  Factors/elements • Opportunity closely related to business in which corporation is engaged • Director found out about opportunity in connection w/ her duties • Offeror is intending opportunity to go to corporation • Opportunity is something director should reasonably think would be of interest to the corp • Director / senior executive knows opportunity is business in which corp is actually engaged or plans to be engaged in (regardless of how directors finds out about opportunity)  Delaware Factors( Guth/Broz) • Ct analyzes equitable factors. court orders Ford to pay dividends. seeking damages & order for lights on baseball field and night games. o Judicial presumption that Ds have acted in accordance w/ duty of care. o Or the Majority of the shareholders approve o Or the transaction is fair to the corporation at the time. Dismissed.• • Gross negligence. unless the majority of the disinterested directors vote for it. but don’t have to. but because of the large amount of cash on hand. Ds have more discretion.Includes Duty of Good Faith o General  Core requirement that directors favor corporation’s interests over their own  All FD claims are concerned with the process/procedure used to evaluate. • Balancing factors  Whether D breaches FD by taking a bus opp depends on – May Not Take IFo Corporation is financially able to take the opportunity o Opportunity is in the corporation’s line of business 25 . etc. Court believes Ford abused its discretion. esp re dividends  • • • DGCL 141-A o The business and affairs of every corporation organized under this chapter shall be managed by or under the discretion of a board directors. disclose. recklessness. In many case. deference to BJR). Dodge v Ford Motor Co.

 Northeast Harbor Golf Club. fairness). interested parties. no okay to interest. waive repayment altogether. Held: Court choose ALI approach  Broz v Cellular Info Systems: Cell territories for sale. interest or expectancy. surrounding land for sale. Globe Woolen v. recusal) will settle concerns about substance of deal. or self-deal. must disclose.o Corporation has an interest or expectancy in the opportunity between director’s self-interest and that of the corporation o Embracing the opportunity would create a conflict of interest • An Officer or director may take a business opportunity if: o o o the opportunity is present to the director or officer in his individual and not his corporate capacity the opportunity is not essential to the corporation the corporation holds no interest or expectance in the opportunity o resources of the company in taking or negotiating the opportunity. Held: Broz not req’d to make formal presentation b/c he had reason to believe CIS not interested in opp / couldn’t take advantage even if offered. then canceling • • •  Tyco -. Conflict of Interest  General o the director or officer has not wrongfully employed the • • Modern rule: conflict of interest of transaction voidable only if transaction / conduct of interest parties as unfair to corporation If. financial ability. Example: o Enron – brokers signing sales agreement. Concern with process  good procedure (disclosure. and must oppose transactions they know are ruinous Court  finds Fiduciary Duty • 26 . collecting bonus. interested parties can’t sit silently. purchased / developed by director. then must remove themselves from decision making process.interest free loans to directors. Utica Gas and Electric • Rule  conflict of interest transaction voidable. and fully disclose position. Inc. and weighs them all. OK to be an interested party. Delaware approach: ct looks at equitable factors (line of business. Broz/RFBC purchased. v Harris: Golf course.

usually at their cost. but great benefit to D at P’s cost. D can’t fails to prove fairness. with others act. and that party receives corporate assets (benefits) to the exclusion of other shareholders. D-majority sharehold breach fiduciary duty to other shareholders by not enforcing contract. But there is an exception for the controlling shareholders. Sinclair Oil Corp. may be betrayed by silence as well as the spoken word. even thought the disinterested directors be less than a quorum. if there is improvidence or oppression. • o Intrinsic Fairness Rule  used when parent has received a  Standard If a party is on both side of the deal.  o Held: self-dealing transaction. who hold a majority of the shares o Note  Stockholders don’t usually have a fiduciary duty to the o Statutes  § 144 – (cleansing conflicts) Interested Directors. He cannot rid himself of the duty to warm and to denounce. controls both sides of the transaction. company. there would be a presumption that the directors act with good faith and due care. Burden on D-party to show transaction is/was intrinsically fair to complaining party. v. or lurking beneath the surface. or sets of person. if all if equitable and fair. but to visible to his practice eye. Then burden would be on P to rebut.”  Self-dealing • Def: a transaction involves self-dealing if one person.GO TO INTRINSIC FAIRNESS RULE FIRST THEN DETERMINE BJR benefit to the exclusive of the minority shareholders of the subsidiary and at the expense of the minority shareholders. OR 27 . No benefit to P.” “The trustee is free to stand aloof. and body in good faith authorizes by majority vote of disinterested directors. IF o (1) Full disclosure of interest of authorizing body or committee. Levin: D-majority shareholder directs Pcompany to not enforce breach of contract against a company he owns. o BJR DOES NOT APPLY FIRST.o o “A beneficiary about to plunge into a ruinous course of dealing. [note] If this was just business judgment rule. either apparent on the surface. Quorum • (a) Transaction shall not be voidable solely because officer or director is an interested parties.

Lord: Board approves stock option plan which gives fully vested options to directors as incentive to help ailing company. the directors can approve stock options plan. o Options plans must provide reasonable safeguards to ensure the corporation receives the benefit of its bargain.” o Rule  if it would reasonable to expect that a directors exercise of independent judgment would be compromised. decision lies outside BJ Rule’s protection  Delaware Fairness Test [for ex comp] • (1) Benefit Prong: is there an identified benefit to the corporation. Stockholders share for breach of FD. Stock backdating Scandal  Is back dating illegal?  • Not necessarily illegal if: 28 . o Under §157(a).” Issue is whether a director is per se interest because of family relationship. Court uses special test for stock options: Court applies fairness test. one director leaves right after getting the options which are fully vested. • Held: options did not provide reasonable safeguards to ensure corp would received benefit of plan because options were fully vested.  (b) In the absence of actual fraud in the transaction. the Board has authority to fix compensation of directors (DGCL §141h). Should be reasonable in relation to the benefit  o this basically. BUT. the judgment of the directors as to the consideration of received for the options is to be considered conclusive. just like consideration analysis o Byrne v.  Shapiro v.o o • (2) Disclosure to voting shareholders and the shareholders approve in good faith (3) The transaction is fair to the corporation at the time it is authorized (b) Interested directors can be counted in determining quorum. • • (2) Value Prong: Is the value of the options reasonable in relation to the benefit. Held: remand for determination of director’s interest. Conflict and Executive Compensation  Unless otherwise restricted by COI or bylaws. • Court  summarizes ALI and MBCA as: an “interested director” is either (1) has an personal interest in the transaction. Greenfield  definition of “interested director. the director will be deemed an interested director. or (2) has lost independence because a director with no interest is controlled by a self-interested director.

Van Gorkum: shareholders sue directors after directors make an uninformed recommendation to allow buyout at a below market shareprice.  Minimal duty b/c of business judgment rule  To have violation.Entire Fairness Doctrine • o o o 29 . DETERMINE LIABILITY BJR Applies First. boards required to focus on decision making process to ensure that they are well informed.” • Defense to Duty of Care: D can show “Entire fariness” of the transaction o (1) Fair price and o (2) fair dealing  Consequence of Smith was shocked incredulity. in good faith and in the honest belief that action was in best interest of the company. every disclosed and decisions have reasonable basis. • Process over substance. IF BJR is overcome by the P. BLR doesn’t apply. these conditions are rarely met. • Court  BJR assumes directors acted on an informed basis. • Court  Duty of Care: “Representation of the financial interests of others impose on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. Where no informed. FD may be violated. • Nobody wanted to be directors because of increased liability. “ Rule  Breach of Duty of Care  Party must prove gross negligence by directors who failed to inform themselves of “all material information reasonable available to them.o o o o • No documents forged Backdating is clearly communicated to the company’s shareholders Backdating is properly reflected in the earnings Backdating is properly reflected in taxes BUT.substance of the Deal  Then the Defendant must show that the deal was Fair. director action must be grossly negligent or reckless o Policy arguments for limiting reach of Duty of Care  Shareholder voluntary assumption of the risk  Court’s institutional competence in assessing business decision  Incentives for directors to take risk and to innovate o Duty of Care in Decision Making  Smith v. making backdating of grants illegal in most cases. Where the process is bad. • Fiduciary Duties of Care and Good Faith o General.was there a good process to the decision making  Burden is on P to show that D was grossly negligent and Directors Failed to inform themselves of material facts that were reasonably available.

