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Business Organizations Outline


CHAPTER 1: Agency: (Restatement (Third) Agency 1.01 -

A Fiduciary relationship that results from: (1) the manifestation of consent by one person ( a “principal) to another (an “agent”) (2) that the agent shall act on principals behalf and (3) subject to the principals control, (4) and the principal manifests assent or otherwise consents to the acts of the agent


To have agency there must be an agreement, but it does not necessarily have to be in writing/ or a contract between the parties. Agency may arise even if the parties did not call it an “agency” and did not intend the legal consequences of the relation to follow. Agency may be proven by circumstantial evidence that shows a course of dealings between the parties; when proven by circumstantial evidence the principal must be shown to have consented to the agency since one cannot be the agent of another except by consent. Agent acts on the principal’s behalf and subject to the principal’s control.


For Agency to Exist: 1) Both must consent to agency; 2) Agent must act on behalf of Principal; and 1

3) Principal must exercise control over Agent. 4) The agent consents to or assents to the control


SECTION 1: Who is an Agent?

i. Gorton v. Doty: (1937) (pg. 1) Doty loaned her car to Garst (football coach) to transport members of the team to the game. While driving Garst had an accident and died, and Gorton (player/passenger in car) was also injured in the accident. Gorton’s father sued Doty (teacher and owner of the car), arguing that Garst was Doty’s agent while transporting the team in Doty’s car because she had said, “Don’t let any of the kids drive the car.” • Issue: Whether the relationship of principal and agent exists when a person undertakes to transact some business or manage some affair for another by authority and on account of the latter? Rule: The relationship of principal and agent exists when one undertakes to transact some business or manage some affair for another by authority and on account of the latter. a. Notes: The court reasoned that she consented that Garst should act for her and on her behalf is clear from her act in volunteering the car upon the express condition that only Garst should drive it, and that Garst consented to act for Doty by his act of driving the car. b. Furthermore, the car’s ownership alone establishes a prima facie case against the owner for the reason that the presumption arises that the driver is the agent of the owner. i. It is not essential that there is a contract or that there is compensation for the Principal-Agent relationship to exist.

Four Elements of Agency: 1. Manifestation of Agent’s intent to act 2. On the principal’s behalf 3. Subject to the principal’s control 4. And the Principal manifests assent or otherwise consents to the act


A.: (pg. eventually. Gay Jensen Farms Co. (Warren) v. Cargill.ii. 4 . • • Issue: Whether a creditor who assumes control of his debtor’s business becomes liable as principal for the acts of the debtor? Rule: A creditor who assumes control (de facto) of his debtor’s business may be held liable as principal for the acts of the debtor in connection with the business. took over the day-to-day operations of Warren. 7) Cargill loaned millions of dollars to Warren and also. Inc.

Mill Street Church of Christ v. • Issue: Does a person possess implied authority as an agent to hire another worker where such implied authority is necessary to implement the agent’s express authority? Rule: A person possesses implied authority as an agent to hire another worker where such implied authority is necessary to implement the agent’s express authority. and 4) The church treasurer had even paid Sam for the half hour of work he had done prior to the accident. Bill hired his brother to help and Sam’s ladder broke and he broke his leg. a. 2) Bill needed assistance to do the job—the interior of the church simply could not be painted by one person. Sam filed a Worker’s Comp claim. Hogan: (pg. the Church had allowed Bill to hire his brother Sam to assist. 3) Sam believed Bill had the power to hire him. In the past.SECTION 2: Liability of a Principal to Third Parties in Contract: iii. the church had allowed Bill to hire Sam to assist in projects. Notes: Bill had the implied authority to hire Sam for several reasons: 1) In the past. as had been done in the past. • 5 . 14) (Implied Authority case) Church hired Bill to paint the building.

” o Customs vary depending on time and location. customary. (Implied is broad). however.01 (pg. Implied Authority: Authority the Agent reasonably believes he has as a result of the principal’s conduct based on: P’s conduct. the agent reasonably believes. or 2) To act in a way the agent believes the principal wants him to act based on agent’s reasonable interpretation of principal’s objectives • • • • Both express & implied are actual authority Both kinds of Actual Authority depend on communication between P and A.Three types of Agency: Authority is authority. “Express” Authority depends on solid communication. a. 6 . custom or usage Authority to: 1) Do what is necessary to get the job done. Actual Authority: ReS 2. in accordance with the principal’s manifestations to the agent. that the principal wishes the agent so to act. (Express is narrow). Express Authority: expressly granted in writing or orally—depends on the “reasonable belief” of the Agent. 18)-An agent acts with actual authority when at the time of taking action that has legal consequences for the principal. b. or proper —and can be based on “a wink and a nod. Any type of authority will do. “communication” is liberally construed. “Implied” Authority can result from things that are typical. usual. 1.

16) (Apparent Authority Case) Dweck is the Principal and the Third Party. but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. Apparent Authority: ReS 2. iv. Dweck v. Shibboleth was not the attorney of record for Nasser (it was kurt Heymna). as the Agent of Nasser.e.2. apparent authority or estoppel. This is the “Principal” communicating (via the uniform) with the Third Party. 3. Shibboleth. A police officer at your door. who was not the attorney of record for Nasser.03 (pg. to agree to the Settlement? Rule: 7 . Wachtel. but by his words and actions he reasonably led Dweck’s attorney. • • Issue: Whether Shibboleth.” the people he represents are the Principal. Nasser (pg. Inherent Agency Power: (Allot of courts do not follow this rule) The power of an agent which is derived not from authority. Agency by estoppel is where the P did not take reasonable steps to protect the third party and the third party experiences a detriment in reliance on the apparent authority. • • • The authority the agent possesses on behalf of the principal upon a reasonable belief by a third party. He is suing Nasser for acting as the Principal to the Agent. to believe that they had an agreement. wearing a uniform is “Apparent Authority” b/c the uniform is the “Apparent. “Apparent” occurs when Principal communicates directly with the Third Party—this is often unclear. 19) – Is the power held by an agent or other actor to affect a principal’s legal relations with third parties when a Third Party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principals manifestations. The P has no rights against the third party i. I. had the authority. • You see this when you have an undisclosed principal. and the Police Officer is the Agent.. This is different from agency by estoppel.

” Moreover. Joyce could expect reasonably expect Kay to speak for the company. Was Kay an agent and capable to execute the deal? 8 . 23) (Apparent Authority Case): Kay’s (a salesman) accepted on behalf of the company the right to sell memory cores to Kay. In light of the communications and since nothing was said otherwise. Based on Implied Authority: Even though Shibboleth was not Nasser’s attorney of record (Hymen was). b. v. Given this behavior. he told Shibboleth that he would execute any agreements that Shibboleth and Hymen presented to him. Ampex (pg. • Issue: a. There was reasonable belief by Kay that there was apparent authority.a. it was certainly reasonable for Shibboleth to assume he was authorized to settle the agreement—implied authority is based on the reasonable belief of the agent. Nasser directed Shibboleth the settle the action and permitted him to speak “in his name. and the long-standing close business relationship with Nasser. Three-Seventy Leasing corporation v. Based on Apparent Authority: A principal (Nasser) is bound by an Agent’s (Shibboleth’s) Apparent Authority which he knowingly permits the Agent to assume of which he holds the agent out as possessing—apparent authority is based on the reasonable belief the Principal allows the Agent to convince the Third Party that the Agent has to negotiate on the Principal’s behalf.

26) (Inherent Agency Power case) Fenwick (bar owner) authorized Humble as a purchasing agent. Humble exceeded this authority when he bought cigars. but only for specific items not cigars. 2. Was it an offer or a solicitation? • Rule: Apparent authority of an agent is sufficient to bind the principal Questions (pg. It would appear through custom that Allie had manifestation of apparent authority & inherent agency powers. Joyce could have determined who had the ability to sign and who had authority to bind the company. No the company had the ultimate responsibility vi. can that agent bind the principal on matters related to such agency even if he was not authorized for that particular type of transaction? Rule: YES. • Issue: Whether when one holds out another as an agent. 3. To protect itself the company could have used a form contract or communicate better to potential customers that only certain people have authority. Fenwick: (pg. 9 . even if the agent was not authorized for a particular type of transaction. that agent can bind the principal on matters normally related to that agency. The only recourse the principal would have is subrogation and go after the agent • Questions on Page 30: 1. When one holds out another as an agent. Who wins? Zelda. 26): 1. Watteau v. No. a.b.

” This is ratification. P could not identify the salesman and the one they thought was him was on vacation at the time of sale. Agent. the D could not confirm her payment. There was no ratification. “Thank you. Rule: Agency must be proven on the fair preponderance of the evidence. and Third Party. • Issue: Can there be specific performance? No. 21) .Ratification: ReS 4. If P talks to Third Party then it is Apparent Authority. Reversed TC holding and dismisses against Mary & remanded for new trial against Walter. in that the P did not take steps to protect the third party and the third party experiences a detriment on relying on the P’s apparent authority. This gets more difficult when P uses A to talk to a Third Party. West Coast delivers the car to the principal who takes the keys and says. Stefanovicz (pg. No title search was requested from his attorney so one was not done. After waiting for delivery. vii. • The P has no rights against the third party. 1. • Estoppel this is Different from apparent authority. There is always a Principal. Marital status cannot in and of itself prove the agency relationship.01 (pg. (pg. And the D refused to honor their lease sale. viii. Just because the wife let him handle some business does not make him her agent. 1.. The P has the burden of proving agency. If P talks to A. Hoddeson v. 10 . Reversed and remanded fro new trial. nor does the fact that they owned the property together. Some of the items were on back order. 35) (Estoppel) – Hoddeson wanted to buy furniture from D. 31) (Ratification) – This case is and appeal from the TC ruling about the sale of real property when only an undivided half interest was owned. i. The D never said he was acting as the agent for his wife “Mary”.e. Koos Bros.When the Principal acknowledges the authority of the agent • I. Botticello v. She got a gift from her mom and went shopping at D’s store and paid in cash but got no receipt. under apparent agency they would. it is Actual Authority. The purported salesman was a con artist. ii.

Rule: The proprietor has a duty to exercise reasonable care to protect a customer from a loss coming out of the false appearance of apparent authority. 11 .• • Issue: Does the evidence that there was a purported salesman substantiate the existence of apparent authority and liability by the principal? YES.

Atlantic salmon v. D never told P of the existence of Marketing Design which was in not a viable entity.04 – An employer is subject to liability for torts committed by employees while acting within the scope of their employment.Agents Liability on the Contract Respondeat Superior ReS 2. A/S Curran (pg. Reversed and remanded in favor of P. but also identify the principal. A dissolved company Marketing an Design was doing business as Boston seafood exchange with D set up as the president. It is the duty of the agent if he wants to avoid personal liability to disclose not only that he is acting in a representative capacity. director for a company that did not exist (seafood). • • Issue: Does the fact that an undisclosed principal relieve the agent of liability? Rule: NO. 38) – P Appeals lower courts verdict. ix. D presented himself as treasurer and mkt. 12 ..

agrees to work. 13 . • • Issue: Whether a party may be liable for a contractor’s torts if he exercises substantial control over the contractor’s operations? Rule: YES. o o o In general. but is not under the principal’s control insofar as the manner in which the job is accomplished.” the mere appearance that a master-servant relationship exists may subject the principal to liability. a. liability will not be imputed on the principal for the tortuous conduct of an independent contractor. Notes: A party is not normally liable for the torts of contractors. A gas station owned by Humble and operated/contracted by Schneider had a car on its lot that rolled away and hit Martin and his two children before any gas station employee touched it. Under “Apparent Agency. Humble Oil and Refining Company v.” According to the Restatement: • • A master-servant relationship is one in which the servant has agreed to work and also to be subject to the master’s control.SECTION 3: Liability of a Principal in to third party in Tort: ISSUE IN THESE CASES IS WHETHER THE RELATIONSHIP IS “PRINCIPAL-AGENT” OR “EMPLOYER-INDEPENDENT CONTRACTOR. A party may be liable for the contractor’s torts if he exercises substantial control over the contractor’s operations. No control over how the work is done • An independent contractor. but when that party so substantially controls the manner of the contractor’s operations. 43) Appeal that Affirmed the trial ct. the contractor relationship breaks down and a master-servant relationship is formed. on the other hand. Martin sued both Love (owner of the car) and Humble Oil. The amount of Control over how the work is done is how you determine if there is an independent contractor x. Martin: (pg.

Less control.Lady staying at a holiday slips and falls from moisture from an AC unit. certainly enough to justify a master-servant relationship. Holiday Inns. Humble Oil paid some of Schneider’s operating expenses. Disclaimers may not be solid if acting in a way contrary to the disclaimer. therefore there was no Master-Servant (Employee) relationship. Rule: The court did find a Principal-Agent relationship. xi. Sun Oil Company: (pg. xii. 14 . Franchise Take away rules: 1. The court found that an independent contractor does not have enough control for liability for tort to flow from the Independent Contractor to the Principal. Hoover v. Whole lot of control puts the franchisor at risk of liability. The hotel is Franchised by the Betsy-Len Motor Hotel Corp. The court found that while Sun had some control. less risk of liability. 45) Summary Judgement for D. Standards to follow will probably not be enough to create liability to the franchisor. but did not find a masterservant relationship. The franchisee maintained control of the inventory and operations. Barone retained full control of his operations. Summary. and also controlled the station’s hours. including what inventory to stock.b. Court looked and several factors of control that holiday in may have had and the fact that holiday inn was not part of the day to day control as seen in the maintenance which would have had the opportunity to keep this incident from happening. Evidence showed that Humble Oil mandated much of the day-to-day operations of the station. In this case. 3. but there is less control of the Sun Oil Company over the operator of the gas station (Barone). Murphy v. Lady sues Holiday Inn. • • • The test here is to determine whether the franchisor (Sun) retained the right to control the details of the daily operations of the franchisee (Barone). Inc. 2. The Agreement to franchise claimed the Holiday Inn was not an agent. Similar fact pattern as above. less unified product. Schneider was obligated to perform any duty Humble Oil imposed.

in this case liability for tort will flow to the Principal.Customer bit into sapphire eating big mac. Actual agency. McDonalds may have been seen to have this control as it was stemming from food handling which was one of the points of control. therefore liability for tort will not flow from Principal to Independent Contractor. Case was to review whether or not summary judgment was granted incorrectly and whether this should have been a question for the Jury. Apparent Authority.One who represents that another is his servant or other agent and thereby causes a third person justifiably to rely upon the care of such apparent agent. But if there is more control you might have a Master-Servant (Employee) relationship. Employee acting within the scope of employment xiii. Apparent Agency Rule. Apparent agency. 15 .power perceived by a third party in a supposed agent where there third party relies on the actions of the agent through his apparent authority. xiv. Miller v.3rd party understood the operator of the McDonalds was an agent of Mcdonalds.Did M rep to customers that the restaurant was acting as its agents? Apparent agent. Issues. Summary.due to the amount of control that M had over the franchisor.5. a. Must be the “right to exercise control” mainly to the physical conduct. McDonalds’ Franchisee (and not McDonald’s) had the control of the instrumentality that caused the harm. Once you establish that Agency exists (see above) the next question to ask is in what manner/how much control does the Principal have over the Agent? • If the control is minimal then the Agent is probably an Independent Contractor.

16 • . b. Notes: This case is the high-water mark for Scope of Employment Issues. i. Ira S. Inc. This amounts to Strict Liability for employers as long as a connection of time and space can be made with the employment xvi. where liability falls to a Principal for anything an Employee does that is Foreseeable.: (pg. Arguello v. v. Incidents took place at two different types of stores: 1) Independently-owned Conoco branded stores. but if there is too minimal an amount of control then the person in question is not even an agent. – an act may be within the scope of employment although consciously criminal or tortuous. Servants use of force is within the scope of employment if it expected by the master. xv. a. which caused part of the floating dry-dock to sink. Before he went onboard he turned some wheels on the dry-dock. Like a bouncer or police officer. This case changed the law. § 231 of ReS. and 2) Conoco-owned stores whose clerks were employees. • • Issue: Whether conduct of an employee may be within the scope of employment even if the specific act does not serve the employer’s interests? Rule: Conduct of an employee may be within the scope of employment even if the specific act does not serve the employer’s interests. Inc. where several AA and Hispanic patrons had been subjected to racial discrimination while purchasing gas and other services. 66) Class-Action law suit was brought against Conoco stores. Bushey & Sons. previously liability was based on whether the Agent’s actions were motivated by a purpose to serve the master. c. United States: (pg.• One more point: an Independent Contractor is subjected to only a little bit of control by the principal. Conoco. • Issue: Whether a plaintiff must demonstrate an agency relationship between the defendant and a third-party to impose liability under civil rights legislation for the discriminatory actions of a third party? Rule: Plaintiff must demonstrate agency between Defendant and Third Party to impose liability under Civil Rights legislation for the discriminatory actions of a Third Party. the new law loosened the requirement to impose liability on the Principal if the conduct arose out of and in the course of employment. causing damage. 59) (Scope of Employment Case) Drunken Coast guard returned to his ship while it was in dry-dock.

