OVERVIEW What do businesses do and what do lawyers for businesses do o Why does someone own a business  Most people

own a business to make money  Friedman: “In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom…The key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation and his primary responsibility is to them…there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” o Views of courts & legislators  Smith v. Barlow (p. 5) • Defendant corporation made a donation to Princeton. Shareholders sued arguing that he was not authorized by the articles of incorporation to be able to make this gift. • Court said that laws enacted after incorporation that allowed directors to make charitable gifts without approval from shareholders applied to this corp, and as long as the gifts contributed to the corporate interests, they were appropriate.  33-3-102(13) (p. C13) • A corporation can “make donations for the public welfare or for charitable, scientific, or educational purposes.” • Expressly allows charitable donations.  33-3-104 (p. C14) • Ultra vires: beyond the scope of authority or power granted to a corporation (would void an action beyond the scope of authority) • Of little practical significance today. Corporations are now deemed to have the power to engage in any lawful business activity. • Cannot challenge acts of corporation on the grounds that it doesn’t have the powers to act.  Enacted to stop litigation that argued a company did something it wasn’t authorized to do- but it still goes on  Shareholders can still challenge to enjoin an act or in a proceeding by the corporation directly or through a receiver  If brought by a shareholder, the court can award loss (other than profit) suffered by the corporation o The Board of Directors is not acting as an agent; it is functionally a principal (this is the common view although the officers waffle on this) o See §33-8-101 for Board of Directors o Provides that Board will manage the company o In theory these are the ones who manage the company – this is true for large corporations, but not for small onesour statute anticipates this and provides a few other options o Most people say that the Board acts as the principle and not the agent and therefore makes the decisions o Certificate of existence and articles of incorporation- a document issued by a state authority granting a corporation its legal existence and the right to function as a corporation- normally filed with Sec. of State o Cert of Existence says that the corporation is in good standing in SC- but 33-1-280 is deceptive- most of the problems a corporation has will not be with the Sec of State, so it will be in good standing even though it is in trouble with other agencies- Dept of Revenue o § 33-2-102 is the Articles of Incorporation – which lists what you have to do to set up a corporation o 33-3-102 provides General Powers of a corporation  corporation lasts forever unless something happens  corporation has the same powers as an individual would have to conduct its business o General building block concepts: o The law views a business, at least a business in the corporate sense, as a separate entity, a separate legal person o A body of law—both statutory law and case law—has developed to control the actions of that separate entity or person o Real persons act for the corporation—they are agents o A business with more than one owner, at least a business with more than one owner that is a corporation, can distribute and use its funds in ways that are opposed by at least some of the owners Page 1 of 148

o o o o o o o o

o

o o

o

 o

The owner of a business can make money from the business by: Receiving distributions of all or part of the money the business has earned (this is called a dividend) or Selling all or part of her ownership interest in the business for more than she paid for it A lawyer for a business is hired: To help the business make money or To help the owner get money from the business or To help the business and the owner protect that money from the claims of others How do you know how much a business is worth? See the financial statements  33-16-200 (p. C98): A corporation is required to furnish its shareholders with financial statements, etc. See also 33-44-408 and 33-41-520. Partnership Records in SC o 33-41-520 – just have to keep books in accordance with partnership agreement and all partners must have access to them o So not much guidance on what they have to have LLC statute gives even less guidance on what financial statements they have to keep They are prepared according to GAAP – Generally Accepted Accounting Principles o Matching- costs or expenses should be booked in the same period as the revenues those expenditures helped generate o Conservatism- the date should be conservative – they should present the firms financial data in an accurate way but err on the side of understating its revenues and the value of its assets and on overestimating its costs and liabilities Off –balance sheet financing- this is what Enron did- its liabilities were carried out through subsidiaries, so the liabilities didn’t appear on the balance sheets o This only works when the subsidiaries’ debt is nonrecourse debt- meaning the parent company could never be liable for it- in Enron’s case, the debt was recourse  Income Statement • Shows the profit for a corporation over a given period based on data about revenues and costs • Formula = Income – Expenses – Depreciated value of assets – Taxes= Net Income • We depreciate because the machine is getting less valuable each year since we are using up part of it. The portion we use up is called depreciation. Accelerated depreciation might be used for tax purposes.  Cash flow statement • Shows how much more cash a business has at the end of the year than the beginning • Formula = Profit after tax + depreciation taken out – cost of investment in that year. • In other words, it’s the income statement over a year without allowing the business to depreciate the cost of investments. We put depreciation in because it is non-cash  Balance sheet • A snapshot of the value of a business at a particular time • Assets on one side (include things like cash, land, buildings, accounts receivable, and machinery and equipment) • Liabilities on the other (include things like accounts payable, wages payable, and debts) • Assets = Liabilities + Stockholder Equity or • Owners’ equity = assets - liabilities • Thus, profits accrue to equity A key component in the valuation of any business is the future profitability, which is not necessarily reflected in the financial statements (look at cash flow/income statements) Problems on 21 o don’t buy the company for 189k because there are significant liabilities  but we would recommend buying for 80K because that is the amount of equity- but valuing business is a very complex topic so yes you want to know the assets and liability and equity – but what the buyer would want to know is the future income stream- what is it going to make in the future  it also depends on the type of business Lender would be interested in balance sheets, so it can determine whether they would be able to pay o Looking at cash flow statements  Don’t sell for 3,700 because that’s the same amount you are making, and if you keep it, then you will make this again next year- and probably more  20,350 – this is equal to the cash flow for five years, but this is still low  The cash flow statements does help a prospective investor and certainly helps lenders Page 2 of 148

o

o 

The Sarbanes-Oxley Act and Corporate Governance o Mainly apply to publicly traded major corporations, but some of the general principles should still apply to the smaller business o Passed in 2002 in reaction to Enron. Purpose is to try and prevent fraud o Frauds had to do with the financial statements discussed above o Public corporation have an auditing committee the oversees the financial accounting including the SEC filling o Auditors will use a principle of sampling certain random transactions as well as looking at suspicious looking ones to make sure they really did happen o Fraud is motivated by the fact that if the numbers on financial statements look good, then stock prices will go up  Managers want to make stockholders happy  Also, they often receive bonuses when the numbers are good o Types of Fraud  Off-balance sheet • Move liabilities off you balance sheet and onto a subsidiary  Hiding costs  Two basic types are • Representing the company’s financial condition as better than it is • Or misappropriating the wealth of the company for private gain o Sarbanes-Oxley clarifies the role of auditors, company management, and boards and audit committees as well as impose new process and responsibilities on these parties  Ie- have to say whether their auditing committee has a financial expert  § 404 says the company must design internal controls and test their effectiveness  CEO and Chief Financial officer must attest to accuracy of statements under penalty of criminal liability o Lots of companies have said that this is to much regulation and is costing them way too much money to prove that they are honest  To get out from under Sarbanes-Oxley, they are becoming private- cashing out the public holders and becoming private • This means that we wont have anything to invest in What are the basic business structures? What are the primary driving forces behind structure choice? • Taxes - how profits are taxed • Liability - the exposure of the owners to liability for the corporation’s actions Sole Proprietorship • A single person • For taxes and liabilities, the person and the business are treated as the same person • Profits are taxed as personal income • Liability of the company goes straight to the owner • Note that a sole proprietor doesn’t need to file with the state • Don’t need an atty to form a sole proprietorship C- Corporation • Owners of corp are protected from personal liability • The corp pays taxes on income, and the recipients of dividends pay taxes on them (known as double taxation). • The incentive for forming a c-corp is that if you can pay out all of your income as salaries, then the company will not show a profit and it will avoid the double taxation problem. S-Corporation – SC 33-18-103 • This entity is taxed like a partnership but has the liability protection of a corporation. • Profits are distributed directly to partners, and as such are taxed only as the income of the partners – no double taxation problem (this is known as flow through taxation and the tax is paid by the shareholders) • IRS places a bunch of restrictions on who can be an S-Corp o Can only have one class of stock o Must be domestic, and wholly owned by US citizens o No more than 80% of revenue can come from non-US sources  Ex – Shrimp boat business in Charleston fishing in international waters. o No more than 100 stockholders o No more than 25% of revenue from passive sources (rent, interests, royalties). o Only individuals, estates, and certain trusts can be shareholders. Page 3 of 148

7. LLCs are governed primarily by state law.then an LLC or partnership would work What are the capital requirements and cash flow characteristics of the business likely to be? if you require venture capital. through authorized statements by the agent. Factors that go into whether you choose one style of business over another • Who will the investors and owners be? If small group of investors. 3.02 – definition of agency. or from other indicia of authority. o Agency is a fiduciary relationship. Created when:  The principal manifests consent to act on his behalf to the agent  The agent consents to act on the principal’s behalf subject to his control • Authority – the extent of the agent’s power to act and bind the principal • Actual Authority – R3 2. you will probably need to be a corporation bc venture capitalists wont invest in LLC because of the personal tax liability  But this isn’t really the case.02.01. and its easier to change from an LLC to a corporation .03. 3. • Offers protection both from liability and from double taxation (you are taxed as a partnershiponly the individuals are taxed) • SC – don’t need an atty to form an LLC • Don’t have to file an annual report with the SOS office. that the principal wishes the agent so to act. o Created by manifestations of the principal to a 3rd party which reasonably cause the 3rd party to believe that the principal wants the purported agent to act for him. General Partnership • taxes are paid only as money is distributed to partners. Just start doing business Problems of Sole Proprietorships:  Employees and Agency – Creates Contract Liability • R3 § 1. • Apparent Authority – R3 2.     o Limited Liability Company – (LLC) • Just like the S-Corp • Rather than complying with IRS laws. Limited Liability Partnership -(LLP) • Has limited and general partners • General partners have management responsibility/control and unlimited liability for the business • You would make a corporation the general partner so the individuals are protected • Limited partners are liable only for what their capital contributions to the business were. in accordance with the principal's manifestations to the agent. 2. taxes are paid at the individual level. Page 4 of 148 . pass through taxation • partners are EACH jointly and severally liable for actions of the partnership • So an injured party can go after any partner for the full value of their claim. at the time of taking action that has legal consequences for the principal.01 and 1.08 o Apparent authority exists when a third party reasonably believes the actor has authority to act on behalf of the principal. o The information can come to the 3rd party directly from the principal.but not visa versa • Who will own the business? • Who will manage it? • Who will reap any profit? • Who will bear the risk of loss? • Who will pay taxes on profits? SOLE PROPRIETORSHIPS o The good things about sole proprietorships  You don’t need a lawyer or any forms to start one. the agent reasonably believes.01 (R3 mixes actual and implied authority together) o Authority to do an act can be created by  Written or spoken words (Express Authority)  Other conduct (Implied Authority) o An agent acts with actual authority when. Family partnerships are common in SC because they are an estate tax avoidance technique.03.people still invest.

if not then yes – 6. there is no express authority and there is no apparent authority because the call was made by the supposed agent and not the principle. o RSA § 322 – if the agent is purporting to act on his own behalf.01.07 – Scope of employment o TO find the employer liable. Propp is bound by 2. second part depends on whether the P is disclosed or unidentified or undisclosed – if the first then no. o R3 6.03. 36  Problem 1: Agee might be legally obligated b/c R3 6.In SC you would have to pursue this as a K claim instead of a tort claim Disclosure of Principal – When the agent is liable for a contract o R3 6. Legal Consequences of Actual or Apparent Authority  See problems on p.01 Actual Authority.03  Problem 2: Propp might be obligated to pay even though agent ordered more than principal allowed under the theory of apparent authority.even though the P is exposed. prop is liable because there is apparent authority – Prop knew that Agee had made prior orders from TP and that he has paid it. o Factors to Consider finding employer/employee relationship  Extent of control the employer can exercise over details of the work*  Whether or not the person employed is in a different kind of business from the master  Whether the type of work is generally done with or without supervision  The skill needed by the employee  Length of time of employment  Whether work is regular business of employer  Whether the principal is in business  *Whether the employer supplies the tools (Imp in SC)  *Method of payment – per time or per job (Imp in SC)  *Express manifestation of creation of employer/employee relationship (imp in SC)  *Whether the principal has the right to fire the employee (imp in SC) R3 7. Page 5 of 148 .• •  • • • o No detrimental reliance is needed o Giving an agent a job that typically carries an authority can create apparent authority  Ex – hiring an atty grants the atty the apparent authority to act in the client’s bests interests to protect the client.employer is better able to shift the cost • Employer maybe could have prevented the accident o All servants are agents but not all agents are servants o Some independent contractors are agents and some independent contractors are not agents. the agent is liable for the contract. The independent contractors will not be servants. Also this is outside the scope of Agee’s authority so there is no implied authority • Finally.07(3) – Creation of a employee o an employee is an agent whose principal controls or has the right to control the manner and means of the agent's performance of work o Why should an employer be liable for torts committed by the employee? • Cost of business. but is in fact acting on behalf of an undisclosed principal.03 – If there is partial disclosure of the principal (3rd party knows agent is an agent. Agee may or may not have to pay. the Agee will be liable. Agee might be liable under a misrepresentation type claim. Master/Servant – Creates Tort Liability Must create a master/servant relationship to have tort liability R3 7. and 6. Propp should have taken action to let him know • Is Agee liable to TP – an agent is liable if he makes a misrepresentation to TP – but authority is split on whether this is a K claim or a tort claim  Problem 3: Propp would not be liable. It could be considered a tort claim instead of a K claim. there is a misrepresentation.02 – If the principal is known to the 3rd party.01 and 6. 6. the agent is not liable for any contracts entered on behalf of principal. but doesn’t know who he is an agent for) then the agent is liable for the contract.02. so TP would reasonably believe that Agee still has this authority. the worker must be an employee working in the scope of his employment. o Attorneys are typically independent contractors who are agents.

then intentional torts might not be unexpected o Coming and going doctrine – travel to-from work in most cases is not within scope of employment unless that travel is part of the job o Frolic v. place. o Hayes v. and purpose of the act  Previous relations between employer and employee  Extent to which the business of the employer is apportioned between different employees  Whether or not act is outside the enterprise of the master  Whether or not the employer has reason to expect that such an act will be done (forseeability)  Similarity in quality of act done to act authorized  Whether or not instrumentality of harm was furnished by employer to employee  Extent of departure from normal method of accomplishing an authorized result  Whether or not act is seriously criminal o Problems on pg 39  Is Servantes a servant – yes • What’s the difference b/w servant and agent o A person who employs an agent is a – Principle o A person who hires a servant – employer o No term for hiring an IC • How do the agent and employee groups overlap? o You have employees as a subset of agents – the P must have control to be an employer – circle would be inside the agent circle o THe IC circle would overlap – because they could be agents or not  Attorneys o See page 49  The CEO of GM is a servant as is the pilot • You would not be liable for the accountant’s tort because they are an IC  Yes you are liable for the coffee spill – employee = respondant superior • Still liable even if he tells him not to spill coffee • Is Servantes also liable – Yes – just because the employer is also liable doesn’t get you off the hook for your own tort – but he wont be able to collect twice  Prop is not liable for the tort committed while Servantes was on the way to work.Conduct is in the Scope of Employment It is what he was hired to do It occurred for the most part within time and space limits of employment Work is done to serve the employer If use of force is part of the job. and Hayes tried to reject the settlement on the grounds that the lawyer didn’t have the authority to settle. 40)  Hayes sued for wrongful termination.07 – kind of conduct within scope of employment o Conduct of the same general nature as that which is authorized o Determining whether conduct is so similar as to fall within scope of employment  Whether or not commonly done by such employees  Time. National Service Industries (p. Her lawyer settled. Detour  Generally depends on how different what the employee was doing was from acting in the service of the employer • R3 7.its outside the scope of employment  Is Propp liable for the cook hitting the customer with a frying pan • Employers are liable for some intentional torts – but it depends how closely the act is related to the employment  Does he need an atty if he hires an atty • That would cover a lot of it. o     Page 6 of 148 . but not all o Other business agency relationships o Attorney-client o Note that an attorney is most likely an independent contractor who is also an agent.

 P had two theories as to why vicariously liable: actual agency relationship (because of control asserted by McDonalds) and apparent authority/agency.which people will assume is your agent and has authority to act on your behalf  Malpractice protects the attorney o The agent cannot create his own authority no matter how persuasive he is Franchises o Agency will arise if the franchisor-principal has the requisite degree of control over the franchisee-agent. Tuomey (SC Case from 2000)  Page 7 of 148 . the use of the McDonalds name and uniformity of operations and appearance and the fact that patrons rely on the McDonald’s name to find “quality” was enough to create a question of fact as to apparent servant. the franchise agreement specified that 3K was an independent contractor and responsible for it’s own torts. Specifically.  Court looked at MASTER SERVANT relationship. it creates an agency relationship that does not otherwise exist while apparent authority expands the authority of an actual agent  See R3 on apparent authority • Apparent agency is the wrong term because this is a tort problem it should be Apparent servant • P must hold the franchise out as its agent and the TP must rely on that to her detriment • Texaco case. but control day to day operations. that is enough to cause them to be liable. 44)  Facts: Lady bit into a really classy heart shaped sapphire when she chowed down on a big mac purchased at a McDonald’s franchise owned by 3K Restaurants.  Note: the agent cannot create his own authority – this case gave the lawyer apparent authority which is designed to protect the third party o The manifestation of authority comes from the act of hiring an attorney. and looked into the details of control that McDonalds could exert over 3K in its day to day operation.(some courts might say that setting standards would be enough) Simply controlling the lay out and setting standards wouldn’t be enough (Shell case) but controlling the detailed performance of the franchise and its employees in how they meet those standards does (Hilton) o it does here. they must exercise control over anyone using it  Court also looked at RSA 267. McDonalds (p. Jurisdictions differ on the P’s burden of establishing detrimental reliance on an appearance of agency and in probative significance assigned to a party’s failure to correct misimpressions that others may draw about the nature of a relationship. This is apparent agency. and decided that this created a right to control and thus was a question of fact as to whether McDonalds was a master and responsible for tort? The generally accepted principle is: If the relationship between McDonalds and 3K is such that McDonalds has the right to control daily operations. • Applies right to control test bc employer-employee relationship doesn’t work well here 3k would be the servant – so if the tort occurs within the scope • Must not only set standards.  § 267 appears to have disappeared from the Rest.  RSA § 267 – Apparent Servant Doctrine. McDonalds tried to defend on the fact that they didn’t own the restaurant. which is different from apparent authority. In this case. but Burkhard assumes § 267 is alive and well in SC. o Miller v.which is the cause of the tort in this case • One difficult problem that franchisors have is that to protect their trademark. 3d.apparent authority where national ads and logos at site lead customer to believe the service station was the A of Texaco • Franchise agreement must require franchisee to act in ways that identify it with the franchisor – this is the case here so there is apparent authority • ∆ argues that there was a sign that said it was owned by 3k – but that wasn’t enough • Centrally imposed uniformity is key • Π does not have to prove that the other McDonalds she went to were owned by McDonalds rather than being franchises  3K is directly liable and McDonald’s is vicariously liable o Simmons v. so there is • One big thing is that McDonalds controlled the food handling.o Rule on Atty’s Apparent Authority: The court held that simply hiring an attorney to deal with third parties creates apparent authority to act on behalf of the client UNLESS the client expressly limits the authority and communicates the limitations to the 3rd party. If a party (1) represents that another party is a servant and (2) a 3rd party reasonably relies on this representation then the apparent master can be responsible for torts. notwithstanding the customary boilerplate provision in the franchising agreement that the parties do not intend agency relationship o Sometimes courts apply the theory of apparent agency or estoppel to hold franchisors liable.

Med. which of course. the risk is higher. On the other hand.Pledge personal or corporate assets against the loan as a form of collateral to secure the loan o Promise to pay the money back in a short time = more certain predictions o Give the creditor some measure of control over the business  Loan covenants  Participation in business decisions.This restatement lowers the RSA § 267 from detrimental reliance on the part of the third party to a reasonable belief. but so is the potential return. We are using other people’s money and paying less to them than we can make with their money (preferred shareholders). They then applied Restatement of Torts § 429 (essentially they’re saying that 429 is really an expression of nondelegable duty) to find a hospital liable for the torts of a doctor who would otherwise have clearly been an independent contractor. both up and down.o • • • o o SC court adopted 429 as the basis for applying liability. Assuming that it is not this is important because its BOP is lower than the Restatement of Agency Problems page 51  2) court didn’t care about the agreement and it shouldn’t. instead he must use debt funding o Way to structure a loan so it will be perceived as low risk o Security . A plaintiff’s attorney would rather 429 apply. the equity owner has no right to repayment • Debt has a fixed cost: the interest rate the business pays to borrow the money is the cost of those funds. They said a hospital owed a nondelegable duty to render services. The concept is called leverage. it is an investment that the business receives for selling a part ownership in the business • Debt funding has a legal obligation to pay back. Equity • Equity funding does not come with a legal obligation to repay. the P should alert the public that there is no agency relationship o This article on page 67 is important because the author became the reporter of the Rest of Agency 3rd  see 2.05 429 is better for Π because it only requires reasonable reliance and not detrimental reliance as Rest 2nd of Agency 267 does o This is important in SC because in Simmons v. being an owner has a higher risk. • So a sole proprietor can’t use equity funding and still be a sole proprietor. • Debt is riskier to the business (leveraged is a term used when the company has debt funding. Center  The employees working in the ER are not hospital employees but IC  The SC Crt App and the SC both concluded that the hospital is still liable • The Sup. If the owner puts in his own money. it is not a debt to be repaid  Debt v.like a seat on the board o Lender may also want profit share instead of interest o Should you automatically arrange the company as a corporation so you wont be liable for the loan o Wont work because the bank will require you to personally secure the loan o See handout with comparison of capital structures. We don’t know if 429 applies outside the world of hospital/doctor cases in SC?? That is the only place it has come up so far. flows right to the sole proprietor • Compared to being a creditor. but there is normally question of whether it goes to the employer/employee level Growing a sole proprietorship  The owner can put his own money in. it will serve as an investment or equity. not the boiler plate. Page 8 of 148  . Sum of Rest 267 cases ∆ win most of the cases. Court adopts 429 as the basis for finding liability – however the did so saying they did not adopt a view totally against delegable duty o Not sure if 429 applies outside the world of hospitals – but it probably does. the cost to the business of the equity is uncertain.many people think it is stupid to hold the franshisor liable for torts committed by the franchisee – others o Notes Agency by estoppel is used to hold liable a party who benefits from a relationship in which the parties did not intend the legal consequences of agency – ie you don’t get the benefit without the risk o To avoid this.  4) YES you would take advice of counsel  The indemnification clause is good  As are the clear warnings – especially the sign requirement which says the place is owned by someone other than the company  There is almost always an agency relationship between franshisor and franchisee.  Rest of Torts 429 . because it the acts. Tuomey Reg. or he can take loans. the lender has leverage against them and can force them to pay). at the time the equity is sold. but they did it in a strange way.

1 – using lend would have helped. it doesn’t negate the other aspects o 2.000 of liability insurance or higher if your partnership renders professional services. but she has.this is common – many people enter into partnerships just by going into business with another and that there are consequences o Therefore her claim to her brothers assets come in behind Villabona Problems page 61 o 2.PARTNERSHIPS o Estate of Fenimore – DE Rule for finding a partnership (p. The court said that receiving a share of profits was prima facie evidence of a partnership. But you can have a single member LLC. o Issue: Equity Investment in a Partnership vs.3 – taking out the profit sharing (or at least use clearer terms) and clearly writing the document to be a loan agreement. but it probably wouldn’t trump the profit sharing. Villabona loaned him some money for the same business. o Courts have said that not all partners have to share in the decision making and liability – but they do have to have at least one. You are taxed on the money. Often business entities become partners. Thus. and both the sister and Villabona wanted a cut.  Entity approach (RUPA – not followed in SC) – the partnership is an entity in itself • Tax – the partnership reports income on one statement but the individual partners pay their portion of the taxes.” Further. o To become a limited liability partnership. a condition of the loan was that she would receive profits from the business. Also you must demonstrate that you have at least $100.and there must be an intent to share profits – not all courts would agree with this.ie sharing liability o The BOP is less strict when at third party is involved then when the dispute is b/w the 2 partners  This lowered standard plus the fact above mean that this was a partnership agreement  She may not have intended to enter into a partnership. sister would have priority as she made the first loan. Problems page 63 o Can’t be both a sole proprietor and a partnership. o A corporation can be a partner. nor can you start a partnership by yourself. she was a partner. Loan. o A joint venture is a limited purpose partnership (Meinhard). Later. whether or not it is paid out to them or not.  Tax – the NET INCOME of the partnership flows to partners. You can create a partnership without realizing it. and didn’t get her loan back. She said “advanced” rather than “lent. but the court didn’t care. § 33-41-1130. You have to file to be a limited liability partnership. o Cant be both a corporation and a partnership – you’re one or the other o SC allows a corporation to be a partner § 33-3-1029 o What is partnership law? Page 9 of 148 . His sister loaned him some money for his business. 58) o Facts: Fenimore died insolvent. only reactive – ie that he cannot initiated a transaction o Important but may not be controlling o But beware – veto power may be enough o What is a partnership o For this class. The court acknowledged that she didn’t intend to be a partner. But there is a risk that a court will say it still meets the requirements of 210 o 3 – need more than a “veto” power to be considered a partner o Note 5 – Martin v. The estate inherited $20K. we will be looking exclusively at the UPA (don’t worry about RUPA) b/c SC mostly follows UPA. Peyton held that Peyton was not a partner where he had no active control. Villabona argued that the sister was really a partner. If both were deemed to be creditors. o DE Rule for the Existence of a Partnership: The court looked at the terms of the sister’s loan. o UPA § 6/ 33-41-210 –Partnership Defined o A partnership is an association of two or more persons to carry on as co-owners of a business for profit o “Persons” includes entities o Rule: that anything not specifically formed as something else under the laws of the state is automatically a general partnership. and is taxed to them on their individual tax returns. but not absolute o Agreement looks like a partnership  Intent of parties  Sharing of profits  Allocation of expenses.. These concepts are important.  Aggregate approach (UPA – the SC approach) – the partnership is an aggregation of individuals. and the fact that she made no decisions wasn’t enough to rebut that evidence. look at § 33-41-1110. and her “loan” was an equity investment”.

 Rights to property can’t be assigned unless all partners assign their rights (Mutual Consent for Assignment)  Creditors can’t attach to partnership property unless they are making a claim against the partnership. However. But if they do. A8) – Extent of Property rights of a partner o Has the right in partnership property o Has interest in the partnership o Has the right to participate in management – this can typically be modified by the agreement o UPA § 25/33-41-720 – Nature of a partner’s right in partnership property o Partners are co-owners with “tenancy in partnership” o How tenancy in partnership works:  The partners each have an equal right to use partnership property for partnership purposes. you need to put in the agreement that you have the most say and get 70% of the profit. but there are some that it does not allow you to side step it – often this is when disputes with third parties are involved o Modification of the Partnership Agreement: o Under UPA-SC the lawyer drafting the agreement must look section by section to see if a particular section can have the rights and obligations modified in the agreement. and you could make it clear with better drafting – so do so o Says that profits shall be “divided” which is not the same as “distributed” o Extent of Partner’s Ownership Interests o Who owns what? o UPA § 8/ 33-41-230 – Partnership property o All property brought into the partnership or later acquired on account of the partnership is partnership property. 67 o 2. o See § 33-41-230 for what happens if real property is conveyed to a certain partner. but no right to the property for any other purpose without consent of partners. they probably need separate ones – but that’s an ethic issue o However often only one lawyer does it – but be sure to think carefully o Problem with sample agreement on 86 is that it doesn’t tell us what “mutual agreement” is – it doesn’t say what the vote has to be on decisions – this would get us in trouble. New tables and chairs are partnership prop o Page 10 of 148 . and as such can only be sold in the name of the partnership. o If property is owned by one before the partnership is formed and the partnership uses it  Does the property get treated as a capital investment  SC 33-41-230 • All prop brought into the partnership stock is partnership property • But not clear what is brought into the partnership – so make it clear in agreement o What if property is acquired by the partnership with the funds from one partner – what if it is in the individual’s name o 33-41-320(4) – says it doesn’t matter.The rights and privileges of partners are primarily governed by the partnership agreement. Cash and credit card receipts from operation are partnership property o 4. Page 65 o You don’t have to have a partnership agreement to operate as a partnership – but they should o They don’t need a lawyer. o Problems p. but that’s not totally clear. the language is imprecise o It may mean unanimity. The UPA contains fall-back provisions in the event there is no partnership agreement or the partnership agreement does not cover the issue. the equitable title passes to the partnership o UPA § 24/ 33-41-710 (p. otherwise RUPA and UPA kick in and a majority vote rules decisions and profits are shared equally o Somewhat misleading – the statute does allow you to trump it. a partner’s right is vested in the other remaining partners. o Both RUPA and UPA serve as the default rule when partners fail to agree on a rule in the agreement o So if you contribute 70% of the capital. o Unless there is some appearance of contrary intent by the partnership. On death of the last partner. the property goes to his legal representative  Next of kin can’t attach to partnership property o Essentially you have the right to use the property that the partnership owns  Partners rights in specific property is not assignable unless they are transferring everyone’s rights in the property – so you cant sell a part of something unless the partnership agrees o UPA § 26/33-41-730 – Nature of a partner’s interest in the partnership o Partner’s interest in the p-ship is his share of profits and surplus and his personal property. there are a number of provisions of the UPA that say they cannot be changed by K.  On death. Cooking equipment used in restaurant might be partnership prop depending whether it was loaned or contributed o 3. property acquired with p-ship funds is p-ship property o You can buy property in the p-ship name.

” o Because Salmon’s position within the p-ship gave him exclusive access to opportunities and information. Salmon took the deal and didn’t let Meinhard have a shot at it. somebody approached Salmon with an offer to develop some new apartment buildings. Partnership owns the property.If a partner is restricted from acting in some way. No act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners. o Basically. owe to one another. you’re looking for a partner taking advantage of the business of the partnership for his own personal gain • ∆ appeared to the owner to have the lease in his own right. it must be consented to by all partners.Duty of Partners to Give Information o Partners shall render on demand true and full information of all things affecting the partnership o Case law says that as a fiduciary a partner has a duty to make a disclosure regardless of demand • UPA § 21/ 33-41-540 – Partner Accountable as a Fiduciary o Every partner must account to (present information to) the partnership for any benefit he gets from any transaction connected with the formation. o (2) – An act of a partner which is not apparently for the carrying on of the business of the partnership in the usual way does not bind the partnership unless authorized by the other partners.  Partner’s Duties to One Another • Meinhard v. 70) o This is the most important business case ever decided in the US. this “usual way” is considered from the perspective of a 3rd party. o “Joint adventurers. o Also. Near the end of the lease.if you are in charge. Some people agree with the decision and some people don’t o Facts: Meinhard and Salmon were in a partnership where Meinhard paid to renovate a building.o o o o 5. is then the standard of behavior. No honesty alone. Salmon (NY) (p.UPA § 18/33-41-510 (8) o If the partners disagree as to an “ordinary matter.merely a joint venture for a limited object to the end of a fixed time – so it was a one shot deal o The new project is much bigger in size and duration – it wasn’t a mere renewal o If this had been a general partnership he would agree with the majority.” o Test for Partner’s Duties to One Another: Partners must treat one another with a punctilio of honor – the duty of the finest loyalty. you have a greater duty to look out for your partners • Dissent • Says there wasn’t a general partnership. like copartners. he sees no fid duty other then that which is within the scope of the limited venture • He also thinks that these ventures are distinct enough that even if there was a partnership. and Salmon managed the building during a 20 year lease. but because he didn’t the court is going to give the Π an interest in the venture o The fact that he had sole power to make decisions means he had an even higher duty to disclose  He robbed Π of a chance of renewal • So there is a graduated scale. o (4) . Partners as Agents – UPA § 9 / 33-41-310 o (1) – Every partner is an agent of the partnership for the purposes of its business when he is apparently carrying on the business of the partnership in the usual way-binds the partnership  In all likelihood. if an act goes against the p-ship agreement. while the enterprise continues. for a breach like this. A trustee is held to something stricter than the morals of the marketplace.” the disagreement shall be resolved by a majority vote. the development plan would have been presented to both Π and ∆. the duty of the finest loyalty. the ∆ was still in the right to act alone • 33-41-530.  Who decides what the p-ship will do? Solving General Disagreements . his actions aren’t binding if the 3rd party has knowledge of the restriction. he had a duty to disclose to Meinhard. Partnership agreements are private agreements that are not made public. but he didn’t act as such and acted as if he held it as his own  He acted in secrecy • If he had told the Π and they had competed for it. conduct. or liquidation of the partnership or from any use of the partnership’s property • UPA § 22 /33-41-550– A partner has a right to a formal accounting of p-ship affairs: Page 11 of 148 . Cited more times that any other business case in America. Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. but the punctilio of honor the most sensitive. then he might be able to keep it as his own. Salmon breached that duty. but in fact he held it as a fiduciary o If he had acted as such. “Salmon appropriated to himself in secrecy and silence. but since its not.

L. case law shows that there doesn’t have to be a demand and that a partner has a fid duty to make a disclosure regardless of demand o These two sections are the only times that the UPA talk about fiduciary duties o 1. SC. see 530 and 540 o Would SC find these two to be a partnership – yes – see §210 they are both in a lease arrangement to make money o Most attys would say that a joint venture is a kind of a partnership – a limited purpose partnership o If so. lie cheat.§540 says a partner will hold as a trustee any profits derived by him without consent from the others from any transaction connected with the formation o §530 – Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner or any partner under a legal disability  This wouldn’t kick in in the Meinhard case because Meinhard never demanded the information  However.  If partner injures TP in scope of business. 275 (2004) o Compares fiduciary duties of partnerships to LLC – written by Toal o Takes position that despite 409 – there are more fiduciary duties owed by partners then by members of LLC o Would the language in 5 work? o Problem is that not everyone will be in equal bargaining position. there is an argument that it would have come out differently.the kicker is though that neither the DE. a point of honor  Liability in Partnerships o Partnership liability as an Entity o UPA § 13 / 33-41-350 – Liability for Wrongful Act of a Partner: The partnership itself is liable as an entity and is bound by any wrongful act of a partner acting in the ordinary course of business.o If he is wrongfully excluded from the business by his co-partners o If the agreement gives him the right.2 – you could say that the opinion would come out differently – the nondisclosure issue wouldn’t arise. you can say there is no duty of loyalty – this wouldn’t fly in SC. or if the partnership receives it and a partner misapplies it – the partnership must make good the loss o UPA § 14 / 33-41-360– P-ship is bound by a partner’s breach of trust.just trying to make some money o Read 56 S. its fine.§ 33-41-370(a) Page 12 of 148 .you can put in an LLC agreement that if anyone wants to steal. o Joint and Several Liability of the Partners o Liability of Partners  RUPA – partners are jointly and severally liable for all obligations of the partnership  UPA – partners are jointly –NOT severally. so there is room to challenge it o Delaware .Rev.3 – probable would reach the same result – Cardozo talks about managing partner having a higher duty but they still have a duty as partners o On page B-17 § 33-44-409 o Fid duty as contained in the LLC statute – its very different then what is in the partnership statute – but is similar to page 98 of the text (RUPA) o Also look at B-5 LLC  Operating agreement may not change • Duty of loyalty – but may id types of activities that do not violate those duties • Cannot reduce standard of care • Rules of goof faith and fair dealing o What if Meinhard case was an a SC LLC – what section would have helped Meinhard the most o 33-44-409(b1) o To Salmon? o 409(e). o If a benefit was received as described in § 21 o catch all: Whenever the circumstances render it just and reasonable Problems on 74 o 1. but he still may have taken something that didn’t belong to him. nor the Leg was willing to delete their language which we find in SC 409(d) – which talks about K obligation of good faith and fair dealing o Burcky thinks this will be used by DE courts to reach the same result as you would if you said there was a duty of loyalty o Debate that SC statute is too rigorous o What is a punctilio? A detail about which one is fastidious. then the partnership is liable to the same extent as the partner  When partner acting in scope of apparent authority. receives money or property from 3rd person and misapplies it. Partnership is bound to make good the loss when 1) one partner acting within the scope of his apparent authority receives money or property of a 3rd person and misapplies it and 2) when the partnership in the course of its business receives money or property of a 3rd person and the money or property so received is misapplied by any partner while it is in the custody of the partnership.liable in contract BUT ARE jointly and severally liable in tort  SC – partners ARE jointly and severally liable for K and tort.C.

agent. unless the partner was at fault for appointing or supervising them.• Liable for everything chargeable to the partnership UPA § 15 / 33-41-370 (modified in SC): Nature of Partner’s Liability  (A) All partners are jointly and severally liable for claims against the partnership. a plaintiff is free to go after a single partner. o 15-35-170: Judgment against a Partnership  Burkhard says that this has never been used against partners (its purpose is to nail the unions). o 15-5-45: Suing Partnerships  A plaintiff can sue a partnership with or without joining any of the partners. and force them to go out and get the rest of the partners. o RSA § 404 – Liability of agent for use of principal’s assets  Agent who uses for his own purposes the assets of a principal’s business is liable to the principal for the value of the use. which means they are not liable for the acts of others  Doesn’t protect from K claims o D) if you take part in the services you are liable  If someone else in the limited liability partnership does it. o Should name the partners and the partnership as defendants o §170  an “anti-union” statute. for debts.  (B) A partner is not liable by way of indemnification. you can go after the personal assets of the partners if you can manage to join them in the suit. wrongful acts. obligations and liabilities charged to the partnership arising from negligent. P could also sue E. § 370(a) o 2) how can P enforce judgment against the partnership – o Because all the partners are not named in the case.  Not liable for use of time he contracted to the principal in some other matter. unless he violates a duty not to act in competition with the principal. and the partners are personally liable for any judgment. (Except as provided in B below) • Note that with joint and several. If you get a judgment against a partnership. regardless of whether they are tort or contract claims. and also allows the partnership to sue. o Page 13 of 148 . supervising or cooperating with them. or representative of the partnership • Unless that person was under his direct supervision • Or a person rendering personal services on behalf of the LLP. who is another partner – SC makes us severally liable.3 – yes. Not sure how negligence would fall o §370 o Allows for some partnerships to qualify as a registered Limited liability partnership. or otherwise. due process says you can’t collect from a party unless that party is a named party of the lawsuit. contribution. and the partners as people o 4) P can collect from both o Entitled to indemnification o 5) 510(2) – the partnership must indemnify every partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of its business or the preservation of the business or property o So yes. aimed at unions (don’t like unions in SC) o 1. You better name all of the partners. but there is nothing in SC act that give a TP the right to sue the business –aggregate idea comes in and says you have to sue the partners o §15-5-45 and §15-35-170 – on TWEN allows you to sue the partnership. but he must qualify. then you are not liable for torts unless you are at fault for appointing. Problems page 77 o 1) looks like an easy answer.  Judgments against a partnership bind its real and personal property. • There is no protection against K claims o 33-41-510: A partner is entitled to contribution or indemnity from other partners if the personal liability was reasonably incurred by him in the ordinary and proper conduct of its business or for the preservation of its business or property o 33-41-1200(g): addresses the liability of the partner of a limited liability partnership for a partner who transacted business in a state without a license.2 – yes P can sue A –the tortfeasor o 1. the partners as partners. which equals violation of DP if you aren’t named in the lawsuit – so this is a problem because the statute says you are jointly and severally liable o So to collect against the partners they have to be joined – name the partnership. or misconduct committed while the partnership is a registered LLP and in the course of the partnership by another partner or an employee.

However. Debt in essence levers up the return on equity. Earnings from Business Operations o Must consider if the partnership can earn a higher return than the partners can individually o They should be distributed unless the partnership has some lucrative use for the funds o Problem 81  2 partners want to invest. it would be easier if the partner signed the loan agreement. the question is whether amending the agreement is in the ordinary course of business. the partner might not care because the bank could come after the partner anyway under joint and several liability. Additional Owners o UPA § 18 / 33-41-510(7)– adding a new partner requires consent of all partners unless the agreement specifies otherwise. It almost always increases the investor’s return but it also increases the investment’s risk. Agee and Propp who work at the partnership can receive a salary while Capel does not (he doesn’t work there)  §33-41-510(6) says that no partner is entitled to a salary o 2. 82 o 1. criteria for making a capital call. Capel can prevent Agee and Propp from increasing their salaries if the salaries are in the partnership agreement (can’t change without the consent of all partners)  if it is not in the partnership agreement. you still are liable for the torts of your partners o Growing a partnership Contributions from Existing owners: Rules on Capital Calls o If the partners agree. there should be something in the p-ship agreement that states what vote is required for a capital call. o Normally. it must be unanimous • Problem 2) o §390 – partner IS liable for existing partnership obligations that arose before you joined – except for liability that is to be satisfied only out of partnership property o Privity of estate says he will only be liable for property obligations from the time he enters to the time he leaves  New partners are not liable for preexisting liabilities. so they will need to change the agreement to add this – which is why they come to you • Answer depends on whether amending is in the ordinary course of the business – if so then a majority vote will do – if not. and how things will be handled if a partner can’t or won’t respond to a capital call. they can decide that the partners will contribute capital to the partnership. 1 wants to use profits to pay school loans • Majority vote rules because paying profits out is in the course of ordinary business (only need 51%) o How do owners make money? Salary o The assumption is that partners make money through distributions o UPA § 18 / 33-41-510 allows salary if the partners put it in the agreement o Problems p. Capel can’t compel the partnership to employ him and pay him a salary o Page 14 of 148 . Input from outside lenders o Discussion on leverage.  If the partnership agreement requires the consent of all existing partners and they want to amend the partnership agreement to provide that admission can be approved by a majority. they could change it by a majority vote because it is an ordinary matter o 3. Liable for the time period in which he enters to the time he leaves.  Problem page 81 • Default rule says they all must agree.o o o o o o o This statute is mainly the result of lobbyist for accountants from out of state said they were pulling out of SC unless they passed this statute How do you become a limited liability partnership – A-18 o § 1110 (A) says you must file an application with the Sec. o If the bank forces a partner to sign a guarantee on a loan. of State – this is unlike a general partnership which can be created without any paperwork o Must renew registration every year  Failure to do so will make you a regular partnership o Must have at least 100k of insurance  Or more if your professional licensing board requires you to If you are a registered NC LLP and you come into SC to do business but forget to register in SC o 1210(C)  Doesn’t matter.

when you sell your interest. doesn’t matter who put in what. Partnership Agreements change the default rules and can provide for how profits are allocated o 3. but continues until winding up of affairs is completed UPA § 31 / 33-41-930 – Causes of dissolution Page 15 of 148 o . the partnership is still compelled to buy the partnership interest if the partner withdraws – but how much he gets is up to the agreement and statutes  Tells you what happens when someone dies or quits  Normally you provide that you can buy out the dissociated partner’s share o Withdrawal / Dissolution– Compelling the partnership to buy your interest. which the new partner does not inherit by statute o Also he can only transfer his right to share profits and losses and receive distributions – so not control o UPA § 26/33-41-730 – a partner’s interest in the partnership is equal to his share of profits and surplus. get the other partner’s approval. o Dissolution of the Partnership UPA § 29 / 33-41-910 – Dissolution Defined: a change in the relationship among the partners when any partner terminates his association with the partnership.  Easier to sell to the partnership then to an outsider = buy-sell agreements allow the partnership to do this  Need to include • Whether the partnership is obligated or has an option to buy • What events trigger that option • How is the selling partner’s interest to be valued • What is the method of funding the payment  Absent such an agreement.that only comes up when the partnership ends. profit distribution is specified in the p-ship agreement o UPA § 18 / 33-41-510(1) provides default rule: each partner shares in profit and losses equally unless agreed otherwise. so the partnership will determine how much the business made and then allocate on its books what everyone’s share is  Right to receive distributions – is the actual physical paying out of your % of the profits Sale of ownership interest back to the partnership o Buy-Sell agreements – the partners can agree to buy an individual partner’s interest from him. o Dissolution is the start of the process to end the partnership UPA § 30 / 33-41-920– The partnership is not automatically terminated upon dissolution. You have to quit to no longer be a partner o 2) not automatically unless he is voted in. 83 o 1) §740 says no. you only sell rights to distributions and liabilities –this does not necessarily give a right to make decisions  This is different than being a partner under 510 which requires a unanimous decision  If you sell your interest you are really selling your financial rights – this doesn’t mean that you are no longer a partner.  Can only sell your financial rights without the consent of the other partners o UPA § 18(g)/33-41-510(7) :by default. only entitles them to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled. (Does not by itself trigger dissolution)  Doesn’t give the assignee any mgmt or administrative rights in the partnership. They have discretion.  Selling financial rights doesn’t necessarily end your participation in the partnership unless you quit. Majority vote would rule for an ordinary matter regarding profits o 4. Aside: you do not have to make a capital contribution to be a partner o 2. Presumably it is an ordinary matter (decision) for the business Sale of interest to 3rd party – doesn’t cause dissolution by default o Remember that the selling partner will have to find someone. and work out an agreement about his prior obligations. when partnership ends partners would be repaid contributions before profit divided o Problems p. The creditors care and the IRS cares (because this could be income shifting to get from a high bracket to a low bracket) Profits o Generally. Don’t get confused about liability to partners.they should put it in the partnership agreement what % they get. o UPA § 26/33-41-740 – Effect of assignment of partner’s interest in partnership and this is assignable.o o o o o o 4. and his personal property. Default distribution is equal to all. 82 o 1. which leads to dissolution of the partnership. The partnership can pay Capel a salary even though he doesn’t do any work for the partnership. adding a partner requires consent of all partners  So the sale of transferable interest to a third party does not automatically make that person a partner unless they’re voted in o Problems p. Yes they can. o 3) Partner’s Share of Profits – these are computed at the partnership level.

 Express will of all the partners who haven’t assigned their interests or suffered them to be charged with their debts  By expulsion of a partner in accordance with a power to expel conferred in the agreement o You can have a dissolution in violation of the agreement if a partner quits in a way that isn’t provided for in agreement. and the expelled partner is discharged of all of his liabilities under 33-411010. then the expelled partner gets his net amount owed in cash.  The wife was not satisfied with the accounting.Dissolution in Contravention of the Partnership Agreement -When a partner wrongfully dissolves o The partners who didn’t cause the dissolution  get all the rights under paragraph § 38(1) -33-41-1030 (can get cashed out if his liabilities are paid off) and the right to damages for breach against the dissolving partner  May continue the pship under the same name if they pay off the dissolving partner less damages for breach o The partner who caused the dissolution  Gets his payout minus damages  Does not get his share of the value of the good will of the business if the p-ship is continued o Note that this can all be modified in the agreement Dissolution is the beginning of the end and Termination is the end RUPA says any partner has the power to dissociate at anytime but there could still be legal issues Unless the agreement says otherwise.  When will he be paid .§1040 • he is liable for damages (but not sure how to compute that) • if they continue under the same name – you pay him off • do not consider value of good will in computing the assets – so you’re getting a discounted amount o 5) partner can rightfully withdraw when there is no specified end date Creel v. (unless otherwise specified in the partnership agreement)  If the dissolution was b/c of an expulsion. This is wrongful and you have breached your K obligations. o If an event occurs that makes it illegal to carry on the business of the p-ship or for the partners to be associated with the pship o Death of a partner o Bankruptcy of a partner or the partnership o If the court says so in accordance with UPA § 32 UPA § 32 / 33-41-940 – Dissolution by Decree of the Court • UPA § 38(1) &(2) – How to handle dissolution situations o 38(1)/ 33-41-1030 – When dissolution not in violation of partnership agreement  Each partner can have partnership property credited against his liabilities and can have the net amount owed to him paid in cash. the court looked at the “termination” section of the p-ship agreement and decided that the partners intended this section to take the place of automatic dissolution under UPA and that the agreement doesn’t mention forced liquidation. and the partnership wound up and accounted and paid the estate Creel’s share. However. accounting and the deceased share of the remaining profit was distributed to him – this is all the surviving members need do  Document need not account for every continuation as long as intent is shown  Burcky says the court is reaching here because the document isn’t that great o Court says agreement has a “continuation clause” in the form of a buy-out option by providing that the deceased partner’s share of the partnership goes to his estate Page 16 of 148 o .a partner in a “partnership at will” (one with neither a specified end date nor a specific undertaking to complete) can quit at any time without it being wrongful Problems 85 o 1) yes he can withdraw but it will be wrongful 930(2). and wanted the pship assets liquidated. Lilly (MD) (p.If the agreement specified a term and that term expired  A partner expresses that he wants to dissolve if there is no express term or particular undertaking specified in the agreement. o Note that this can all be modified in the agreement 38(2)/ 33-41-1040 . presumably b/c they were selling memorabilia that was worth much more than its book value. 86) o Facts: Creel started a NASCAR store and eventually entered into a partnership to expand. Creel died.o o o o o o o Without violating the agreement  Term Expiration .full inventory. o The court states that the UPA entitles the wife to automatic liquidation unless specified otherwise in agreement.  Section title “Termination” but really covers dissolution and ‘winding up’  It says the assets and liabilities be ascertained – but this does not mean by liquidation  The ∆ followed the winding up method.

it ceases to exist o SC follows this o But court gets language wrong – agreement can’t prevent dissolution. they have dissociated. Almost all of these provisions can be changed by an operating agreement. you take the status of an assignee – kind of like creditor – you continue to receive your share of the profits (but they will vote to change these once your gone) • When the term is over. Ct says this is ok b/c the Business in its infancy stages probably doesn’t contain goodwill and Book Value is ok. it must first be offered to the partnership Rule: If the partnership agreement provides for otherwise other than liquidation upon an event causing dissolution. BUT remaining partners must elect to buy out the dissociating partner o UPA requires buy-out provisions to be in the agreement. It means something slightly different in the context of the LLC than it does in the partnership context.it should say “termination” • RUPA – entity allows continuation. it means that the ₪ is going to go into termination and liquidation • §601 gives a laundry list of items of causes of dissociation o 1 is important – it occurs when the company has notice of the members express will to withdrawal on the date given o 7 talks about when someone gets in financial trouble o Death.  The Court’s comment about the UPA rule requiring automatic dissolution of the partnership upon the death of a partner is wrong because when a person dies there is automatically a dissolution.  Key Points • LLC is deemed like a corporation to be an entity (not aggregate) so if someone leaves. the court can decided for you  §704 Page 17 of 148 .  The court said that if the agreement clearly states the intent of the partners. Should make clear in the agreement which measure of value you will use. many jurisdictions switched to RUPA • UPA – aggregate theory – one dies. then that intent controls even though it didn’t provide for every possible contingency. appointment of guardian. Market Value (that would include Goodwill). they have instead dissociated o When the LLC statute does use dissolution. When a member leaves an LLC. the entity is still there and the LLC can continue • Withdrawal of member is NOT a dissolution. The court noted that RUPA doesn’t have a forced liquidation. such as the death of a partner.says you can leave unless the agreement otherwise provided  Not sure how this operates • §603 – withdrawal of member o What happens depends on whether you are an at-will LLC or a term LLC  At-will means the other members will simply buy you out  Term – the members do not buy you out. and in this case. 33-41-603 explains the effect of an LLC member’s dissociation. but RUPA does not – but they must actively choose to buy out  Under RUPA – the estate cannot compel liquidation  Of course – the partnership agreement can trump both Rule: Liquidation Value of a business: There is also a dispute between Book Value (Cost of the Goods in the Store) vs. the intent was “clear” that they didn’t intend for liquidation  b/c of the automatic dissolution absent consent from estate or provision in partnership agreement. The withdrawal of a member from an LLC is not an event of dissolution.o o o o  If the estate wishes to sell that share. you get your capital • all of these default provisions can be changed by provision in an agreement  if you can’t agree on how much to pay someone who leaves an LLC. then the intent of the partners in the agreement will prevail. or judicial decision saying he is incompetent • §602 o There are rightful and wrongful events of dissociation  Wrongful methods result in consequences • Withdrawal against agreement provision • Bankruptcy o 602(a) has some ambiguity. but Burkhard said that is wrong under UPA 33-411030 (below)  Court is wrong to say that UPA wouldn’t require termination if the agreement doesn’t provide otherwise  §33-41-1030 would require liquidation to pay off the debts and pay out the assets Comparing to SC LLC provisions: Our LLC provision 33-44-601 follows the RUPA description in the Creel case. 33-41-602(b) points out what would be wrongful dissociation.

.§1030 – right to liquidate • What if withdrawing partner wants the partnership to terminate but the other partners don’t – they still have to liquidate under 1030 o If partner dies and widow wants the partnership to terminate. then they may and the withdrawing partner becomes something like a silent partner (?) • What if it’s a term partnership and one tries to leave before its over o §1040 says that the others can continue the partnership Page 95 • Are the debts owed to a partner that he lent to the partnership treated differently than outside creditors o Yes .b – is he liable for tort claim that arises after he leaves o Partnership doesn’t end at dissolution – so during windup phase. outside creditors can collect directly from the partners o But from inside creditors issues of indemnification come up – we won’t look at this Page 96 • (1)Yes they need to agree to partnership accounts because the beginning capital account for Capel is 250K.§1060(2) gives order –outside creditors collect first • If the partnership has no assets. . 970 o 970 is key – after dissolution a partner can bind the partnership by any act for winding up and by any transaction that would bind the partnership if dissolution had not taken place .we then distribute 1/3 to each partner • Problem 3 o Says only 20k is left over.§33-41-1010 – dissolution does not discharge the existing liability of any partner • 6.c – liable to long time TP supplier for orders made after he leaves o §1011. the other partners can continue to operate the partnership if the leaving partner allows it (?) • After one partner leaves the other partners cannot continue after windup . the partnership can either Page 18 of 148 §801 • • § 806 • Events causing dissolution and winding up of corporations The ₪ must be wound up on occurrence of stated events .a – is he liable for the property lease o YES .000 – so their capital accounts are different o Represent all 3? • (2)We also need to know how much money the partnership earned during the time the P was in business o §510 and 1060 say that each partner gets the remaining capital accounts at termination – but these accounts will be reduced by what is distributed to them o C = 250 -150 = 100 o P 150-142= 8 o A 2-0 = 2 o So we owe the partners a total of 110 – so deduct 110 from 200K (the remaining money) = 90K . they have to liquidate under 1030 o But if the withdrawing partner gives consent to the others to continue. he can be liable for K claims if windup is still going on – merely because you leave the partnership does not get you off the hook for something that happens after you quit o Also read 980 Page 94 • When one partner leaves. it is still a partnership. Agee 2. o Yes.  Tells you who gets what when you go out of business Problems page 91 • 6. 960. and he would still be part of the partnership. so if the tort happens during the winding up stage. Propp’s is 150K . so we don’t have enough to cover the remainder of their capital account o So 20k – 110K = -90k loss o Statute says the partners share the loss equally absent provision o So each suffers a 30K loss  C is owed 70K  P has to put back in 22k (8-30)  A has to put back in 28 (2-30) o So 22 + 28 + 20 (money left over) = 70K  Liability of Dissociating Partners o When a partner withdraws under RUPA. there is a strong likelihood that the withdrawing partner is still liable • 6.