unlawful payment of dividend or unlawful stock purchase or redemption o for any transaction from which the director derived an improper personal benefit. o  • • o Holding  if all the P can show is a duty of care argument.  If they can’t prove it was fair then directors were liable for monetary damages Statutory Exculpation Provision  DGCL § 102(b)(7) . Malpieda v.no self dealing o Act or omissions in bad faith. and provision in articles] Intersection of Duties of Care and Good Faith  Landscape • (1) Duty of loyalty o o Usurpation of corp opportunity Conflict of interest / self-dealing beyond gross negligence o Bad faith/ breach of good faith (Caremark and Stone)  • (2) Duty of Care o  General • Emphasis on all fiduciary duties is on decision-making process and procedure. In contents of the Certificate of Incorporation.Pretty Much Limits Duty of Care completely. bad procedure. And the deal was fair. That the deal got a fair price • 2. provide that the provision doesn’t eliminate o Duty of loyalty. can result in liability.o • 1. 30 . bad faith. intentional misconduct. Gross negligence o Good process and bad results tolerated under BJR.Statutory Exculpation Provision. or violation of law § 174. [need to have statutory validity. then the statutory exculpation clause is a complete defense. failure to disclose/monitor. BUT it leaves duty of loyalty • Companies can include in their charter a provision eliminating or limiting the personal liability for director or shareholders for monetary damages for breach of fiduciary duty as a director. Townson: Shareholders sue the directors for violate of duty to of care for agreeing to a restrictive deal agreement and not soliciting other bids.

After compliance situation has arise. and (4) internal communications between the audit committee. or acting in bad faith.o BJR doesn’t apply where directors uniformed.  Practical Consequence of Caremark: • • Created further emphasis on procedure used by boards to conduct business. • What is an Effective Compliance program 31 . (3) communication between the audit committee and the board. the CFO. Directors need to: o Be appraised of compliance. under circumstances may render a director liable. • Court  o Board must exercise good faith judgment that the corporations information and reporting systems in concept and design are adequate to assure that board appropriate information will come to their attention in a timely manner. need to have a qualified financial expert. Held: there is a duty to monitor but Caremark doesn’t lose. • Rule/Test  o Duty to monitor beached when there is a sustained and systematic failure to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system – will establish a lack of good faith. o Changes included:     (1) the independence and expertise of audit committee members. • Auditing Committees  Major changes to strengthen. The shareholders claim the board was inattentive to the violations of the Anti-Referral Payment laws. (2) the audit committee’s control over the financial audit process. litigation and similar risk-related matters. including selection of the outside auditor. Failure to do.  In Re Caremark International: The shareholders sue Caremark brought in a derivative action for breach of duty of care. board must be involved in the approved design of an effective complains and monitoring program. that is a necessary condition to liability. and individuals charged with carrying out the internal auditing function. the CEO.

Foodservice: Company has cause of action against CEO whole lied to board in bad faith. • Rule  Court applies Caremark standard but clarifies that the breach of good faith is a violation of the Duty of Loyalty (outside scope of exculpation provision) Caremark Standard  necessary conditions predicate for director oversight liability. • • •   Training Reporting/monitoring Enforcement Board and management oversight Implement improvements o Procedures and programs   Closely tailored to a Company’s particular business and associates legal risks Currently verifiable and effectively understood by all employees  Stone v.    Assess ricks Establish/revise company polices to address ricks Establish procedures to ensure compliant with company policies. Shareholders alleged failure to monitor under Caremark. OR (b) having implements such a system or controls. or bad process in decision making can be so bad to constitute breach of loyalty and avoid 102(b)(7) exculpation. and personal liability.  Miller v. Ritter: shareholder lawsuit against directors for failing to comply with federal banking laws. CEO has FD to board and company. • Special Aspects of Derivative and Direct Litigation 32 . resulting in big settlement to feds. consciously failed to monitor or over see its operations thus disabling themselves from being informed of the risks or problems requiring their attention. o o (a) the directors utterly failed to implement any reporting or information systems or controls.o Effective compliance programs generally consist of fie main areas. • • Holding/Point  failure to act. Liability attached.

Arise out of an injury done to the corporation as an entity •  Delaware’s Test  • Tooleys two-pronged standard to determine which type: o o Who suffered the alleged harm. the corporation. Arise from an injury directly o the shareholder. Cause of action belongs to the corporation as an entity.o General  Direct and Derivative Suits • Direct Suit  bring cause of action in the name of stockholder. or a suit that would affect the interests of the directors Allows shareholders to hold directors accountable Plaintiff-side concerns o o o • Any recover goes to the corporation (settlement or trial) Lawyer is real party in interest (they make huge contingent fees out of any recovery). • • Defendant-side Incentives o Strike Suits:  o Settle to go away Meritorious suits against insider defendants   Indemnification: Corporation must reimburse director’s expense if successful defense Settlement in which director doesn’t pay anything deemed a success. o Demand on Directors  General 33 . Cause of action belongs to the shareholder as an individual. Corporation also must pay plaintiff’s legal fees if there is a substantial nonmonetary benefit. so they may not be inclined to bring a suit for the corporation against themselves. or the stockholders? Who received the benefit of recovery?  Policy Concern • Director’s might be interested parties. Derivative Suit  Brought by a shareholder on corporation’s behalf.

shareholders best shot against board it to show futility. Facts about his health. Need to show more than just is age. and owned 46% of the stock.  Futility Exception  if the Shareholders can show that such a demand would be futile. • What kind of facts would show this: o o o o o Family ties b/w parties Financial interest of parties. P had alleged that D had appointed the board. Shareholders must allege with particularity of facts why it would be futile. shareholders must make demand on board. and invokes BJR. Board can then reject demand after consideration (show process) and then rely on BJR to defend their decision. approved contracts at issue. facts that would show a problem with the process. P argues that because the board approved agreement they will be liable.• Shareholders are required to make a demand on directors for the desired action before bring suit against directors. o Director Response to Demand 34 .  If shareholder want corporation to sue to enforce a contract. play golf. the demand require will be excused. o Practice Point. o Importance  Because.Never make the demand. • Burden of demand  once board consider demand. • Rule/Test: Demand will be excused if the plaintiff can create a reasonable doubt that o (1) that the directors are independent and disinterested (procedure) OR o (2) that the challenged transaction was the not product of informed business judgment (substance).. directors can demand rejection of demand with BJR. Court holds that P needs to alleged facts with particularity that would show liability. Anything to show reasonable doubt. sickly. always argue futility as demand implies the board is not disinterested o Aronson v. P must show the board is not disinterested. o Analysis/Example. Lewis  Court holds that the facts alleged where not sufficient to excuse demand requirement. and as such would be suing themselves. does he go on vacation. parties doing business with each.

DGCL both authorizes indemnification but limits it in important ways i. settlement or criminal fees Indemnification rights come from 1.  o Breach of Loyalty.] a. In re The Limited Inc. at the lowest offered prices which gets the buyer the number of shares it wanted. Buyer then buys shares. Indemnification and Insurance i. sellers offer to sell at a price of there choosing. Claim requires allegations that corp received literally nothing in consideration.” Court looks at directors financial ties to corp. Concern is limiting Director's risk of litigation costs. there is a claim for breach of duty of loyalty. TO PROVE Prong one of the test o Aronson Standard  demand excused if the P can show reasonable doubt that the board is disinterested. demand is excuse. o Waste   NO. the less independent. the greater the tie. [Dutch Auctions  buyers gives range for price and amount that it wants. or lacking independence  Court applies a “subjective test.  Because 6 of the directors were interested. Common law and statutory rules a. ii. Corp bylaws 3. Contract 2. 145 (c) requires indemnification of Ds if they are "successful on the merits or otherwise in defense of any suit" 35 . Today all states have statutory provisions authorizing indemnification to some degree. Shareholders Litigation • • Shareholder derivative claims. At CL corporate employees were entitled to indemnification for expenses incurred on the job including certain legal liabilities but directors were not b. Court finds b/c there is reasonable doubt a half of the directors.

