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Major Themes..................................................................................................................................1 Fiduciary Duties ..............................................................................................................................1 Agency.............................................................................................................................................7 Partnership.....................................................................................................................................13 Corporation Basics.........................................................................................................................16 Disclosure......................................................................................................................................22 Insider Trading...............................................................................................................................24 Proxy Fights...................................................................................................................................29 Control Issues................................................................................................................................32 Mergers & Takeovers....................................................................................................................36

1. 2. 3. 4. 5. Fiduciary Duties Risk & Control Default rules; ability to contract around many rules Relationship of agency and partnership law to corporate law. Various types of business associations (partnerships vs. corporations), determined by various control, tax, liability factors. 6. Theory of law vs. Practice of law 7. Intractable problems (e.g. alcoholic partners)

1. Definition a. Vague and broad golden-rule-like duties requiring a party to exercise fairness, honesty, loyalty and good faith in dealings with another. i. Default rules modifiable through contract ii. Arise in a variety of contexts, including agency and partnership relations iii. Persist to some extent after termination of relationship that gave rise to the duties, so that the fiduciary cannot use previous position to advantage themselves unfairly against former relations 2. Purpose a. Serve as default presumed intentions of fiduciaries and the objects of their duties in certain areas where no express agreement exists b. Encourage fiduciaries to devote energy to objects of their duties 3. Business Judgment Rule (BJR) a. Definition: Courts will not reverse or hold companies (or corporate actors) liable for business decisions, except when the business decision involved: i. Gross negligence (i.e. violation of the duty of care) 1. Main protection BJR offers is protection from ordinary negligence, which would be the standard under traditional agency law. ii. Conflict of interest (i.e. violation of the duty of loyalty) 1

iii. Fraud iv. Illegality v. Waste: A decision so bad as to be wasteful (very rare to find) b. Purpose: Exists because of the relationship between profit and risk: since profit and risk correlate, risky business decisions are presumed acceptable. Without BJR, such risks would be discouraged by potential for liability because it is easy ex post but not ex ante to determine what were good and bad risks (i.e. courts are bad at evaluating risk/return calculus that directors and managers face). c. Example Kamin - whether or not to declare a dividend or make a distribution is exclusively a matter of business judgment for the board of directors, and thus the courts will not interfere with their decision as long as it is made in good faith. 4. Duty of Care a. Definition: Exercise the level of care that an ordinarily prudent and diligent person would in the same circumstances. i. This is agency law, and theoretically applies to corporate directors (agents of the corporation), but the BJR shields most business actions of directors (though not agents in other situations), even when they do not meet this avowed standard of care. ii. Usually becomes a grossly negligent standard with business decisions b. Main violations: i. Physical Damage to Third Party or Employer: If a principal is liable to a third party through respondeat superior for torts negligently caused by an agent, the principal can recover the damages from the agent. Principal can similarly recover if physically injured by agents negligence. 1. Usually covered by insurance, and thus a non-issue 2. Although available in theory, little used in practice because of the seeming unjustness of recovering from low level employees (though it is perhaps a different story for high officers + directors). ii. Grossly Negligent Business Decisions: Can recover for damages caused by grossly negligent business decisionsotherwise protected by BJR. (Bane) 1. Directors usually have liability insurance, so the incentives to act properly created by the duty of care are uncertain. c. Duty-Bearers: i. Agents: Liable to principal for injuries caused by negligence or business damages caused by gross negligence, recklessness, intentional misconduct, or knowing violation of the law. ii. Partners: Liable to other partners for damages arising from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. (RUPA 404(c)) iii. Directors: directors owed that degree of care that a businessman of ordinary prudence would exercise in the management of his own affairs. (Francis) violation makes director personally liable money damages to the corp. Objective standard lack of education no excuse 1. Recipients of Director Duties: a. Shareholders



4. 5. 6.


b. Corporations c. Creditors (only if corporation is a bank/trust holding money for others, or is insolvent) (Francis) d. NOT employees Knowledge About Corporation/Business: a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged. (Francis) Keep Informed: Directors are under a continuing obligation to keep informed about the activities of the corporation. (Francis) a. Francis: Being an alcoholic is no excuse. Should have resigned or hired attorney if not going to keep informed. Cannot Ignore Corporate Misconduct: Directors may not shut their eyes to corporate misconduct. (Francis) General Monitoring: Directorial management [requires] a general monitoring of corporate affairs and policies. (Francis) Regular Review of Finances: Directors should maintain familiarity with the financial status of the corporation by a regular review of financial statements. (Francis) In good faith, directors can usually rely on reports from independent public accountants, CPAs, or the corporations president or CFO (Francis) (subject to Caremark/Stone). Can lead to contingent duties: a. Duty to Inquire Further: The review of financial statements . . . may give rise to a duty to inquire further into matters revealed by those statements. (Francis) b. Duty to Object to Illegalities or Resign: Upon discovery of an illegal course of action, a director has a duty to object and, if the corporation does not correct the conduct, to resign. (Francis) c. Duty to Seek Advice of Counsel: Sometimes a director may be required to seek the advice of counsel. (Francis) d. Prevent Illegalities by Co-Directors: A director may have a duty to take reasonable means to prevent illegal conduct by co-directors; in any appropriate case, this may include threat of suit. (Francis) Certify Corporate Information & Reporting System: Director needs to make good faith effort to assure some sort of adequate corporate information and reporting system is in place (Caremark; Stone) a. Director liable if (Caremark; Stone): i. Utterly failed to implement any reporting or information system or controls; or ii. Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being