: (pg. PMA’s stated each store was an independent business and not agents or partners. Notes: The Conoco-branded stores in this case where independently owned. so no agency existed. Where the Principal engages an incompetent Independent Contractor c. Where the activity contracted is a Inherently dangerous activity (ultra hazardous / nuisance per se) 17 . However. Liability is absolute for work that is “ultra-hazardous. Majestic Realty Association.) • Issue: Whether a person who engages a contractor. and which involves grave risk to persons or property if done negligently. • • Exceptions where a Principal can be liable for the actions of an Independent Contractor (Typically they are not liable unless): a.” but this work was not in that category. but were still owned and operated by Conoco. some of the stores in the Complaint were not independently-owned. such as making sales and using the intercoms. although Conoco did not control daily operations or personnel decisions. but had a PMA (Petroleum Marketing Agreement) which allowed them to market and sell Conoco brand gasoline and supplies in their stores. b. Toti Contracting Co. v. Notes: Inherently dangerous work is work that must be done with special skill and care. is liable for negligence of the contractor when the contractor performs inherently dangerous work? Rule: A principal is liable for the work of a contractor if the contractor is hired to do inherently dangerous work (ultra hazardous / nuisance per se). Landowner maintains control of the contractor actions. xvii. b. The employees of these stores were acting within the scope of their employment b/c they were performing authorized duties for Conoco. who conducts independent business using its own employees. Inc.a. 71) (Shows that sometimes a Principal can be held liable for the actions of an Independent Contractor. a.

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c. Singer was hired. • • Issue: Whether an Agent who takes advantage of the agency to make a profit dishonestly is accountable to the Principal for the wrongfully obtained proceeds? Rule: An Agent who takes advantage of the agency to make a profit dishonestly is accountable to the Principal for the wrongfully obtained proceeds. i. 76): deterrence. b. The remedy is to give up (disgorge) ill gained profits The purpose of these is punishment and Reading v. General Automotive Manufacturing Co. Notes: It does not matter if the Principal has NOT lost any profits nor suffered any damages. 79) Singer was hired by a small machine shop to solicit customers and to do machining work. to bring in business. 76) (Loyalty) Reading was in the British military and while employed used his uniform to allow ride with trucks from one end of Cairo to the other to pass them through military inspection points. It should belong to the master b/c the servant obtained it solely by reason of the position the servant occupied as a servant of the master. Issue: Whether an Agent that draws business away from his Principal for his own enrichment is liable to the Principal for his profits from that action? 2. v. After his employment ended the shop became aware of his side jobs and sued for the profits from those ventures. At times he solicited side-business of the type done by his employer. Singer: (pg. nor does it matter that the Principal could not have done the act himself. in part. 19 . If the servant has unjustly enriched himself by virtue of his service w/out the master’s sanction. Rule: YES.SECTION 4: The Fiduciary Duty of an Agent (pg. such servant ought not to be allowed to keep the money. 1. Regem: (pg. Notes: Part of the fiduciary duty of an Agent is to be loyal and not to do anything to the economic detriment of the Principal. which breached his fiduciary duty and was disloyal. a. The remedy is to give up (disgorge) ill gained profits b. An Agent who draws business away from his Principal for his own enrichment is liable to the Principal for his profits from that action. so his “moonlighting” was drawing money away.

Inc. He took the old company’s list of clients to build up his own business. 1. Rule: Former employees may not use confidential customer lists belonging to their former employer to solicit new customers. 83) On appeal. Newbery: (pg. v. 20 .Town & Country H & H Service. which he left with other employees to start his own company. Newbery worked for a housecleaning company.

Control Partnership by Estopell (main elements)1. The relationship was terminated and the UCC sought to determine whether Chesire was an employee or partner for the purpose of assessing liability under an unemployment compensation statute. She requested a raise and Fenwick agreed to give her a raise if the income of the shop warranted it. share in profits and losses.” the essential element of co-ownership was missing. CHAPTER 2: Partnership: Who is a Partner?: Control is critical. 2. It said she would get a yearend bonus of 20% if the business warranted it and that the partnership could be terminated by either party upon 10 days’ notice. Notes: Although the agreement was termed “Partnership.II. Chesire made no capital investment. The agreement was merely one in which Fenwick agreed to share profits with Chesire. Actual partnership (main elements)1. An agreement was drawn up by a local attorney stating that Chesire and Fenwich associated themselves as a “partnership” for the operation of the shop. Share profits and losses 2. In this case their partnership was determined to be a compensation agreement. • • Issue: Is a partnership an association of two or more persons to carry on as coowners a business for profit? Rule: A partnership is an association of two or more persons to carry on as coowners a business for profit. all partners are liable to each other and owe each other fiduciary duties. Chesire got nothing from the agreement other than the possibility of a bonus and she risked nothing from it. a. partnership isn’t taxed. and was not liable for any losses. 21 . Unemployment Compensation Commission: (PG. had no control over management. Representation Reliance Fenwick v. however. 87) Fenwick hired Chesire as a cashier and receptionist for his beauty salon.

Southex bought SEM and wanted to renegotiate the deal for 22 . 5. Martin v. in order to have a “partnership” the existence of an intention to form an association to carry on as co-owners a business for profit must be proven. of appeals affirms. 4. saying there is no partnership under Rhode Island law. Peyton and his associates were designated “Trustees” and kept advised of important matters with KN and K. RIBA (pg. The intent of the parties as evidenced through the language of any written agreements. and an option to join KN and K. A written partnership agreement will not necessarily create a partnership and lack of a written partnership agreement will not necessarily preclude the finding of a partnership. Control of property and management of the business. The existence of a partnership must be determined based on the totality of the circumstances test. Issue: Whether the absence of an explicit partnership agreement precludes the creation of a partnership? 2. the right to share in profits. 2. but drew up an agreement where they would loan $2. The agreements in this case do not show the parties intended to be partners. the obligation to share in losses. Notes: In the absence of an explicit partnership agreement. Class 2 Southex Exhibitions v. The absence of a partnership agreement does not preclude the creation of a partnership. 1. 97): An appeal of the DC ruling that no partnership exits. This money wasn’t enough and KN and K suggested that Peyton and his associates (Perkins and Freeman) should become partners. The rights of the parties on dissolution. b. claiming their investments made them partners and therefore liable for KN and K’s debts. They refused. if desired. The Ct. Peyton: (pg. were having financial troubles and Peyton loaned them $500K.5 million and would get 40% of KN and K’s future profits until the loan was repaid. There is an agreement between RIBA and SEM to host the shows at the civic center. Rule: No. 92) A company. Martin (a separate creditor of KN and K) filed suit against Peyton and his Associates. KN and K. i. The documents were merely a loan of securities with provisions to insure their collateral. 3.Factors that exist in a Partnership: 1.

3. 1. (UPA 1914 §24 & §25) In this case there was: of the shows. Jones (pg. No corporate property 4. 2. 101): On the basis of the unqualified audit letter from the Bahamian PWC. The way they conducted business and were referred to did not say partnership Questions to ask to see if there is a partnership: 1.C. • They were trying to get access to the partnership assets. The financial statement was falsified. SEM bore the risk of loss solely 3. which is the reason for the suit. Only slight control by RIBA. Who was entitled to the profits? Who bore the risk of loss Who had control? What was the duration of the relationship? Young v. most control was with SEM 2. 4. However. 1. P seeks partnership by estoppell based on the marketing literature of PWC. Rule: The existence of a partnership must be determined based on the totality of the circumstances test. RIBA expresses dissatisfaction with Southex’s performance and entered into a contract with another management company. and that the US subsidiary had anything to do with the audit letter. PWC-US and PWC-Bahamas deny operating as a partnership. Rule: Two things you have to show for partnership by estopell (UPA 1914 §16) 23 . bank. the P’s deposited cash in the S. there is no evidence that the deposits were made because of the marketing material.

Representation Reliance 24 . 2.1.

Salmon’s conduct excluded Meinhard from any chance to compete or enjoy the opportunity that had come to Salmon by virtue of the venture entered into by BOTH Salmon and Meinhard. Only a limited number 46% of proxies approved the merger and therefore did not give a majority as required under the partnership agreement. Meinhard provided most of the money and Salmon managed the property. Salmon: (pg. Perretta v. iii. The merger was still completed and it was unreasonable to reverse. Notes: Salmon kept to himself. Salmon did not tell Meinhard of the negotiation of the new lease until the deal had been completed and therefore deprived him of an opportunity to take advantage of wit. an opportunity that should have belonged to the joint venture. which in effect was an offer to buy out all of the limited partners if a majority of them approved the merger. and it is now on appeal and Meinhard won. Prometheus Development Co. Meinhard sued. 1. The new lease was signed between the owner and Salmon’s realty company. b. Inc.SECTION 2: The Fiduciary Duties of a Partner: ii. The proxy statement mentions that the merger company is adverse to the interests of PDC. The remedy is damages unless the D could prove the merger was undertaken in good faith and was fair to the P’s.) Salmon entered a joint venture with Meinhard to lease a hotel in NY for 20 years. the owner approached Salmon with an offer for a new lease. Rule: An interested partner is not allowed to vote in ratification of something against the good of the unaffiliated partnership but in favor of the interested partner. The new lease was for 20 years with a possibility to expand to 80. 105) (Disclosure is the lynchpin to the duty of loyalty. D notified P that they were considering a merger with a company owned by D. He was due 49% and the D 51%. • • Issue: Whether joint adventurers owe to one another the highest fiduciary duty of loyalty while the enterprise is ongoing? Rule: Yes. As the old lease nears its end. Meinhard v. in secrecy and silence. The new lease was an enlargement of the old lease. (UPA 1914 §404) a. and both partners were responsible for any losses. It is “manifestly unreasonable” 25 . Joint Adventurers owe to one another the highest fiduciary duty of loyalty while the enterprise is ongoing..: Appelle (defendant) promethius (PDC) was a general partner and Apellant (plaintiff) Peretta were limited partners.

Lawlis v. It said no second chance and he signed. Meehan and Boyle did nothing wrong in preparing to leave. The firm decided to oust him with a vote even though he had not had a drink in approx. and they weren’t planning to leave until December. A partner has an obligation to provide true and full information of all things affecting the partnership to any partner. a. they may not otherwise violate their fiduciary duties. Rumors circulated they were leaving as early as July. while they were asked by other partners Is it true you are leaving? Meehan should have acknowledged they were leaving. The firm drafted a “program outline” which outlined the conditions he would need to meet in order to continue his relationship with the partnership. Boyle didn’t respond for two weeks. Lawlis (P) worked with a firm (D) until he became partner. He fell off the wagon and the firm gave him a second chance. He tried to say the got rid of him against the fiduciary duties. They denied leaving on several occasions. but probably not given the facts in this case. Meehan and Boyle commenced an action to receive amounts they claimed were owed them under the partnership agreement. but the appeals court affirmed 26 . DC found for P’s and on appeal it was reversed in favor of D’s. and tortuously interfered with their advantageous business and contractual relationships by engaging in improper conduct in withdrawing cases. Kightlinger & Gray (pg. and since he had not been drinking he wanted them increased. 2.) Meehan and Boyle were partners in a law firm and decided to terminate their relationship with their law firm and start their own firm. b. Meehan v. After leaving the firm. during which time he already got permission from his clients to take their cases with him. His kept getting lowered. 117) (Case is probably wrong—lawyers can leave a partnership with their clients. He developed an alcohol problem and sought treatment.iv. except they did breach their fiduciary duties by unfairly acquiring the consent from clients to remove cases from the law firm. Law firm asked Boyle to ID which cases he wanted to take with him. and law firm personnel. • • Issue: Does a partner have an obligation to render on demand true and full information of all things affecting the partnership to any partner? Rule: Yes. The firm put in place an addendum where the partners can vote to lower partnership units. breached the partnership agreement. This case was a breach. v. The law firm counter-claimed that Meehan and Boyle had violated their fiduciary duty to the firm. clients. but admitted their plans in November. then told the firm. 125) DC found for D and P appeals.5 yrs. Shaughnessy: (pg. Notes: Although fiduciaries may plan to compete.

Since she had a partnership interest and conveyed • Rule: Once a partner has sold their entire interest in a partnership. The banks were sued that honored the checks and P was suing for her (50% = 34.000) stake in those funds before she sold her ownership interest out. 132) – P owned a stake in the gin company and wanted to sell it to get out from under the debt. they are no longer able to claim a right in back unpaid profit. For all of the debts. P then died. Putnam v. 27 . she was not entitled to any part of the bank refund since she sold her interest. If the P would pay a little cash the D would assume the personal liab. P gave the property over by way of a quit claim deed. and the D took over and fired the old bookkeeper. Shoaf (pg. The old bookkeeper was embezzling.

if performed on behalf of the partnership and within the scope of its business. Notes: If a Majority of partners disapprove of the transaction before it was entered into. National Biscuit Co. buy out formula 6. The acts of a partner. v. Stroud argued that his notice to the bread company that he would not be liable for any more deliveries relieved him of any obligation to pay. The bread company eventually sued Stroud to recover the cost of the bread that had been requested by Freeman when the partnership still existed. so neither had a veto power. but Freeman requested more bread from the company. c. On the day of the last delivery. But in this case Freeman and Stroud were equal partners. • Things you might want to add in a Partnership agreement: 1. Stroud: (pg 140) Stroud and Freeman entered a general partnership to sell groceries.II. • Issue: Whether a partner may escape liability for debts incurred by a co-partner merely by advising the creditor. SECTION 5: The Rights of Partners in Management: i. AND even an act outside the scope of the business may bind a copartner if ratified by that partner. then they may escape liability. Rules for transition out 28 . all partners are equally liable for all obligations of the partnership. Stroud told the bread company he would not be liable for any more bread orders. According to UPA. Indemnification 3. The assets were liquidated and most of the money went to Stroud to pay liabilities. b. in advance. that he will not be responsible for those debts? Rule: No. Authority to purchase up to a certain limit 2. In the agreement define who does what 4. LLC etc (formalities) 5. Events that can cause dissolution 7. Stroud and Freeman dissolved their partnership. Both had equal rights to manage the business. All acts performed within the scope of the business are binding on both partners. a. for either a LP. are binding upon all co-partners.