in suits brought by or on behalf of the corp may indemnify • • • • for only expenses. including attny fees but not jments ONLY If they acted in good faith If the D was held liable to the corp he can only be indemnified with court approval  (c) corp MUST indemnify a director or officer who "has been successful on the merits or otherwise" • As for Directors and officer who are unsuccessful check whether indem is allowed under (a) or (b).  (e) the corp may advance expenses to the officer or director provided that the latter undertakes to repay any such amount if it turns out he is not entitled to indemnification (f) corp May enter into written agreements with D's / officers that go beyond the statute. statutory rights shall not be deemed exclusive of any other rights  36 . iii.indemnify the D or Officer 145 (c) requires indemnification of Ds if they are "successful on the merits or otherwise in defense of any suit" OR ALLOWS indemnification If not successful in suit but had acted in good faith 1. OR ALLOWS indemnification If not successful in suit but had acted in good faith 1.MAY but need not . So no indemnification where found to NOT Have acted in good faith • DGCL 145  (a) Direct suits .Derivative suits. So no indemnification where found to NOT Have acted in good faith ii.ii.In suits by SH or third parties " a corp may to indemnify the director or officer for • • • • • expenses (including atty fees) plus jments fined and amounts paid in settlements IN both civil and crim proceedings…" ONLY If the person acted in good faith and reasonable belief that they were in best interests of corp and not illegally  (b) . If so the Corp .

or at least. Articles must state that you elect to be a closed corporation • o Problems that can arise in closely held companies   Controlled by majority shareholders.default manager control but can K 37 . there is no secondary market for the shares Risk of being frozen out of decision making and compensation o o Minority shareholders may have no control over company’s activities May be denied compensation if denied employment  • LLC’s solve problems by agreement or K Contracting as Devise to Limit the Majorities Decision o Contracting and Director’s Decision.• • See Owens CorningCan make additional K to create presumptions to grant D indemnification as long as it doesn’t violate the statute. fired. § Governance and Control in Closely Held Corporations • General/Introduction o Close Corporation  DGCL 342 • 30 or less shareholders. Lock in / Frozen out • Locked in as shareholders o o • Close corps often restrict share transfer Even if no formal restrictions.Member managed or Manager Managed  can get kicked out. just get outvoted on the board. stock must be subject to transfer restrictions and no publicly issued stock.

The agreement doesn’t constrain parties voting as directors. Can’t contract around with agreements that require board to keep someone on the board. Taft (NC Supreme Court . Stoneham (NY) o • Cannot K to remove Director/Manager FD or prevent them from making independent decisions/judgments Clark v. Dodge (NY) o P and D control 100% of company. 38 . Basic contract analysis case. o Rule  shareholders can abrogate directors rights. and fix their • Zion v. Dodge and effectuated the intent of the parties who had signed a “shareholders agreement” even though the company had not formally become a close corporation. D-company believe the provision is a bylaw and only needs majority vote to be amended. own rights. gives minorities shareholders a bit more control. owed FD to shareholders to do. • Courts holds provision is bylaw. violates FD> • McQuade v. and board would not give unreasonable salary t others.Mostly will enforce K • Where shareholders agree to vote together in a certain way. Rule  Directors must exercise their independent judgment. receive salary. D agrees to vote to keep P on the board.  Dissent makes a good argument for the formal requirements of becoming a close corporation as necessary to warn future purchases of the company’s share. only when required by the corporations best interest. nor the directors generally. us1978) P argues a provision of bylaws agreed to by shareholders is actually a “shareholders agreement” which requires consent of all shares to be amended. o Contracting and Shareholder Voting  Shareholder Voting Agreements. Court upholds on basis   No 3rd party shareholders Court believe restrictions on D were negligible. applying DE law 1980) o Court followed Clark v. Does not effect D’s FD  Blount v. restricts SH role only.  Ramos v. Kurtz (NY court. Estrada (Cal. • Rule  Voting pool agreement valid between the parties with respect to voting shares as shareholders.) Court enforce shareholders agreement which created a voting pool required they vote together.

• Holding  The agreement is valid. 39 . • Two controlling families had agreement that they were to vote together. o Vote Pooling Agreements: Enforce mechanisms  Ringling Bros. partner.. etc. One family later sues. In the event of deadlock. DGCL § 218: a copy of trust document must be filed with corporation’s registered Delaware office • Some states limit to 10 years.Permits shareholder voting agreements as does CA law. Advantages   Efficiency Disadvantage •  Loss of control and flexibility. who becomes the nominal. the disagreement was to be determined by an arbitrator. arguing that having the arbitrator vote for the shareholders is against public policy.• o DGCL 218. not against public policy to agree to a third-party mechanism to voting.DEALING WITH ILLIQUIDITY PROBLEM o Starting point:  Analysis • What kind of business association is this? o o In capacity are individuals operating? Shareholder. if any. director. Solutions to Background Rules  Agreement relating to limitation on the board’s discretion • Voting Trust o Agreement amount shareholders under which all of the share owned by the parties are transferred to a trustee. • Fiduciary Duty and Threat of Dissolutions as a Check on Majority Action (closely help corporations). record owner of the shares  o Trustee votes the shares in accordance with the provision of the trust agreement.

they rules where in the bylaws. • Court rejects special close corporation fiduciary duty o Ex ante filing and contracting. When shareholders buy in.g.• Did individual violate a contractual or default obligation or duty? o Some obligations are immutable.) • Court holds that shareholders in close corporation owe each other an utmost good faith and loyalty” similar to a partnership. Blackwell (De) minority class-B shareholders argue that company can’t give extra liquidity to class A shares. (b) grounds for dissolution are 40 . Sinclair Oil v. amend the bylaws. Rodd Electrotype Co. . court uses intrinsic and entire fariness standard o Partnership Analogy and FD  Donahue v. Levien) o Majority shareholder was self-dealing. (Mass. no ex-post judging • Involuntary Dissolution Buyout o General    o Method to prevent oppression via power of dissolution Minority has broad grounds to ask the court for dissolution If court orders dissolution. can fill for an involuntary dissolution on specific grounds in (b) •  Statute not limited to statutory close corporation. etc. o Shareholder Fiduciary Duties  At early common law. Holds the majority opting to buyback shares from shareholders at different/unfair prices violates duty down. shareholders qua shareholders had no fiduciary obligations to firm of fellow shareholders • Some erosion vis-à-vis controlling shareholders of public corporation (E. o Only good law in Mass  court decides to treat as partnership. Court holds that different treatment of classes is fine. would not happen in DE.  Nixon v. some are contractual. majority can buyout minority for reasonable price California General Corporation law § 1800  (a) Shareholders holding 33 1/3 of the shares or equity of corporation.. or any shareholder of a close corporation. and you would need to contract around with a shareholders agreement.

• Share Repurchase Agreements o General  Two types • •  o Sell back – orderly liquidation if someone dies Buy back – if someone leaves If shares subject to a repurchase agreement must be listed on stock certificate. need real expectations. if they can’t agree. court has a process to help figure fair value. court looks at reasonable expectations of P • Disappointment note enough. but court things that at some point. • • •   o § 2000 the corporation.  Gimpel v. Interpretation/Enforce 41 . Bolstein (not DE) court holds the majority cannot forever freeze out P-minority shareholder. and wrongful conduct. can avoid dissolution if the buy all of the shares from those seeking dissolution for fair value. (NY) could order dissolution because oppression. deadlock) Oppression Cases  Re Kemp & Beatley. they either need to buy him out or cut him back in to proceeds. • Court defines oppression as o o • (1) violation of reasonable expectations (2) burden. P is an embezzler and bad actor. mismanagement abuse. Inc. unfairness toward any shareholder or its property is misapplied or wasted in any close corporation to protect the rights of the shareholder. harsh. where majority cut of P salary and dividends which he had since beginning. lack of honesty & fair dealing. Would not have happen in DE. or person w/50% of the shares.• • abandoned business for more than one year board deadlock deadlock by shareholder factions those in control guilty of knowingly countenanced persistent pervasive fraud. Delaware  o Only grounds for voluntary dissolution is corp w/ 2 shs (50/50.