• (8) – creditors to the deceased partner’s interest in the partnership have a priority over other creditor’s of his estate • (10) use of the deceased partner’s name does not make his individual property liable for any debts contracted by him or his partnership o Death . if any.During the wind-up which can take a long time.o o o o o o Purchase his interest and continue the partnership o Dissolve. but it means the scope of the partnership contracts to completing work in process and taking other such actions necessary to wind up the business Winding up the business entails o Selling its assets o Paying its debts o Distributing the net balance. • Often problems arise with valuation/goodwill  Estate is a New Partner • One way to do this is to .  Ct will conclude that what happened in the post dissolution behavior is that the business has gone into a wind-up mode. and terminate Under RUPA. liquidate. the deceased estate can make 3 arguments and the court then decides what to do:  Business Has Continued – • 33-41-1080 – Rights of Retiring Partners or estate of deceased partner when business is continued. The wind up can take a short time or a long time o 33-41 -1030 – Application of property upon dissolution not in contravention of agreement: at the end of the wind-up mode we liquidate the business o Buy-Out – Business Continuation  all of the remaining partners get together and buy out the other one’s share. the value of the partner’s capital is what it would have been the day he or she left.Sell the Partnership.During the Business Continuation period the value is calculated at the day the partner dies – so if they settle up 5 years later.the Accountant comes in and values the partnership and after bills are paid the partners divide up the remaining value.  He can agree with the creditor and the remaining partners to have his obligations assumed by the partnership – this agreement can be inferred from a course of dealing between the partnership and the creditor Page 19 of 148 .In the event the dissolution is caused by death or incompetency. then during liquidation the withdrawing partner or his estate gets his or her share of the value. dissolution isn’t the end.  one of the remaining partners buys-out the withdrawing partners’ share • Problem .  Liquidation • Partnership will be valued at the time of death. UPA indicates 3 Ways that you can handle Dissolution o Liquidation . • Usually the deceased partner will agree to this prior to death o UPA § 36 – 33-41-1010: Effect of Dissolution on Existing Liability of a Partner  A withdrawal doesn’t change the liability of the partner that existed before his withdrawal. the business terminates RUPA rules for distributions to partners according to their interests o Unless partners agree to the contrary  They share responsibility not only for the losses from operation of the partnership business but also for partners’ losses from investments in the partnership  SEE page 126 If the Partnership Agreement is Silent.Convert this partnership interest to a limited partnership interest. and the partnership agreement is silent as to what to do. One of the problems with the long wind-up is the estate or withdrawing partner may be subject to creditor’s claims.  Problems . the withdrawn partner is still entitled to his or her own share of the profits. (Death of a Partner) – o Deceased partner is entitled to the value of his interest at the date of dissolution with interest (Liquidation will be valued then) o or in lieu of interest the profits attributable to the use of his right in the property of the dissolved partnership. to the partners according to their interests When the winding up process is completed.  33-41-1070 .Liability of Persons Continuing Business in Certain Cases (Business Continuation) • The liability of the dissolved partnership attaches to the continuing business • (7) the liability to a 3rd person becoming a partner in a partnership to creditors of the dissolved partnership can only be satisfied out of the partnership property.

000. • Ex: Capel puts in $250 (earlier distributions/withdrawal= $150)).So subtract $30. then the lawyer is liable Liability for Contract Claims –  UPA § 33 / 33-41. they have to pony up and pay what they owe so that losses from investment are shared equally  Option #1 . Statute is silent regarding liability for Tort Claims that occur after a partner withdraws.  UPA 34 – 33-41-960 – Liability of Partner for Acts (BOC) of other partners after dissolution – Contract Liability • All the partners are still liable for any pre-dissolution contract liability claims caused by another partner. and the dissolution hadn’t been advertised in the newspaper in the area where the business took place • Liabilities created under (1) are charged against p-ship assets • Exception (990): the partnership isn’t bound by the act of a partner after dissolution if o dissolution was because it would be unlawful to carry on business unless the act was appropriate for winding up. • Dissolution terminates the partner’s authority to act for the partnership (with the exception as so far is necessary for the winding up affairs).  If this is an event that occurs during the wind-up. presumably.970 . paying debts. total loss is $90. unless that partner knew at the time he created the liability of the dissolution. Prop now owes $22.950 – Effect of Dissolution on Partner’s Authority to Act. • Ex . so $110 is owed. the partnership has to pay it  If some partners owe to the p-ship. Prop puts in $150 (earlier distributions/withdrawal= $142). If the partnership is worth $200 then all of them get paid off and then they divide the $90.000 equally so they all get $30. he probably will be liable for anything that accrues before winding up. the partner will be discharged from the liability if the creditor knows of and agrees to the new deal Tort Liability: Not clear whether a dissociating partner is liable for torts that accrue after dissolution. the former partner is on the hook. and Agee puts in $2.  On dissolution. and distributing the surplus to partners according to their interests UPA § 40 /33-41-1060– Settling of Accounts between Partners: Rules for Distribution  The assets of the Partnership are the partnership property and the contributions of the partners  liabilities of the partnership – ranks of creditors Settlement of Partnership Accounts  Partners are responsible for operation losses and individual partner’s losses from investments in the p-ship.000  Option #2.If there is a surplus after paying off all debts. Apparently.  UPA § 35 – 33-41. Divide this loss equally and it will be shared equally amongst all partners. Capel now is owed $70. if a partner is owed money in account.000.000 and  Page 20 of 148 . Same example as above except profit is only $20.  Track this with partnership account – track how much each partner put in and how much each partner took out  At Dissolution we must determine what the remaining capital accounts of all 3 partners is to determine what their share of the profits is.If there isn’t enough to pay all the accounts after paying debts: • Determine how “short” the partnership is with respect to the partnership accounts • Divide the short amount by the number of partners – they divide losses equally • Subtract this amount from each partner’s account and voila! You have the cash out amounts • In Class Ex. it’s easy – pay off the p-ship accounts and then divide the remainder equally.A lawyer who leaves a law-firm and then his partners subsequently commit malpractice. So total owed to partnership is $110.000 from the amount all of these are owed.000.Power of a Partner to bind the p-ship after dissolution • After dissolution.o o o  o o o If someone assumes the liability. Section 510 . o the partner has become bankrupt o where the partner has no authority to wind up affairs Winding up of Business – Post Dissolution Winding up = selling assets. a partner can bind the p-ship: o with any act appropriate to winding up the business o with any transaction that would bind the p-ship if dissolution hadn’t happened IF  the other party had extended credit to the p-ship prior to dissolution and didn’t know or have notice of the dissolution OR  the other party knew of the partnership and had no notice or knowledge of dissolution.

and just like they could expel each other for other disagreements. Reed (CA) (p. or services that are to be paid for before profits are computed – however the court might be misconstruing these cases. they can do so for accusing each other  Court says that partners can’t expel each other for self gain. but Burky doesn’t think it follows the statute o §1060 . but he doesn’t have to contribute to the money loss • Rationale is that the labor rendered is equal to the money spent o This is not a mainstream case and most of the time it would come out the other way  Reaches fair result. it was ok to expel her. Butler & Binion (TX) (p.o o Agee now owes $28. when one partner contributes money and the other contributes labor. No need to go into these ideas of trust and client tension o Focuses on the at-will nature of a partnership and even more importantly there is a fiduciary relationship and duty to the clients and this duty trumps all of the concern that the girl was not treated fairly (expelled her even though she did what she did in good faith) o Some argued that there should be protection for a whistleblower.  Partners have a fid duty to one another to deal in honesty. They didn’t discuss loss. land. Kovacik v.they didn’t base their decision on this basis  IN cases like this. the real reason is that your throwing her out for being stupid/ having bad judgment – which you can do. partners and joint adventurers intend to share equally in the losses and profits of a common enterprise – regardless of how much each contributed to the capital employed in the venture – the losses are to be shared in the same proportion as the profits  BUT this rule only applies where each party has contributed money. Take the amounts they both owe and add the $20. The firm expelled her by reducing her partnership distribution to zero and eventually voting to expel her. how would they get around the tension and how would that effect the client  Others say this doesn’t make sense. see 33-41-1060(2) and 510(1) o Law presumes that absent an agreement. However. o Minority Rule –CA Rule: Court stated the general rule that members of a partnership are expected to bear profits and losses equally.ironic because that’s always why they are expelled  So trust issue trumps here Page 21 of 148 . they would have breached their fiduciary duty. or else they would be discouraged from reporting unethical conduct – even if they were wrong  Court rejects this argument  Partners must trust each other.000 the business made and this equals $70. If they expelled a partner in bad faith (for personal gain).000 which equals the amount owed to Capel – Balances. and the other his labor – so the ∆ doesn’t get paid. they would split profits 50-50.SC rule is that the worker owes the money to the p-ship UNLESS you have trumped the statute – put in an express agreement. 97) o Facts: Kovacik invested $10K in a venture to do kitchen remodeling and told Reed that if he would be the superintendent. the ∆ should have had to pay o If this same situation happened between members of an LLC.000. where one contributes the money against the other’s skill. neither party is liable for losses to the other without an express agreement to the contrary  (Burkhard says that this is the ONLY case that has come out contrary to the statute – so you would try to argue this case but it isn’t the law – so in SC don’t allow your clients to get stuck in this relationship and draft the agreement that ensures your clients don’t get stuck in). o Rule: Court said that there is no duty that partners have to remain partners. o Majority Rule .says who gets what when the P ends  (2) the liabilities shall rank in order of payment – and subsection c says those owing to partners in respect to capital o Then look at 510  Each partner will be repaid his contribution and each partner will contribute toward the losses regardless of what he put in in relation to his share of profits o Reading these statutes together. the working partner would not be liable for his half of the losses because the whole point of an LLC is to eliminate personal liability. The girl is a brand new partner to the firm. tangible property. and because the trust and loyalty that must exist between partners can’t survive Bohatch’s actions.  Expulsion of a Partner Bohatch v. but they have no duty to remain partners  “at the heart of the partnership concept is the principle that partners may choose with whom they wish to be associated  If she stays. then neither is liable to the other for losses • That way the each looses his capital – one the money. The venture ended up losing money and Kovacik came to Reed for his share of the loss. 100) o Facts: Partner in a firm reported another partner to the managing partner for overbilling.

The other brother argues that it is a partnership at will and he can quit whenever he wants. the dissolution would be wrongful and the plaintiff would be liable pursuant to § 1040. It lost money for a few years and the plaintiff’s corporation made a big loan to the business. If you do this. the P has the power to dissolve the partnership by express notice to the D.says you can’t throw someone out for self-gain purposes. Issue: Can you expel someone b/c her actions are unprofitable to the partnership (question 1. however. however the termination was in bad faith and so the result is that the little guy gets to stay on as a partner  Rule: a partner is not bound to remain in a partnership regardless of whether the business is profitable or unprofitable. and the plaintiff attempted to terminate the partnership. but not if the other partner shows you are doing so in order to take control of the business for yourself. o 4 Sources of Corporate Law: Page 22 of 148 .  Court found that this was a partnership with no term or purpose. but the economic impact of the few larger corporations is what drives the U. o Different from a partnership. Expulsion 3. In this regard his fiduciary duties are at least as great as those of a shareholder of a corporation.  SO – you can dissolve at anytime. Freeze out 2. Withdrawal followed by purchase of interest or dissolution 4. Page (CA) (p. she had a right to be paid her share of the value of the partnership unless it was trumped by the partnership agreement. with a SC or a Corp in any state you MUST file with the Sec of State’s Office. reasons for expelling a partner have to be set out in the partnership agreement.  Court says that in this case. so under UPA can be terminated by either partner at either time. 137) Ct of Appeals . Partnership converted into or merged into another corporate structure  o o CORPORATIONS o What is a corporation and how does a business become one?? o A corporation is a creation of state legislatures where o It is its own legal entity o The owners usually aren’t personally liable for the debts of the corporation (the most you can lose is what you paid for the stocks) o Most American corporations are very small business.o o o o o SC Rule: UPA does not give an automatic right to fire partners. Summary of the Different ways a person’s partnership interest can end 1. however. the court suggests that whenever a partner is dissolving he or she can not merely do what is in their bests interests. economy.  Page Case Rule: Whatever remedy the Court is suggesting. but this Court disagrees with them and suggests that anytime you throw someone out it is for self-gain When they threw her out. Freeze-out of a Partner Def of a “Freeze Out”: when a majority owner (superior financial position) acts to force a minority owner to sell their interest Page v. A partner may not.105)  Facts: 2 brothers each chipped in equal amounts to start a laundry business. a termination that results in one partner freezing out the other and putting the business to his own use breaches the duty of good faith and is not permitted. Sale to third party of transferable interest 5. However. by use of adverse pressure “freeze out” a co-partner for his share of the prospective business opportunity (two opposite sentences). One brother argued that it was a term partnership and that his brother was obligated to stay until he could pay-off all the notes.2 p. If. it is proved that the P acted in bad faith and violated his fiduciary duties by attempting to appropriate to his own use the new prosperity of the partnership without adequate compensation to his co-partner. When you read the dissent you get an entirely different approach than when you read the majority.  There is much debate about whether or not a dissolving partner in an at-will partnership has a fiduciary duty to his or her partner. Then things started looking up. then you must adequately compensate the other partner i.  Rule: If the partnership agreement does not contain an express term then the partnership can be terminated at will by either partner at any time.S. they have a fiduciary duty to his or her partner – very different from Bohatch case  SC Rule – Toal would probably follow the Page rule.

o o o o o o

o o

State Statutes Articles of Incorporation Case Law Federal Statutes • Federal Securities Statutes • Federal Tax Statutes What are the legal problems in starting a business as a corporation Necessary Papers = the articles of incorporation- 33-2-102 is the statute of articles of incorporation and the CL1 A corporation doesn’t exist until these are properly executed and filed with the sec of state Once this is done, you issue shares to shareholders, who then elect directors, who will then create bylaws if needed The MBCA suggests that a corporation comes into existence as soon as articles are filed, but also seems to mandate that a corporation adopt bylaws – normally statutes don’t require this o Bylaws may provide any provision for managing the ₪ that is not inconsistent with the articles of incorporation Bylaws o Much more inclusive document than articles o Tells how corporation will be run o Title and description of officers o Procedures for calling meetings for directors and shareholders as well as how they will be run o How the organization will be run legally o Problem is that people don’t sit down and go through each article  Instead the atty normally downloads a form from the SC form book and then fills in the blanks  So it’s boilerplate –  As long as everyone is getting along, there is no problem, but if something comes up, there can be trouble o Articles will trump the bylaws if there are any inconstancies – but this shouldn’t happen Avg atty cost for setting up corporation in SC is 1-2K – which encourages many people to form LLC which they can do themselves Preparing the necessary papers o SC 33-2-xxx – our incorporation statutes o Articles of incorporation (must be filed with the sec of state for all corps- the corporation doesn’t exist until these are filed)  SC CL-1 Form • IRS form • Filed every year • Most likely filled out/filed by company’s accountant  33-2-102 - SC Articles of incorporation: • Must have – Mandatory!!! o Approved Name that satisfies 33-4-101  Can’t use a name that is grammatically similar to one that is already on file with the Sec of State.  Name recognition in SC and most states relies on CL principles  There is nothing on the form that says you must use that name after commencing business  Mere filing of name does not necessarily give you the right to use it o Number of shares and classes of shares that the corp can issue  If I check box A, these are common shares  If I check box B, you have to rank each class of stock by preference  Must describe how the shares will operate  relative rights, preferences, and limitations of the shares of each class, and of each series within a class o street address (no PO box) and o name of agent  Should it be someone in the company  Or should it be the lawyer  The signature line is not in the statute and could be waived if you were in a rush o name and address of each incorporator  All they do is file the documents  No real risk of getting sued for this o attorney’s signature (this rule unique to SC)     Page 23 of 148

o o

Must have a signature Must file the CL1 at the same time  Some things on the form are not included in the statute or the articles, so for instance number 3 – nature of the business- if you change it, you won’t get in trouble  Always say “not yet commenced” when asked for date the business started because you never start the business before articles are filed  Issued shares – zero because you do not issue shares until after the articles are filed  Form is important because • Goes to department of revenue • It appears on every corporations tax return filed with dept of revenue in SC, so it is prepared every year and it is public information that a Π could get for a law suit • May have - Discretionary!!! o names of the initial directors o provisions not inconsistent with law regarding  purpose  management and regulation  defining, limiting, and regulating powers of corp, directors, and shareholders  par value for shares  imposition of personal liability on shareholders o anything that is permitted in the bylaws o What are the differences between Articles of Inc & bylaws: How do you decide what goes into each?  Articles control – the bylaws should not be inconsistent.  The bylaws are a much more comprehensive document.  The lawyer will tell the client that they need to have bylaws and will pull a set of boiler plate bylaws and stick them in the record book. No one thinks about it for 2 seconds. That’s wrong but it’s the reality. o Bylaws  SC 33-2-106 • You shall adopt bylaws • The bylaws can contain any provisions for running the business that are not inconsistent with the law or the articles of incorporation.  Articles of incorporation always trump bylaws  Under the default corporate code, directors can change bylaws while the shareholders must vote on any amendments to the articles. Contracting Prior to Incorporation • Promoter = someone who acts on behalf of the corporation before formation • Sometimes you need to jump on a contract (e.g. a lease contract for retail space) before incorporating. Typically this is done through a promoter • Promoter liability: 33-2-104 (Liability for Pre-incorporation Transactions) o Every state has a section similar to 104, but the language differs (the presumption of liability differs – SC’s is reasonably friendly to the promoter). o Anyone acting on behalf of the corporation before filing articles is jointly and severally liable. o Exception: If the person was acting under a good faith belief that the articles had been filed, no liability under this section (important defense) If the promoter enters into a contract, the corporation will not be liable when the articles are first filed o The corporation wasn’t around when the K was entered into – it must take some action to adopt the K Secret Profit Rule o Not a real issue in practice  Promoters aren’t the bad guys, but the book is pointing out that once you agree to do this, you have to treat the investors fairly = fid duty o After incorporation, if the promoter sells property to the corporation, he must disclose any profit that he is making, if he doesn’t, the corporation can seek to recover his “secret profit” o Arises out of fid duty to corporation o But there is no fid duty for pre-incorporation actions because the corporation is not yet in existence Page 24 of 148 o o

o

 o

Determining Profit  For property acquired before he was acting as promoter, you look at the price the corporation paid minus the fair market value of the land, so you don’t just look at what the promoter paid  For property acquired while acting as promoter, you look at the amount the corporation paid minus the amount the promoter paid – fair market value is irrelevant o If he discloses the profit, he gets to keep it • Promoter liability: RSA o RSA § 320 – if the principal is disclosed, the promoter isn’t liable o The promoter does owe a fiduciary duty to the company. o RSA § 330 - However, if you misrepresent that you have authority to bind someone that you don’t actually have, then you are personally liable for the loss caused by the misrepresentation • Rule: Generally, the corporation has to adopt the actions of the promoter after incorporation in order to release him from liability and take it upon itself. • Best advice to a forming company is not to do anything until the articles are filed Problems – page 117 o 1.1 - yes –  Under agency principle he has made a misrepresentation because there is no Bubba’s Burritos yet – so he cant say he is acting for it  SC § 33-2-104 says he will be jointly and severally liable when there is no corp yet • One caveat – if the promoter in good faith believes the articles have been filed, then he is not liable • 1.2- same answer • 1.3 – there is a legal theory L&L can sue Agee on is the legal theory of acting as an apparent agent; or could argue they were jointly and severally liable under partnership law – if arguing under 33-2-104 – Agee could argue he was not “purporting to act as or on behalf of a corporation”- could interpret the language to say that he silent partner is off the hook; although split, some cases say only active partners may be liable o Π would argue under partnership principles that the three had a joint venture to start a corporation and so they are jointly and severally liable  Caveat to 104 may come in if they all thought the articles had been filed  Another defense is that we have no evidence that the other two are acting as or on behalf of the corporation, so they wouldn’t be liable • 2 – Corp not liable unless it does something that directly adopts the action pre-incorporation – usually done by the BOD – ratification by implication is not enough  Attorneys get burned here because simply agreeing to form the corporation does make it liable for your legal fees • 3 – Yes, Can still enforce the lease against Propp (promoter) individually; even if the corporation is on the hook, the promoter is still on the hook as well • Until the corporation is formed, the people that are out there trying to put the corporation together owe NO fiduciary duty to their clients. Issuing Stock Shares of stock = the units of ownership in a corporation • 33-6-103(a) – A corporation can issue as many shares of stock as are authorized in the articles of incorporation. • 33-2-102(b)(2)(iv) – a corp can have par value stock in SC – they can determine their own par value – what are the implications of this?  Says you may have par value, so you don’t have to  Accounts are going to want you to have par value  1220 is a tax statute that says that tax returns is based on a formula that basically results in the par value, but you don’t have to have it, so make the accountant figure it out • 12-20-50 - Tax statutes – the license tax of a SC corporation is to be computed paid on the stated capital and capital surplus (the terms still exist in the tax statutes, however they are not defined) o The Accountants will insist that they have par value so they can determine the proper taxes on the company. • When a company is formed and they become shareholders it is the company that is issuing stock. The articles will determine the # of shares and the types of shares that will become issues. o This is a big issue when setting it up – how many shares should the corporation say it is authorized to issue then it initially does o Page 25 of 148

 Page 26 of 148 . but you get first dibs incase there isn’t enough o Looking at sample on 160  Here. or redemption rights. o Preferred stock is treated more favorably in one of the following areas than the other class of stock: dividend rights (ex. liquidation rights (typically you would see a fixed liquidation value). it gets paid out before any common stock is – but this is unusual – normally they are paid out at the same time with the exception of liquidation  Liquidation is also different because normally there is a fixed value. you don’t want many more authorized than are issued. o Outstanding shares consist of issued shares that the corporation has not reacquired (the corporation can buy stock back from shareholders. every company must have stock that has the two features of common stock. but here there is only a fixed minimum. but you can for more • Also. not a fixed price. Many states don’t require a par value. only issuance form the company  This is a concern in SC  Some states require you to state whether common and preferred stock have a par value.o If you represent the minority share holder.the minimum price for which a corporation can issue its shares – • Cant issue for less. it is an issuance • A corp doesn’t have to issue all the shares authorized by the articles • Can have various classes of stock each of which comes with different rights • Issuance terminology o The shares that the corporation actually does issue are called issued shares.  Also remember that par value doesn’t apply to shareholders. preferred stock holders usually can’t vote or have limited voting power  Stock that gets special treatment – such as being paid out first  Normally pertains to • Dividend rights – such as being paid 3 times the amount of common stock – more commonly it would be a set amount that must be paid out first if the corporation is liquidated. and those shares that have been issued and not reacquired are outstanding) o Common stock has two characteristics: unlimited voting rights and common stock gets the residual value of the corp when the corp goes out of business • In SC. So you might get less. the excess goes to the Capital surplus o This money can be distributed back out as dividends • Market Capitalization – total intake form stock sale = Stated Captial + Captial Surplus o Stated Capital = par value * number of shares sold  $ went into this in theory could never be paid out by the shareholders and the $ that went into capital surplus you had to jump through a million hoops  The purpose of this complex system is to protect the creditors – many states have abolished this entire system. Par value is just a minimum issuance price. bc you may lose what control you initially had A corporation does not have to issue all of its authorized shares • When a corporation sells its own stock. this doesn’t effect how much the holder could later sell that share for on the stock market  States that require par value also require two separate funds • Stated capital o Includes the aggregate par value of all issued shares of par value stock  Ex – 50 shares at 1K each = 50K stated capital fund o Cannot be distributed to shareholders – supposed to serve as cushion for creditors • Capital Surplus o When shares are issued in excess of par . first guarantee on dividends or non-cumulative right to get a certain amount per year). so they get value equal to common stock  Most preferred stock have provisions that can force the corporation to buy it out – here there is a provision that says they can call a vote to make them do so • Liquidation rights • Redemption rights  Family Business often use preferred stock • You trust your kids and you want to get them money by having mandatory payouts and such o Par value = the minimum issuance price a corp can receive for a share of stock.which is set out in the articles  Def.

the shares go into escrow until the note is paid or the services performed.  So consideration can be in many forms as long as the board considers it adequate. most questions will already be answered by case law o Secretary of State office is efficient Page 27 of 148 . then we don’t exactly know what the value is – so this could be how this situation comes up  Choosing the state of incorporation • In SC – the rule is you should always incorporate in SC unless you have a very good business reason.figure these numbers out  so Capel is hurt (if she pays more. but can be given to shareholders through articles. The shares of people who already own them would decrease in value. It has no relation to the actual value of the stock o 8) Yes. not sales between shareholders o She would do this if the company is going down in value o 6) yes o 7) no. o You may run into setting up the issuance of preferred shares in the setting up of a small business in SC Problems 124 o 2) corporation cannot issue stock for less than par value o 3)corporation can sell it for more than the par value – the excess goes into the capital surplus (today if there is a par value. if more stock is sold. each of the shares is worth less. o Shares can be issued in exchanged for any tangible (like land) or intangible benefit to the corporation.  Exception: if the corporation is subject to the 1934 Exchange Act. Usually you incorporate either in the state you’re doing business or DE • Almost all the fortune 500 companies are incorporated in Delaware  commerce clause – instead the business must be intra state • Reasons to incorporate in DE: o Delaware corporate law is the most sophisticated corporate law in the country o Highly developed. then Agee will be hurt because here shares will be devalued)  But if Agee is putting in property rather than cash. If the note is never paid. this must be adequate compensation – which we assume it is here)  What impact will the issuance to Agee have on Capel • It lowers the value per share o Before 100 a share o Now its 96 a share. most corporation make a tenth of cent so it isn’t much) o 4) 6. the corporation can reclaim the shares and distributions.000 because the stated capital is par value times amount of shared sold o 5) yes she can do it b/c par value only controls issuance price. Any benefit could be a release from a claim. • You can incorporate in any state. 33-6-210: Issuance of shares o Power to issue generally reserved for directors. the shares don’t have to go into escrow when issued for future services if the plan has been approved by the shareholders. she doesn’t care what the par value is or whether is one. • The laws of the state of incorporation become the default rules that govern the internal affairs of the corporation. o If you issue for a promissory note or a promise of future services. even if you have no business there.  Rule: The board must decide if consideration received for shares is adequate.• o Capital Surplus = price per share over par value * number of shares sold (premium over par value that the shares were sold for) o Market Capitalization: Total intake from stock sale = stated capital + Capital Surplus o If you sell stocks for less than the par value. but they can’t issue below par value. your voting power will decrease o Also the price at which the additional stock is sold may effect the value of the corp and the shares Capel owns  Say Capel and Propp both bought 100 shares @ $100 each  Later Agee says she will buy 100 shares @ $90 (remember. (29000/ 300).

Corp was formed with $5000 in capital. • Reasons not to incorporate in DE o Higher legal fees  If there is a squabble – jurisdiction is in DE and your folks are not going to be happy going up to DE to resolve a conflict. it is questionable whether you can even do this since you are not licensed in DE. 126) • Obtain authorization from state agency • Appoint a registered agent in the state • File annual statements • Pay fees and franchise taxes • But you only have to do this if you are transacting business in the state o Most statues list what does not qualify as transacting business. Flemming Fruit Company (SC Case) – lead case (p. and he had contracted with Dewitt to ship fruit around. Why do you want to invest in Co’s as a shareholder? • Want to make $ • You have no personal liability as a shareholder Who is liable to the corporation’s creditors – When will a shareholder be liable? See 649 S. this business was not undercapitalized b/c all he needed to run the business was a telephone. and so Dewitt sued to “pierce the corporate veil” and hold Flemming personally responsible • There is no longer any requirement that you have to capitalize your corporation with any specific amount of money (there used to be a requirement like this). 132) o Facts: Contract claim. Page 28 of 148 . he had no overhead as a middle man. Mgmt controls where the Co will be formed – they have the power to move it to DE.E. o Double Tax .  Key Decisions always favor Mgmt.Corporation will be subject to taxes in DE and in the state of operation o You will have to file as a foreign corp in SC and be treated as a foreign company  Foreign Corporations (p. • Arguably.read this case before you take the bar exam. • Elders suggests that inability to pay debts and high risk business are determinative for undercapitalization.2d 135. o  o o  o Protecting Management – the law of DE is geared to protect mgmt not shareholders. • Issue: When is it ok to pierce the corporate veil and hold a S/H personally liable for the actions of the corporation? • Says separate entity is just a theory and wont be recognized if doing so would extend the principle of incorporation beyond its legitimate purposes and produce injustices or inequitable consequences  But piercing will be done reluctantly and cautiously  Requires case by case analysis • Holding: Court said that veil piercing was to be done on a case by case basis. 344 S. and that a number of factors are to be considered: • Rule: Factors to Consider in order to Pierce the Corporate Veil: o Fraud is NOT a requisite to pierce the veil o Substantial ownership by a single person combined with additional factors:  Inadequate capital on hand • Burkhard thinks that the most important one is undercapitalization. but don’t define what is – Interstate business will not make you register as a foreign company because of interstate o Ethical issue: If a SC corp wants you to incorporate them in DE. $2000 was immediately drawn out by shareholder. Flemming was the 90% owner of a fruit distribution company. The principle shareholder orally promised Π that he would personally pay if the corporation did not – but this is not enforceable because of SOF • The company couldn’t pay.2d 869 TP can sue corporation but not the shareholders Exceptions o Contractual – if the TP makes the shareholder personally guarantee the payment – TP lenders use this when they loan to corporation with limited assets o Judicial  Cases will show below  Piercing the corporate veil Dewitt v.E.

the company closed before paying the judgment.1 – yes you can have only one shareholder o No.3. However. Some think you should just be penalized if you don’t play by the rules o 1.      •  shareholder  Fairness Consideration: Finally. he dispersed money to the farmers – so its kinds of like an escrow function of an atty. o Penalty Factors o If you don’t play by the rules. but not clear if it would have “saved the day” o At a minimum. courts will pierce. and they didn’t pay him. so once you had trucks involved. his wife. Sifly (SC) – Expands Dewitt Piercing TEST!!!! • Facts: Sturkie was hired as a sales agent by D’s company.6 – of course. and we don’t want him to escape liability to them o Oral guarantee – the court says SOL takes this issue out. • Fact always mentioned when this case is cited but then they say it wasn’t important: oral guarantee to pay o Here it was closely held.not necessarily. The fact that the corporation is a façade for the operation of the dominant Alter Ego o Court looks at reality and not form of how the corporation operated and the shareholders’ relationship to that operation o One big thing looked at is the lack of capital in comparison to the undertaking  The obligation to provide capital begins with incorporation and continues afterwards –  So how much do you tell him to put into it to assure that it isn’t undercapitalized • You have to look at what its doing. • Flemming tended to take money out of the corp as soon as it went in (undercapitalized) – siphoning of funds by dominant S/H • Also. and he. then ∆ gets the protections of the corporation without putting in capital and sharing the risk = unfair o All this combined with his personal assurance is grounds to pierce the veil o Two things also going on here o When Flemming got the check for the fruit. Problems page 136 o 1. ∆ owned 90% of the stock. but its clear that it factors in • Red Flag of Case: Suggests if you don’t follow corporate formalities. Defendant had not Page 29 of 148 . not the stockholders o There was little capital for what he tried to do. and atty were the incorporators o It was personally operated – no other stockholder ever received a salary or dividend or exercised control o He withdrew what he wanted – company operated for his good. it is less likely that your business will operate correctly.4-it’s hard to say whether the Π was adversely affected by the failure to comply with corporate formalities. Sturkie test as amended by Hartfield o 1.5 yes creditor should be happy dividends aren’t paid out – as long as its not be siphoned off o 1. need to make sure clients are complying with corporate formalities  Sturkie v. it would be unfair to allow Flemming to make a bunch of money at Dewitt’s expense just by hiding behind the corporate veil. the court will look to see if it would be fundamentally unfair or lead to injustice for it not to pierce o Failure to observe corporate formalities Siphoning funds by dominant shareholder Insolvency Non-functioning of other officers or directors Absence of corporate records Non-payment of dividends Burkie says this is scary.capitalization begins with incorporation and continues afterwards (see Elders) – so are these cases saying when we hit hard times and your capital drops you have to either go out of business or risk piercing the veil – this worries Burcky – big time o 1. all he had to cover was the phone – so 5k would have been enough • But you must adapt as things change.2 – mystery of life o 1. they didn’t have shareholder meetings – no formalities.when the company started. you needed more • In this case. and it appears that the corporation always operated on ∆’s capital  So if the veil is not pierced. there were no formalities such as records. He went out and got a judgment for lost wages.

Elders then bought the other holder out o He then opened 2 bars on property he owned o Held liquor license in his name o 3 years later he reinstated EE to run the bars  Capitalized with only 1. • (d) talks about how you can compute these numbers  § 33-8-330 talks about who is liable for unlawful distributions. Only liable if they didn’t perform their duties in compliance with a code section that talks about how you go about making decisions.which may have affected the holding Sifly and Water were sole stockholders in Carolina Furniture o Startup capital of only 5K o corporation was in trouble so S and W got personal loans which they then loaned to the company o When the corporation had money. • Facts: Girl was injured by a drunk driver and sued the bar that got the driver all sloshed. S and W would take from the account to satisfy the loans o No records or meetings corporation lost 265K in 1977.  2 PART FAIRNESS TEST:  D had to be aware of P’s claim against corp  D acted in a self-serving manner with regard to property of corp and in disregard of the P’s claim o In this case. Sturkie lost because he couldn’t prove that the company was aware of the claim against them when they were draining the corporation.” • Piercing the veil is an equitable remedy • In SC. no automatic liability. o Recover distributions made by respondents to themselves under § 33-6-400  33-6-400: improper distribution to shareholders • (c) – no distribution can be made if (1) it would make the corporation unable to pay debts that come due or (2) if total assets would be less than total liabilities and the company wouldn’t be able to satisfy the rights of people who would be higher in the chain of preference to the people who received the distribution if the corporation would be dissolved at the time of the distribution. and had family members as officers who didn’t even know it. Π brought suit to pierce corporate veil under 33-11-240 for improper distributions to the ∆’s stockholders o Fails o One thing at play here is that the receiver is the Π instead of the injured party. but whatever. Perhaps it’s a given. Elders (SC) – Torts Piercing the Veil Case. EE was incorporated original to sell tires and had two shareholders. he transferred several shares to his Wife and Niece Page 30 of 148 . Shareholders who receive the money can also be liable if the shareholder accepted knowing the distribution was made in violation Note that it seems we can skip the “unfairness” question in tort cases. But because there was a receiver involved things get skewed • Plaintiff also made a claim under SC  This provision comes up all the time. There is a safe harbor. She won. and when the bar couldn’t pay she wanted to pierce the veil against the bar owner. the corporate form may be disregarded in the interests of justice.000 for each bar  Equipment was leased to EE from other business owned by Elders o Later that year. Hunting v. the argument that they were aware was that they had a contract they didn’t pay and they transferred the furniture in a self-serving way. She brought suit against Elders as the alter ego of the corporation. Apparently he was missing several important records.• • • •   o complied with corporate formalities. Seems like it is a director. siphoned off money for his personal use. piercing of the corporate veil is a 2 part test. S and W then moved unfinished inventory to a company in NC held by W and Carolina Furniture ceased to exist Ruple won a 39K judgment later that year against Carolina Furniture for wages o Π is his receiver • “When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder.  You would think that would know that they weren’t paying the guy. and took money out of the corporation to satisfy loans they had made to the corporation. o Factors from Dewitt o An element of injustice or unfairness if the acts of the corp are not regarded as the acts of the individuals. Of course.

It is adopting an S-Corporation status so the factor considering the non-payment of dividends is not as important. from a SOL perspective. but decides that in many cases. It appears. would lead to knowledge” • This is a scary case for small businesses in SC. “The essence of the fairness test is simply that an individual businessman cannot be allowed to hide from the normal consequences of carefree entrepreneuring by doing so through a corporate shell. • Question: when I bring my lawsuit initially. the defendant was undercapitalized and that along with the lack of formalities was enough to pierce.”  Failure to observe corporation formalities  Nonfunctioning of other officers  Absence of corporation records o Also federal law allowing S corporations has diminished the importance of lack of dividend payment • Statutory close corp – this is something the court has to think about because it’s not a normal corporation – ie the corporation formality factor doesn’t matter. and especially tort cases. The court says that this anti-piercing provision doesn’t always work. • At what point is undercapitalization determined? It begins with incorporation and continues thereafter.SC statutory change has diminished the importance of several of these factors by allowing “statutory close corporation status. as the second prong of the Sturkie test requires. the second option is much better.   . undercapitalization is the most important one. it should be more capitalized than other entities. if pursued with due diligence. The comment to this section says: this section does not prevent a court from piercing the corporate veil of a statutory close corporation if the circumstances should justify imposing personal liability on the shareholders where the corporation not a statutory close corporation.First Prong • Change In LAW o Statutory Close Corporation  Allows corporation to act with less formalities  It may operate without board of directors  Need not adopt bylaws in certain circumstances  Need not have annual meeting unless the shareholders request one  * purpose of law was to eliminate argument that shareholders can be personally liable for debts and torts of the business because the corporation did not follow the classical model of a corporation. • The court couldn’t figure out how to apply the Sturkie factors in a close corporation setting. The Fact that it is an S corporation which means the dividend factor isn’t important o Changes the required records and duties of officers Page 31 of 148 Wife was VP Niece was Sec/Treasurer • But she didn’t know she had any shares or was an officer  There was a record of these transfers o Money was siphoned for elder’s personal use  Records were not kept for accounting o Evidence that Elders altered his personal tax forms before trial to hide dividend income from investment accounts Elders held while running the ₪ o Freeman testified that Elders was running the corporation as a façade and that the bars were grossly undercapitalized for the purpose of running bars and the risk of liability associated with alcohol • In this case. • § 33-18-250 says that the failure of a statutory close corporation to observe the usual corporate formalities is not ground for imposing personal liability on the shareholders. It merely prevents the court from piercing the corporate veil because it is a statutory close corporation. • The court also clarifies the “awareness” test of the unfairness branch of Sturkie: “notice of facts which. It tolls the statute of limitations against the shareholder. • This was a close corporation (with one shareholder) and it didn’t have to meet the normal business formalities because it is not a standard corporation (it is a statutory close corporation). • The court writes. From a plaintiff’s perspective.ie that of a large corporation o **. there was a bifurcated trial as to liability and as to piercing.” • The facts in the opinion don’t say that the defendant was aware of the plaintiff’s claim against the corporation. do I have to allege independent liability of the shareholders (I may not even know who they are) or can I wait and once I get my judgment against the corporation then bring an action against Elders alleging a piercing claim? This opinion suggests the second option. This is an anti-piercing provision. and this is a huge advantage because it gives you time. Because a bar has lots of risks. the clock doesn’t start running until I file my piercing claim.

and evidence that it was a façade go against the ∆ o Lack of records and dividend payments don’t matter o Crt App Agrees that the 8 factor prong of the test is satisfied in favor of piercing Second Prong • 1)knowledge of claim 2) subsequent self serving act and disregard of claim • Knowledge prong o Constructive knowledge will do • Here ∆ knew of the claims and still siphoned off money and comingled funds. but was missing normal business records • Income statements etc.ie forming a corporation to avoid an obligation or liability you have already assumed. but court recognizes that the trial court coupled this with the siphoning on funds to make its decisions o Lack of dividend payments shouldn’t have been considered • Burcky comments on close corp and S corp o A statutory close corporation has unique features  33-18-250 – says failure to observe corporate formalities is not ground for piercing the veil • This provides some protection. MECs budget had to be approved by Bristol. Bristol had its name and logo on the breast implant packages. which made and sold breast implants. and Bristol set MECs employment practices. and other obligations of its subsidiary corp unless there is a contractual or judicial exception to the rule  In re silicone breast implants – (AL)TORTS Peircing the Veil Case – Parent/Sub (p. 138) • Can you hold the parent liable for the torts of the sub? This different analysis applies when you start shifting from one individual shareholder to a corporate shareholder.∆ says he kept the minimum needed  Court said he did have bare minimum. but the court glosses over it • This element is also satisfied – so the veil is pierced • Court says “the essence of the fairness test is simply that an individual businessman cannot be allowed to hide from the normal consequences of carefree entrepreneuring by doing so through a corporate shell” – this isn’t Sturkie. but not sure if it makes a difference o Parent-Subsidiary Cases o Court is going to shift from Sturkie analysis once you get away from close held corps Notes o Well recognized basis for piercing is to avoid fraud. and the class action tried to pierce the veil and get Bristol. a majority or all of the outstanding stock of which is owned by another corporation called the parent corporation o A parent corporation is not liable for the contracts. which is known as a subsidiary  A subsidiary is a corporation. Also transferred stock to others without consideration and then dissolved the company – Problem is that all this occurred before the accident occurred. siphoning of funds. • Relationship btwn corporation o MEC has a 3 member board  2 members were Bristol executives  The president was not employed by Bristol Page 32 of 148 . • Facts: Bristol Meyers Squibb was the sole shareholder and parent corp of MEC. The test says it has to be subsequent. The board of MEC consisted of MECs president and two officers from Bristol. but nothing shows money was ever put into their capital accounts o Also the inherit risk of alcohol increases how much capital it had o corporation was undercapitalizes according to court  ∆ defends saying it could always pay its bills. Also. • Cash flow sheet  May have been some fraud in the election of officer records  Lack or records alone wont be enough. but burcky suggests that it really isn’t that big • SO o Undercapitalization. torts. Also transferred his own funds to other corporation he held. but it wont save you from piercing if the other factors are met • This statute is also in the LLC section and will probably have the same effect (§B14 • Issue of capital o The bars made plenty of money. Plaintiffs made 2 piercing claims: corporate control and direct liability. but the risk analysis comes in o This is an important factor.such as not to compete in a certain area o Corporations can also be shareholders o They are often the only shareholder of another corporation. We know what happened.

when a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder. However. the fact that Bristol put its name on the implants was a showing of support for the product subjects Bristol to liability if it failed to exercise reasonable care. Basically Bristol controlled MEC  Bristol also had to approve MEC’s budget. o There must be control. Limited liability is the rule.” • Court said that there was no need to show fraud in a parent/sub case. court again looks at totality of circumstances and a bunch of factors to find corporate control • Issue: What is the test to pierce the corp veil in a torts case for a claim of corporate control and direct liability? • TEST to Pierce the Corp Veil for a Corporate Control Action: Parent/Sub o Common directors between parent and subsidiary o Common business departments o Parent and sub file consolidated tax returns o Parent finances subsidiary o Parent caused incorporation of sub o Sub is undercapitalized o Parent pays salaries and expenses of sub o All of subs business comes from parent o Parent treats subs property as its own o Daily operations of parent and sub are not separate o Sub doesn’t observe corporate formalities The facts meet several of these factors o Fraud is not require to pierce  Also most jurisdictions that require fraud in K cases. the corporate form may be disregarded in the interests of justice.• • One of the Bristol execs on the board couldn’t be outvoted by the other two  And several MEC presidents didn’t recall having a board let alone being members to it o MEC prepared reports for Bristol on the implants. do not require it in tort cases • This is becaues a party to a K can ask for further assurances from the parent o Significant is the fact that Bristol put its name on the packaging – it would be against equity to allow Bristol to escape liability from those who were induced to believe it vouched for the product  This is similar to McDonalds case – that the court gets you because you represented yourself to the public  So this would prevent summary judgment in favor of ∆ even if fraud was required • (Restatement Torts § 324A . Thus. and there is definitely no need to show injustice in a tort case. not the exception.Under a theory of direct liability). which consisted of filling out Bristol forms  Bristol controlled employee polices o Other subsidiaries of Bristol distributed MEC’s implants o Bristol’s name was also included in the packaging o No dividends were paid out to Bristol  They had consolidated federal tax returns but separate state tax forms o At time of suit MEC had ceased operation and only has a 57 million demand note towards Bristol and a 2 billion insurance policy Π suing on corporate control to pierce and also direct liability o The risk of abuse of the corporate structure is greatest when there is only one shareholder – but the court recognizes that shareholders must exert some control over the subsidiary  Limited liability is rule not exception o Must look to see if MEC is the alter ego of Bristol  ∆ here have moved for summary judgment – this is hard to do in alter ego case because it is so fact specific and jury needs to look at it o Court goes through totality of circumstances • “A parent corporation is expected…to exert some control over its subsidiary. not mere contacts for the veil to be pierced Piercing is almost exclusive to close held corps Public corps won’t be pierced – but they could be reached as a parent of a subsidiary Courts pierce more often to get at an individual than at another corporation Courts have actually pierced more for K claims than tort claims Piercing can also occur in LLC Page 33 of 148 Notes o o o o o o .

and so the assets can’t be taken out of the corp o Deep Rock Theory  If a corporate insider has loaned money to a corporation. he would treat all the companies as one and the plaintiff would be able to recover from the combined assets of all the companies. Idea was to insulate Carlton.Courts will pierce the LLC veil by applying the same test that is applied in the corporate situation Hasn’t happened in SC yet. Kincaid applied enterprise liability. which owned a number of companies that owned 2 cabs and had the bare minimum to keep them running. but we will probably follow the other states  Other Theories of Liability: o Parent liability under agency concepts (doesn’t usually happen) o Agency is consensual. then it can be directly liable o Personal jurisdiction: sometimes you pierce the veil so that subsidiaries’ contacts with a state are imputed to the owner o Enterprise liability o Concept that although technically separate. Walkovszky v. Carlton (2 cabs in each corporation)  See facts – they support the Enterprise theory – you had ∆. his claim will always be subordinate to claims of outside creditors o Page 174 – statistical piercing analysis  In 40% of piercing attempts. 190-91. so they could collect from wherever the money was  See Mid-South Management also in bar folder: went after them under piercing theory (lost). and watch over the executives Page 34 of 148 o o . court actually pierced  Always directed to closely held corps (less than 9 shareholders)  Courts pierce more often to get an individual who is a shareholder in a corp (Dewitt) than to get to a corp who is shareholder in another corp (Bristol)  Courts are less likely to pierce in tort claims than contract claims  Undercapitalization and failure to follow corporate formalities are important. The all operated out of the same garage with central dispatch  See Kincaid saved in SC Bar Exam folder. See. so the parent corp would have to consent to have the subsidiary act on its behalf and the sub would have to consent to act on the Parents behalf o This isn’t how businesses work in this situation o Parent liability on a control theory o If the parent corp exerts direct control or operation of something owned by the sub. who in turn choose executives. The feds love to go after the parent corporation.  Family had several corporations – • One purchased land • One advertised • One actually built houses on the land  There are reasons other than liability for having three companies instead of one • Π sued all three companies for problem with house • ∆ said you could only sue the company that built the house • Crt App applied doctrine of Enterprise liability and said it was the business as a whole. o Who makes decisions for the corporation?  The general notion is that shareholders elect the board of directors. P. two corps that are commonly-owned and in reality engaged in one enterprise together should be treated as a single legal entity for purposes of liability o Business today has developed so that a large-scale business doesn’t have one company but instead has a holding company that owns smaller corps  This is far from the conception of protecting individuals. this allows a single corp to subdivide and reduce liability by being able to isolate it  So the individual corps should be treated as a single enterprise that is liable as one  If a plaintiff’s theory of enterprise liability is successful. enterprise theory (the court didn’t buy this one). but only show up in a small number of cases  Piercing has been used a lot in the environmental cleanup area. silicone breasts alter ego parent analysis (this test is now recognized in SC) o Reverse piercing  Occurs when you are suing an insolvent shareholder of a company with no cash. and you go after his percentage of the assets of the company  Generally can’t occur because the shareholders’ claim to the corporate assets is subordinate to any creditors claims. instead. oversee corporate policy.

or interfere with the rights of minority stockholders. closely-held company. This is what practically happens. 196-197 for functions the board should and may perform o 33-8-400: the positions of officers in the company are established in the bylaws. endanger.(NY Case) (p.  In actual practice. excepting upon the unanimous and mutual consent of the parties. make sure the person who signs it has authority to do so under the law of Agency. all corporate powers must be exercised under the supervision of a board of directors o RSA § 14C – neither the board nor individual directors are agents for the corp or the shareholders. This is a closely held corporation with a limited number of shareholders. They are the principal collectively (make the decisions) so not an agent. it wouldn’t be reasonable to think he had authority to do so. • Powers of Officers o See p. Keep this statement in the back of your mind: Generally. significant policy changes and shifts in business direction o Directors can elect each other to be officers.otherwise agency principles would make the shareholders liable for the actions of the company through the directors o The Directors generally make the big decisions that fall outside of the general operation of the business: mergers. you as a third party probably don’t have a right to rely on a title  2) you would want the President to sign the loan not the director or the shareholder.”  The agreement said nothing was to be done to affect the rights of minority stockholders without unanimous consent. implied and apparent authority • Second – probably no. This was an action for specific performance. Stoneham .  But also get proof that the board has approved the loan • McQuade v. most shareholders play virtually no role in making decisions regarding the operation of the business (for most shareholders of corporations with more than four or five shareholders. if a corporation has more than four or five shareholders. he wanted his job back.  Also make sure the BODs has approved the loan!  Ex – The 2 things to think about to determine whether the actions of the Officer are valid under the law of Agency? • Does the officer have actual authority? • Does the officer have apparent authority? (b/c the reasonable law student would presume that the officer would have the legal authority to hire) o Does the officer have implied authority? o Problems 153  1) does a VP of a corp have authority to bind the corporation if he offers you a job – yes. the primary shareholder/owner will make almost all decisions and ignore the corporate formalities. McQuade sued for breach of contract for not using best efforts to keep him in his position as Treasurer. the board of directors is the decision-maker for a large. their only important decision is when to sell shares). closely-held corporation (although sometimes it is made by the president and rubber stamped by the board).  Board members are not agents for a corporation but officers are  Directors and Officers • Powers of Directors o 33-8-101: Unless stated otherwise in the articles or bylaw. no change in the amount of capital or the # of shares. Then a new guy came in and Stoneham and McGraw didn’t vote and allowed McQuade to be voted out of his position. McQuade had a minority stake. o McQuade Agreement: “there shall be no change in salaries. For a small. because he is the one that makes these actions. no change in the amendment of the by-laws of the corporation or any matters which may in anywise affect . an individual may hold more than one office at a time o 33-8-410: the duties of the officers are either set forth in the bylaws or prescribed by the board of directors or an officer authorized by the board to prescribe duties to other officers. 153) o Stoneham was a majority shareholder of the New York Giants. Also there weren’t supposed to be any change in the number of shares Page 35 of 148 . As part of the transaction in purchasing his minority shares he entered into an agreement with Stoneham that the parties would use their best endeavors to have the same 3 people remain directors and officers AND that contract also fixed the officer’s salaries – there was no durational aspect in the K. and may be able to bind the corporation  Note 33-6-250: any stock certificate issued must be signed by two officers who are designated in the bylaws to have this power  SO if you’re making a loan to a corporation. o An officer IS an agent of the corporation.

the Π voted for himself to remain as Treasurer. and the 3 new members voted against him and in favor of Bondy. Their motives may not be questioned so long as their acts are legal. McQuade could not be reinstated as Treasurer. not the shareholders. make the decision as to compensation o Issue: Was the contract valid? (the part of the K that appointed the directors themselves was not invalid? o Ds argued that the K was void b/c the directors had a duty to act for the corporation and use their best judgment and that any K that compels a director to vote to keep any particular person in office and at a stated salary is illegal. 158) Page 36 of 148 • . they were selected by him and he had complete control over them • At a meeting in 1928. (You can’t take power from the Directors and put it into the shareholders pocket). The bad faith or improper motives of the parties does not change the rule. they cant contract to control them afterwards in their selection of agents o Section VIII is partially valid. They were under no legal obligation to deal righteously with McQuade if it were against public policy. so it is also void • VIII is ok because shareholders can combine to elect directors.it is an employment K Note: NY has since changed its view from McQuade – in closely held corps. the ∆ added 4 more board members. but ∆ got pissed bc Π challenged ∆’s control over the treasury. and any agreement that compels their vote to keep someone in office is illegal  RULE – Directors may not by agreements entered into as stockholders abrogate their independent judgment  So part X of the agreement is void because it attempts to abrogate authority of the Board to set salaries and give it to the shareholders • IX does the same thing. however McQuade probably had an action for damages for wrongful discharge on breach of contract. However.o o  • Later. to be exercised according to their unrestricted lawful judgment. o Thus. the shareholders may enter into agreements controlling board decisions  This is now the majority view Shareholders Villar v. the ∆ and McGraw refrained from voting.  The other director’s duty was to the corporation and the S/Hs. BUT the part that says they will try and control the composition of the officers. o Note: This would be fine as long as it was approved by the directors. Kernan – (Maine Case) (p. by agreement among themselves. o Note: The holding here is only that the contract wasn’t specifically enforceable. who became treasurer o Thus ∆s didn’t keep their agreement to use their best efforts to keep him as treasurer • Lower court refused to reinstate him.  S/H’s may not. they had to exercise their best judgment to act for the company. He did nothing wrong. Directors may not by agreements entered into as S/H’s abrogate their independent judgment . Court also found Π was protecting the company and minority stockholders  ∆ argues the agreement was void because as directors. stockholders couldn’t have an agreement to divest the directors of their power to fire an unfaithful employee  Nor can stockholders by agreement control the director’s exercise of judgment Stockholders can only combine to elect directors  But this is limited to election. o NY Rule: Under NY law shareholders of a closely held corporation CAN band together to make agreements to elect directors.stockholders may combine to elect directors. not to McQuade as an individual. the court would not give McQuade back his job as treasurer.which the shareholders cant do because the directors must make these decisions  Also. but did award damages  Π was ousted because of a falling out btwn him and ∆. a contract that places a limitation on the power of a director to manage the business of the corporation is improper and unenforceable as against public policy. control the directors in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries. but shareholders can’t elect officers o Section IX and X are invalid because the board.

o Most states say that if you meet many of the CL statutory requisites you can have a McQuade like agreement. which is why its covered by the board  Therefore this type of agreement is covered by the statute. o Villar is stuck now. Page 37 of 148 .wrong.  Stephan later became a 2% holder – taking one % from both  Relationships fell apart • Stephen became allied with ∆ ∆ entered into a “so-called consulting agreement” with the corporation whereby he got automatic payments of 2K a week  This was ratified at a shareholders and board meeting at which the Π was not present • ∆’s argument that this is outside the statute is wrong because controlling salaries is a direct limitation on the judgment of the Board  Π eventually filed suit for breach of the no salary agreement o Maine Rule: Permits shareholder agreements to limit director and corporate discretion as long as are in writing or in the articles of incorporation. then you can o If authority of the board is limited. it prevents ∆ from being hired as a consultant and it effects the distributions of dividends because money that would go to salaries would reduce that available for dividends – this is a direct limitation on the board. Kernan entered into a consulting contract with the business and started getting $2K a week. and you operate as a partnership almost o Lets you get around all the formalities o If the agreement between these two had been in writing the case would have come out differently b/c the statute clearly states that if it is in writing it is enforceable. it can still be enforced if the rights of the TP challenging them are not prejudiced there is no TP here but.statutory close corporation o Unless otherwise provided in the articles or a unanimous agreement of the shareholders which is noted in the articles then you must operate in accordance with the statutemeaning you cant mess with the board o But if you make these changes. He can’t sell his shares b/c there is no market for them. If the business was an at-will partnership. • relate to a phase of affairs of the corporation such as management • transfer management duties to the shareholders  However.  Maine has a statute that allows such agreements to exist even if they • restrict the powers of the directors. allowing him to get something from his partnership. and because it fails to meet its requirements. it was unenforceable. the articles shall describe who is to pick up these duties • Statutory Close Corporation – see the Elders case o On page C-105 o § 33-18-210 different paper work is filed. Villar could withdraw from the partnership and dissolution would take place. SC has a specific statute  If the shareholders want to control the board – can they in SC? • C-38  There are 3 types of Corps in SC • Regular ones – shareholders would have little control – these are the big ones • §33-8-101 – Quasi. They had agreed that nobody would receive salary – just distributions.o o Villar had 49% and Kernan had 51% of a brick oven pizza business.  The problem is that if this is viewed as a Partnership for a Term – he would be viewed as a wrongful dissolver – but he may be better off as a wrongful dissolver than being tied in a closed corporation. or if an amendment to the articles it must be adopted by a unanimous vote. the exceptions still not cover the writing requirement – so all such agreements must be in writing o Basically what they needed to do in this case was to follow the statute. the agreement must be included in the articles of incorporation and any subsequent shareholders must be made aware of it • If these requirements are not met. After a while. it is not enforceable – therefore ∆ was able to hire himself as consultant and pay himself a salary o Holding: Since this agreement was oral.  Has to be in writing  ∆ claims it isn’t covered by this section because it doesn’t affect the right of shareholders. in addition to being in writing.

regardless of whether the corportation was incorporated in one of the 18 states with a special statute like SC o 33-8-101 – Burkie says this may be the most important section of the corporate code!!!!!!!  Shareholders can agree to limit or change the authority of the board.• o o • o o • 2 Options in SC that Give Shareholders Ways to Control the Board: See pages C105-106 for ways to change or do away with board and bylaws Book notes that most people use the term ‘close” or “closely held” corporation to refer to a corporation with relatively few shareholders.  You can set up a business that operates very differently from the standard normal business. it wasn’t in the articles of incorporation. but it must be: • unanimous agreement among shareholders AND • disclosed in the articles AND on stock certificates  Can be added into the AI’s as an amendment via 33-10-103 – 2/3 vote to the amendment. these don’t always meet all the requirements to be a statutory close corporation. Also indicates what the corporation should do if operating without a BOD.  33-18-200: Shareholders can agree to eliminate or restrict the board • 33-18-200(e) might give a way for a shareholder to dissolve the corporation if the right is contained in the articles of incorporation.  33-18-220: You don’t need bylaws  33-18-230: You are not required to hold an annual meeting  33-18-330: The articles can allow the shareholders to dissolve the corp at any time  People usually refer to a corporation as a close corporation or a closely held corporation when there are few shareholders and the stock is not publicly traded. However. you have to do it by amendment in the articles. the majority shareholder will decide each one Page 38 of 148 .  SO in SC you can get create a very different type of corporation for your client as long as you abide by the statutory rules.which it does here Shareholder Voting Methods o Shareholders vote to choose the board of directors o Straight Voting  A shareholder may vote their total number of shares for each available seat  There is a separate election for each seat on the board.If you are going to eliminate the BOD. so the statute wont save it unless it doesn’t effect another shareholder’s rights. (Villars could have had an option) • One of the hallmark differences between a corporation and a partnership is the ability to dissolve the partnership  33-18-210 . Each shareholder gets to cast her number of shares in anyway she desires for each of these separate elections  Each share = one vote and because you can cast all your votes in each election.  You can put it in the articles and spell it out or you can put it in a contract if the contract is mentioned in the articles (incorporated)  Burkhard says this provision allows for a quasi-close corporation!!!  Basically makes a McQuade-like agreement possible (similar to a partnership) o 33-10-103 – Amendments to the AI’s by the BOD and S/H o 30-10-104 –(d) – “shares are entitled to the voting rights granted by this section although the articles of incorporation provide that the shares are non-voting shares o 33-18-xxxx: Statutory Close corporation  Second option (instead of the quasi-close corporation)  I can operate my corporation almost as if it were a partnership (doing the kind of things they want to do in the McQuade and Villar case)  You have to have special articles of incorporation and you have to specify that the corporation is a Statutory Close Corporation. the stock of which is not publicly traded. 162 1) shareholder agreement that restricts directors discretion 2) No. Problems p.