The agreement stated that when one is unable to work he hires a replacement at his own expense.143) P entered into a partnership with D to run a trash collection business. claiming changes after the merger had made working there intolerable. iii.8. Eventually this lack of payment resulted in the lawsuit which P only got partial relief on and appealed. Sidley & Austin: (pg. as written in his partnership agreement. When the exec committee began talking about a merger all the partners agreed to it. including Day. P eventually decided to hire the worker full time but the D would not pay for any of the expense. Day chose not to attend any of the other meetings that took place concerning the merger. 144) Day was a senior partner in a law firm and got a percentage of the firm’s profits. but he was not a member of the firm’s executive committee which managed daily operations. Mainly he did not 29 . therefore it is unjust to penalize the one partner for the benefit of the other. Dooley (pg . Day v. How to bring in new partners ii. Summers v. • • Issue: By his behavior the non-consenting partner ratified the act of hiring the third person as he took profits earned by him Rule: The D did continually voice his objections. Day resigned 3 months after the merger. he was also privileged to vote on certain matters.

the concealment of which does not produce any profit for the offending partners. The court said he could not substantiate those claims. NO court has recognized a fiduciary duty to disclose the kind of information handled by the executive committee involving the merger. a. Notes: HOWEVER. Partners have a fiduciary duty to make a full disclosure to other partners all info that may be of value to the partnership. • • Issue: Do partners have a fiduciary duty to make a full and fair disclosure to other partners of all info that may be valuable to the partnership? Rule: the fact his status of the Washington office was removed and this is why he claimed fraud and breach of fiduciary duty. 30 .

however the P 31 . a. owned by the P. but the agreement to pay Collins is the only thing that matters here. The appelles sought breach of contract. Collins v. not the ability to pay the bank. The partnership’s biggest creditor is a corp. Owen v.III. but continues until the winding up of partnership affairs is completed. i. This was a partnership for an implied term. 150) – This case is about selling the assets to settle the partnerships affairs. On dissolution the partnership is not terminated. a. The court took control and it was decided that the D had done acts inconsistent with it and that it needed to be dissolved. Page v. Lewis: (pg. The jury could find that the partner did meet his end of the bargain. • Rule: The court ruled under UPA 32(1)(d) that the partner was willfully not doing things consistent with the partnership and ordered dissolution. 153) – Appellants who own 50% of the L-C Cafeteria sought receivership of the business and dissolution of the partnership and foreclosure of a mortgage on the appelles partnership interest. The Partnership operated for a loss but was improving. Both leased a downstairs part for opening a cafeteria for 30 yrs. P&D had a partnership to operate a bowling alley. which Lewis did. Lewis had an agreement to pay Collins and Collins assured him the bank note secured in his name would stay open. The court denied both arguments. Cohen: (pg. SECTION 6: Partnership Dissolution: Dissolution (as defined in UPA (1914) § 29): the dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. • Rule: You can’t just dissolve a partnership for term because you unreasonably think your partner has not met his end of the deal. At the Trial the trial court denied the relief sought by the appellants. iii. Partners (brothers) are in an oral partnership agreement to operate a linen business. Page (pg. The D argued that the problems were not big enough to dissolve the partnership and that the loan could not be paid back since it was supposed to be paid out of profits. 158) – On appeal P wins a reversal. Entered into a partnership agreement which is not complete and is only ascertainable based on the oral agreements. They started to have issues with each other. Collins tries to claim default by Lewis on not paying the bank note. The legal effect of a dissolution is that the partnership does not legally exist ii.

and the D appeals. and the D could not provide facts to support that it was. The D did not want the P’s to be able to bid on it. elects to continue the business. 161) – An appeal where 2 of 3 partners at will (P’s) running a shopping center are seeking dissolution of the partnership. They did and won. If a partner. Dale and PSC began dissolving the partnership w/out Meersman/Vasso’s assent. affirms and says the D was withheld from management. Notes: Wrongful termination invokes the provisions of the UPA. D says he was wrongly excluded from the partnership. The TC says there is partnership at will and a receiver would sell the shopping center. The partnership was to be permanent and not to dissolve w/out mutual assent. and an accounting.: (pg. • Rule: A partnership at will is not bound to stay in the partnership. iv. They claim that the one partner did not provide his proportionate share of the operating losses. 164) Dale and PSC had the patent for concrete paving machines. This is a partnership at will. return of its patent. partners who have not wrongfully caused the dissolution have the right to continue the business in the same name and to receive damages for breach of the agreement. however he must act in good faith and not freeze someone out and take all of the benefits. after a wrongful termination. he has the right to possess the ownership property. When Meersman heard this he moved into an office at PSC and physically ousted Dale. when a wrongful dissolution occurs. PSC then filed suit for a court-ordered dissolution of the partnership. v. but there was no indication that it was done with the wrongful purpose of obtaining the partnership assets. and assumed daily operations of PSC. There was no understanding as to the duration or term of the partnership. Prentiss v. but must compensate the • 32 . Vasso Corp. The D had the same right s to bid on the sale • Rule: there is no rule against a partner bidding on the sale of the partnership assets. Sheffel (pg. partners who have not wrongfully caused the dissolution have the right to continue the business in the same name and to receive damages for breach of the agreement? Rule: Yes. The appeals Ct. when a wrongful dissolution occurs. Dale and PSC formed a partnership with Meersman and Vasso.wanted to terminate the partnership. a. in order to manufacture and sell paving machines. Pav-Saver Corp. • Issue: Whether. v.

Notes: The general rule is that in the absence of an agreement to the contrary the law presumes partners and joint ventures intended to participate equally in profits and losses of the common enterprise. Reed: (pg. HOWEVER.withdrawing partner. is either liable to the other for contribution for any losses sustained? Rule: No. 170)Kovacik asked Reed to be his superintendant on several remodeling jobs. They did not discuss losses. when Reed refused he filed suit. b. each sharing possible losses in the same proportion as he would in the profits. The oral joint venture lost money and Kovacik demanded Reed contribute. c. Buyout or buy-sell agreements (pg. Kovacik said he had $10k to invest and that if Reed would superintend and estimate the jobs. • • Issue: Whether. Moral of the story the partnership agreement was not specific enough. in a joint venture where one party contributes money and the other labor. vi. 173) – these are agreements that allow a partner to end his relationship with the other partners and receive a cash payment or series of payments or some assets from the firm in return for his interest in the firm. However in this case it was a permanent partnership which did not allow for details of the dissolution. he would share the jobs with him 50/50. a. minus any damages caused by the wrongful withdrawal. each party would lose his investment. this presumption applies only in cases in which each party had contributed capital or was to receive compensation paid to them before computation of the losses or profits. vii. Some of the things you would want to think about: • • Trigger events Obligation to buy versus option 33 . in the event of one or a buy-out clause. The rationale is that in the event of a loss. Kovacik v. one money and the other labor. b. In a joint venture in which one party contributes funds and the other labor. neither party is liable to the other for contribution for any loss sustained.

Appellees say the filing of the complaint did not dissolve. They next argued over the buyout agreement on the capital account (and what exactly that was) and how it should be valued FMV or cost. Limited Partnership that owned a condo complex. The p filed suit to dissolve the partnership. but gave the court the power to dissolve. 34 . and while pending the general partner died and the P wanted to continue the partnership and assume the dead partners interest. Appelant says the filling of the complaint is dissolution and want liquidation for more proceeds to the estate. 174) – On appeal.• • Price Method of payment viii. How the value of the dead partners interest is to be computed. This suit is related to the misconduct and death of a general partner (Nordale). There are 2 issues: 1. P is a limited partnership. G&S Investments v. Belman (pg. The dead partner was a coke head and disruptive. whether the surviving general partner is entitled to continue the partnership after the other partner’s death? 2. It was determined cost.

ownership is called ownership units. 305) Rule: You have to file the dissolution papers in order for members to avoid being personally liable for any assets received in the termination of the LLC. 299) Rule: Obligation to act in good faith and aide by what is in the operating agreement. 282) Rule: You have to disclose you are an agent for the LLC in order to get the advantages Elf Atochem v. New Horizons Supply cooperative (pg. 287) Rule: What in the operating agreement rules Kaycee Land and livestock v. 294) Rule: Piercing the corporate veil applies to LLC’s and corporations McConnell v.III. Flahive (pg. Westec v.(pg. Jaffari (pg. Hunt Sports Enterprises (pg. and organization is performed with the articles of organization Partnership owners are called partners (limited/general) Public traded company owners are called shareholders. 35 . Lanham. Chapter 4: LLC’s (look at power point slides) Exam tip: GET PARTIES RIGHT • • • LLC’s owners are called members.

The law does permit incorporation of a business to limit liability. together with liability insurance.CHAPTER 3: Formation of Corporations: I. Walkovsky claimed this structure was an “unlawful attempt to defraud members of the general public. It also alleged these corps were operated by a single entity. Carlton: (pg. Overview and Structure i. Notes: In this case. Enterprise Liability—this is a horizontal “pierce” of the corporate veil. Disregard of the Corp Entity (“Piercing the Corp Veil”—means ignoring the corporate rules of limitation on liability)—this is vertical 36 . It is very important to note that the Seon Corps saved themselves by following formalities and kept good records. Rule: No. if the amount is insufficient the remedy lies with the legislature. Respondeat Superior (Agency)—Cab is an agent of Carlton iii.” • • Issue: Whether Walkovsky’s complaint stated a sufficient cause of action to recover against each cab company. 189) (Enterprise liability case) Walkovsky was run down by a taxi owned by Seon Cab Corp. “The company is out of money. Complaint said each company carried only the minimum auto liability insurance of $10k required by state law. a. the corporate form may not be “pierced” simply because the assets of the corporation. however. where you go after other corporations with the same owners ii. The company had the min amount of required insurance. so the veil could not be pierced. Walkovsky v. In his complaint. Delaware General Corporate Law: §§ 101-121 II. so who can we sue?”) i. and each company had only two cabs registered in its name. are insufficient to assure recovery. not the courts. b. There was no evidence of commingling of funds. Three Possible Legal Doctrines (Theories) P could invoke: i. Limited Liability: (Question in these cases is. Courts will disregard the corporate form (“Pierce the Corp Veil”) to prevent fraud or achieve equity. this privilege can be abused. Walkovsky alleged Seon was one of ten cab corps of which Carlton was a shareholder.

Undercapitalization 37 . Failure to maintain adequate corporate records 3. but then could not collect b/c Pepper Sauce (PS) had dissolved. This may not be required in a tort case Reverse piercing – This is when a P tries to pierce the corporate veil of one of D’s corporations to get to the assets of another one of their corporations. • Issue: Whether the corp veil will be pierced where there is unity of interest and ownership between the corporation and an individual and where adherence to the fiction of a separate corp existence would sanction a fraud or promote injustice? Rule: Yes. • **Piercing the Veil 2 prong test: 1. But on remand the court said SL had to show the kind of injustice necessary to evoke the court’s power to prevent injustice—b/c an unsatisfied judgment by itself is not enough to show that injustice would be promoted. Sea-Land Services. v. sole shareholder of PS and other corps. 194) Sea-Land shipped peppers for Pepper Sauce. personally liable. unable to recover. Pepper Sauce: (pg. 2. Unity of interest: When there is an entity such that the separate personalities of the corporation and the individual no longer exist. PS also had no assets. Commingling of funds or assets 4. and acknowledgement of the separate corps would sanction fraud or promote injustice i. a. Sea-Land filed another suit seeking to pierce the veil and hold Merchese. Notes: Corp formalities had not been maintained and funds and assets had been commingled with abandon—different corp assets were moved and borrowed w/out regard for their source (First prong of the test satisfied). Inc. the corp veil will be pierced where there is a unity of interest and ownership between a corp and an individual and where adherence to the fiction of a separate corp existence would sanction a fraud or promote injustice. **General factors to determine if piercing the veil is appropriate: 2.ii.

The Pope. also that the Archbishop and others are a “mere conduit” for the Pope and Vatican. and Father Cretton. The Arch of S.F. One corp treating the assets of another as its own • To avoid veil piercing owners of corporation should abide by the formalities. etc. a. Notes: (1) The Archbishop of S. Bernard dog. thus negating any possibility that the Arch so controlled and dominated the Swiss so as to be liable for it under the “Alter Ego” doctrine. Complaint alleged there was a “unity of interests” and ownership between all of the defendants. (2) No. • Issue: (1) Whether where a parent corporation controls several subsidiaries. 200) (Attempt to claim a subsidiary is liable for another subsidiary) While in Switzerland.F.C. and (2) Whether the “Alter Ego” theory may be applied where the unsatisfied creditorplaintiff will merely not be able to collect if the corporate veil is not pierced? • Rule: (1) No. from a Roman Catholic monastery. meaning to have meetings and votes and separate bank accounts. Sheffield entered an agreement to buy a St.F. It is not sufficient to say that Sheffield should 38 . had no dealings with the Swiss monastery. There is no Respondeat Superior between subagents. iii. and that all the Defendants were “alter egos” of each other. Where a parent corporation controls several subsidiaries.5. Archbishop of San Francisco v. may be an “Alter Ego” of the Pope. the corporate veil of one subsidiary may be pierced to satisfy the liability of another. with whom he had made the agreement. Sheffield: (pg. The “Alter Ego” theory may not be applied where the unsatisfied creditor-plaintiff will merely not be able to collect if the corporate veil is not pierced. The monastery breached and Sheffield sued The Archbishop of S. R.. on installment payments. (2) A requirement to pierce the corp veil is that failure to pierce would lead to an inequitable result. The Vatican. but the Archbishop is not an “Alter Ego” of another subsidiary of the Pope (the Swiss monastery). the corporate veil of one subsidiary may not be pierced to satisfy the liability of another. the Catholic order in question.

Also. 204) (Piercing is allowed w/out fraud in tort cases to satisfy justice. injustice. a. or inequity in a Contract case may not be required in a Tort case. may veilpiercing ever be resolved by summary judgment? Rule: Yes. summary judgment for veil-piercing could be proper if the evidence presented could lead to but one result. A showing of fraud. in a corporate control claim seeking to pierce the veil.” the courts may use it as grounds to find “Enterprise Liability” or “Respondeat Superior” for the purpose of “Piercing the Corporate Veil.collect from the Arch of S. which was a subsidiary owned by Bristol-Meyers.) Plaintiffs from many states claimed they had been injured by breast implants produced by MEC. Notes: Summary judgment was denied here b/c a jury could find that MEC was the alter-ego of Bristol. Factors to consider in determining alter ego in order to pierce the corp veil: 1. Parent and subsidiary have common directors or officers 39 . even though Bristol had not manufactured the product. veil-piercing is often allowed when it is sought to satisfy a judgment. P’s wanted to pierce the veil. and to satisfy a judgment. c.F.” iv. • Alter Ego: When a corporation uses another corporation to its advantage. the corp structure may be denied in the interest of justice. b. • • Issue: Whether. when a corporation is determined to be using another as an “alter ego. In Re Silicone Gel Breast Implants Products Liability Litigation: (pg. just because to sue in Switzerland or Italy would be prohibitive. When a corp is the alter ego of another.

state legislation adopted in the public interest can be constitutionally applied to the preexisting corporations under the reserved powers. the reserved power may be invoked to sustain later charter alterations even thought the affect contractual rights between the corporation and its stockholders. Co. Notes: 50 years prior to the incorporation of A. NJ courts repeatedly showed decided that where justified by the advancement of Public Interest. 3.2.P. They have common business departments They file consolidated financial statements and tax returns The Parent finances the Subsidiary The Parent causes the incorporation of the Subsidiary The Subsidiary operates with grossly inadequate capital Parent pays salaries and expenses of subsidiary Subsidiary only receives business brought to it by Parent Parent uses the Sub’s property as its own The daily operations of the two corps are not kept separate Sub does not observe the basic corp formalities. Barlow: (pg. A. 7. Shareholders argued the corp’s charter (1) did not expressly authorize the power to give to charities. but the shareholders sued. 11. • • Issue: Whether state legislation adopted in the public interest can be constitutionally implied to preexisting corporations under the reserved powers? Rule: Yes. 5. the NJ Legislature provided that every corp charter would be subject to the discretion of the legislature (“Reserved Power”). 10. such as keeping separate books and records and holding shareholder and board meetings III. and (2) the New Jersey statute legalizing charitable giving by corps did not apply b/c the corp was in existence before the NJ statute was passed. 4. v. i. 6. 40 . The shareholders argued the law did not apply to them b/c they had been incorporated before the laws were inacted. SECTION 4: The Role & Purpose of the Corporation i. 9. a. 264) Corporation wanted to give $1. Smith. 8.P.500 to Princeton University. Smith Mfg.

who rejected the offer. a corp’s primary purpose is to provide profits for shareholders.ii. illegality. or conflict of interest? Rule: A shareholder’s derivative suit can only be based on conduct by the directors which borders on fraud. Shlensky v. illegality. or conflict of interest. ii. despite profits of almost $174 million. There were valid reasons for not wanting night games on the part of Wrigley. Wrigley believed lights would have a detrimental effect on the neighborhood. The Dodge’s filed suit attacking the dividend policy and Ford’s plan to expand manufacturing. c. a. Wrigley: (pg. 270) In 1916. but also by a desire to avoid funding the Dodge’s venture (is this fraud. b. 275) Shlensky (minority shareholder) sued Wrigley b/c they refused to put lights on Wrigley field. but there was no showing of fraud. The court was clearly swayed by the philanthropic concerns and devoted much of the opinion to discussing the economic and social importance of corp contributions. illegality. Ford announced no future dividend would be paid. • Issue: Whether a shareholder’s derivative suit (suit by a third party on behalf of the corporation) can be based on conduct by the directors that does not border on fraud. illegality. as discussed in the next case?) iii. notwithstanding his personal feelings about the game. b. • • Issue: Whether the primary purpose of a corporation is to provide profits for shareholders? Rule: Yes. Notes: The power of the corp’s directors is to be employed to provide profits to shareholders. especially to universities. Ford Motor Co. a. or conflict of interest. • 41 . Notes: Shlensky was trying to force a business judgment on the Board of directors of the Cubs. The real reason for this ruling was that the court realized Ford was motivated not just by a desire to expand Ford’s manufacturing. which would have allowed for night games and increased revenues. The Dodge brothers offered to sell their $35 million in shares to Ford. There was also no showing that night games would significantly increase revenues.: (pg. Dodge v. or conflict of interest.