informed of risks or problems requiring their attention. b. Partly because of the advent of criminal liability for directors, Caremark requires duty even without suspicion, which replaced the old law: i. Allis-Chalmers Rule (Old Law): absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists. 8. Bank Director Duties: The obligations of directors of banks involve some additional consideration because of their relationship to the public generally and depositors in particular. (Francis n.1) a. Reinsurance company functions like a bank, and thus incurs extra bank duties. (Francis) iv. Officers: Owe a similar duty of care to the corporation as the directors (indeed, because they have more intimate knowledge, their standard of care may be even higher than that of directors). v. Shareholders: In closely held corporations, may bear the duties of directors. 5. Duty of Loyalty a. Definition: Fiduciary duty to promote the interest of the party to whom the duty is owed without regard for personal gain. This great rule of law is designed to avoid the possibility of fraud and to avoid the temptation of self-interest. (Bayer v. Beran). Main violations: i. Self-Dealing (Conflict of Interest): A situation where one takes an action in an official capacity that involves dealing with oneself in a private capacity and that confers a benefit on oneself (i.e. the party is on both sides of the transaction). 1. Not protected by the BJR subject to an inherent fairness test: BoP on defendant to show its transactions were objectively fair (Sinclair) ii. Taking Opportunities: Fiduciaries cannot appropriate opportunities to themselves that arise from their fiduciary position, especially when such opportunities are usually shared. Must disclose to relevant parties and give chance to participate. 1. Corporate Opportunity Doctrine: 3 Typical Examples a. Opportunity in same line of business: lawyer at law firm hears about a case cant take on his own. i. Applied to officers, not directors. ii. Ebay was in the biz of investing in securities b. Hear about it in corporate role: Executive hears about opportunity in role as executive. Must give the corporation first dibs. i. Ebay - unique, below-market price investment opportunities were offered by Goldman as financial

inducements to maintain and secure corporate Ebay business c. Use corporate resources: Opportunity becomes available to you by use of corporate resources (e.g. discover something while working in corps lab). Corporation gets rights. 2. Insider Trading: Seemingly a variant of taking opportunities, directors and officers are not allowed to engage in insider trading because of statutory and regulatory restrictions (10b-5, 16b) that build on already existent fiduciary duties of trust and loyalty. iii. Competition with corp/partnership b. Duty-Bearers: i. Agents: Liable to principal for any profits made from cheating principal or made secretly as result of agent position (taking principal opportunities) 1. Reading: Court finds agent liable to principal for secret profits made by using his position as a servant even though agent was acting outside scope of employment and thus not in a fiduciary relationship with principal. 2. Secret profit liability is premised on breach of fiduciary duty rather than tort notion of making principal whole, thus the secret profits are owed to principal even if principal would not have made those profits himself. 3. Ebay officers under duty to account for profits obtained personally since Goldman offered as inducement/gratitude for Ebay business. ii. Partners: owe to one another, while the enterprise continues, the duty of the finest loyalty (Meinhard). The essence of a breach of fiduciary duty between partners is that one partner has advantaged himself at the expense of the firm. (Day) 1. Partnership Opportunities: Have duty to disclose any benefit derived from being a partner or using partnership property (Meinhard). They also have duty to concede chance to participate (Meinhard). Thus, partners have right of first refusal to partnership-created opportunities (RUPA 404(b)(1)). a. Duty to Truthfully Disclose: A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner (Meehan denied plans to leave law firm on 3 occasions) 2. Not Act Against Partnership Interest: Cannot conduct partnership business on behalf of party with adverse interest to the partnership (RUPA 404(b)(2)) a. Cannot act for purely private gain (Meehan) b. Cannot without the consent of the other partners, acquire for himself a partnership asset, nor may he divert to his own use a partnership opportunity (Day) 3. Non-Compete: Cannot compete with partnership in the conduct of its business before it dissolves (RUPA 404(b)(3))