C35: SC 33-7-280: Voting for directors: cumulative voting • Directors are elected by plurality of the votes cast by the shares entitled to vote. B would put all 60 of his votes on one guy or himself and A will put at least 61 of his votes on 2 people so as to be sure to get at least 2 people. cumulative voting tends to reduce the influence the minority can have  P. Shareholders have a right to cumulative voting unless the articles say otherwise o SO our default rule is to have cumulative • But cumulative voting is only the default if the meeting notice or proxy notice conspicuously states that cumulative voting is authorized – o Or a shareholder gives proper notice – see statuteo So you have to do something before you can exercise your cumulative voting rights • Unless provided otherwise. he must either give 48 hours notice OR give notice at the meeting and then they have 2 hours  If a shareholder gives notice at the meeting of his or her intent to vote cumulatively . I get to vote 50 times for each position and will basically determine who the 3 directors are.  With the same example above. shareholder voting is cumulative • 280(c) .  Suppose now the board consists of only 3 directors.the other shareholders have a right to adjourn the meeting to figure out what they are going to do  A minority shareholder would prefer to announce at the meeting his intention to vote cumulatively b/c there is a chance that the others will screw up their math in 2 hours  280(d) – prevents the majority from being able to amend the articles of incorporation to prevent against cumulative voting = (if the # of votes cast against the amendment would be sufficient to elect a person onto the BOD if voted cumulatively) Page 39 of 148 . it is to my advantage to have a limited number of directors. the more shares you need – so majority shareholders want fewer directors if they use cumulative voting  If I’m a majority shareholder and I want power. they will be able to select every director Cumulative Voting  Directors are not elected on a seat by seat basis  Rather. How many shares would be needed to elect Epstein? 251  Why would a corporation not want cumulative voting – it protects the minority shareholder  The less directors.  Formula: Number of shares to elect one director: • [S/(D + 1)] + 1 • S= total number of shares voting (not multiplied by seats).  Formula for more than one: [(NxS)/ (D+1)] + 1 • N = number of directors the shareholder wants to elect • S = total number of shares voting • D = total number of directors to be chosen at the election  Problems: there are nine directors to be elected and the corporation has 1000 outstanding shares.o  Ex – If I have 50 shares and the other shareholder has 20 shares.  Note that with staggered director voting.  Result: if there is a majority shareholder. each shareholder has votes = number of shares * number of open seats  Those total shares can be cast in any way  This tends to give minority shareholders a better chance at choosing a director or two. • D = total number of directors to be chosen at election. How many shares to ensure Epstein is elected to the board? 101 How many to ensure both Epstein and Roberts are elected? 201. and there are 3 director positions.Triggering event must occur to allow cumulative voting: o The meeting notice needs to say the voting is to be cumulative o If a shareholder is going to vote cumulatively.

o The meeting to remove the director must contain some notice that a vote to remove the director will be held So if 7-280(d) prevents you from doing away with cumulative voting.  Problems p. But Ohio court voted against this. 33-8-106). – you are protected against the majority’s removal of him.o o • o o  Note that cumulative voting is only used when adding (and tangentially. the majority will want to reduce the number of directors so as to get more control o BUT 8-103 throws up some blocks  If the number of directors is in the articles. you can’t say anything because it is a conflict of interest. If they come to you and ask whether you recommend cumulative voting.If you represent the majority shareholder they don’t want cumulative voting. o If cumulative voting is not authorized.the shareholders could amend the by-laws to reduce the # of directors. This gives the majority shareholders greater power. If a 48% shareholder is not a director. then it’s harder. The majority is the one who is going to be able to elect that one (you can do that by combining § 33-8103 with 33-10-200 and 33-8-108).  There must be notice of the charges and the director must have a chance to refute the charges o If a director is elected by a voting group of shareholders. the minority shareholder has trump power)  § 33-7-280(d) does not allow the board to amend the articles to remove cumulative voting if the votes casts against the amendment would be sufficient to elect a director the board of directors  Built in safety valve – once the minority gets someone on board. which means the majority’s voting power becomes much stronger. o If cumulative voting is elected – majority cant fire you – this is to preserve the minority protections of cumulative voting o With cumulative voting. a director may be removed only if the number of votes cast to remove him exceeds the number of votes not cast to remove him. • 33-8-108: Removing directors o You can remove without cause unless the articles state that cause is required  Cause = fraudulent or dishonest acts or gross abuse of authority. This is another end-run. But if its in the bylaws.this is also a takeover defense by making it harder to fire off the directors if a outside buyer comes in Note – class shares are a better protection than cumulative voting • 33-8-103 – Directors only serve their designated terms. § 33-8-105 allows the majority to reduce the number of directors (or stagger the elections of the board.  If minority gets someone on board – the majority is stuck with them. Uniformly shareholders have the right to vote on 4 “fundamental corporate changes”: o Amendment of articles of incorporation o Dissolution o Merger with another corporation o Sale of all or substantially all of the corporate assets o In SC – Shareholder also has the right to:  To create a SC corporation  To change the form of business But on these decisions. the company probably does not have cumulative voting or he would have gotten on the board. o SC is one of the few states that reduced the # of staggering to 6 (you can have a staggered term board if you have a minimum of 6 directors)– done to protect some majority shareholder of some corporation. Conflict of Interest . you can’t remove a director if the number of shares required to choose him as a director are cast against his removal (in other words. only the shareholders in that voting group may participate in voting to remove him. the directors can change it o So next they will stagger the terms so that fewer are elected at a time. the shareholder is merely giving approval of boards decision Normally a supermajority approval requirement Page 40 of 148 . • 2. removing) directors. you can’t just get rid of him by firing him. if you represent the minority shareholder they want cumulative voting. • 33-10-200 . all the way down to 1. 213 • 1.

It must be between 10 and 70 days.No cumulative voting o Note that shareholder votes other than selecting directors is actually considered approval (or disapproval) of the board’s actions o If I want to have a corporation run by the shareholders. You can have your lawyer prepare a set of minutes and have each shareholder sign off (most SC corporations do it this way).  If you bought after record date and it’s important to you to vote.  The bylaws can fix the records date  § 33-5-105 allows for notice 10 days prior to the meeting  Not more than 70 days before the meeting  Shareholder as of record date gets to vote regardless of whether they subsequently sold.2 Capel because he was the owner at the record date even though he isn’t at the time of the meeting. Because the shareholders collect last. and only record owners as of that date are entitled to notice of a vote at a meeting o So mainly used in public companies o Brokerage firm – most people buy stock from brokers. most shareholders in publicly traded corporation wouldn’t vote o R 14a-9 prohibits false or misleading statements in soliciting proxies o 14a-8 deals with shareholder proposals Problems page 167 o 1. You need notice of purpose for a special meeting o 33-7-107: Record date  The person who has the legal right to vote at an annual meeting or special meeting of shareholders is the record owner.  This is the way SC closely held corps vote  If you don’t want to have an annual meeting you don’t have to. (so owner at record date gets to vote even if they don’t own at time of vote) o Page 41 of 148 . you can enter into an agreement with the seller to cast his votes for you. if 10% of the voting shares demand a special meeting. o 1.1 looking at 105 and 107 – the latest would be 10 days before the meeting and the earliest is 70 days before. and the brokers have to vote how the real owner tells them too o If a bank is given bond in a corporation as part of a loan agreement. so corporation will fix a record date. There is not a precise answer to this question in our code. This is called street name ownership o Laws make the brokers give notice to the street name owners. The real owner is in the brokerage firm’s records. except in event of a takeover vote o Record owner – person who has right to vote at annual or special meeting o corporation must send notice to them of meetings o Record date – 33-7-107 problems with giving notice come up because shares are sold by the holders.  If it is notice of an annual meeting. they need to be in control o A proxy can be revoked at anytime – even if it says it is irrevocable o It is only irrevocable if it says that it is and is coupled with some interest in the stock – look at SC statute for definition of this o There are Federal Rules regulating proxies because without them. The brokers are the ones who are the record owners in the corporation records. they’ll get one (this is unusual…most states don’t allow shareholders to call their own meeting) o 33-7-104: Action without meeting  Shareholder action can be taken without a meeting if the action is taken by all of the shareholders who are entitled to vote. o 33-7-105: Meeting notice  Shareholders with voting shares must get notice between 10 and 60 days prior to the meeting date. that bank doesn’t have a right to vote because they collect first. the only provisions that are worth a hill of beans are 33-7-101 or the section on creating a closed corporation (above) • Where shareholders vote and who votes: Special Terms o 33-7-101: There shall be an annual meeting (usually the only thing you do at an annual meeting is elect directors) o 33-7-102: Special meeting (any meeting other than the annual)  At the call of its board of directors or  If it isn’t a public corporation (company whose stock is publicly traded on the NYSE). no purpose needed.

 Proxy appointment is revocable UNLESS the proxy form states that it is irrevocable AND the appointee is • a pledge (lender –who you pledge a stock of the security) • someone who bought or agreed to buy the shares • a corporate creditor where the terms of the loan required their appointment as proxy • an employee whose contract requires their appointment • a party to a voting agreement under 33-7-310 – “voting trust” • We really need to have irrevocable agencies under certain circumstances  A solicitation in the proxy statement cannot contain a statement which at the time it was made was false or misleading w/r/t a material fact or which omits to state a material fact necessary to make the statements made not false or misleading. A proxy appointment expires if a time period is specified or within 11 months. All that is required is that the fact would have been regarded as important. b/c you can’t get everyone together to vote. o Proxies are generally only a feature of publicly traded companies.Also specifies that an omission of a material fact in a proxy is a violation. but in SC. Federal Proxy Rules: false or misleading statement of fact o Rule 14a-9  §33-7-220(i)  (a) – no solicitation shall be made in any proxy statement.  The shareholder must show that there was a material misstatement or omission in the proxy materials. written or oral.Proxies  Only a shareholder can vote by proxy  A proxy appointment is effective when the appointment form or electronic submission is received by the secretary or other officer to agent authorized to tabulate votes. the board of directors can make business decisions without the approval of the shareholders 3) generally.o o o • • o 1. Scienter is not required for insiders. mirrors the federal proxy rule below  You have a state and federal proxy fraud action o Proxy solicitation: when a shareholder receives a proxy. grant someone else the right to vote my stock because I don’t want to be present at the meeting) o The agent is the party that is casting the vote o Proxies are the exclusive province of shareholders – there are NO director proxies. o Proxies are generally revocable UNLESS  it states that it is irrevocable and  is coupled with an interest in the stock o 33-7-220 .  The defendant had to knowingly make a misstatement or omission (?). Instead. as a shareholder.  The shareholder does not have to show that he relied on the falsehoods. containing any statement that is false or misleading with respect to any material fact  Non-disclosure of a material fact . injunction. the court will presume that injury was cause as long as the falsehood or omission was material.3 you need to know if that got changed on the company’s records.  This changes the normal fraud statutes because you can’t have a defense of silence. the P may not recover. 170) Page 42 of 148 .  Remedies: damages. If it didn’t then Shepherd might not be able to vote 2) no they won’t have to approve this change. or would have assumed actual significance in the decisionmaking of a reasonable shareholder. Mere negligence is sufficient. o Generally a proxy is a yes/no vote on the director/shareholder action. We are one of the few states that has our own proxy fraud act. it usually comes with a statement that solicits the shareholder to grant the proxy for their shares. Sandberg (VA Case) (p. that’s key There is an implied right of action on behalf of individuals who have been injured by a violation of proxy rules. an omission is actionable.  There has to be an essential link between the solicitation and completing the transaction. or in an extreme case an undoing of a consummated transaction o Virginia Bankshares v. lenders don’t vote. If the P’s votes aren’t necessary. see §33-1-400(26)  “creditors of a corporation may have the rights of a shareholder as allowed in the corporation’s articles of incorporation” Proxy Statements – S/H authorization to Vote o Proxies are simply an agency appointment (I.

then it shouldn’t effect her vote • But this all depends on the mix of the true and untrue • The jury here found that the true facts did not neutralize the false conclusions  Second issue – should there be liability when the minority shareholder’s vote wasn’t needed in the first place.these 2 theories are the same as the essential link that solicitation played in Mills o Π is speculating about what the ∆ would have done. • Note: a misstatement as to the director’s motive for seeking the proxy may not be material. • An opinion as to a general fact is not necessary a material misrepresentation. The COA only exists if the Πs vote is required and it wasn’t here Page 43 of 148 . • The merger was going to force the minority shareholders to sell their stock • The corporation was going to pay them $42 per share • The law didn’t require their vote. VB owned 85% of the stock of a bank. One of the issues though was when we are voting on whether to freeze out shareholders then we don’t need the votes of the minority shareholders (15%). This isn’t going to win the day.  But under the rule. because there was a conflict of interest issue because on of the Bank’s directors was also on the ∆’s board. and solicited the remaining shareholders for a proxy vote in favor of a merger that would get them “high value for their stock” and a “fair price.” The court said that even though “fair value” sounds like a statement of opinion. then it may not be material. just that the misstatement was made in tenor of the solicitation in the number of minority shareholders’ needed to make the vote o This relation is called the “essential link” • But that court wasn’t dealing with a class of minority shareholders who had no right to vote anyway – so no essential link o Π claims Mills’ statement of the essential link is here trying to expand it  Either because ∆ wouldn’t have proceeded without minority approval because of ill will that would stem • Also claimed they were trying to keep their place on the board and this would help • So they wouldn’t have done it without them  Or. the statement of opinion was material. They should have gotten $60 per share • The statement was conclusory in form – purporting to give the reasons for why the directors were recommending the merger – when in fact it was the Π’s statements and not the directors • Also Sandberg’s approval wasn’t needed anyway since the corporation had enough votes  The P’s in this case are being cashed out.  The Ps argue the directors lied was so they could keep their position on the board (the motivation behind your lying was to preserve your jobs)  Fundamental Test as to what is MATERIAL: The court defined a material fact as one where “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. because in the corporate context. and if its obvious that the statement isn’t true. Π must show the misstatement was knowingly made • ∆ argues that by publishing true facts with what is a false conclusion makes the misleading proposition too unimportant for there to be liability – after all its only a material misstatement if it effects the shareholders vote. it is a freeze out merger (the merger is going to force the shareholders to sell their stock). In this case. Electric – ∆ had 50% of vote but there had to be a 2/3. but they wanted it  corporation sent out proxy statement asking for their proxy  Sandberg refused to give his proxy and sued for violation of 14a-9 which prohibits the solicitation of proxies by means of materially false or misleading statements • Claims that the proxy lied in saying they were getting a high value for their stock.this is the bigger issue here • Mills v. so the minority approval was needed to keep this from voiding the merger • Court disagrees.” Minority shareholders sued for a violation of Rule 14a-9. a shareholder expects that opinions are based on facts that justify the statement. but a misstatement as to value of company or stock is material • Note: if the statement includes enough correct facts to allow a shareholder to neutralize the misleading statement. court had to decide if the minority shareholders had to show that the misstatement had a decisive effect on the outcome ie that they were actually mislead – court said no.

If you follow this rule closely. He likes the second theory but the facts are wrong here  CAUSATION: The solicitation doesn’t cause damages unless the proxy is given because of the solicitation were necessary to complete the transaction.• o He says I see what you’re saying. o The company will try to avoid putting it in. To resolve issues related to 14a-8 (ie things the corporation wants to put in or leave our of its proxy solicitation). The company bears the cost of these proposals – federal gov’t has stepped in and said this is something we are going to mandate on behalf of all the shareholders of publicly traded company o The company will submit and request a no-action letter by the SEC granting the companies exclusion of the proposal in the proxy – if the SEC grants a no-action letter it will be essentially permitting the company to leave the proposal out of the proxy.  If the reason they wanted our vote was to keep the company’s good name out there so that the board of directors can maintain their position. leaves the proposal out . Proxy Rules: Shareholder Proposals and Exclusions o It is important to distinguish between a full-fledged proxy solicitation and a shareholder proposal pursuant to Rule 14a-8 (often a political statement. but this solicitation would not cure those two problems. that there was an “essential link” between the solicitation and completing the transaction. Souter said nope because there is no way to know the reason they wanted the minority shareholders to vote. the minority shareholders argued there was an essential link. and there was no loss of state remedy to connect the proxy solicitation with hard to minority shareholders irredressable under state law. Souter says not under these facts but maybe sometime under different facts. In this case. Also. occasionally a shareholder will also try and solicit the votes of other shareholders.  It is very RARE that you have disputes over proxies b/c it is usually very difficult for the shareholders to determine what is going on. because VB didn’t need the proxy to complete the merger. • Under certain circumstances. and there are some reasons the SEC will allow them to keep it out – and not recommend enforcement action to the SEC if the co. a shareholder can require the company to send out a proxy solicitation regarding a proposal of the shareholder.  Comes up when the shareholder is not happy with how the company is running  But the cost is too expensive for this to come up a whole lot o 14a-8 provides that a shareholder can ask the company to send out a proxy solicitation regarding a proposal of what the shareholder wants and not the company.kind of like a declaratory judgment o But the SEC can be bypassed and the injured party can still sue in court – but this is very rare o Rule 14(a)(8)(i) –REASONS FOR EXCLUDING S/H PROPOSAL (reasons SEC might grant a no-action letter): o Page 44 of 148 . then the company has to send it out at no cost to you – this saves you millions o The SEC allows the shareholders of a public company to request that the company send out a proposal for the shareholders to vote on. Souter said that the minority votes were inadequate to ratify the merger under state law.  Holding: So in this case the misstatement as to the value was material but there was no causation so no violation of Rule 14a-9. lawyers rely on SEC bulletins and no action letters o No action letters are recommendations by SEC staff that the full commission not challenge specified conduct  Seek these in advance of taken a specific action.  Politically & Socially Motivated – cheap & efficient way to get the word out with our political concerns. o In addition to corporation soliciting their holders for votes.  Mgmt control devices . it is very expensive.  As a practical matter you can’t determine if the reason someone voted the way they did was because of the solicitation.  The minority shareholders also argued that the minority votes would cure a later attack on the merger based on conflict of interest. o 2 Primary Types of Shareholder Proposals (most of the proposals come from organizations or church groups). there was no causation.Directly addressing management issues of publicly traded companies. not something that the shareholder actually wants to passnot something that shareholders can mandate…they can only request) o Rule 14a-8 (handout): companies have to include shareholder proposals up to 500 words if the shareholder has at least $2000 in securities that he’s held for at least a year. Basically.

we need some way to communicate with the other shareholders. or to further a personal interest. or foreign law to which it is subject  Violation of Proxy Rules – If the proposal violates Rule 14a-9 – prohibits materially false or misleading statements in proxy solicitation materials .Materially or directly impugns character.if the proposal would. it is not within the scope of the shareholder’s sphere of authority. given the McQuade case. o Must own 2K or 1% of the company’s securities for at least one year o You can only submit one proposal per meeting o Proposal and supporting statement must be 500 words or less o Deadlines – must be received not less than 120 days before the date of the company’s proxy statement released to shareholders in connection with the previous years annual meeting o Question 9 – if you have complied with the procedural requirements. cause the company to violate any state. which is not shared by the shareholders at large  Relevance: Proposal relates to operations that account for less than 5% of net assets or net earnings and not otherwise significantly related to companies business  Absence of Power /Authority . o Ex – Xerox proposal. Then argues that the proposal contains misleading statements and therefore violates 14a-9 – for attacking character and personal reputation without factual foundation o SEC gave Xerox a no action letter o Based on 14a-8(i)(8) o So the SEC wont pursue an enforcement action to make this proposal be included in the proxy Looking at 14a-8 – Shareholder Proposal o See handout o Motivation of SEC is that it wants shareholders to get involved in the operation of the company. or if it is designed to result in a benefit to you.  The lawyer used the word “request” in their resolution b/c. special interest: if the proposal relates to the redress of a personal claim or grievance against the company or any other person. if implemented. it is within the director’s sphere of authority. Improper under state law. on what other basis may a company rely to exclude your proposal? Page 45 of 148 . And to do this. o See page 236 – Xerox wanted to exclude shareholder proposal asking for replacement of all inside directors  Holder had stock through Employee Stock Ownership Program (ESOP) • 3 step process of getting new directors o Inside – those employed by the company o Outside – those not employed by company  Xerox claimed that it could leave it out under 14a-8(i)(8) because it deals with the election of directors  A 1976 release from the SEC said that 14a-8 is not the proper means for conducting campaigns or effecting reforms in elections of that nature since other proxy rules including rule 14a-11 [election contests] are applicable • But these have been directed at proposal for specific nominees or select group that the new directors are to be selected  Also claims that 14a-8(i)(3) allows exclusion of anything against the proxy rules.Company has no power to resolve the problem  Mgmt Functions: Relates to company’s ordinary business operations – Mcquade case  Relates to election of directors (under the rules there is a limitation on that)  Conflicts with the company’s proposal: if the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting  Proposal has already been substantially implemented  Duplication  Resubmissions (there are specific rules about this) o Ex – McDonald’s shareholder proposal –  Coordinated campaign to try to address human rights concerns involving China. integrity or personal reputation  Personal grievance. federal.if the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization (usually proper if phrased as a recommendation or request)  Violation of law.  The primary reason this shareholder proposal was excluded was b/c it related to the election of directors.

Kortum is CEO of WAG.  TEST for SHAREHOLDER INSPECTION (WAG): A shareholder must show • They complied with the form of making an inspection demand: a written demand under oath • The stated purpose of the inspection they seek is the actual purpose and that purpose is legitimate.o o o o o o • o o o Improper under state law  Most proposals that are requests are ok Personal grievance Relevance – if it relates to less than 5% of company’s total assets Management – if the proposal deals with a matter relating to the company’s ordinary business operation  So its hard to fit something in between this one and the Relevance of 5% Election. In SC: 33-16-xxxx  We have no director inspection statute like DE does  33-16-101(e): Corporate Records: Page 46 of 148 . WAG also has a controlling interest in a competitor of WSI. o Valuing one’s shares is proper purpose. he should be granted unfettered access • SC has no statutory director rights.  Notice that the shareholder has a much more restricted right to look at the records than the director. since he has promised not to do so. In this case.to monitor performance • Shareholder – to value its shareholder interest • ∆ said it would let him view in his director capacity but he couldn’t share that with WAG  Shareholder has brought a 230 action to view the records – SC has nothing like this  TEST for DIRECTOR INSPECTION (Kortum): Director has access to any records reasonably related to his position as director (almost unlimited rights of inspection and the burden is on the other side to prove there will be a misuse of the information). Once the director has demanded access.  Issue: What is the scope of a S/H’s right to inspection when an agent of the S/H is a director of the Company. and a director of WSI.  WSI wants to prevent Kortum from having access to inspect books and records because they think he’s going to give the information to WAG who will give the information to direct competitor. the burden is on the corporation to show why access should be denied or conditioned. but you could draft it into your AI’s as a statutory or quasi close corp.  273 action in DE – DE has a law that provides a company like WSI (2 shareholder co) either of those shareholders can bring an action to dissolve the company. regardless of whether you plan to sell or not • The scope of their inspection is “essential and sufficient” to their stated purpose. The court says that the speculation that he will use the information competitively is not enough to restrict his access. The court said that the fact that a shareholder was a competitor didn’t reduce the entitlement.  There are two requests for information: a director of the company and a shareholder  The director and the shareholder are the same person here and asked for records in both capacities • Director. which is to vote for directors – which means its hard to communicate with other shareholders about who they want to vote Resubmissions  If you want to keep submitting the same proposal there are requirements – see # 12 Shareholder’s Inspection Rights When can they look at books and records? Kortum v. but may make conditions proper. and further. o SC statue requires these things for S/H inspection also!!!  The shareholder has right to inspect.or nomination – this seems contrary to the fact that the one thing they always have a right to do. the promise not to disclose to the competitor was sufficient. 186)  Facts: WAG and Magna are 50% stockholders in the joint venture of WSI. Webasto Sunroofs – (DE CASE) (p. of whom WAG owns 50%.

 33-16-103: Scope of Inspection right: • (a) The attorney or agent of the shareholder has the same inspection rights as the shareholder. you can also look at tax returns. they will talk to an arbitrator who will decide for them. The arbitrator makes a decision. you must establish 3 things (note: so for the good stuff.) • (c) Your demand was made in good faith for a proper purpose • Describe with reasonable particularity your purpose and the records you want to inspect • The records you want to inspect are directly connected to your purpose  (d) the right to inspection granted by this section may not be abolished or limited by the AI’s or bylaws. H says the agreement was invalid or revocable  Agreement said they would consult and vote together • Arbitration was to be had if they failed to agree • Said it could be terminated by mutual consent  Voting was cumulative • They each had enough individually to elect 2. o Depositing stock in a person or corporation as a trustee with the right to vote as a Voting Trustee for up to 10 years o Her argument was that you had to set up a voting trust to do this • Court says ∆ is wrong – there are numerous ways shareholder can make agreements with each other about voting. and Mr Dunn – voted only for H and her husband • As a result.  BIG NOTE: SC doesn’t have statutory director inspection rights. 196)  The two Ringling sisters are in an agreement to cast their voting shares together. Also. SC 33-16-102: Shareholder Inspection Rights • (a): Shareholder has a right to inspect anything in 101(e) with written demand and at least 5 business days notice. accounting records & shareholder record. if you have at least 1% interest.  At issue is a voting agreement bw shareholder regarding election of directors • 3 shareholders – Edith. you have the DE limitations from Kortum.  SC 33-16-104: Court Ordered Inspection • If the company gives you the Heisman on your 102(a) demand the court can order it. • But this wouldn’t give you what you need if you where in a Kortum squabble – wouldn’t let you figure out the value or what the directors have been doing • You get this info in the annual report  (b): KEY RECORDS – In order to get the key records: minutes of the meeting. • (d) If a S/H or agent requests a S/H record it must be compiled no earlier than the date of the demand. the willing party becomes the implied agent in possession of an irrevocable proxy of the breaching party’s votes • The court ordered a new vote to be had with H’s shares cast in accordance with the agreement  ∆ alleges that a voting agreement is invalid that takes voting power irrevocably away from the owner except an agreement that complies with § 18 of Corp Law • This section covers voting. and then a 5th by voting together (there were 7 total) • See ft note 1 for the math  Dispute • E was to vote for herself.• • Mandates the types of records we have to maintain. her son. but one sister doesn’t go along with it.complied • H was to vote for herself. Shareholder Voting Agreements Agreements btw directors are void – McQuade o Agreements btw shareholders are valid – Ringling o Ringling Brothers v. voting by proxy. and Mr Dunn . copy costs go to the company. and if they do. E claims H was bound to vote for a certain slate of directors. This statute doesn’t cover the type of agreement at issue here. Haley and John.One of the most landmark cases (p.  Page 47 of 148 • . and if they can’t agree as to who to elect. John was able to get in 3 of his directors instead of only 2  Trial court said the agreement was valid • That when one party breaks the agreement. her husband. Ringling: DE Case .

so Haley had the right to cancel this interest.  Court says that the voting trust should not be the only way to control the voting rights – rejects Haley’s argument based on Section 18 of DE law. we allow specific performance of voting agreements as long as they are written and signed. so the 6 people J and E voted for are now directors o Doesn’t decide what to do about the vacant spot  Issue: Is a S/H voting agreement that provides in the case of disagreement an arbitrator will decide the voting of the shares valid?  Haley’s basic argument that she can do whatever she wants with her votes (go against the agreement) Is b/s she suggests that you can’t contract away shareholders voting rights – DE law says that the way you do what you want to do is set up a voting trust  Haley’s primary argument: Basically. Ringling b/c the composition of the board when they throw the votes out makes any decision a stalemate. o If Haley cancelled the K right. you can set up class shares. o SC Rule on Voting Agreements.o o Class shares. so this case would have come out differently. and both are ok  Pooling agreement – this is what this is. o When you transfer them you know longer have ownership of the shares and the person who contributed must now vote the shares. irrevocable proxy. then Haley’s choice would have been elected and they would have had the majority on the board. the court invalidated her votes and the result was that there ended up being only 6 board members when there should have been 7. and it is valid • Shareholders have wide discretion to vote or agree however they want as long as they don’t breach a duty owed to another shareholder • Its fine for them to vote to gain an advantage  Remedy • Johns votes should count since he breached no agreement • Likewise E’s votes should count • But court throws H’s votes out completely. Someone had to have agency authority to cast the votes. instead of requiring Haley to cast her votes according to the agreement. which takes an interest in the stock along with the proxy. If the votes had been required to be cast. and even if he did it wasn’t irrevocable b/c it wasn’t coupled with an interest (he didn’t own shares). the argument is that Haley couldn’t be forced to vote her shares according to the agreement because that would have required an irrevocable voting trust. The decision clearly favors Mrs. here we are dealing with shareholders trying to influence one another’s voting decisions.  Holding: The court says that an agreement among shareholders to cast their votes in a certain way is valid and enforceable. • Is the result in this case less favorable. Page 48 of 148 . she might have been liable for damages but Ringling doesn’t have a right to specific performance. or pool agreements (contracts)  33-7-300: Voting trusts • You can place your shares into a voting trust. more favorable or in the middle result to Ringling? – o Ringling had the most power until there was a change in allegiance. 33-7-300 . o DE Rule: In order to mandate the votes there would have to have been a proxy coupled with an interest. • However. voting trusts. Shareholders are allowed to influence voting but are not allowed to do what they did in McQuade. beneficiaries. As a remedy. o One of the objections that was raised initially with these voting trusts is that a voting trust is public information. o Court said they didn’t know if he had a proxy. etc o So you can have shareholder agreements or a voting trust. and agreement with the corporation. they invalidate the votes that were cast against the agreement.  Distinction between Ringling and the McQuade Case: shareholders trying to influence a director’s right. You must file the trustee.310  To get someone to vote the way you want them to.

he votes selfishly in a way that benefits him. illegality or conflict of interest? – should the Court evaluate the boards decision as good or bad Page 49 of 148 o Trustee has essentially absolute power over the shares.  This is a shareholder derivative action. • the agreement is not subject to the provisions of the voting trust statute 33-7-300 • the agreement is SPECIFICALLY enforceable (note distinction from Ringling – would have changed the outcome)  33-8-104 – Election of director’s by certain classes of shareholders: • If the AI authorizes setting up different classes of stock.  The court is not convinced that the decrease in revenue will be offset by installing lights b/c the decision may deteriorate the neighborhood. they are paid to the voting trust certificate holder Only valid for 10 years unless extended or amended You can get as much as a 10 year extension with approval of the . The motivating force here is the lawyer. Plaintiff states that the reason Wrigley isn’t putting up lights is because he doesn’t like night games.  Even though you have given up stock to trust.• • trustee • (d) – indicates that the voting trustee is allowed to vote without the consent of the voting trust certificate holder – Also indicates that the voting trust certificate holder has the right to dividends.You might use something like this when you’re giving interest in the family business to the kids. A closely held corporation is run by the owners (completely different) • Breach of Duty of Care by Improper Board Actions – BJR!!! o Shlensky v. o Issue – can a derivative suit be brought for something other than fraud. Sued the directors for mismanagement in not putting lights in Wrigley field. which is against the interests of the corp.BJR: The court will not evaluate the business decisions that the directors or the officers make unless they border on fraud. they are paid through the trust to you as the holder of the certificate • no article that alludes what would happen if the voting trustee’s actions were injurious to them.so if there are any dividends paid. but wanting to maintain voting power – people will still invest o Family situation – where the parents want to control the votes and don’t trust their children yet. • Each class constitutes a separate voting group.Why would you want to have a voting trust? (mostly an exclusive feature of small corporations) o You may have a small corp set up by one person.unclear what would happen • Ex . The trustee has the right to vote the shares as he/she chooses o If there are dividends. the AI’s may also authorize the election of one or more director’s by holders of one or more authorized classes of shares. the only thing that matters is that each one gets to elect one director. b/c if there is a big win then they get the fees. stating that the club would make more money if they had night games. • Different classes of shares is the traditional control device that lawyers recommend! o Duties and Responsibilities of Corporate Decision makers: Stockholder Derivative Suits  Director’s Duty of Care  The directors of a publicly traded company are responsible to the shareholders.  33-7-310: Voting agreements (Pool/contract agreement) • 2 or more shareholders can agree to vote in a certain way with a written and signed agreement. • It doesn’t matter how many shares of stock are issued to each. illegality. • You get a voting trust certificate.  DE . looking for investors. or conflict of interest. but you don’t want them to begin exercising their voting power until they’re older ‘cause they don’t know jack • The only reason to do this is to tie up the voting power . the statute allows for this. 205)  Facts: Plaintiff was a minority shareholder in the Cubs. Wrigley (IL -DE law applies) – BJR Case (p.

to continue the litigation. Ct App – 2nd Circuit – I think NY Case?)(most cited case on director’s duty of care) (p.  The Special litigation committee is to act on behalf of the Co.  Page 50 of 148 . Court evaluated the decision of the inside directors to terminate the lawsuit b/c they had a conflict on interest.208)  NY BJR Case  Procedural Aspect: Shareholder filed a derivative suit on behalf of the corporation. • The whole notion of risk is what is key to business – the greater the risk. OR • Egregious as to amount to a no win situation (gross negligence)  Reasons for the BJ rule: • Shareholders assume the risk of bad judgment when they buy.Don’t want to create legal incentives for directors to avoid risk. So in this case DE law governs the internal affairs of a baseball team that operates in Chicago.  Court discussed 2 forms of derivative suits: • An action against the corporation for failing to sue when it should have • An action on behalf of the corporation (that the corp.S. o Joy v. • It is very difficult to recreate the decision process in hindsight Looking back on a decision is a bad method of evaluation. in this case DE. this is a proper decision for the board to make and it will stand o Rule. failed to bring) against the directors for harm to the corp.  2 business decisions the court has to decide how to evaluate: • The liability of the “outside directors” – a director who is not an employee of the corporation. and if the directors judge that this is better for the corporation then increased cash from night games. The board of directors created a special litigation committee which decided to terminate the suit.and their judgment absent fraud is final – presumption that it was made in good faith and in best interest of the corporation o Π claims that directors are acting on personal interest and not those of the corporation  Court is unconvinced bc integrity of the game and concern for the surrounding neighborhood are legit concerns for the company. The special litigation committee decided to terminate the suit. and whether it is in the best interests of the Co. govern the internal affairs of the corporation. the greater the likelihood of return . Court evaluated the process of the outside directors’ decision making and found that they did not get the benefit of the BJR b/c they were not informed • Court says that lack of knowledge is not a defense.Derivative suit must touch on  Fraud  Illegality  Conflicts  You must Touch these before the court will look any deeper  Shlensky’s only option now is to sell his shares – get the heck out of Dodge!!!!  The laws of the state of incorporation. North (U. OR • is tainted by conflict of interest. • The vote of the litigation committee to terminate the lawsuit?  BJR is the concept by which courts wont hold officers and directors liable for negligence simply for making bad decisions that lose money  NY BJR: Court said that the business judgment rule applies unless there is evidence that a decision • lacks a business purpose. so be it  Absent fraud. allowing the other directors to make a decision for them will still be considered a breach of fiduciary duty.Davis v. Louisville Gas & Electric – Directors had one view and majority of shareholders have another • They asked court to decide which view should prevail • Court said it will not interfere with policy and business management • The board is elected for this purpose.  Holding: The Court said neither of these decisions are protected by the BJR. illegality or conflict.

o Smith v. they will be liable o If not. • In this case. employee • Legal counsel / Accountant • Committee of the BOD which he is not a member  (c) . o If so.a director’s decision is in bad faith if he knows it is NOT REASONABLE to rely on one of the sources in (b) and he does anyway  (d) SOL – an action for a director for failure to perform his duties in this section must be brought within 3 years after the COA has accrued. or within 2 years after the time when the COA is discovered. SOL – does not apply if the breaches of duty were concealed fraudulently.  (b) . and as such was not protected by the business judgment rule. and when the directors (or a committee of uninterested directors) refuse a demand. however. the Bank was extending credit to a developer named Katz that was very risky o It was no win – he continued to give extensions.General Standards for Directors –  A director must discharge his duties as a director. Court said that in most cases a shareholder must demand a corporation sue on its own behalf before bringing a derivative suit. the decision not to sue was so bad it could be considered gross negligence. 213) Page 51 of 148 . so the action shouldn’t have been dismissed against them  A directors who willingly allows others to make major decisions affecting the future of the corporation wholly without supervision or oversight may not defend on their lack of knowledge • SO the BJR wouldn’t prevent the derivative action from prevailing • The court remands to have an individual review of outside directors to determine their role and why they didn’t act o 33-8-300: SC BJR . The interest could have been earned by diversifying o So Special Litigation Committees report that there was only a possibility of finding negligence was wrong • Court says the inside directors may dispute the outside directors claim that they had no knowledge of what was going on. the only potential profit was the interest but the loss was the entire principle.so the court looks at their decision and applies BJR to see if they should have brought suit. • in good faith • with the care an ordinarily prudent PERSON in like circumstances would do (negligence std) • in a manner he reasonably believes to be in best interest of the corporations. business judgment rule applies to the refusal to sue. including his duties as a member of a committee. Despite risk. Van Gorkom (DE case) – BJR Case (p.  The duty runs to the shareholders and the corporation o You can draft the duty out in the articles of incorporation if it is a publicly traded company. and then the court will apply BJR to determine whether their refusal was proper • The group that decides whether to bring suit is called the Special litigation Committee. then the shareholder is out of luck  Application • Court looks at likelihood of success in bringing suit • The Π wanted to sue its board of directors for being negligent in extending credit to a risky investment that had little gain to offer o The Board set up a special litigation committee to decide on the issue of whether to sue o Committee moved to dismiss action against outside directors – ie the ones who aren’t officers because they weren’t given notice of what North was doing • North was in control of the Banks board and management o He didn’t provide materials or agendas to other members before meeting • Under his direction.  Special Litigation Committees • Decision to bring a suit falls under BJR o So shareholders must first demand the directors to bring suit. and ignorance is no defense anyways.lists the 3 sources that the director is reasonable to rely on in making decisions • Another officer or co.

BJR: The court will not evaluate the business decisions that the directors or the officers make unless they border on fraud. 219) • Andrews was a director of an auto part maker. most of the $ came from the co. illegality.  “The rule itself is a presumption that in making a business decision. rather he asked how long it would take the buyer to pay off the note they were going to incur.o •  (some lawyers say this is the worst decision. the directors were did not exercise due care and were grossly negligent in making this decision. the directors of a corporation acted on an informed basis. • Gross Negligence – DE BJR o VG’s presentation did not rise to the level of a report because he didn’t know about the information that provided the basis for his report. There were two scheduled directors meetings.failure to investigate o fraud. Breach of Duty of Care by Director’s Failure to Act – Oversight Liability Barnes v. Thus. or deceit. in good faith and in the honest belief that the action taken was in the best interests of the company…Thus. He didn’t pay that much attention to the affairs of the company. Andrews (NY) (p. He presented the possibility of the merger to the board at a meeting where none of the attendees knew they would be discussing a merger. Finally.  DE . that bought the company. for $50/share  If the deal went thru in this situation – the shareholder would have no choice – cash out merger – the shareholders would be forced to sell the stock. Key executives were opposed to it. and he missed one. While he was a director a bunch of crap went wrong that cost the company money. o self dealing o or other unconscionable conduct. the Board agreed to selling the Co. they didn’t even know about it before the meeting. • The plaintiff claimed that the defendant failed to give adequate attention to the affairs of the company which had been conducted incompetently Page 52 of 148 . The whole proposal was made orally in 20 minutes.  Rule: The Burden is on the P with the duty of care . and no written materials were presented. as distinguished from a duty of loyalty…The applicable standard of care…is predicated upon concepts of gross negligence. the board decided to vote yes  Subsequent to the Board’s decision. • Exceptions to BJR: o gross negligence – lack of due care* o lack of good faith* . o The court said that a director is fully protected if he relies in good faith on reports or informal personal investigations by corporate officers o Must inform themselves of all material info reasonably available to them prior to making the decision –  This is a fid duty owed bc he is acting on behalf of others • Contrasts duty of care from duty of loyalty o Bad faith: Not investigating the source of the $55 offering failure to investigate that is a failure of good faith.BJR cases and court will focus on the process  Damages Award: The directors should have quit immediately…some of the damages came from insurance $ but no one knows where most of the money came from.”  So this is also different from both Jones and Shlensky  Π must rebuke the presumption that the decision was an informed one  The problem is not the substantive decision that was made but because they weren’t informed. Van Gorkom negotiated a deal for merger of the company. there was a gap period where the Co. put themselves up for auction.  DE BJR Exceptions – BOP is on P: • Not making a informed decision or failure to use all of the material information available. a # of steps were taken to cover the Board’s decision.  He didn’t ask what the company was worth. a director’s duty to exercise an informed business judgment is in the nature of a duty of care. However. some say it is the best decision)  Class action by shareholders seeking either to rescind a merger or get damages from the board. and as such do not receive the benefit of the business judgment rule.

and as long as the process used to come to the decision was rational and employed in good faith. Allis-Chalmers Mfg. she couldn’t trust the sons Her defense was that she wasn’t involved and didn’t know what was going on Court nails her anyway and holds her personally liable for the losses Graham v. Several mid-level employees of a large corporation were indicted and pleaded guilty to violating federal antitrust laws by engaging in price fixing Π shareholder brought derivative suit arguing that the directors breached duty of care by failing to monitor the employees o Court found in favor of directors Too many employees meant that board could only be liable for broad policy issues – not immediate supervision o Went so far as to say that the board did not have a duty to set up a monitoring system until they had some reason to suspect that the employees were not being honest Next case shows that while board can depend on subordinates. • Before there had to be cause for suspicion before a duty to monitor arose o But court says this is wrong. United Jersey Bank ∆ was warned that if her H died and she inherited the stock. Shareholders filed derivative action against directors for breach of duty of care in supervising employees. • Substance of the decision isn’t important as long as the process is reasonable and in good faith • Concern of after the fact review • All that is required is a good faith effort to stay informed o * Failure to act or monitor in a situation where attention would have prevented the loss. Thus.follows the Barnes standard – Duty is on the P to show failure to act and Causation. • SC. the loss would have been avoided (causation). the holding in Graham merely means that directors can’t be held liable for assuming the integrity of its employees o o Page 53 of 148 . Co. In this case. there is no liability. The level of monitoring is a business judgment question. 224) • Caremark violated a bunch of Medicare rules and ended up with fines over $250M. and in part to protect the American way of doing business.that is for the officers  Directors can act individually only by counsel and advice to them • Directors don’t have to guarantee that his judgment is good • Court said that: o Rule: Directors have an active duty to keep themselves informed in some detail of the operations of the company. plaintiffs have to show that had the director performed his duties. This includes a duty to make sure that an adequate corporate monitoring system exists. this dependency must be reasonable In Re Caremark (DE Case) (p. the burden is on the shareholder. However. no liability for director. the director would be in a very difficult decision to come up with the proof that they did in fact pay attention to detail – they would be in a very hard position. we apply the business judgment rule. a complaining shareholder must establish some linkage between the director’s bad behavior and corporate loss – ie causation Sarbanes-Oxley increases the duty of directors to stay informed and involved Francis v. the plaintiff was not able to show that if the director had known what was going on he could have made a difference.  BOP – P: Apparently the duty is on the plaintiff/shareholder to show breach of the duty or director’s failure to keep himself informed!  Directors must make efforts to learn of the actual affairs of the corporation and not serve as a mere figurehead o Loss Causation: Upon a breach of that duty. • In this case. • Court says there are 2 ways to bring liability: o BOD makes a bad decision that results in loss because it was ill advised or negligent.o o o • • • • • • • •  No negligence in attendance of meetings If there is liability it must rest on his failure in general to keep advised of the conduct of the corporation affairs  So we see duty to stay informed o Directors aren’t to be involved with the actual conduct of the corporation .  Unfair to put the burden on the Director: If we were to put the burden on the director. the director violated his duty to stay informed. RULE – An action against an inattentive director.

and as such was enough to survive a motion to dismiss. allegedly with knowledge of board. the P’s alleged that intentional or reckless disregard can be inferred from the failure to act in the face of audit information. then there is no fault • Holding: In this case. certain reckless acts or omissions also would not be in good faith and are therefore not capable of waiver  Taking the totality of the facts here. There was a clause in the articles that removed the duty of care for directors for anything short of intentional misconduct.” o For liability. the only way the fraud could have taken place is with either reckless or intentional disregard of warning signs. the conduct could arise to recklessness and therefore could not be waived under the statute – so they can be liable • The court did not address the validity of the waiver.such as an utter failure to attempt to assure a reasonable information and reporting system exists o However. the plaintiffs alleged that because of the experience of the directors as managers. which the board concludes is adequate. and that failure to do so under some circumstances may. so no violation for directors. However.there was a good faith system and if they didn’t know. or knowing violation of the law** important  duty imposed by 33-8-330 (unlawful distributions) • note that 330 refers to 33-8-300 – Director’s Duties. I am of the view that a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system. the court says that the board does have an obligation to ensure that its information is accurate o But the amount of such systems falls under the BJR  There must be a good faith judgment that the corporations information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations. o In particular. Senior management.o Noting the need for information. o Gross negligence is the standard for bringing a derivative suit o Test – only a sustained or systematic failure of the board to exercise oversight. • Note that McCall seems to indicate that an allegation of recklessness is enough to get you into court when intentional is the standard. in theory at least. intentional misconduct. the NY times investigation into Col’s billing practices and the inaction by the BOD. was using illegal practices to increase revenue. there was no evidence of a sustained violation of the oversight function.Π doesn’t have to show a director intentionally acted to harm the corporation  The ∆ had pointed to articles that says it requires intentional misconduct to overcome the waiver of liability  What waiver –they put in the articles that it had to be intentional • There was a statute in Del that said you could put such a provision in your articles o However court interprets statute to mean that in addition to intentional wrongs. allegations brought against Columbia is a qui tam action. They reversed the motion to dismiss and remanded the case. the extensive federal investigation. so you can draft that out in the articles. there must be a sustained and systematic failure to exercise oversight  Π hasn’t show this here. ongoing acquisition practices. 229) • Another derivative suit against directors of health care company for breach of duty of care. South Carolina 33-2-102(e): Limiting director liability for monetary damages for breach of duty of care o The articles can limit liability of a director for violation of fiduciary duty as long as there are no limitations on liability for:  breach of duty of loyalty to the corporation or its stockholders  **acts or omissions not made in good faith or made with gross negligence. Scott (DE Case) (p.  transactions from which the director got an improper personal benefits. • Most lawyers consider this to be a duty of care case.  McCall v. exists. which seems to set up a negligence standard for the duty of care of a director. • “Thus. render a director liable for losses caused by noncompliance with applicable legal standards…Here the record supplies essentially no evidence that the director defendants were guilty of sustained failure to exercise their oversight function. • Note that 33-8-300 sets the standard for breach of duty of care for directors as negligence. Page 54 of 148 • . but the handout (Stone Case) says that Caremark deals with a duty of loyalty. • Holding: Ct held that the P’s pled particularized facts that presented a substantial likelihood of director liability for intentional or reckless breach of the duty of care.

the BOD’s decision will be upheld unless it cannot be “attributed to any rational business purpose”  When a P fails to rebut the presumption of the BJR. the conduct giving rise to a violation of the fiduciary duty of care (i. gross negligence). Page 55 of 148 . the Caremark standard for so-called oversight liability draws heavily upon the concept of director failure to act in good faith.e. and more culpable than. Detyens (SC) • The closest thing we have to a case that talks about business judgment in SC.o o o o  Statutes like this were passed all over the country to negate the effect of the Van Gorkum Case. • 33-2-102 o Publicly held corp with over 25 million in assets or 500 shareholders may in their articles provide:  A provision eliminating or limiting the personal liability of a director to the corporation or its shareholders for monetary damages for breach of fid duty as a director  Provided that the provision shall not eliminate or limit the liability of a directors • See C-10  The key is “for acts or omission not in good faith or which involve gross negligence. so they declared it an emergency and it passed • Court Said this decision fell under the BJR and that absent a showing of o Lack of good faith o Fraud o Self dealing o UNC conduct • The directors wont be liable Disney Case –( DE 2006)–BJR – Present Standing – Handout! • As evidenced by the language quoted above. Plaintiffs can’t recover from directors who screw up. Dentions 294 SC 86  Dockside v. you can sue most companies in SC for mere negligence whereas in Del. intentional misconduct or a knowing violation of law • Different from Del is that you cant indemnify for gross negligence – but this means that we can indemnify for Negligence • In other words. They would have to meet gross negligence • Knowledge and Notice – 33-44-102 o Question is often when does an entity receive knowledge or notice of some event  Actual knowledge  Or when the event would have been brought to the entities attention if it had exercised reasonable diligence. she is not entitled to any remedy. unless the transaction constitutes waste.3 Part Test: BOP on the P o Presumption that “in making a bus decision the directors of a corporation acted on an informed basis…and in the honest belief that the action taken was in the best interests of the company (and its S/Hs). o In the absence of this evidence.which means it maintains reasonable routines for communicating significant information to the individual conducting the transaction for the entity and there is reasonable compliance with routines • Recent statement of the BJR o Is that some decisions are just so bad that they are actionable • SC and the BJR • Dockside v. • Probably holds that we recognize the business judgment rule in SC o One amt of votes were needed to pass assessment.such as an utter failure to attempt to assure a reasonable information and reporting system • The BJR . bad faith. legal or equitable. o The presumption applies when there is no evidence of fraud. but a different amt was needed if it was an emergency o Votes came up short. if you’re big). or self-dealing in the usual sense or personal profit or betterment” on the part of the directors. o Caremark says director may be liable if it fails to monitor what goes on to the company if there is a sustained and systematic failure of the board to exercise oversight. This only applies to certain corporations If the corp meets a bunch of qualifications (essentially. where we held that a failure to act in good faith requires conduct that is qualitatively different from. That is consistent with the definitions of bad faith recently approved by this Court in its recent Disney decision.

its Delaware. They were talking to existing clients and set up a corp before walking out.Competing with the corporation Breach of duty is when your saying the board is lazy or dumb Breach of loyalty is when you say they are greedy and put their own interests ahead of the corporation Look for cases where the director o Competes with the company o Takes for herself a corporate opportunity o Has some personal pecuniary interest in a corporation’s decision  Jones v. The Court has said in the LLC context that even though you can contract away your rights for breach. but it’s probably going to have significant influence down the line. 234) • A bunch of the directors got together and formed a new competing co. there would be no sanction o But since it happened prior to leaving the Πs corp. breachable duty – does NOT establish an independent fiduciary duty – only a subpart of the duty of loyalty. They got together to discuss buying out the business prior to resigning. then when you go to the statute it doesn’t address loyalty in the section about liability for breach of duty of care – so there is a defense here • DE ct says that b/c a showing of bad faith conduct of this kind is essential in establishing director oversight liability. He thinks Caremark is describing a duty of care when they talk about good faith. o 3 Ex’s of Failure to act in Good Faith (test for bad faith):  Fiduciary intentionally acts with a purpose other than advancing the best interests of the corporation  Fiduciary Acts with the intent to violate applicable positive law  Fiduciary intentionally fails to act in the face of a known duty to act. • Burkhard disagrees but this case is the law. o o o o o o DE court makes a distinction between the a Breach of Fiduciary Duty of Care – Gross Negligence associated with the Caremark case and Failure to Act in Good Faith – which constitutes more culpable conduct. Duty of Loyalty (directors put own financial interests ahead of corporation) IN DE & SC – you can’t indemnify against breaches of a duty of loyalty!!! Breach of Duty of loyalty . the ∆’s had already talked with the clients about coming with them o If they had done it on Aug 22.  But then court goes on to say that failure to act in good faith is not ipso facto an establishment of director liability – instead good faith goes to loyalty not care • That good faith isn’t a separate fid duty but a subsidiary of loyalty • This is hard to swallow  This is not SC or NY. This might have an effect. there is liability because they were directors and had a duty of loyalty to the company – so we look at what happened before. The Disney case is calling it a duty of loyalty. thereby demonstrating a conscious disregard for their responsibilities they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith. before they resigned. – Necessary to establish oversight liability! • DE said that Caremark applied the correct std . • Ct says Failure to comply with good faith is not a separate. not after  If you are the ∆s you have a serious problem that they have to deal with Page 56 of 148 . you can’t contract away the duty of good faith.  The dates are important in this case • June 28th. that the fiduciary duty violated by that conduct is really a duty of loyalty. He’s not sure where all of this is going. Or having implemented such controls failure to monitor or oversee its operations thus disabling themselves from being informed of the risks or problems requiring their attention. demonstrating a conscious disregard for her duties. but its likely everyone else will follow  If it’s a breach of loyalty. there was a meeting of ∆s • July 3rd – one of the ∆ told Jones that he either has to sell or they are going to set up a new corp • Aug 6th – negotiations fail • Aug 22 a new corporation is formed • Before any of these dates.held that a necessary condition for oversight liability as a sustained or systematic failure of the BOD to exercise oversight-such as an utter failure to attempt to assure a reasonable information and reporting system exists. Burke (NY) (p. • Elements of Finding Director Oversight Liability: Where director’s fail to act in the face of a known duty to act.