42 .

Ownership: ability to make cap gains when they sell stock • What does the Board do? a. which makes them all agents of the Corp c. Decide other rare. Compensation Committee iii. Vote on whether to be acquired b another corp e. Employees of the Corp.iv. The ability to make more money—get percentage of ownership i. Vote on mergers and acquisitions (decide to buy other corps) d. Anything a corp says it can do b. Other Corporation Stuff: • Sources of power for a corp are: a. Anything state law allows • What can shareholders do? a. Vote on decisions that are big and rare • What do shareholders get for their money? a. Appoint Committees—Specialists i. Control (as listed above) b. Chosen by the board b. Decide to issue dividends c. Accounting Committee to conduct audits in accord w/ Fed law ii. Nominating Committee • Officers: a. Appoint Officers b. Vote on the Board of Directors b. Fiduciary duty to shareholders and Corp 43 . Vote to dissolve the Corp c. important decisions d. big.

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Directors. 45 . We don’t want shareholders second-guessing the business decisions of Officers iv. There must be allegation of fraud. and deliberate Duty of Loyalty a.CHAPTER 5: The Duties of Officers. Courts are incompetent? No. BJR promotes a lot of successes and also ends in a lot of failures 2 fiduciary duties owed by directors that are prerequisites to application of the BJR 1. this is not true. 2. How? i. Prompts risk-taking b/c there is little fear of retaliatory litigation 1. illegality. and Other Insiders Business Judgment Rule: Doctrine relieving corporate directors and/or officers from liability for decisions honestly made in the corp’s best interests. How? i. but can’t act selfishly or with grossly negligence or egregious conduct. Duty of Care a. illegality. Avoid conflicts of interest (self dealing) fraud. bad faith Rule: Directors have carte blanche authority to make dumb mistakes. Wide berth to make decisions ii. or conflict of interest to bring a Cause of Action Reasons for the BJR: i. Gather material information reasonably avail. courts rule on complicated things all the time iii.

qualifications. Courts will not interfere as long as the decision is made in good faith. illegality. number. Delaware General Corp Law: i. guaranty of obligations of employees and officers iv. It is not enough to charge that the board made an imprudent business decision or that some other action would have been more advantageous. in derivative action. failure to elect. employees and agents. Smith v. CEO of Trans Union.Van Gorkom: (pg. § 142: Officers.: (pg. removal ii. RULE: NO. • V. SECTION 1: The Duty of Care: IV. classes of directors. Whether or not a dividend will be paid is exclusively a matter of business judgment on the part of the board. On 9/18 Pritzker (the corp takeover specialist) demanded Trans Union respond to his 46 . it was later worth only $4 million. There would have to be fraud. Kamin sought. ISSUE: Whether the courts should interfere with a board of directors’ good faith business judgment as to whether or not to declare a dividend or make a distribution? ii. • NOTES: The Business Judgment Rule applies here also (see above). committees. § 143: Loans to employees and officers. duties. § 144: Interested directors. This rule is used to provide a wide-birth for the board so that it can effectively and efficiently pursue the corp’s best interests rather than being constantly influenced by the need to practice “defensive management” or to prevent being held liable. 314) (Cases will probably never be decided like this again) Van Gorkom. Am Ex made a decision to declare a special dividend and distribute a dividend “in kind” (meaning not of cash) by giving away the $4 million of DLJ stock. approached a corporate takeover specialist to stage a leveraged buyout of Trans Union at $55/share. i. but Kamin charged this decision was negligent b/c it negated a possible tax savings of $8 million. quorum v. or conflict of interest. but no other members of the board were consulted. insurance VI. terms and quorum. term. Such a charge cannot give rise to a cause of action. § 141: Board of directors. 310) Am Ex acquired almost 2 million shares of common stock of DLJ at a cost of almost $30 million. action without meeting. Van Gorkom only consulted the company’s controller. a declaration that the dividend was a waste of corp assets and sought damages. selection. nonprofit corporations. powers. titles. Peterson. § 145: Indemnification of officers. reliance upon books. Kamin v. vacancies iii. American Express Co. directors.A.

after taking reasonable measures to substantiate it. c. Four Concepts for Van Gorkom i. The BJR presumes the officers are making sound decisions and this presumption must be rebutted. • NOTES: A director or officer may not passively rely on information provided by other directors or officers. or authorized committees. Van Gorkom called a special meeting of the board the next day. the directors or officers acted on an informed basis. i.” The concept of gross negligence is the proper standard to determine if the business judgment reached by a board of directors was an informed one. outside advisors. on 2/10 the shareholders voted to approve the takeover. VII. but under BJR there is no protection for officers who have made “unintelligent or unadvised decisions.offer in 3 days. The director may only rely on credible information provided by competent individuals. This option is faster. RULE: The Business Judgment Rules shields directors or officers of a corporation from liability only if. availing themselves of all material information reasonably available. ISSUE: Whether a director or officer of a corp is shielded by the business judgment rule when he relies on the representations of other directors or officers? ii. Van Gorkom executed the merger agreement on 9/22. § 102(b)(7) was created b/c of and after this case. b. Smith and other stockholders filed a class action law suit against Trans Union and the board. W/out reviewing its contents. which means there will be less time for the board to deliberate 47 . the board approved the agreement based on Van Gorkom’s 20 minute presentation. The court concluded that the board’s failure to inform itself before recommending a merger to the stockholders constituted a breach of fiduciary duty of care and rebutted the presumptive protection of the business judgment rule. in reaching a business decision. Van Gorkom chose this option b/c he was close to retirement and wanted to cash-in. If you issue all the shares at one time then you can charge a premium for the control you are giving over to the buyer. iii. However. Options for the use of Trans Union’s cash: • LBO: a.

Next question is who fixes the problems. economically. which makes this a 20/80 or 4x LBO.) 48 . Issuing a Dividend is the exact same thing.d. Like an LBO b/c you put some amount of money down and then borrow the rest. Even if they could have gotten more money later they might not have been able to find a buyer • • • Issue a Dividend Purchase another company Buy back outstanding shares which decreases the amount of shareholders (probably). Steps of LBO: The point is that this process takes a long time and is a lot of work. Look at Public Info b. there is an appraisal (the appraisal must take place after the Bid b/c the seller won’t let you appraise w/out placing a Bid b/c the result of their appraisal will be pubic information. This is a way to find the bottom value of the company P/E is way to value if you know the whole value and then can divide by the number of outstanding shares • iii. The interest rate will be a large factor in determining amount of return. This is similar to issuing a dividend. Sometimes people with lots of money still engage in LBOs. The appraisal is for one reason: trying to find reasons to lower your Bid. If Bid is accepted. A buyer right now means there is certainty right now. as buying back shares. ii. a. Also. so the money goes from the company to the shareholders. typically put 20% down. Someone places a bid (there is an evaluation of the Bid) c. the seller cares who the buyer is b/c when they pick a buyer they are also turning down a bunch of other Bids. a. Worth of the Company is based on: (Ways to value) • • • Future Income Comparing the company to other companies Value of assets—this is difficult b/c difficult to assess and these assessments are usually the lowest possible valuation. Why is this? • • LBO vs. do you lower the price and fix it yourself or keep the same price and tell them to fix it. Non-LBO: leverage greatly magnifies your amount of returns. LBO: Buying a house is like an LBO.

or self-interest. • • Duty to act in good faith Duty to be informed on the business 49 . Rule: BJR only applies if there were decisions actually made—she made no decisions.) Lillian Pritchard inherited a reinsurance brokerage from her husband and her sons illegally withdrew over $12 million from the company for personal needs. Company goes BR and is sued by the Trustee—claim is to cover the misappropriated amount i. Directors will be personally liable for their carelessness. After all this there is the mortgage contingency. Needs illegality. which says “If you can’t get the funding by a certain date. fraud. Issue: Whether individual liability of a corp’s directors to its clients requires a duty. the deal is off. e.” You have to find financing w/in a certain amount of time and it must be at some interest rate. breach. no informed business decision will be overturned. Francis v. but the court was wrong c. Rules for Veil Piercing • BJR: If you don’t like the way the company is being run you can’t just sue the board as a shareholder. Not having BJR in place opens you up to negligence complaints. Mrs. Also. Van Gorkom: tells us in the absence of illegality. Pritchard didn’t make ANY judgments. a. 328) (BJR only applies to business judgments—in this case Ms. ii. f. This caused applicable insurance rates to increase 600% b.d. Pritchard was completely ignorant of the fundamentals of the business and paid no attention to the affairs of the corp. the point of this case is that the court got it really really wrong i. What businesses have learned since Van Gorkom is that they need to do a lot of paper work here to show they have been meeting the Duty of Care— this is to cover the requisite formalities • VIII. Next the buyer has to shop for the financing (this involves providing lots of information) Closing: they hand over the deed and you hand over a check iv. United Jersey Bank: (pg. and proximate cause. The court said there was not enough Care used by the Board. and their power gets limited. The BJR is the legal mechanism by which the shareholders get kept in their place. fraud. self-interest/self-dealing.

Liability of a corp’s directors to its clients requires a demonstration that: 1. a duty existed, 2. the directors breached that duty, 3. The breach was a proximate cause of the client’s losses.

• • •

Notes: If she had at least resigned she would have signaled to the shareholders that there was something wrong with the company. This is a departure from the general BJR that a director is immune from liability and is not an insurer of the corp’s success. Directors normally do not owe a duty of care to third parties unless the corp is insolvent. The nature of the reinsurance business distinguishes it from most other commercial activities in that reinsurance brokers are encumbered by fiduciary duties owed to third parties. In other corps, a director’s duty normally does not extend beyond the shareholders to third parties. Reinsurance companies’ and some banks’ Directors have a fiduciary duty to both the corp and its stockholders. This requires basis understanding of the corp’s business and a duty to keep informed of its activities.


B. SECTION 2: The Duty of Loyalty Duty of Loyalty:

These will fall into two categories: (1) Corporate Opportunities or (2) Interested Insider Transactions • Loyalty questions are always trying to figure out if the transaction in question is “fair.”


Interested Insider Transactions: They cause the corporation to go into some transaction that will benefit an insider. • I.e., Salary negotiations—if a board is going to decide a CEO’s salary and the CEO is on the board we might have an Interested Insider Transactions.

ii. Direct Interested Insider Transactions: I.e., Salary negotiations iii. Indirect Interested Insider Transactions: I.e., Stock options or suspiciously beneficial loans (interest free loans) or, for example, if company A buys stuff from company B at an outrageously high price and we later find out a board member is on the board of both companies

X. XI.

Corporate Opportunities: Duty of Loyalty. Duty of Loyalty cases will involve the “self-dealing” factor of BJR. Once you’ve made the case that self-dealing is present the BJR no longer applies.

i. Bayer v. Beran: (pg. 336) (BJR only applies if loyalty to the corp is not violated) The Celanese Corp had an advertising campaign prior to 1942. After 1942 the FTC said all Celanese products had to be labeled as “rayon.” B/c they believed their products were better than “rayon” The Celanese Corp commenced a radio advertising campaign costing $1 million/year. The decision was made based on studies by the in-house advertising dept., and the employment of a radio consultant and an advertising agency. The wife of the president of The Celanese was selected to perform in the radio program. The board was charged with negligence in its selection of the radio program and self-interest in initiating the program. 51

• •

Issue: Whether the courts may question decisions of business management made by a corporation’s board of directors. Rule: No. “As long as a contract is fair it is valid, even if disinterested directors have not yet approved it.” (Pg 341 of book) Policies of business management are left solely to the Board of Directors and may not be questioned absent a showing of fraud, improper motive, or self-interest, even if the decision is later judged to be unwise or unprofitable. a. Notes: However, the BJR only applies to personal liability for negligence if directors have not violated their duty of loyalty to the corporation. b. When directors have personal transactions with the corporation, the transactions are vigorously scrutinized—and are voided if there is unfair advantage. c. Although the radio advertising expenditure was not agreed to by resolution of the entire board, it is not to be considered ultra vires (“beyond the power”) of the board b/c the members authorized it individually.

Structural Bias Theory: Says there is no such thing as an independent board member; after a certain amount of time, all board members have some level of bias (new, cynical view of boards).

ii. Benihana of Tokyo, Inc. v. Benihana, Inc.: (pg. 341) Benihana needed to renovate so they hired Morgan Joseph to come up with a plan to raise capital. Abdo was on the board at Benihana, but he was also on the board at BFC. BFC offered to provide the capital based on the plan Joseph had arranged to raise money for renovations. Abdo made the presentation to the Benihana board on behalf of BFC. However, at that time the board was not specifically informed that Abdo was the person at BFC who was actually doing the negotiations with Benihana. Upon agreement, Abdo sent a memo to Joseph, Schwartz (CEO of Benihana), and Dornbush (counsel for Benihana) listing the terms of the agreement. He did not send this memo to all the members of the board. The trial court found the board was NOT informed that abdo had negotiated the deal on behalf of BFC. A few weeks later, Schwartz sent a letter to the board saying it should abandon the transaction and seek other funding based on the directors’ conflicts, the dilutive effects of the deal, and questionable illegality —this was on behalf of Aoki (WHY DID AOKI REALLY WANT TO DO THIS??) • • Issue: Whether Abdo breached his duty of loyalty when he used Benihana’s confidential information against Benihana? Rule:


” • Issue: Whether the Corporate Opportunity Doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity? Rule: Yes. and iv. Broz offered $500k over Pri-Cell’s offer and bought MI-2. Broz v. Nine days later Pri-Cell acquired CIS and CIS brought suit against Broz for breaching his fiduciary duty to CIS by usurping a corporate opportunity that belonged to CIS. Inc. • • The corporate opportunity doctrine is one application of the fiduciary duty of loyalty The corporate opportunity doctrine only applies if the opportunity was not disclosed to the corporation. CIS was aware of Broz’s potentially conflicting duties to RFBC and did not object to his actions on RFBC’s behalf. and not corporate. CIS did not have the financial capacity. ii. officers. Notes: Broz was within his rights b/c: i. and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation. capacity. the opportunity became known to him in his individual. 53 . and that Broz should have “formally submitted to CIS’s board. The CEO of CIS did not object. the opportunity was more closely related to the business of RFBC than CIS. 347) (Gives factors to determine whether what happened was fair—if not fair. a. both in rural parts of Michigan. Cellular Information Systems. iii. Pri-Cell was also trying to buy MI-2. they submitted an offer that would stand unless someone offered $500K more than Pri-Cell’s offer.Begins the Second Type of Loyalty Claims: iii. CIS had just come out of BR and had divested of several cellular licenses AND Broz even told CIS’s CEO that he might buy MI-2. • Corporate Opportunity Doctrine: The corporate opportunity doctrine is the legal principle providing that directors. Pri-Cell was trying to buy CIS. Mackinac contacted Broz to see if he wanted to buy MI-2. the Corporate Opportunity Doctrine is implicated only in cases where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corp and the self-interest of the director as actualized by the exploitation of the opportunity. then it was disloyal. At the same time.: (pg.) Broz owned RFBC and also served on the board of CIS. RFBC owned MI-4 cellular area and Mackinac Corp owned MI-2 cellular area.

• •

When the corporate opportunity doctrine applies, the corporation is entitled to all profits earned by the fiduciary from the transaction. If the opportunity was disclosed to the board of directors and the board declined to take the opportunity for the corporation, the fiduciary may take the opportunity for him- or herself. • How is an Interested Insider Transaction different from the Corporate Opportunity Doctrine? a. In a Interested Insider Transactions a Corp Officer is making money, whereas in a Corp Opportunity some Officer or Corporation is spending money

*** 4 Factor Corporate Opportunity Test: 1. Is the corporation financially able to exploit? 2. Is the opportunity within the corporation’s line of business? 3. Does the corporation have an interest or expectancy in the opportunity? 4. Is the opportunity within the official or individual capacity?