and shareholders agreement had no termination provision Holding  Court use partnership analogy and holds for P. 1986)  Shares subject to a repurchase agreement with set price and provision to reset price at board’s discretion. Shareholder dies. Court is partnership friendly. which clearly allows for termination for any reason at any time. or other obligation to contribute cash.C. Probably wouldn’t come out the same in DE. P gets nothing. o Pedro v. This court favors the contract over the equities. arguing the directors unfairly did not revalue. 1992)  P is fired by company for investigating other shareholders be believes are embezzling. Rustin (D. o Subject to general contract principles Concord Auto Auction v. property. and sues for violation of FD. P sues on basis that he expected lifetime employment. Estate sues to have repriced. repurchase agreement trigger at original below-market set price. or to perform services  Liability • Members stand to lose capital contributions. Of Mass. prior to vestment. Award value of stock + salary through the age of 72. but their personal assets are not subject to attachment 42 . Court relies on contract. Lambert (NY 1989)   Company fires P 15 days before stock under a shareholders agreement would have vested. P loss. a promissory note.  o Gallagher v. they believe D violated it’s duty to P. fired him in bad faith. number and type of shareholder) applicable to S corporations  Funding of an LLC – very flexible • Members contribute capital • Contribution may be cash. services rendered.g. P’s shares are subject to repurchase agreement at 75% of book value on death or consent of P. Pedro (Minn. Holding  court enforces shareholder agreement. and violated FD> Holding  this court is not willing to intervene in a shareholders agreement solely because the result may seem unfair. property. individual income o Avoids the double taxation on corporate taxes (corporate tax + dividend/capital gains tax) • Limited liability of corporations • None of the restrictions (e.  Limited Liability Companies • Limited Liability Companies o General  First new legal business concept since the S corp (1950)  Cross between partnership and corporation • Tax advantages of partnerships o Pass-through taxation.

most statutes allocate profits and losses on the basis of the value of members’ contributions o Withdrawal  Member may withdrawal and demand payment of this/her interest upon giving the notice specific in the statute or the LLC’s operating agreement • Management rights o Absent contrary agreement. each member has equal rights in the management of the LLC  Most matters decided by majority  Significant matters require unanimous consent (default) o Manager-managed LLC option available. and Brothers • Court hold  even through they had authority. the statute requires that “deal fairly” with the other members. and sell company – effectively cutting the third member. Being on both side of the transaction didn’t prohibit them from voting under the statute.  Gottsacker v. Role of Fiduciary Duty  VSG v. issue stock.o o Tax • Pass-through. turn in a corp.  Can structured as a “board of directors” a CEO. come up with LLC. vote out third manager.Rule  the court holds the managers owe a duty of loyalty to both the managers and the members. generally need to include LLC in the name o Designate office and agent for service of process o Draft operating agreement – the basic contract governing the affairs of a limited liability company and state the various and duties of the members. or both  Must be specified in articles of organization Important Role of Contracts  Del LLC Statute (6 Del 18-1101) • (b) It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and the to the enforceability of limited liability company agreements. Remand to determine “fairness.  43 .” • Rule Contract interpretation is key. You can’t contract around the duty of loyalty. There are no cases to refer to. and the statutes are unclear. The fiduciary duty which comes from close held corporations. Castiel (DE) • Two managers meet without giving notes to third manager. who sues.  Member’s rights include: • Financial interest o Profit and loss sharing  Absent contrary agreement. • . OR • Corporate  Formation • Must file the articles of organization in the designated state • Other formation tasks: o Choose and register name. Monnier • G.

o Equity Cushion  Initial Purpose: reduce riskiness of extending credit to corporations 44 .o o LLC . o This value can be calculated by multiplying the par value times the number of outstanding shares issued. The DE statute provides a dissolution mechanism. BUT if the stockholder pulled out he would not take back any of his investment unless there was a residual amount after all creditors were paid out. Fleetway  Issue is what does the “withdrawal” mean in the contract? Does it include dismissal? Court holds that the ‘withdrawal” means an intentional act. • Can an investor force the remaining members of the enterprise to buy back the departing member’s interest? o Haley v. This capital was determined to be held by the corp. Partner wants out. to be used to pay its debts if needed. The court uses the dictionary definition  case is all about contract interpretation and drafting.value of stock at the initial offering. Talcott  Two buyers no sellers  Incomplete drafting.Liability  Member’s are only liable to the extent of their contribution. Thus the Stockholder cannot withdraw his purchase capital o The courts saw the investment as the Stockholder buying in and being entitled to any profits. the court imposes to allow the leaving partner’s exit. Situation comes up that operating agreement covers. Thus others can determine what the corporation is worth at least under Par Value.  Insolvency test  you can’t pay dividends if you liability are greater than you assets. LLC . PAR VALUE • MBCA deleted these provisions. o Basically the certificate of incorporation states what the par value is. The Delaware codes still has this. § The Corporation as a Device to Allocate Risk • Equity Cushion o General • Historical Overview was that what the stock holders paid to purchase the shares of stock was the Capital of the firm.Exit and Liquidity  Similar to exit issue in other closely held enterpises: • Can the majority use statutory or contractual power to force the minority out of the enterprise and acquire the minority’s ownership interest at a contractually specified sum that often is low relative to the then current value o Love v.

shares) if corporations certification states a “par value” for stock  this amount of money (shares X par value) must be set aside. payments. But shares don’t have to have par value.0001 per sh o DGCL 154 . then must be majority of outstanding stock w/voting rights on subject. Consideration may be cash. o If cash falls below capital requirement.  Quality and Valuation of Consideration • DGCL § 152 – issuance of stock o Amount of consideration in 153 to be determined by directors.  Limits on Distributions to Shareholders • DGCL § 154 – amount of capital. converted shares (a)(3). wasting assets o Dividends payable from  Surplus. or  Out of net profits in the fiscal year the dividend is declared and/o the preceding fiscal year. surplus and net assets defined o Allows the specific of min capital – any amount.001 or $. purchased/redeem shares (a)(2). must be effected by amending certificate of incorporation. (per value x no. change in the par value of stock(a)(4). o Statutes  Min.Delaware requires minimum equity (per value x no. if no par value. • DGCL § 242 o To change par value or an change to authorized stock.reduction of capital o Board of directors may by resolution reduce capital by amount equal to that represented by: retired shares (a)(1). can take any consideration. o Net profits = income after expenses and taxes • DGCL § 244 . shares) if corporations certification states a “par value” for stock  this amount of money (shares X par value) must be set aside. any tangible or intangible property or any benefit to the corporation or any combo thereof. but not less than amount equal to the aggregate par value of issued shares having a par value. o Directors can change certificate by resolution & majority vote of holders of outstanding shares entitled to vote.• Minimum Capitalization Requirements  Par value: minimum price/share that shares must be issues for in order to be fully paid • Typical par value: $0. capital. if certificate requires vote. But shares don’t have to have par value. • DGCL § 154 – amount of capital. 45 . must fix before any dividends. surplus and net assets defined o net assets = total assets – liability o surplus = net assets – capital • DGCL § 170 – dividends. capital. Initial Capital Requirements • DGCL § 153 – consideration for stock o Share must be sold at issuance for at least par value.

perpetuate fraud.  But you need all three.” bad faith or fraud in evaluating the value of assets. commit a crime. o AND • (2) Shareholder use control of corporate form in unjust fraudulent.That Veil piercing can be done when the Corporate Veil/Limited Liability is being used to perpetrate fraud o It could be grounds to pierce the corporate veil if the corporation maintains inadequate capitalization 46 . or wrongful way. Olsen  • • RULEo Court looked to rules stating. amount. etc. Consumer’s Co-op v.  Klang Rule (DE)  directors can use FMV as the appropriate reference point to value assets • Deference to director’s method of calculating surplus. o Note  board could buy back stock. unless plaintiffs can show that directors used “unacceptable date. par values. However a corporation’s veil will be pierced whenever the corporate form is employed to evade an existing obligation. o AND • (3) Shareholders’ unjust use of control cause actual harm to plaintiff. • RESTATEMENTo Usually the separateness of the corporate entity is to be respected.o reduce capital requirement. Valuation of Assets  General • Book Value: what you paid • Fair Market Value: what you can sell it. or work an injustice.  This is a fact intensive test that everyone seems to use but in different ways. or redeem stock in order to Piercing the Corporate Veil • Piercing the Veil o General  Disregarding the corporate fiction  Way to make corporate insiders (shareholders) personally liable for corp’s activities  More common in closely held corporations • Shareholders are operating the company directly for their own benefit. • Directors can increase equity by revaluing assets. circumvent a statute. but needs shareholder approval to do anything with alter authorized stock.  Liability / Payments • DGCL § 174 – liability of directors o If directors willfully or negligently declare dividend payments or purchase stock or redemptions they shall be liable for the full amount unlawfully paid. o Veil-piercing “RULE” Court will pierce the corporate veil (and hold the shareholder liable) when the plaintiff proves: • (1) Shareholder had complete domination and control.