However. But some case law suggests that SC allows you to take some acts – such as filing for articles of incorporation setting up the corporation going to the bank to get financing BUT CONTACTING EXISTING CLIENTS AHEAD OF TIME IS NOT OK!!!. The club Page 57 of 148 . • They were bound to exercise the utmost good faith and loyalty in the performance of his duties • You cant benefit yourself to the detriment of the corporation • If they had quit and then started a new corporation.how do you fix it Ad agency. Later. o • o o ALI says you cant compete unless • The competition would benefit the corporation more than hurt it. then you may compete. But the conspiracy started while there was still a fid duty o Ct rejected the defense that the directors did not avail themselves of the benefit of the customers and personnel diverted from the P until after they informed the P that they were leaving. It is unclear if she was a director. SC Case: Futch v. They pursued a course of conduct which resulted in a benefit to themselves through destruction of the P’s business. • Rest (3rd of Agency) . but it never went through • The ∆ had already “pre-sold” the customers on their plan. began to suffer hard times because of behavior lapses of its founder.Section 804.Usurping a corporate opportunity Must identify what a corporate opportunity is and what a director has to do when he is offered one Doesn’t matter if you are an officer or an agent  Northeast Harbor Golf Club v. after termination of their employment. or there is no foreseeable harm • The competition is authorized in advance and ratified by disinterested directors • “” by disinterested shareholders  Serving on another board does not qualify as competition because you are not pursuing your own interests by doing so Breach of Duty of Loyalty . imposed on defendants by their close relationship with plaintiff corp. like Jones can always draft or set up a covenant not to compete if it wanted to protect itself.must determine when the bad things occurred – prior to leaving the firm or after they left – they are liable for disloyal acts while they were still employees • Duty of Loyalty Test: Directors are prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost good faith and loyalty in the performance of his duties. and they incorporated before resigning from the Π’s corporation o Also took majority of Πs employees with them • The ∆’s here were shareholders and officers in the corporation • Issue: Timing here is critical – did the director’s breach a duty of loyalty prior to leaving the firm . McCallister Towing • Rule: Pre-Competition Set up Activities are OK and does not constitute a breach of loyalty. Duane Jones Co. while playing golf with the postmaster she found out about another parcel of land that might be available and bought it. 237) • Facts: Harris was president of the club for a while. • Holding: the directors are liable for advantages secured by them. dead silent on all of this • Lawyer Tip: A co. Several of the officers start a competing agency • The stole key clients and employees and then resigned from Duane Jones o This cost the Π 6.5 million The Π had been flaking out. disclosing later to the board that she bought it but indicating to the club that she was not going to do anything with the property that is not in the best interests of the club. although this is not easy. in violation of the fiduciary duties. She was offered a piece of property b/c of her position. She bought it for herself and notified the club afterward. • Rest (2nd) – Duty not to Compete: Once you quit. and the ∆ testifies that the customers either want the ∆s to buy him out or start a new corporation • They had entered into negotiations about buying him out.       Notes  • Jones is running the company into the ground. it might have been ok. there are some limitations that you can’t use trade secrets NOR can you violate a continuing existing duty. as a result of opportunities gained by reason of their employment relationship. Harris (Maine) (p.

The board however took no action. o Court didn’t apply this test b/c it is hard to decide if an opportunity is in a line of business and the ability to pay prong acts as a disincentive to resolve financing problems.however this is somewhat disputed • ∆ then tried to develop in 1988 and the board brought suit for breach of fiduciary duties Π claims she breached in buying the lots without giving notice to the corporation and time for it to buy the lots if it choose • Seeks injunction and constructive trust • Line of business test: If the opportunity is in the corporation’s line of business and the corporation is financially able to undertake the opportunity. the first opportunity would definitely be a corporate opportunity because it was offered to her in her official capacity.05 -ALI test) – 2 prongs – page 323 o A corporate opportunity is  Any opportunity to engage in a business activity of which a director or senior executive becomes aware either • In connection with his job or under circumstances that would reasonably lead him to believe the opportunity is being offered to the corporation OR • Through the use of corporate information or property and would reasonably expect it would be of interest to the corp. then the officer or director can’t take the opportunity for himself.  OR Any opportunity that is closely related to a business in which the corporation is engaged or expects to be engaged. Harris decided to make a little subdivision out of the property. She then bought another parcel in 1985 (which she learned about in individual capacity) in which she didn’t tell the board until after the buy. Then another lot o She says she had no plans to develop at that time. • Maine applies.director or senior officer can’t take the an opportunity unless (full disclosure prior to taking the opp is key)  first offers it to the corporation AND  the opportunity is rejected by the corp AND • the rejection is fair to the corp (burden on the insider to demonstrate fairness. – (Broz Case would have applied here) o In this case. a broker contacted ∆ to see if the club wanted to buy some adjacent land o Fact that it was offered to her as President is key. Later. and that such plans didn’t develop until 1988 • Court found that the club would have been unable to make these purchases because it never had any money. • ∆ bought it in her own name for 45K in 1979 without discussing it with the board. The club sued for breach of loyalty ∆ was president of ∆ corporation. The second opportunity might be a corporate opportunity because it might be closely related (they wanted to prevent development) o If it is a corporate opportunity .  didn’t have the cash to buy the property anyway.Corporate opportunity doctrine (5. During her tenure. the opp is offered to the corp and rejected according to the criteria above.they had proper disclosure) OR • the opportunity is rejected in advance by disinterested directors following disclosure OR • the opportunity is rejected by disinterested shareholders and the rejection isn’t a waste of corporate assets (can’t give away something that they shouldn’t give away) o Special rule Concerning Delayed Offerings – Way to Cleanse liability after litigation commences: Relief based solely on failure to first offer an opportunity to the corporation is not available if  Such a failure resulted from a good faith belief that the business activity did not constitute a corp opp  Not later than a reasonable time after suit is filed challenging the taking of the corp opp. • Application o First lot it was offered to corporation o Second – it was closely related to the business Page 58 of 148 . the club thought about developing land to raise money but never did • At one point.

it is not determinative [B(2)]  Broz v. 244) • Facts: Broz was a director of CIS. o CIS couldn’t afford it –not able to financially undertake o CIS had no interest or expectancy o Further. At this same time. There was Page 59 of 148 o . He did not inform HMG that he held an interest in NAF.Under the ALI approach – Corp Opp Approach: this could have been a corp opp (don’t know if it was closely related or not) and if it had been then Broz was required to make the offer to the Board.• So if the opportunity is closely related or the director learns of it while acting as director or with the understanding that it will be offered to the corp.Self Dealing by Interested Directors  Self Dealing: A contract or other transaction that occurs between a corporation and 1 or more of its directors or any other corporation. in whom he holds an interest. but it is likely that we will follow the ALI approach Breach of Duty of Loyalty. PriCellular was in the process of acquiring the Π.  ∆ never formally disclosed to the Π. He bought it for RFBC. and therefore didn’t have to consider the interests of the potential buyer. and he did so without giving CIS a shot at refusal. firm or entity in which one or more of its directors are directors or officers are financially interested. CIS no longer had operations in Michigan. o This problem rarely comes up with publicly traded companies. So CIS could not have an expectancy. Cellular information systems (DE) Approach to usurpation of corp opp. it is relevant. then he is breaching his duty UNLESS  the opportunity is presented to the director in his individual capacity AND  the opportunity is not essential to the corp AND  the corp holds no interest or expectancy AND  the director has not wrongfully used corporate resources to exploit the opportunity • Holding: Was not a Corporate Opportunity: • Reasons ct held no corporate opportunity in this case o He became aware of it in his individual capacity. So. and is their primary negotiator. • Issue: What do you do if you are on 2 different Boards? o This problem only comes up in the context of closely held companies. but he did mention it to the CEO and one other member who said they weren’t interested in the license. Broz was given a chance to buy cellular licenses in Michigan. then there is a opportunity  Facts support this here – ie first lot  Board must then show it didn’t have an opportunity to take it or that it didn’t reject it properly  She can then defend on grounds that taking the opportunity was fair – but she cant use this is there was no offer of the opportunity to the corp • Court adopts ALI test o Thinks Guff test is hard in that it asks you to determine what is in the line of business  Also you shouldn’t worry about whether the company has the ability to buy the property o Questions page 243 –  1 – the fact that the corporation couldn’t purchase the properties is not determinative. finances wouldn’t matter  2 – yes. • Important . o Also – in SC there are NO reported cases having come up on this issue  REMEDY: Remedy is to unwind the transaction  SC Rule: doesn’t have an explicit rule. Gray (DE) (p. the fact that he didn’t present the opportunity to CIS didn’t create a violation per se. Broz was only required to consider the facts as they stood when he accepted the offer. no. There was a company buying CIS that would have been interested in the licenses. and was also the sole stockholder of another cellular company. 249) • Facts: Gray is a director of HMG. Cookies  HMG v. and it WAS interested in the license • DE Court applies the Line of Business Test: o (1)there is an opportunity that is in the line of business of the corporation AND o (2)the corp is financially able to undertake it AND  (3) the corporation has an interest or expectancy in the opportunity AND o 4) Director takes the opportunity. He negotiates a sale of land to NAF. (p.

They brought him in for help. there couldn’t have been fair dealing because the main negotiator was on both sides of the deal. Gray and Fieber are two of five directors in Π corp. • Gray negotiated a sale to NAF • Fieber owns an interest in NAF but he discloses and abstains from voting • Gray. did not satisfy his BOP to show that the price was fair – in other words HMG would not have gotten way more if he had been disinterested. The Court partly unwound the transaction and gave some of the properties back to the company. Lease Value – Court says if the property is subject to a long-term lease. Distinguish corporate opportunity cases from interested director cases: • In corporate opportunity cases. Cookies. disclosed. Also profitability is not dispositive (Cookies) • In its valuation the court says that the appraisals were out of date. • In this case. one would expect the court to impose the following remedy: take the opportunity out of the pocket of the wrongdoing director and give it back to the company • Corporate opportunity takes something away from the corp • Interested director probably causes less total harm (here no one is stealing…the price just wasn’t right. 254) • Cookies made BBQ sauce. BURDEN ON DIRECTORS (defendants). Herrig was a minority shareholder and owner of a distributing Co. the entire fairness standard is used • Because the vote was made without disclosure it will be deemed non voidable only if fair to the Π at the time is was made • ∆ have BOP to show that it was fair under careful scrutiny • RULE on Validity of Interested Director Transactions: o Director self-dealing will not void a transaction if a majority of disinterested directors ratify the deal.    also a director Fieber who had an interest in NAF which he disclosed. Instead. OR the shareholders ratify the deal. Shareholders Page 60 of 148 . The defendants want the business judgment rule to apply so they don’t have the BoP. and he started kicking butt. The rental income from these properties was increasing. • REMEDY should be the difference in the fair value and the price they should have received.  Fair Price: You have to show that the result is fair.however not the case in this instance so you need to look at the fair market value of the fee simple. so other shareholders got squat. you probably look at the value of the lease . regardless of ass kicking. Then made a bunch of deals giving his own businesses expanded deals and he gave himself a bunch of increases. did not pay dividends. OR o If there is no disclosure. through relatives and related business entities also owns an interest in NAF but he does not disclose and he votes and he negotiated the sale to NAF o He is on both sides of the company • Fieber knows of Gray’s buy-side interest but doesn’t disclose it o Court finds breach of fid duty of loyalty and care • Bad behavior was discovered 13 years later and the court still dives into it Proof of undisclosed self-dealing is suffcient to rebut the presumption of the BJR and its protections. negotiated. and assent to the deal obtained. Just because a price is in the range of market price doesn’t make it fair if the corp might have refused to make a transaction if it had known some material fact.”  Fair Dealing – You have to show the Process was Fair: Fairly timed. Herrig became majority shareholder and put his guys in the director’s chairs. Eventually. the transaction is not void if the self-dealing directors can establish the fairness of the deal: both fair dealing and fair price. The court applies the so-called “Entire Fairness Test. • Cookies also added the BJR to evaluate this prong and added the aspects of Good Faith and Honesty. so somehow we make up the difference as the remedy) • The remedies for each bear this distinction out Cookies v. as the interested director. Lakes Warehouse (IOWA) (p. and they weren’t very good at marketing. Fieber knew of Gray’s interest and did not disclose that interest. but ratification is only valid if the material facts as to the director’s interest are disclosed to the body that ratifies the deal. which buys and sells commercial real estate. o Holding: Gray. The Court here hammered the defendants (fairly unusual remedy).  Also mistake in valuation in this case: Fee Simple Value vs.

there was no evidence that Herrig’s fees were too high. o However. OR o The contract or transaction is fair and reasonable to the corp. Page 61 of 148 . honesty and fairness on the part of the interested party  Seems like Del says the same thing but maybe not • The question is had this deal been made nonvoidable by the statute: he disclosed his interest to the directors and they voted. court says that in addition to showing one of these three.  BOP on director to establish that they acted in good faith. The concern is that he put all his own guys on the board. However. but not with application • Duty of good faith requires not just a showing of profitability. honesty. then the burden of proving that the transaction was unfair falls to the party claiming unfairness.argument is that he could have used the money he paid himself to pay off the loan so then they would be able to pay out dividends.  Negotiations • There must be an ear mark of arms’ length negotiations • Π claims the court should look at market value of ∆’s services rather than the success ∆ brought to Π • Court agrees that success should not be the sole criterion. but also a showing of the fairness of the bargain to the interest of the corporation –thinks this was not shown here • ∆ failed to show that his rates were comparable to others in the locality. so disclosure to board is enough • The board here was aware of Herrig’s interest. but definitely is enough if the BOD has approved it. • Dissent • Agrees with law. and fairness in duty of loyalty cases!  Fair price: Court said that profitability alone doesn’t establish fairness. • Yes there can be challenges to the fairness of the deal – but if is proved under (3) – director has showed it is fair – that is enough.  Why are shareholders suing when company is making bank • The minority guys aren’t getting dividends and cant sell it on the stock market because its not a public company – so its harder to sell • But they couldn’t pay dividends because of the loan – so why would they bring suit knowing this o You could take the money they were paying him to pay off the debt • Cookies test for self dealing transactions (very similar statute to previous case): o The interest was disclosed or the deal approved by the BOD without the votes of the interested director – (this case!). but these facts doent show he was unfairly compensated • Court finds the success is important though and court doesn’t think the company would have been as successful without Herrig • So they say they did meet this burden but they don’t say how – which is the dissent’s problem  Duty to Disclose • The duty does not extend to minority holders • The decisions are management activities. It was his BOP to show the fair market value and that his rates comported to that o This was his burden and simply showing profit doesn’t meet it  SC 33-8-300: General Standards for Directors: SC has specifically imposed a duty on directors to act in the best interest of company and shareholders.  Fair Dealing: Court also applies the Business Judgment Test to assess whether they were fair or reasonable to the Company. there must be a showing of good faith.  A3 is unique to SC – director has to act in best interest of the company and the shareholders – so there is an added burden compared to most states  SC 33-8-310 – Test for Director Self-Dealing • Apply the Same test in Cookies with 1 exception – BOP on P. so there was disclosure  SO no breach • Holding: Court held that the self-dealing was ok b/c Herrig had disclosed his transactions and the material facts to the BOD who approved it (although there is the question of the fact they were all his guys). OR o Interest is disclosed to shareholders who authorize such a transaction by vote or written consent. • (a) – If disclosure to directors or shareholders was proper and transaction was approved by the BOD. This is different from most states.

there may be cases in which we question the directors’ ability to make an impartial decision about whether the corporation ought to sue. On the other hand. o She stands in the shoe of the corporation in asserting the claim against TP  So the COA must be one that the corporation has o Right to sue is a management decision ie they did something wrong. but we may allow the shareholder to do so because the directors are not impartial o But there will be strict limits on the shareholders right to sue o One is that they must provide security against the corporation expenses  Ie provide a bond in case he loses  But many states don’t require this if the shareholder has a large amount of stock in the company – because they wouldn’t sue and risk their investment unless it was really worth it o Distinguish derivative suits from direct suits in which the Π has a personal claim o One hint is that the conduct affects only some shareholders rather than all of them o Eisenberg v. which has FTL as a subsidiary o Not saying the directors have done something bad and should be accountable. (e) a member of a member-managed company does not violate a duty or obligation merely because the member’s conduct furthers the member’s own interest  F) a member of a member-managed company may lend money to and transact other business with the company.o  Conflict of interest transaction statute Not voidable by the corp solely because of directors interest if • Disinterested board has approved • Disinterested and informed shareholders approve • Fair to the company  If one or two has been accomplished.  Ex of Direct Suit: • Separate Injury –S/H injury that was separate from the corporation • A director action that restrained the right of conversion from preferred to common stock. On the one hand. so they no longer had a vote in the company that runs the airline. Flying Tiger (NY) (p. just that they made a bad decision o Π sues arguing that this merger deprived him of any control of the company that runs the airline  Issue: Is it a direct claim or derivative suit?  Court said that a derivative suit was one brought in the right of a corporation to obtain a judgment in its favor. we do not want to permit untoward second-guessing of management. o Π (owned stock in)  Flying Tiger line (Flying Tiger) (freight and charter airline  Flying Tiger Corp (FTC) (wholly owned subsidiary) FTL (subsidiary)  Flying Tiger then merged with FTL – so that Flying Tiger ceased to exist and FTL survived and ran the airline  Stockholders in Flying Tiger got stock in FTC (not FTL).   Page 62 of 148 . then the shareholder will not be allowed to bring suit o BUT if the suit is against a director. As to each loan or transaction the rights and obligations of the member are the same as those of a person who is not a member subject to other applicable law  So LLC can have interested members Who sues and who recovers? Shareholder Derivative suits o A derivative suit is when a shareholder sues to vindicate a claim that the corporation should have made (questioning a corporate decision). so the BJR will apply  Most derivative suits fall into this category o If the Corporation has a good faith reason for not wanting to sue. Flying tiger merged into FTL. which was just a holding company. 273)  Plaintiff owned stock in Flying Tiger Airline which owned FTC which owned FTL.so Π owns stock in the holding company. but the shareholders of Flying tiger got stock in FTC. then there is a good chance that the corporation won’t bring suit. the burden of proving unfairness is on the party claiming unfairness  Look at statute for other provisions • Ie indirect interest if he has direct interest in another corporation is a party to the deal  SC 33-8-111: addresses director compensation  Unless the articles of incorporation or bylaws provide otherwise the board my fix the compensation of directors for their services as directors or any other capacity – ie officers  So this insulates compensation decisions from claims of conflict of interest  SC 33-44-409: The LLC statute is very different.

356: “suits are now derivative only if brought in the right of a corporation to procure a judgment “in its favor. But this case is in the gray area  Π says it deprived stockholders of vote  ∆ says it affected shareholders secondarily because the real affect was dissolution of the corporation  Note that if this suit had been characterized as an action against directors for changing forms to a holding company.  Rule: Action by the directors that negatively impacts the ability of a S/H to vote his or her shares is a direct claim – the harm is to the S/H not the corporation. there is a big incentive for them to settle = a strike suit. was the duty breached a duty owed to S/H? o If you’re going to have a direct claim. and if gets these shares wrongfully then it hurts the stockholders  The action has to be brought to procure judgment in favor of the corp.o o o o o • Actions to compel dissolution are direct because the corporation cannot benefit from the action. the harm to the shareholders must be separate from harm to corporation o You can have a direct suit even if there are a number of harmed shareholders • Who will receive the benefit of recovery or remedy?  Shareholder direct injury must be independent of any alleged injury to corp  Shareholder must demonstrate that duty breached was owed to shareholders and she can prevail without showing an injury to corp Court sides with Π and finds this is a direct suit  Lazar v Knolls – held direct suit where shareholder was not allowed to attend a stockholder’s meeting • This is similar to what Π challenges here – that the ∆ has interfered with his right as a stockholder  Horwitz v. • A proposed recapitalization that will benefit one class of stock more than others is direct.”  P. not the shareholder – this is the new test  Cases show that where shareholder sues on behalf of himself and other shareholders to enjoin a proposed derivative right – he is enforcing a right common to all the shareholders which runs against the company • Here is it even stronger since the shareholders normally retain voice in the company after the merger – here they no longer have voice in it Fact that Π didn’t sue for money is important because when you sue directors for money.”  Majority Test for Determining Whether a Suit is a Direct Suit or a S/H Derivative Suit: Current DE test is found in Tooley: • Who suffered the harm – Corp or S/H – o Independent of the Corp. to its stockholders. Balaban – Π sought to restrain the granting of conversion rights to the president by the corp = direct • Why is this direct rather than derivative • Not sure what conversion rights mean in the context of this case but presumably it gives the president some right to stock in the company. but to a number of shareholders • #2 clarifies that this fact is not a bar to a direct suit – the injury can happen to many S/H just not the corporation Page 63 of 148 . Here is suing for his rights as a shareholder. and through it. Not for the companies rights Whether it is derivative or direct depends on:  who suffered the harm  the Corp or  shareholder individual  who should receive the benefit of the recovery or other remedy  corp  shareholder Both of these are recent statements by Del SC –  what was happening were a series of lawsuits where the defense was that it had to be a derivative suit because it wasn’t to the individual shareholder. Preventing strike suits is one reason there are burdens in bringing derivative suits. or whether it is to compel the performance of corporate acts which good faith requires the directors to take in order to perform a duty which they owe to the corporation. that would have been derivative because changing forms is a business decision and the duty runs only to the company  Majority Rejects the old NY Test: “whether the object of the lawsuit is to recover upon a chose in action belonging directly to the stockholders.

Derivative Hypo’s – problems pg 276  Conversion Rights: . but the big bucks go to the atty..  Robert is the minority shareholder in Co. • Joinder of corporation and alignment of parties o Corporation is a necessary party and must be joined because  Recovery goes to corporation  To ensure that the claim that the judgment will have a claim preclusive – ie res judicta effect o Usually the corporation is joined as a defendant But because the corporation has failed to enforce the claim. X. meant to protect shareholders from director’s wrongs because they cannot be expected to sue themselves • Class action is a direct representation of a whole mess of similarly situated shareholders. Shepherd can sue Freer and the company for vicarious liability  Usurping a corporate opportunity is generally: Derivative  Payment of Dividends?: Derivative – step 1: must determine if $ should be paid out of the corporation – and that consideration is a determination of what is in the best interests of the corporation. He sues the controlling shareholders.o o  o  o Direct v. Specifically. he alleges that while they have had the corporation hire them and purchase their stock for cash.right of a shareholder to convert their shares into preferred stock –Direct  Issuance of shares without regard to preemptive right (co. the injury is to the corporation  Vicarious liability – problem 5. however.7 (bouncer punches guy the face)-: Direct. alleging that they have breached fiduciary duties by oppressing him.  Directors waste funds: Derivative because how company uses funds is related to the company  Shareholder in a close corp improperly takes money from the corp: likely derivative even though it might only hurt one shareholder. and a CA Π may get something. So attys look for these claims and then finds a shareholder or class member to represent o Potential for abuse is real – the ∆ will be willing to settle. it is named ad a “nominal ∆” – then realigned as a Π o Wrongdoers are joined as real ∆ o Because the corporation and the directors have different interests they will require different attys  As a practical matter there has a been an atty representing the company for a long time and has had no contact with S/H but lots with the Directors – so who do they represent in the derivative suit • Stock ownership and Standing – SC 33-7-400 and SCRCP 23(b) below Page 64 of 148 . which is a close corp. Class action • Rule: Derivative and class action suits are used to assert different substantive claims • People tend to see derivative suits and class actions either as (1) wonderful tools for achieving justice or (2) legalized blackmail • Burkhard thinks derivative suits are a method of preventing justice • Derivative suit – an individual steps up to sue on behalf of the bests interest to the corporation – basically b/c the corp has failed to bring suit. they have refused to allow the corporation to do such things for him: Could be Derivative or Direct – harder to tell in this case Clearwater Trust – SC didn’t catch on to Del rule that a direct suit can involve injury to many shareholders – instead it said that this type of case was a derivative suit Derivative Suit vs. Yes the Π in a DS could get higher dividends. issues more stock and doesn’t give the S/H the first right to buy more stock): Direct or Class Action  Suit for failure to permit shareholder to inspect: Direct  Directors enter into a new line of business not allowed under the articles: Derivative –(nature of the business is something concerned to the corporation as an entity. trying to interfere with business operations of the company). which means the other class members or S/H wont get much  Which is why there are regulations • Such as security bond in DS to pay corporation litigation expenses if it wins • New Chancery Court Rules have limited class action solicitation activity by atty’s : DE has stepped up with a new set of rules with who can be the head plaintiff and who can be the atty Procedural requirements of derivative suit • 33-7-400: Procedure in Derivative Proceedings: Derivative suits may be maintained on behalf of SC corporations in Fed and State Ct in accordance with the applicable rules of Civ Pro. the representative is also asserting her own personal claim Common traits o Representative cases – both Π’s are representing someone other than themselves o DS and CA are often lawyer driven.

no one could bring the suit. Akers – (NY) . o Most states follow DE rule: the decision not to honor the demand or demand refusal can be tested  P can commence an action and make a demand  BOD Refuses Demand  P can complain that the BOD’s refusal to honor the demand should be questioned  BJR applied to BOD’s demand refusal .BOD’s decision will be honored unless the P meets his burden of showing the demand was reasonable under the circumstances. P moves to get the corp to reverse the increase in compensation/ Plaintiff made no Page 65 of 148 . • LLC statute – person who receives an interest in an LLC b/c of death doesn’t get same rights – gets financial rights but not legal rights –no standing to bring suit these limitations do not apply to an inheritance or devise of an interest in a corporation. o Requirements of a Complaint:  P must verify that he was a S/H or member at the time of the transaction about which he complains and that his share or membership devolved him by operation of the law. o No minimum value of stock necessary So you cant buy stock after the wrong and sue – contemporaneous ownership requirement  Assumption is that he didn’t suffer an wrong because the stock would have had a lower value in reflection of the wrong doing  Continuing wrong – some courts allow standing if you owned stock at any point of the wrongdoing – so you could buy it after the initial wrong and still bring suit if the whole impact hadn’t occurred yet SC Civil Rule 23(b) – page C36: Derivative Actions by S/H o Has nothing in the Code on Shareholder Derivative Suits – only have RCP.o • • • o o o o o Must have been a shareholder at the time of the transaction you are complaining about o A transferee by operation of law can stand in the shoes of the shareholder who owned at the time of the transaction and sue.How to Argue the Demand is Futile. o B 39 LLC ‘s–33-44-1101-1104 .  Ex of a Difference btwn Corp and LLC: • Corp . 280) Plaintiff brought a derivative suit against directors both for giving themselves improper raises and giving the executives improper raises. however sometimes there are. (p. Demand Requirements – Jurisdiction Depending: Note: Most states have a rule requiring you to make a demand first. Marx v.under Rule 23 if a S/H dies the stock “devolves” on the beneficiary – beneficiary will still have standing without the allowance.  Must also verify with particularity efforts made by the P to obtain the action he desires from the directors or reasons why he failed to make the effort  Action may not continue if it appears that the P does not fairly and adequately represent the interests of the S/H or members similarly situated. Security for expenses o Required in NY o SC – no requirement Demand on Directors o THIS IS THE BIG ONE!! 75% of all litigation involving derivative suits revolves around this o General Rule: you have to make demand on directors in a derivative suit unless demand would be futile. you have to show lack of informedness or conflict of interest  P almost always loses! o So the Norm in most jurisdictions is for the P to argue in their initial complaint that they don’t have to make a demand – demand is futile– that is the norm in most jurisdictions that follow the NY mold. Idea here – inheritance of shares after original shareholder died. If BJR kicks in.Derivative Suits Code Section  So you have to consider both the Civil Rule and the Statute in dealing with S/H derivative Suits and LLCs  Most of the time there are no inconsistencies between these two.

and as such making demand is an admission that demand isn’t futile – SC does NOT have this rule! UNIVERSAL DEMAND (ALI test): Demand required in all cases. If demand rejected the decision to reject the suit is tested by balancing the character of the suit against the deference the directors must receive. This has been adopted by Georgia and NC among other states. D’s argument – P was required and failed to make a demand. D’s moved to dismiss the case based on the pleadings – in all of these types of derivative actions you are dealing generally with what is in the pleadings.  Discourage “strike” suits commenced by S/h’s for their personal gain rather than for the benefit of the corporation. This means that derivative suits are worthless since demand is a kiss of death  Problem: If you have a universal demand and you follow the DE approach as the evaluation of the demand – which is he BJR – BOP on P. o A reason to doubt that the action was taken honestly and in good faith or o SEE HANDOUT ON TWEN SITE • Court says these two prongs are “disjunctive” o Meaning that the “and” should be “or” o So show either one and you win • If you meet the first prong – ie you show director interest – the BJR is out and demand is not required o Or if you show the director was influenced by the interested party • Whether there is valid business judgment depends on whether o They were informed (procedural due care) o And substantive due care .  DE/NJ/SC -To Establish Demand Futility.Aronson: P’s must allege with particularized facts which creates a reasonable doubt that: • Directors are disinterested and independent or there was undue influence by an interested party AND • The challenged transaction was a product of a valid exercise of business judgment by the director’s. 3 Different Approaches to Determining the Futility of a Demand: DELAWARE Approach: Must state with particularity the fact that you made demand on directors unless it would be futile OR establish with particularity the reason you did not make a demand was b/c the demand was futile. making demand is an admission that the directors were disinterested.  Series of complex rules to evaluate the BOD’s decision to reject the demand! NY – 3 Prong Test: Must make demand unless you can state with particularity that:  A majority of directors are interested in the transaction OR  The directors failed to reasonably inform themselves about the transaction OR Page 66 of 148 . there is no cause of action for either of these types of behaviors Claim is that IBM wasted money by giving excessive compensation to its executives and outside directors – ie selfdealing and breach of fid duty  So two claims • Paying officers too much • Paying directors too much Issue: Is a Derivative Action based on Improperly Raising the Director’s Compensation a Demand Futile Case? Two defenses  Court finds that demand was not excused and no COA is stated so case dismissed – reasoned that excusing the demand simply because all board members are named ∆’s would completely undermine the BJR as it applies to deciding when to bring suit  Demand is not excused and no COA is made because there is a statue allowing the board to set compensation for its members without facing self-dealing accusations  Remember that DS is brought on behalf of the corp to secure a judgment in its favor NY Ct states 3 Purposes of the Demand Requirement:  Relieve courts from deciding matters of internal corporate governance by providing directors with opportunities to correct alleged abuses. Only allows filing before response ot demand if there is threat of irrepariable harm. and even if they had.terms of the transaction • Some criticize the reasonable doubt standard  Note: in DE. P always loses!  This approach is somewhat plaintiff friendly.o o o o o o o o demand.  Provide corporate boards with reasonable protection from harassment from litigation on matters clearly within the discretion of the court.

the atty would have the board create a “special litigation committee” that excluded the interested members. or perhaps so reduce the assets as to threaten the corporation with insolvency. However. and this consists of a majority of the board – so demand would have been futile under this fact  But there is no COA because the statute allows them to do this and the complaint only makes a conclusory allegation that it is excessive • He needed to show breach of fid duty or fraud o BOP shifts depend on whether it was approved by interested of disinterested shareholders • Here the raises weren’t excessive on their face to give rise to breach of fid duty r fraud o The Court would be willing to question compensation in the case of fraud. I would much rather bring the case as a direct suit. cases were allowing conclusory allegations. This committee would then make the motion  Problem is that the interested ones are involved in appointing members to this board  Courts vary on how they address these committees o Special Lititgation Committee Hired to Evaluate Demand Refusal:  Nowadays. etc. the case was still dismissed because the complaint didn’t state a cause of action because directors set their own compensation and the complaint didn’t allege compensation rates excessive on their face. universally the committee will consist of directors that have no relationship with the alleged wrongdoer. then the court wont recognize the motion bc of the conflict o To get around this.o The challenged transaction was so egregious on its face that it could not have been the result of sound business judgment  Considers Barr v. so court states new requirements • Particular allegations that majority of board is either directly interested or that it its members are controlled by interested directors • Particularity that they did not fully inform themselves • Particularity that it is so egregious that there could not be sound business judgment o Holding: The court applied NY and excused demand in the claim against the directors because 12 of 15 were interested. and the corporation rejects.  The committee will universally hire an expert to guide them in their evaluation and this will usually be a retired judge and hire an expensive corp law firm – almost universally they will always decide to file a motion to dismiss!  Page 67 of 148 . usually a committee is appointed to evaluate whether or not the lawsuit will continue. their suit is likely dead in the water What if the Demand is deemed futile and Π is allowed to proceed o Settle or litigate o OR directors will move to dismiss arguing that the potential benefits from the corporation continuing the suit are not worth the costs o Traditionally such motions are proper when the suit is against a TP because the shareholders are disinterested and the BJR applies o But if the DS is against the directors. If I was a shareholder.  Π claims directors were interested because they were awarding themselves compensation and that the others simply acquiesced  Officers: demand was not futile to them because they do not make a majority • Only 3 got a raise.there has to be a majority that is interested • Doesn’t say they failed to use business judgment • So demand is not futile as to the inside directors  Outside Directors • However.  Thus. P almost always loses. Wackman – board accepted less favorable terms for a merger after being offered considerable compensation in various forms • Demand was excused b/c of self-interest of board members for those receiving benefit • Demand was also excused for outside members that were disinterested because it was a breach of due care and diligence to the company by rubber stamping the interested directors plan • But you can’t just make conclusory allegations o There must be particularity  After Barr. if the shareholder has to make demand. o Why do we care about demand?  If a shareholder makes demand. that rejection is subject to the business judgment rule. the Π also alleged that a majority of the board was interested because the outside directors also set their compensation. where directors or officers appropriate the income so as to deprive shareholders of reasonable dividends.

the court wont review the decision o So basically have to show you were informed. 294)  Facts: Plaintiff brought derivative suit without demand. Maldonado (DE) (p.o After you file a Motion to Dismiss – these next cases deal with that: These cases come after the demand futility mechanism as a defense bar. o This decision is classic business judgment.   Page 68 of 148 . since all the directors participated in the acts he specified. Committee (in the shocker of the year) decided to dismiss the suit. o This is the only consideration that the court will review o Courts are well equipped to review the method and procedures used to investigate facts and determine legal liability o Must choose the methods of investigation in good faith – if you do this. but dragging this out will bring the corporation down or negatively effect the directors will hurt the company more than its worth o The reason they decide to dismiss does not have to relate to the merits of the claim So Auerbach limits review to the procedures and good faith investigation of the SLC without regard to the ultimate decision o Zapata v. Bennett (NY) (p. we got some new board members who were by definition disinterested.  Π argues that no SLC appointed by the ∆ directors should not be recognized • Court rejects – the directors are the only ones who can appoint such a board and the only ones that can authorize suit against the interested directors • So court just assumes that the SLC is disinterested and independent • To side with Π would be to deny the board its ability to make business judgments for the corporation regarding the suit o If someone outside the board made this decision. and shareholders successfully initiated a derivative suit. and Zapata made them into a litigation committee to investigate and decide what to do.  2 Prong Test to Evaluate Committee’s Decision to Terminate Litigation: • Was the committee independent and disinterested • Was their process satisfactory  The court said that so long as the members of the committee were disinterested (the court assumes the committee was disinterested in this case). The company created a minority litigation committee of 3 disinterested directors to decide if they should pursue the litigation. it’s cool. so doesn’t get looked at much • Application o Record does not show deficiency in methods used by SLC. He claimed that. They made through investigation of pertinent areas o Use of special counsel o Reviewed report of audit committee o Questioners were sent out • As a practical matter what these committees do today is to hire someone with high profile to advise the committee – normally a retired judge = CYA o Also use best corporate law firm they can think of o 90% of the decisions are to dismiss – everyone knows they will dismiss  Often hang hat on saying that yes we can get money. the action to dismiss was proper IF • The committee’s procedures in pursuing the decision to dismiss were appropriate. 290)  Facts: Directors had been authorizing bribes. o Auerbach v. Four years after filing. demand would be futile. and the question is whether business judgment rule should apply to the decision to terminate the suit. o As long as the methodologies were created and followed in good faith.or took measures to be informed • If the decision to dismiss was properly predicated on the data produced by the process. it would be a breach of the nondelegable fid duty of the directors to act in the best interest of the corporation  Issue: They decided not to pursue.

. was going to get an equivalent deduction that was equal to the amount of tax that the people were going to get. not to continue it if the directors elect to dismiss  Also Sohland had special facts in that the board voted against the suit. the Π has lost  Rule #2: The court says if the S/H makes a demand and it was refused.$10 in this case. the decision to dismiss the case is NOT tested by the BJR  Same as last case in looking at the procedure used  But they differ on how they look at the decision made • Del court is going to look at the decision if the corp shows it acted independently Two Part  Corp has to show that it acted independently and disinterested – procedure  BJR to the decision • Informed and in good faith • But court says the lower court may look at this and in practice. the refusal will be evaluated using the BJR!!! – page 393 – FN.  And the company doesn’t get as large a tax deduction if they exercise the stock option early like they wanted to do than it would if they waited to the date that they were initially allowed to exercise it  The SEC has gone after a # of companies recently for going after stock options. few have elected to do so If there is a SLC the practical matter under either NY or Del. but helped him to bring it But BJR won’t protect decision to dismiss if there is a breach of fid duty – Two contexts  Wrongful refusal to sue • Meaning the BJR rule applies as well as its exception o Lack of being informed o Fraud  When demand would be futile – conflict of interest A big issue was whether the interested directors could appoint a SLC – would it really be independent and disinterested  Π says it can’t be  Court says that it can • Someone has to act on behalf of the company and the directors are the only one to appoint the ones that will However.  How is the Co. The corporation was also going to get a larger deduction if the stock options had been exercised later down the line. it makes sense to exercise the option.  It was to the directors’ advantage to have them exercise the option early.? (Remember: S/H derivative suits – must show an injury to the Co.  Rule #3: A committee of disinterested directors can dismiss the suit if the committee can establish that • it is independent. so where is the injury? Who was injured? It just don’t look right that you should be giving the directors this special benefit. AND Page 69 of 148 .  This is a derivative suit.)  2 Theories: • One argument was that it wasn’t right – • Co.o o o o o o o  Required them to pay a tax – difference between the original value the stock was issued at and the price the stock is now selling.  But the issue in this case is that the shareholder was going to have to pay tax on the differential. So if the price of the stock increased. they would have gotten a larger deduction later First issue was whether the SLC has the authority to make the decision to dismiss for the company  Yes it does and this is the same in SC  Issues • S/H continuing right to maintain DS after the corporation decides not to sue • SLC’s authority to move to dismiss • Role of court in resolving conflict bw SLC and the S/H Right of SH in a DS  No right to continue with DS once demand is made and rejected  Sohland – prior case that says the SH could continue after the demand is rejected but NOT when the motion to dismiss is made  SH only has right to start the law suit. hurt if they allow the S/H to do this? – what is the injury to the Co. AND • it acted in good faith.

(1) DE finished or (2) SC  or if the P wins the suit continues  Zapata p 395 suggests D may move to dismiss If the P claims the demand is futile. Page 70 of 148 that there was a basis for its conclusions o Balancing Test –: “the final substantive judgment whether a particular lawsuit should be maintained requires a balance of many factors-ethical. the rule is clear that this is an equitable action so there is no jury.01 in the right circumstances. has rarely opted to exercise its own BJR. promotional. public relations. applying its own business judgment rule – taking account the various justifications above. is used AGAIN to evaluate the committee’s decision to dismiss the litigation There is a split whether plaintiffs are entitled to a jury trial for a derivative suit in the Supreme Court.  A special litigation committee will almost always be appointed – and they will almost make the decision to terminate the litigation b/c it is in the best interest of the company. or (c) NY  if the P wins (the demand is futile) the D can move to dismiss and (1) Auerbach. Defendants claimed that the plaintiff didn’t make demand. and that the decision was reasonable (this last step is different) • Demand Futile – Does not have to be made – (Aronson – DE Test) o Claim that the majority of the directors are interested in the transaction OR o Create a reasonable doubt that the transactions were a valid exercise of business judgment • Demand Made & Refused:  BOD must prove 3 things to prove that refusal of demand was appropriate.  Independent and disinterested  Acted in Good Faith w/due care in their investigation of S/H allegation  BOD’s decision was reasonable. as it would be under the normal BJR. not on the P. The court in essence makes its own business judgment as to whether or not the case should be dismissed (THIS IS A HUGE CHANGE IN THE PHILOSOPHY OF COURTS IN THE PAST!) • The court. 33-8-250: Committees -you can establish an independent committee to evaluate the . Court has to approve the settlement. employee relations. it is definitely implied that the court would adopt 7. Can do so by showing • The directors or managing board are themselves the wrongdoers in a breach of trust and had control over the corporation. even though it doesn’t actually apply it in any of the above cases. and as such the court didn’t have jurisdiction. you have to decide whether to make a demand or claim the demand is futile. fiscal as well as legal – we are content that such factors are not “beyond judicial reach” • Note: the BOP is on the Committee. If the P makes a demand and the D rejects the demand  P challenges D’s rejection and the test is: (a) Delaware=BJ or (b) NJ three prong  If the D wins. (2) Zapata. In SC. does ALI § 7. they acted in good faith with due care in investigation of shareholder’s allegation.• o o o o o o o o o o o o litigation. (2) Zapata. the D can do nothing and the defendant moves to dismiss in which case (1) Auerbach. • The court. (b) ALI. however. commercial. or (3) new NJ test It is almost impossible from the plaintiff’s case to win a derivative suit o Grant v. If no. Gosnell (SC)  Facts: Shareholder sued bank for mismanagement. the D can challenge the P’s futility claim (a) DE. you’re home free. you’re home free.  NJ Demand Rules • Look this up on TWEN • The New Jersey rule will apply if there is a motion to terminate or if there is a committee and a rejection • Burden on the corporation to demonstrate that in deciding whether to terminate the suit: the parties were independent and disinterested. Is claim derivative or direct? If direct. If derivative. then above 3 prong test. SC Demand Cases When you read these three cases.  Issue: Do you first have to make a demand on the BOD to rectify the problem?  SC TEST: Court said that generally you have to make demand unless you can show sufficient reason not to do so. or (3) New NJ test If the P claims the demand is futile. will evaluate whether it thinks the case should be dismissed.01 apply? If yes.

o In evaluating whether or not to require a demand. they were worth a lot more money and Whittle and the board knew that or should have known that. the transaction looked like proper business judgment (the court makes a really strange argument about rescinding)  SC – • Court will be strict in requiring particularized facts  Page 71 of 148 . he was also on the board o Places more importance that the named ∆ have a majority of the stock and dismisses a requirement that the named ∆ consist of a majority of the board o Funny because it’s a director decision not shareholder decision to proceed – and there was a new board (maybe court is saying they are not disinterested. the court should be lenient (the Whittle case cuts back on this a little bit)  In this case. and the bonuses went through the roof. describe the factual basis of the wrongful acts and the harm to the corporation. Whittle (SC)  Facts: Bank was involved with another company. The company went public.All the board members are named as defendants  Test: did the directors get the same improper benefit they are complaining about  Argument that the board was controlled by Whittle (good argument but no particularized facts that board members were beholden to Whittle) o Create a reasonable doubt that the transactions were a valid exercise of business judgment. but did not refer to it as required in the rules of civil procedure. Affinity gave the bank stock options. and the requested relief.  Factual question whether demand is excusable – so case by case • Here it was because a named ∆ owned 51% of corp. the stock options were at a point that they could be exercised. the business judgment rule applies. They valued the options at $0. o So b/c they did not refer to this issue in their initial complaint. In exchange. it could be presumed that he wouldn’t respond to demand and as such no demand was necessary. Further. so the court said they didn’t plead with particularity that they had made demand.  Affinity was about to go public and Whittle knew it = insider trading  Π didn’t make demand. a lot of money. same as Delaware. but the bank could not itself exercise the stock options because of federal regulations. The board had gotten a letter saying the shares were worth very little. because Gosnell had control of the majority of the stock. so the particularized part is really strict  The plaintiffs couldn’t show that a majority of directors were interested b/c only 3 got the stock and there was no evidence that the remaining shareholders were beholden to Whittle.  SC Heightened Pleadings Rule for Demand (SCRCP 23(b)(1) • Court rejected the P’s claim on the basis that they did not make a sufficient demand on the BOD: o The plaintiffs attached their demand letter. but Whittle had a plan to go public.88 a share.  The Court found the plaintiff did not plead particularized facts that would excuse demand. Some time later after that all occurred.Board is controlled by Whittle  Ex . and he knew the stock would go up 20 fold. but they don’t say so) Carolina First Bank v.  Issue #2: Can the P’s claim that failure to make a demand can be excused. The bank simply gave the stock options to Whittle and some others directors of the bank as bonuses. company. they couldn’t raise the issue on appeal – Pleadings Rule! o This Complaint is not particular enough  RULE – at a minimum a demand must id the alleged wrongdoers. At the time.  The court said that demand must identify the alleged wrongdoers. They were really getting stock worth somewhere around $10-$12. The allegations were that the bank loaned Affinity. judged under the available information at the time. describe the factual basis of the wrongful acts and the harm caused to the corporation and request remedial relief  If you fail to make a demand. • The SC court also rejects the Delaware trap by stating that making demand is not an admission that demand isn’t futile – So if you make a demand and it is rejected then you can still argue a demand was not required in SC (or that demand can be excused). • The court applied the SC test for demand futility from the Aronson decision: o Claim that the majority of the directors are interested in the transaction OR  Ex -All of the board members are interested  Ex .

So no wrongdoing other than bad info – so once the information became public the court says there is no reason to infer that they weren’t capable of rescinding the bonus if it thought it was good business judgment o This analysis is pretty weird because we are looking at the original decision. but Burcky says he is being punished for doing the responsible thing in mitigating the damages o Rule: Any suit for misappropriation of the corp assets or liability for mismanagement of corp assets should be brought as a derivative suit. Page 72 of 148 • • . o Issue – Can a former SH bring a direct suit against an officer and director of the corporation for breach of duty owed to the corporation  Court rejects proposition that former shareholder has standing to bring a direct suit • This action belonged solely to the corporation • There is some support that a direct suit can be brought by a minority shareholder in a close held corp – but these don’t apply here because Π sold his stock  Jacobson v. so the bank demanded the computer.01 only applies if the suit would have been brought as a derivative suit but 3 requirements are met. There is no mention of rescission Davis v. so the majority was not involved nor had self –interest • The second allegation – the Π only made a conclusory allegation that the ∆ controlled the board – must be particular in alleging that he controlled the other members o This argument would have worked if they had made particularized allegations • Merely naming the board members as ∆ wont make demand futile if they aren’t interested  Second Prong of Aronson Test • Π then says if Del law is being applied then demand is excused if they create a reasonable doubt that the board exercised valid business judgment in making the decision and the ∆ fails to rebuke the assertion with particularized facts • Court says the Π failed to create a reasonable doubt – they allege that the board was misled in making its decision by Whittle and a few others.• But if such facts are there. Hamm (SC) o Facts: Davis was a shareholder and Hamm was president and director. The company had borrowed money to buy a computer and couldn’t pay the loan. Hamm gave the computer to the bank. Hamm tried to defend suit from Davis in that his duty ran to the corp. which creates a reasonable doubt as to the boards business judgment  WRONG  First Prong of Aronson Test • The interest must be more then involvement in the original decision. it will be lenient in finding demand was futile Aronson test will be applied in determining whether demand should be excused (Delaware case) o Whether the board was disinterested o Whether the decision was a valid exercise of the BJ  Π claims that the following are basis for claiming futility • The board is not disinterested • The board is controlled by the wrongdoer • Almost all board members are named as ∆ • The board was responsible for the original actions complained of.there must be a personal interest involved o The Π has claimed that only two members engaged in self dealing here. Yaschick did allow a former shareholder to maintain a suit – but there were only two SH in that Corp • Rule from this case – Officers and directors of a corporation must make a full disclosure of all relevant facts when purchasing shares from a stockholder o This is a minority rule • This rule is inapplicable here because there was no failure to disclose and he sold to an outsider  He might have been able to bring suit as a minority shareholder for oppression from the majority – but he sold his stock and lost this standing • We still have this statute allowing a minority shareholder to bring a direct action against an oppressive majority holder in a close corporation • Court said it didn’t apply because he was no longer a shareholder. Davis brought a direct suit against Hamm because he had to sell his stock at a loss. Rule 7. but he had no right to take the computer from the company.

so it would be detrimental to the creditor to allow a SH to bring a direct suit to satisfy their personal debts by asserting a claim that belongs to the corporation • Brown v.reasons for Allowing a Direct Claim over a Derivative Claim:  Prevents multiplicity of suits from shareholders. and  No danger of prejudice to other shareholder interests. not the corporation. by allowing the individual s/h to bring claims it could jeopardize the corp. Value of corp went way down. and defenses applicable only to derivative actions.01 . As it turned out.  33-14-300: a shareholder who can allege and prove oppressive conduct. Page 73 of 148 . o ALI – 7.  Protects corporate creditors by putting proceeds of recovery back in the corp. Relied upon a GA case which allowed a direct suit if certain criteria were met. Dixon Case. Dixon – a Ga case where SH were allowed to bring a direct suit against a director where the reason for requiring a DS were absent • Court says the facts are different here because there is an interest to protect corporate creditors o They have priority over shareholders. • Burkhard thinks this was BS and is dead wrong! • One of the first cases to acknowledge there would be a close corporation exception.  Adequately compensates injured shareholder by increasing the value of his shares. o Babb v.  Holding: Court rejects the 7. Stewart (SC)  Brown bought 20% of mid Atlantic. if it finds that to do so will not:  unfairly expose the corporation or the defendants to a multiplicity of actions  materially prejudice the interests of the creditors of the corporation or  interfere with a fair distribution of the recovery among all interested persons o GA’s Thomas vs. o P argued close corporation exception for direct suit – where a plaintiff need not employ the form of a derivative action even though the action alleges in substance a corporate injury:  if there was no danger to corporate creditors  No danger of a multiplicity of suits.   o Court stated that 1) the assets of the corp belong to the corp. • Unlike in Thomas this case involves the protection of corporate creditors (a reason compelling derivative action). the other shareholders used the cash he paid for his share to cash out their own investments in the corp (fraudulent representations). and order an individual recovery.  Π argues that ∆’s cant assert the claim for a setoff because it involved corporate property and is therefore the corporation’s suit • Court agrees.  Protects the interests of all shareholders by increasing the value of their shares instead of letting one shareholder take all.’s creditor’s claims. Shareholders tried to argue for the right to sue directly for misappropriation of corporate assets. court responds saying his claim is not valid because he is no longer a current shareholder SC may allow direct over derivative when none of those factors are present SC upholds this ALI test. Davis would have been allowed to bring this as a direct suit for misappropriation of corp assets under the close corp exception if he had not sold his shares.01 claim – says you haven’t met the requirements for the exception. In this case.01(d) (exception)– pg 417 – In the case of a closely help corporation the court in its discretion may treat an action raising derivative claims as a direct action. SC 33-8-300 – Directors fiduciary duty runs to corp & S/Hs!!!  THERE is also a statute in SC that directors owe a fid duty to both the company and the shareholder • Doesn’t apply because she is no longer a shareholder  Holding: Ct says that a director has a fiduciary duty to the corporation and the shareholders. Dixon – applying 7. and 2) the liability for mismanagement belongs to the corp. Sued for breach of fiduciary duty and Brown tried to argue that he should have a direct claim – that the duty should run to him. any suit for misappropriation of the computer would have to be derivative.stated in the GA Thomas v. exempt it from those restrictions. they should have brought a derivative suit  ∆ cite Thomas v. Rothrock (SC)  Facts here are irrelevant – squabble amongst the shareholders.

the fraudulent stock sale claim is a potential winner)  Did he have a right to rely – jury issue • He didn’t have a right to rely and he should have used due diligence and his failure to do that wipes out any fraud claim he might have had. They started another company and excluded the plaintiff from that company.should have been a derivative claim – basic derivative suit o P says they have a way to get around it . the corporation gets the recovery o The successful plaintiff gets costs and attorneys fees o There is also a res judicata effect of the suit if the corporation wins o Who really pays with regards to these o Directors seek to protect themselves o Statutes allow them to limit liability except for o Intentional or reckless or gross negligence (in SC) o but these only cover claims brought by the shareholder or company  and don’t cover breach of loyalty  Insurance • All publicly traded companies have director insurance Page 74 of 148 . but it was used for something else) o Direct claim • Mishandling of sale (breach of fid duty) o Derivative  ∆ told Π they had each invested 25K when in fact they had characterized their funds as loans. • The court stated the Thomas factors in Davis.Allegation  Two Basic Claims • Fraudulent Stock Sales ( you told me my money was being used for one thing.  Did he have a breach claim? • Basic Defense against this claim: standing. your loss has to be separate and distinct from that of the corporation.  Rule: Breach of duty of loyalty runs to the corporation. They had told him it would be used to buy equipment and hire people  Also made misrepresentations about the state of the company  Also alleges breach of fid duty in negotiating a sale that was favorable to them and unfavorable to the Π o ∆ claims defenses for fraudulent stock sales  They had no confidential relationship with Π to justify his reliance on their statements and that they didn’t misrepresent anything  Also that Πs loss is his own fault in failure to exercise due diligence  Court concludes there were issues of fact that should go to trial o The fraudulent stock sale is a direct claim (even though he didn’t win. o Right to Jury Trial • In SC you don’t get one because the derivative suit arises from equity • Federal Court – if the COA that you are asserting on behalf of the company would entitle you to a jury trial (ie being an action in law) then you get one Court Approval of Settlement or Dismissal • Because it is a representative action. but the shareholder is allowed to recover costs and fees o Recovery in derivative suits o Generally.can argue the 7.they then used his investment to repay these loans with an interest of 16%. Brown didn’t join the other stockholders (he originally joined them but then he dismissed them. Burkhard says this behavior is more egregious than what is being argued in the case itself. which can only happen in this case if the fiduciary duty runs to the shareholder. To get an individual action as a stockholder. the court must give approval it like it would for a class action Recovery in Derivative Suits • The corporation recovers. this was a silly mistake)  Burkhard said that he could have also argued corporate opportunity. but declined to apply them b/c the injury to Brown was the same injury the corp had incurred (not separate and distinct).01 exception.

o 33-44-403 Indemnification for LLC o Members SHALL be indemnified for liabilities incurred in the ordinary course of business o It is possible to opt out of this requirement Questions 304 o 1) she may be indemnified in both  Page 75 of 148 • . o Rule: A guilty plea or a finding of liability do not preclude indemnification – as long as the 3 requirements above are met – o May not indemnify if  Director is liable to the corporation  Director gained an improper benefit from the transaction • 33-8-520 – Mandatory Indemnification o If a Director is found not liable (wholly successful on the merits or otherwise) he has the right to recover reasonable atty’s fees o This is still true even if he or she prevailed on a technicality such as a SOL. when an agent suffers a loss that should be borne by the principal under the circumstances o 33-8-500(5)  Distinction in capacity – was it in his official capacity or was he working for someone else at the time? • 33-8-510: Authority to indemnify o May indemnify if director (pre-conditions to getting the Cash)  Conducted himself in good faith  Reasonably believed that his conduct was in the best interest of the home company  In the case of a criminal proceeding. although this is not allowed under Sarbanes Oxley.  The corporation may advance the director expense of the litigation if • Written affirmation of his good faith • Written underpayment in to repay the company if he looses • A determination that the facts are such that he wouldn’t be denied indemnification • 33-8-540 –Court Ordered Indemnification . bylaws and articles.that the amount is reasonable – got to make sure there is enough money to pay • 33-8-560 – Indemnification of Officers. and K o Rest 2nd – Exceptions to CL director’s right to indemnification: If Director’s actions  Illegal.  Asking the company to indemnify  Company cant do it unless • Determination that director is qualified to be indemnified – by the board • Authorization. OR  Not to the benefit of their employer. o If the AI’s limit indemnification or advance for expenses.court can order indemnification in some situations. • 33-8-530 – Advance to Expenses: o Normally a corp can loan fees to its directors to defend. but they have to make the determination if the person is entitled to money and if they are entitled whether or not the payment can be made. OR  Negligent o Rest 3rd of Agency–814 .it is rare for small SC corps to have director insurance Indemnity • Directors do not have a common law right to indemnification because the director isn’t the agent of the company. So it has to come from statutes. • 33-8-570 –Insurance: You can buy director insurance and it can be broader than the insurance provided for by statute • 33-8-580 –Application of Article: cannot change the scope of the statute in your articles. he had no reason to believe the conduct was unlawful. • 33-8-550 – Determination and Authorization of Indemnification: Board has to determine if indemnification must be made. Employees and Agents: an officer who isn’t a director is entitled to indemnification.Agents of the corporation are entitled to indemnification  Principal has the right to indemnify an agent in accordance with the terms of the contracts. it is only valid to the extent it is consistent with the articles.