What are Broz’ options if he wants to buy MI-2? a. He can get formal ratification from the board of CIS, or b. He can quit his position on the board at CIS

iv. In re eBay, Inc. v. Shareholders Litigation: (pg. 352) Goldman Sachs “rewarded” lots of eBay directors and officers by allocating to them thousands of IPO shares, managed by Goldman Sachs, at the initial offering price. Shareholders of eBay filed a derivative suit against those eBay directors and officers on the grounds that such conduct usurped a corporate opportunity that belonged to eBay, which regularly invested in marketable securities, and constituted a breach of fiduciary duty of loyalty. • Issue:

(1) Whether corp officers usurp a corp business opportunity when they accept IPO allocations at the initial offering price instead of having those allocations offered to the corp?


(2) Whether Goldman Sachs aided and abetted a breach of fiduciary duty when it made these allocations while knowing the corp’s officers owed a fiduciary duty to the corp? • Rule: (1) Yes and (2) Yes. a. Notes: The concern of the shareholder in this case is that if some bank comes along later that could do the job of Goldman Sachs at a better deal, the Officers of eBay will be persuaded by opportunity of kickbacks— therefore they might not be getting the shareholders the best deal b. Spinning: Allocation of shares of lucrative IPOs of stock to favored clients.

v. Sinclair Oil Corp. v. Levien: (pg. 357) (When to apply the BJR vs. when to apply the Intrinsic Fairness Test. Appeal by Sinclair from an order for an accounting in a derivative action brought by Levien (minority shareholder) to account for damages sustained by Sinven (wholly owned subsidiary of Sinclair—located in Venezuela) for breach of fiduciary duty, overpayment of dividends, and denial of industrial development. It is not disputed that Sinven was a wholly owned subsidiary and that the Board was nominated by Sinclair and that Sinclair owed Sinven a fiduciary duty. Trial court found that b/c of the fiduciary duty, the BJR did not apply. Instead the court said the “Intrinsic Fairness” test should be applied. Sinclair argues the court should apply the BJR. • Three claims: a. Too much dividend payment (like the Ford case). This doesn’t hold up b/c the money paid out went in equal proportion to the Plaintiff and to the Defendants. Sinclair had 97% and Levien had 3%, but at what percentage does this become a problem? At what percentage of ownership does a shareholder start to have to deal with lawsuits of this nature? b. Foregone Business Opportunity c. Breach of Contract—Sinclair was found liable here b/c the other subsidiary that had a contract with Sinven breached its contract. • • Issue: Should the Intrinsic Fairness Test be applied to business transactions where a fiduciary duty exists but is NOT accompanied by self-dealing? Rule: No, the Intrinsic Fairness Test does not apply where a fiduciary duty exists between a parent and subsidiary in the absence of self-dealing.


a. Notes: Intrinsic Fairness Test did not apply here because there was not selfdealing. The dividend payments in question went to Sinclair, but they also went, in equal proportion, to the minority shareholders of Sinven. b. HOWEVER, wrt the allegation that Sinclair did engage in self-dealing when it forced Sinven to contract with Sinclair’s wholly owned subsidiary Sinclair International Oil, and then failed to abide by the terms of that contract, the Intrinsic Fairness Test did apply. AND b/c Sinclair could not show (under the Intrinsic Fairness Test) that its action under the contract were intrinsically fair to Sinven’s minority shareholders, Sinclair was required to account for damages under that claim.

Intrinsic Fairness Test: Involves both a high degree of fairness and a shift of the burden of proof to the Defendant who must show, subject to careful judicial scrutiny, that its transactions with the Plaintiff (Sinven in this case) were objectively fair.

***When to apply the Intrinsic Fairness Test: Only when the fiduciary duty is accompanied by self-dealing • • • There must be self dealing. Self dealing is the situation when the parent is on both sides of a transaction with a subsidiary. It shifts the burden and puts the burden on the majority shareholder to show that the transaction with the subsidiary was objectively fair. If there is NO self dealing then the court relies on the business judgment rule

vi. Zahn v. Transamerica Corporation: (pg. 361) Axton-Fisher had three kinds of stock: preferred, class A, and class B. The charter said that upon liquidation a set amount was to go to the preferred stockholders with the remainder of the assets to be distributed to the A and B stockholders. Class A holders were to receive twice the amount per share as the B holders, but the charter also said the A stock could be redeemed by the board by paying $60/share plus unpaid dividends. Over time, Transamerica bought 80% of the class B stock and 2/3rds of the overall voting stock—they had also appointed the Board by electing a majority of the Board members. Between 1942 and 1943 that tobacco assets of AxtonFisher went from $6 million to $20 million. B/c of this, the Transamerica controlled Board of Axton-Fisher redeemed the class A stock and then sold the assets of the corporation, thereby liquidating it and benefitting Transamerica who owned most of the remaining nonpreferred stock.


upon vote of the shareholders. In 1970. 367) Lawrence. Lawrence: (pg. ratification by a majority of the disinterested shareholders does shift the burden to the objecting shareholder (P) to show the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets. but it is still possible. President of Agau. Agau was also granted the option to purchase USAC if the properties later became commercially available. there has been a breach of duty. even though he is only acting as a shareholder.000. Agau exercised to option to acquire USAC. acquired certain properties under a lease-option for $60. and when he benefits from the dealings in the corporation he has the burden of proving good faith in the transaction and also fairness to minority interests. a.000 shares and for an accounting. 2) Also. Rule: There are two bases for such a suit: 1) A dominant shareholder has the same fiduciary duties as a director. You can still prevail without ratification. Shareholders brought a derivative suit on behalf of Agau to recover the 800. when a director votes for the benefit of an outside interest. a. without risk to Agau. claiming the officers and directors wrongfully usurped a corp opportunity and profited from it.000 shares of its restricted investment stock for all authorized and issued shares of USAC.• Issue: A suit can be maintained by a minority shareholder against a majority shareholder where the majority uses his vote for personal benefit at the expense of the minority. so the capital could be raised through the sale of stock. rather than for the benefit of the shareholders as a whole. you just have the burden to prove it is intrinsically fair. but after talking to Agau’s Board it was determined that Agau’s legal and financial position would not allow the acquisition and development at that time. Notes: This case shows that a majority shareholder owes a fiduciary duty to the minority. Lawrence agreed to transfer the properties to Agau. • vii. • 57 . Fliegler v. Agau’s directors decided to transfer the properties to USAC. Agau was to deliver 800. The Board voted to do this and a majority of shareholders approved. a closely held corporation formed for this purpose and a majority of whose stock was owned by Agau directors. • Issue: Whether ratification of an interested transaction by a majority of fullyinformed shareholders shifts the burden of proof to the objecting shareholder (P) to demonstrate that the terms of the transaction are so unequal as to amount to a gift or a waste of corporate assets? Rule: Yes.

These transactions are not voidable if approved in good faith by a majority of disinterested stockholders. viii. the court has decided the merger was approved by a fully informed vote of a majority of WTI’s disinterested stockholders. a. Notes: Generally. • Fiduciary Duty Claim: Since the disclosure claim was rejected by the court.469 Waste shares for each WTI share they held. the duty of care was met by the Board—they had ratification. The P’s only argument was that the Board meeting to “carefully consider” the merger was “only 3 hours” and therefore not long enough for them to have fulfilled their duty to “carefully consider” the merger. A fully informed. • • Issue: Does fully informed. saying the basis of a short meeting was not enough to assume the Board had not come to an informed decision. 370) Waste Management bought 22% of WTI. 58 .b. and 2) WTI shareholders would receive . the rule is the burden of proof involving an interested director or officer is on that director/officer to prove the transaction was intrinsically fair. therefore breaching their fiduciary duty. In re Wheelabrator Technologies. Disclosure Claim: DE law says the Board has a fiduciary duty to disclose all material facts to the shareholders. Inc.574 WTI shares and . WTI has a Board meeting w/ presentations where all speakers declared the transaction was “Fair”. • • *** The Duty of Loyalty Claim: Two kinds of claims: 1) “Interested” transactions between a corporation and its directors. Shareholders Litigation: (pg. good faith shareholder ratification serve to extinguish a duty of loyalty claim? Rule: No. The court dismissed this notion. good faith ratification does not extinguish a duty of loyalty claim. but it serves to make the BJR the applicable review standard with the burden of proof resting on the Plaintiff stockholder. Two years later Waste and WTI negotiated a merger in which: 1) Waste would acquire another 33% of WTI stock. i. The Duty of Care Claim: Since the court said the shareholders’ vote was fully informed. all board members voted in favor and later majority if WTI shareholders approved the agreement. The court noted that Board members of the two companies had been working together for two years.

When there is an interested director transaction with majority ratification of the fully informed disinterested shareholders the “Business Judgment Rule” is used. what happens next depends on whether the D is a Director or a controlling shareholder. Corporate opportunity – ID the act and the Defendant • Apply BJR. When there is a controlling shareholder involved in a merger the court uses the “Entire Fairness” doctrine to review the merger. The good faith approval invokes the “Business Judgment Rule” and limits judicial review to issues of gift or waste w/ the burden of proof on the attacking party 1. i.ii. illegality. The burden is on the Plaintiff to show fraud. the burden shifts back to the P to show the transaction fails the Entire Fairness Test. ix. 1. 2) Cases involving transactions between the corporation and its “controlling shareholder”. How do you Prove “Unfairness”? See Broz and Sinclair. If you have a circumstance where there is alleged disloyalty from a controlling shareholder. with the burden of proof shifting to the Plaintiffs. See § 144 of DE General Corp Law on Page 118 in Supplement. Roadmap for Fiduciary Duty of Loyalty: • Identify the act a. These usually involve parent-subsidiary mergers conditioned upon receiving a majority of the minority stockholder approval. with the burden of proving the merger was unfair falls on the Plaintiff. ii. Interested Insider Transactions – ID the act and the Defendant b. The standard of review here is usually “Entire Fairness”. with the burden of proof shifting to the Defendant • When there has been ratification. or self-dealing (or Carelessness or Non-feasance) 59 . even if you have ratification on the part of shareholders. a.

a. Use the Broz Factors to determine if it is “Fair” for Corporate opportunity acts b. then case is over b. To prove this there is a shift in burden to the Defendant (the following applies to the Defendant’s burden of proof): i. The burden gets shifted back to the Plaintiff to try to prove Waste or something like that—this is functionally a loss b/c they won’t prove Waste (probably). § 144(a)(3): No Ratification • § 144(a)(3): If no Ratification then all that is left is an analysis of “Fairness” which must be shown by the Defendant. If you get either (a)(1) or (a)(2) ratification. then you are once again concerned with either the Interested Insider Transactions or Corporate opportunity act.• Ratification—ask whether the act in question was ratified a. and the Def is a Director or Officer then the Plaintiff is out of luck. If the Def is a Controlling Shareholder w/ ratification. If the act in question is a Duty of Care case and it is shown to be ratified by the Def. a. § 144(a)(1): Board Ratification ii. § 144(a)(2): Shareholder Ratification 1. If the act in question is a Duty of Loyalty case and it is shown to be ratified by the Def. Use the Beyer case to determine if it is “Fair” for Interested Insider Transactions acts 60 . the burden goes back to the Plaintiff who then has to prove the act was “Unfair” iii.

This was also an action for breach of fiduciary duty for Waste. Upon being fired Ovitz got about $130 million.” It is defined. • • Issue: Rule: The law presumes that in making a business decision the directors of a corp acted on an informed basis. That presumption can be rebutted if the Plaintiff shows that the directors breached their fiduciary 1) duty of care or 2) of loyalty 3) of acting in bad faith. but ultimately the BJR was used and Disney. Conscious disregard for one’s responsibilities”—this is Recklessness. i.” This is fiduciary conduct motivated by an actual intent to do harm. The most culpable kind of Bad Faith is “Subjective Bad Faith. Bad Faith Continuum: a. and Ovitz all got off. 376) Eisner hired Ovitz as President of Disney. They show the obligation of good faith in two key areas: executive compensation and oversight. This was a derivative suit alleging breach of the duty of care of a fiduciary on the part of 1) Eisner and the Board and 2) Ovitz. but is not “Disloyal. and good faith. The Fid acts with the intent to violate applicable law b. I. This is “Disloyal. If that is shown. Derivative Litigation: (pg. the Board. in accordance w/ his contract.” c. the burden then shifts to the director defendants to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders. This middle-ground is also “Disloyal. in part.” Examples: i. in good faith and in the honest belief that the action taken was in the best interests of the company. This was very costly for Disney to fight. Obligation of Good Faith IV. 61 . In re The Walt Disney Co. The middle ground of Bad Faith is “Intentional dereliction of duty. A Fid intentionally acts with the purpose other than that of advancing he best interests of the corporation • ii.C. Eisner. He was fired a year later b/c the relationship was not working out. Obligation of Good Faith: Obligation of Good Faith: These cases trace the “triad” of care. loyalty. which is the breach of the duty of care. At the other end of the continuum of Bad Faith is Gross Negligence.

The defendant directors and Ovitz moved to dismiss these claims. Notes on “Oversight” pg. Depending upon the circumstances.: (pg. Thus. This is just a case that articulates the argument in favor of the market. Officers too. but should have basic knowledge of how the business works.P. at a minimum. 392) P’s sued. saying the percentages paid to advisors were reasonable if tied to market rates b/c investors would sell the mutual fund and buy a different one if the fees were too high. attend board meetings regularly. Jones v. and routinely review financial statements. in the hiring of top executives. Gross Negligence CANNOT be considered Bad Faith. in negotiating their personal employment matters. because it may serve as a warning to corporate decision-makers that Delaware courts. they argued the mutual funds advisors were being paid too much b/c the determination of the fees was based on “market prices. complaining the fees for the mutual fund in question were too high.” Without more than this. First. 62 .as “A failure to inform one’s self of available material facts. engage in general monitoring of corporate affairs. they must do so in a fair and impartial manner. 395: Directors are not expected to know all details of a company. and possibly other states’ courts. the estimated costs of the compensation package that they are approving. directors must carefully consider the proposed compensation packages of officers and executives before approving them. • Notes: The plaintiffs also alleged that Ovitz breached his duty as an officer and director to the corporation by maximizing his own interest in his employment and termination negotiations at the expense of the corporation. keep informed of the business’s activities. the court concluded that the allegations supported claims for breach of fiduciary duty against the directors because they failed to make any good faith attempt to fulfill their fiduciary obligations in the hiring and termination of Ovitz. Specifically. L. as opposed to regulation. cannot engage in conduct that unfairly benefits them at the company’s expense. and the compensation of similarly situated executives at other firms. This case also makes the point that the market is the best tool to determine reasonable fees and that “reasonableness” imposed by courts and judges would not be better. iii. and (3) engaging in meaningful and critical discussion regarding the proposed terms of the hiring (and retaining a written record of such discussion). may not permit them to hide behind the business judgment rule for failing to act in good faith in carrying out their duties. The case is also important. it offers guidance to corporate managers and executives regarding the boundaries of acceptable corporate behavior in the context of hiring and terminating executive employees. In declining to dismiss the plaintiffs’ claims. ii. Harris Associates. (2) reviewing in advance of approval all agreements pertinent to the hiring. directors should strongly consider: (1) retaining a compensation consultant.” The court disagreed. The Disney case is important for two reasons.

The Caremark decision changed the standard. but there has been little commentary concerning the duty of ongoing review and revision of the program— the case potentially expands the duty of the Board. It is significant in this context that good faith on the part of the Board will be evaluated within the analysis of whether the Board has exercised its duties of care and loyalty. Where directors fail to act (they must knowingly fail to act) in the face of a known duty to act. 63 • . The Chancery Court dismissed the complaint on the basis that. thereby demonstrating a conscious disregard for their responsibilities. not just to implement a compliance program.” The Caremark decision held that the decision as to the elements of a compliance program remains squarely within the business judgment rule. while AmSouth maintained a program to monitor Bank Secrecy Act compliance. • iv. which is “Bad Faith. • Rule: Liability for bad faith is a failure of the Duty of Loyalty and only arises when the Board knowingly fails to act. Prior to Caremark. they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith. 396) The lawsuit alleged that the directors of AmSouth had breached their duty to act in good faith because. the duty of care did not require that they "install and operate a corporate system of espionage" by implementing a corporate compliance program. holding that the Board could not escape liability unless it took some actions to implement a program to detect potential violations of law or corporate policy and exercised a duty of oversight.. directors can only be liable in situations involving a sustained or systematic failure of the board to exercise oversight. Ritter: (pg. This is understood to require that the compliance program incorporate procedures by which the Board can track and analyze compliance problems that surface and take steps to assure that they do not persist. and the Court found that the complaint did not establish the requisite lack of good faith on which to base liability. but to update it. “Caremark Claim”: only a “sustained or systematic failure” of the board to exercise oversight—such as a complete failure to assure a reasonable information and reporting system exists—will establish the lack of good faith necessary to have liability. Allis-Chalmers Manufacturing Co4. raising the question of good faith. 6 eliminating potential liability where the Board has arguably exercised due care. and therefore the Board must satisfy the standards of due care and loyalty. this failure to act is a failure of the Duty of Loyalty. the program was not adequate to prevent the violations giving rise to the fines and civil penalties. Stone v. which established that unless directors had reason to believe there was wrongdoing within the corporation. Failure to do this might render a director liable for losses caused by non-compliance with applicable legal standards. the duty of corporate directors in instances of corporate wrongdoing was defined by the rule announced in Graham v. but may not have reasonably considered all of the risks that should be addressed by the compliance efforts.• Directors must attempt in good faith to ensure that a corporate information and reporting system is in place and is adequate. under Caremark.