a. Cannot use their position of trust and confidence to the disadvantage of [the partnership] (Meehan - only provided firm with the list of clients they sent letters to after a majority had agreed to leave.) b. Planning to compete (e.g. making leases, obtaining financing) is acceptable (Meehan) c. Courts differ as to whether it is acceptable to solicit clients while still in partnership (Town & Country not ok; Meehan ok if you provide them with full info - choice to leave or stay) 4. Higher Duty for Managing Partners?: Salmon had put himself in a position in which thought of self was to be renounced, however hard the abnegation. . . . He was a managing coadventurer. . . . for those like him, the rule of undivided loyalty is relentless and supreme. (Meinhard) a. Ramseyer: makes sense to have this duty for hired hand partners who are brought in solely to advance partnership, but it does not make sense for financiers brought in solely to provide money but who do not otherwise tend to affairs or management of partnership (i.e. Meinhard). Thus Cardozos rule seems to go a bit overboard in its sweeping nature. 5. Can contract around fiduciary duties (Lawlis) a. Day - Partnership agreements vesting decision-making control in executive committee doesnt violate fiduciary duties iii. Directors: 1. Self-Dealing: BJR does not protect business decisions by directors where a director was acting with a conflict of interest. These transactions are voidable if not ratified. a. Subject to an intrinsic fairness test: BoP on defendant to show its transactions were objectively fair (Sinclair; Bayer) b. Shareholder (or director) Ratification: Shareholder ratification (by majority vote of fully informed independent shareholders (or directors)Fliegler) can absolve disclosed self-dealing decisions. (Bayer v. Beran). Ratification shifts the burden of proof to an objective shareholder to demonstrate that the terms are so unequal as to amount to waste. (Fliegler) c. Standards and Burdens of Proof: Contracts enforceable if it is (1) ratified after full disclosure; OR (2) intrinsically fair. Conflict of Interest Ratification Burden of Proof Standard No Plaintiff Waste Yes No Defendant Intrinsic Fairness (Fair & Reasonable) Yes Yes Plaintiff Waste

2. Corporate Opportunity: Director cannot take for herself a business opportunity that properly belongs to the corporation without disclosing to the corporation and giving it the right of first refusal (Fliegler; Ebay) 3. Insider Trading: Having a fiduciary duty gives rise under 10b-5 to duty to abstain from trading on material nonpublic information or disclose it, otherwise insider will be making secret profits (Cady; Dirks). See Insider Trading below. iv. Officers: Have similar duty of loyalty as directors (Ebay) and, in regards to leaving a company, a similar duty of loyalty as partners. v. Controlling Shareholders: Shareholders normally have no fiduciary duties. However, controlling shareholders have fiduciary duties to minority shareholders (Zahn), and violate this duty if they dominate the board and have it act in their interest at the expense of the minority shareholders or if they vote in shareholder meetings contrary to interests of minority owners. 1. Sinclair: Parent is controlling shareholder of subsidiary. Transaction between parent and subsidiary corp, with the parent controlling the transaction and fixing the terms (self-dealing) test = intrinsic fairness, BoP on parent (controlling shareholder). 2. Closely Held Corporations (Wilkes): Shareholders of closely held corporations have fiduciary duties to each other equivalent to those of partners. Majority owes minority duties, and minority owes majority the same duties (Smith). 3. Dividends: Dividends cannot involve self-dealing unless there are multiple classes of stock, one of which is entirely controlled by controlling shareholders who dividend only to themselves at the expense of minority shareholders of other classes of stock. 4. Insider Trading: Controlling shareholders, because they have fiduciary duties to their minority shareholders, have affirmative abstain or disclose duties under 10b-5. See Insider Trading. 5. Tender Offer Control Premiums: Generally control premiums need not be shared with minority, but some courts have held that they must if its the result of looting the company (Perlman)

1. Definition a. Fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principals behalf and subject to the principals control, and the agent . . . consents so to act. (R3) vi. Agency always contemplates 3 parties: principal, agent, and 3rd party with whom the agent is to deal. 2. Rationale

a. Contract: Increase principals ability to engage in transactions: The very purpose of delegated authority is to avoid constant recourse by third persons to the principal . . . . Once a third person has assured himself widely of the character of the agents mandate, the very purpose of the relation demands the possibility of the principals being bound through the agents minor deviations. (Kidd) b. Tort: i. Incentivize principals to structure contracts with agents to set standard of care at optimal risk levels for tort purposes 1. But, in practice, employees are often judgment proof and thus need not abide by high standards of care, which means that employers must exercise greater supervision. ii. Loss spreading to non-judgment proof parties (Bushey) iii. Hold businesses accountable for dangerous practices 3. Elements a. Agent and Principal agree b. Principal controls Agent i. What matters is whether agent agreed to be controlled, not whether agent was actually controlled (Cargill; McDonalds n.3). ii. Lender (creditor) liability creditor who takes enough control of debtors business may be held liable as principal (Cargill), but most courts do not impose it (Martin v. Peyton even with a lot of control and sharing profits, not enough to be considered partners). iii. The amount/type of control the principal exercises determines whether agent is servant or independent contractor agent 1. Does the principal have control over just the results (IC) or also over exactly how the agent goes about doing the work (servant)? c. Agent acts on behalf of Principal with power to affect Principals legal rights and duties i. Agency liability occasionally found when not all elements are met (e.g. Gordon v. Doty, where purported principal had insurance, both 2nd and 3rd elements absent). ii. Parties cannot technically contract to avoid an agency relationship if in fact these three elements are satisfied (Holiday Inns) 4. Legal Ramifications a. Makes principal liable for contracts executed by agent b. May make principal liable for torts committed by agent (master/servant) c. Agent owes fiduciary duties of care and loyalty to principal 5. Types of Agency Relationships a. Principal & Agent i. Also Sub-agent (But NOT agents agent) 1. Subagent is someone authorized by the principal to be hired; agents agent is not authorized. Usually no implied authority to hire subagent where job involves discretion (Millstreet Church v. Hogan) see actual implied authority below b. Master & Servant