• Interest pmts are deductible • Loan payments get paid first • Debt doesn’t usually vote • SC. B/C there is no question as to whether or not a corp can purchase this insurance if they are willing to pay a premium. a corporation can o Borrow Money  Lenders like borrowers with unencumbered assets that can be used as collateral for the loan  Covenants – used by lenders to require financial and operational commitments until the loan is repaid – ex. and debt has a greater risk of bankruptcy o Issuing more stock o Dilution – if stock is issued so that the percentage of ownership changes.o o Insurance o o 2. Consideration in Purchasing D&O Insurance: o Business questions such as whether to buy D&O Insurance and if so what kind o Contract law questions such as what is covered by the policy and who makes what decisions with respect to litigating and settling claims. they might cause more shares to be issued and have them issued to themselves or to a TP • The would then be able to outvote C and get him out the picture • So ability to issue more shares is very important Page 76 of 148 . B. For closely held businesses insurance is probably unavailable at economic cost. your interest is diluted if you own a smaller percent o Preemptive rights – if you have this. Debt v.limits on distributions  Default is defined by the parties – so it could reached if the assets reach a certain level o Sell interests in the corporation o Use Earnings o Borrowing  Businesses often prefer debt over equity  Adv of Debt • Allows for leverage • Less risky than equity • Costs less to co.Insurance – Most states have provisions authorizing corporations to purchase and maintain liability insurance to cover their directors. so each can elect 1 of the 3 directors  If A and B decide to gang up on C.1 – maybe but not likely 2.SH A. o How does a corporation grow? o To Grow. we allow for voting debt  Equity Adv • Lenders only lend amt they are sure will get paid back • fear of bankruptcy – too much debt in low cash flow yrs • Reduces risk in capital structure by lowering amt of debt and the fixed costs associated with debt. Equity o Equity holders get higher return than creditors because they take a bigger risk o They are not guaranteed to be paid back o Have no collateral o Creditors get paid first o So you pay less for debt. C  Each owns 10 shares. o Corp. and you get a tax discount – so there is big incentive to use debt financing o But bankers will only give you so much. then you have the right to purchase the number of shares of any new issuance of shares that will enable you to maintain your percentage of ownership o Hypo o Close held corp.2 Always put indemnification provisions in the articles Corporations can buy liability insurance for their directors and officers (D/O insurance) Most close held corps don’t have this o Claims don’t come up o Its to expensive o 308 – Question 3: Our statute says in this case they are not allowed to pay (510) o D&O .

If there needed to be an amendment to the AI’s to issue more shares. 320)  Defendant held 90% of the outstanding stock.  Holding: Court says NO – there was a general breach of fiduciary duty claim in this case. made a vote to eliminate shareholder preemptive rights. reducing the control of the plaintiff from 10% to 1%. and the dilution of the shares implicated that duty. which he bought. whether the Minority shareholder would have had enough voting power to stop something from happening that will injure them down the road. and then issued 50. There is a question as to whether these 50. there is a chance that the Π could have vetoed this – SC would allow him to do so unless 2/3 voted to amend  Π claims ∆ breached fid duty to him as a shareholder • Close held exception applies here o Including fid duty to minority shareholders o Similar to SC in calling for duty to both the company and the shareholders • Says Π had right to sue individually because shareholders in close corporations are similar in relation to partners o Cites Donahue case that says a close held corp should be treated more like a partnership than a corporation • Applies ALI 7.  Holding: Direct Suit is OK .  Π owned 10% and ∆ owned 90% • ∆ changed bylaws to do away with preemptive rights • Issued more stock so Π only had 1% o If these shares were not already authorized. o No indication of injury to creditors by virtue of successful challenge to the issuance of stock o no risk of multiple lawsuits b/c only 2 shareholders  Issue #3: D alleges that P is only asserting a pre-emptive right in this case and that VA laws allow Dir to remove this right.when a ct may treat an action raising from a derivative claim as a direct claim Even though this is a federal case. o If bought at a price less than the FMV is there an injury? – No b/c the corp bought at a price less than the FMV.701(d) – Exception for Close Corporations. VA would recognize and apply 701(d).000 shares. then they would have had to change the articles  If so. Vivadelli (VA) (p.  VA Rule: Under VA law the directors owe a fiduciary duty. not only to the Corp.000 shares were originally authorized in the AI’s or whether the shares had to be additionally authorized by an Amendment to the AI. not just a claim about pre-emptive rights  the preemptive statute does not relieve the ∆ of his fid duty to the shareholders o Page 77 of 148 .Injury to the Co – they wanted a price less than the fair market value.01 • BUT this might be able to be a direct suit regardless – the argument is that they have reduced the Π’s voting power and that you haven’t hurt the company o The counter is that the value of the company was diluted and so the company was injured  But counter to this is that the shares have devalued and not the company so the individual shareholders can sue directly  Issue #1: Do the Directors owe a parallel fiduciary duty to shareholders as well as the Corp?  Holding: The court stated that the Defendant owed a fiduciary duty to the plaintiff.o Now we have 5 SH  Each puts in 200 per share  Then sell more at only 100 per share  The old guys shares become less valuable – so o So preemptive rights can be used to prevent diluting control and to prevent sell of shares at such a low price as to dilute the equity value of the shares of the prior SH Preemptive Rights and Other Rights of Existing Shareholders o Byelick v. BUT ALSO to the shareholders!!! • SC Rule equivalent to Davis Case  Issue: Was it ok to bring this suit as a Direct Suit rather than a Derivative Suit? • Notions why a Derivative Suit would be appropriate.

to be able to sell the shares to a whole group of people).  One third of venture capitalist companies wind up in bankruptcy. o Sarbanes-Oxley makes it much more expensive to be a public corporation  How to go public • You hire an investment banker who goes out and shops your stock for you. then no breach of fiduciary duty. Consequently. o Shares sold for something other than money.issuance at favorable prices to directors (but excluding other shareholders) or the issuance of shares on a non-proportional basis for the purpose of affecting control rather than raising capital may violate that duty  VA Rule . It is a way for the folks who start the business to convert their investment into cash. • (d) – IMP. 33-6-300: Shareholder’s preemptive rights  Shareholders automatically have preemptive rights unless the articles say otherwise. Codifies the result in the Vivadelli case!!!!! • Burky says soon will be changed to apply only to close held corporations Venture Capitalists  Venture capitalists are looking at 4 things before they invest: • Downside protection – such as liquidation preference • Upside opportunities • Voting and veto rights • Exit opportunities  One of the real concerns today is whether or not these types of firms will invest in LLCs. there is a still a fid duty in the issuance of shares. . Going Public  Why go public • Cheapest source of a lot of capital • The folks on the inside use it as a way to make a lot of money. • Should attempt to raise at least two years of operating capital – maybe more depending on how long it will take to make a profit  Why not? • Expensive: o It costs hundreds of thousands of dollars to go public – the stock is not priced until after all the hundreds of thousands of dollars are spent.  MAIN RULE OF CASE: dilution of shares without via removing a S/H to preemptive rights is a breach of directors duty.dilution of shares without regard to preemptive rights is a breach of directors duty.BOP on the D to show – no benefit of the BJR • the board’s consent to the issuance was fair to the corporation and • the sale itself was fair  If the Corp was able to show this was fair. venture capitalists demand high returns because the successful one-third of their investments must cover the losses generated by the other two-thirds.  VC’s will do this through private placements –an exempt transaction.o o o Even if there are no preemptive rights. but we would allow the Co. • 2 methods to go public: o Best Efforts – the IB will give their best efforts to sell the stock at a specified price – new companies…most are best efforts o Firm commitment – the IB buys all of the stock – usually at a discount – and they take the downside risk – big companies with a track record are usually firm commitments Page 78 of 148 • .(opposite of the MBCA)  If there is no express statement that there are no preemptive rights in the articles • shareholders have preemptive rights to get proportional amounts of shares issued by directors • shareholder can waive the right • No preemptive right if the shares you’re holding are: o Issued as compensation (stock options) o Issued to satisfy conversion or option rights o Shares issued within 6 months of incorporation (1st person to buy would then have the right to keep buying all of the stock.  Venture capitalists demand protective covenants.

     o Public Offering o Involves a registration process and a marketing program o Underwriter – normally an investment bank that manages the process of drawing up the offering memo that is filed with the SEC. some of the $ goes to buy them out.burcky doesn’t agree Market value – price of shares x number of outstanding shares But if you haven’t gone public yet. o New shareholders benefit more if their money went into the company. • Prospectus (this is the offering document) Page 79 of 148 Where does the $ go after the offering? o To the Co. Then Bubba’s should sell for 20 times it expected future earnings • Then divide that number by shares outstanding = value per share • So if Bubba’s expected value is 10 Million – then the current value is 200million (10 x 20). then it needs to issue 1. which gives incentive to raise as little as is needed to grow o Fear – go after as much as you can because if the Intial Public Offering goes bad. your valuation is harder to calculate and depends on future earnings. then they get the money  If a VC is selling.the more you raise. the corporation gets the money o If the founders are selling their own shares. • If it has issued 8 million shares to its founders. it is responsible for structuring the offering. not past ones – so its got a little art to it Then you figure our your current value – often by comparing yourself to similar publicly traded corps Ie if McDonalds sells for 20 times it past earnings. you might not get a second chance o This balance normally results in raising enough for 2 years.” the facts investors would find important in making an investment decision. then the value per share = $25/share o This is the price it will sell new shares for • If the company wants to raise 30 Million.2 million (30 / 25 = 1. o To the existing S/H o If venture capitalists were involved with the offering from the beginning. then its no big deal  But if the CEO is selling then it is viewed disfavorably o Costs continue after the offering Legal Constraints on issuing stock • Registration requirements for public offerings o SEC – Federal Requirements  Securities Act of 1933 requires • The Securities Act generally requires companies to give investors “full disclosure” of all “material facts. rather than merely go to the old shareholders to make them rich How Much $? • Fear vs. where it could be invested on their behalf to generate earnings. the more ownership you give up. pricing the securities amd maintaining a market for the securities after the offering o The underwriter and the corporation officers go on a road show to do some marketing o The offering price is set the night before it goes public because the market changes so fast o Got to watch out for tricky underwriters that might undervalue the price so as to pass savings onto clients o Where does the money come from o Underwriter activities are conduct one either a firm commitment or a best efforts basis  Firm commitment – the money comes from the underwriter • It buys all the shares that are being offered and then resells them  Best Efforts underwriting • Money comes from the public • The underwriter helps with the marketing • Most new companies only get this one o Where does the money go o Underwriters and attys take a large amount o If they are new shares.2) • . Greed o Greed.

Common Law Fraud and Misrep and Rule 10b-5 Constraints on Any Stock Issuance • If you are exempt from registration.  Once a tax lien is filed on the property. mail or facilities of a national securities exchange (or anything related to it)  To defraud  To make any untrue statement of material fact or omit to state a material fact necessary in order to make the statement made in the light of the circumstances under which they were made. Mark Knight found they were selling unregistered securities but they were not engaging in securities fraud. not misleading  Engage in any business that would operate as a fraud or deceit upon any person in connection with the purchase or sale of any stock o Most of the law around this rule deals with resale of stock or corporate combinations such as mergers rather than at the initial sale o Majors v. the Page 80 of 148 .all people who might buy your stock (probably not enforced) o Prospectus May Include:  Description of business. you are sill subject to CL fraud and Misrep o An investor can bring K claim of misrep to rescind her K to buy stock o Or bring a tort claim of fraud for damages • 10b-5 covers all securities (there are no exemptions) and applies an antifraud rule o Comes from 1934 act • 10b-5 o Unlawful for any person directly or indirectly by use IC. the property is either foreclosed and bought by the government or the holder of the tax lien now owns the property. The government sometimes sells the tax lien for the cost of the taxes and some of the interest that’s due. and you sell a security without registering.  What property you own.  Material transactions involved with your directors. then you are usually not required to register with the states – SC USA. or determine if the securities offered are “good” investments. you are still subject to the anti-fraud provisions. the owner usually has a 1-3 year period to pay the taxes that are due as well as the interest and penalties. Practically make you tell the world that you are stealing. your sale is unlawful  Registration Rule: Even if the co. there are also SC registration requirements. and therefore have a “federally covered” security.” This is when you can start selling. The SEC staff reviews registration statements and declares them effective if companies satisfy disclosure rules. If the taxpayer doesn’t pay within that time period his or her taxes. does fall under an exemption. is selling securities to  Legal proceedings involving company and its officers or directors  Where the $ is going to go  What the risk is in investing in this company  The SEC does not evaluate the merits of offerings.  Competition  Info regarding officers and directors and their compensation.  The SEC’s job is to review all documents to make sure that the corporation has made full disclosure of all factors an investor would want to look at – “The SEC staff reviews registration statements and declares them “effective” if companies satisfy disclosure rules.  If you are a public co.  However.  In addition to federal registration requirements.  Registration Rule: Basic deal is if you’re not subject to an exemption. they can require the company to make disclosures that would likely make it impossible to sell your stock. SEC (SC 2007)  People in MB were selling tax lien certificates. The key date is the “effective date. if something doesn’t seem right.o Preliminary o Final o The prospectus must be delivered to all offerees. Two issues: claimed they were selling unregistered securities and they were engaging in securities fraud. Within a three year period.  Who the co.

and TLA assists in those sales • You pay the county the taxes plus interest. makes the deal that if that happens the tax lien holder owns half of the house and TLA owns half of the house. then the property is either foreclosed by the government and sold. and then you own the property – if this occurred. o If the Principle sells any of the liens. in general and any interest or instrument commonly known as a security o Also includes any profit-sharing agreement  Possibility #1 is that this is an investment contract. Π is president and sole shareholder of TLA.but it will be a lower amt then the taxpayer owes • Then the tax payer has to pay you the full amount what he would have owned anyways – so you make money on the difference of what you paid  But sometimes the taxpayer doesn’t pay. • There was an investment of money in this transaction. and then you can sell the property  You can loose out if the taxes are worth more than the property o SC Sec Commission saw this as an investment K. Under the Howey test. (iii) with an expectation of profits garnered solely from the efforts of others. or the holder of the tax lien owns the property  People normally cant pay these liens off. • The three things that might be a common enterprise are vertical or horizontal commonality or both. But if not. In this case. the Principle keeps all the monies. If the lien is redeemed. First sub issue o Commission did have authority to issue a cease and desist order under § 35-1-60 Second sub o Violation of DP because Commission had already issued the order before giving a hearing and had thus developed an interest in winning o WRONG – there was no violation of DP o The Hearing Officer had no direct involvement in the case even if the Commission did  DP is only violated when the admin officer who is involved in the investigation is also involved in the adjudication o So its ok that it issued the first order and then investigated because a non involved member was later appointed Security o If it is a security. People are buying these certificates with cash. so the county wants money and will sell the tax lien to people. TLA says it owns 50% of the property. it must be registered or exempt o Defined as any certificate of interest or participation in any investment K or. (ii) in a common enterprise. TLA.  The way you can lose on this is if the taxes were worth more than the value of the property. The problem is that sometimes the homeowner will elect not to pay the taxes and then the tax lien holder owns the house. TLA get 50% ownership  So basically the principles invest money that TLA uses to by title lien certificates (TLC) these were all over the country. TLA gets first right of refusal o TLC  Tax payer defaults  State puts lien on the property and the owner has 2-3 years to pay it off plus penalties and interest  If he doesn’t pay it off. Page 81 of 148 .o o o o o o homeowner will pay off the debt to the owner of the tax lien certificate. Vertical might be divided into two parts. an investment contract exists where there has been (i) an investment of money. the company. a SC corp o TLA is a purchasing agent of tax liens for its Principles o For each one it buys on the principals behalf TLA gets a cashiers check made payable to the County Treasure for Tax Liens o Complicated process. and thus a security that has to be measured  The other way this could be a security is that it is a profit sharing agreement – the opinion doesn’t talk about this much  Side note – 33-1-102(29) if freaking broad – any note! The ∆ alleges that Π is selling unregistered securities and engaging in securities fraud o Gave Π a notice of a right of hearing o The hearing officer found that Π was selling securities because all the K’s it had with its many principals were investment contracts Major Issue – was Π’s investment opportunity a security  The court held that the sale of tax lien certificates is a sale of securities that requires registration in SC.

The language in the opinion signals that is true.  To have horizontal commonality. They look at § 35-1-102(29)(D): “a common enterprise means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment. Almost every limited partnership interest will be a security. That is what they did not do correctly. Do the others have to do everything and I do nothing? The courts have said that is not what is required. The courts have further identified two kinds of vertical commonality: broad vertical commonality and strict vertical commonality. Do the shares have to be registered with the SEC and SC? The answer is Page 82 of 148 . o As a general guide. so because this exists under the current facts. form the "essential managerial efforts which affect the failure or success of the enterprise. Investment contracts may be found where the investor has duties that are nominal and insignificant or where the investor lacks any real control over the operation of the enterprise. he would have had to have pooled the investors money to purchase the TLC • Courts have struggled whether a vertical or horizontal commonality is needed or both • Vertical – pooling of the interests of the developer and each individual investor • Horizontal – also requires pooling among the investors – ie investor uses funds from several investors to buy one security • There are two kinds of Vertical o Broad. The key determination is whether the promoters' efforts. o Every state will accept horizontal commonality. there is a common enterprise – 331-102(29)(D) – spells out that we apply strict vertical commonality and we also allow horizontal commonality – so both • The third part of the Howey test is the efforts of others. vertical commonality requires only a pooling of the interests of the developer or promoter and each individual investor. you need to know if it is a member run LLC (if member run the third element might not exist under the Howey test) or a manager run LLC. • Π claims Commission erred in applying a strict vertical commonality test – wrong o Horizontal commonality is not here because the Π had individual K and investments with each principal that resulted in one title lien certificate for each investor. "Strict vertical commonality" requires the fortunes of investors be tied to the fortunes of the promoter.” Thus. not that of the investors. o The question is what kind of vertical commonality would work if anything? The court says that since this case was tried the legislature has amended the statute and has spoken as to the issue.fortunes of investors need be linked only to the efforts of the promoter – where investor provides the money and the broker invests it o Strict. then its not a security – ie efforts of others • If you set up a professional corporation for five doctors and they each invest money in their own professional practice and they are going to set it up as a PC and each doctor will receive from that PC shares of stock in the professional corporation. See § 35-1-102(29)(E).  Π asserted that the principals had a say in the TLCs and therefore were not solely dependant on the efforts of others  BUT This is a relaxed prong  As long as the Πs efforts form the essential managerial efforts which affect the failure or success of the enterprise – which they did here  The key determination is whether the promoter’s efforts not that of the investors form the essential managerial efforts which affect the failure or success of the enterprise • They failed to register with the state of SC. For an LLC. • Howey Test is applied to LLC and limited liability partnerships and probably general partnerships if one doesn’t act as a manger • For the LLC you must look to see if all the members are running it – if so.requires the fortunes of investors be tied to the fortunes of the promoter – exwhen there is profit sharing between the two ( so are you linked with their work or with their profit) • Strict is adopted. and maybe a general partnership. • You have to go through the same three steps for interests in a limited partnership. a third party.o An example of horizontal commonality is if you used several different investors to purchase one TLC. the court adopts strict vertical commonality as the test. To establish "broad vertical commonality. a limited liability corporation. while "horizontal commonality" requires as well a pooling of interests among the investors. or other investors. You as the investor can have some involvement in the transaction and that doesn’t defeat it from being a security." the fortunes of the investors need be linked only to the efforts of the promoter. Horizontal commonality is the pooling of investor funds and interests. Vertical commonality is the dependence of the investors' fortunes on the success or expertise of the promoter.

but Burkhard thinks it is important b/c of the definition below)  § 35-1-102: a security means any note. what I am usually doing is asking if there is an exemption at the state and federal level. debenture.  Possibility #2 is that this is a profit-sharing agreement (this disappears from the opinion. bond…INVESTMENT CONTRACT • Investment contract brings business relationships like partnership interest into the area of securities • Interest in an LLC o If member run.SC Securities Registration Requirements  35-1-102(29) defines a “security” • Note." • Ralston Purina – co. security future. wanted to allow their employees to buy stock at a discounted price/bargain price. with 4(2) being your last safety net!!! Never rely on 4(2)!  Reg D Exemptions –See Chart • Note that all regulation D registrations require notice of sale to be filed with commission within 15 days of first sale. stock. certificate of interest in a profit-sharing agreement.SEE Chart o Amount: Limited to $5M in a 12 mo period o Eligible issuers: No issuers involved in past securities wrongdoings Page 83 of 148 . doesn’t necessarily have to be called a prospectus or have all the exact same information as long as the same type of information is provided o Manner of offering o Absence of redistribution • Lawyer Tip: Try to structure your deal such that your offering has another exemption. the interest is a security  35-1-810: Registration of SC Securities • Must be registered in SC to sell a SC security unless it is federally registered Common exceptions to federal registration requirements – PLI Article  § 4(2): Private placement exception . you are NOT deemed to be a Fed Covered Security. evidence of indebtedness. • This case is still sort of the gospel even though it’s really old • Issue: was this offering public – Supreme Ct says that this offering does not qualify as an exemption under 4(2). treasure stock. etc. • In order to come within Section 4(2): Qualifications of a Private Placement: o Must look at everyone who is an offeree. So. collateral trust certificate…investment contract. stock.  Burkhard thinks the court could have also said this was a certificate of interest in a profit-sharing agreement  Look up article on security exemptions and a table on Reg D on Westlaw and look at the securities problem and read Leventis case Chapter 35 .o o yes unless there’s an exemption. not just purchasers o Offeree qualification – each offeree must be sophisticated investors o Availability of information –must have access to the same type of information that would have been made if the offering been public. • If you qualify under Reg D. not a security o If manager run. still have to meet state requirements • Rule 504 -See Chart!!! o Amount: Limited to $1M in a 12 mo period o Eligible issuers:  No Exchange Act or “Blank Check”  Not available to development stage corps with no business plan  No large publicly traded corps  No investment companies • Rule 505. bond.provides an exemption for transactions "by an issuer not involving any public offering.

that may get them in trouble). o Persons whose net worth (or joint net worth) exceeds $1 million.Intrastate Offering – page D19 • The exemption was intended to apply only to issues genuinely local in character.a lawyer may try to end run the regulation process by saying all the buyers or offerees will become partners or executive officers. o Offeree restrictions:  Unlimited accredited  Not more than 35 unaccredited  Investor Qualifications: sophisticated  All unaccredited investors must be qualified by having financial knowledge such that he can evaluate risks/benefits • Rule 501(a) . • Persons claiming the availability of the rule have the burden of proving they have satisfied all of its provisions. § 4(6) exemptions • Eligible issuers: no restrictions • Amount: no more than $5M • Offeree restrictions: accredited investors • Method restrictions: no general solicitation • Must file some notice with the SEC Regulation A offerings • Limited to no more than $5M in a 12 month period • Number of offerees: no limit • Resale restrictions: none • Must be non-publicly traded US or Canadian company • No securities may be sold before the actual registration • Registration requirements: must make a mini-registration to SEC with offering statement • Must include offering circular to offerees Rule 147 . which in reality represent local financing by local industries.   # Offeree restrictions: Unlimited accredited Not more than 35 non-accredited o Registration requirements:  If purchased only by accredited: none  If purchased by non-accredited: see List on sheet.Accredited Investors. and is expected to exceed that amount in the current year. o Persons whose individual income or joint income with spouse for each of the past two years exceeds $200. executive officers or partners of the issuer (this is the troubling one. respectively. o any entity with total assets in excess of $5 million. • Eligible issuers (must meet all):  Company must be resident of same state as offerees (see D20 for more specific requirements)  Issuer must derive 80% of gross revenues from operations in the state  At least 80% of issuers assets must be located within the state  At least 80% of proceeds from offering must be used within the state  The principal office of the issuer is located in the state • $ amount: no limit • Offeree Requirements: All offerees must reside in the same state as the issuing company o   Page 84 of 148 . carried out through local investment.000.000 and $300. • Rule 506 (this is the 4(2) safe harbor) o Amount: No Limit o Eligible issuers: None. o directors. (8 categories of potential investors who will be deemed to be "accredited" for purposes of Rule 505 and 506 offerings) o certain types of financial institutions.

Must obtain a written representation from each purchaser as to • Manner of offering: no restriction as long as offer is only made to residents of the state. no solicitation. if the transaction is part of a single issue in which • Not more than 25 purchasers are in SC during a 12 month consecutive period other than specified by the above bullet • A general solicitation or general advertising is not made in connection with the offer to sell or sale of the securities • A commission or other remuneration is not paid or given directly or indirectly to a person other that a broker-dealer registered under this chapter or an agent registered under this chapter for soliciting a prospective purchaser in this State. no commissions paid • 10 – Limited pre-organization subscriptions o Exempt if there are less than 25 subscribers o There is no remuneration paid for soliciting a subscriber o No subscriber makes a payment prior to filing articles of incorporation o Note: this section being eliminated in the revised statute Page 85 of 148 . residence = Ex . individuals.principle office must be in SC. Dahl o SC is guided in defining the term security by federal cases interpreting the 33 Act o Look at economic reality. D1) o Reread them – explains the Howey test in Majors. and the issuer reasonably believes that all the purchasers are purchasing for investment  Sell or offer to sell to • An institutional investor • A federal covered investment advisor • Any other person exempted by rule adopted or order issued under this chapter  A sale or an offer to sell secured by or on behalf of an issuer. AND • the issuer reasonably believes that all the purchasers in this State other than those in paragraph 13 are purchasing for investment  35-1-320: Exempt Transactions • 1-8 . not the form of the security  2 Types of Exemptions in SC: • 31-1-201 – Exempt Securities • 31-1-202 – Exempt Transactions o (13): may sell to an institutional investor or a federal covered investment adviser o (14): no more than 25 purchasers over 12 months. no general solicitation or advertisement.o principal residence) o o his residence corps: residence = principal office. however an inadvertent bad offer can spoil the deal • Resale Restrictions: May not be resold for 9 months except to resident of same state • Registration requirements: None o SC Registration exemptions – SC USA  Must meet federal and state exemptions Official Cmts to 35-1-102 (p. o Risk capital test – there is a security when an investment is subject to the risks of an enterprise with the expectation of profit or other valuable benefit and the investor has no direct control over the management of the enterprise o You can be a seller of securities without being the owner if you solicit a purchase and are motivated in part by the desire to serve your own financial interest or the interest of the seller – Pinter v. no commission to anyone other than the broker-dealer.not important • 9 – Limited offerings o Must meet residency requirements of Rule 147(c) – intrastate company and offerees o Offered to no more than 25 people  Important: the commissioner can modify this exemption  Commissioner has narrowed this to less than 10 purchasers (see below).

$ contributed by later investors generates artificially high dividends for the original investors.  Integration • • Commissioner Rule . Cowburn sued the lawyer for securities violations. as it was described to Cowburn. you got to make sure they all live here o Make sure you disclose enough to avoid fraud o Yes. high interest rate notes and bonds for the purpose of funding the automobile title lending industry o ∆ atty talked him into it  He set up an account at Fidelity National Bank which allowed the Bank to invest in the program o Program got busted as illegal Ponzi scheme and Π lost money.so he sued bank and atty o Does the Security Act apply o Yes the definition of security includes any note or bond. then we look at the following factors  Are the offering part of a single plan of financing  Do the offerings involve issuance of the same class of securities  Are the offerings made at or about the same time  Is the same type of consideration to be received and  Are the offerings made for the same general purpose Shrimp Boat Problem Is he exempt under Fed Regs • Reg D o Does it comply 504 –  Problem with the advertising  Advisable filing requirement to the SEC of the prospectus and he doesn’t want to file anything o So NO • 4(6) – accredited investors o No – the advertisement • R 147 o No prohibition on ads o May not because the advertising will go outside of SC – but you can get around it by saying offers only good to SC residents o But one issue is that Offers can only be made to SC residents as well – so when talking with people. o The Program. Ponzi scheme . Notes are considered “Securities” under the SC USA. which in turn attracts larger investments. Leventis (SC)  Facts: Cash for title program. The Π received both of these for his investments into the program.so that you are exempt if there are less than 10 purchasers • No solicitation: You can’t have general solicitation or advertising • no commissions/renumerations: The person doing the soliciting can’t receive a commission Commissioner Rule 113-21 • You still have to file with the state commissioner o two or more issues can be integrated and potentially destroy the exemption Two tests o 6 month buffer before and after the offer or sell during which no other issue can be distributed if integration is to be automatically avoided o If a second issue does occur in this 6 month buffer. so his securities were bought o But does the ∆ sale of those securities fall under the act? Page 86 of 148 . Cowburn also raises a Breach of Fiduciary Duty Claim Against Leventis in this case. engaged in the business of issuing short-term. Plaintiff believes Leventis is liable because he is selling unregistered securities (as an unlicensed broker). you can pay broker commissions o No filing required o Does it comply with part C of this rule  Nope if the boat goes into international waters or Ga waters (would have to stay in SC waters for the exemption to work) • So you try and rely on 4(2) o But it’s a crap shoot and you need to know a lot about the offerees Cowburn v.113-22 • Narrows 35-1-320(9) – limited offerings.

o

o

o

o

 The act does provide a private action for fraud o There was a violation of the Act because ∆ failed to register these securities FN2. Section 35-1-1490 states that any person buying a security from someone acting in violation of sections 35-1-410 or -810 may "recover the consideration paid for the security, together with interest at six percent per year from the date of payment, costs, and reasonable attorneys' fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security. Damages are the amount that would be recoverable upon a tender less the value of the security when the buyer disposed of it and interest at six percent per year from the date of disposition."  Issue #1: Were the short-term promissory notes from Leventis considered “securities” and if so were they exempt from registration? • If the security is NOT exempt - Leventis will be required to pay the $ back that the other guy lost.  Holding: Yes – the statute says notes are securities. There are two kinds of notes – short-term (9 month) and long-term (several years). Court finds that these long-term notes are not exempt as rollover transactions. • Questions of fact as to whether he is a seller or broker and whether the securities are exempt  Section 35- 1-310(9)exempts short-term commercial paper from the registration requirements of  Some of Π’s investments were short term commercial paper, but some were not- so there is no exemption  ∆ claims these were rollover transaction – but they aren’t because the Π didn’t invest with the same issuer each time • "[a]ny transaction pursuant to an offer to existing security holders of the issuer, including persons who at the time of the transaction are holders of convertible securities, [is an exempt transaction], if (a) no commission or other remuneration, other than a standby commission, is paid or given directly or indirectly for soliciting any security holder in this State or (b) the issuer first files a notice specifying the terms of the offer and the securities commissioner does not ... disallow the exemption...."  Issue #2: Is Leventis Acting as a “Seller” An "offer to sell" securities is defined in section 35-1-20(13)(b) as "every attempt or offer to dispose of, or solicitation of an offer to buy, a security interest in a security for value." In this case, Leventis' role in the Program went beyond simply recommending an investment to a friend; rather Leventis played an integral role in the Program o Evidence supports a finding that he did make an offer of sale  Holding: yes he is a seller; Court also finds that Leventis is a broker – still argues that the securities are exempt and the court says this won’t get him out of trouble b/c they’re not sure if the securities are exempt  To be a seller, Leventis does not have to own the notes and then transfer title to a purchaser – other factors show that he is considered a seller • Has introduced investors to the program • Received referral fees – this is probably what got the court’s attention • Provided investors with appropriate forms • Regulation 97003: requires brokers to file some papers, which Leventis did not do (this regulation is probably no longer in existence) • Questions of fact as to whether he is a seller or broker and whether the securities are exempt So there is a real issue of fraud, and also that ∆ didn’t register as a broker – so SJ shouldn’t have been granted o Section 35-1-20 defines a "broker-dealer" as "any person engaged in the business of effecting transactions in securities for the account of others or for his own account" and an "agent" as "any individual, other than a brokerdealer, who represents a broker-dealer or issuer in effecting or attempting to effect purchases or sales of securities." Issue #3: Was Leventis a Broker and if so, was he exempt? o Broker: Assists in the Sale o Defense: Although I might qualify, since I am selling exempt securities, I haven’t run afoul of the statute. o Didn’t file so there is no protection under regulation. o Coburn brings break of fiduciary duty. Burkie says lawyer may have made a tactical mistake. o Brings this against him as the broker RATHER than as his role as an attorney. Presumably, defense would have been that Leventis wasn’t his attorney. Burkie says this defense is weak because courts focusing on what is “reasonable expectation of the client” and it would be a reasonable expectation on Coburn’s part. Page 87 of 148

o

∆ argues he is exempt from registering because he only dealt with exempt securities- but there is an issue of fact about this as explained above – ie they aren’t exempt so neither is he o ∆ also argues that he is exempt from registering because he acted on behalf of the company and didn’t except payments – court says he didn’t comply with the requirements of this section o Also another argument that the company was a class D company that is exempt from registering securities- but this wasn’t argued at trial o But fraud claim’s dismissal was upheld because Π failed to specify any misrepresentations o Cowburn argues there was a material issue of fact regarding his claim that Leventis owed him a fiduciary duty, violated that duty, and acted negligently. Cowburn maintains Leventis's duties to him arose because Leventis acted as a seller of securities, and Leventis breached this duty by failing to investigate investments under the Program. We disagree. o A broker or dealer of securities is an agent of the buyer, and therefore, generally owes the buyer fiduciary duties. These duties often include the duty to account for all funds and property belonging to the buyer, to refrain from acting adversely to the buyers interest to avoid engaging in fraudulent conduct, and to communicate any information he or she may acquire that would be to the buyers advantage. However, Cowburn has not cited any case that imposes a fiduciary duty upon a broker to investigate for any unknown potential risks of investment. • So no duty on broker to investigate into the wiseness of the investment  Leventis is an attorney. He brings the breach of fiduciary duty action against him in his role as broker rather than his role as attorney. Burkhard says to watch out for this. Did the client think you were representing him? If it had been pursued this way, it seems like Cowburn would have had a much stronger claim. o Gordan v. Drews (SC)  Facts: Drews was going to start a hardware store in West Ashley, but they decided they needed shareholders. Drews went out and solicited potential buyers and got 11 shareholders. Gordan was one, and he bought in after assurances that a loan from the SBA was “in the bag.” Gordan sued under the SC Security act 35-1-810, and Drews tried to defend that he was exempt from registration  Issue: Was his offering exempt under 35-1-320 – as a limited offering?  35-1-1490 - creates liability for the seller of stock in violation of registration requirements, and he is liable directly to the person who he sold the stock to, so Drews is hosed if he can’t find an exception  Holding: Not exempted under 35-1-320 • To be exempt, Drews would have had to OFFER to less than 25 people, and he couldn’t prove that he offered to less. • Even with the changes with 113-22 he would have been in bad shape because they got 11 purchasers • Drews also tried to defend in that he received no remuneration. • Received remuneration: However, there was a plan where he’d get ½ share for every share sold (to retain voting control), and the court said that this was remuneration  Not a seller defense: • TEST to determine “Seller” of Securities • solicit the purchases • be motivated at least in part by a desire to serve either his own financial interest or the interest of the owner of the security he is selling  Holding: In this case, he got a ½ share for every share sold, so he was clearly soliciting and motivated, so Drews was liable for the sale  Important note: the remedy included the loss on the security as well as lawyer’s fees for the purchaser  Unique SOL on securities transactions (Ct talks about Laches which Burkie thinks doesn’t have any real bearing on the case) Common Law Fraud and Misrepresentation and Rule 10b-5 Constraints on Stock Issuance o No transfer of stock is protected from Rule 10b-5, the securities anti-fraud rule promulgated by the SEC. Every securities transaction lives under its protective shade. o 10b-5 provides: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or the mails or of any facility of any national security exchange,  (a) To employ any device, scheme, or artifice to defraud  (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or  (c) To engage in any act, practice, or course of business o Page 88 of 148

which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale This is different from the common law fraud requirements because silence is actionable under 10b-5. The cases that apply 10b-5 are primarily non-disclosure cases. o See problems on p. 336 o Rule 10b-5 does not require that the issuer be the bad guy o See outline in a couple of pages o How do owners of a corporation make money? o Typically, the decision about what to do with earnings for the year goes to directors (majority of the board of directors) o Problems on page 340 o Majority of the Board o Same o SHAREHOLDER OPPRESSION o Who decides which shareholders get salaries o Often, in a small corporation, people buy shares with employment as the only guaranteed return. Over the years, both legislative and judicial efforts have been made to ease the plight of the oppressed close corporation shareholder. Two significant avenues of relief have developed. First, many state legislatures have amended their dissolution statutes to include oppression or a similar term by the controlling shareholder as a ground for involuntary dissolution of the corporation. Moreover, when oppression is established, actual dissolution is not the only remedy at the court’s disposal. Oppression has evolved from a ground for involuntary dissolution to a ground for a wide variety of relief. Particularly in states without an oppression-triggered dissolution statute, a second avenue of relief has developed for close corporation shareholders. Some courts have imposed an enhanced fiduciary duty between close corporation shareholders and have allowed an oppressed shareholder to bring a direct cause of action for breach of this duty. o Salaries do not qualify as distributions. Distributions are considered to be dividends and stock options. See SC 33-6400 but this doesn’t cover salaries o Hollis v. Hill (S/H Oppression Case) –MA law applied (p. 341)  Hill and Hollis were both 50% owners of a corp. that made loans. Hill didn’t think Hollis was carrying his weight. Hill stopped paying Hollis’ salary and proposed a buy out which Hollis rejected. Hill stopped sending financial reports for a while. Then the business went really bad, and Hill reduced Hollis’ salary to zero again. At the time of the lawsuit, the company’s value had declined to $100,000.  Issue: Hollis sued for shareholder oppression. The question was whether Hill owed a duty of loyalty to Hollis, and whether a buy out was the proper remedy.  First, note that the Texas court applied the internal affairs doctrine and applied the law of the state of incorporation: Nevada (doesn’t have an oppression statute or case law, so they have to look at the law of other states) o Internal affairs of the foreign corporation, “including but not limited to the rights, powers, and duties of its board of directors and shareholders and matters relations to its shares,” are governed by the laws of the jurisdiction of incorporation o NV does not have a statute for oppression. (most states allow petition for dissolution when there is oppression) So the court turned on principles of duty o FFUSA seems to be more of a partnership than a corporation so court imposes fiduciary duties akin to a partnership. Ie two shareholders at 50% and splitting the managerial duties o Because NV doesn’t have any laws on point, it doesn’t necessarily mean that we will automatically find a duty exists. Court declined invitation to apply law of DE, instead applies a series of cases out of MASSACHUSETTS .  MA Rule: Duty of S/H to other S/H: Court followed Massachusetts law and found that there is a duty between shareholders in a close corporation that is the same as the duty between partners, so Hill had a fiduciary duty to Hollis. Shareholders in close corporations owe each other a duty of utmost good faith and loyalty.  They argued that there was a legitimate business reason to do what we did. When a legitimate business purpose exists, the minority shareholder must be given an opportunity to demonstrate that the purpose could have been achieved through means less disruptive to shareholder interests.  STEP 1 (Wilkes test): Determination as to whether a fiduciary duty to pay the S/H a salary existed: you would have to show that the shareholder’s interests in the investment took the form of employment. • FACTORS: • Whether the corp typically distributes profits as salaries. • Whether the shareholder/employee owns a significant percentage of the corps shares. • Whether the shareholder/employee is a founder of the corporation. • Whether his shares were received as compensation • Whether the shareholder/employee has made a significant capital contribution o o Page 89 of 148

then dies. they have to show they acted with fairness. o The court found that the corp never paid dividends.  Brodie v. from being disguised as salary. • Unless she’s bought out. What are the legal limitations on salaries o Exacto Spring v. stops paying her. Wife brings claim under Donahue-Wilkes rubric. • MA cuts back a little bit. Commissioner of IRS (Fed – Tax Ct) (p. 353) o Facts: IRS brought suit against Exacto Spring to show that they were giving an excessive salary to their CEO and principal owner (which is deductible) instead of awarding dividends (which are taxable).(Wilkes test) • BOP on P .Plaintiff must allege that the defendants have done something bad – here. which was when Hollis’ salary was reduced to 0. After that. Burkie notes that Grady states that if directors act on both sides of a transaction (which is essentially what Hill was doing). o Issue: Was the salary reasonable? o Trial court applied this test: Director Salary Reasonableness Test: 7 Factors:  Type and extent of services rendered  Scarcity of qualified employees  Qualifications and prior earning capacity of the employee  Contributions of the employee to the business venture  Net earnings of employer  Prevailing compensation paid to employees with comparable jobs  Peculiar characteristics of employers business o Court does not like the test the lower court applied because  They are vague and non directive • Doesn’t say what weight is to be given to the factors • Also they don’t tie up well with the statute that allows the corporation to pay salary (or to prevent deductions when dividends are being paid out as salary) o That statute is mainly to prevent gifts from being disguised as salary – so as long as services are rendered the corporation can determine what is a reasonable amt Page 90 of 148 • . which are not deductible from corporate income. it’s termination of employment – breach of a fiduciary duty. co. Wife inherits.it’s the need to downsize b/c of lack of business.Ct held that the date to value the company for the buy-out remedy was the date the oppression began. which is. so that without the salary. o ∆ was a close corporation  Paid CEO 1 million in salary  IRS thought this was excessive and applied the excess to the ∆’s income. which doesn’t have shareholder oppression • Although. Jordan – MA Supreme Court • 3 guys ran machine shop. this is a defense o Purpose . the plaintiff has the opportunity to show than the means could have been achieved by a less disruptive means to his interest. Value is in the stock which she now can’t do anything with. • BOP back to P . if the oppressed shareholder has an opportunity to redeem his shares at a fair price.o **Whether the shareholder/employee has shown that he had a reasonable expectation that the return on his investment would be in the form of continued employment • *Exception: There is no breach.If the majority can show that the reason they did that was for a legitimate business purpose.  Same analysis has been seen in SC.When a legitimate business purpose exists. One retires. • BOP on D . or if the corporation redeems his shares for a fair price  STEP 2 . which might come to the same result. • Court says act might have been viewed as oppressive but that doesn’t give her the right to be bought out – she would be getting more than entitled to.  Dissent: NV would not apply MASS law. she’s still stuck in a mess. which meant that ∆ was deficient in the taxes it paid  Trial court found that a reasonable salary was somewhere between the numbers offered by the two parties o The purpose of § 162 is to prevent dividends. however. NV is a mgmt friendly state so they would apply DE law  DE Rule – no S/H oppression • Dissent says that they should have followed Delaware law. so DE might not be that much different from MA. but not necessarily in business cases  Remedy: Buy out . Hollis’ shares were worthless.

without the big salaries.o o o • Also the tax court shouldn’t be second guessing these decisions • Lack of direction will result in arbitrary decisions • uncertainty o Posner . o This Case represents a problem of closely-held corporations b/c:  No market for shares if shareholders are unhappy with executive salaries  Shareholders and directors and officers are often the same people  SS taxes not paid on dividends – this be a good or bad thing. and as such they bore the burden of showing that the transaction was fair to the corporation. The owner pays the manger a salary and in exchange the manger works to increase the value of the assets t that have been entrusted to his management – the increase can be expressed as a rate of return to the owners investment • The higher the rate of return (adjusted for risk) that a manager can generate. and were guilty of oppressive conduct. 356) o Facts: Plaintiffs were minority shareholders. the defendant’s didn’t carry their burden. o Holding: His salary was reasonable  Ct rejected the gov’t argument that low level dividends paid by the co. the company would have been more profitable.  Methods of proof that the increase on return is due to the efforts of the executive.  Indirect market test – a corp can be conceptualized as a K in which the owner of assets hires a person to manage them. indicated that the corp was paying Heitz dividends in the form of the salary.  BOP on D’s b/c they are interested: (they voted big salaries for themselves). o VA View on S/H oppression: conduct by corporate managers toward stockholders which departs from standards of fair dealing. depending on whose perspective is taken into account Giannotti v. Judicial Dissolution Kiriakides v. That’s why both of these cases are included in the book. Plaintiffs sued to have the court dissolve the corp. but we don’t know o Holding: The court relied upon the fact that the “profit per bed” of their nursing home business was far lower than average and found that.  Also important factor in the result is that a bunch of directors who were getting paid nothing voted for the director to get this raise.so evidence of it really being a dividend could make it fail this test o Criticisms of Posner’s analysis & the Indirect Market Test:  Ratios may not be that accurate – nothing says how to establish the baseline projections. o Dissent noted that while profit/bed was low. the greater salary he can command • So the more he is making. and the court couldn’t use equitable powers to arrange to pay back the corporation. o The Hill v. and remit some of their salaries on the theory that the actions were oppressive.  § 33-8-111 might reverse that burden. the more he can be paid o However it must also be a bona fide salary. To comply with the standard. Thus the directors didn’t have to pay back their salaries o The statute doesn’t allow them to just pay a greater dividend to the shareholders and to just say they won’t pay such high salaries in the future. the CEOs salary is presumed to be reasonable  Rule: Presumption can be defeated by showing that the return is not due to the CEOs work (ex – a company finds that it is sitting on oil reserves). Thus. liquidate the assets. this case is based on a statute. and that they voted huge salaries for themselves while not paying dividends.  Ct noted that S/H may not have wanted dividends and instead have wanted to increase the value of the co. they must show that their actions were fair to the corporation. Hollis case is based on common law. overall profitability numbers were through the roof. His salary was approved by disinterested board members. o Remedy: As for remedy. Hamway (VA) (p. They asserted that the defendants controlled the majority of the voting shares of stock. Atlas Food Systems (SC) – S/H Oppression Case Page 91 of 148 .Indirect Market Test: page 355 (“killing the goose that lays the golden egg”)  Hangs hat on fact that the directors that approved the salaries were disinterested in the sense that they were the ones being hurt if anyone was by the payment of these large salaries to the officers  Rule: When the investors of the company are receiving a far higher rate of return than they had any reason to expect. the court looked at the statute and decided that dissolution was the sole remedy.

or  Whether the reasonable expectations of the minority shareholders have been frustrated by the actions of the majority. Plaintiff sued for shareholder oppression. SC rejects NC View on S/H Oppression: focuses on the reasonable expectations of the minority shareholders (like Hollis). which was WAY low. or  A deprivation by majority shareholders of participation in management by minority shareholders. ∆ (Alex) is majority holder and has been in charge of finance and corporate affairs  He controls the board  Alex and Π John had a rift between them and John became distrustful of ∆’s management of the corporation  Alex pretty much ignored John’s impute on the company and acted unilaterally without putting decisions to a vote – and also acted contrary to decisions that were put to vote  John said he was going to quit. However. or unfairly prejudicial to any shareholder. The plaintiff stopped getting along well with his brother who unilaterally made some business decisions without consulting him. Plaintiff was one of the brothers who had a 37% share. fraudulent. including a buyout SC Rule on Opp .  Burkhard says a compromise in SC would be to apply the Wilkes test. He was offered $1 million and an $800 cancellation of a loan for his share.  Before the Kiriakides opinion. or  A breach of the fiduciary duty of good faith and fair dealing. Reasonable expectations test was wrong Page 92 of 148 . He then made it clear that this was not his intention  Alex then told John he was no longer to be president of the corporation.o o o o o o o o Facts: Atlas was a family owned company. You almost have to focus on the expectation of the minority shareholders to recover. the analysis in the case says we cannot focus on the interests of the minority shareholders. Factors the court will look at are:  A visible departure from the standards of fair dealing and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely. you would have said that the SC statute was more protective than the NC opinion/statute. or  A lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members. buyout of his shares.Court will find oppression using the totality of the circumstances on a case by case basis.  33-14-310 • Allows a court to grant relief other than dissolution. but FN 25 then seems to say that we can’t apply it (a court may never consider the parties’ reasonable expectations) SC says this is too broad (really focuses on the reasonable expectations element – burcky says he’s not sure this was such an important factor in the crt app test)  Notes amendment adding “unfairly prejudicial conduct” allows remedy for the frozen-out minority shareholder when there isn’t any fraud • Note policy concern for the oppression of minority shareholder was a nation wide issue and particularly for close held corporations  The meaning of oppressive fraud or unfairly vary from case to case and court looks at case law • Lack of dividends o Not oppressive where suspended for purposes of improving the corporations finances o Yes where suspended to freeze out the minority shareholder • Actions taken to depress value of corporate stock  SC finds the factors listed by the Crt App are too strict bc the Leg didn’t list such requirements Leg didn’t intend for there to be dissolution based on the party’s reasonable expectations  This would require court to look into the intentions of closely held family corps – it isn’t going to do this • Other courts place emphasis on rights and interests of the minority shareholder BUT SC places emphasis on the conduct of the majority – so the Crt Apps. oppressive. Alex’s son then became a board member and president  Alex and ∆ corp then offered to buy out John’s interest • John believed the offer was too low  Π brought suit for accounting. The statute seems to say we can apply the reasonable expectation of the parties. and damages for fraud  Subsequent offer of 4 million was made – Π believes his shares are worth 10 million  Trial court found evidence of fraud and oppression and that a buyout under 33-14-300(2) and 310(d)(4) were in order • This statute allows a court to order a buyout rather than dissolution Court cited to 33-14-300(2)(ii) that allows the court to force dissolution if it can be established that the directors or those in control acted in a manner that is illegal.

not the rights and interest of the minority shareholders as the NC statute says  Criticizes reasonable expectation approach for providing too much protection to minority holder and not requiring a bad faith prong against the majority before holding them at fault  BUT burcky says Toal was smoking some gonga – the SC statute has much more language regarding the shareholder and that you have to focus on what the minority holders lost if you are to determine what the majority did o The court wont define oppressive or other terms absent Leg direction. Page 93 of 148 . The present case presents a classic situation of minority “freeze out. oppressively. the removal of a minority shareholder from a position of management. is totally estranged from John and Louise.o o o Statute focuses on conduct of majority shareholder. majority shareholder in total control of Atlas. or officer of the corporation)  Directors are deadlocked in the mgmt of corp affairs  there exists other grounds for judicial resolution under 33-14-300 • S/H can not commence a proceeding under this section if has agreed in writing to non-judicial remedy • If S/H also has dissenter’s rights with respect to the corp action. for the stock of a close corporation. fraudulently. 4) the fact that Alex and his family continue to receive substantial benefit from their ownership in Atlas. If one of these remedies will solve the problem. the refusal to declare dividends. Common freeze out techniques include the termination of a minority shareholder's employment.” The referee considered the following factors: 1) Alex' unilateral action to deprive Louise of the benefits of ownership in her shares in Atlas. he must commence a proceeding under this section 1st. and 8) the fact that Atlas is not appropriate for a public stock offering at the present time. it has indicated it would not do so in the foreseeable future. there is no such market. o 33-18-410 – ordinary relief  Remedies for oppression basically allow the court to resolve the problem internally without dissolving the company. SC Dissolution Statutes o 33-14-300: The court can grant dissolution o 33-14-310 . and subsequent reduction in her distributions based upon the reduced number of shares. In a public corporation. or unfairly prejudicial to the petitioner (whether in his capacity as a S/H. 6) the fact that Alex. 7) Atlas' extremely low buyout offers to John and Louise. but they are not determinative o Lots of factors are listed at headnotes 11 and 12 o It’s a bigger mess the Higby on a Saturday night after a fifth of tequilla and a shot of jager • Application o This is a classic example of freeze out o Close held corps enable the majority holders to allocate the benefits of ownership arbitrarily o Occurs where the shareholder has a trapped investment and an indefinite exclusion from participation in business returns  This is magnified in close corporations because there isn’t the protection of being able to readily sell your stock • So they are held hostage o Looks at lots of factors that show how ∆ benefited and how o BJR does not apply in S/H oppression cases: directors only get the benefit of the rule when they can demonstrate that they acted in good faith. and the siphoning off of corporate earnings through high compensation to the majority shareholder. oppressive and unfairly prejudicial. director. 5) the fact that Atlas has substantial cash and liquid assets. notwithstanding its ability to declare dividends.Dissolution o 33-18-400 – Court action to protect S/H: a S/H of a close corp may petition the court for any of the relief in 410430 if  the directors have acted illegally. o We find this case presents a classic example of a majority “freeze-out. the minority shareholder can escape such abuses by selling his shares.” and that the referee properly found Atlas had engaged in conduct which was fraudulent. however. very little debt and that. so it must be a case by case determination  They are “elastic terms” o You can consider the reasonable expectations. these tactics are used in combination. 2) Alex' conduct in depriving John and Louise of the 21% interest of Marica stock. 3) the fact that there is no prospect of John and Louise receiving any financial benefit from their ownership of Atlas shares. then order it.320: Procedure for judicial dissolution  allows for appointment of a custodian SC Close Corporations . Often.

it depends on whether it will attract investors When can/must a dividend be paid Definition o The SC code defines anything that goes out to the shareholders as distributions o 33-6-400: Distribution to S/H’s  Board of directors authorizes distributions subject to limitations in articles of incorporation  If record date not set otherwise. it is the date the board authorizes the distribution  You CANNOT make a distribution if • The corporation would not be able to pay its debts as they become due in the normal course of business OR • Total assets would be less than total liabilities of the corporation + the amount due to satisfy the preferential rights of shareholders whose preferential rights are superior to those who receive the distribution  (e) how to calculate the value of a distribution when it is something other than cash. so they do it in salary. then the court may order dissolution o Receiving dividends from the corporation o Dividend is a payment to shareholders by the corporation out of its current or retained earnings in proportion to the number of shares owned by the shareholder o It’s a management decision and most corps don’t pay them (close held corps don’t want to pay them because you would be taxed more. consists of value generated by the business itself  Consists of all earnings minus all losses minus distributions previously paid  This means you are making real money. o 33-8-330: Liability for unlawful distributions  A director who votes for a distribution that violates the distribution rules is personally liable to the corp for anything over the amount that would not have violated the rule IF it is shown that he didn’t act in accordance with 33-8-300: SC BJR  The director can get contribution from every other director who could be held liable under  (a) as well as every shareholder who accepts a distribution knowing it violated 33-6-400 Modern approach: so dividend is valid as long as the corp is not insolvent and the dividend doesn’t make it insolvent Traditional approach (NY and Del) Requires references to different funds or accounts o Earned Surplus (Retained Earnings)– net income retained by the company. o 33-18-420 – extraordinary relief  If ordinary remedies don’t work those remedies won’t work. order the company to buyout the complaining s/h – intermediate step. this is true because most corporations are closely held with salaried employees so they don’t want to pay double tax. every corporation will avoid paying dividends if at all possible  Many publicly traded companies do pay regular dividends. but it’s a decision based on attracting investors o Two views  Paying them may attract more investors making the company more valuable  Not paying them demonstrates confidence that it has attractive investment opportunities that might be missed if it pays dividends o Creditors will complain if the corporation pays out too much in dividends  Most corporations do not pay dividends.000 shares at 2 par = at least 20K and this goes to the stated value o This cannot be used to pay dividends because it is a cushion for creditors Page 94 of 148 . o 33-18-430 – dissolution  If the internal remedies and the buyout won’t solve the problem. and it is a proper source from which to pay dividends Accounts from sale of stock o Stated Capital  Par value of a par issuance plus the amount allocated to stated capital on a no-par issuance • Par means minimum issuance price – if you are selling stock at $2 par value – you must receive at least 2 per share o So 10.o o o o o o • Reversal of action • Termination of office or director • damages • pmt of dividends • etc…. and most corps are close corps) – but its more common for the big boys to pay them o Most publicly traded corps do pay dividends.

he didn’t carry his burden and lost like the big fat loser he was.  But concerning dividends. o Holding: The plaintiff was able to show that the company could have paid a higher dividend. stated capital can’t be used for a distribution o Capital surplus: additional amount from sale of stock over the par value. 370) o Facts: Sinclair had a subsidiary. he said that the American public would benefit from his making cars as cheaply as possible. and plaintiff. Ford kept the cash in the company and paid high salaries and had lower profit margins (but made an assload of cars). Notes o Some criticize the court’s approach to the duty to minority holders – it reduces it to not intentionally harming the minority holder rather than encouraging active pursuit of their interests o Case mainly just shows what to consider and how to approach a claim of oppression for failure to pay dividends o There are no cases were a court has ever forced the board to pay dividends  Exception is the Dodge v. Sinven paid out huge dividends (which go back to Sinclair). pointing to documents that they didn’t rely on any documented financial analysis. Plaintiff thought the motivation behind the dividends was Sinclair’s need for cash. He basically conceded the main point. However. Thus. o Stated capital: par value of the issued stock. He could have testified at trial that he wanted to use earnings to make cars less expensive and to pay higher wages to increase profits. o Court thought this behavior made no business sense. Zidell (OR) (p. Sinven. 366) o Facts: Defendant owned 3/8 of the stock of a closely held corp.Parent/Sub Case (p. the P is arguing that the directors did not really make their decisions on the basis of the factors they claimed to. In this case. When his demand for a raise was refused. the court said it wasn’t enough and found them liable. while Sinclair owned the rest. as a minority S/H.• But par is set at 1 cent to avoid the restrictions of the stated capital fund Capital Surplus  Whatever is raised in excess of the par value can be used to pay dividends o In a no-par issuance o There is no par value and the directors are free to allocate funds from stock issuances to either stated capital or capital surplus o But if they do nothing. o The defense in Van Gorkam was that we knew the corporation. Levien (DE). money made from running the business that hasn’t been distributed as salaries. Sinclair had total control over the directors of Sinven. In Van Gorkam. He would have won. he didn’t show that the dividend paid was so small as to be unreasonable. so it doesn’t matter that we didn’t study all the reports. he quit. and as such forced Henry to pay dividends o Sinclair Oil v. Then he demanded that the corp pay dividends. that duty is met if the decision is made in good faith and reflects legit business purposes rather than the private interests of those in control o BJR . brought a derivative suit because he thought Sinven lost opportunities for not having cash on hand.BOP on P – complaining S/H must show that the decision was not made in good faith and did not represent legitimate business purposes o The result might have been different if he had argued that their salaries were too high. He then complained that the dividends were too small and not set in good faith. Instead. can be used to pay a distribution o Zidell v. Ford case o Dodge v. under the traditional approach. etc. the funds automatically go to the stated capital and cannot be used to pay distribution o three common types of distributions o dividends o repurchases o redemptions o can be paid in money or property o SO a company MAY pay distributions o In a Traditional approach when it uses only capital surplus funds or earned capital o In a modern approach as long as it isn’t insolvent or would become so o Earned surplus (retained earnings): consists of value generated by the business itself. o Ford had legitimate business reasons to use earnings for purposes other than paying dividends including expanding facilities and paying high salaries.  Claims that the corporations had large retained earning and that the actions of the majority shows a concerted effort to deprive him of his right to profits o OR Rule: Co’s have a duty of good faith and fair dealing toward minority shareholders. and was employed as a director. The BOP might not have fallen on the P. Plaintiff held 3% of Sinven. Ford Motor o The only known case where the court required payment of dividend to shareholders. The court doesn’t buy that. o Page 95 of 148 .