Only the duty of care and the duty of loyalty.a. The duty to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duty of care and loyalty. but only indirectly. Procedure requires Shareholders to go the Board unless they can prove that going to the Board would be futile. Notes: this case says the failure to act in good faith is a failure of the duty of loyalty. A failure to act in good faith may result in liability. A duty of loyalty does not only apply to cases involving financial or known fiduciary conflicts of interest. The duty of Loyalty also encompasses cases where the fiduciary fails to act in good faith. Failure to act in good faith results in two doctrinal consequences: i. • Demand Requirement: Derivative actions procedurally require shareholders to go to the company prior to suing them. may directly result in liability. where violated. Shareholders must make a demand of the Board first. 64 . ii.

A contract transaction or scheme where a person invests money (includes options/ both purchaser and seller) In a common enterprise and is led to expect profits by a third party 2. The size of the offering 4. Can’t get out of the fraud aspect 65 . Register To register you must: 1. If it is a security you must: a. The prospectus must be delivered to the purchaser before sale b. II. Or be exempt: 4 factors to determine if the transaction is exempt: 1. Securities may not be sold until the registration statement has become effective 3. May not be offered for sale through the mail or by any other means of interstate commerce unless a registration statement has been filed with the SEC 2. What is a security? “Howey” Test for a security: I.Disclosure & Fairness (things to know) – CH. The manner of the offering c. Number of offrerees and their relationship to each other and the insurer 2. III. 5 1. IV. The number of units offered 3.

Intent or recklessness misrepresentation 3.Materiality standard – An omitted fact is material if there is substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. deceit. Fraud. A Security is: 66 . Cause of harm 5 basis of insider trading liability: 1. or misrepresentation about information in connection with the sale or purchase of a security a. 14e-3 with tender offer 4. 16b1 – smaller group of insiders 5. Information must be material and disclosed to the public and make a material change in the price of the stock Have to show: 1. • • If you can prove this you get reliance element satisfied. Reliance was made based on the misstatement 4. Traditional insider trading (Dirks case) 2. the price of the company’s stock is determined by the available material information regarding the company and its business. Fraud on the market (10b) “the Basic Case”– A market theory that is based on the hypothesis that an opened securities market. mail and wire fraud 10(b)5 case: 5 Elements: 1. Knowledge of misrepresentation 2. Misappropriation (O’Hagan case) 3.

In a common enterprise iii. material fact a. From another person 2. Reliance a. insider a. Access to private business information b. Reliance on the misrepresentation actually causes the harm 67 . If you prove fraud on the market reliance is satisfied c. 4. b. With the expectation of profit iv.i. Whether it would be fair to use it 3. A person invests money ii. Fraud on the market – this says that the availability of material information about a company influences security prices 5. One a reasonable investor would consider in evaluating their conduct with a stock. Cause of the harm a. The person relied on the material fact that was misrepresented b.

but were not legal. 3) Incumbents are reimbursed whether they win or lose 4) Corps may reimburse insurgents.1. Rosenfeld v. so he tries to take over the management by proxy. Fed Securities law requires companies to send out these long proxy statements each year. ii. but only if they win i. ii. • Rule: Incumbent directors may use corporate funds and resources in a proxy solicitation contest if the sums are not excessive and the shareholders are fully informed. Chapter 6: Problems of Control: II. Levin Rule: Incumbents can defend themselves from insurgents and spend Corp money on proxy solicitation if the amounts spent are reasonable. • Issue: In a contest over policy. Levin v. Such a rule protects incumbents from insurgent groups with enough money to take on a proxy fight. Inc. 2) Corp can only reimburse reasonable expenses for proxy solicitors. Fairchild Engine & Airplane Corp. do directors have a right to make reasonable and proper expenditures from the corp treasury for the purpose of persuading the 68 . The new Board also paid $28K to the old Board for the remaining expenses incurred after the proxy contest. who owned only 25 shares. What are those rules? i. How these elections work: To bring an insurgent election you would have to send out your own proxy statement. Over $100k was spent by the old Board in defense of their positions in the proxy contest. There are SEC proxy rules. argued the expenses were reasonable. Metro-Goldwyn-Mayer.: Levin owns 11% of MGM and doesn’t like the current management (O’Brien Group).: Over $200K was paid out of the Corp treasury to reimburse both sides in a proxy contest. The new Board was paid expenses in the proxy contest. III. Proxy Rule and Proxy Fights: Rules: 1) Can’t just be about personnel (must be policy related). Corp Elections: Are expensive b/c of proxy firms and public relations and when it’s done it must be paid for it. The insurgents won in the proxy contest and ousted the old Board. P.

stockholders of the correctness of their position and soliciting their support for policies that the directors believe. the old Board was reimbursed for expenses. Stockholders also have the right to reimburse successful contestants for their reasonable expenses. i. a. If they didn’t have that right incumbent directors wouldn’t be able to defend their positions and corp policies—as such. • 69 . in a contest over policy. Notes: The purpose of § 14(a) is to prevent management or others from obtaining authorization for corporate action through the use or false or misleading proxy information. in all good faith. Fed trial court held the fed stat only allowed for declaratory relief and other remedies would have to be sought under state law. If you paid an insurgent whether they win or lose you would greatly increase the number of proxy fights. Case Co. are in the best interests of the corp. are in the best interests of the corp? • Rule: Yes. • Issue: May a shareholder seek rescission of a merger or damages for a violation of a federal regulation relating to proxy statements where no private right of action is specifically authorized nor private remedies specified? Rule: Yes. a private civil action will be construed and the court is free to fashion an appropriate remedy. directors have a right to make reasonable and proper expenditures from the corp. P sought rescission of the merger and plus damages for himself and other shareholders. whether they win or lose. where a federal securities act has been violated. The WI state stat requires a posting of security expenses of $75K. There HAS to be a policy dispute. treasury for the purpose of persuading the stockholders of the correctness of their position and soliciting their support for policies that the directors believe. § 14(a) prevents management from obtaining illegal proxies. Insurgents only get paid when they win. J. a. v. Borak: P contended that the proxy solicitations that took place prior to a merger were false and misleading in violation of § 14(a). iii. which really means it can be about almost anything except disputes that are purely about personnel shifts. b.I. Incumbents are reimbursed. in all good faith. contending the SEC act authorized a private right of action by implication and that he was not limited to state courts for other than declaratory relief. P refused to pay security and all was dismissed. P appealed. but no private right of action is specifically authorized or prohibited.

2.: Mills brought a derivative suit and class action against the management of Auto-Lite and other companies to set aside a merger obtained through misleading proxy solicitations. Also. a. the Iroquois case (below) expanded this to issues of ethical or social concern Look at §14(a) in the Supplement again—this is a long list of things that you can use to keep a Shareholder proposal out of the proxy (on Page 298) iv. This is partly a result of this case and this trend and also a result of Sarbanes-Oxley. • Rule: Where a trial court makes finding that a proxy solicitation contain a materially false or misleading statement under § 14(a) of the Securities Exchange Act of 1934.” P has to show this omission was “material” meaning it that if the omission had not occurred it would have CHANGED the shareholders’ votes. In the Corp context there are also rules and limitations. § 14 only allows you to bring proposals that are structural/procedural in nature and not substantive (i. Electric Auto-Lite Co. • 70 . In the CA initiative context there are rules to who can bring initiatives. a proposal to link pay to performance for top officers or a proposal to have all votes done on secret ballots). This is governed by § 14(a) in the Sec Exchange Act Rules (Pg. like making very high pleading standards. The Sup Court has started to decrease this amount of litigation by making changes to procedures for bringing litigation. In this case the “lie” was an “omission. a stockholder seeking to establish a cause of action under such finding does not have to further prove that his reliance on the contents of the defects in the proxy solicitation caused him to vote for proposed transactions that later proved unfair to his interests in the corporation. Birdthistle made a comparison to this kind of thing and California’s Direct Democracy initiatives as a way to show that it cripples efficiency. ii. b.e.• This case allows shareholders to attack the corps for whatever. 296) in book. 1.. The final cost ends up being that this ass load of private litigation of shareholders suing corporations eventually drives businesses away. Mills v. i. What are the costs of this? The main cost is that there is an “ass load” of litigation.

this case is about the Board members losing their seats.) Lovenheim wanted to add information in the proxy relating to the cruelty of producing foie gras. P argued his proposal was should not be disallowed based on economics. but allowed b/c it was of ethical or social significance. this is a lot cheaper for the insurgent group. In this case the insurgent group just wants to add info into the existing proxy statement. a shareholder proposal “relates to an election” if it seeks to amend the corporate bylaws to establish a procedure by which certain shareholders are entitled to include in the corporate proxy materials their nominees for the Board of Directors? Previously (in above cases). citing SEC Rule 14a-8(i) (8). or 71 . • • • Fed Proxy Rule Stuff: Accessing Shareholder lists is a doctrinal mess b/c it is controlled by Fed and State law. §14(a)(7): Discusses access to Shareholder lists.v. • Rule: A shareholder proposal can be “significantly related” to the business of a securities issuer for non-economic reasons. including social and ethical reasons. The companies can either: 1) turn over the list. Foie gras made up less than . Birdthistle says corps fight this kind of thing so hard b/c CEO types HATE to be told what to do. Iroquois Brands. Ltd. §14(a)(7) says to get a list of shareholders the person who wants it has to ask the company for the list. vi. which provides that a company may exclude a shareholder proposal “[i]f the proposal relates to an election for membership on the company’s board of directors or analogous governing body. AIG said no. The State law is covered by §220 (Page 144 of Supplement) of the Delaware State Corp Law. an insurgent group would have to create and mail their own proxy statement. and therefore may not be omitted from the issuers proxy statement even if it relates to operations which account for less than 5% of the issuer’s total assets. during proxy battles. This is a Federal Securities Rule. Obviously. Rule § 14(a) of the SEC Securities Exchange Act required D to allow information regarding proposal to the including in the proxy materials. Inc.05% of D’s sales so they cited a rule saying they didn’t have to allow it in the proxy b/c it was less than 5%.: (see § 14 notes just above in Mills. Why did AIG fight this so hard? This is not like the pate question. Also.” • Issue: Whether. under the Rule in question. AFSCME v.: P wanted to add names to the proxy statement of people that it wanted to be able to vote on the Board of Directors. He wanted to propose a study into the cruelty. Lovenheim v. AIG.

72 . Ana refused Crane’s request for the list. Crane had 11% of Ana’s stock.) These are more limiting. This is all Federal. • • • Usually. when given the choice between 1 & 2. where Crane wants to offer to buy Anaconda’s stock from the shareholders) Crane proposed a tender offer of Anaconda’s stock. v. • vii. 2) own a minimum amount. Crane Co. companies will choose 2 (mailing the materials themselves) because they don’t want to give out their list of shareholders. State Proxy Rule Stuff: State laws have similar traits WRT limiting access to shareholder lists. as a matter of public record.: (Tender Offer Case. whereas. These are usually institutional investors. WRT next two cases. 3) have owned the stock for some minimal amount of time. To get a shareholder list you must: 1) be a shareholder. whereas. proxy rules apply to Crane b/c they are trying to take over the company. not just during special circumstances. most public corps must make public anyone who owns 5% or more. etc. state proxy rules apply all the time. claiming Crane’s motives were not for a purpose relating to the business of the corp. and to rebut misleading statements disseminated by Anaconda. Crane requested a copy of Anaconda’s shareholder list for the purpose of informing other shareholders of the tender offer. making them the biggest shareholder. • Generally. Anaconda Co. Why? B/c if they did give out this list then it would be easier for outsiders to try to gain control over the company. and 4) you must “aver” a reason (this entails being deposed by a lawyer) to determine if your purpose is tied to the financial benefit of the company. Legally.2) mailing the materials itself at the shareholders’ expense. during election settings. in Pillsbury proxy rules don’t apply b/c that case is not about taking the company over. the Fed Proxy Rules apply during special circumstances (M & A.

Pillsbury v. a. Notes: The pendency of a tender offer relates to the business of the corp and to the safeguarding of the shareholder’s investment. records. Pillsbury submitted two formal requests for the inspection of Honeywell’s shareholder list and corp. in order for a stockholder to inspect shareholder lists and corp records. • Issue: Whether a stockholder must demonstrate that he is motivated by a proper purpose related to his economic interest in the corporation in order to inspect shareholder lists and records? Rule: Yes. a. Notes: A “proper purpose” is those related to a shareholder’s economic interest in the corporation. a shareholder wishing to make a tender offer should be permitted access to the company’s shareholder list unless it is sought for an objective adverse to the company or its stockholders. Pillsbury bought a sufficient amount of shares to give him a voice in Honeywell’s affairs for the purpose of altering its policies. viii.: After learning of Honeywell’s involvement in the production of bombs for the war in Vietnam. regardless of any economic implications to himself or the corporation. the stockholder must demonstrate a proper purpose relating to an economic interest. Honeywell. Honeywell refused and Pillsbury sued. Pillsbury’s SOLE purpose was in seeking these records was for the furtherance of his personal political views. Inc. • 73 . However A shareholder with legit concerns for the economic implications of Honeywell’s armament production on his investment would have a purpose germane to his investment.• • Issue: Whether a qualified stockholder may inspect the corp’s shareholder list for the purpose of soliciting a tender offer? Rule: Yes. State ex rel. b. In this case.

• But you could be Widely held (by lots of people) but NOT be Publicly traded. • Proprietary Interest: According to the P’s a proprietary interest involves property. may prescribe whatever restrictions or limitations it deems necessary in regard to the issuance of stock. Privately held vs. Class B shares would not get dividends. Class B shares have no rights to dividends and they get nothing in the event of liquidation (bankruptcy). Closely Held: i. Irony: Stroh is arguing that their stock isn’t worth anything. Stroh v. The court says it can simply be a vote. • A lot of subsidiaries of Public corps are these Private and Closely held corps. a. but they can sell the Class B shares. Private is close to Closely held. You might want to do this to avoid the regulation that comes along with being publicly traded. a corp.200 for it. Shareholder Voting Control: i. They won’t be worth much w/out dividend rights or liquidation rights V. a. but the shareholders’ rights to vote are guaranteed and must be in proportion to the number of shares possessed. Shareholders sued claiming that a limitation on their rights at dissolution rendered their shares invalid. The articles also said that in the event of liquidation.IV. Each share was entitled to one vote. provided that it not limit or negate the voting power of any share. a. may proscribe the relative rights of classes of stock. Widely held vs. • • Issue: Whether a corporation may prescribe whatever restrictions or limitations it deems necessary in regard t to the issuance of stock? Rule: Yes. Note: A corp.: Blackhawk’s articles of incorporation provided for the issuance of three million shares of Class A stock and 500. even though they paid over $1. Stroh owns all the Class B shares. 74 . Blackhawk Holding Corp. which they bought from the original promoter. Publicly held corp vs. b. Public is close to Widely held.000 shares of Class B stock.

but later the Board of 7 men voted him out of office. Ben transferred his shares to his wife Emma’s possession as trustee. McQuade v. salaries. Galler: Ben and Isadore (brothers) Galler owned an equal share of stock in Galler Drug Company. There is nothing wrong with a majority (or minority) uniting to make their powers felt. Basically the Court said that the contract in question (to keep McQuade in power) was not legal. The agreement also prohibited the amendment of salaries. The court said that Directors may not by agreements entered as stockholders abrogate their independent judgment. and Stoneham entered into an agreement to make sure all three of them stayed in office. or policies or retaining individuals in office. Galler v. and in contravention of their agreement. Also. salaries. • • Issue: Whether a shareholder agreement that precludes a Board of Directors from changing officers. a. Stoneham: McQuade (P) and McGraw (D) each bought 70 shares of stock in the NY Giants baseball team from Stoneham (D) in exchange for an agreement an agreement to preserve themselves as directors and officers of the company. They entered into a shareholder agreement providing for the support and maintenance of both families. P argues the opposite. a shareholder agreement is illegal if it prohibits the Board from changing Officers. and each of their spouses also as directors. the job of the court in this case is not to protect McQuade from the possibly immoral decision of Stoneham and McGraw to push him out of the company. and remove herself as a director. McQuade was made Treasurer of the corp. Notes: McQuade.” iii. absent express contractual consent of the parties. The courts do not enforce “mere moral obligations. or bylaws of the corp except the unanimous consent of McQuade. The agreement bound the shareholders to elect Isadore and Ben as directors. • Issue: Whether shareholders in a closely held corp may contract in regards to the company’s management? 75 . Isadore sought to have Emma modify the shareholder agreement. and Stoneham. After McQuade was pushed out and the law suit ensued. but this power to unite is limited to the election of directors and is not extended to contracts whereby limitations are placed on the power of directors to manage the business of the corporation by the selection of agents at defined salaries.ii. McGraw. shares. The job of the Court is to protect the shareholders’ investment. the D’s argued that any contract that compels a director to vote to keep a particular person in office and at a stated salary is illegal. McGraw. She refused and initiated suit. an agreement amount directors to continue a man as an officer of a corp is not to be broken as long as the officer remains loyal to the corp. or retaining individuals in office is void and illegal? Rule: Yes. with McGraw and Stoneham abstaining.

since he does not have the option of selling his shares on the open market. and mandatory dividends. so their agreements are often the result of informed decisions—the safeguards that apply to publicly held corps do not apply. and threat of public injury. Notes: The general rule is that majority shareholders in a corp have the right to select its managers.• Rule: Yes. The appellate court had disallowed the agreement in this case b/c of “indefinite duration. Shareholder’s interests in publicly traded corps must be distinguished from those in closely held corps. election of officers. s/h’s in closely held corps are usually also its officers and directors. Also. 76 . a. The s/h in the closely held corp ins in greater need to protect his investment. salary continuation. shareholders in a closely held corp are free to contract regarding the management of the corp absent the presence of an objecting minority.” but the Sup Court of Ill said there was no reason to disallow the agreement based on the durational limits for voting trusts for publicly held corps in the absence of fraud or disadvantage to minority interests.