i. Servant agrees to be subject to masters control over his physical conduct in how he performs his duties. c. Employer & Agent-Type Independent Contractor i. Contractor who agrees to work on behalf of principal but is not subject to principals control over his physical conduct. ii. Control over end result, but not manner in which its completed d. Apparent Agent: Principal holds out to 3rd party that a person is his agent (though he is not) and 3rd party reasonably relies upon that representation. Principal is liable for torts of apparent servant (Mcdonalds) 6. Similar But Non-Agency Relationships a. Buyer & Supplier (Cargill) b. Lender & Borrower (but see Cargill imposing lender liability b/c creditor took over control of debtors business) c. Employer & Non-Agent Independent Contractor i. Contractor who operates independently and simply enters into arms length transactions (i.e. carpenter hired to build a garage who takes no directions from homeowner). 7. Principal Contractual Liability (Agents Power to Bind) a. Actual Express Authority: Power explicitly given to an agent i. Note: Liable even if principal is undisclosed to 3rd party b. Actual Implied Authority: Actual power principle intended agent has but did not give it expressly - inferred from circumstances. (based on communication between P & A). Found in: 1. Penumbras of the actual express authority i.e. a corporate president is authorized to manage day to day business affairs. 2. Boards reaction to other similar actions by corporate agents may indicate an implied approval to the action. ii. Actual Implied authority for an act can exist when: 1. Usually accompanies or reasonably necessary to achieve express duties 2. Agent reasonably believes principal wishes agent so to act. 3. Principal has previously permitted agent so to act. iii. Ex: If CEO booked hotel room in course of negotiations. iv. Millstreet Church v. Hogan Hogan had actual implied authority to hire a helper (subagent) due to above factors. But v. Generally, an agent has no implied authority to hire helpers (subagents) for jobs involving significant discretion because the agent was likely picked to accomplish the duty in her particular reputed manner. c. Apparent Authority: Principal engages in conduct that leads a third party reasonably to believe that the agent had authority (based on communication between P & 3rd party). i. The reasonableness standard is one of custom: actors have apparent authority to the extent that similar agents in that industry typically have such authority. 1. Will often turn on question of whether action is ordinary or extraordinary. If it is something without apparent business

justification or of such importance board approval would seem necessary, the outside party is under a duty to verify authority for this extraordinary act. ii. Typically arises when principal has given an agent secret limits on her authority without informing the third party and the agent exceeds those limits when contracting with third party. iii. An agent can create her own apparent authority if she had actual authority when it was created (and then the principal later revokes agents actual authority, but doesnt communicate that to 3rd party). iv. To abolish apparent authority, principal must contact third parties to inform them that the agent has no authority to bind the principal. v. Salesperson (370 Leasing) and secretary usually can bind company by apparent authority (if within the scope of normal duties) vi. Cf. Apparent servant agency (possible under McDonalds) - McDonalds holds out 3K (franchisee) as their agent even though 3k isnt agent. McDonalds controls look of business, training, food preparation, etc Stretching of classic agency law to find the deep pocket. d. Estoppel: No control (no agency), but liable anyway: where a proprietor of a place of business . . . enables one who is not his agent conspicuously to act as such . . . the appearances being of such a character as to lead a person of ordinary prudence . . . to believe that the imposter was in truth the proprietors agent, in such circumstances. (Hoddeson) i. Can be viewed as either agency by estoppel or a tortious dereliction of duty owed to an invited customer. (Hoddeson) ii. The appearance of authority must be shown to have been created by the manifestations of the alleged principal (i.e. not recognizing imposter salesperson) and not solely by the supposed agent. iii. Could be viewed as apparent servant agency (cf. McDonalds) e. Inherent Agency Power: Power inherent in the customary scope of a general agents duties, even when contrary to principals instructions (Watteau). i. A recent academic creation not followed by a number of courts because contrary to common law definition of agency ii. Employee must be a general agent (endowed with authority for series of transactions w/o fresh authorization for each - more than a single specific purpose, e.g. vice-presidents, general managers) as opposed to a special agent. (lawyer, outside accountant) 1. General agents work as regular employees for principals (not irregularly). iii. Agent acts in unauthorized way, but way that usually accompanies or is incidental to transactions which general agents are usually authorized to do. iv. *Difference from apparent authority* = undisclosed principals (Watteau) where there cannot be apparent authority (because no communication between principal and third party). v. Watteau bar manager purchases drinks other than ale/water