We have to ask whether Sinven was injured instead of the minority shareholders. but its been 3 years since dividends were last paid out – so 4 years worth are to be paid = 8 per share before the CS gets a cent • Leaves 24K for the 10000 CS = 2. o App  Sinclair caused Sinven to pay out so much that it became a corporation in dissolution  Π concedes that the dividends were in compliance with the statute but were improper because they were motivated by Sinclair’s need for cash  Court says this isn’t enough since the statute was complied with – they will have to show that the decision wasn’t grounded on reasonable business objectives – BJR o Rule: Court said that the intrinsic fairness test only applies in cases of self-dealing (Sinclair is getting a benefit that the minority shareholders aren’t getting).40 per share o Preferred participating stock not only gets paid first (because it is preferred). o § 33-8-310: there is a conflict of interest in this case under 33-8-310(b)(2) because these directors are not disinterested so that their votes can cure the conflict. Therefore. the court applied the BJR and the P’s lost.Securities act of 1934 o It is unlawful for any person by the use of any means of interstate commerce in connection with the purchase or sale of any security  To employ any device. where BJR – BOP on P. or artifice to defraud.000 (10 CS and 2 PPS) = 3 per share • CS = total of 3 per share • PPS – total 5 per share  PPS – is not cumulative. Since intrinsic fairness wasn’t applied. Sinclair was not self dealing. which causes the DOP to shift and for it to meet a test of intrinsic fairness – ie under careful judicial scrutiny that its transaction with Sinven were objectivly fair  Sinclair argues the BJR should apply and not the intrinsic fairness test with its shift in BOP o Plaintiffs argued for the court to apply the “intrinsic fairness” test to the dividend. not the shareholders • So court is inconsistent with the principles of a derivative suit o * Note: Intrinsic Fairness Test – BOP on Directors – applies to Self-Dealing. scheme. but different classes can have different rights o Buying and selling stock at a profit o Common law Fraud and Rule 10b-5 o Rule 10b-5 . Participating thus means that these shares also get paid. which would place the burden on the directors to show that the dividend was fair to the corporation. The court technically should have focused on Sinven. along with the common shares. Would take precedence over common shareholders. So they get paid twice!  Ex – PPS gets $2 preference • There are 2000 PPS and 10000 common stock • Declared dividends = 40K • PPS – first paid out $2 per share = 4k (2000 * 2) • = 36K left / 12. the holders would still only get 2 per share o Common stock o Preferred stock: paid first o All the shares in a particular class must have the same rights. in what is left over after payment of the preference. so the determination whether there was self-dealing that injured the ∆ . they don’t get the benefit of the business judgment rule and the SC court would likely come out the opposite. even though they have approved it. the injury is supposed to be to the corporation.we should have looked at injury to Sinven. o If this is a derivative suit.  So same facts as below. since they are not disinterested under the SC statute. o Page 96 of 148 . so if its not paid out one year. and in this case since the shareholders all received the same proportional benefit. Types of stock: o Cumulative preferred: if the dividends are to be paid in a certain year and they can’t be paid then in subsequent years those dividends that were missed will be paid when the company has the money to do so. applies to S/H oppression cases. but also gets paid again.o SH claims the corp paid too much in dividends as opposed to too little (they also complained about diversion of business from Sinven to other subs and a number of other complaints) o Derivative action of a SH in Sinclair Oil Corp to require Sinclair to account for damages it sustained when it subsidiary (Sinven) paid out dividends  Sinclair owns 97% of Sinven’s stock • So Sinclair ran Sinven and was basically taking all of Sinven’s funds for itself o Lower court found that Sinclair had a fid duty to Sinven.  But this may be wrong – this is a derivative suit.

 Fraud on Market Theory – only applies to public misrepresentations . o Board resolutions. the price of the company’s stock is determined by the available material information regarding the company and its business. b/c the market reflects this information into the stock price. This states that false public information creates a presumption of reliance for anyone suing on the transaction. – TSC Industries.  In addition: “There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available. Levinson (Federal Case – 10b-5) – Public Cause of Action (p.o o  To make an untrue statement of material fact OR  to omit to state a material fact necessary in order to make statements made not misleading.  Court says these types of presumptions are helpful. o instructions to investment bankers. Also the presumption can be defeated by: Page 97 of 148 . and are common sense. • Probability factors: o indicia of interest at the highest corporate levels. They sold there stock at a lower price than they would have had they known about the merger. and they would have held on otherwise.  The Court remands the case on this issue for reconsideration of the question whether summary judgment is appropriate on this issue. • Magnitude factors: o the size of the corporate entities. – Basic Test o The Management argued that this test should be applied and a line should be drawn: the discussions become material at the point where they have agreed on price and structure. o potential premiums to be paid over market value. Registration exemptions have no effect on whether a transaction is subject to 10b-5 Basic Inc v.  To engage in any act which would operate as a fraud or deceit on any person Note: Any security means any security. They were asked questions and publicly denied that they were in merger talks. even if not directly. o Materiality Holding: Court rejects this argument and indicates the general materiality test in this case should be applied on a fact dependent basis – indicia of interest in the transaction at the highest corporate level  Probability / Magnitude Test .  Only four justices approved of this part of the opinion  Theory that in public trading.The court stated that the test would be a balancing of the probability of the event vs. Plaintiffs brought a class action on the theory that they sold in reliance on the fact that there would be no merger. the significance of the event.the market has incorporated misleading information into it and I have relied on this information. o and actual negotiations. 377) o Facts: Defendant directors of Basic had conversations regarding a merger. o Presumption of Reliance Holding: The court also allowed reliance to be shown with a “fraud on the market” theory. but the realities of modern market means that the concept of reliance must also evolve – there will be a presumption because it would be an undue burden for Π to show • The reasoning behind the theory is sound to sense information directly effects the price and therefore indirectly effects the shareholder  A rule 10(b)5 action involves reliance. there wont be a class action because each member would have to show personal reliance and then the individualized issues would overwhelm the common issues • ∆ claims that allowing it means that the Π wont have to show reliance on the statements  Court says reliance is an element of 10b-5. o Issues:  What should the standard of materiality be with regards to preliminary merger negotiations?  Whether a presumption of reliance based on the Fraud on Market Theory is appropriate to certify a class action? o An omitted fact is material if a reasonable S/h would consider it important in deciding how to vote. supported by empirical evidence. Misleading statements defraud purchasers therefore even if they don’t rely on the misstatements directly  Should there be a presumption of this reliance? • Without it.

Echocath (Federal – 10b-5) –Private Cause of Action (p. Six months after IPO. • EP Medsystems v. Contracts never materialized. that the misstatement or omission concealed something from the market that. the statement must be forward looking.  Scienter: court said that a complaint must plead with particularity facts that give rise to a strong inference that the defendant acted with scienter.  The court said that a term like “imminent” could not be forward looking. when disclosed. nothing less..” o Loss causation “is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff. o Court says this case in not the typical fraud on market case b/c here the P is not basing its claim on public misrepresentations or omissions that affected the stock price purchases. absent a duty to disclose. the loss in question was not foreseeable.. typical SC law matter. is not misleading under Rule 10b-5.  Bottom page – 380 o Additional Notes:  The Defendants in this case where the directors of Basic and the Corporation. There’s something wrong with inside information. • Rebut Transaction causation – show that the seller would have traded anyway. Echocath tanked.” i. “a plaintiff must allege . render a misrepresentation immaterial as a matter of law. rather than possible.  The court was also pretty sketchy on allowing cautionary language in a 6 month old prospectus was proximate enough to the misrepresentations to apply o 2) Have to meet Scienter requisites  There is no definitive test in a private COA as to what scienter is – most lawyers think that the P must show the statement was made either intentionally or recklessly. and requires only an allegation that “but for the claimed misrepresentations or omissions.” Thus to establish loss causation.e. Lentell v. Page 98 of 148 .  Damages . instead it deals with direct inducement as a result of personal representations made to its executives by Echocath’s executives and that those representations were false and misleading. However. – TSC/Basic Test  2 Defenses to Misrepresentations: • Statutory safe harbor – 1995 Reform Act . Echocath CEO met with Medsystems to get them to invest.. 384) o Burkhard: This is the typical case for a small firm. and the cautionary statements must be directly related to the statements. silence. “No Comment “ statements are generally the functional equivalent of silence –  If you don’t like it then you can have legislature change the law. Otherwise.o • Rebut Loss causation – show that “market makers” knew the truth and as such the market price wasn’t effected – No in this Case OR o Burkhard: Correct information shouldn’t be out in the market. the stock could be sold a number of times after the merger. o Echocath made a fancy ultrasound machine.conceivable the damages could skyrocket and become huge in this case. Merrill Lynch o A securities fraud plaintiff must prove both loss and transaction causation o Transaction causation is akin to reliance. negatively affected the value of the security. Echocath IPOd and of course issued a prospectus that detailed risks.an issuer is not liable for statements identified as forward looking and accompanied by meaningful cautionary statements • “Bespeaks caution” doctrine – CL doctrine not statutory Cautionary statements. as it implied that the contracts were certain. the plaintiff would not have entered into the detrimental securities transaction. if sufficient. He told them in a private meeting that a bunch of contracts to sell the machine were imminent. – No in this Case o Note: the court also says that the only way you can respond to a direct question in a way that isn’t false is with a “no comment” Rule 10b-5. and Medsystems sued under 10b-5 for making false statements in connection with sale of securities. that the subject of the fraudulent statement or omission was the cause of the actual loss suffered. o 1) Have to show materiality of statements  Materiality: court said for a misstatement to be material the disclosure would have to be viewed by a reasonable investor as having significantly altering the total mix of available information.

 Waiver? . This is a huge burden. o Issue: Was there a duty of the directors to provide accurate information to the S/H’s without a S/H action? o Rule: This case deals with a state action for breach of duty. Reminder: the Disney case has substantially changed that.The court said that reliance followed as a matter of law. and loyalty.  Π bring action for misreps that caused them not to sell their stock – Birnham rule doesn’t apply because they only bring state claims • The misrep was in a document that was not related to any shareholder action  Mercury had overstated its earning for 3 years. directors who knowingly disseminate inaccurate info have violated either a corporate duty or a duty to the shareholders. as the lie itself has to cause the decline in value. now good faith is apparently a subset under the duty of loyalty. not a 10b(5) COA.decline in value.DE . the Market capitalization (# of shares * value) fell by 2 billion  Π alleges they breached fid duty of disclosure (∆ is one of the directors) o They didn’t bring this as a 10(b)(5) COA because the plaintiffs didn’t buy or sell anything. 394) o Facts: Defendants were directors of Mercury. good faith.common law-state fraud action – not 10b-5!! (p.Not the Usual Case o Normally the Π must show how the misrep caused the stock to decline in value and not just that it induced the transaction o But this case is different from most cases sense the misrep was personal and caused the Π specifically to purchase shares at an inflated value o This issue should be left to the jury after it makes a determination of causation o For along time there have been to notion of causation in 10b-5 claims  Transaction causation – the misrep was the but for cause of the investment  Loss Causation – the misrep caused the loss in value  But this opinion doesn’t clearly explain what loss causation is and how to apply Loss causation: Plaintiffs must show two kinds of causation • Transaction “But For” causation: Misrepresentation caused the person to make the transaction or sale AND • Loss causation: P must show that the Misrepresentations caused the pecuniary loss. you have no cause of action under 10b-5 • Malone v.o 3) Was there Reliance? (FOM theory not applicable b/c not dealing with public misrepresentations)  Reliance: the plaintiff must show reasonable reliance on a false statement or omission of material fact. Notes o But-for causation – you wouldn’t have bought the stock but for the lie o Loss-causation – must show both that the lie caused you to both buy the stock and to suffer a loss o So if the stock plummets for something other than the lie. See Case Below!!!!! If you decide not to act because of a misrepresentation or omission. a P can only recover if the decline in the value of stock was a result of the misrepresentation. 10b-5 requires you to be a purchaser or a seller (not just holding on to stock). at least in the corporate arena. Even in the absence of a request for information. and ignored the fact that the plaintiffs signed a waiver stating that they did not rely on any representations o 4) Was there Transaction & Loss Causation?. you cant recover because of the Reform Act o But courts are still struggling with how to apply loss causation o For instance. There are three situations where a disclosure to the public can implicate the duties – since this case was decided in 1988 – the DE court has massaged this language dramatically. b/c the guy that holds onto his stock. Brincat . o Court said that directors have 3 duties that run to the shareholders: due care. how do you show an omission causes a stock to decrease in value? • Note: Birnham rule – a S/h who sits on their stock and does not “buy or sell” has no cause of action – in order for a private cause of action for damages under 10b-5.Weird Result . directors owe a duty to disclose. In Delaware and SC. – o Ex – so the authors suggest that under the reform act. Plaintiffs sued for breach of fiduciary duty of disclosure. which overstated its earnings for 4 years. When it used the correct numbers. Page 99 of 148 . o Rule: The DE supreme Ct says YES – there is a duty. you must have bought or sold in the face of misleading information.

who is a buyer of the client’s company – SC sup ct says buyer can definitely sue the atty or the accountant based on 552  This section gives third parties a claim against a lawyer.  Directors make a statement to shareholders in conjunction with a request for a S/H action (request to vote) • The court doesn’t tell definitively how much information the company has to give when it is asking the shareholders to vote but it wants to keep information confidential for the benefit of the company. o Possibility of a Tort Action – Rest 552 (p. never expressly assert a derivative claim on behalf of the corporation. the MBC governs • What are legal duties applicable to buying or selling stock o Holding: Directors owe a fiduciary duty to the company as well as to the shareholders to not make material misrepresentations to S/H  Reason this duty should be imposed – policy reasons to protect the beneficiary interests . Justice Breyer.  Issue: Is the 9th Circuit statement of Loss Causation Accurate. • Here the complain it bad because it says the corp lost all its equity. or rely on the information – Has been used frequently by SC Courts (so far not against lawyers)  3rd Party info: Lawyer gives advice to a client. • When action is requested. the person may be subject to liability. and loyalty apply • If the misinformation is deliberate. including S/Hs • any public statement is governed by SEC rule 10b-5.Control is separated from ownership. but do not request shareholder action (this case) • This gives rise to a state common law action • The duties of care. alleging that defendants' false statements regarding expected future (FDA) approval of a new asthmatic spray device artificially inflated price of stock. good faith. The plaintiffs. This liability is limited to loss suffered by the person (or groups of persons) the informer intends to use. Broudo (Federal 10b-5 – Private COA)  Facts: Purchasers of stock in Dura brought securities fraud action (10b-5) against company and certain managers and directors. then there is a breach. client passes it on to a 3rd party. however.  DE rejects the Fraud on the Market notion • No state claim because it is covered by federal regulations and because there was no sell here. the plaintiffs will have to prove reliance and damages. a direct claim or both. o May include routine advertising  Directors make a statement to shareholders. extends lawyer exposure Notes o So I think this case says o 1) if the info was requested. NO  Holdings: The Supreme Court. so it should have been a DERIVATIVE suit but the Π filed a direct claim o But they should have leave to amend and file a derivative suit or make proper pleadings for a direct suit o On remand. 531) – If the person provides false information for the guidance of others.• o 3 types of Corp Disclosures that Trigger the Director’s 3 Duties : Directors make a public statement to the market. all you have to show is that the misrepresentation is material. which can result in a derivative claim or a cause of action for damages • Informing S/H about the affairs of the company • In order to have a claim against the directors for breach. held that: o  Page 100 of 148 . Fed law wont give a coa  Claim may be brought as a derivative claim. you just have to show that the misrep was material  But if it was not requested you have to show all the factors laid out in the EP Medsytems case including reliance and lost causation  But fid duty still applies o 2) if it’s a fed claim you have to have sold or bought  But a state claim exists if you just sit 10b-5 and buying or selling with inside info Dura Pharmaceutical v.

The court found no grounds for inferring fraud or conspiracy. and kept secret that he had sold land for a ton of money. Agassiz (MA) .(prior to 10b-5) (p. who was a director of the mining company. to touch upon a loss is not to cause a loss. essentially stopped all mining activities in Michigan – b/c they would be able to get the land cheaper. then relief may be granted to the stockholder.  Plaintiff did not sue for buying with inside information but rather for failing to disclose material. would he would have not sold his shares. the plaintiff has suffered no loss because the inflated purchase price is offset by ownership of a share that possesses equivalent value at that instant.o o • an investor may not establish loss causation by alleging that security price was inflated because of misrepresentation.10b-5 actions can be brought by a buying or selling defrauded S/H – the S/H does not have to be involved in the mgmt of the company. Tried to defend on the fact that the telephone calls weren’t interstate commerce. Page 101 of 148 . In addition. The Ninth Circuit's holding also is not supported by precedent.” • First. since other factors may affect the price. o If it had been a face to face transaction. 403)  Facts: Plaintiff sold stock in a mining co. Co. Director bought shares b/c he was aware that the co. on a public exchange.  Issue: What involvement of interstate commerce is required to have a 10b-5 claim?  Holding: Court found that intrastate use of a telephone is enough to constitute interstate commerce.. as the Ninth Circuit found.  An inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove “loss causation. and • investor’s allegations were insufficient to state fraud claim. the result might have been different. There was no communication between plaintiff and defendant b/c the trades were done on the open market. bought the shares. as a matter of pure logic. The complaint's failure to claim that Dura's share price fell significantly after the truth became known suggests that the plaintiffs considered the allegation of purchase price inflation alone sufficient. it was clearly an arms-length transaction on an open market. o Burkie says the problem with this case seems to be that ??? Dupuy v. the most logic alone permits this Court to say is that the inflated purchase price suggests that misrepresentation “touches upon” a later economic loss. Also it went through the banking system which involves commerce  Note . so he called him up and asked for the shares.  It is not hard to find enough of a interstate connection to bring a 10b-5 action. The complaint contains nothing that suggests otherwise.  Classic Case – facts are identical to Texas Gulf Sulfur Case  Issue: Do directors have a duty to their shareholders when buying their stock?  Holding: Court said that the fiduciary duty of directors runs to stockholders. the information that had he known. Dupuy (Federal 10b-5) (p. The common-law deceit and misrepresentation actions that private securities fraud actions resemble require a plaintiff to show not only that had he known the truth he would not have acted. but generally a director has no common law duty to disclose inside information when buying or selling stock. and grant federal jurisdiction over the cause of action. the moment the transaction takes place. and it turned out that the defendant. 401)  Facts: Defendant was trying to get his brother to sell his shares of the company at a deep discount. However. was buying land that was rich in copper deposits. • And the logical link between the inflated purchase price and any later economic loss is not invariably strong. but does not proximately cause any economic loss. Ninth Circuit's approach would allow recovery where a misrepresentation leads to an inflated purchase price. Goodwin v. there was no representation here. He told him a project was stalled. but also that he suffered actual economic loss. o In this situation.  Holding: Thus. so there was no breach of fiduciary duty to disclose.  Exception: • Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts in his knowledge that the stockholder can’t get from other available information.  Analysis: The Ninth Circuit held that a plaintiff can satisfy the loss causation requirement simply by alleging that a security's price at the time of purchase was inflated because of the misrepresentation.

the P loses. Texas Gulf Sulphur (Federal 10b-5) (p. A director. or their position towards each other.  Rule on Insider Trading: Directors with insider information that is MATERIAL must either disclose the info to general public or abstain from trading in the securities until disclosure is possible:  The general rule under 10b-5 is that anyone trading for themselves who has direct or indirect access to information intended to be used only by the corporation knowing that the person they are trading with doesn’t have the information is precluded from doing so. Yaschik (SC) (1967)  Facts: Plaintiff owned ¼ of the stock in a Charleston corporation. o Key Language from the Case: The duty to disclose may be reduced to 3 distinct classes:  where it arises from a preexisting definite fiduciary relation between the parties. Page 102 of 148 . and he shorted her about 20%. Defendant owned the remaining ¾. SEC alleged that defendants had bought on material inside information. the people entrusted with the corporate information must either disclose or refrain from trading.  Note that this duty only arises from one who receives his information because of his position as an insider  Also note that this duty only runs to shareholders. o “Special Facts” Exception: The exception is when the insider has knowledge of “special facts” (facts not available on the books that enhance the value of the stock) that are not known to the shareholder.  The nature of the investments in this case are key – the fact that they purchased call options is indicative that they knew the stock was going to rise. SEC v. is intrinsically fiduciary and necessarily calls for perfect good faith and full disclosure without regard to any particular intention of the parties. but didn’t tell the P that he had entered into a contract to sell all of his shares for much more. in which case he must disclose. in its essential nature. some employees. a person that accidentally overhears insider information does not presumably have a duty to disclose b/c there is no fiduciary duty – probably safe under SC rule too. The problem is that the P might not know what they can prove. When the news broke. • Minority Rule (adopted by SC): Officers and directors stand in a fiduciary relationship with shareholders and regardless of special facts. Under Goodwin.  A call option is a contractual right to purchase stock at a specified price in the future. When it is material. such a trust and confidence in the particular case is necessarily implied. Kept it quiet for a while in order to buy land on which to dig. the stock went nuts. In SC. 407)  Facts: Defendant found a huge mineral deposit in Canada.  Election of remedies: plaintiff can choose whether they want equitable or legal remedies.o o • Court also took into consideration that the P in this case is a stockholder who has particular knowledge of this kind of injury (he was sophisticated). and their “tippees” bought stock. Jacobson v. The courts generally force the plaintiff to make the election pretty darn early.  These problems are easier to answer in SC because almost all of the answers in SC would be to pay up.  SC Rule.  Material Test (insider info): balancing of the probability the event will occur with the magnitude of the event. probably applies on buy and sell side o Problems – Page 405  Under the Goodwin rule. and that defendants had tipped others for use in buying stock. the nature of their dealings. so it only exists on the buy side (unless the buyer already has some stock). The basic test of materiality is whether a reasonable man would attach importance in determining his choice of action in the transaction in question.  where one party expressly reposes a trust and confidence in the other with reference to the particular transaction in question.  Court stated 2 rules • Majority (Goodwin Rule): there is no duty for a director to volunteer inside information when buying stock from a shareholder. If the stock doesn’t go up in value. D bought Ps shares for $30K. the fiduciary duty requires full disclosure of all relevant facts when purchasing from a stockholder. or else from the circumstances of the case. it is questionable whether it fits within the 3 classes of the duty of disclosure. SEC brought a 10b-5 against defendant and directors. unlike Goodwin.  where the very contract or transaction itself. then the call is worthless.

Under Jacobson.”  The court also found that the tipper in this case was just as liable for any transactions that his tippees were involved in. 10b-5(3) makes is unlawful to “engage in any act. Mere silence would not be a fraud without a relationship that creates a duty to disclose • Therefore the ∆ did not violation 10b-5 or common law fraud because he had no duty to the shareholders that would require him to disclose  Dissent wants to extend the duty to include people who have misappropriated nonpublic information – he suggests we focus on the way in which the buyer acquires the information which he conceals from the vendor should be a material circumstance.  The majority says that they disagree b/c the jury wasn’t properly charged on that theory. Notes o The holding in Chiarella is said to espouse the “Classical theory” of insider trading o Note – SEC 14e-3(a) makes it unlawful to trade on material nonpublic information concerning a tender offer o Chiarella is probably consistent with the special facts doctrine (ie fid duty) Page 103 of 148 . you have a duty to disclose al material info that you learn about because of your position as an insider before buying or selling stock in that company o There is special relationship between the insider and shareholders of his corp  So the fid duty creates a duty to disclose • But if there is not a fiduciary relationship. and as such did not violate 10b-5. which also makes him liable o One question is whether he is also liable for the amounts that these tippees made – but not sure • Damages o Courts have held that the wrongdoers have a duty to cover the amt that the seller missed out on Questions p. absent a pre-existing duty to the shareholders. 413)  Facts: Chiarella worked at a print shop that published merger materials. US indicted him for violation of 10b-5. He was smart enough to piece together the inside information and invest and make some quick money. Notes • One issue is when can insider’s buy stock in the company (which is something we want so they have a personal stake in the company) o One method is to have a set amt of stock to be bought by them each month o Others allow them to buy after a public disclosure.  If all of the guys in this case are liable then what do you do as a corporate officer if you want to purchase stock in your company. there was no need to show causation (transaction or loss). practice. They don’t necessarily say that they disagree with the theory. Holding: Information was material and omission/non-disclosure of the material facts prior to trading was a violation of 10b-5(3). or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security. then you would have to make an actual misrepresentation to commit fraud. NO criminal violation. Dark is also focused on here o He was the one who tipped of the tippees. the duty arises from the fiduciary duty to the shareholders. so doesn’t run to Chiarella. a. but that they have to wait a reasonable amt of time for the info to fully disseminate and act • Mr.  Rule: The court held that. United States (Federal 10b-5) (p. yes he would be liable – fid duty to share holder Reread note 6 • Be sure that you do not give insider information that you obtain as a lawyer to your friends o Chiarella v. 411 2– no liability under Common law or Goodwin.  Rule: because this was not an action by a stockholder to recover but instead an action by the SEC against insider trading by a director. • But in Cady the court held that a corporate insider couldn’t trade in its own stocks unless it disclosed o So if you work for the company.  The court stated the general rule that a corporate insider must abstain from trading in shares of his corporation unless he has disclosed all material inside information known to him. However. Chiarella committed no fraud. • Co’s can have pre-existing stock options and employee purchase plans • You can’t buy stock immediately preceding the occurrence of a major corporate event.

Sometimes the tippee will not be treated as a tippee but will instead be treated as an insider. lawyer. “Under certain circumstances. SEC (Federal 10b-5) (p. Doesn’t matter that insider was a former officer in this case because he obtained the info while he was still serving as an officer and had a duty to the shareholders There can be temporary insiders o Such as a lawyer or accountant working for the company – these people will have a Cady duty o They will be treated as a tipper not a tippee – ie as an insider. SEC brought him up on a 10b-5. or consultant working for the corporation.  Tippee responsibility must be related back to insider responsibility by a necessary finding that the tippee knew the information was given to him in breach of a duty by a person having a special relationship to the issue not to disclose the information. and tried to assign liability to him as a “tippee. The tippee is liable when the tippee: • Receives the information improperly. He bought Pillsbury stock and made a shit ton of cash. but this opinion focuses on his role as a tippee o Where tippees—regardless of their motivation or occupation—come into possession of material corporate information that they know is confidential and know or should know came from a corporate insider they must either publicly disclose that info or refrain from trading  Issue: When will a tippee be liable under 10b-5?  Unlike insiders who have independent fiduciary duties to both the corporation and its shareholders. but he discussed his finding with his investors. 420)  Facts: Dirks was a broker. ∆ had no stock in the company. 428)  Facts: D was a partner in a law firm hired by Grand Met to help acquire Pillsbury. D didn’t work on the case. The test is whether the insider will benefit directly or indirectly from his disclosure.there has to be some type of improper behavior on the part of the tipper and the tippee must know about it AND o The insider received a personal benefit from the disclosure (benefit is required to show the breach).  Some type of financial benefit  The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend  Reputational benefits that will transfer into future earnings • OR the tippee could also have entered into a special confidential relationship with the business and are given the information solely in regard to that relationship. accountant.” ∆ worked for a broker-dealer firm and specialized in analyzing insurance companies o A former officer of Equity Funding of America told him the company’s assets were overstated because of fraud and asked him to investigate o Some evidence corroborated the story. He investigated and decided it was true.o o o Dirks v. Page 104 of 148 Notes o o o . This type of tippee carries the same insider duty. such as where corporate information is revealed legitimately to an underwriter. He couldn’t get any of the newspapers to print it. So he can’t be liable on that theory AND the tipper received no personal benefit so Dirks did not receive the information improperly. o It comes from an insider in breach of his fiduciary duty to the shareholders . who sold their stock = 16 million o Equity eventually got caught and the SEC investigated Dirks SEC found that Dirks violated 10b-5 by giving the info to investors = tippees o Dirks really both a tipper and a tippee. and got a tip from someone at Equity Funding that they were overstating revenue. but he did tell his clients. In determining whether a tippee is under an obligation to disclose or abstain. these outsiders may become fiduciaries of the shareholders. the typical tippee has no such relationships. and the rules will be stricter o But they wont be liable if all they do is assist another insider US v. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information. He was indicted for criminal violation of 10b-5. it thus is necessary to determine whether the insider’s tip constituted a breach of the insider’s fiduciary duty. but rather that they have entered into a special confidential relationship in the conduct of business with the enterprise and are given access to information solely for corporate purposes.”  Holding: Dirks is not an insider. O’Hagan (Federal 10b-5) (p.

he violated the trust and confidence of his employer. There must be a deceptive act – there is one case where the outsider stole from the company but no 10b-5 violation because the docs they used said they were stealing o Deception found in fact that ∆ took information the company trusted him with and used to to make a profit  O’Hagan is not liable under a misappropriation theory b/c he bought the shares of the target.3K o Charged with 17 counts of securities fraud under 10b-5 o Side issue. His firm was retained by Grand Met to negotiated a tender offer to acquire Pillsbury Co. not his client. that if breached in a securities violation. but it would not be common law fraud according to him). or sibling. However. a fiduciary’s undisclosed. so there was no pre-existing duty against misappropriation. If the communication is intra-family. in breach of a duty of loyalty and confidentiality. he uses the information to purchase or sell securities. you have the proof for common law fraud (Burkhard says this is not true…you would be fired and the law firm would stop you from doing it. without disclosure to his principal. there can be circumstances when that doesn’t apply. as soon as you make that statement. This new rule creates a fiduciary relationship when a person receives or obtains material. they can defeat the misappropriation theory by disclosing to the person that gave them the info that they are about to trade on it (then there is no deception)  Of course. Court holds that misappropriation theory falls under 10b-5(1) – “conduct involving a deceptive device or contrivance used in connection with the purchase or sale of securities” But breach of duty isnt enough. that information is supposed to remain confidential.  The Court also focuses on the fact that deception is a fundamental notion of 10b-5.  Holding: Hagan is liable under 10b-5. defrauds the principal of the exclusive use of that information.“classic” insider trading is when a corporate insider trades on the basis of material nonpublic information.  So there must be a duty owed to source by the • “Outsider” • who has access to • Material confidential information • If someone receives this information. app court. He worked for Grand Met. ∆ used some of the profits to replenish client trust fund that he has converted money from o Trial court found him guilty. not when the fiduciary gains the confidential information. parent. This was not classic insider trading because he had no affiliation with Pillsbury. ∆ sold his stock for a profit of 4. However. o ∆ didn’t work directly on the matter. and this qualifies as a “deceptive device” under 10b-5. SC found him guilty and adopts the misappropriation theory Classical Theory of insider trading also applies to attorneys o But this theory doesn’t apply in this case because he wasn’t an insider since he didn’t work for Pillsbury Co. all you need is disclosure to be able to use the info o Court is adopting narrower sense of misappropriation theory – the disclosure need only be made to the source – here his law firm and Grand Met. Reversed. non-public information from his/her spouse. The misappropriation theory is thus designed to protect the integrity of the securities markets against abuses by outsiders to a corporation who have access to confidential information that will affect the corporation’s security price when revealed. there is a 10b-5 violation. which would require disclosure to the market (p. self-serving use of a principal’s information to purchase or sell securities. 431.  10(b)(5)(2) – SEC attempt to define when there is a fiduciary relationship. then the ∆ would need consent to use the property entrusted to him o Under misappropriation theory or 10b-5. FN 6) o SO 10b-5 isn’t violated if the outsider discloses to the source that he plans on trading on the nonpublic information  But your gonna get fired and stopped from doing it Page 105 of 148 .this is different than the misappropriation theory advanced by Burger in Chiarella. but he learned of it and bought stock and stock options in Pillsbury o After the acquisition.  Misappropriation Doctrine: when someone misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. but when. there are other ways for the SEC to prosecute the case. Deception is Important o If you used the CL rule of a trustee relationship.o o o o ∆ worked with a law firm in Minneapolis. but who owe no fiduciary or other duty to that corporation’s shareholders. The fraud is consummated. So he owes no fid duty to the Pillsbury shareholders o So classical theory applies only if you use inside info that you learn from your company to trade in shares of your company  There is a theme running through the text that we shouldn’t assume 10b-5 is the only thing out there. Under this theory. child.

but the additional 34K was added and was to be used in operating the business after the takeover at which time it would be paid to seller once the total net worth of the business was determined o After the Π took over. That is what the case is all about. you still have to pay the difference – see number 3 page 585 – he made 1 million  See problems on p. Reliance v. so even if you lose money. Not to the defrauding of any seller or purchaser – so the fraud need only attach to the act. Therefore. o §16B – if you own 10% or more of a public company and buy stock and sell it within 6 months the corporation will be able to recover the profit you make o You don’t link two sells together if there is a difference of time and buyer o Purpose is to prevent insider trading o Must own the 10% both at purchase and at sell. The problem was that Reliance Electric came along and made a better deal. the profits on the second sale did not have to be paid back to the company. they had a CPA audit the corporation to determine the net worth and determine how much it owed to Δ o Brings suit under 62-309  Which says it is unlawful to offer or sell securities by means of any untrue statement of material fact or by omission  The buyer does not have the BOP to show that he didn’t know the truth o Page 106 of 148 . The question is who is a beneficial owner. They met the Δ. • Burger’s misappropriation theory is different from the misappropriation in O’Hagan because in O’Hagan. there were arguments that they hadn’t disclosed changes in their accounting methods. So they tried to take advantage by selling stock to reduce their holdings to 9. Emerson (covered at end of semester) (p.96%. 434)  16(b) of the Securities Act requires an owner to pay back money to the corporation because it assumes you have used inside information (has something to do about within 6 months. otherwise you wont be a “beneficial owner” and the act ownt apply o The company only gets the profit – so if you by at $10 and sell at 20 – the company only gets $10 a share o Government only looks at the difference. • O’Hagan could have been charged as a temporary insider under Chiarella fn#14 if Pillsbury knew that they were going to try to buy them. The problem presented in this case is that Emerson Electric acquired 13% of Dodge Manufacturing. Reliance said that doesn’t work so you owe us the balance on all of it. • FN 6 suggests that the shareholders of Pillsbury would not have a private cause of action. not the seller or purchaser involved in the trade o Remember that 10b-5 comes into play only if the ∆ uses the info to trade stocks o Finally says that misappropriation was not rejected in Chiarella because the argument was never submitted  Questions on p. 584 Bradley v. The argument is that the second sale that would occur shortly thereafter wouldn’t be covered because they would no longer be a10% shareholder so they wouldn’t have to pay back the company.  The Supreme Court said that the lawyers for Emerson are correct and you don’t link the two transactions together. And put down 10. there is an allegation that the offering document was wrong/misleading o Δ was given exclusive right of sale over corporate stock of Paul’s Pontiac –Buick – a SC corp o Π hired Glen Covey Associates to locate a dealership for them to buy. the disclosure obligation runs to the source of the information as opposed to Burger’s reading that the disclosure obligation ran to those with whom the misappropriator trades. not when he obtains it – this is important because the fraud must be “in connection with the purchase or sale of stock” o 10b-5 says it applies to fraud connected with any sale or purchase. but in this case they didn’t know so fn#14 wouldn’t apply. 433 • Chiarella would be held to have violated 10b-5 after O’Hagan because he had a relationship of trust and confidence with his employer. and the takeover.000 in earnest deposit o Δ retained control of the dealership until closing of the stock purchase agreement  At closing the Π paid an additional 55K  And gave a note for 160K o The total purchase price was 200k subject to any increase in value occurring between May 31 1974. Hullander (SC)  The buyers of this automobile dealership noticed the following things were wrong: information in some of the financial statements was wrong. Yes.o o The source of the information does not have to be involved in the transaction because the fraud occurs when he uses the info. There is always a gap between signing of K and closing – nothing material is supposed to happen during this period o Originally only 90K was to be paid at closing. The statute talks about being a 10% shareholder at the time of purchase and at the time of sale.look this up). The question is whether Emerson has to pay profits back.

o I also might sue them for breach of contract. Also the Π received 2% equity participation in Litchfield plantation once the Δ bought it Page 107 of 148 o . there would be no problem today bringing a security claim.  Should the sellers be responsible for the prospectus (offering document) that they did not prepare? Yes…if the accounting firm only used information that the sellers gave them. you bring a 509 claim in state court. Under 10b-5 you have to show loss causation and transaction causation. o But this doesn’t fly bc technically you are buying all the stock and the assets just come along with it  The opinion seems to say that everyone is interested in the company’s balance sheet so that automatically becomes material information (automatically material to the transaction).  See discussion of § 35-1-509 below (and additional discussion of differences below) o The SC 35-1-509 at issue is taken from 12(2) of the Sec. or that the sale would not have occurred absent the omission (ie transaction causation) o Π’s sophistication in the securities and the availability of the information to Π is immaterial  And they do not have to show that they could have discovered the falsity upon reasonable investigation o Δ violates 12(2) by mere negligent misreps or omissions o And BOP is on seller to show that he was not negligent or reckless or acted intentionally o SO under 12(2) all the Δ has to show is that there was a material misrepresentation. The courts today say that because you are buying the stock of the company instead of the assets of the company. not a security. If the accounting firm/broker generated these on their own. it is a very difficult agency question to answer (unclear whether the sellers would be liable).  That such misstatements or omissions rendered the statements made misleading  And that Π did not know the truth o A material fact is a fact about which an average prudent investor ought reasonably to be informed before purchasing the security o Π DOES NOT have to show reliance.” Biales v. The Δ will then have to show that he didn’t act negligently o As to Culpability what is the difference between 35-1-509 and 10b-5 o In SC you need only be negligent o In 10b-5 you need to be reckless o How about a due diligence defense o SC allows this – ie that Π didn’t use due diligence in finding out the truth o Not clear if 10b-5 would allow this  In SC negligence is enough for culpability but under 10b-5 you have to be at least reckless. causation. That is why you would bring an action under 509 instead of 10b-5. not 12(2) o To recover the Π must show  The Δ misstated or omitted to state certain material facts.  “Section 12(2) does not require that plaintiffs show reliance. Young o Δ negotiated a 275K loan from Π for use in a Garden City Resort o Gwin served as Δ’s atty o Loan secured by promissory note and a second mortgage in the units. Act of 1933 – I think the following applies only to the SC statute though because there are some differences between the two as discussed below – plus we looked at 10b-5 in class.o Buyer may sue in law or equity to recover consideration paid plus 6% interest per year How would you go after these guys o Fraud o Breach of K o 10b-5 o 35-1-509 / § 12 under SEC o Breach of warranty o The first cause of action is to sue them for fraud and try to rescind the contract. o Could sue for negligent misrepresentation o Could sue under 10b-5 o Might be able to sue under the Unfair Trade Practices Act o Could sue under § 35-1-509 (which is what they did sue under in the case)  There is an argument that this isn’t a security at this point because they were selling the whole business. causation or that the sale would not have occurred absent the omission. You would bring a 10b-5 claim in federal court.  In SC you don’t have to show reliance.  In SC.

statements that they were not going to merge in deciding to sell their stock back to the corporation. – Burkie says Incredible Result!!! – for better or worse. so when the merger occurs they are getting a larger share of the pie than anyone else • Holding: The court throws this out saying this should have been brought as a derivative suit and the guy brought it as a direct claim – the injury is not to the Co.Now by legislative enactment there is a 10b-5 private cause of action in SC.  Issue: Why wasn’t this a classic 10b-5 case – why didn’t they sue under 10b-5? – SOL problem. this was enacted after the case was decided o SC .  Scary result for the court to say the ONLY fiduciary duties to a S/H are the ones read in the statute and that all the common law duties are null and void. equivalent to 10b-5? – all the same claim. it is to the individual S/Hs who are bringing the lawsuit. Bunting’s. Bunting (SC – 10b-5/501)  Facts: S/H were trust beneficiaries who relied on one of the officer. but you must try and sell it Gwin did not offer or solicit an offer nor did he pass title o Thus there was no offer or sale = no violation Clearwater v. . but they must  Solicit the purchase  And be motivated at least in part by a desire to serve his own financial interest or that of the owner of the security (ie a broker) SO you don’t have to have Privity to come under the act. Why not? This is a recent amendment to the statute that did not exist at the time this transaction occurred. • Claim #2: Insiders issued stock options to themselves – they are able to buy the stock cheaply. • This opinion indicates that the reporter’s comments involving the code sections dealing with directors and one involved dealing with officers. but another SOL hadn’t run out.3 million because they didn’t wait to sell the stock after the merge.General Standard for Directors: the comments then clearly indicate that the legal principle of a direct duty to S/H was retained in SC. . • The plaintiff tried to argue that certain amendments created a private cause of action…the court says no go! • The plaintiffs argue that he had a dual role as a shareholder (as well as an officer) because the officer SOL had already run out.o o o o o o o o o o Gwin was to hold the loan in escrow until the plantation was purchased o But Gwin says he didn’t know he was to act as escrow and distributed the funds directly to the Δ Gwin gave notice to the Π that he had distributed the money and Π did not respond Δ never bought Litchfield and eventually went into bankruptcy after spending the money Π claims Gwin breached his fid duty as escrow and violated SC Uniform Sec Act o Trial court found no breach because of waiver o And that no violation of Sec Act because Gwin was not a seller Sec Act Violation o 35-1-1490(2) “ Any person who: Offers or sells a security . (same language as above) o An offer or offer to sell includes every attempt or offer to dispose of or soliciation of an offer to buy a security or interest in a security value. but at the time of this case there wasn’t. 2) Breached his fiduciary duty of disclosure.C. or o it is a violation under the S.  They also did not argue 35-1-509(c). Differences between SC 501 and 10b-5 Page 108 of 148 . • Holding: Any duty that Bunting had owed was negated by the fact that the SOL had run – the code rules and the SOL had run – no chance of a COA on common law duties. o A sale includes every K of sale of or disposition of a security or interest in a security value Pinter Test: o A person who offers or sells is not limited to the owner of the sec.  2 Basic claims: • Claim #1: o 1) Misrepresented the status of the company. o 33-8-300 – BJR . • 35-1-501 – however at the time of this case the law was clear that there was no private cause of action. They lost $1.

Standing to Sue: 10b-5 covers buyers and sellers of securities 501 only allows the buyers of the security to sue the sellers Materiality About the same. scheme. or course of business that operates or would operate as a fraud or deceit upon another person. o 501 violations in 509.doesn’t carry attorney’s fees • 501 – private cause of action thru 509 carries o the security o consideration paid o interest o attorney’s fees SC USA . • to employ a device. the purchaser not knowing the untruth or omission and the seller not sustaining the burden of proof that the seller did not know and. although 501 talks about the average prudent investor Culpability under both 10b-5 and 501 the seller must be reckless in his omission or o    Due diligence defense There is no defense to 10b-5 501 has the defense but you probably can’t prove it Plaintiff’s knowledge of the truth of the statement is a defense in both cases Causation • 10b-5 and 501 requires proof of causation Remedy • 10b-5 private cause of action .applies to buyers and sellers • (b)A person is liable to the purchaser if the person sells a security in violation of 301 or 501 or. directly or indirectly. does not require not loss or transaction causation. • 501 .Fraud & Liability Statutes 35-1-301 – Registration of securities 35-1-501 (Used to be 1490)–SC equiv to 10b-5 – Fraud – • It us unlawful for a person. • a problem •  • •  • which may be a lower standard  • false statement  • •    Jurisdiction: for 10b-5 to attach.places liability on a seller’s to buyers for illegal or fraudulent sales or offers • Court also said that that selling an entire dealership is the same as selling a security • Note the split – the US supreme court has said that sale of a whole business is not a security 35-1. or purchase of a security. sale. the offer must originate from SC. practice. by means of an untrue statement of a material fact or an omission to state a material fact necessary to make the statement made. not misleading . in the exercise of reasonable care. in connection with the offer. in the light of the circumstances under which they were made.509 – Civil Liability.only requires proof materiality. all you need is interstate commerce which is never For 501 to attach. not misleading or • to engage in an act. could not have know of the untruth or omission. o Standard is negligence • (b)(2) Purchaser can recover You can also just sue for damages r recover o Consideration paid for the security + 6% interest o Costs and ATTORNEY’S FEES o Minus any income received for the sale of the security Page 109 of 148 . reliance. or artifice to defraud • to make any untrue statement of a material fact or • to omit to state a material fact necessary in order to make the statements made. in light of the circumstances under which it was made.

but SC does not have this language) o A person with actual knowledge that a person is committing an act sufficient to violate § 501 and intentionally furthers the violation becomes an aider and abettor and thus jointly and severally liable • (j) – cause of action must be brought in three or five years depending on which section is violated • (m) – unless there is a specific statutory remedy there isn’t anything else – purpose to cut off any implied private cause of action. but we don’t know if SC is going to adopt fraud on market. but from a buyer that will ruin the company. and they didn’t do any checks for outstanding judgments – they trusted his reception at the Jonathan Club. and the bank was the executor for his estate. Essentially the only thing that needs to be proved is materiality. The looter killed the company. officer. • 509b – standard of conduct is negligence • Causation is another critical difference o 501 requires loss and transaction causation be proved o 509 – Bradley case .  Why would you want to bring a COA under 509b and not 501? Differences between 501 & 509: • See Bradley case above for further discussion of the differences between 509 and 10b-5 • There are no 501 cases in SC. o Π brought a direct and a derivative action against the bank  Case proceeded as a derivative action  Trial court found that Bank liable for breach of duty owed as the majority shareholder to the corporation it controlled • Awarded 473. • Presumably all the jurisprudence that has grown up around the federal cases will be applied in SC.NEITHER loss nor transaction causation need to be proved (at least under (c)). and one that is lower but from someone who will help the company o Nothing tells us what to do in the statutes Control Premium o Extra amount a buyer will pay over the value of stock because that block will give him majority control o Some see this as a company assets but nothing requires the SH to actually demand it on the sale CL gives guidance to these issues DeBaun v.one that is higher. 438)  Plaintiff was a minority shareholder in a closely held corp. o Another thing that 509b does that the federal statute does not do is clarify what the remedies are – there is not a private cause of action under SC 501.     o (g) – Aider and Abettor J/S liability – o Person who indirectly or directly controls person liable o Manager. The majority shareholder died. Common law duty of selling shareholder. The bank sold the shares to a guy who was clearly a corporate looter. First Western Bank (CA) –Derivative Suit (p. Looking at situations where a majority SH is made an offer and knows that a minority SH also wants to sell o Is there a duty to condition sell on the offeror also buying the minority share Also where the SH has two offerees.836 o Computed by adding 220K (value at time of transfer) o Plus amt equal to anticipated after-tax earnings of the corporation of the ensuing 10year period – and considering an 8% growth factor o Also gave sum needed to defend against its creditors claim  Rule: Duty of Goof Faith and Fairness encompasses an obligation of the controlling S/H in possession of facts “such as to awaken suspicion and put a prudent man on his guard that a potential buyer of his shares] may loot the corporation of its assets to pay for the shares purchased” Page 110 of 148 • . director o Individual who is an employee who materially assists in the conduct – much narrower than the persons who used to be liable (under the Uniform Act the language is “an individual associated with” which opens up liability. • 501 – requires the showing of scienter – but the standard is recklessness or intentional.

has not been followed but the language in the opinion is important to think about.  In this case. you will get paid more o Π claims that the minority SH should get a cut of the consideration given for this “power” – ie the Control Premium – the amt given in excess of the value of the shares in exchange for the control those shares confer  Trial court said such a right doesn’t exist and that majority shareholder is free to act in his own best interest absent a threat that the buyer will loot the company  Also says Π failed to show inadequate consideration was given o What did he do wrong according to Π  Sold control shares for a premium – ie more than what anyone else could sell theirs for  Corporate opportunity – ie missing out on building business relations with other purchasers during this time of scarcity because they sold to a purchaser (and he got a premium) Page 111 of 148 o . has a Duty of Good Faith and Fairness. (p.a power held in trust by the majority shareholder to control the corporate product in a time of scarcity.  Damages: • pay the debts incurred during the looting • pay S/H’s . Feldmann – Case is in every Corporate Text. he agreed to allow the buyer to replace the entire existing board  You don’t have to have 51% to control. presumably the remedy would have been much more limited  How does the Lawyer help them investigate – • Pull a Dun & Bradstreet report on the buyer. the ∆ sold a corporate asset.this was transferred by the ∆ act of resigning his old board upon the sale. it can be a lot less – ie here it is only 30% • If you can transfer control with your block of share.RULE – In any transaction where the control of the corporation is material.their share of the value the corp would have had had it not been looted • Attorney’s fees – b/c the real party in interest here is the trust. o Perlman v. Shareholder got a premium for the controlling share. • Bank references – ask for Certified Financial Statements if they are available – • Internet Search o (It could be malpractice not to do this). Share holder  If this had been a direct suit by just DeBaun.obligation to conduct a reasonable investigation of the buyer and not to sell if he finds facts that would put a reasonable person on notice that the buyer would loot the corp. so thus it is appropriate to award atty fees. 445)  37% shareholder of a publicly traded steel company sold his shares to a steel company that wanted to guarantee supply during tight markets.  Goodwill factor and anticipated profits were properly added to the damages • As was requiring Bank to pay off claims against Corporation by creditors  Trial court found that Bank liable for breach of duty owed as the majority shareholder to the corporation it controlled • Awarded 473. which allowed the buyer to elect its own board  So he didn’t just sell his shares. the controlling majority SH must exercise good faith and fairness from the viewpoint of the corporation and those interested therein  This duty requires the controlling shareholder in possession of facts  Such that awaken suspicion and put a prudent man on his guard  That a potential buyer of his shares  May loot the corporation  To conduct a reasonable and adequate investigation of the buyer  Rule: Selling S/H. o Minority SH bring derivative suit against ∆ for damages incurred from his sale of his controlling interest in Newport Steel Corp  ∆ was also CEO and President o Π claim along with shares. the Bank clearly had the duty and breached. in any transaction where the control of the corp is material. The court measured the damages that the bank was to pay TO THE PLAINTIFFS (this was a derivative suit).836 o Computed by adding 220K (value at time of transfer) o Plus amt equal to anticipated after-tax earnings of the corporation of the ensuing 10year period – and considering an 8% growth factor o Also gave sum needed to defend against its creditors claim  Is this overkill? • Why does he have to put the company back to 100% of where it was when the Π only owned 30% o The other 70% goes back into the trust that the bank was presiding over for the family of the maj.

The duty means he must exercise business judgment with respect to any dealings that may affect the corporation. • Cessation of the Feldman plan. or the guy would probably just re-loot the money Stock deals that stack the board  This is when a majority shareholder sells his share along with an agreement that his directors will quit. • Usurped a corporate opp that belonged to the Co.D had to show fairness in the deal by proving that there was no possibility that the company would do better under the Feldman plan o fiduciaries always have the burden of proof in establishing the fairness of their dealings with trust property. 454)  Page 112 of 148 .  The question is raised…aren’t you really selling your vote. and that deal can be enforceable. but they could get these loans in exchange for selling them steel • Counter is that the purchaser is going to improve the company itself because it wants as much steel as possible  Another issue was that there was another buyer who offered to pay a premium as well. – See above.03 – but it was selling for only 12 per share. because the ∆ sold his controlling shares.  Rule: sale of a true majority of stock can carry such a deal.  3 Theories of what he did wrong in this case: • Sale of Control and the receipt of a premium for that share is wrong – can’t usurp control of that. the premium really represents a corporate opportunity..  Remedy is unusual in this case – the Court says even though it is a derivative suit – the remedy/award goes straight to the minority S/H’s not the corporation b/c the extent that the buyer should get any recover here they may still be in cahoots with Feldman . These funds could have been used to improve the corp  However.  IN this case the sale meant the company would no longer operate the Feldman plan. the buyer was able to make the Corp a supplier for only itself – thus limiting it opportunity to grow = lost corporate opportunity  ∆ had BOP to show that such opportunity did not exist.that they couldn’t pay the proceeds of the suit back to the corporation. but that you cant do so if it results in sacrifice  Rule: Majority shareholder has a fiduciary duty to the corporation and to minority shareholders.  The ∆ sold his block for 20 a share – so we see a control premium ∆ did have a fid duty (as a maj SH and as a director) to corp and to minority SH  As a director his conduct is closely scrutinized. and it did not meat its burden Court not saying you can never sell majority shares to a buyer that has an interest in your product. including selling his shares. but it would have gone to all the shareholders rather than just the him Book value of stock was 17. where he used tight markets to secure interest free loans to expand the business. • BOP on D . leaving room for the new guy to put his people in place immediately. the Π are entitled to recover Here the possible gain was to get Feldmann plan funds – interest free advances from purchasers in exchange for a promise to supply them with steel. Many courts say that lesser shares can carry such a deal.o o o o o o  • • But the flip side is that the purchaser will be buying from them Loss of Feldman Plan • Way to get money – they couldn’t up the price of steel because we were at war and needed it. – o Although there is another argument that the buyer themselves would actually put in the case to improve the facilities. To whom can a shareholder sell Redemption and Equal Access o Donahue v Rodd Electrotype (The Equal Access Rule) MA (p. and he must not have allowed his personal interest affect his business decisions  He has this same duty as a majority SH because he selects the directors and thereby assumes their liability This isn’t normally breach of fid duty  But court is holding them to the “punctilio of an honor” standard  So fact that ∆ took advantage of a favorable market situation is not consistent with the undivided loyalty he should have for the corp and minority shareholders  Here he has taken a corporate opportunity for himself • The opportunity need not be absolute – as long as there was a possibility of corporate gain.