Wilkes. in a closely held corp. As Springside became profitable each received a weekly stipend. Each was to be a director and each would play an active role in management. the court determined there was no legit business purpose given to justify Wilke’s termination. Selling assets at inadequate prices 6. Each invested equally and received an equal share in Springside Nursing Home. Relations began to strain and one of the original four. This is a “freeze out” case.VI. Abuse of Control: i. Failure to declare dividends to a minority shareholder 5. In this case.” a. Notes: Determination of whether the required good faith standard has been breached is decided on a case-by-case basis. Wilkes v. This case could have been avoided with a “Buy-Sell Provision. where Wilkes losses his salary and his divs. The board then ceased his salary and did not re-elect him as an Officer or Director. the majority s/h’s have a duty to deal with the minority in accordance with a good faith standard.: Four guys got together to start a Nursing Home. S/h’s in closely-held corps are held to a similar standard as is required between partners. • Ways to freeze out in closely held corporations: 1. Not letting minority sell shares at same price as majority 4. the court must balance the legitimacy of the intended purpose against the practicality of the less harmful alternative. Springside Nursing Home. Then the minority may answer that the same objective could be reached through less harmful means. Inc. In reaching a determination. Deny salary and employment 2. The burden is on the majority to show a legit purpose for its decision related to the operation of the business. High salary and bonuses to only a few majority shareholders 77 . announced his intention to sell his shares. nor was there any evidence in the record legitimizing the majority’s action. Pay exorbitant rent 3. • Issue: Whether a minority s/h in a closely held corp may charge majority s/h’s with a breach of fiduciary duty in terminating his employment or ousting from his position as Officer or Director? Rule: Yes.

they simply remained silent when Jordan quit and tendered his stock. Jordan v. P told his employers he would stay until the end of the year in order to get the increased value of his stock. a. Inc. The “Special Facts” doctrine says that 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. It even told Jordan what the book value would be so he could decide to stay longer. it is material and should be disclosed if there is a substantial likelihood that. Close corps have a duty to disclose material facts. Easterbrook: says the absence of a duty to disclose may not justify a lie about a material fact.” Fiduciary duty to disclose in a closely held corp only applies when it meets the “materiality” standard—meaning you only have to disclose if you could have done something about it. P heard the Duff & Phelps was in a pending merger and that the stock he had sold upon resignation would have been worth a lot more money if he had not resigned or sold his stock until after the merger.ii. Closely held companies are special/different because in a closely held corp. the “victim” status goes up as compared to a shareholder of a publicly held company. Notes: Close Corps that purchase their own stock must disclose to the sellers all info that meets the standard of “materiality. After resigning from his job. This is because in a closely held corp there is no market. This assumes a duty to disclose. the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. P refused to cash the check he received when he sold his stock upon resignation. Duff & Phelps. so there is no way out for shareholders when things go wrong. which would fail the “self-dealing” portion of the business judgment rule. as shareholders. i. The course of dealings between Duff and Phelps and Jordan suggest the firm did not demand that employees decide whether to stay or go without regard to the value of the stock. P sued for damages measured by the value his stock would have been under the terms of the acquisition. • • Issue: Whether a close corp buying its own stock back has a fiduciary duty to disclose material facts? Rule: Maybe. The firm did not demand he left once it knew he had switched loyalties—in fact. After resigning. it allowed him to stay to receive max value of his stock. but Duff and Phelps did not lie to Jordan. under all the circs. materiality also means the “importance” of something. This fact proves that Duff and Phelps had not received an express or implied agreement that it could negotiate 78 . This case is just like Wilkes in that in both cases once you fire the person in question the money they lost goes to the other people in the closely held corp.: P bought stock in the closely held corp at book value.

But Easterbrook argues “at will” does not imply an employer may fire someone for any reason.” Easterbrook then says Causation is a question for the jury. an avowedly opportunistic discharge. while the Agreement fixed the price to be paid to those who quit. Posner says that failure to disclose depends of the finding of a duty to disclose. ii. whether written or not. So. So. He says this is because information is very valuable and its production is discouraged if its producer must share it with the whole world. it is still a contractual relation. whereas “misrepresentation” does not depend on the finding of a duty. He says Easterbrook finds this duty in the fiduciary relationship between the closely held corp and the shareholder. And in every contractual relation. it did not establish terms on which anyone would leave. The dissent argues that none of this matters b/c Jordan was an employee at will and could have been fired. saying that the timing of the sale and the materiality of the information of about the merger is for a jury to decide. Posner’s Dissent: Begins by disagreeing with Easterbrook that there was a duty to disclose. so the question is whether. AND that he would have stayed AFTER the first deal fell through to eventually get money in the second deal. Easterbrook’s second point (II) is that even though the initial $50 million merger fell through. Easterbrook sums up. in this instance. and will be hard for Jordan to show b/c he would have to show that if he had known of the merger he would have stayed employed there. He agrees that withholding information is wrongful if there is a duty to disclose. Duff and Phelps made an undertaking (and therefore assumed a duty) to disclose to any stockholding employee who announced his resignation information regarding the prospects of a possible future sale. there is the implied term that neither party will try to take opportunistic advantage of the other. even though it is unwritten. even of an “at will” employee. even if he already knew about a merger. 79 . would be a breach of contract. Duff and Phelps was still probably going to have a high value since the value of an asset is “usually what the second-highest bidder will pay.around the duty to disclose—the closest they came to negotiating around the duty to disclose was the provision in the “Agreement” fixing the price of the stock at book value.

Hanson Holdings: Controlling shareholder sold its shares at a premium price—the premium is for gaining control and in this case it doubled the price. Inc. Notes: P’s are really saying that they want a portion of the premium—they want an equivalent proportion of the premium paid to the previous controlling shareholder. • • Issue: Whether the right of first refusal to buy shares at the offer price should be interpreted narrowly (when is this right of first refusal triggered)? Rule: ROFR should be construed narrowly b/c they bring a third party into the transaction which in some ways short circuits the free-market b/c it circumvents the bidding war. so it gets him in the deal at the same/premium price. then the majority s/h must buy the minority s/h’s shares–this is a called a “Tag Along Right”—and exists so that the minority s/h gets two benefits: 1) he gets the right to get out if he doesn’t want the new management. This circumvents that process. And Jensen-Sundquist Agency owns First Bank of Grantsberg. Birdthistle says this is a simple straightforward case. Zetlin v. • V. and 2) he gets to sell at the premium being offered to the majority. First Wisconsin negotiated to acquire Jensen-Sundquist b/c it wanted the bank. Here the diff between Merger and Acquisition makes all difference in the world. Jensen-Sundquist Agency. Frandsen v. Judge Posner says the ROFR doesn’t apply in this case b/c this is a merger and the ROFR only kicks in for a “sale”—in the terms of this deal First Wisconsin Bank agreed to a merger. The ROFR is a constraint on alienability. without giving a proportional amount of that premium price to the other shareholders. and is a purchaser free to buy that controlling interest at a premium price? Rule: Yes. Transfer of Control in Closely Held Corps: i.VII.: Frandsen has 8% of Jensen-Sundquist and Jensen Sundquist Agency owns 52%. a controlling shareholder is free to sell and a buyer is free to buy a controlling share at a premium price. Notes: Right of First Refusal functions to circumvent a bidding war—b/c usually after someone bids on a company other buyers also show up and a bidding war ensues. This case says that ANYTHING you can get for your shares is yours and you don’t have to share it. Second clause of the ROFR is that if the minority s/h refuses to buy. • • Issue: Is a controlling stockholder free to sell. • ii. Mergers and Acquisitions: 80 . even though they often seem very similar.

Also.” If we make a purchase using stock as currency then we need to get the approval of the acquiring company’s stockholders. as long as the other side is willing to accept it • Stock: To buy a company by issuing stock you first determine how much stock is “authorized”—max # of shares authorized by the s/h. 3) some combination of both. the equivalent value will return and as a matter of econ the new 81 . in an asset acquisition. • Asset Acquisition a. You might be surprised down the road—you might realize you bought something more problematic than you thought. b. Pros of a Stock Acquisition: This gives you the company quickly. Pros of Asset Acquisition: Gives you more choice in what you want to buy. What are you buying when you buy a company?: 1) Stock. What is the difference between buying a company through stock acquisition vs. Asset Purchase: Has occurred when you buy “all or substantially all” of the assets ii. Business Mechanics of M&A: In all of these deals something is being bought and something is being used as currency to buy it. if you leave out the liabilities from your purchase then the price of the acquisition goes up. 2) Assets (& Liabilities). asset acquisition? Buying all the stock is a fast way to acquire. Treasury—the Stock the Corp buys back • Value: If you issue more shares to buy something and you issue just enough stock to buy what you want. but you end up buying the bad stuff along with the good stuff. Currency: What are you using to buy?: 1) Stock. Outstanding—Stock that is owned by stockholders d. Authorized—Max amount authorized by the shareholders b. The amount “authorized” is the biggest number. or 4) you can pay with anything you want. a. 2) Cash. but is less efficient. At what point does buying assets in a company becoming buying the company? i.I. • Stock Acquisition a. Issued—Amount that was authorized which the Board later issued to make money c. But are their usually more shares “issued” or “outstanding.

Also.The state corporation laws allow a short-form merger. but not in the case of acquisitions. However. etc. what does get diluted is the voting rights. Farris v. even though. as a practical matter. For this reason paying appraisal rights sucks. In all states there is an appraisal right for a merger. (The minimal level of concentration is stipulated by state law. s/h of both companies AND the Boards of both companies must agree to a statutory merger. Appraisal Rights: To determine value to pay in appraisal rights you generally have to go to court.e. a. through a wholly owned subsidiary purchases 38. like which company will go away and which one will survive. but there has been no economic dilution—in fact. the value has gone up. Short-Form Merger: If you buy a big enough percentage then you can give money to the remaining s/h’s and force them out. After Glen Alden issued more stock. with each stock issue Bill Gates’ voting rights have been diluted.. b/c if you thought your company was going to increase in value the last thing you’d want to do is to give any of your stock away. Glen Alden was having some financial difficulties. a merger and an acquisition are treated differently as a matter of law. • • Proportion: A and B sit down and negotiate and decide what percentage of stock Appraisal Rights: If s/h of A doesn’t want to own stock in B he gets appraisal rights —also known as Dissenter’s Rights. Merger: § 251(a) of DE Corp Law (Page 153 in Supplement): A “Merger” is an operation of law. so most businesses want to avoid this. the pre-existing s/h’s voting power was diluted. they start in the same place and end in the same place. What is communicated when a company uses a stock issue in order to make purchases? It usually means the company is having problems.) .” in which several things are designated. De Facto Merger Doctrine: i. I. as always. They did it this way to avoid appraisal rights—Penn allows appraisal rights in the case of mergers. A short-form merger is permissible when the following circumstances exist: . A short-form merger is a merger that proceeds without a stockholder approval process. iv. List. This involves a “merger agreement. ii. the majority shareholders and board of directors approve the merger without soliciting the approval of the minority shareholders.5% of 82 .” In this case they use Glen Alden stock to buy List.value will replace and the value of the stock should not go up or down—it should stay exactly the same. which is strange b/c List is about 3x as big as Glen Alden. so they wanted this to be an asset buy or an acquisition. II. Glen Alden Corp (Minnow Swallowing the Whale case): Birdthistle says this is a crazy case that “you’ll be wondering why you studied later. iii. When these conditions exist.Shares of the company are disproportionately concentrated among a small group of shareholders who approve of the merger. In this case GA’s s/h’s went from owning 100% of the stock to less than 25% of the stock.

These factors show that after the merger List Alden was essentially a different company. 5) Directors of both GA and List would become directors of List Alden. 4) GA would change its name to List Alden Corp. List’s members would make up the majority of the Board and the issuance of an additional 3. GA sent a proxy statement recommending approval of the agreement (6 terms above)—a majority of s/h’s voted to approve. and 6) List would be dissolved and List Alden would carry on the operations of both corps. Notes: When a corp combines with another so as to lose its “essential nature” and alter the “original fundamental relationships” of the s/h’s to themselves and to the corp. GA would issue 3.. 3) GA would assume all of List’s liabilities including a $5 million note incurred by List in order to purchase GA stock the previous year. In this case the resulting amalgamation would change GA from a primarily coal mining company to a diversified holding company with interests in motion pictures and textiles. and 3) it did not contain copies of the text of certain sections of the Bus Corp Law as required. To not allow appraisal would mean the P’s stock value would go from $38/share to $21/share after the merger. which would then distribute the stock to List’s s/h’s. A minority s/h (Farris-P) of GA filed a complaint in equity to enjoin the agreement. but to the practical effect.6 million shares of stock to List.6 million shares would have reduced the P’s proportionate interest to only two-fifths of its pre-merger amount. This acquisition of stock allowed List to place 3 people on GA’s board. • • 83 . The gravamen of the complaint was that the notice of the annual s/h’s meeting did not conform to the requirements of the Bus Corp Law in three respects: 1) it did not inform s/h’s that the true intent of the meeting was to effect a merger. The new company doubled in size and increased its long-term debt sevenfold. • Issue: Whether this is a “merger” or a “sale of assets. to determine if a transaction is a de facto merger or only a sale of assets a court must look NOT to the formalities of the agreement.” subject to s/h approval which contemplated the following actions: 1) GA would acquire all of the List assets--$8 million on cash held chiefly in the treasuries of List’s subsidiaries. Plus. 2) it failed to tell s/h’s of their right to dissent to the merger and claim fair value of their shares. a s/h is entitled to the appraisal value of his stock.” and whether “reorganization agreements. require conformance by the corporations to the merger statutes? Rule: Yes. 2) for consideration.” which are de facto mergers. A “reorganization” is a merger if it so fundamentally changes the corp character of the company that to refuse the right of appraisal (selling of his stock back to the corp) would in reality force the owner of stock to give up stock in one company and buy it in another.Glen Alden’s outstanding stock. A transaction which is in the form of a sale of corp assets but which is in effect a de facto merger of two corps must meet the stat merger requirements in order to protect the right of minority s/h’s. 5 months later the two companies entered a “reorganization agreement.