•  The capital must be illusory or trifling compared to the business done  Should not reward errant businessmen using corporate shells o Factors to Consider 1.That the shareholder had COMPLETE Domination of the corporation.Is this just an alter ego of the shareholder or truly a separate entity?  To determine if the shareholder is really using the corporation as a shell to avoid liability. All parties remotely connect to the injury via the company.  Looking at instance where the P is a third-party had ability to have born the risks. so there is no assumption or bargaining for the risk. Was the corporation under capitalized  2. Where a tort-plaintiff is probably a 3rd party without a prior relation to the D. • This can be proven by failure to follow the formalities of a corporation.ie majority owner does what he wants  2. o Piercing the Veil – difference in Contract vs. Davis 47 .  Externalizing costs • Who is in a better position to prevent costs? • A contracting plaintiff. does not have enough adequate capital or insurance. o Western Rock v. who is probably vicariously liable. Tort  Assumption of risk • Usually an establish relationship btw P and D. is in a good position to account for risks and account for cost insurance and defensive business practices • A tort-plaintiff usually doesn’t have the opportunity to prevent the injury. Such control was used to perpetrate a fraud or violation of a statute or other duty or violate plaintiff’s rights or violate law  3. P might have contract for the risk.  Who do you sue? • Everyone. The entity had no separate mind of its own.if not then may lead to a finding that there was no separate existence of shareholders and the corporation o RULE. This control caused injury to P • Need all three to be proven to pierce the corporate veil COURT o The adequacy of capital is to be measured at the time of incorporation o Suffering financial setbacks does not lead to inadequate capitalization o Additionally the amount of capital as being inadequate is measured as “obvious inadequacy of capital or insufficient when measured with the nature and magnitude of the undertaking: • Tort Liability and the Veil o General  Comes up when the company. Was the corporation following appropriate corporate formalities. Control. must find all of the following  1.

Shareholders try to argue that they are protected from liability through the corporation.  PIERCED VEIL • Shareholders ran business • Shareholders using limited liability to avoid paying damages • Caused harm. Looking for agent who was clearly acting on behalf of parent directing the operations of the subsidiary at the facility level.bad faith o Baatz v. 48 . o US v. P also sues the owners of the bar directly. and not cause of injury. doesn’t mean they are controlling the subsidiary. Bestfoods  Superfund case  the superfund CERCLA language which provides that “any person who at the time of disposal of any hazardous substance owner or operated any facility can be held liable to repay the fund for clean up costs. Bar has minimum level insurance require by law. Dual-board officers not enough. Held: doesn’t pierce corporate veil to get owners. Arrow Bar  P injured by a drunk driver who has no insurance. State laws extends liability to the licensed entity who serves some visibly drunk.• Shareholders held liable for injury resulting to their companies negligent blasting.Individual in charge can be liable. intentionally did the blasting knowing people were being harmed and did it anyways. Investor supervision not enough. Agents in charge of the facility wearing the Parent Corps hat can be used to show direct participation o Under CERCLA . exercised control over the operations of the liable subsidiary o Must be directly managing this subsidiary • Additionally. o NO SEPARATE MIND  § Friendly Transfers of Control and Fundamental Changes • Mergers and Dissenter’s Rights o General  o Friendly/Unfriendly determined w/r/t managers or officers Statutory Merger: Stock for Stock  Company A trades stock for the assets and liabilities of Company B.”  COURT • Corporate veil can be pierced to go after the parent corporation when the parent o Actively participated in. Held: Court pierces the veil. Control was not unjust. kept serving the D after he was visibly drunk. We must examine the internal decision making process of the subsidiary. Same test  majority shareholder needs to have complete control in order to pierce the corporate veil. Lake Asbestos  Rule Just because a company is a majority shareholder. Parent and Subsidiary Corporations o Craig v. P sues the bar that served the drive in violation of state law.so Agent might be liable • Majority ownership not enough.

alter cert of inc.De Minimus Merger • • (1) Company issuing less then 20% shares or cash in the transaction. and (3) shares before and after are the same. § 253 . then the surviving company doesn’t get to vote. must file certificate of merger. (2) not altering cert of inc. or adversely affect any shareholders interest.   § 251(f) .DGCL § 251(a) (authorizes statutory merger) • • (1) Boards adopts and approves merger agreement that meets statutory requirements. Merger v. obligations are not impaired and attached to the surviving company. • • (4) Once ratify. (5) Agreement may by provision allow directors to terminate.consolidation o DGCL § 259(a) Legal Effect of a Merger  Target goes away. BJR applies. Consolidation   A + B = A (B goes away) . (3) Majority of all shareholders of outstanding stock in both companies ratify o Voting Rights Exceptions:  § 251(f) .. surviving gets all duties and obligations of target.  What needs to get sent to shareholders • Public Company: proxy statement 49 . (2) Board gives notice & disclose terms of merger to shareholder.Short-Form Mergers: • Where A owns 90% of B.merger A + B = C (new entity) . rights of creditors. all liens.   o Company B shareholders receive shares of Company A Company B ceases to exists. o Process: fundamental changes which requires both director & shareholders  Basic Procedure .No vote if no shares have been issued. Company B shares canceled Company A assets and liability are combined with Company B assets and liabilities into a the Company A. or alter merger agreement w/o vote ( as long as they don’t alter/change share. Notice must be 20 days before vote/meeting. then no shareholder vote required. surviving company gets all assets.

50 . Merger under 251(f) de Minimus o (b)(2)  Exception to (b)(1) Appraisal Rights reactivate  If Selling firm shareholder is publicly trade.Appraisals Rights • General o Potential Appraisal Remedy  Appraisal rights give dissenting shareholders the right to demand that the corporation buy their shares at a judicially determined fair market value. or consent to merger Gets judicial process to determine FMV • 262 (b) Market Out Rule o (b)(1)  No Appraisal Right If    Buying/Selling firm shareholders if the firm is publicity traded More than 2000 holders of record. OR Shares of stock in a non-public company o (b)(3)  No Appraisal Right If  Merger under 253 short form mergers • Merger has nominal/trivia effect on value.•  Private company: document as require by state corporate law DGCL § 262. BUT consideration is for these shareholder is • • Cash.” o Appraisal Rights Given to:   Selling firm shareholders Buying firm shareholders • Unless their vote was not required under DGCL § 251(f) • Requirements 262(a) o Shareholder   o must holds shares through date of merger not vote in favor. “perfecting appraisal rights.

 o Mergers vs. the buyer take what they want.Available Techniques o Sale of Assets  DGCL § 271 • Target company has voting rights. Asset Sales  When a merger becomes effective.  if majority votes to ratify.) No appraisal rights. Hewlett-Packard Co. then dissolves distributing the assets via the statutory priority (debtor. -. gets cash. with the exception of the surviving corporation. Only the board of the purchasing corporation needs approve the transaction. Votes challenge under rule 252.  Buying gives cash for assets. preferred stock holders. may assume some liability (or may not). comes to an end In an asset sale. The target company votes to ratify. • Getting Around  Voting Rights. the target company remains in existence at least for a little while after the assets sales has been completed  only title of assets have changed In a Merger title to all property owned by each corporate party is automatically vested in the surviving company In an asset sale. court looks at process and thinks it was done in good faith. which actually purchases the target company B. P has burden of show material misrepresentation of fact. buying company does not. BJR. • DE does not require that the shareholders of the purchasing corporation approve the transaction. 51 . stock holders. As opposed to a merger. In a merger all liability transfer over automatically In asset sale. doesn’t take anything unless contract for by a written assumption      o Triangular Merger (reverse or forward)  Entity A creates a new subsidiary entity A1. documents of transfer must be complete for each assets. where the dissent would have a statutory appraisal right to of appraisel to muck things up later. the separate existence of all corporate parties. etc. DE requires approval of a sale of substantially all of the corporations assets by the board and shareholder of the selling corporation o • Shareholder approval must be by a majority of the outstanding shares entitled to vote. Hewlett v. • Court fails to find evidence of vote buying or fraudulent disclosure claims. everything is done.