• They could buy all of the plaintiffs’ shares at the price they paid Harry – which is the option the P wanted – they wanted equal access.  Definition of a Close Corporation: • a small number of stockholders • no ready market for the corporate stock • substantial majority stockholder participation in management Court concludes that we apply partnership standards of fid duty when it’s a close corporation as opposed to normal corporate standards • The two are similar • A close corporation is one where o There is a small number of stockholders o No ready market for the corporate stock o Substantial majority stockholder participation in the management. and the company denied her request. and operations of the corporation • Long opinion but basically says that SH in a close corporation depend on confidence and trust of the other SH. so the company bought out his shares. so the same fiduciary duty applies o Majority SH cannot “freeze-out” the minority SH When the directors make self-serving decisions. or. He wanted to retire. • So Court found that a close corporation is essentially a partnership. if a stockholder whose shares were purchased was a member of the controlling group. • So. • SO when there is a freeze out. Page 113 of 148 . She sued the company to either force Rodd to buy back his shares or to buy her out. • Π claims this breached the majority SH’s fid duty to her has a minority shareholder o Ie that the majority shareholders were allowing corporate assets to be distributed to the majority shareholders but not the minority shareholders because it would only repurchase the majority shareholders shares • ∆ claims there is no right to equal opportunity for such purchases  Equal Access Rule: Court said that in a closely held corporation shareholders have a duty of utmost good faith and inherent fairness obligation – similar to the heightened duty that partners have towards each other. Plaintiff wanted to be bought out too. the BJR will protect these decisions. the minority shareholders can bring action as a violation of the directors fid duty to the corporation • The problem is that when it comes to dividends and salaries.that were injurious to the minority S/H • For a provision to market your own shares • To provide access to corporate assets for your own use  Alternatives Remedies: Court found that this was a close corp. and as such had two options.utilized corporate assets in 2 ways . direction.  Harry Rodd was the majority shareholder of Rodd electrotype. they could force Harry to buy back his shares. the minority SH must either suffer or seek a buyer – this is a problem for minority SH in close corporations because there is no market and he lacks ability to dissolve the company o So they can only deal with the majority – which is the whole purpose of the freeze-out – ie to make them sell at an inadequate price This duty therefore requires majority SH in a close corporation to act in good faith when entering into repurchase agreements – so if the repurchase agreement is with the majority SH. the controlling SH must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at identical price This concept applies to any situation where the majority SH acts to confer a benefit or opportunity to the controlling group – there must be equal access to this opportunity for the minority SH  Court found that he did 2 things . • First.     This case and the Wilkes case has been cited in shareholder friendly jurisdictions – unlike those DE. the controlling shareholders must extend the same offer to all other shareholders. and it is much more like a partnership.

o  Selling Fiduciary offices with the controlling interest o Sells of controlling blocks of stock often include agreements that directors that are friendly to the seller will resign  =delivering a stacked board to the buyer o Everyone agrees that sell of a true majority of the stock will make such deals legit o But for those sells of less than 50%. there is a readily available market for the stock • Buy-Sell agreements. There are five principal techniques by which the transfer of shares in a closely held corporation may be restricted: o Right of first refusal o First option at fixed price. Page 114 of 148 Notes o  Note: this is a direct suit. The minority S/H’s complained that the controlling S/H should not be able to get a premium on his stock over and above the amount the minority S/Hs were going to get. Warlick – (SC)  Facts: Owners of the coke bottling plant in Asheville wanted to buy out the Anderson plant and they bought out the controlling S/H. • Court said that the majority S/H has an absolute right to receive a controlled premium for his stock  SC Rejects Equal Access Rule: it’s not a breach of fiduciary duty to sell a controlling share for a premium and not share the premium with the rest of the shareholders – Favors Majority S/H.  This rule applies in SC??(see below where it says it doesn’t apply) Shoaf v.  Also. • Opposite of Feldman Case . • Sinking fund – very uncommon • life insurance – owners in the corporation will buy these policies that will fund the repurchase of shares at certain events o usually someone’s death o sometimes at disability or retirement o You have to worry about estate tax and income tax o Majority of the buyouts are paid over time. although much of the language in the case focuses on the derivative nature. o Generally 4 types of Buy-Sell Agreements  One way: Enables a 3rd party to buy shares of a dead or departing owner. you should anticipate the Donahue types of problems and should set up a mechanism that allows the minority shareholder at some point to exit the corporation – ie buy-sell agreements o Every corporation should have one o This is a contract that requires the corporation or the majority shareholders to purchase shares in specified situations at a specified price o 3 Requirements in a Buy-Sell Agreement  What events triggers the sale  What price will be paid for the stock  How the stock purchase will be funded. courts require that the buyer purchase sufficient stock to give working control in view of the high dispersion of the remaining shareholders o Unlike Partnerships. price determined by the agreement o Consent required for sale o Buy back rights: enable it to buy back shares on the happening of certain events whether the holder wants to sell or not o Buy-sell agreements: corporation is obliged to go through with the purchase upon the happening of the specified event Authors say that anytime you are involved in a small business. there is no corporation law that requires the corporation to repurchase stock from its shareholders o BUT there is an “equal access rule” as developed in Donahue – this will only come up in a close corporation because in a public one. no one is contesting that the amount paid was invalid – what is not contested is that the book value and the liquidating value is the same this is never the case as a practical matter.Close Corporations o The stockholders of a close corporation will usually agree to limit the transferability of shares in the corporation.

notice must be printed on shares. (i.  Cross purchase: obligates surviving owners to purchase a deceased owner’s interest directly from the decedent’s heirs.  Entity or Stock Redemption: Each owner agrees to sell back to the entity upon a triggering event. and the business agrees to purchase such interest. “the rights of a S/H in a close corp may differ from those of a regular corp.  Wait and see: Owner or estate is obligated to sell. Page 115 of 148 . firing vs death) • In your agreement you need some sort of method as to deal with defining what constitutes “disability” SC .Buy-Sell agreements 33-6-270 – Restriction on Transfer or Registration of Shares or Other Securities .  To preserve exemptions under Fed or state securities laws  For any other reasonable purpose. • Can shift control of the corporation so you have to be careful. Ways to value the business  Goodwill multiplier  Rate of return on assets  Last five years’ average earnings  Use of a capitalization factor  2 book value methods • Most common method is the combination book value approach – establishes a value for the business based on its past and present financial position. o Must be noted conspicuously on the stock certificate and the stockholder must have knowledge of the restriction. not sell stock. • Different prices depending on different triggering events.  33-18-110 – Close Corp share transfer prohibitions – limitations on ability to transfer stock. 33-18-103 – definition of close corporation o Must contain a statement in the AI that it is a close corp o Can be incorporated into the AI by amendment . cross-purchase. o A restriction on the transfer or registration of shares is authorized  Make sure that you comply with the federal requirements for s corporations  To maintain the corp’s status when it is dependent on the # or identity of its S/Hs. but the business is not obligated to buy. • Requires less life insurance policies. to exercise their options then the corp is required to purchase the remaining shares. • The notice required by this section satisfies all requirements of this chapter and of section 33-6-270 that notice of share transfer restrictions be given  S/H may request these documents that indicate the restrictions at any time upon the S/H written request and the corp must provide them. general economic conditions. the AI’s may restrict transfer or affect voting rights – • A S/H receiving notice of these restrictions is bound to them and even if they did not receive notice if they have knowledge they are bound to them.o o o o • Tax rule: Usually the life insurance proceeds are not subject to tax unless they are owned by the decedent. o B/S agreements can include stock options or convertible securities.e. and wait and see all valid agreements  A buy sell agreement can require the approval of the corp as long as the requirement is not manifestly unreasonable  A B/S agreement can prohibit the transfer of restricted shares to a designated class of persons as long as it is not manifestly unreasonable.must be approved by 2/3 of the S/H – of each class  If a S/H objects he or she has dissenter’s rights.. • Can shift control of the corporation so you have to be careful. • If using life insurance proceeds for the buy-out then there has to be many policies. book value and earnings. entity/stock redemption. o One way.  Rule: The parties must all agree as to the valuation method and the value.When the company can place restrictions on a shareholder’s ability to sell his shares. All of the S/H would buy a % of the stock at a certain time.  33-18-109 – Close Corp . If any stock remains after the corporation and S/Hs have had the opport.

 33-18-120 – Close Corp Share transfers – Corp has 1st Right of Refusal • A S/H wishing to transfer his shares must first offer them to the corporation by obtaining an offer for the shares for cash from a 3rd person who is eligible to purchase the shares under 33-18-110(b). • If the corp does not deliver acceptance to the offeree within 75 days the offer is rejected. (Offer from the 3rd person must be in writing and state all the specifics) • The S/H must offer the corp to purchase the shares on for the same price as offered by the 3rd person • The corp has 40 days to call a S/H meeting and the offer must be approved by a majority vote of the shares entitled to be case at the meeting. Page 116 of 148 . the corp has the right to purchase the shares from the transferee for the same price he purchased them and can specifically enforce this sale obligation  33-18-140 – Close corp-if provided in articles. o Problem is that the period is too short – in SC they probably will not be able to close out the estate within that time period. but the remaining holders of the same class of shares are given the first option to buy any remaining shares that have not been allocated. the S/H has 120 days to transfer his shares to the third person in accordance with the terms of his offer to the cop – 3rd person must purchase ALL of the shares. • If the corp decides to purchase the shares it may allocate them as it wants. Corp must deliver a purchase offer to the person within 75 days after the effect request notice accompanied by the corp’s financial statements.  33-18-130 – Close Corp . • If a S/H votes against the amendment he is entitled to dissenter’s rights if the amendment would alter or modify his rights to have his shares purchased. • § 33-18-150 through 33-18-170 do not prohibit any other agreement providing for the purchase of shares upon a shareholder’s death nor do they prevent a shareholder from enforcing any remedy he has independently of these sections  33-18-150 – Close Corp – If the estate of a S/H wants to exercise his compulsory right to have the corp purchase the shares then it must provide this request to the the corp via written notice within 120 days after death (Burkhard says this time period is way too short cause no one will think of it that fast) • Corp has to call a S/H meeting within 20 days of receipt of notice and the vote to purchase requires a majority of S/H votes entitled to be cast at the meeting.• Start with the notion that you cannot transfer stock of a statutory close corporation • Can only not transfer shares except as permitted by the AI’s. S/H must accept within 15 days. If the corp makes a counteroffer the S/H has 15 days to accept the counteroffer or it is rejected. you can force the co. If the corp accepts the S/H’s offer or the S/H accepts the Corps counteroffer the certificates must be delivered within 20 days. • If the corp rejects the offer. to purchase of shares after death. o Exceptions – unless the AI provides otherwise:  Transfers within the corp to the same class or series of shares  Transfers to immediate family or to a trust of which the beneficiaries are immediate family (most people don’t like this and you can prevent it by putting a restriction in the articles)  Transfers approved in writing by all of the S/H’s  Transfer to an executor upon death or a trustee as a result of bankruptcy. • If a transferee received shares in violation of a transfer prohibition that is not binding on the purchaser b/c he didn’t have notice. insolvency or dissolution or similar proceeding brought against the S/H  Transfer b/c of a merger or share exchange  Transfer of a pledge for a loan or collateral – as long as the pledge has not voting rights  Transfers made after the corp terminates as a close corp. • If this provision is being added or deleted to the AI by amendment it requires the 2/3 votes of each class of shares approval.Attempted share transfer in breach of prohibition.

If he had known. (p.  33-18-160 – Close Corp . o Was the sale when he announced his retirement or when he got his check? Court said could be date he announced retirement o Was the withheld information up to that date material? Court said the information was material when they were negotiating  Problems w/bringing this as a 10b-5 claim: difficult to show proper degree of • Scienter • Loss causation – Non-disclosure caused the stock to rise • Transaction causation – problem showing that the non-disclosure caused Jordan to sell his stock. and there may have been a continued duty to disclose o Note – court says that if the sale is found to be in Dec. He found out later that when he left the company was in the final stages of negotiating a merger which would have shot his value through the roof. • Co must notify all of its S/H of the proceedings • Court determines the fair value of the shares.  The Court also held that this was a close corporation – if not the fiduciary duties of the shareholders would have changed a great deal. but that didn’t happen here o Page 471 – lists information about mergers and intentions of board that the Π clams are material and that should have been disclosed at time he sold his shares o ∆ claims that nothing after Nov.o • If the price and terms of the compulsory purchase are fixed in the AI’s then the corp is bound to these terms and if they do not uphold them then they are in default and it is grounds for dissolution.If the offer is rejected or no offer is made then the person exercising the compulsory purchase may commence a court action to compel purchase. when the Π offered resignation had to be revealed o Π also claims there was info before November that should have been disclosed o When was the Sale o Nov 16 . He left for personal reasons and sold back his stock. Notes Page 117 of 148 . and this was before his stock was valuated. Jordan v. • The court said that you can contract this duty out in the stock sale. he would have delayed his decision to end his employment. 83? • Was the info material • What was the date of the sale?  Rule on Duty in Close Corporation: when an insider or the corporation is buying stock. the information is material and had to be disclosed o Was there even a duty o ∆ claims that it had not affirmative duty to disclose this information o Wrong – Close corporations have a duty to disclose material information when buying their own stock – Jacobson case in SC o This is also analogous to the special facts doctrine which holds that principle insiders in closely held firms may not buy stock from outsiders in person to person transactions without informing them of new events that substantially affect the value of the stock – this doesn’t apply in SC  Timing: the judge decided that the information became material when they had structured the merger. • Ct can order the corp to purchase shares or right to have corp dissolved.∆ argues that resignation = irrevocable sale with differed delivery  But court notes that ∆ agreed to value the stock at the Dec 31. so couple this with possibility that jury could find the sale took place on the later date. have a duty to disclose the information or the pending merger negotiations to Jordan before he cashed out on Dec 1. so a jury could have reasonably found that the defendant had a duty to disclose and breached that duty. then as a matter of law. o Co. which suggests the sale may have been on the day of delivery  There is also a possibility that Π could have revoked resignation. can show financial reasons why the court should modify the value. Duff & Phelps (Federal 10b-5) – Close Corporations. there is a duty to disclose material facts – S/H have a duty to each other as in a partnership.  Issue: Did the Co. 469)  Facts: Plaintiff had purchased stock in a closely held corp pursuant to an agreement that required him to sell it back if he quit or was fired. 1983 date rather than the 1982 value.

b/c most people would say that the Board’s decision to consult with an IB firm and discuss financing alternatives would be material to someone considering selling their stock – would be enough to meet the materiality test. West announced a merger that made the stock worth a lot more.Common Law Non-Disclosure Case (p.  One question is whether this case would have fared better in Federal Court – 10b-5 claims are federal jurisdiction and common law non-disclosure claims end up in state court. o o Page 118 of 148 . At the time Berreman retired.Failed • Court used the reasonable shareholder standard from Levinson to decide if it was material • Probability Magnitude/Basic Test Applied: probability at the time of retirement was too low to be overcome even by the large magnitude of the transaction. West bought his shares.  Materiality Test . it could still be considered a close corp because of the other close corp factors (Donahue Case). sometimes SH that oppose it may have a right to force the corporation to buy them out (Dissenting SH right of appraisal) o Inform the state of the change by filing with Sec of State o Sometimes there are events that the SH can trigger o If SH approval is required. has ended o Co goes into a wind-up mode. He decided to retire. About 4 months later.things the BOD cant change on it own o Amendment to articles o Dissolution o Merger o Sale of all the substantially all the assets Fundamental changes all follow the same pattern (p. the court noted that although there were hundreds of shareholders in West.  Burkie says this is a strange result. o 7th circuit has gone no further than to say a corp’s decision to seek a buyer may be material. o West had made no decision to solicit bids for the sale of West. 480) o BOD has to recommend it o Notice to SH o Special meeting to vote o If approved.o o o o o o  2.  Factors to Determine Close Corp: • Lack of a public market • Managerial role of West’s S/Hs o West’s decision making was concentrated in only a few individuals and the numerical structure should be analyzed from that viewpoint. there had been no discussions.1 wouldn’t do any good to say this is not a trade of securities – you cant modify out of it But maybe you can say that termination of employment does not create duty to disclose o Berreman v. West Publishing (Minn) Close Corp . • Rationale supports – b/c majority S/H of a close corp can deny minority S/H income from their investment. but the directors had started to think about a merger  First. minority s/h are in a vulnerable position. much less initiated discussions with any potential buyers. 474)  Facts: Berreman was an executive at West and had a bunch of stock. SC requirements will be changed For nonfundamental decisions. o Corporate Endgames (Fundamental Changes to the Corp) Fundamental Changes. and as part of the buy-sell agreement. you only need a majority of the votes that are cast o This is the modern view But for fundamental decisions – the states vary – many require a higher number than for nonfundamental issues DISSOLUTION – Steps page 483 o Dissolution does not mean that the co.  Holding: West was a Close Corporation and as such the shareholders owed one another a fiduciary duty as in a partnership – utmost duty of care – which includes a duty to disclose material facts. then a vote All these events require filing with Sec of state Voting schemes for these events can vary greatly depending on the event and the statutes also vary from state to state o By the time we take bar.

o Must pay all debts bf giving any $ to S/H o Creditors who are not paid during dissolution may seek to recover from S/H o Notice of dissolution has to be filed with the Sec of State’s office – give creditors notice of their right to be paid o No document that the Co. can file to bring finality. Dissolution • Judicial dissolution – allowed when a SH establishes that those in control have acted in a manner that is illegal, oppressive or fraudulent • Voluntary Dissolution o Follows scheme above – ie BOD approve it, SH vote, ect • In both o The corporation continues after dissolution for limited purpose of winding up o Winding up includes  Collecting and liquidating assets and usig the proceeds to pay creditors o Creditors must be paid in full before SH get anything  If creditors not paid,, they can recover from SH to extent that they received money after dissolution o Notice filed in same records as articles o Written notice shall be given to known claimants and publication may be used for unknown Question page483 • How much will it cost them dissolve when they owe 100K to creditors and assets are only worth 90k o How do you get out of this mess. If you do it in the right way, there won’t be any personal liability, so the SH won’t owe anything o so what does the atty do  follow the statute step by step to make sure it is done correctly o 33-14-102 – Dissolution by the BOD and S/H – how they approve o BOD must recommend the dissolution to the S/H unless it determines that b/c of a conflict of interest or some other circumstance it should not make a recommendation and communicates the basis for its determination to the S/H. o If the holders of at least 10% of any class of voting shares of the corp propose dissolution, the BOD must submit the proposal at the next meeting o Dissolution must be approved by 2/3 of the S/H entitled to vote – unless the AI’s require a different vote but it must be at least a majority. o 33-14-103 –Articles of Dissolution o After dissolution has been authorized co. may officially dissolve by delivering the articles of dissolution to the Sec of State’s office – this will be the effective date of dissolution. o 33-14-104 – Revocation of Dissolution o Dissolution may be revoked within 120 days – must be authorized in the same manner it was approved unless the authorization permitted revocation by the BOD alone. o 33-14-105 – Effect of dissolution o Dissolved Corp continues its corporate existence but may NOT carry on any business except as appropriate to wind up and liquidate assets. o 33-14-106 – Effect of known claims against the Corp o Co must provide written notice of dissolution to creditors and claim of creditors may be cut off if they don’t respond to notice of dissolution in time. o If the Co. rejects a claim and the rejection gave the heads up on the 90 days deadline, a creditor only has 90 days to commence a proceeding. o A claim does not mean contingent liability or events post dissolution. o 33-14-107 – Effect of unknown claims – give notice one time in newspaper of general circulation with a mailing address and the notice must state that claims must come forward within 5 years after the publication date. o A claim can be enforced against the corp’s undistributed assets or against a S/h of the dissolved corp, but only to the extent of his pro-rata share or the amount he received from the co’s liquidation assets. o 33-14-420 - If you have a corporation dissolved before 1999, no one can get any money from anyone connected with the corporation. o MERGERS - 70% of mergers are structured in order to cash out on minority shareholders. o 70% of mergers are structured to cash-out minority shareholders o Surviving Corporation and Disappearing corporation (one that disappears after merger) o Find out whether there the surviving corp assumes debts and liabilities of disappearing o Stockholder protection (4 types) o Sue the directors who approved the merger alleging breach of common law or statutory duty of care  See 33-11-101 Page 119 of 148

o

o

o

o

o

Vote against the merger Assert the dissenting shareholder’s right of appraisal  No state requires unanimous vote – but those that dissent may have right to be bought out at a “fair value” as determined at a judicial appraisal process  Ex – A merges into B – merger agreement says A is work 3 million. SH owns 10%. Rather than accepting the 300K that SH would get from the merger (which could be stock in B, other stock, property or cash), he may assert the dissenting SH right of appraisal – the court could appraise A at 5 million, so SH gets more  But there are lots of requirements to get this o Sue the directors who approved the merger alleging a breach of loyalty Question 1 page 484 o 33-11-106  Holds that McDonalds as the surviving corporation would assume the debts of Bubba’s  This applies to both secured and unsecured creditors  Capel as a SH of Bubba’s is entitled only to what is provided in the merger agreement • This could be shares in the survivor • But more than likely it will be a cash buyout of your shares. The value of which will be in the agreement o Unless you are able to bring a dissenting shareholder right of appraisal action Often the SH does not want to be cashed out o To do this, you have to bring it to a vote. So we look to 33-11-103 (e) and (f)  This requires 2/3 votes – so Capel at 51% could have stopped the merger unless he got stock Triangular Merger o M creates Newco. M transfers some shares into newco and Newco transfers all of its shares to M o B then merges into Newco and the shareholders of B now own shares of M whereas M now owns all the shares of B Purpose o Don’t have to get approval of M’s shareholder (which you probably wont need anyway) o You might not want B to be a part of M – there are more protections if you keep B as a subsidiary Question on 485 – see 33-11-101 and 103 o 33-11-101 – Definition of merger  Sets forth what must be included in the plan of merger o 33-11-102 – Share Exchange  A corp may acquire all of the outstanding shares of one or more classes or series of another corp if the BOD of each corp adopts and its shareholder, if required by 33-11-103, approve the change. o 33-11-103 – Action on Plan - what is required for a merger to be approved –  (a) Co. being acquired submits a plan of merger or share exchange to be approved by its S/Hs.  (b) – For the plan to be approved the BOD must recommend the plan and the S/H entitled to vote must approve the plan.  (d) Corp must notify each S/H of the meeting, whether or not they are entitled to vote, and the notify them that the purpose of the meeting is to vote on the merger or proposed plan.  (e) – require 2/3 vote entitled to be cast on the plan (2/3 from each voting group).  (f) the AIs can require a different vote but it must be at least a majority of the S/H of each voting group entitled to vote on the merger.  (g) Separate voting by voting groups is required if the plan of merger contains a proposed amendment to the AI which would require action by separate voting groups under 33-10-104.  (h)Vote of the surviving co’s S/H is NOT required if • The AIs of the surviving corp will not be different • If the increased shares (voting or participating) are not going to exceed 20% of the shares of acquiring co pre-merger then a vote of the surviving S/H corp is required (if the number of outstanding shares will go up by more than 20%, then the shareholders in McDonalds also have to vote) • See the statute for other circumstances • The notion is that the shareholders of the surviving company normally do not vote on the merger. Normally it is only the shareholders of the disappearing company who are entitled to vote. o 33-10-104 – voting on amendments by voting groups  Holders are entitled to vote as a separate group in the following circumstances… o 33-11-104 – Merger of Subsidiary into Parent  A parent corp owning at least 90% of the outstanding stock of the subsid. Corp may merge the sub into itself without approval of the shareholders of the parent of sub,  Articles of merger under this section may not contain amendments to the AI’s of the parent corp. o o Page 120 of 148

o

o

o

33-11-108 – Merger of parent into subsidiary  A parent corp owning at least 90% of the outstanding stock of the subsid. may merge the into the sub without approval of the shareholders of the parent of sub,  Articles of merger under this section may not contain amendments to the AI’s of the sub corp except for amendments under 33-10-102 by the BOD. o 33-11-105 – Articles of Merger or Share Exchange  Surviving or acquiring entity must deliver to Sec of State – a merger or S/E takes effect upon the effective date of the articles of merger or S/E. o 33-11-106 –Effect of Merger or Share Exchange  Everything vests into the surviving corp  Surviving Corp has all the liabilities of each party to the merger • A proceeding pending against a party to a merger may be continued as if the merger did not occur or the surviving entity may be substituted in the litigation.  Former S/H are entitled only to rights provided in the articles of merger or dissenter’s rights under Chapter 13. o 33-11-107 – Merger or Share Exchange with Foreign Corp 5 Steps for all 4 Methods of Corporate Change: o BOD approves the change o BOD must notify the S/Hs and its recommendation of the fundamental change must be approved o Special meeting of the S/H must be held, at which they vote on the deal. If it is approved the corp will go thru the change. o If the deal is approved the S/H who did not approved the change might have a right to force the corp to buy them out o Corp is usually required to inform the state of the fundamental change by filing a document with the sec of state. Stockholder Protection – Rights of S/H who are unhappy with the fundamental corporate change o Sue directors for breach of duty of due care. o Vote against merger. o Sue the directors for breach of duty of loyalty (see below in outline-green) o Assert Dissenting shareholders’ right of appraisal – Chapter 13- “Dissenter’s Rights” o Rule: If stock is traded on a public exchange, you can’t have dissenter’s rights. o 33-13-101(3) – Definitions –  (1) – Dissenter must own the shares before the corporate action, or the surviving or acquiring corporate action by merger or share exchange of that issuer.  (3) “Fair value” = With respect to a dissenter’s shares, the value immediately before the effectuation of the corporate action to which the dissenting shareholder objects, excluding any appreciation or depreciation as a result of the action to which the dissenter objects. The value of the shares is to be determined by techniques that are generally accepted in the financial community. o 33-13-102 – Right to Dissent  A S/H is entitled to dissent from, and obtain payment of the fair value of, his shares in the event of any of the following corporate actions: • Merger o Must have right to vote against merger (and thus have done so) in order to be entitled to have right to dissent. • Share Exchange • Sale of Assets • Amendment of the AIs that materially or adversely affects the rights in respect of a dissenter’s shares o Alters of abolishes a preferential right to the shares o Modifies a right to redemption o Modifies a preemptive right o Modifies the voting rights of the shares o Reduces the # of shares owned to a fractional amount if that amount is to be acquired for cash. • Any corporate action that the AI’s or bylaws provide a right to dissent • Conversion or plan of conversion of the Co. into a LLC, GP or LP pursuant to 33-11-113  (B) – no dissenter’s rights if the co. is publicly traded b/c theoretically you can share your stock easily if you don’t like it o 33-13-103 – Dissent by Nominees and Beneficial Owner  Partial Dissent is ok by Record S/H– but must dissent as to all of the shares of a beneficial owner o Page 121 of 148

co must pay you the fair value of the stock plus interest. o 33-13-280 – Procedure if shareholder dissatisfied with payment or offer  A dissenter may notify the corp in writing of his own estimate of the fair value of his shares and demand pmt of his estimate or reject the corps offer if he believes that the amount paid is less than the FMV or the interest was calculated incorrectly OR  the corp fails to make pmt within 60 days after demand or fails to return the certificates after not taking the corp action. does not take the corp action within 60 days after the date set for demanding payment. vexatiously. The HMO Board approved the Merger and sent a proxy statement to the S/Hs. When the merger was approved. or not in good faith in demanding pmt under 33-13-280. o 33-13-200 – Notice of Dissenters Rights  If it is an action that is going to trigger dissenter’s rights you must tell them at the first available time – or meeting that this action will trigger dissenter’s rights.  If the corp does not do this w/in 60 days they must pay the dissenter the additional amount requested  Dissenter is only entitled to Ct’s determined amount if it exceeds the amount paid by the corp/ o 33-13-310 – Court Costs and Counsel fees  The court shall assess the costs for the attys and appraisers against the corp except to the extent the court can allocate part of the costs to the dissenter’s if the court finds that the dissenter’s acted arbitrarily.4M. but SSM didn’t want them to. o 33-13-210 – Notice of Intent to Demand Payment  Person who wishes to assert dissenter’s rights must • Give a written notice to the corp prior to the vote of his intent to demand pmt for his shares • Must NOT vote his shares in favor of the corp action (have to make a decision real quick) • A vote in favor of the corp action by the holder of a proxy solicited by the corp will not disqualify a S/H from demanding pmt for his shares (? Statute doesn’t say this and Burkhard didn’t mention) o 33-13-220 – Dissenter’s Notice  If a corp action is authorized at a S/H meeting corp must notify w/in 10 days S/H who voted against it and satisfied their dissenter’s notice requisites under 33-13-210 and there is a deadline for re-submitting the payment demand back to the corp. o 33-13-230 – Shareholders’ Payment Demand –  If the payment demand is not submitted in a timely fashion then S/H loses his right and is not entitled to payment. the corp shall commence a proceeding within 60 days after receiving the demand for additional payment and the court will determine the FMV.o  Beneficial owners of shares may assert dissenter’s rights only as to all of the shares they are the beneficial owner of –Must notify the corp in writing and include the contact info for the record S/H. If the action is taken without a vote of shareholders. and each took a minority stake. SSM was pissed. SSM (WI) – Appraisal Case (p.  If the dissenter does not notify the corp of his demand in writing within 30 days after the corp makes the offer. o 33-13-250 – Payment  If you comply with the payment demand requisites as soon as the corp action is taken. SSM demanded appraisal. o Issue – Can “minority discounts” be applied to determine the fair value of the dissenter’s shares in an appraisal proceeding –  NO  Minority Discount address the lack of control one the theory that non controlling shares of sotck are not worth their proportionate share of the firms value because they lack power to control corporate actions  This is different from Marketability discount which address fact that there is a limited market for shares in a close corporation (not addressed here) Page 122 of 148 . and sued. certain co. HMO-W was set to merge. SSM got a pre merger appraisal and it said the business was worth $18M. the corporation shall notify in writing all shareholders entitled to assert dissenter’s rights under Section 33-13-102. must be accompanied by an explanation of how the fair value was calculated. the co. and a notice of what steps to take if the S/H does not like the payment.  If a S/H complies with the time requisites he is entitled to all other rights of a S/h until these rights are canceled or modified by the taking of the corp action. SSM’s expert said the value was $19M. he waives this right for additional pmt under this section o 33-13-300 – Court Action – provision for the court to set the value. 486) o This was a Direct claim o A bunch of corporations each formed a health care system (corporation). must return the share certificates and release the restrictions imposed. HMO-W v.  If demand for additional payment under 280 remains unsettled. HMO-W went out and got a new appraiser and found the value to be $7. o 33-13-260 – Failure to take Corp Action  If the co. financial statements.

o 2 Issues:  Whether a minority discount may apply in determining the fair value of a dissenter’s shares  Whether a court in making its fair value determination may consider evidence of unfair dealing relating to the value of the dissenter’s shares.Appraisal rights represent a legislative response to the minority’s lack of corporate veto power and the consequential vulnerability to majority oppression. A dissenting shareholder is thus entitled to the proportionate interest of his or her minority shares in the going concern of the entire company. is not a precise science.  Rule on Considering Unfair Dealing in Valuation of Minority Shares: Evidence of unfair dealing by the corporation when valuating shares can be considered in an appraisal proceeding. even though the court ruled that they had to be paid the 16-18MM amount in the initial appraisal for their shares.  Appraisers are Important: If we were representing any of these companies you would need to know how your experts went about valuing the company. and unfairly enriches the majority shareholders who may reap a windfall from the appraisal process by cashing out a dissenting shareholder.  The United shareholders appear to have been defrauded because they paid for the company based on the first appraisal. – Whether the S/H is entitled to bring an action for breach of fiduciary duty?  Rule: When appraising shares. • However. an involuntary corporate change approved by the majority requires as a matter of fairness that a dissenting s/h be compensated for the loss of the S/H proportionate interest in the business as an entity. This case demonstrates that trying to value a co. • Are we valuing SSM stocks individually or are we valuing the business as a whole.  Court points out that the petitioners did not assert detrimental reliance. so the minority shareholder had a veto power) • Court concludes that applying such a discount frustrates the equitable purpose of DSRA – so its not applied in appraisal  Which Appraisal • Π alleges unfair dealing. in this case getting an independent appraisal wasn’t enough to make the court factor it in. the HMO S/Hs lost out b/c they paid too high a price. two types of discounts commonly apply • Minority discount: reduce value for lack of control of block of shares – non-controlling shares of stock are not worth their proportionate share of the firm’s value b/c they lack voting power to control corp. • To fail to accord a minority shareholder the full proportionate value of his shares imposes a penalty for lack of control. but didn’t claim breach of fid duty o Ie that the corporation misrepresented the value on the proxy and then after vote they were told its worth a lot less • Appraisal is the only remedy for a dissenter absent fraud or breach of fid duty o Π is trying to bring a claim for appraisal and for breach of duty – that the misrep is wrongful and that they should get something for it  But court says there are not two COA. • SC about to amend the statute to say this! o Rule: Consistent with the statutory purpose in granting dissenter’s rights.  Tracing DSRA • Arose to reconcile victimization of minority shareholders when states started allowing majority consent for fundamental changes (use to be that there had to be unanimous vote.  This is a very strange result b/c if the SSM shareholders had approved the merger to begin with they would have received the higher amount. (SSM argues that you should value the entire business and give them their proportionate share) • Court agrees with SSM . and as such a minority discount cannot be applied. so this argument was out. actions (they did apply this discount) • Lack of marketability discount: reduce price for relative lack of liquidity of the shares on the theory that there is a limited supply of potential buyers in a closely held corporation (they didn’t apply this discount in this case)  Rule on Minority Discounts: Court said that the intent of the dissenting shareholders rights were to give the shareholders their proportion of the business. and it is a lot of guess work. there is only one o States split on whether breach of fid duty and fraud must be brought as separate action from appraisal o This court doesn’t answer this question because it finds that unfair dealing goes directly to appraisal Page 123 of 148 . a clearly undesirable result.

• Have no idea how they got their ratio’s and they did not do any weighting of the methods. o But probably in this case the shares were between family members and so they were sold at a reduced price so it is hard to get a FMV of the stock. the market value. so the court was free to set the value regardless of what the prior appraisals said  Therefore the value adopted by the trial court is fine.There is no indication in this opinion how the court assigned the % weights to each of the variable methods  DE has actually rejected the DE block method. 15% to the market value using and EPS multiple. and then the court weights each assessment based on the relative value to the evaluation • Net asset value – the total assets minus liabilities • Market value – what shares have sold for recently • Investment Value of the Dissenting Stock o look at similar companies o look at their published market cap  Problem with this method .  Finally the Court approved the using the block method in this case and assessed a 60% weight to the Net Asset Value. Presumably because it is the most reliable method. Its not the same as if the ∆ had done something to affect the true value – the misrep was of the Valuation. not the value – ie you just miscounted the money. • Rule: You should essentially use the most reliable method. – • This is weird b/c with an ongoing business Net Asset Value is really not a good assessment of value. – No idea where they get these ratios. • Often you would use you look at what the stock would sell for at an arms length transaction (Problem in Close Corps b/c no marketability for the stock and selling to family members is not an arms length transaction. Said the key factor in this case was the net asset value – you can actually go out and value those assets. and the investment value.  Court in this case gave low weight to market value because other recent transactions were not at arm’s length.o However. which entails looking at the net asset value. you didn’t take anyway o Court finds the Π failed to show that the misrep was the but for cause of the merger  The didn’t rely on it because they didn’t vote for the merger.  33-13-103(3) –key statue in SC for stock valuation • Any legitimate method of valuing stock is acceptable in SC. the question is should this be the method in SC?  3 Things the Court said the Appraisers did wrong • Earnings method used an only 1 year average • Used the wrong multiplier – used a price earnings multiplier for a # of publicly traded securities which was wrong b/c they are not comparable – Belk stores are privately owned.  Method of Valuation – Ct takes from the Santee Case: Apply DEe block method. Page 124 of 148 • . and they asked for the appraisal • The court is the sole body that determines the fair value. the unfair dealing here didn’t change the value of the Π’s shares because the inflated value was never accurate. and 15% to the DCF multiple. but the minority discount should not be subtracted from the Π’s shares Appraisal Process in SC • 33-13-101 o Fair Value – make sure you know it • 102 o Right to Dissent  Includes that an amendment to the articles could trigger rights • Look at all the notice statutes as well • Know all of the 33-13-200’s o And 300s  Its real easy to screw up as a minority SH if you are trying to bring a DSRA o SC is changing statute to say that minority discounts are not to be applied Woodside – Finance prof COC  Used comparable companies analysis – of other co’s like Dillard’s – Ct rejected this method  DCF analysis – court accepted this method but this is weird b/c essentially you use cash flows from comparable companies like Dillards to run this model so it is essentially the same. gave low weight to investment value because there weren’t any really close examples of similar companies.

be valued at $20-21 instead of $24 – but this difference would have limited impact on Signal but a significant impact on the S/H. o Footnote 7: Although perfection is not possible. That information was never disclosed to UOP. The board of Signal and the board of UOP had to approve the merger. there were no negotiations. and the Signal directors didn’t vote. This means that the so-called Delaware block or weighted average method was employed wherein the elements of value were assigned a particular weight and the resulting amounts added to determine the value per share. the Chancellor perceived that the approach to valuation was the same as that in an appraisal proceeding. However. o “In this breach of fiduciary duty case. They are asking for a valuation of the stock they currently hold as if there was no merger. Signal’s people are controlling the UOP’s board. it does not exist. meaning they had to show fair dealing and fair price. o Rule: If directors that are of both sides of the deal are involved in the merger negotiations – there is no fair dealing b/c they could not have been at arms length. it was a close corporation and therefore the minority shares were sold at a discount b/c there was no marketability. case for rescission (undo the deal) not appraisal – the plaintiffs want the value of their stock. Court decided that in DE fair value would be calculated using all relevant factors: Rejected the DE method of weighting various methods (which is the Belk method of appraisal). You need to bring an appraisal case before you bring a common law breach of duty of loyalty action for a merger that was approved by interested directors o Page 125 of 148 . • Court reversed for a determination under this calculation. 2 of those directors who were also officers of Signal prepared a report for Signal that stated Signal (parent) should buy the rest of the shares of UOP (subsidiary) at up to $24/share. UOP (DE) – Breach of Duty of Loyalty (p. or expected. The UOP board approved a cash-out merger at $21/share. it is now clearly outmoded. So you only get rescissory when appraisal wouldn’t be fair to other parties who relied on the transaction. • Rule: This case suggests in DE. They used information that would only be known to UOP and said it would be a good deal up to $24 a share. Must pick out a DCF multiple. the stock will go up in value.  Arledge and Chitea were 2 of the Signal directors that made the disclosure to the Parent and not the Subsidiaries. o In this case the court says they will allow them to have rescissory damages. But said P should bring an appraisal action instead of breach of loyalty claim. Liability of Interested Directors who approved the merger for Common Law Breach of Duty of Loyalty o Weinberger v. and the UOP directors weren’t made aware of the $24 study. but they have pursued this according to the common law notion that there was a breach of duty. If the merger were rescinded. UOP had the burden of showing the overall fairness of the deal or be in breach of their duty of loyalty to UOP. In this case. Consistent with precedent. 12 S/H have no control of the company. he rejected plaintiff’s method of proof and accepted defendant’s evidence of value as being in accord with practice under prior case law. They most show fair dealing and fair price in order to withstand a breach of the duty of loyalty  Court said in a case like this must focus on Fair price and Fair Dealing (aka fair process): • Process was not fair– deal was controlled exclusively by Signal who also controlled the negotiations looks at the timing (only gave them 4 days) and negotiation of the deal. They created reports suggesting that the Co.5% of UOP and controlled 7/13 directors. the court said they would only be awarded when appraisal of a company isn’t an adequate remedy.  Court said that since UOP had interested directors on both sides of the transaction. 494)  Facts: Signal owned 50. to the extent it excludes other generally accepted techniques used in the financial community and the courts.  Dissenting plaintiffs sued and wanted rescissory damages. Presumably. UOP then solicited its shareholders recommending to vote for the deal. the result here could have been entirely different if UOP had appointed an independent negotiating committee of its outside directors to deal with Signal at arm’s length • Price was not fair: the question would be based on an appraisal of the company. This procedure has been used for decades.  Rule: When directors are on both sides they are held to the utmost good faith and the most scrupulous fairness.” o Court in this case said they would permit any generally accepted method of valuation considered acceptable in the financial community Recommended DCF as the best analysis– try to predict what the future cash flow over a relevant time period. • Rule on Rescissory Damages: As to rescissory damages. It is time we recognize that in appraisal and other stock valuation proceedings and bring our law current on the subject…We believe that a more liberal approach must include proof of value by any techniques or methods which are generally considered acceptable in the financial community.

 Used the Block Method  Pick your experts wisely!! Page 126 of 148 .914. even though Weinberger threw it out years ago. was $134. Thompson is one of the dissenting shareholders of the surviving corporation – Belk of Spartanburg.15 241. 1996. 265 S. Court shot that down b/c they say they can’t see a business purpose if UOP is going out of business.2d 789.493. because we have some qualms about his reasonings. Belk of Spartanburg v. the guideline public company value method).05). of course. the trial court adopted Woodside's weighting. and the precise weight to be given to any factor is necessarily a matter of judgment for the court in the light of circumstances in each case. means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects.60 $ 884.• • Finally. 217 S. There is nothing in the opinion that they use to justify the weight that they give to the different factors.C.10 on October 4. o Clarkson and Way are the dissenter’s experts. it is unusual for the S/Hs of the surviving corporation to have dissenter’s rights. the Plaintiff tried to get the DE court to adopt a test that requires the merger to be a legitimate business purpose.606. Woodside weighted each of his four methods equally.50 (90 x $1.474. with respect to dissenter’s shares. o The court said that the experts did not apply all three of the Weinberger factors and that the experts didn’t determine a method of weighting the factors. we arrive at the following valuation: Determined Weighted Value/Share Weight Value/Share Net Asset $1. She wants her stock to be re-valued. 270. Santee Oil Co.  Clarkson is a CPA and a lawyer and the former tax commissioner in SC and Way was a financial planner out of Charlotte – no PHD.25 373.53 Value: Discounted $1. we accordingly distribute the weighting differently than the trial court. o The court uses large department store models to determine the ratios. Burkhard says this is wrong because the factors were not affected by the merger. o The court ultimately concludes that most of these transactions were arms length.E. Probably what is going on here is that Belk of Clinton bought Belk of Spartanburg but retained the Belk of Spartanburg name (similar to FU/Wachovia merger). o Issue: How to value the stock – there was a large discrepancy. o It is odd that the Court of Appeals criticized the appraisers for not following Santee and the Court of Appeals also does not follow Santee in arriving at the weight to be given to each factor. and that a freeze out couldn’t be a legitimate business purpose..04 Cash Flow: Market $1. 1996. but it does not allow other types of ratios to be used. The court does allow some modifications of the methods that are suggested. the value of Thompson's BDS stock on October 5.499. The court allows the ratio for discounted cash flow (weighted it 15%). o The court throws out some of the factors based on the fact that they occurred after the time of the merger and cited to 33-13-101(3). Market value is the price paid for sales of stock. we find Thompson is due the additional sum of $2. o § 33-13-101(3): Fair value.05 Value: o Using this value. o Three factors are usually considered in assessing value: they use the DE block test (see the factors from Weinberger). o Another weird thing is the scope of review here. o Resulting Total Valuation.21 0.749. Because BDS paid Thompson $132. In arriving at his final valuation. Based on our discussion above.93 0. but they say that that factor (market value) is not the be given much weight.48 Value: Final Determined Fair $1.90 0.165. but adjusted the figures to correspond to the size of Belk. the Ct of appeals gets to decide the facts de novo. Burkhard says the court goes back and forth in its analysis. Although we largely agree with Woodside's methods (except.499. SC recently applied it.40 from BDS. Under the SC statute. Thompson (SC) o Merger btwn Belk of Spartanburg and Belk of Clinton. o Appraisal is not an exact science. excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable. The value of the shares is to be determined by techniques that are accepted generally in the financial community.

because it has been so long since the merger. then was the merger fair given the totality of the circumstances. Plaintiff had some of the nonvoting stock. serious problem. and they are asking for more $. SALE OF ASSETS . similar to the Mass one. New England Patriots (MA) (Not an Appraisal Case – Class Action for Recission) (p.  DE Rule: Appraisal is still an exclusive remedy. the ct said rescissory damages were allowed to be considered • Rescissory damages are given as the present value of the stock as it would be if the merger were rescinded plus interest. that appraisal actions are the exclusive remedy of an unhappy shareholder.  MA Rule. which cannot be a legitimate business purpose. Applied the Business Purpose Test  SC Rule: a decision was made NOT to include a provision. and he cant do that so he tries to get rid of all the minority S/Hs  He used the corporation to secure a personal loan. the seller distributes the remainder to its shareholders • Franklin v. He made a new company and performed a cash out merger. an unhappy S/H can bring a breach of fiduciary duty claim similar to Coggins. then the court will analyze under fairness-TOT – whether it it was fair to the minority (maybe by proving the value of the price was fair). The state law required majority vote of all affected classes of shares. when this was rejected he argued that this claim had to be brought as an appraisal claim. Found that the real reason was to pay back personal loans.Successor Liability/ Effect of sale of assets on creditors  General Rule: a buyer of corporate assets is not liable for seller’s corporate debts  Rule: A sale of assets doesn’t automatically end existence of selling corporation unless the corporation subsequently dissolves.  MA Court applied the business purpose test – Rejected the DE Rule • DE Rule: There does not have to be a legitimate business purpose. which included getting rid of those nonvoting shares as a marketing tactic. 509) Page 127 of 148 . The nonvoting shareholders don’t get stock in the new company but they are cashed out at $15 a share. other folks besides the minority S/H are effected by the merger. o If the D can show a valid business purpose.  Sullivan argued that there were 3 corporate reasons he structured the deal in this way. So court did not have to go to the fairness analysis. USX (CA) Successor Liability – Sale of Assets (p. o Then…the BOP shifts to the defendant to show that the freeze out was for a legitimate business purpose.  Effect of sale of assets on shareholders of seller and buyer • First.Court says that although the statute indicates appraisal is an exclusive remedy. and had to borrow a bunch of money from the bank to buy back all the voting shares. He was supposed to pledge the corporate assets for the securement of the loan he used to cash out.o o Coggins v. Owner was ousted. 502)  Owner of NE patriots issued a bunch of nonvoting common stock.  Rule of Rescission Damages: Court said that while the typical relief for an improper freeze out is rescission of the merger. it is a class action – class being all the S/H who challenged the transaction.  MA 2 Part Test to determine the fairness of a Freeze-Out Merger: • Was there a legitimate corporate purpose • If Yes. o P bears the initial BOP of showing that a freeze out was taken for no legitimate business purpose. creditors of the seller are paid • Then. in this case the Court can allow the action to proceed as a non-appraisal action (CL) for rescission. dissented. A condition of the loans was that he had to structure the team to best pay back the loans.  Ct rejected Owner’s arguments that there were legitimate football reasons not to have the nonvoting stock floating around. He decides to get rid of all the minority shareholders so that he would be the only person who could complain (which he obviously wouldn’t do). • SC – 30-10-104 –(d) – “shares are entitled to the voting rights granted by this section although the articles of incorporation provide that the shares are non-voting shares  Issue: Is appraisal an exclusive remedy for an unhappy S/H? No see below  This is not an appraisal case. That is a serious. and sued. He set up a new company to merge with (the nonvoting stockholders voted for the merger). if a S/H is unhappy with the merger. In SC.

and ConCal agreed to assume all liability.  De Facto Merger. ConCal then sold those assets to ConDel with no agreement.  Although SC does have the rule that a surviving co’s S/H get must approve a merger if the it will increase the stock more than 20% .’s S/Hs in a sale of assets get to vote on the assets purchase if it would require the issuance of more than 20% issuance of additional stock. Co. – Whether Condel acquired successor liability.’s S/Hs. o Hite was minority shareholder of Flo co. so USX can’t be liable. o 3 Ways to Acquire a Company:  Buy all of the stock of the co. Col authorized the issuance of more shares from Flo and then organized a stock exchange between the companies where Col rolled into Flo. o Issue: Whether the WPS liability followed through the ConCal to ConDel sale.o Girl was exposed to asbestos from her dad who worked for WPS.Transaction is entered into fraudulently to escape debts o Court said this could possibly be a de facto merger or a mere continuation of the business  Test de.did not adopt the rule from the MBC that the buying co. • Key: Inadequate cash consideration o Cash purchase is more predictable than a stock purchase. Alad): o No adequate consideration paid for the corporate assets (most important) o Officers/directors of the seller became officers/directors of the buyer o Holding: The court said that since the transaction was adequately financed with cash.Purchaser expressly or impliedly agrees to the assumption.Dissenter’s Rights and Equitable Remedies for Minority S/H o 2 SC Co’s – Florence & Columbia Companies. long after the transfer of assets defeats the legitimate expectations the parties held during negotiation and sale.  Acquire by Merger  By all of the Outstanding Assets of the Co – When you buy the assets you don’t acquire all of the liabilities unless you expressly agree to it. because presumably there are creditors of the seller to protect.Transaction amounts to a consolidation or merger. All of the WPS assets were purchased by ConCal. You would assume that an easy way to do that would be to merge the two companies together. liability doesn’t follow the assets UNLESS  Agreement . o If the purchaser continued the enterprise after the sale o If the shareholders of the seller became shareholders of the purchaser o If the seller liquidated o If the buyer assumed the liabilities necessary to carry on the business of the seller • Test for Continuation of the Business (Ray v. and majority shareholder was another corporation. Col. o Rule of Successor Liability on a Sale of Assets: On a sale of all assets to another corporation. – the acquired co.’s into one. ConDel merged into US Steel who became USX. o Issue #1: Do the Col.facto merger: o If consideration paid for the assets was solely stock of the purchaser.  Fraud . Howard & Howard (SC) – Share Exchange.  Ensure Marketability: Also b/c they want to make sure there is a market for troubled companies o 33-13-102 provides dissenter’s /appraisal rights for the selling corp. neither exception could apply. The result was that plaintiff’s control went from 33% to 11% and he wasn’t allowed to have his shares purchased for fair market value. Shareholders have sufficient voting power to approve the merger? Page 128 of 148 .  Continuation: Purchasing corporation is just a continuation of the selling corporation. • Hite v. – their objective was to merge the 2 companies into one. o Additional Policy Reasons not to Impose Liability:  Significant Time lapse: Also said that the imposition of successor liability on a purchasing co. and they are going to want a solid asset to come after for debts. is a wholly owned subsidiary or merge the 2 co. The people who are driving all of these transactions are the people of the Col.

o Issue #4: Should Hite have brought this as a derivative suit? . Florence owns 4143 shares. Hite would have had dissenter’s rights. • Ct rejected Mich Rule: where reduction of ownership percentage of an acquiring corporation could allow for dissenters rights where the acquiring corporation issued more than 100% of its original shares.says if Hite has the right to vote he is entitled to dissenter’s rights for a merger. “separate and distinct.32-11-103(e) – only requires 2/3 of the S/H votes to approve share exchange. The directors of Columbia will undoubtedly approve the exchange and the director’s of • Florence will approve the exchange b/c it is controlled by directors of Columbia • 33-11-103(a) only the S/H of the corporation whose shares are to be acquired in a S/E must approve the deal. In the next step. if required by 33-11-103. o Issue #4: Does Hite have dissenter’s rights in a share exchange?  No . • Scen #2: 33-11-103(h)(3). Hite would still have the right to dissent. He did not vote no to stop this b/c of § 33-10-103(f) because even if he had voted no they still had enough votes to pass this. § 33-13-102(4) does not allow for dissenter’s rights by virtue of this action that they wanted to take. Hite has no right to vote and thus no dissenter’s rights under 33-13-102(A)(3). • Scen #1: 33-11-103(2) If the surviving Co. o Our ending structure at this point in the game is that the plaintiff owns 55 shares. they are going to conduct a parent/subsidiary merger and the rules are different.” • Loss in value separate to Hite: Also. Hite would still have the right to vote against the merger b/c the # of shares of the surviving corp. is Columbia. o Columbia distributed 110 shares to Florence shareholders so it was wholly owned by Florence.  Cut out of his dissenter’s rights Page 129 of 148 . They decided to do a share exchange instead so they didn’t have to deal with dissenter’s rights. o Issue #2: Does Hite have dissenter’s rights if it were a Merger?:  33-13-102 and 33-11-103(e) – Yes . • So both boards will undoubtedly approve the exchange in this case. Hite had the right to vote on the amendment. if Hite is claiming loss in value.-If Florence is the surviving Co. since Florence is the acquiring co.33-13-102(a) – Share Exchange: A corp may acquire all of the outstanding shares of one or more classes or series of another corp’s stock if the BOD of each corp adopts and its shareholders .No  The defendants also argued that this should have been brought as a derivative claim and not a direct suit.. Florence pre-merger would have increased by more than 20% post merger (165 to 600). Columbia’s lawyers decided to do a stock exchange instead o The first step they took in order to implement the share exchange was to increase the number of shares.Court concludes that this was properly brought as a direct suit b/c the fact that Hite lost his voting power was individual to him. The defendants had the exact number of votes required to approve the merger (Hite owned 55 shares and the majority shareholders owned 110 shares (2/3))  If they had merged the companies. approve the exchange. he can bring it as a direct claim b/c co hasn’t really lost anything-it is just a shift in who owns the value o Holding: Court first said that this was a corporate action that caused a specific loss to a particular shareholder (voting rights). The defendants own 531 shares. Hite would have the right to vote.33-11-103(e) No he has less than 2/3..Reasons he brings this action. Therefore.  So b/c Hite had dissenter’s rights either way if it were a merger. then. o Issue #3: Does Hite have enough shares to vote against the share exchange?  No . • Loss of Voting Power Separate to Hite: No . They did this by amending the articles of incorporation. Yes. and therefore he could bring his suit directly rather than derivatively o Issue #5: If Hite has no dissenter’s rights under a Share Exchange were does this leave him? o 3 Things Hite is Mad About.

without limitation. director. the court may mane such order or grant relief. an order: • (4) providing for the purchase at their fair value of shares of any S/H.CA • Agreement. are acting. or unfairly prejudicial either to the corp or to any S/H (whether in his capacity as a S/H. fraudulent. However. then you ought to get stuck with the liabilities that come along. There is no evidence that the grounds for dissolution have been met here.e. directors. either by the corp or its S/Hs.If the K between the seller and the buyer is silent. i. o What triggers this remedy is when the S/H requests dissolution under 33-14-300 and in this case Hite did not make the request – Ct said it didn’t matter but Burkie questions this.. We decline to extend the exception to cases in which there is no such commonality of officers. Page 130 of 148 . or will act in a manner that is illegal. o Why didn’t Hite bring up the Pre-emptive Rights provisions – why these provisions did not help him out (§33-6-300) o Burkhard wanted to know why Hite didn’t argue preemptive rights. or shareholders. the dissent advocates an expansion of the mere continuation exception.•  His voting power has gone down the tubes. Make sure you don’t lose track of this case for other situations.  His shares have depreciated (his share value has gone down) – exchange ratio is unfair – D’s proportion of the entire co. • De-Facto Merger: Circumstances around the transaction warrants a merger of the 2 corps  If a company transfers all of its assets in exchange for stock in a new company and then the company passes the stock along to its shareholders. o Another question is whether Hite would have met the threshold under 33-14-300 that constitute grounds for dissolution  33-14-300 – it is likely that he would have requested dissolution under (2)(iii) – the directors in control of the corp have acted. including. then the successor is deemed to have assumed liability and accepted those liabilities. Simmons v. **** o 33-14-310 Procedure for Judicial Dissolution: provides for judicial dissolution and broad equitable remedies  (d)(4) In any action filed by a S/H to dissolve the corp on the grounds enumerated in 33-14-300.  SC Test for Successor Liability in Sale of Assets (Brown Factors) – Similar to Test in USX . Mark (SC -2005) – Successor Liability – Tort Case o Worker brought products liability action against manufacturer of a scissor lift and company that purchased manufacturer’s assets at bankruptcy sale. or officer of the Corp. He couldn’t because of the way the share exchange was structured. other than dissolution. as noted by the dissent. that should be treated as a merger. oppressive. o Court says this is a free-standing remedy. is unfair o Hite argued that this was equivalent to a merger and he should have dissenter’s rights.” • Fraud: transaction was entered into fraudulently for the purpose of wrongfully deceiving creditor’s claims o Issue: was the purchaser of assets liable for a torts claim of a prior worker as a successor? o Holding: Co was not liable? o Dissent – Burnet  If you buy the goodwill. o Holding: Court said rejected Hite’s argument that it was equivalent to a Merger and said that he did not have a right to vote under 33-11-103 and was not entitled to dissenter’s rights under 3313-102 BUT said he had a remedy under 33-14-310(d)(4). the majority of courts interpreting the mere continuation exception have found it applicable only when there is commonality of ownership.There is an Agreement to assume debts o Note: article in SC Lawyer Magazine . directors and shareholders. as in its discretion is appropriate. the predecessor and successor corporations have substantially the same officers. • Continuation: Successor co was a mere continuation of the predecessor  Footnote: “Essentially.