vi. But See Restatement (Third) 2.06 (p.29) rejects inherent agency power f. Ratification: Affirmance by a person of a prior act which did not bind him, but which was done or professedly done on his account. (Botticello) i. Actor need not be an agent. ii. Elements: 1. Actor explicitly or implicitly purports to act on behalf of principal 2. Actor does not have actual authority 3. Actor could have been authorized by principal 4. Principal affirms ex post facto the actors transaction a. Principal must intend to ratify b. Principal must possess full knowledge of all material circumstances of the actors transaction. c. Can be express (oral approval) or implied (taking action that can only be seen as ratification) d. Mere non-action is not enough for ratification. iii. If a tort was committed in bringing about a contract, then ratification of the contract is ratification of the tort. iv. Ratification is usually an all or nothing thingeither the whole deal is ratified or not (otherwise would be thwarting intentions of party). 8. Principal Tortious Liability (Respondeat Superior) a. Elements: i. Agency relationship 1. Courts often forget to examine all 3 elements and instead go right to control analysis (McDonalds) ii. Master-servant - principal has control over agents physical conduct in fulfilling his task. Factors: 1. Control over day-to-day operations: e.g., hours, uniforms, work standards, procedures (Humble Oil). These factors are usually not determinative because they are manipulable (Hoover) 2. Investment/Risk: The more financial investment in the agent, and more risk on the principal, more likely master-servant (Humble Oil, Hoover) a. Hard to determine control after the fact, so risk (i.e. financial exposure) is used as a proxy 3. Franchise: way of organizing economic activity that does not fit well into servant/independent contractor dichotomy. Cases reach different outcomes on franchises (insufficient control in Holiday Inns; sufficient control in McDonalds under apparent servant agency) a. Not dispositive - the fact that an agreement is a called a franchise contract does not insulate the contracting parties from an agency relationship b. EEs of franchisee unsuccessful in suing franchisor for torts committed (robbery/rape) at franchise (Vandemark v. McDonalds and Wendy Hong Wu v. Dunkin Donuts)


4. Employees skills: skilled irregular workers are more likely to be independent contractors than servant. 5. Principals skills: if principal has same skills as agent, more likely to be master-servant because principal with same know-how is better able to supervise and control the agent. 6. Power to Terminate: Servants usually terminable at will (Humble Oil) 7. Extent of employment: Part-time employees cannot be servants. Servants work for one person/company whereas independent contractors usually work for many iii. Tortious act was within scope of employment. Elements: 1. Kind of conduct EE is authorized to do a. Can be construed narrowly or broadly to achieve desired result b. Usually construed broadly otherwise no tort would ever be within scope of employment (e.g. Arguello: clerk yelling racial epithets to minority customers within scope because clerk was on duty and performing authorized duties for Conoco such as conducting sales.) 2. Committed during authorized time in authorized place a. Issue is whether the job and its related authorization put the employee in a position to commit the tort. b. Frolic: not really within authorized time/place (wearing the UPS uniform and supposed to be working, but not really on the job) Principal not liable. c. Detour: Stops to grab some lunch so that he can work through lunch Principal is liable. 3. Motivated at least in part by purpose to serve master a. Prevents strict liability on employers for their employees torts. b. Unless court follows Judge Friendly foreseeability test changed this element to whether the master could have foreseen the tort (Bushey), but most courts have not followed (Clover) c. Tort committed in response to an interference with employees work is sufficient Manning (element satisfied when pitcher threw baseball at heckler fans who were presently interfering with his warm up) d. Under strict interpretations of this element, courts could rarely find respondeat superior. To incentivize companies to hire agents who would not commit torts, courts sought to circumvent it while still paying lip service 4. If force involved, must have been reasonably foreseeable b. Exceptions - Principal Liability for Torts by Independent Contractor Agents: i. Principle: You have the power to select your own independent contractor, so if you do a bad job and someone gets hurt, you should have to pay


ii. This is like a non-delegable duty doctrine iii. Exceptions: 1. Tort committed = Fraud 2. Principal hires incompetent independent contractor a. Incompetence in skill b. Incompetence in financing/lack of insurance (Majestic) 3. Landowner retains control of the manner and means of the independent contractor doing the work (IC is really like a servant). 4. Activity contracted for is nuisance per se (inherently dangerous): necessarily requiring the creation during its progress of a condition involving a peculiar risk of harm to others unless special precautions are taken a. Different from ultrahazardous, which is when no precautions can remove a serious risk of harm. 9. Fiduciary Duties Owed by Agents a. Duty of Care: liable to principal for injuries caused by negligence or business damages caused by gross negligence, recklessness, intentional misconduct, or knowing violation of the law. b. Duty of Loyalty: liable to principal for any profits made from cheating principal or made secretly as result of agent position (taking principal opportunities) i. Reading: Agent liable to principal for secret profits made by using his position as a servant (in military) even though agent was acting outside scope of employment and thus not in a fiduciary relationship with principal. ii. Ebay officers under duty to account for profits obtained personally since Goldman offered as inducement/gratitude for Ebay business. iii. Town & Country Duties after termination of agency grabbing and leaving - former employees may not use confidential customer lists belonging to their former employer to solicit new customers. 1. But see Meehan - acceptable to solicit clients to follow you while still in partnership

1. Definition a. An association of two or more persons to carry on as co-owners a business for profit (UPA 13). i. Every partner is an agent of the partnership for the purpose of its business, thus each can bind the entire partnership (Nabisco v. Stroud) ii. Firms that call themselves partnerships but do not share profit and control are not partnerships; and vice-versa (Fenwick) 1. Partnerships require no formalities to be created iii. Almost all partnership rules can be contracted around (UPA 18) 1. Partnership agreement vesting decision-making control in executive committee who doesnt disclose info they handle to rest of partners does not violate any fiduciary duties (Day) iv. Burden of proving partnership is on party claiming partnership.