its liabilities are assumed by the survivor. i. Then you have to get the other side in the contract to sign something that says they “waive the contract. You can designate the survivor to be either A. 2) Arco agrees to call a s/h meeting for the purpose of approving the plan and the voluntary dissolution. the other side in the contract will consider this a great bargaining tool and they will often try to get more money. The second ground was abandoned. i. one corp dissolves. Hariton v. Acquisitions Notes: In both cases you start with 2 companies and end with one. one of the key questions is which company will allow them to operate with the most flexibility WRT any outstanding contracts. as consideration for the transfer its sh’s acquire a majority of the shares of stock of the survivor. iii.” Frequently. but it also maintains the distinction between mergers and sales of assets. its execs and directors take over the management and control of the survivor. More Mergers vs. or some hybrid with a new name that you create. Arco Electronics. and. It will designate which company is going to go away and which one is going to remain—often based on name recognition. as part of a purchase of assets. When two companies merge and create some new company. a sale of assets involving dissolution of the selling corp and distribution of the shares to its s/h’s is legal. Merger vs. The plaintiff loses here and the court says this is NOT a merger. but a sale of assets.000 shares. and 3) Arco agrees to distribute the Loral shares to its s/h’s. Inc.” To execute a merger you have to have: • A Merger Agreement: What goes in it? a. Notes: This case is like Wilkes. b. • • • Issue: Whether a sale of assets that results in a de facto merger is legal? Rule: Yes. P argues it is illegal b/c the steps taken are the same as if Arco were merged into Loral. How do we decide who gets the stock in the new company? These decisions are made by the Boards of the two companies and the s/h’s just 84 . or B. Minority s/h (one of remaining 20%) sued based on: 1) the Plan was illegal. III. At the meeting 80% of the Arco s/h’s approved the Plan. Purchase of Assets: A purchase of assets becomes a “merger” when.: Three provisions of the plan: 1) Arco agrees to sell all its assets to Loral and Loral agrees to give Arco 283. Mergers: Merging is a legislative provision b/c the legislature has said if you do certain things you will be “merged.a. and 2) it was unfair.

so you don’t even need to talk to the Board. i.) Would you rather deal with the Board or the s/h’s? Economically. The solution to this is the Short Form Merger. Acquisitions (also called a “Practical Merger”): In a Merger the Target and Acquirer are determined by agreement of the Boards on the Merger Agreement. b/c if the Board starts trying to extract too high a price you can stop dealing with them and deal directly with the s/h’s instead. If things do go wrong the Acquirer just sells of the Subsidiary. • Stock Acquisition: You buy the stock from the s/h’s. the first thing that happens is the Acquirer goes to the Board of the Target. the designation of the Acquirer and Target is sometimes driven by who came up with the idea first. The assets and liabilities that flow to the Acquirer almost always flow into a subsidiary so they can separate the liabilities in case something goes wrong. or who “wants” it more. which says (DE Corp Law) that once you have acquired 85 . ii. but what should really make that determination is which arrangement will make more money—see Glen Alden Corp. or they can wind-down. in which we pay with cash. then it must be worth more. Problems of dealing with s/h’s: 1) they might say that if you are offering me that price. Cash—In an asset acquisition. it pays its remaining liabilities (if any). b.have to approve the end result—percentage of stock and who gets what positions (the previously two CEOs have to decide who will now have the sole remaining CEO job) in the new company is largely based on the bargaining. What can the Target do with all that cash? They can do anything their charter allows—they can go back into their previous business (if allowed by the agreement). 2) there is an emotional side or stubborn side or side where people simply don’t open their mail. Two kinds of Acquisitions: • Asset Acquisition: Entire company is bought with either Cash or Stock a. which all might work to make it hard to deal with s/h’s. (You don’t just want to buy up a company’s stock piece by piece b/c by buying stock you raise the price. case above. To wind-down. the company will buy their certificates with that final payment of dividends. In an Acquisition. you just enter a Tender Offer. it is the same b/c the price is theoretically the same. plus you’d be paying for each transactions cost. and then disburses its cash to s/h’s via dividends. or. Typically. This way if something does go wrong it would take down the Acquirer with it. Stock—The Acquirer sends the Target the Stock in the form of a Dividend (Dividend can be paid in either cash or stock) and the Target sends the assets and liabilities. ii. or they can buy some other company. Cash goes to the Target and Assets then go to the Acquirer.

GE wanted control of RCA’s assets. • • Issue: Whether a freeze-out merger approved w/out full disclosure of share value is valid? Rule: No. So. When important info is withheld from s/h’s their consent to a merger cannot be informed. who had voted against the sale. filed an action seeking to enjoin the merger. which means the sale was not fair. • • • V. For a freeze-out merger to be valid it must be fair. Weinberger v. Introduction: P’s are saying the company is doing one thing. Notes: In this case a report existed that showed that a share price of $24 would be beneficial to Signal. i. To be fair two conditions must be met: 1) S/h’s must be informed of all relevant factors prior to the vote. and 2) the price given must be fair. after paying them something. Inc. UOP. which resulted in a forced sale of all shares. Signal decided to acquire all of UOP. Freeze-Out Merger: Merger whereby the majority shareholder forces minority shareholders into the sale of their securities. Stock IV. paying $21/share. Later. usually FMV. RCA Corp. but I want them to be forced to do another. A freeze-out merger approved w/out full disclosure of share value to minority shareholders is invalid. Signal then announced to the minority s/h’s that it was offering $21/share to acquire all shares of UOP. which means it was void. At the annual s/h meeting of UOP a majority of the minority s/h’s approved the sale. so instead of a merger GE could have affected a stock or cash asset acquisition.90% of the stock. Cash b.: Originally. A report was generated by two directors of both corps which concluded that a share price of $24 would be a beneficial deal for Signal. In this case/jurisdiction the burden to show unfairness was on the plaintiff and the others challenging the transaction. material information was withheld. De Facto Non-Merger.: (Case is like Sinclair) Signal Company bought a majority interest in UOP through market purchases and a tender offer. And the preferred s/h’s in question are saying if this were structured as an asset buy with redemption instead of a merger they would have gotten $100/share instead of $40/share. a. you get to make the decision to boot-out the rest of the shareholders. Rauch v. Analysis: The burden of proof can often determine the winner in these cases. Freeze Outs: i. When does a “redemption” actually 86 . Had the minority s/h’s known this they might not have voted to approve the $21 cash out. Weinberger (P). but the burden to show the vote had been done with full disclosure was on the defendant (Signal Corp).

if that is true. SO. It has long been DE law that when a corp decides to reorganize any consequences of that reorganization are not invalidated by the mere fact that a similar result could have been reached by a different type of reorganization that would have been advantageous to a particular s/h. In this case they still had to get the approval of the s/h’s b/c they all still have a vote. In fact. • • Issue: Whether the cash-out merger that is otherwise legal triggers any right the s/hs may have with respect to share redemption? Rule: No. along with redemption of preferred shares. was to be paid at $100/share. in a practical merger. the Board members are 87 . Often. Takeovers Introduction: To acquire you can go to either the s/h’s or the Board.occur—under what circumstances would the preferred have been “redeemed. Whereas. Plaintiff in this case is trying to argue that the merger that took place was in fact a de facto non-merger that was actually a sale of assets that should have included a “redemption” of stock. Typically. a valid cash-out merger does not trigger any rights a s/h may have WRT redemption. The $100 was a fantasy # that was never going to happen anyway. then RCA would have a lot of cash on hands which they would then give out to s/h’s in exchange for the stock. if GE had paid cash to RCA for assets. you would want to deal with the Board if the Board members are also the s/h’s. there were a lot more common s/h’s than preferred s/h’s. I. mergers are governed by certain laws and redemptions are covered by others—they are considered equal WRT validity. they approval of both the common and preferred s/h’s. you need approval of both groups for any fundamental transactions—so. which helps the court come to the conclusion they reach. as in most cases. $40 is the number that is the result of the business realities. Is there a premium when you deal with the Board? Yes. when you deal with the Board you are usually talking about a Merger or an Asset purchase. when you deal with the Board it is a “friendly” takeover and when you deal with s/h’s is it usually a “hostile” offer that involves a tender offer. ALSO. This would have led to the same result. merged RCA corp with itself. a majority s/h in RCA corp. Notes: This merger could have been accomplished by a sale of assets of RCA. then why would the preferred have agreed to $40 instead of $100? Answer: they agreed to $40 b/c it is a fair amount AND if they don’t agree then they deal won’t go through and the preferred will get nothing. Rauch argued that the articles of incorporation stated that his class of stock. Rauch was a minority s/h of a class of stock valued at $40/share.” One way would be if the company had too much cash and wanted to give it out to s/h’s. BUT. When you deal with the s/h’s it is a takeover and it usually involves buying shares. Redemption: The repurchase of a security by the issuing corp according to the terms specified in the security agreement specifying the procedures for the repurchase. • • VI. But in this case. GE. if redeemed. For instance. In a takeover there is almost always a premium. Under DE law. So. but redemption rights would have been triggered. redemption is typically part of the process. Rauch argued the merger had the same effect as a redemption.

*To elect someone to a new seat on a Board of Directors you have a proxy fight and you simply need more yea votes than nay votes. and those are the guys that are constantly bringing derivative suits. Cheff v. the directors will not be penalized for an honest mistake of judgment. the second it costs a penny more to deal with the Board than to do a tender offer you switch to a tender offer. Whenever there is an issue of self-dealing we: 1) first have to shift the burden to the P’s. but they are willing to buy him out b/c he is a minority shareholder. president of Motors Inc.almost always fired after these deals. This means that there is always an element of selfdealing when dealing with the Board. Eventually. approached the other Board members about fending off the acquisition. if the judgment appeared reasonable at the time it was made. where the Rule was that the main purpose of a corp is to make money for the s/h’s. Birdthistle says this flies in the face of the Ford v. A board can use greenmail or any other takeover defense measure to get rid of a raider as long as they have a legitimate business objective. You start with the Board b/c there are less transaction costs and it is often more certain than doing a tender offer. a. He had a history of looting companies. but they also almost always get severance packages. but. even at the expense of the s/h’s. when FMV is about $14.. began buying shares. Birdthistle says this is the equivalent of bribe. • Issue: Whether the defendants satisfied the burden of proof showing reasonable grounds to believe a danger to corp policy and effectiveness existed by the presence of the Maremount stock ownership? Rule: Directors satisfy their burden of proof that they were not simply self-dealing by showing good faith and reasonable investigation. Once the burden is shifted and the P’s have met the burden by demonstrating a legitimate business purpose. Greenmail or greenmailing is the practice of purchasing enough shares in a firm to threaten a takeover and thereby forcing the target firm to buy those shares back at a premium in order to suspend the takeover. so Cheff. • • • 88 . brought this derivative action contending the Board had effected the sale from Maremount using corp money solely to preserve their positions. This case privileges continuity and stability over liquidation. He then bought a bunch of shares and demanded a seat on the Board. a minority s/h. They pay him a premium of $20. 2) then BJR applies. President of Holland. i. Mathes: Most of Holland Furnace company’s shares were held by family members. Why do these people usually get severance packages? Answer: you give them a severance if the price of the severance is less than the cost of the tender offer. Maremount. Notes: The real reason why the Board wants to get rid of Maremount is b/c they don’t want to lose their jobs. Mathes. the Board decided to buy-out Maremout by purchasing its own shares back from Maremount. Dodge case.

Unocal was faced w/ a hostile takeover in the form of a tender offer in a “two tier” structure such that the s/h’s who first tendered their stock got a greater value than those who tendered later. Mesa sought to have Unocal’s offer enjoined. • • • Issue: Is a selective tender offer to thwart a takeover invalid? Rule: No. Therefore. directors must continue to put the needs of the s/h’s first. big investment companies pay investment bankers to give them this information. the Board must show they did it for a legit business reason. Mesa was specifically excluded from the offer. the conclusion that such a threat existed must have been made after reasonable investigation and in good faith. All these rules make it harder for acquirers (by adding costs) and easier for incumbents • Anyone who gets 5% of another corp has to ID themselves to the world. Development: i. Also. How do they do that? They have to file with the SEC. Unocal Corp. a selective offer to thwart a takeover is not invalid. the severity of the tactic must be reasonable in relation to the perceived threat. Unocal’s defense to this takeover was to issue an exchange offer for its own stock at an amount higher than what Mesa offered. a.: New Law: You can launch a defensive measure. Notes: The usual deference given to decisions of the Board under BJR is somewhat circumscribed b/c Directors in such situations are dealing with an inherent conflict of interest—due to the threat to their survival. Mesa Petroleum Co. acts of the directors to thwart takeovers must first be shown to have been done b/c the takeover represented a danger to corp policy and effectiveness. Four rules governing Tender Offers. In spite of this.” Two Pronged Test: • 89 . but reversed on appeal. This prevents s/h’s from making slow. Rule for Tender Offers: Are governed by Federal laws. creeping tender offers b/c once they have 5% they have to declare their intentions with the SEC.ii. Who is reading this stuff? Analysts that watch companies. Often. but it must be proportional to the threat perceived. Also. which was granted by the Chancery Court. v. • • Anyone making a tender offer has to make several filings with the SEC If the acquirer raises its price during the tender offer you have to give them new price to everyone who has already tendered—you can’t low-ball the first s/h’s that sell The acquirer has to keep the offer open for at least 20 days • II. In this case Unocal was facing a coercive takeover by a reputed “Greenmailer. Also.

Rule: Yes. Rev used a defensive strategy whereby s/h’s exchanges their shares for bonds. Poison Pill: Also called a “Shareholder’s Rights Plan”: is a term referring to any strategy. v. Long term corp interests are no longer considered. Notes: This case gave rise to “The Revlon Rule. a. d. Inc. This form of poison pill is sometimes called a shareholder rights plan because it provides shareholders (other than the bidder) with rights to buy more stock in the event of a control acquisition. Issue: Whether lockups and other defensive measures are permitted when their adoption is untainted by director interest or other breaches of fiduciary duty? b. P made a series of everincreasing tender offers. This dilutes the percentage of the target owned by the bidder. to increase the likelihood of negative results over positive ones for a party that attempts any kind of takeover.25/share. Revlon. The amount of force we use in our own test must be proportional ii. There is a point when a company is inevitably going to be sold. c. usually common stock or preferred stock. and makes it more expensive to acquire control of the target. This is usually when a second bidder gets involved. Pantry filed an action seeking to enjoin the agreement between Rev and Forstmann.” which holds that when it is clear that a target is going to be sold. generally in business or politics. The Board then announced a “white knight” buyout by Forstmann at $57.a. The new rights typically allow holders (other than a bidder) to convert the right into a large number of common shares if anyone acquires more than a set amount of the target's stock (typically 15%). The target company issues rights to existing shareholders to acquire a large number of new securities. Identify the takeover person and expressly state the threat that person poses b. Part of that deal was a lockup provision of a division of Rev that would have made any acquisition of unprofitable. Pantry offered to buy for $45/share and Rev’s Board rejected the offer. lockups and other defensive measures are permitted where their adoption is untainted by director interests or other breaches of fiduciary duty. 90 . Once it becomes inevitable that a company is going to be bought the main duty of the Board becomes the duty to sell the company for the highest price possible.: • Revlon became the object of interest of potential buyer Pantry Pride. Mac Andrews & Forbes. The Chancery Court so ordered and it was affirmed on appeal. Inc. the directors become little more than auctioneers. which the Board opposed. e.

f. but if it is public then the management will take it private. which when operating in concert are coercive and preclusive. The particular nature of the MBO lies in the position of the buyers as managers of the company. NCS Healthcare. Omnicare. on the basis that the management know more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company. Management buyouts are similar in all major legal aspects to any other acquisition of a company. a lockup agreement is required by an acquirer before making a bid and facilitates negotiation progress.: • Rule: Lock-up deal protection devices. are invalid and unenforceable in the absence of a fiduciary out clause. v. The major or controlling shareholder is then effectively "locked-up" and is not free to sell the stocks to a party other than the designated party (potential buyer). the due diligence process is likely to be limited as the buyers already have full knowledge of the company available to them. iii. 91 . The seller is also unlikely to give any but the most basic warranties to the management. Typically. In many cases the company will already be a private company. Inc. g. In particular. and the practical consequences that follow from that. Lock-ups can be “soft” (shareholder permitted to terminate if superior offer comes along) or “hard” (unconditional). Inc. Lock-up provision is a term used in corporate finance which refers to the option granted by a seller to a buyer to purchase a target company’s stock as a prelude to a takeover.