 If you are converting and everyone is not getting an ownership interest. is essentially the same co. o Unocal thought they were justified because Mesa’s bid was inadequate and coercive. Page 131 of 148 . you can use § 33-9-100. o After domestication laws of SC apply and for prior claims laws of the foreign state apply o o   • SC is maybe the 11th state in the US to add this domestication process in. o Conversion of corporation to limited liability company: See § 33-11-111. normally they would be protected by giving them dissenter’s rights.Domestication of a Foreign Corporation – • 33-9-100 – Articles of Domestication: Contents o The motivating force being this chapter was the insurance co. They would be giving Mesa some value they could use. also by offering debt securities the financial position of Mesa changes dramatically. There are now 11 separate code sections that provide for conversions of entities. o Note: the directors are in a bad position b/c they have a duty to Mesa as a minority S/H. has the option to merge the two o (c)(4) – no S/H approval needed o (f)(1) .o  Also critical of the notions that if you hold successor companies liable that lots of bad things will happen as a result. It allows for the movement of a company from another state to SC. Going from an LLC to a corporation will probably not create a huge tax problem. and pay junk bonds for the rest of the stock. must file articles of dissolution with previous state w/in 5 days of domesticating  Burkie objects to this b/c the co. After it reached 51% it would go thru a merger. The conversion from a corporation to an LLC does provide dissenter’s rights. Hostile Takeover Defenses A hostile takeover is an acquisition to gain control over the objections of a corporation’s directors Takeover defenses Unocal Corp v. not all of the conversions provide for dissenter’s rights. Everything in SC can be converted into another thing. Domestication: In order to just legally move an existing corporation from Connecticut to South Carolina without merging (used to have to merge). $54 per share but it would be in the form of junk bonds. they would be financing Mesa’s takeover. but they are making the offer to every S/H except Mesa (cause that would defeat the purpose). etc. name and the previous entity owned prop in SC – must give notice of name change to the SC register of Deeds • 33-9-110 – Effect of Domestication: o All the former liabilities stand. However.Unocal’s board adopted a defense that if Mesa got close to control. • Chapter 9 –. o Mesa sued because they are already minority shareholders and this exclusion breaches a fiduciary duty to Mesa. and the corporation (to determine if it is not in the interests of the co. we do not require confirmation of good standing with the foreign state. but they also have a duty to the other shareholders. a captive insurance company is essentially an insurance company that is owned by its insured. o Defensive Tactic. That is one possible way to get rid of someone. co.Must file articles and an initial annual report o (b) –Domesticating co. o From a Federal Tax point of view there are no tax ramifications. They would be helping Mesa in their tender offer. Mesa already had 13%.’s in SC. 2/3 votes are required for approval.Addresses title search issue. o (a) Domesticating co.) o Issue: Can Unocal’s Board exclude Mesa from the offer? o A defensive measure like this one can get business judgment analysis if it meets some requirements. Part of the motivation is to put Unocal into debt to make them less attractive. . Unocal would buy the rest of the stock for $72/share in debt securities (promissory note).  You should never convert a corporation to an LLC because it will usually create terrible tax problems. o Unocal thought this was okay because if they made the offer to Mesa.if you have changed you co. Mesa had a 2 tiered offer where it would pay $54/share in cash for the first half of the shares it needs (37%) to reach the rest of the stock. Mesa Petroleum (DE) (p. 518) o Mesa (Raider) was trying to takeover Unocal (Target). where it would be a cash-out merger.

the defensive measure gets the business judgment rule. Revlon accepted that deal which included a bunch of bad provisions if the deal fell through. o Issue: To what extent can the corporation consider the impact of a takeover threat on constituencies other than S/Hs? o Issue: What is the extent of a director’s duty in the course of a bidding war? o Rule: Court restated Unocal rule that since Directors defensive measures always carry the appearance that they are self interested. • ALI Test 6. Page 132 of 148 . then board response might not satisfy Unocal. looks more like the fairness test.50 and 1/10 share of preferred stock that included covenants not to incur additional debt. • Chesapeake – If an offer is too low. junk bonds are bad for the co. Obviously. they have to show reasonable investigation and reasonable response to threat to get business judgment for the defensive measures. rather than those of the corporation and its shareholders. but would be getting more debt (in violation of the agreement on the preferred shares). 525) o Pantry Pride tried to takeover Revlon. o “Because of the omnipresent specter that a board may be acting primarily in its own interests. employees) o risk of nonconsummation o quality of securities being offered in exchange o the board may consider the basic stockholder interests at stake.02(c) Different from Unocol Test b/c the BOP is on the P . Satisfied by Showing: • Good Faith o enhances when independent outside directors approve the defensive move b/c it prevents the minority S/H from arguing that they are approving the defensive tactic only to save their job (essentially b/c disinterested directors are not officers of the corp).50/share. because the action was approved by disinterested directors. whose actions may have fueled the coercive aspect of the offer at the expense of the long term investor (Burkhard thinks this statement is wrong) o can also consider the effect on both short and long term stock price • The term greenmail refers to the practice of buying out a takeover bidder’s stock at a premium that is not available to other shareholders in order to prevent the takeover. Forbes (DE) (Director’s Duty in a Bidding War) (p.e. Revlon v. and since Mesa couldn’t prove that the directors were acting to save their jobs. Then FLC came in and offered $56/share. the threat was high. customers.” • Reasonable Investigation  Directors must show that the response to the takeover attempt was reasonable in relation to the threat posed : • Factors to Consider in the Element of Balance: o the inadequacy of the price offered o Coerciveness: nature and timing of the offer o impact on constituencies other than shareholders (creditors. Chesapeake case: “A board’s unilateral decision to adopt a defensive measure…is strongly suspect under Unocal and cannot be sustained without a compelling justification. and the response was properly tailored to the threat. there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.” • Holding: In this case.• o Unocal 2 Prong Test: duty to the minority S/H can be overcome and defensive measure upheld if: (different from the Business Judgment Rule. but isn’t coercive. because the offer was both inadequate and highly coercive. including those of short-term speculators. o Further. and then FLC re-upped and offered to take care of the preferred stock.a person who challenges an action of the board on the ground that it fails to satisfy the standards of subsection (a) has the burden of proof that the board’s action is an unreasonable response to the offer. Unocal satisfied its burden of good faith and due care. Revlon directors had stopped the bidding to protect themselves from a law suit from the preferred shareholders.and the burden is initially on the board to show the reasonableness of their actions and decisions)  BOP on Directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed (i. Revlon countered with an offer for $47. Burkhard says this isn’t very different from the Unocal test. Pantry Pride re-upped. First they offered $47.

the directors of a corp acted on an informed basis. then Revlon doesn’t apply – but Unocal does o no violation of the Unocal rule. etc because we don’t want new management to decide what is good for me. o Holding: In this case.” Court said that the concern for the other constituencies (i. It also helped that 12/15 directors were non-interested. Time directors approved defensive tactics. in good faith and in the honest belief that the action taken was in the best interests of the corp.  No violation on the first offer because they didn’t put in defensive measures – Unocal not implicated. in an unintentional bidding war (Paramount v.  In this case. and authorized agents to negotiate a sale  If the BOD response is found to only be defensive measures and an abandonment of existence is not intended. o Court shot down the argument by Revlon directors that they were protecting “other constituencies. the BOD of Time imposed the duties discussed in Revlon to maximize SH value – this is wrong  A merger doesn’t trigger this role. it has to be inevitable that there will be a dissolution or a breakup  When the corporation creates an active bidding process looking to sell itself or • The director’s can place the co.“market forces must be allowed to operate freely to bring the target’s S/Hs the best price available for their equity. A poison pill makes a raider negotiate with management.e noteholders) has to be rationally related to the benefits accruing to the shareholders.” is an action by the target’s board that creates rights in the target’s existing S/Hs other than the bidder. so Revlon duties not triggered. the directors’ duty changes from preservation of the corporation to maximization of the company’s value. Time was doing neither of these. their rights were already fixed by contract.”  Thus as the trial court rules. Paramount v. once it is clear that there is a bidding war and the breakup of the company is inevitable. Time thought that the bid was a threat to the “Time Culture” and was concerned that the time shareholders wouldn’t recognize the long term benefits of the Warner deal. 532) o Paramount made a big offer for Time. the S/H interests necessitated the Board to remain free to negotiate in the fulfillment of that duty.  No shop provision was a breach . Even though Paramount’s offer was way over the share price. a target abandons a long term strategy and decides to break up.” o Revlon Rule: Director’s Duty During a Bidding War: However.  We don’t want to have these supermajority provisions for the board of directors. QVC)  In response to a bidder’s offer.” also known as a “Rights plan. o Revlon duties to maximize corp value are triggered only in 2 circumstances. This is unlike Revlon where the BOD considered a bust up sale. Also the directors could not make the requisite showing of good faith by preferring the noteholders and ignoring its duty of loyalty to the S/H. o so Unocal doesn’t come into play until a defensive measure is taken • – basic BJR applies  When Time took the defensive measures. Unocal was implicated. Time was in the middle of finalizing a deal with Warner that the directors said would be in the long term best interests of the S/Hs.•  “There is a presumption that in making the business decision. Paramount brought a Revlon claim and a Unocal claim.  Π is claiming that by entering into merger agreement with Warner. the concern wasn’t related because stopping an auction with active bidders is never related to shareholder interests. • Court also found that Time was well informed about risks and benefits of Paramount because of prior negotiations with it • SO the threat can be more than inadequate cash value or threat of coercion– it can be threat to long rang plans Page 133 of 148 . Time I (DE) (Board Knows Best Rule) (p. There is a fine line between management being able to negotiate a higher price and management interfering.  Note a “poison pill. to acquire debt or stock of the target at bargain price upon the occurrence of specified events such as the bidder’s acquisition of a specified % of the target’s stock. Although it would appear that there was a violation because the price offer was more than fair. the court gave wide berth to the Time directors to preserve the long term strategy. Director’s duty job is to get the highest value possible for shareholders. when the noteholders needed no further protection.

 Paramount entered into a deal with Viacom that basically would have placed complete control of the company in one man. but Paramount wanted 70 • Final agreement held that Paramount would merge into Viacom o each share of Paramount was to be .10 in cash o Note. o “Although a number of materials were distributed to the Paramount Board describing the Viacom and QVC transactions. control. stock option).at this time Viacom’s stock value had increased allegedly because Redstone was inflating the market value by buying up stock o Both Viacom & QVC are close corporations.• o Rule applied in this case: “Board Knows Best” rationale for implementing takeover defenses. The stock option agreement is significant b/c if Paramount’s stock went up then they would have to pay Viacom. Control gets shifted from the public S/Hs of Paramount to Viacom.” o “Board actions in the circumstances presented here is subject to enhanced scrutiny. QVC then upped their offer to $90 a share. president of Paramount was going to get to stay on. QVC made a big offer anyway – $80 a share. The public stockholders are in the majority Page 134 of 148 . including the information on which the directors based their decision. Paramount entered into a deal with Viacom that basically would have placed complete control of the company in one man. Also. QVC (DE) (p. (b) the fact that an asset belonging to the public stockholders (a control premium) is being sold and may never be available again. .”  Unocal – the approval of a transaction in a sale of control  Revlon – adoption of defensive measures in response to a threat to corp. the only quantitative analysis of the consideration to be received by the stockholders under each proposal was based on then-current market prices of the securities involved. As far as sale of control.  Court when the sale of the control of a company gets the enhanced scrutiny of the Unocal test with the burden shifted to the board to show • that they investigated and • that their response was reasonable. however the Court said that there are rare situations where enhanced scrutiny of the director’s conduct are necessary  There are two alternative tests that the court talks about: (1) the enhanced scrutiny test and (2) even higher scrutiny if there is self-interest which could possibly implicate the entire fairness test (they don’t apply it but they alert you that is a possibility)  This court applies the enhanced scrutiny test (see below) o “The key features of an enhanced scrutiny test are: (a) a judicial determination regarding the adequacy of the decisionmaking process employed by the directors. not on the anticipated value of such securities at the time when the stockholders would receive them” suggesting that is something the board should have done o Court said the normal rule of director’s actions is the BJR. since the Paramount shareholders were getting mostly non-voting stock in the exchange. termination fee – waiving of the poison pill. and (b) a judicial examination of the reasonableness of the directors’ action in light of the circumstances then existing.1 share of Viacom voting stock and . o Viacom upped their offer to $85/share. since the Paramount shareholders were getting mostly non-voting stock in the exchange. • Then the court will insert its own judgment on the reasonableness of the director action o The theme that runs through this case is that if we are “selling control” then the transaction changes. 542) o Now we have Viacom and QVC bidding for Paramount. • The CEO of Viacom owns 85% of its voting stock.9 share of nonvoting stock. o Features that made this company less attractive to other buyers: There is a termination fee and there is a stock option with a feature that requires Paramount to pay to Viacom the difference between the value of the shares and what they would ultimately be paid in a competing offer back to Viacom. The directors have the burden of proving that they were adequately informed and acted reasonably. and (c) the traditional concern of Delaware courts for actions which impair or impede stockholder voting rights. o Holding: Unocal Rule triggered in this case. Paramount was originally controlled by a “fluid aggregation of shareholders” and that control would go over to a single person in the Viacom deal. so the enhanced scrutiny is applied. Plus 9.court gave wide berth to the Time directors to preserve the long term strategy. Paramount v. so he pretty much runs the show • Viacom initially offered 61 per share in stock and cash. Such scrutiny is mandated by: (a) the threatening diminution of the current stockholders’ voting power. The agreement with Viacom had some pretty stiff provisions if it were to fall through (no-shop.

and are not able to become voting unless the remaining target S/H’s approve or give them their voting rights back and it must occur at the next S/H meeting (which can be a long time) or the raider can ask for a meeting within 50 days (but the raider has to pay for the meeting). those people who had it are entitled to be paid for it. o Court rejected Paramount’s argument of the holding Time Warner case in that the court clearly stated that in addition to the 2 circumstances there are “other possibilities” where Revlon duties may be implicated. o Court also reiterates the Weinberger rule: where actual self-interest is present and affects a majority of the directors approving a transaction. and there is no way the director’s argument in favor of the reasonableness of their decision based on corporate vision cannot be justified b/c the shareholder’s are losing over $1B (Viacom’s offer was $1 billion less than QVC’s – Director’s primary duty in this case shifted to the maximization of S/H value. o Key features of enhanced scrutiny test  Judicial determination regarding the adequacy of the decision making process employed by the directors. o These types of statutes are passed to protect the Board and the Indiana Operations. • Actions don’t have to be perfect. It was passed to keep the companies safe and the jobs in the state. Page 135 of 148 . the co. o Triggers Revlon Rule: Court said that in a sale of control. o Preemption Analysis  Williams Act: • Under the Williams act you have to disclose to the SEC whenever you get a big chunk of stock. The Court essentially says you cannot contract away your fiduciary duties. the raider’s shares immediately become non-voting. and it appears the primary reason is that the QVC offer was so large. Federal and State statutory regulation of Hostile takeovers • CTS v. although unintentional. the director’s duty is to maximize shareholder value. whether or not they are presumptively valid in the abstract. Some of the ways a board can fulfill its obligation to seek the best value are:  Conducting an auction  Canvassing the market. the corporation may redeem the control shares from the acquirer at fair market value. The court shot the whole thing down. 564) o Indiana had a law that kicked in when a company got a control share of a public Indiana corporation. “Such provisions. The statute also says that it is not automatic. has to elect to have the statute apply to it. may not validly define or limit the directors’ fiduciary duty or prevent the directors from carrying out their fiduciary duties.” o Holding: The realization of the best value reasonably available to the stockholders became the Paramount directors’ primary obligation under these facts in light of the change of control. The directors’ initial hope and expectation for a strategic alliance with Viacom was allowed to dominated their decisionmaking process to the point where the arsenal of defensive measures established at the outset was perpetuated (not modified or eliminated) when the situation was dramatically altered. If the shareholders do not vote to restore voting rights to the shares. and the Paramount Board’s process was deficient. Dynamics (Fed) – Preemption –IND law (p. In addition the Court said that this case also falls within the 1st category in that the “Paramount Board. including the information on which the director’s based their decision  Judicial examination of the reasonableness of the director’s actions in light of the circumstances then existing. QVC’s unsolicited bid presented the opportunity for significantly greater value for the stockholders and enhanced negotiating leverage for the directors. There would no longer even be any public shareholders. etc. had initiated an active bidding process seeking to sell itself by agreeing to sell control of the corporation to Viacom in circumstances where another potential acquirer (QVC) was equally interested in being a bidder. That obligation was not satisfied. and there are provisions that protect shareholders through the period of a tender offer. now and after this transaction a single person is going to have the majority voting rights. The former stockholders would end up owning only non-voting shares and have no control. If a company got control shares. o Corporate raider tries to argue that the Indiana Law was preempted by the Williams Act and violated the dormant commerce clause. just reasonable. The right to control is valuable and when that is being sold or transferred. but it is not required to do so. It is to protect the corporations. o Paramount argued that they did not shop around because of the no-shop provisions. Only impacts a company incorporated in Indiana. a court will apply enhanced scrutiny.

Managers frequently realize gains for investors via voluntary combinations (mergers). In the absence of this evidence. unlike Indiana statue. o Wisconsin had a “third generation” takeover statute that forced corporate raiders to wait 3 years after gaining control to merge the target or acquire more than 5% of its assets. the board’s decision will be upheld unless it cannot be attributed to any rational business purpose (allowed to consider the substance of the decision) or I can attack the substance of the provision and show no rational business purpose or that the transaction constitutes waste o Unocal (may be a separate test from enhanced scrutiny or they might be the same) Page 136 of 148 .” (this statute protects management) o Skepticism about the wisdom of a state’s law does not lead to the conclusion that the law is beyond the state’s power. Getting to the assets is what secures the loan. State created defensive mechanism that makes it way more difficult for a raider to take over a Wisconsin Co. Fraud.  Dormant Commerce clause • Rule: To violate the dormant commerce clause. • Rule: Court found that the Indiana law actually furthered Williams. the standard is gross negligence (maybe not in SC)  Handout on TWEN: quote from Disney test: the business judgment rule is not actually a substantive rule of law but instead is a presumption that the directors were informed. Statute. o Issue: This statute screwed Amanda because their financing was dependant on a quick second step merger. so no federal preemption. The financiers are after a lien on the assets. but managers balk. Without the merger they can’t do that. law where you are incorporated governs. page #s correspond to what has triggered the test and what the test might be. o Court said that a Wisconsin buyer gets no advantage over a buyer from another state. Summary (ways to evaluate the director’s behavior). 570) o This is not a Sup Ct opinion. acted in good faith. in good faith in the honest belief that the action was taken in the best interests of the company. that the gov’t doesn’t like. and in the honest belief the action was taken the best interest of the company and the shareholders. the reason is that we don’t have many publicly traded SC corporations left. and those don’t violate DCC.  Holding: the ILL he statute can be said to protect S/H and there are substantial connections with the state’s interest. so no dormant commerce clause violation. tender offers are investors’ way to go over managers’ heads.  General rule is that corporate law is state law. • SC: 35-2-101 & 35-2-201. the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one. Universal Foods (WI) (p. it is a 7th circuit opinion. the law has to favor Indiana raiders over other raiders. the court shot down an argument that this would impede tender offers. The waiting period doesn’t change the Williams disclosure procedures. All raiders here are treated the same. Court said that there are all sorts of ways states impede tender offers now (like higher votes for mergers under corporate law or staggered directors). bad faith. So. The tender offer is the device for the shareholders to get rid of ineffective management. was not self-electing but automatic. Also dissenter’s rights are accepted. In Delaware. Since enactment. o Ct says the practical/economic effect of this is to eliminate all hostile leveraged buyouts of Wisconsin Corporations. • Amanda Acquisition v. The delay in getting the approval to vote the shares is ok under Williams.o • Court distinguished the Indiana law from an Illinois law that changed the Williams process. o Court said that as long as the state law doesn’t alter the process in Williams. The statues also say that the board of the target can waive that provision. this isn’t preempted. we have an equivalent of BOTH the Wisconsin and Indiana statutes. Thus. there is no preemption. • Further. and self-dealing will knock out the application of the test. gets more strenuous as you go o Business judgment test  282+handout: Van Gorkam: the rule is a presumption that in making a business decision the director’s acted on an informed basis. “We believe that antitakeover legislation injures shareholders. neither of these statutes have really come into play. If gains are to be had.

when there is an existing conflict situation (look at Weinberger and Sinclair for examples)  Test: 335. maybe there is a reason to apply Unocal instead of the BJR. where directors stand on both sides of the transaction. o Generally  Like a partnership with two types of partners • General partners – personally liable for the debts of the limited partnership • Limited partners – not personally liable for debts  Subject to state and federal securities laws o Advantages: 2 significant benefits over general partnership  Less liability than a regular partnership • if it is done right the limited partner is protected from any of the debts of the business Page 137 of 148 . that would trigger Unocal. If I transfer all of the property into a limited partnership and start gifting out limited partnership interests to my kids. they are subject not only to limited partnership laws but also to general partnership laws. • A lot of people invest in Hedge Funds which are done as Limited partnerships  Estate Planning Area – Limited Partnerships as opposed to LLC’s are the desired estate planning tool • Ex – I own a large tract of timber land in SC and I want the prop to be inherited by my kids and I want the least amount of tax possible. and 599: defensive purchase of shares (unocal) or breakup of the company (Revlon) or Paramount. when the board implements antitakeover measures  Test: 699 and 711: directors have the burden of proving they had reasonable grounds for believing there was a danger to corporate policy and effectiveness. fair dealing and fair price No Decision and Good Faith (off on its own)  No decision has been made at all by the board and the shareholders argue that you should have done something and you didn’t  Trigger: 296: failure to act  Test: 296+handout: we won’t penalize the board for failing to act unless there has been a systematic failure….  Limited partnerships are also subject to federal securities laws such as 10b-5 and state securities laws. they have the burden of demonstrating entire fairness (utmost good faith and the most scrupulous inherent fairness). a lot of it is tax-motivated  Because of the hybrid nature of limited partnerships. 742. Atlas. 670.If something is addressed in a limited partnership statute. 542 A. an interest in a limited partnership is going to be viewed to be a security and triggers registration rules. • Historically a lot of real estate deals were done as limited partnerships. the property transferred is entitled to certain marketability discounts.  There are a lot of them out there. its relationship with S must meet the test of intrinsic fairness. Rule: regular partnership statutes usually apply . a burden satisfied by a showing of good faith and reasonable investigation  If there is a conflict (even if we don’t think they did anything wrong but they are faced with a conflict).2d 651  Not covered in our class!! Entire Fairness (both sides of the deal)  Trigger: 664. handout confirms that Caremark case is the current state of the law today (stone case) but more importantly in the Stone case the court talks about the role of good faith (see the handout)  LIMITED PARTNERSHIPS o Why worry about Limited Partnerships?  What would have been a limited partnership would now probably be registered as an LLC. 489: involves high degree of fairness and a shift in the burden of proof.  Almost all hedge funds are done as limited partnerships. one of the things you can argue is that the limited partnership interests are entitled to discounts so you can transfer the property at a lower cost. Rule: Almost always. At death. go find it in the regular partnership interest. Enhanced Scrutiny  Trigger: 740. language in the Pearlman case that says the trigger is the sale of control by Pearlman of 33% of the company  Test: 743: (a) a judicial determination… and (b) a judicial examination… and 599: burden of proof and fiduciaries language Compelling Justification  Blasius v. 489: because of fiduciary duty and its control over S.o o o o Trigger: 699 and 711: if management purchases shares in response to a tender offer.

 33-42-300 – General Partner’s Authority • SC LLP has to file the names of the general partners who are authorized to transfer property with the deeds. • There are restrictions in naming the LLC. but they can file in any state they choose – probably advantages and disadvantages to doing this.  33-42-60 – at minimum there has to be a written agreement/document at their office that contains certain limited information about the business. o By default. the limited partners don’t vote. the agreement can grant the power to vote to all or a specified group of limited partners.  So usually the limited partners are in it strictly as investors. • Need an Atty: Almost crucial that a lawyer be involved in forming a limited partnership b/c it is critical that the agreement be carefully drafted. they can be granted voting rights. in a limited partnership the decisions are generally made by the general partner. What are the legal problems in starting an LLP?  Do not come into existence until there has been a public filing  33-42-210 – Certificate of Limited Partnership • (a) Must file a certificate of limited partnership with state including: o Name o Address of office and name and address of agent o Name and address of each general partner o Latest date the partnership is to dissolve o Any other matters  Some lawyers like to put the pship agreement here  Clients don’t want this stuff public since the agreement probably sets forth their shares  (b) LLP is formed at the time of filing with sec of state or at any later time specified in the certificate if there has been substantial compliance with 210 • Filing is required b/c the limited partners are not personally liable for the obligations of business.o o General partners are still liable o You can make a corporation the general partner. • Although the limited partners do not usually have voting rights.  Liability • To 3rd parties – most critical Page 138 of 148 • . they have no mgmt responsibilities or control rights. What are the legal problems in operating an LLP  Control • Start with the assumption that limited partners never have the right to vote although the partnership agreement can give them voting rights (almost all will give them voting rights in some circumstances) • 33-42-420: Voting o Subject to 33-42-430. o 3 options of Voting rights of the Limited Partners  Unanimous vote to do certain things  Majority vote of limited partners to do certain things  limited partners get no vote (consistent with statute). it does not automatically trigger dissolution • You can structure the Lim Partnership if someone leaves the business or dies this does not affect the business  Profit Distributions – unlike partnership • Are usually according to each partner’s contributions if the agreement is silent whereas with a normal partnership the distributions would be equal. o Different from a general partnership. This is to help with title searches and make sure that property was transferred with proper authority. which essentially means that no individual will have personal liability for the liabilities of the LLP  Same Tax Benefits as Partnerships • Taxed as a partnership rather than a corporation (no double taxation problem)  Non-Dissolvable entity – unlike partnership (need careful drafting to make it non-dissolvable) • If someone leaves a limited partnership. the general partners make the decisions.

and therefore should be liable as one. or shareholder cannot be found to be exercising general partner control o Important to note that the safe harbor provisions in the law have to be adopted into the agreement to take effect  Holding: Wilf was not liable to the 3rd party: • Wilf was acting as an officer not as a GP o It didn’t matter that he didn’t represent that he was acting in his capacity as an officer to the third parties.  Rule: The General Partner’s liability to 3rd parties can not be limited by the partnership agreement 33-42-630 – General Powers and Liabilities:  GP has the liabilities of a partner in a regular partnership  A GP is liable to the other partners just like a partner in a partnership  the obligation and duties amongst and between the parties in an LLP can be changed in the partnership agreement: BUT NOT the GP’s liability to 3rd parties. and the plaintiff who was owed significant money came after Wilf under the theory that he had acted like a general partner. Things collapsed. which is strange because most statutes don’t have the same language) • you need reliance and knowledge by the other party: if the limited partner’s control of the business is not substantially the same as the power of the general partner. o The plaintiff was aware of the structure of the business and knew Wilf wasn’t a general partner  There is an argument that even if P did rely. and Wilf took over acting as an officer for the LLP. the limited partner is liable only to the persons who transact business with the limited partnership with actual knowledge/reliance on his participation. director. the P was supposed to get a consulting payment for several years . When the Plaintiff transferred his rights to the partnership. he Page 139 of 148 .  Wilf court says there is a distinction btwn the exercise of control and participation in control. arranged for financing.000 was made before Wilf became a partner and there is a statute that says if that occurs you are not personally liable. Things started to go bad. • No reliance on the part of the plaintiff that Wilf was a general partner.$27K. this statute would apply even though we are dealing with a limited partnership and not a regular partnership. SO that was the P’s problem in Wilf.Court noted that a limited partner acting as an officer.he negotiated the leases. but if they are just a participating a little bit in the running of the business then they are only liable to people who rely on them. 33-41-390 – Liability of a Partner Joining Late  someone who becomes a partner subsequent to the partnership formation is not liable for the pre-existing obligations of the partnership. There is an argument that the K to pay $27. a general partner is liable for debts to third parties just like a partner in a regular partnership. and has been in charge of the deal. Wilf stops paying the P. If the person is really running the LLP and has all the powers of a GC then they are liable. When the deal fails. This is not discussed in the case but Burkhard brought it up. Wilf still might not be liable. Wilf (NJ) (Limited Partner’s Liability TO 3RD parties for acting like a GP)  Wilf and his general partnership were limited partners in an LLP to renovate a hotel. • Statutory Safe Harbor Provision . Zeiger v.o o o o (p. Presumably.  Issue: Can Wilf be held personally liable for the $27K contracted and owed to P under the partnership? Under the statute is Wilf liable?  Court said that • you need control—a limited partner is not liable for the obligations of a limited partnership unless he takes part in the control of the businesslike a GP (the language in this case is exactly the same as the language of the SC statute.  If a limited partner’s participation in the control of the business is not substantially the same as the exercise of the power’s of a general partner. ran the renovation project. Wilf was the bad guy . 586) 33-42-430 – Liabilities to 3rd Parties  Unless provided otherwise. then the limited partner is only liable to people who transact with the LP with knowledge of the limited partner’s participation in control and rely on him. § 33-41-390.

when you learn of the mistake.admits he never relied on Wilf as a participating general partner – knew he was acting as VP of Trenton. The P. One of the investors says that she bought as a limited partner and was not liable for the assessments. o Another theory you could argue for recovery is agency § 602 or § 603 of the restatement.  Court relied on SC 42-440 – with regards to the Condo complex there is no clue as to who the partners are so it is highly unlikely that the folks who sold her the unit believed that she was a GP. • Divides a limited partners wrongful behavior into two types: o Exercise of the powers of a general partner. – that is the phrase that has caused all the litigation. a plumber. o Knowledge of Participation in Control. you are not a general partner and are not bound by it’s obligations if. you’re liable to any third party who contracted before you withdrew or amended the agreement if that third party believed in good faith that you were a general partner. but she doesn’t know that. you • Get the right certificate of limited partnership amended OR • withdraw from future equity participation of the partnership  If you do one of these two things you are protected against future claims and to some extent past claims against the P. he is liable only to third parties who have actual knowledge of his participation in control. o Burkhard: The Ohio Court said that they were liable. She actually entered as a GP. In order to get the protection. the plaintiff has to know who they are dealing with.says you can never hold a limited partner liable as if he were a general partner. The plaintiff has to basically understand the whole picture for the D to avoid liability. Undisclosed or partially disclosed principal.  Rule: 33-42-440 . Ohio court went back to Agency law and said that the partners were not acting as agents for a disclosed principal o Issue: Issue arises out of the Wilf case.  However. sues as the LP is going one of the vice presidents of one of the corporate general partners.Not participating in control if (SC’s statutory safe harbor) • Being a contractor for or an agent or employee of the LLP or of a general partner or being an officer. o The P did not rely on “piercing the corporate veil” case law in Wilf b/c there was no evidence that the corp was undercapitalized or the franchise was (the other factors necessary to pierce the veil). • List of many other actions that do not constitute “participation in control” o GA Rule on Limited Partner Liability: A limited partner may take part in control of the business and if they do that is ok .A limited partner is not liable for obligations of an LLP unless he is also a general partner or he takes part in the control of the business. There has to be disclosure that you are acting as a corporate officer who is one of the general partners in a limited partnership. the problem was that the condo had financial trouble and there were huge assessments made against the units. o 33-42-430 – Liability to 3rd Parties  (a) . director or S//H of the GP that is a corporation. o Recent NC Case involving 33-42-440 -A # of people in a partnership bought condo units as investments in a condo complex.applies to ALL BUSINESS TRANSACTIONS where the person actually believed they were a limited partner. o 33-42-440 – when you erroneously believe you’re a limited partner  If you make a contribution and erroneously but in good faith believe you’re a limited partner.  However. • Ohio Case (Similar to Zieger) o 2 corporations created the general partnership of a limited partnership. Page 140 of 148 .  (b) . Since they are corporations they can only act by the officers of the company. if control is not substantially the same as the exercise of the powers of a GP. So she was not liable. Can you ever recover from a director of a corporate general partner? o Rule: A director of a corp GP can be personally liable to 3rd parties for his actions as an agent of the corp/GP if they did not disclose to the plumber that they were acting as agents of the corporation. The argument was that each of the partners was liable for a portion of the assessments.

or eliminated all together. API. In re USACafes (DE) (p.  Rule: The Director of a Corp GP has a fiduciary duty to the LLP with regards to dealings with the partnership’s property or affecting its business. so that probably wouldn’t apply. But this is a limited partnership.. if it is not covered in the llp sections. The partnership agreement stated that API could compete directly with AREP. the LPs at least have a cause of action against the GPs for this presumably self interested sale for too little. However. Plaintiffs were the limited partners who thought the GPs got kickbacks from Metsa to sell at too low a price. and gave them a duty to the LPs not to convert property for their own use. o Issue: Did the GP Usurp a Partnership Opportunity.• o  • • Kahn v. • In SC. The general partner. o 33-42-830 – sharing profits and losses Page 141 of 148 . • Holding: In this case.  Issue: Whether directors of a corporate GP are fiduciaries for the LLP?  P’s Claim: The GP caused all of the assets of the Corp to be sold too cheaply. the price was not fair to other members of the LLP. AREP had no legitimate expectancy. and thus could not raise the doctrine. – duty not to use control over the partnership’s property to advantage the corporate director at the expense of the partnership. • Ct analogized to trust law where a director or officer of a trust institution who improperly acquires an interest in the property of a trust administered by the institution is subject to personal liability. Look through the llp sections carefully to see if anything applies so we know if the partnership provisions can apply. so there is the notion that it was not a corporate opportunity. and said that a corporate trustee cannot intentionally use trust property in a way that benefits the holder of the trust in a way that harms the beneficial owner.  The directors said their duty runs to the corporation but not the LP’s who were investors  Court analogized to trust law.can be expanded or contracted by statute and this particular partnership agreement allows him to compete o DE Law post Kahn: after this case. you wouldn’t be able to put a similar clause in a partnership agreement in SC. See § 33-42-630 for the answer. 600)  Metsa bought all of the assets of USACAFEs LLP. • Court held that the corporation has to have an interest or expectancy in the opportunity before it can raise the argument. a LLP that buys and sells real estate. is a corporation that is owned wholly by one person (Icahn). because of the compete clause. 594) o Derivative suit against the general partner of AREP.  Rule: GPs are like trustees for the LPs. Thus. The director’s of the GP all received substantial side payments that induced them to authorize the sale of the LLP assets for less than the price that a fair process would have yielded. then the partnership sections apply. Icahn (DE) (p. o DE law: the partners can modify the fiduciary duties between the GP and the LLP . They are suing the corp and the directors for fiduciary breach of duty of loyalty and breach of duty of care. No. A Corp was the GP of the LLP. contracted. the DE lawyers got the legislature to expand the law to say that duties could be expanded. o Issue: Is there a difference between usurping a corp opportunity and competition? o Then court looked at corporate opportunity doctrine: • 3 Part Test:  Opp is either essential to the corp or is one in which it has an interest or expectancy  Corp is financially able to take advantage of the opp itself  The party charged with taking the opportunity did so in an official rather than individual capacity. Suit alleged that Icahn made some investments on his own that he had a duty to offer to AREP first. Also the facts indicate that this opp did not come to him as a result of his status in the partnership. How do owners of an LLP make money? Salaries Distributions o These statutes are different from the regular partnership statutes in terms of profit sharing and distribution provisions. would you be able to put a similar clause in a partnership agreement? You can’t contract out a fiduciary duty in SC.

divide according to contributions made by partners that is received but not returned.  Note the difference between this and the default distributions for regular pships.  An LLP agreement formed prior to 7/1/98 can be amended to state specific events when an LP can withdraw  This statute tried to be retroactive – but there is still some question as to whether this applies to pre-1998 limited partnerships unless they specifically state it in the agreement.  A bunch of this stuff is designed to make sure a SC LLP qualifies for tax benefits o 33-42-1410 – Non-judicial Dissolution (one of the adv of a LP is it can be made to be non-dissolvable  LP is dissolved upon one of the following • time specified in the agreement ends • any events specified in the agreement • written consent of all partners • withdrawal of a GP unless o there was another GP and the agreement specifies that the remaining partner can carry on. OR o within 90 days all remaining partners agree in writing to continue the business and to the admission of more GPs. the partnership can get damages from him resulting from breach o 33-42-1030 – withdrawal of LP  Can only do so at the time or upon happening of events specified in the partnership agreement if the partnership was formed on or after July 1. You can redo the partnership agreement to make sure it applies. as needed • Judicial dissolution LIMITED LIABILITY COMPANIES o Most business today are being formed not as corporations but as LLCs o SC has adopted the Uniform Act – DE has not. o 2 Reasons why LLC’s are advantageous o Tax Advantages o Limited Liability for the Investors o Do not need at atty in SC o Do not need to file an annual report o Important Notes on LLC’s – Problems page 815 Page 142 of 148 . which defaults to “equal. Divided according to agreement  If agreement is silent. divide according to contributions. o Rule: Almost all of the provisions indicated in the LLC statutes can be modified in the LLC agreement with the exception of fiduciary duty and protection of 3rd parties (anything dealing with creditor’s claims).  If the LLP was formed prior to 7/1/98 and it doesn’t state in the agreement a LP wishing to withdraw must give 6 months prior notice to each GP  They tried to make it retroactive. he’s no longer a partner unless the agreement states otherwise o 33-42-1020 – Withdrawal of GP  The general partner can withdraw at any time  But if the withdrawal contravenes the agreement. but Burkhard says it might not work for LLPs formed prior to 1998. • SC LP would qualify for special estate tax treatment if drafted correctly. 1998. o 33-42-1220: Assignment of Partnership Interest  Pship interest is freely assignable unless agreement says otherwise  Assignment doesn’t dissolve the limited pship  All the assignee gets is the distribution the seller would have been entitled to  If the partner assigns his interest.” o 33-42-840 – Sharing Distributions  Divided according to agreement  If agreement is silent.

etc. o 33-44-102(e) – Knowledge and Notice: o Attempts to lay out rules as to what circumstances an LLC or an entity will be charged with information that may be known by one or more of its members. if so the term specified  Whether Member run LLC (looks like a GP) or a Manager run LLC (looks like a Corp) • This is where the atty needs to spend a lot of time with the client to see what fits  Whether one or more of the members of the co. o 33-11-111 – Conversion of corporation to LLC o After adopting a plan the board must submit it to the S/H to be approved. As to all other matters.one member of the business knows that it has received $10k. the courts have applied the corp test for piercing the corporate veil.  33-44-201. if any provision of an operating agreement is inconsistent with the articles of organization. but most LLPs would want operating agreement to be private so wouldn’t put it in the articles of organization. depending on which one it is different persons have different degrees of authority. they are like S/H’s o Exceptions:  if you are a manger acting as a member of an LLC and you commit tortuous actions.  SC 33-44-208 – Certificate of Existence – Page 143 of 148 . are to be liable for its debts and obligations under 33-44303(c)  Articles of organization may include operating agreement.LLC is an entity • Attempts to solve the UPA problem as to whether an LLC is an entity or an aggregate. courts will pierce the veil of LLC’s – they will use the veil piercing test in the corporate are will be applied to the LLC transaction • There have yet to be any cases in SC. • Just b/c the Sec of State’s office accepts the name does not mean you can use it in SC  Address of the initial designated office  Name and street address of the initial service of process  Name and address of each organizer  Whether the co. – • So this section puts the 2 of these together to know when we will hold the business to be accountable for the information • Rule essentially mandates that business businesses must come up with an internal reporting system.Bus operates as an LLC. and persons who reasonably rely on the articles to their detriment. o Rule: Members and managers of LLC’s are usually not personally liable as investors.  Articles of organization may not vary the nonwaivable provisions. but in every other state where the issue has been raised. and.o Rule: Distinction Between Member Run & Manager Run LLC’s: If it is member run. (So there is a notion that this statute may apply to every SC business entity today)  Ex . o 33-11-112 – Status of LLC post conversion o conversions takes effect it is essentially the same entity o all the debts/liabilities are the same o All S/H of the converted corp remain as members of the LLC – but that can be changed according to the plan. o Rule: In almost all States the Corp Opp Doctrine applies to LLC’s o SC LLC STATUTES o 33-44-203 – LLC Articles of Organization  Name of the Co. then we apply about the same rules that are required for a partnership – any person can essentially bind the LLC if it is mgr run then only managers can bind the partnership o If you have a client who is considering contracting with a bus structured as an LLC it is crucial that they know whether it is member run or manager run. another person knows that if the organization gets $10K it has to report it to the fed agency. o To make this determination you must check with the Sec of State’s office. o The vote must be approved by 2/3 of the S/H’s entitled to vote. the operating agreement controls as to managers. is to be a term company. o There may be required to be voting by voting groups o A S/H may dissent to the plan of conversion and get the FMV for his shares according to 33-13-101 – 33-13-310. o After approval must submit to secretary of state’s office. you are still liable as an agent for your actions  Also. o Exception: LLC is treated for tax purposes as an aggregate – each member reports his or her taxes separately.

         • you can ask the Sec. 33. 33-44-405 – Sharing and Right to Distribution • -any distribution made by the LLC in winding up must be in equal amounts to each member. 33-44-303 – Liability of Members & Mgrs • (a)A member or manager is not personally liable for obligations and liabilities of the co. • (c) a provision in the LLC agreement can bind all LLC members liable for the LLC debts and liabilities.Member’s Right to Information • To Access & Inspect Records. unless the member had no authority to act for the company in the particular manner and the person with whom the member was dealing knew or had notice that the member lacked the authority. of State’s office for info regarding the status of the LLC (whether or not they are in good standing). • An act of an agent not in the course of business will only bind the LLC if it was authorized by the other members. SC 33-44-211 – Annual Report not Required – • LLC’s are not required to file an annual report with the gov’t – maybe one advantage over corp. Page 144 of 148 . intentional misconduct. or a knowing violation of the law o Must exercise rights consistently with an obligation of good faith and fair dealing. soley by reason of being or acting as a member or manager. One of the members sells the condo complex to Smith for x amount o Important: – (c) says this is valid unless you put in the AI’s a provision saying you can’t do that – all of the Law firms that file AI’s for LLC’s negate this provision.if you don’t like it you can change it in your operating agreement. o A member does not violate this section merely b/c the member’s conduct furthers his own interest. o Duty of Care  Limited to refraining from engaging in grossly negligent or reckless conduct. • Each member of an LLC is an Agent and any act of a member in carrying on the normal course of business will bind the company.44-301 – Agency of Members and Managers – Liability • When someone acting on behalf of the LLC will be able to bind the LLC. property or appropriation of a corp opp  Not to deal with parties having adverse interests  To refrain from competing with the co. o broaden the exposure of the LLC for a member owned LLC – so it is a lot easier to hold the LLC liable than a partnership liable for actions of the members.Liability for unlawful Distributions 33-44-408 .409 – Gnrl Stds of Member and Mgr’s Conduct • Members of a Member owned LLS owe eachother Duty of Care and Duty of Loyalty & Fiduciary Duty o Duty of Loyalty  To account to the co and to hold as a trustee for it any property. Before the dissolution of the co.parallel the corporate model • you can’t pay any money out of the business if o 1) you can’t pay your outstanding bills coming due OR o 2) your debts > than assets –  if either one of these two occurs. • (b) failure of an LLC to observe the usual co formalities or requirements relating to the exercise of its powers is not grounds for imposing personal liability on the members. (as a result of logistical problems with Sec of State’s office). in the conduct of the co’s bus. Operating Agreement 33-44. or benefit derived by the member in the conduct or winding up of the business or derived from the use of the co. distributions should not be made out of the LLC. 33-44-404 – Mgmgt – Voting of an LLC • (b)(3)A New mgr must be approved by a majority vote • (c) Lists of matters requiring a unanimous vote o if you don’t like that you can change most of it by contract.Limitations on distributions . 33-44-407 . profit. 33-44-406 . o (c) Addresses this hypo: If you have a member run LLC – 20 people have invested and own a condo complex.

• Members of a Mgr owned LLC Do not have a Fiduciary Duty to Eachother 33-44-410 – Actions by Members – • grants to an LLC member the right at any time to bring a direct action – legal or equitable relief o Different from partnership model: If a partner is unhappy with another partner’s actions he can bring an action in equity for an accounting action– adv of this an accounting action seems to be a direct claim – maybe LLC member can do the same thing. o If an LLC winds up as a result of a member’s wrongful disassociation. unless otherwise provided in the operating agreement. • Attempts to define EVERY method by which someone could quit.  33-44-502 – Transfer of Distributional Interest – • Distributional interest does not entitle the transferee to exercise any rights of a member.this statute says you can’t do this but there’s a gap – may still bring a claim where the LLC is going on. o Member becomes a debtor of bankruptcy o Death of Member o If a member is an entity and ceases being an entity  33-44-602 : Member’s power to disassociate. and to the other members for damages caused by the dissacosiation. wrongful dissociation • (a) – a member has the power to disassociate at any time rightfully or wrongfully. • (b) – You can ask the court to reach back and account for prior wrongs . • Dissolution means the actual process of going out of $.  Presumably cover this in the operation agreement indicating this is not an event of dissolution.  33-44-501 – Member’s Distributional Interest: • Similar to UPA – LLC owns property not members • If you have a distributional interest in LLC – this interest is personal property and may be transferred in whole or in part. and then the term is over. o Notice of Quitting o Per the Operating Agreement o Transfer the member’s distribution interest (all of their financial rights)  602 suggests this may be modified in the operating agreement. • You can have stock certificates. you will also have voting rights or mgmt rights with respect the LLC  33-44-5-503 – Rights of a Transferee – • a transferee can have rights to an LLC if they receive a distributional interest – if the operating agreement says that someone can transfer his financial and voting rights or if all the other members agree on it • Transferee also becomes liable for the transferor’s liability to make contribution  33-44-504 – Rights of Creditor: • Provides what a creditor has to do is get a charging order against the membership interest – exclusive remedy • Different from the partnership statute – says this section is the exclusive remedy by which a judgment creditor of a member or a transferee may satisfy a judgment. damages the co sustained must be offset by the distributions to the member  33-44-701: Company Purchase of Distributional Interest • Buying out a person when they quit Page 145 of 148  . o A member who wrongfully dissacosiates from an LLC is liable to the co. o so LLC can lock member’s in by putting in a provision saying that a member can’t voluntarily quit and you can’t withdraw when you die • Wrongful Withdrawalso If a member disassociates by becoming a debtor in bankruptcy o If a member quits  At Will LLC – Get cashed out  Term LLC –member becomes as assignee of the corporation – entitled to financial interests.  33-44-601 – Events Causing a Member’s Disassociation (Be careful the comments to this statute have not been updated) • Disassociation in LLC context means someone has left the LLC. member gets his share with everyone else.

Prob 2 age 816 o The court says the fact that the card said EFRS does not give the client notice that they are dealing with an LLC. Corp . The three entities hired Carson the individual as the president of the company.Term Partnership includes LLC’s • Rule: Anytime the word partnership appears elsewhere in the SC code. Carson discloses opportunities to the other members. it automatically includes LLC’s (mostly applies to regulations of hunting. o SC follows this model – Good faith is a contract principle. Carson actually purchased the companies himself. The agreement had two relevant provisions: corporate opportunities have to be presented to the LLC and another provision saying you can do anything you want (engage in ventures) without owing income or proceeds to CLR. and Carson Trust. In the fall of 1996. Carson (Kansas) (p. B/c it was a disclosed principal/agency relationship. In 1997. o This can be changed in the operating agreement 33-44-807: Known Creditors Claims against Dissolved LLC • LLC Must give Notice 33-44. 33-44-802. • SC Rule: you can’t eliminate the duty of care or loyalty – you can tinker with it but no elimination.different names because actual case not covered in book) • Rule: In dealing with 3rd parties you must advise your clients that they MUST disclose that they are dealing with an LLC. • Lynch v. o If Roberts was the agent. unlike the corporate model. 33-44-1205 . Rainbow. • DE: Good Faith in the LLC context is deemed not to be a fiduciary duty but a contract principle. Page 146 of 148 . Water & Land Case. He then discussed this again with the other folks involved and running CLR. is required to maintain a capital account per tax code.808 –Unknown Creditors Claims against Dissolved LLC • Must give Notice 33-44-1101-1104 . Lynch.Post Dissolution Liability • same as corp modes 33-44-803 – Winding Up Process 33-44-805 – Articles of Termination • You can file an article of termination that put everyone on notice that the LLC is dead – starts clock running to put creditors on claims 33-44-806 – Scary section: Distribution of Assets in Winding up• Creditors paid first • Then owners o Tax Regulation issues – attempts to address the default rule – If the Co. motorcycles) LLC vs. Carson told Lynch about other opportunities.Director’s Duty of Care and Loyalty • DE Rule: LLC’s can eliminate the duties of loyalty and care in their articles of organization. therefore he is liable. 33-44-703.Derivative Suits – • Problem – if someone dies and there interest transfers to a family member. all own a portion of CLR. Epstein was a principal. Epstein is liable as the principal even though he did not do the negotiations (Clark was a disclosed agent for Lanhan not PIII.            • You can put in the operating agreement if a person quits an LLC they get nothing. Carson sent proposed plans to other members of CLR for purchasing. the rest must be distributed to members per IRS regulations. that assignee may not have standing to bring a suit. Finally. 618) o Three entities. There is so question as to whether CLR was really interested. In October 1998.A Withdrawing member can still bind the LLC after a period of withdrawal 33-44-704 – Notice of Withdrawal: • But if the withdrawing LLC member files a notice then this puts people out there on notice that their action will not bind the LLC 33-44-801 – Events Causing Dissolution and Winding Up of Company’s Business • Just b/c a member quits doesn’t mean the LLC has to go out of business or wind up. • Waste.

5% of the ownership interest in the LLC – it seems the math is wrong b/c these guys invested much more than Lieberman and they are worth much less – but it suggests there was a drastic appreciation in the value of the LLC or that they were getting profit sharing o Lieberman was terminated as VP of the LLC – Note: a SC LLC can have officers.  The lawyer for Carson made another mistake because he didn’t plead oppression.  Court held that the corp opp was disclosed to the other members of the LLC and thus Carson was ok to do what he did. 33-44-409(h)(1). Gabelli points out that Carson should have brought the suit as a derivative suit. The court implies he is still entitled to his equity which hasn’t been paid to him. Mgr Owned LLCs: A member of a member-owned LLC owes a fiduciary duty to the LLC and to the other co-members of 33-44-409(d) – but a member of a manager owned LLC does not owe a fiduciary duty to the other members of the manager owned LLC. He says he has a way around it because there is an ALI exception (close LLC exception). o Rule: In almost all states.• • • o The key question is whether he has made an offer to the CLR members in a manner required by the operating agreement. Subsequently the members of the LLC threw him out and he filed another lawsuit saying they couldn’t do it (breach of their duty to him and a breach of their duty to CLR). he is also entitled to o his right to manage and o his capital contributions o share of profits  *Court also focuses on the fact he has a certificate of interest Lieberman argues the statute on p. The BJR does not apply because the complaint shows they acted independently of business interests. Lieberman v. 829 should be applied because he would then be entitled to the value in his capital account. Page 147 of 148 . Wyoming (Wyoming) (p. the corporate opportunity doctrine is going to apply to LLCs. The BJR presupposes that directors acted on an informed basis and in the interest of the company. Gabelli’s actions were injurious to CLR. Court says no because the LLC hasn’t been dissolved.but the issue is he entitled to more? o Holding: Even though he withdrew and the statute suggests he is entitled to $20K given his interest. 623) o The issues in this case are mostly state specific so you need to look at the state LLC statutes. Carson says that he just has to make them aware of the possibility of acquiring it. o There was an increase in capitalization of the LLC – from 2 new members – representing 2. o Court says he is definitely entitled to $20K – initial capital contribution .  The court suggests that the lawsuit can go forward because they don’t see any reason why a demand should have been made.  Rule-Different Duties for Member vs. He files a notice – asking the LLC to cash him out if they are going to fire him – he says he is entitled to $400K. o Lieberman invests $20k in the business (in the form of services rendered and to be rendered) and he is credited with a 40% ownership of the capital of the bus for his $20k contribution. By influencing the managers to do what they did.  The first question is whether there is a fiduciary relationship between CLR and Gabelli (in charge of some of the members of the LLC). but the court says no. We don’t really know what this means. B/C the contribution was in the form of services it raises an immediate red flag for counsel b/c presumably that transaction created tax problems for Lieberman (this is something the atty for Lieberman should have covered on the front end).  The defendants argued that all of this stuff is protected by the BJR. This is what the statute says but Burkhard says don’t assume it is that simple  It appears that this suit should have been brought as a derivative claim. they say that he is only entitled to $20K – the initial amt of his initial capital contribution. o The Court says all that is required is that the member offer the knowledge of this opportunity so he hasn’t violated the operating agreement. Is he still entitled to his voting rights in the interim? We don’t know.

you either buy them out or liquidate and distribute according to the winding up. If you look at § 33-44-603. see the same statute (diff section). o Rule: In these cases you have to pay close attention to the statue and the inter-relation of the operating agreement. You would want to see if it was a term LLC or an at-will LLC. he would no longer have voting rights. he would be entitled to distributions. If this is an at-will LLC. o What do you get during the delay while you’re waiting to be paid out. 33-44-501: doesn’t affect my voting rights in the LLC. also see § 33-44-801 which talks about events causing dissolution: if after the expiration of the specified term. o SC Rule: 33-44-701 –LLC will purchase interest at the FMV at the date of disassociation: a term or at will LLC can purchase the distributional interest of a member who chooses to withdraw for its fair value determined as of the date of the member’s dissociation if the member’s disassociation does not result in a dissolution of the co. At the end of the term.• • See SC statutes: § 33-44-701. If you look at 33-44-503(e). The question will be whether or not this is a breach of fiduciary duty. presumably it would end and I would be paid off by virtue of receiving my share of the LLC If this happened in SC. Although the section seems to suggest I have a right to early dissolution. – must focus on the notion that the LLC member may be entitled to the FMV of his shares. o The remaining members would vote to change the distributions. If it is a term LLC. the applicant may be able to request dissolution. Burkhard thinks this only applies when it is actually time for dissolution (so no early dissolution). See SC statute below. you would want to see the operating agreement. If you do this. o § 33-44-806(b): all remaining cash must be distributed according to their positive capital account balances Page 148 of 148 . you would be treated the same as a transferee. o Burkhard said the remaining members of the LLC could by unanimous vote extend the life of the LLC to prevent the term ending.

Sign up to vote on this title
UsefulNot useful