B dissolves. B sells assets. or get appraisal rights. So that there is no need to write any of B’s contracts. Court holds that in effect this was a merge that fundamentally changed the company. • This avoids any re-assignments of contractual obligation. B still exists. Acro Electronics (DE) o Independent legal significance to each statutory section of the corporate code. A1 dissolve. De Facto Merger Doctrine  General • Court looks to substance over form o o Ignoring the transaction structure to grant voting and appraisal rights where end result of transaction is a merged entity. 52 . •  Applestein v. it will be honored. If you follow the asset sale statute. Glen Alden Corp (Pa) • This is reverse merger set up an asset sale. basically) o Independent legal significance doctrine  Farris v. A shareholders do not get appraisal rights. where selling company comes to own and in effect control the target. A owns A1. B dissolves Reverse  B remains. A1 pays for deal with A shares.     o A shareholders don’t get to vote on creation of A1 – only the board votes. Grants voting rights. A1 gets all Bs liability. Does the combination (1) fundamentally change the corp character. (2) force share to take stock in another company with not voting/appraisal rights/ • Rejected in Delaware (and in CA. interest of corp and interest of SH. • Hairton v. Forward  subsidiary A 1 remains. Only the selling entity gets to vote.  Delaware  no de facto merger law here. A1 wants to buy B assets. The shareholders of A do not need to vote on A1. where purchasing shareholders loss control to owner of selling entity. controlling the purchasers. but is now owned by A. Only the shareholders of the constituent corporations get to vote. United Board & Carton Corp (NJ 1960) • Merger setup as an asset sale. B needs to vote and ratify. Court terms as a de facto merger  thinks that the statutory merger is the appropriate for this transaction. If you follow the merger statute. it will be honored.

as majority shareholder in B and C. C holds all of Bs assets and obligations. Structure of cash-out mergers / Squeeze-Out Statutory Merger  Two Stage Transaction - • (1) A goes to Bs shareholders to buy/trade for shares o o A buys enough share to gain control B. § 262. selfdealing. there might be relief outside appraisal. and becomes the majority stock holder Minority stockers remain • (2) A creates a new company-C and mergers B and C o A. vote to ratify. as a wholly controlled subsidiary of A. fraud. waste. Intersection between Appraisal Remedy and Fiduciary Duty-Based Judicial Review o General  o In a cash-out merger what remedies do minority share holders haves. B cancels Bs shareholders. o Test and Shareholder Remedies  Delaware • (1) Appraisal Rights  Exclusive remedy for minorities shareholders in cash-out o available because shareholders receiving cash. such as violation of FD.o • “Doctrine offends the equal dignity of the merger and asset sale provision of the statute. and Bs shareholders receive cash. • (2) “Entire fairness” Exception  where misrepresentation. or gross overreaching. B is extinguished. Dissenting minority shareholders in B have    appraisal rights can sue for recession can accept the buy-out o • Post-Stage 2 o o C remains. Generally inquiry into process: o Court looks at  Fair price 53 .

 o

Fair deal

Burden of proof depends on  (1) if a majority of minority available AND (2) they had full disclosure/candor, THEN burden is on the Plaintiff to show it was not fair. (2) If Plaintiff can show that were not fully informed, then burden can shift back to Defendant to show fairness.

 •

Weinberg v. UOP (DE) o Court holds merger unfair to minority stock holders, b/c company did not disclose full information about directors sitting on both boards, and didn’t disclose

Non-Delware

Business Purpose Test  o o Minorities shareholders can challenge a controlled shareholder merger Defendants have the burden of proving that the transaction has a business purpose other than merely serving the selfish interest of the controlling shareholder.

Coggins v. New England Patriots Football (MASS)

o Court find that cash-out merger did not have business purpose;
designed to allow D to pay off his personal debts. Business Purpose Test

o Remedy  court awards damages calculated by determining

the value of the plaintiffs share had the merger not taken place. Merger was 10 years ago; recession impracticable. NOT GOOD LAW IN DE.

Hostile Acquisitions o General -- The Market for Corporate Control  How do bidders gain control without the target board’s consent?


Hostile  mean hostile to the board. We are looking at how companies, the boards and shareholders defend themselves. DGL 251  requires that the board of each company ratify the merger agreement. Then shareholders vote.

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If board rejects the offer to merger, the purchasing company has two offers: o (1) Tender offer to buy enough shares from shareholders to gain control of the board. friendly to the bidder’s plan.  

o (2) Proxy battle  convince target shareholders to elect a board
Same proxy problems; expensive; hard to communicate to other shareholders. Staggered board; either wait it out; or remove for cause.

Overview of tender offers • A public offer usually made to all shareholders of the corporation in which the bidder offers to purchase target company chares o o The offered consideration can alternatively be cash, stock, or a combination of stock & cash The offer usually has many conditions attached  • Ex. only buy the share if 51% are offered.

Advantages over asset sales or mergers: o Approval by the target’s board of direction is a necessary perquisite to statutory transaction


o

“Bear hug” letter  we want to buy, we love you, but if you don’t sell we will crush you.

Tender offer permits the bidder to bypass the target’s board and to purchase a controlling share block directly from the stockholder

Federal Securities Law o Shareholders Voting in Public Companies; Federal Proxy Regulations   o § 14(a) of the ’34 act Sec Regulation 14A

Tender Offers for shares of public companies Williams Act  Third party tenders offers • • § 14(d) & (e) SEC Rules.

Williams Act Requirements o 20 Day min offering period

55

o o o

Withdrawal rights Pro-rata acceptance All Holder/Best Price Rule  “All Holders Rule”: tender offer must be open to all security holders of the class of security subject to the offer “Best Price Rule”: shareholders are paid MFN; everyone gets the best price.

 o o

Disclosure require from both Bidder and Target Prohibitions  Exclusive method of purchase

o

Goals   Target shareholders more educate, less pressured Equal treatment

o

Critics     Increase prices, reduces number of bids Disclosure reward free riders, second bidders Time delay enable target managers’ defenses Reduces tenders offer power as a check on poor management

Buyer buys a few shares in the target company so that they have standing and can threat a fiduciary duty lawsuit against the board; makes the board consider that offer.

Defenses to Hostile Take-overs o Basics       o Self-tender offers Poison-pills Staggered boards White-knite sales Defensive merger, acquisitions, asset purchases Defensive debt issuance (usually for M&A)

Poison Pill or Shareholder Rights Plan

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 Each share of stock obtains shareholder rights or a dividend declared by the board of directors • Rights are corporate securities that give the holder of the rights the option of purchasing share  The rights become exercisable upon some triggering event. price was reasonable because of the control premium (17% OS) Enhanced Scrutiny – ****** this is the rule to use • o  Unocal Test  Burden on BoD to show that def against hostile takeover: • (1) Reasonableness. BoD offers to buy shares from party attempting take-over. such as: • Acquisition of a specified percentage of target shares o • Typically 15%-20% Announcement of a tender offer for some specified percentage of the shares. Ds have burden to shot legitimate business purpose to restore presumption of good faith • (1) Reasonable grounds to believe that a danger to corporate policy and effectiveness exist o Traditional Review . Judicial Review of Tender Offer Defenses o BJR  Usually doesn’t apply because there is some chance the directors are acting to protect their jobs. FOD suit for paying too much for shares. Court holds that board acting in good faith.Cheff v Mathes (DE): (Pre-Unocal)  o Good Faith and reasonable investigation (2) Director’s did not act for the primary purpose of preserving their own incumbency • Once established – back to BJR  Cheff v Mathes (DE): Greenmail situation.  “Flip-In” Provision • Give shareholders (except for the raider) the right to purchase additional stock at a deep discount to market or receive a distribution of additional stock  “Flip-Over” Provision • • • Give shareholders the right to receive buyer stock in a 2nd stage freezeout merger at a deep discount  stock in the buying entity. Board has reasonable grounds for believing that a danger to corporate policy and effectiveness existed 57 . price well above market price.