2. Purpose a. To achieve the advantages of joint activityif individual contributions could be individually valued, then the business activity could be organized across a market rather than within a firm. 3. Rough Elements a. People engaged in a business b. Share profits c. Share control 4. Dissolution a. When a partner joins or leaves, the partnership dissolves (ceases). b. Many partnerships contain continuation agreements that maintain partnership even if a partner joins or leaves c. Courts can dissolve partnerships (UPA 32; G & S Investments): i. Partner becomes incapable ii. Partners conduct prejudicially impacts partnership business iii. Partner willfully and repeatedly breaches partnership agreement d. A partnership buy-out agreement is valid and binding even if the purchase price (i.e. capital account) is less than the FMV of the partner interest, since partners may agree among themselves by contract as to their rights and liabilities. (G&S Investments). e. Partners who want to dissolve can insist other partners buy him out or liquidate the business. f. Expulsion: expelling a partner does not violate a fiduciary duty when pursuant to a no-cause expulsion clause in a partnership agreement (can K around fiduciary duties). Expulsion violates a fiduciary duty only when it cheats expellee out of contractual obligations (e.g. pay) (Lawlis) 5. Types of Partnerships a. General Partnership: Traditional partnership b. Limited Partnership: One (or more) general partner(s) who have all control and normal partner liability along with other partners with no control and limited liability (akin to that of shareholders) c. Limited Liability Partnership: All partners have limited liability d. Limited Liability Corporation: Corporation that pays taxes as a partnership i. LLCs have come to dominate partnership types because they provide tax benefits of partnerships and liability benefits of corporations. 6. Governing Statutes a. Uniform Partnership Act (1914): adopted in every state but Louisiana b. Revised Uniform Partnership Act (1997): adopted by some states c. UPA and RUPA Regulate: i. Transactions within partnership ii. Transactions between partnership and 3rd parties 7. Characteristics / Factors in determining if there is a partnership a. Right to Share Profits (Fenwick): b. Obligation to share losses (Fenwick no) c. Sharing Control\Ownership (Fenwick - no): i. Management of partnership business


1. In the absence of a contrary agreement, all partners have equal rights in the management and conduct of the partnership business (UPA 18(e)) 2. Partnership business is decided by majority vote of the partners (UPA 18(h)) a. Deviating from the baseline agreement requires a majority b. Nabisco 1 of 2 partners cannot stop delivery of bread, which was an ongoing ordinary/legitimate part of the business c. Summers A not responsible for wages of extra EE hired by B b/c agreement provided that only A/B would work. d. In both Nabisco and Summers, the status quo prevailed. e. If EE sued for wages in Summers, A is liable under apparent authority ii. Ownership of partnership property 1. Partners have an interest in the partnership, not its property. Thus, if one transfers ones interest in the partnership, one sells ones interest in all assets/liabilities of the partnership, including claims by the partnership against 3rd parties (Putnam) iii. Rights to partnership property post-dissolution 1. Dissolving partnerships split property among partners 2. Fenwick no rights, same as if she quit employment iv. Conduct of partners toward 3rd parties (holding themselves out as partners to 3rd parties) 1. Apparent Partnership (AKA partnership by estoppel): holding oneself out as a partner or allowing someone else to do it to a 3rd party makes one liable to that 3rd party if the 3rd party reasonably relies on the representation (Young v. Jones) (UPA 16(1)) a. Same as apparent agency. 2. Fenwick no, she was just a receptionist d. Intent of the Parties i. Fenwick potentially increase her wage scale if business increased, not to form partnership ii. Martin v. Peyton even though agreement gave them a lot of control and sharing profits, no intent creditors intended to become partners e. Language of the Agreement (if one exists) but calling it partnership agreement is not sufficient 8. Fiduciary Duties of Partners see Fiduciary duty section 9. Difference Between Partnerships and Corporations a. Formation: Partnerships can be formed without any formalities or filings whereas corporations must follow certain formalities to be organized b. Personal Liability: General partners have unlimited personal liability for partnership liabilities whereas corporate shareholders have limited liability i. But partnership can be LLP or avoid liability through insurance c. Transferability of Interests: Partnerships require unanimous vote to add new partners whereas corporate stock is freely transferable




f. g. h. i.

i. But partnership agreements can change partner admission methods ii. But corporations can agree to restrict sales of shares / only disposable if you can find a buyer (might be difficult in small corp) Centralized Management: Partnerships are run by all partners equally whereas corporations are centrally managed by officers (i.e. CEO) hired by board of directors i. But partnership agreements usually specify centralized management group ii. But corporate bylaws and articles of incorporation can diversify management structure, or give investors a say Life Span: Partnerships dissolve every time a partner leaves whereas corporations persist indefinitely i. But, in practice, small corporations often cease when officers leave ii. But, in reality, many partnerships automatically reform through contract Flexibility: Partnership agreements are infinitely flexible i. But corporate bylaws and articles of incorporation are pretty flexible too Taxation: Partners pay tax on partnership profits through personal income taxes where corporate shareholders do not pay taxes on company profits. Power to Sue and be Sued: Partnership CANT sue or be sued in its own name; must be done by or against indiv. Partners; Corporation CAN sue or be sued as a legal entity Summation: Differences between partnerships and corporations are mainly default rules that can be contracted around. Tax differences remain, and thus tax law tends to drive firms decisions on how to organize