• • o Review of Poison Pills  Moran  Standard of Review • So. and (2) If it is okay under the statute. DoB of Unocal Unocal makes a responsive selective self. Was the board with the power of author of the board o o (1) Does the statute authorize this defense. directors must show entire fairness: fair deal and fair price.o Burden satisfied by showing good faith & reasonable investigation • (2) Proportionality: The defense was reasonable in relation to the treat posed. does the firm’s charter impose any restrictions on the use of this defense  Unocal v. Analysis  court finds the board’s offers is proportional because Mesa’s front offer was much lower then the company was worth. then directors get BJR deference.tender backed by debt security. most of the legal argument Considerations for assessing threat       Low price Time of offering Questions of illegality Impact of on “constituencies” other than shareholders. o o This is were the action is. directors have the authority to create poison pills. which P can attempt to rebut. (DE) • In response to back-end tender offer. Risk of deal falling apart Quality of securities being offered • • • If they pass. Mesa sues as a violation of FD. If they fail. and the backend offer was junk bonds. Note the selective self-tender not OK under current SEC rules. The idea is to make the company so heavily leveraged that the company’s value is decrease below Mesa’s comfort zone. Mesa Petroleum Co. but in doing so are they subject to review in creating the pill: o Unocal standard:  Reasonableness 58 .

just makes then more expensive. the company is for sale. board is protected by BJR.” o • Once you pass the Unocal standard. Good faith and reasonable investigation •  Proportionality • Have the directors proved that the poison pill was “reasonable in relation to the treat posed. MacAndrews • Board brings in Whiteknight to thwart a hostile takeover. • Poison pills held to be legal.• Burden on directors to show they had reasonable grounds to believe that a threat to corporate policy and effectiveness existed. so that Shareholders will lose control and their present interest is only to get the best value in the transaction. o Defensives Sales  Revlon Rule  • Once the board puts a company up for sale. Inc.  Moran . Court holds reasone to think company would be target of a takeover. Court will review with the Unocal standard. o Role changes from defender of corporation to an auctioneer  which is triggered by going to White Knight. the court will review the decision to exercise or not exercise the poison pill when the hostile bid occurs. Statute give board power and deference to BoD to issue stocks under DGCL 151(a). In addition. o  Revlon v. the BoDs is required the BoD to seek the highest value for the shareholders. and 59 . • *** Reconciling Revlon and Unocal ******* o (1) Appy Unocal Rule to defensive measure (including poison pills)  Directors must show • reasonableness of threat. DGCL 151(g). Household International. they duty of the board is to get the best value for the shareholders. Pill is valid. and gives the White Knight as number of asset lock. which in effect kill the bidding process. Cannot sacrifice shareholder price for returns to other corporate constituencies. and 157. Doesn’t restrict tender offers. Court holds at once the BoD bring a White knight. The company will go through a change of control. again.

the board will be held to the Revlon standard to maximum shareholder value. result in a change of control. Defensive measure are not enough by themselves to trigger Revlon duties. •   Pass then BJR still applies. the company abandons long-term strategy and seeks an alternative involving the breakup of the company.’ look at:     Critically examine the competing tender offers Act in good faith Obtain all reasonable available information on the offers and alternaives Negotiate actively with bidders. o QVC Rule  once the board initiates a transaction that will  If Revlon Duties are trigger: • fails (didn’t get best price lookup assets. Then BRJ applies o (2) If response involves a 3rd party buyer. Risk of deal falling apart 60 . Time Rule   Revlon duties are trigger when (without excluding other circumstances): • • (1) board actively puts the company up for sale or to effect a business reorganization involving a clear break-up of the company (2) in response to a bidder’s offer. o DoB subject to ‘entire fairness.•  proportionality of response. o Court  it is not enough that the transaction might be construed as putting the company up for sale. etc) then. If Revlon duties are not trigger. or merger involve break of company and loss of shareholder control then Paramount v. board will need to deal with them. if another equally interested bidder appears. Considerations for assessing threat • • • • • Low price Time of offering Questions of illegality Impact of on “constituencies” other than shareholders. board is still subject to Unocal.

Redstone will control company. so they recast the merger of Time. Shareholders are getting stock for stock. Time doesn’t want to merge with Paramount. QVC • Paramount agrees to merger with Viacom. changeable and changing marketing. Disclosure and Corporate Governance • Two important aspects of securities law o Full disclosure  o Make sure that the investors have all the information they need to make informed decisions. vote. This is a defensive strategy that depletes the cash in Time. an all-in all-cash offer falling in the range of value that a shareholder could reasonably expect to get is not by itself a “threat. Time can consider factors such as ‘’time culture” as basis for choicing to merger with Warner. Time • Time and Warner are in the process of a merger. Securities 1993 Act 61 . Court notes that this is the last chance for shareholders to get a control premium. they still can sell. Court holds the Revlon duties are not trigger because tender offer of Warner not a breakup of sale of company. Court holds the Revlon duties trigger because merger with Viacom is in effect a “change in control” and as such board has a duty to get the shareholders a the best price and control premium. Merger passes Unocal b/c response not in faith. • o Cases  Paramount v. making a Tender offer takeover from Warner.” Threats are not limited back-end unequal treatment transaction. or inadequate value. when Paramount launches a hostile take over of Time. So Paramount launches an FD law suit. etc. And also circumvent a shareholder vote on the merger. and makes the target Time-Warner more expensive. once deal is done. • •  Paramount v. which is almost wholly controlled by Sumner Redstone. o Merger agreement would not result in a transfer of control because control of the combined entity remained “in a large.•  Note • Quality of securities being offered Generally. fluid. Lower Court Ruling (good to note this language).

restricting. lot’s of it’ Greater liability of CEO/CFO Additional responsibilities (burden?) on the board. or dilute voting rights. states / federalism. •  this would have eliminated poison pills or the creation of classes of stocks with less them 1-vote. o Court vacates the rule on the ground that it exceeds SEC authority. o • Note-. 10-K annual.> Later stock exchanges later adopted similar requirements in their listing. because everything is forward looking Promotes competition b/w companies for investor Protect shareholders for misinformation Directors need information to do their job Enhances monitoring by accountants Facilitate enforcement actions by government Post-Enron regulatory response     Disclosure. From 10 once. Market price depends on access to information. require for any public sale Securities 1934 Act  o Policy       o Periodic. Federal Proxy: Rule 14(a)-9 o 14(a) of the 1934 Act  Allows the sec to regulated proxy solicitations as necessary and appropriate 62 . Are we putting to much pressure on the boards? • 2008 Trend: 42 firms lost big-name directors • Business Roundtable v. 10-Q quarterly. or disparately reducing the per share voting rights of existing common shareholders. prospectuses. SEC o 1988: SEC adopted one share-one vote rule  Rule 19C-4 – prohibited any Self-Regulatory Organization (SRO) from listing any stock of a corporation that takes any action to the effect of nullifying. Cannot eliminate existing shares. o Transaction. only require of registered companies. register/file with Sec. 8-K episodic.

suit under 14(a)-9 for omitted and false information based on members of board being on both side of the proposed merger. but still good law. • • Creates a industry of litigators reviewing proxy statements. omitted statement (2) Must be material • fact w/ substantial likelihood that a reasonable shareholder would consider it important in deciding.) – P gets proxy materials on merger. Federal law supreme over state. misleading. o *** 14(a)-9 Requirements and Analysis   (1) False. Reddington • No private action under Section 17 of the 1934 Act. So P attempts to bring a federal suit under 14(a)-9. o Materiality: An omitted fact is material if there is substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Borak. No express private right of action Individuals have private right of action under JS Case v. Borak (Wiscon.  63 . so it implies individual should have access to judicial relief. TSC v. false with respect to material fact. v. SEC can’t possibly watch over all proxy statements.o Rule 14(a)-9  Prohibits misleading. US attorney come in where there is fraud.  Touche Ross & Co.  This is the standard for materiality in many areas of corporate law. Court allows the suit under 14(a)-9 because the underlying policy 14(a)-9 is to protect shareholders. proxy statement issue. Northway (US 1976) Asset sale (quasi-merge). or omits to state a material fact necessary in order to make the statements therein not false or misleading o Private Right of Action under 14(a)-9  General • • • SEC can bring civil. or criminal actions. can bring injunctions to stop mergers. Probably would come out differently today. sues alleging the information in proxy statement was mislead? Under state law P has 2options: (1) FD law suit or (2) appraisal rights. but Wisc requires a large bond from the P. •  JS Case v.

scheme or article to defraud to make any untrue statement of material fact. it is not actionable.Disclosure related to buying or selling o Section 10(b) – empowers SEC to make rues  o it is unlawful to use or employ in connection with purchase or sale. (3) Statement must have been an essential link in the outcome of the vote. o Mills v. Electric Auto-Lite (US 1970) Merger proxy statement suite by shareholder brought under 14(a)-9. in connection with sale of purchase of securities. Court holds this is a material fact and misleading. Court requires that there me causation between the fact the and vote • 10b(5) -. Proxy materials alleged to misleading b/c they did not disclose that the all directors in target company had been nominated by the purchasing company. rather than the particular defect in the solicitation materials. or to engage in any act. an essential link in the accomplishment of the merger? If it doesn’t matter to the outcome of the vote. public or non public security any manipulative or deceptive device of contrivance Rule 10b(5)  In it is unlawful for any person. or of the mails or of any facility of any national securities exchange • • •  to employ any device. • Causation Test: Was the proxy solicitation itself. or to omit statement of material fact necessary to make statements made not misleading. DOJ (criminal) Private Parties • • No express private remedy under section 10 Private cause of action implied under rule 10b-5 64 . by the use of an means of instrumentally of interstate commerce. practice. o Analysis  who can bring   SEC. or course of business which operates or would operate as a fraud or deceit upon any person. indirectly or directly.

issue is disagreement about value. then there is not duty to disclose the insider knowledge. Needs clear deception and manipulation. Send documents to printer Printer buys shares in the target corp. Inc. court is clear that there is no congressional intent. Policy is full disclosure. courts have set the tone and rules. Here the information was disclosed.Congress  Birnbaum v. this is court made. Lack of business purpose (+ improper number crunching) ≠ fraud TGS- • So if insider has material nonpublic information the insider must EITHER disclose such information before trading or abstain from trading until the information has been disclosed o Based on rationale that traders all have equal information • So anyone has to Disclose if they have this information or not trade. Newport Steel (2d Cir 1952) • One only has standing if connection with sale of purchase. o  Blue Chip Stamps v. or appraisal. Can file a FD. Would have been a violation if he had bought his employers shares as he would be diluting their profits and violating his duty. Santa Fe Industries. Forced cash-out merger is connection to sale or purchase for standing. congress hasn’t said anything while these have been going on. 65 . allege that majority tried to make minority think $125 offer was good deal. o Disclosure means public  Chirella• • Corp is going to buy a target corp. You must allege that relied on information to sale or purchase. Manor Drug Stores • S Ct.  • stays out of the political fray.   o  Cases  Only in connection to sale or purchase. which turned out to be fraudulent. had been going on for 25 years. includes a cash-out merger. not unfairness. Ps were sellers. given appraisal right. when Ps think shares actually worth $772 (math w/ disclosed #s). v Green: • minority SHs cashed out in short-form merger. o No Fiduciary duty here because he is not an agent or employed by the target company. final agrees that there is private cause of action under 10b-5. court finals gets a case and affirms. If there is no fiduciary duty owed by the share buyer to the target corp.

in breach of a fiduciary duty or other relationship of trust or confidence. law firms.• Held: no COA. • Insider Trading Analysis o Materiality . requires fraud.  Factors: • Nature of information • Company response • Market response • Conduct of insiders Insider Analysis  (1) Is the person a classic insider? • Premised upon Fraud  upon the sellers  Does not arise is person is not agent. not fiduciary. etc. not a fiduciary or was not a person whom the sellers of the securities had place their trust and confidence. not everyone has a duty to disclose. bankers. transaction was not deceptive/manipulated. remedy = appraisal Insider Trading.  Can only be liable if you are trading shares of your client/confider o 66 .. not insider.That would b an insider? o 16b Defines insiders o Fiduciary Duty ower is an insider o Chiarella v US (1980): printer who is able to deduce name of target. while in possessions of material or information not publically available.Dirks • Test o (1) obtain material nonpublic information from the issuer with o (2) an expectation on the part of the corporation that the outsiders will keep information confidential and o (3) the relationship at least implies such a duty. • Is this a person who has a FD?.10b5 creates a private cause of action for shareholders/16b covers a limited subset of insider trading • • SEC – “Inside trading refers generally to buying and selling a security.modern test  Whether there is a substantial likelihood that a reasonable investor would consider the omitted fact important in decided whether to buy or sell securities.  Usually comes up w/r/t to services provides.  (2) Constructive Insider. Overview o o o o (1) Insider (2) Possession of material on public information (3) did not disclose (4) used in connection with sale or purchase of a security.”o Is there a violation of 10b5.

history. • To show a breach of fiduciary duty under 10b5  o Look at objective criteria and purpose of tipper.Breaching a duty to the principle you work for by using information you recievied by reason that you work there • O’Hagan  Misappropriation is fraud under common law. (4) Missappropriation Theory . child.  Enhanced reputation. sibling. • The trading parting • The company whose shares you trading • The company whose information you appropriated. AND o (2) the tippee know or has reason to know of the breach of duty. or to any other person who is the source of the material nonpublic information. pattern of sharing information in confidence (implied expectation) o information obtained from spouse. where o A fiduciary’s undisclosed use of information belonging to his principle. etc. • Tippee Liability Test  Tippee is only liable when o (1) the tipper actually breach their “fiduciary duty” from disclosing the information to the tippee.  You need to show this. directly or indirectly from his disclosure  Pecuniary gain. but guilty under tipper/tippee liability. the courts must determine whether the insider personally will benefit. No direct FD. unless shows that history or patter than indicates no expectations of confidentiality. etc. Restatement of O’Hagan.10b5. (nuclear family expectation) (5) Rule 14e-3  fraudulent insider trading w/r/t to a tendering offer • Prohibits anyone from insider trading during a tender offer and thus supplements Rule 10b-5 67 . don’t need to show they used it. o Only needs to show that the person was aware of the material nonpublic information when the made the trade. o person agrees to maintain confidence (explicit expectation) o practice. or the shareholders of that issuer. for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates 10b-5. directly or indirectly to the issue of the security. without disclosure of such use to the principle. Only way around is a 10b5 plan with a predetermined plan.  (3) Tipper/Tippee liability • Tippee inherent the duty to disclose if the tipper breached their fiduciary duty to the shareholders. parent.  This covers. o Breach of duty of trust or confidence. trades on it. described. o Both tipper ad tippee can be prosecuted. • Dirks v SEC (1983) given info by broker. • Rule 10b5-2  situations that create trust or confidence (non exclusive) for the purpose of the misappropriation theory. o Using information from your principle for personal gain • Rule 10b5-1  on the basis of material nonpublic information.

• Tender offer  14e-3 – if a tender offer. o Rule 14e-3(d) prohibits anyone connected with the tender offer from tipping material. who possesses material. • What kind of insider? • No Tipper / Tippee  probably not because there is no tipper • Constructive Insider  no she has no relationship with the target. not relationship with the company. The wife is the tippee and she didn’t trade on it.  very strict  doesn’t mean you’re guilty of 10b-5  just need to give the money back  the SEC doesn’t prosecute this. which requires a breach of FD through tipper benefit.o Once substantial steps towards a tender offer taken. not their information  No material information requirement. who is the insider. officers. Rule 14e-3(a) prohibits anyone. • Hairdresser is not constructive insider. • Probably no violation  Example 11-6  law firm associate gets inform b/c she represents acquiring company? Tells the firms is quiting and trading the stock of the target. • The tipper is really the husband. • Missappropration theory? Perhaps on 10b5-2. • This gets around the 10b-5 limitation. because she didn’t deceive anybody. o This is based on a person status. nonpublic information about it • Rule 14e-3 is not premised on breach of a fiduciary duty. the wife would have an expectation of confidentiality. • Misappropriation theory  10b51 under O’Hagan. Examples  Example 11-5  wife tells her hairdresser that her husband’s company is about to take over another company. not working for the company. nonpublic information about the offer from trading in the target’s securities. except the bidder. owners of 10% of more) from making short swing profits  Purchase and sale with 6 months of each other o Corporation can sue the insiders and make then return any profits.  (6) SEC 16(b). Can the hair dresser trade? • Is she an insider? Not a “classic” insider. Sec 1934 Act (private right action) • Rule o Prohibits certain defined inside (direct. probably yes o 68 .

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