1. Definition a. A business association governed by a particular set of rules in which shareholders invest equity and vote upon a board of directors who choose the officers to run the corporation on a daily basis and make important decisions. 2. Types of Corporations a. Public Corporations: large firms with many shareholders and active trading of shares, usually on major stock exchanges. Shareholders exercise little or no control over operation of business. b. Closely Held Corporations: firms with only a few shareholders (in Delaware, maximum is 30 shareholders) and no readily available market for shares (possibly because of transfer restrictions). Usually the shareholders are also managers who control daily corporate operations. i. In Delaware at least, closely held corporation status allows shareholders to directly manage the corporations business instead of directors, which allows them to do away with certain corporate formalities (p. 617). 3. Governing Statutes a. 1933 Act: See under Disclosure b. 1934 Act: See under Disclosure & INSIDER TRADING c. SEC Rules: See under Insider Trading


d. Blue Sky Laws: State disclosure laws that occasionally exceed the disclosure demands of the federal statutes. 4. Choice of Law a. Rule: Basic rule of corporate law is that the law of the state of incorporation controls on issues relating to a corporations internal affairs, which include responsibilities of directors to shareholders. 5. Characteristics a. Separate Entity: A corporation is its own legal entity; officers act on behalf of the firm and the firm enters contracts, incurs debts, and files suits i. Nonetheless, it is best to not reify the corporation when addressing discrete legal matters and instead attend to the particular corporate participants (directors, shareholders, etc.) involved in the issue b. Limited Liability: As a separate entity, corporate liabilities remain at the corporate level and do not subject shareholders to personal liability i. Rationale: Want people to invest and be able to diversify their investment through trade-able equity claims. So, we need to limit liability, otherwise everyone who owned on June 4th would be liable a little bit in a suit ii. In other words, creditors (lenders) bear most of the risk for corporations. iii. But, problematically, so do involuntary creditors (tort victims) 1. Solutions: large corporations can cover, large and small have insurance (Walkovszky), or shareholder is subject to personal liability (tort), or, finally, corporate veil piercing 2. This is why corporate veil piercing cares about undercapitalization c. Corporate Assets Separate from Shareholders: As a separate entity, shareholders have no right to corporate assets. Thus, they cannot remove their pro rata share of the corporations assets (contra partnership) d. Separation of Ownership and Control: Shareholders have no power to participate in corporations management e. Infinite Duration: Corporations have no time limit f. Freely Transferable Shares: Shareholders can freely trade shares g. Centralized Control: Daily business control is centralized in a CEO h. Formalities: To be created and maintained, must adhere to formalities i. Articles of Incorporation: the corporations constitution. 1. Standardized (usually drafted by CT Corp.) 2. Broad (to avoid ultra vires) 3. Modifiable by vote of shareholders and directors ii. Bylaws (most states do not require) 1. Specialized 2. Specific 3. Modifiable by vote of either shareholders or directors iii. Organizational meetings 6. Exceptions to Limited Liability a. Personal Liability / Respondeat Superior: Holds stockholders of a company personally liable because corporation is a dummy for its individual stockholders who are in reality carrying out the business in their personal capacities for purely personal rather than corporate ends.


i. Upon the principle of respondeat superior, the liability extends to negligent acts (torts) of corporate employees as well as commercial dealings. ii. Note: Whether there is personal liability has nothing to do with whether the court has found that multiple companies are being run as one enterprise. (Walkovsky although enterprise is found, still need to prove personal liability). b. Piercing the Corporate Veil: Holding shareholder(s) liable for debts of corporation as if in a master-servant relationshipissue is whether shareholder is acting as master or corporate president. Vertical liability. i. Alter-Ego Test See rough elements below 1. Note: the alter ego theory makes a parent liable for the actions of a subsidiary which it controls, but it does not mean that where a parent controls several subsidiaries each subsidiary then becomes liable for the actions of all other subsidiaries. There is no respondeat superior between the subagents. ii. Rough Elements (Sea-Land; Roman Catholic Archbishop): 1. Unity of interest and ownership between corporation and shareholder(s): a. Failure to comply with formalities/maintain records b. Commingling of corporate and shareholder assets c. Undercapitalization (either at corporations formation or purposely moving money out needs purposive element, not just that there is no longer enough money now) d. Treatment of corporation as mere shell i. These 4 factors overlap ii. Covers shareholders who are persons and parent and subsidiary corporations e. Corporate Control (In Re Silicone): i. Parent and subsidiary share officers or directors ii. Parent and subsidiary share business depts. iii. Parent and subsidiary file consolidated financial statements and tax returns iv. Parent finances subsidiary v. Parent caused incorporation of subsidiary vi. Subsidiary has grossly inadequate capital vii. Parent pays salaries/expenses of subsidiary viii. Subsidiary gets business only from parent ix. Parent uses subsidiarys property as its own x. Parent and subsidiary share daily operations xi. Subsidiary does not follow formalities 2. Not piercing would sanction fraud or promote injustice a. Something more than creditor inability to collect b. Usually only required in contract cases, not tort cases (In re Silicone). iii. Purpose:


1. Compliance with formalities to ensure creditors (risk-bearers for corporations) are not misled 2. Sufficient capitalization to ensure that tort victims (risk-bearers) can be compensated iv. Alternatives: If veil piercing is not available without overly stretching the doctrine, look to insurance laws (cf. Walkovszky) v. Problems: 1. Prevents planning for future 2. In practice, can only work in closely held corporations c. Reverse Piercing: Piercing the corporate veil to get to shareholder and then reversing to get shareholders assets in other corporations. i. Formally, test is same as for piercing the corporate veil d. Enterprise Liability (Walkovsky): Holding one corporation liable for debts of another corporation when both are altar egos of each other (i.e. an integrated business operation carved into multiple parts). Horizontal liability i. Applied in cases where owner has split what should be a single corporation into several to avoid liability 1. Thus creates a single constructive company 7. Corporate Actors a. Shareholders: Own residual interest in the corporation (receive corporate assets upon liquidation after fixed claims are satisfied). Consequently, they bear risk of loss, although they have only limited liability. They also elect directors, which is their only input into management. b. Directors: Control management of corporation by choosing officers and deciding upon major company decisions (e.g. IPOs, officer selections) i. Meet whenever necessary; usually monthly ii. Usually possess liability insurance, which removes incentive effects of the duty of care to take due care in business decisions. iii. Universal Rule of Construction: Directors are supposed to maximize returns for junior-most securities (e.g. Class B stock over Class A stock over preferred stock). iv. Duties: 1. Duty of Care (see under Fiduciary Duties) 2. Duty of Loyalty (see under Fiduciary Duties) 3. Duty to Disclose (see under Disclosure) 4. Insider Trading Duties (see under Insider Trading) c. Officers: Run the company on a daily basis. Officers generally have actual and apparent authority as agents to bind the corporation. 8. Shareholder Powers a. Shareholder Meetings: i. Generally occur once a year 1. Directors, and sometimes senior officers or shareholders can call special meetings to vote upon fundamental issues (e.g. mergers) ii. There are certain quorum rules (usually a majority, though can be reduced) iii. There are elaborate notice rules iv. Vote upon certain fundamental matters:


b. c.



1. Selecting directors 2. Mergers 3. Amendments to articles of incorporation 4. Sale of substantially all of corporations assets 5. Liquidation Appraisal Rights: If shareholders dissent from a fundamental change, they are entitled to fair price for their shares (except, in some places, e.g. Delaware, these rights do not exist in publicly traded corporations). Voting Mechanisms: i. Proxy Voting: Shareholders can assign their vote to another through a proxy system, which can lead to fights between parties attempting to receive the proxy votes to use en masse. See Proxy Fights below. ii. Cumulative Voting: Method to ensure that minority shareholders have proportional representation on BoD: rather than vote on each BoD position separately, vote on them all simultaneously, with each share being given 1 vote per director spot and highest vote-getters win spots. So long as you have 1/n% of stock, where n = number of directors, you have ability to elect as least one director. (Ringling) 1. Staggered Votes: Cumulative voting is countered by staggered voting for directors (e.g. 1/3 of BoD every year). Derivative Suits: Shareholders sue on behalf of the corporation to enforce rights of the corporation. The shareholder (1) sues the corporation in equity (2) to bring an action to enforce corporate rights (often the action is to sue directors themselves). i. Vs. Direct Suit 1. If there is general injury to the corporation derivative suit (vast majority of suits) a. The shareholder-plaintiff shares in the recovery only indirectly, to the extent her shares increase in value as a result of corporate recovery. b. A duty of care / duty of loyalty claim is more likely to be derivative. 2. If harm is to the stockholder directly (which does not include the corporation losing money) direct suit ii. Attorneys Fees: Corporation pays the successful plaintiffs litigation expenses, including attorneys fees. iii. Statutory Bonds: Many states, including NY and DE, require plaintiffs in shareholder derivative suits to file bonds (security for expenses) in order to deter suits (Eisenberg) Direct Suits Against Corporation: i. Voting Rights (Eisenberg - reorganization deprived him and fellow stockholders of their right vote on Flying Tigers affairs. This was in no sense a right that ever belonged to Flying Tiger itself, but rather is a right that belongs to stockholders per se) ii. Informational Rights inspect corps books/records/lists iii. Dividend Issues (Dodge v. Ford - below)


iv. Overturn improper anti-takeover defenses v. Prevent oppression of minority S/Hs vi. Stock Redemption Rights f. Ratification: Majority vote by independent shareholders to ratify board decisions removes director liability arising from breaches of fiduciary duties (Fliegler). g. Dividends: Shareholders have no right to a dividend (Kamin v. AmEx; but see Dodge v. Ford - below). i. Preferred Shares: If the company issues dividends, a certain specified amount must be first paid to preferred shareholders before other classes of shareholders. ii. Cumulative Dividends: Unpaid dividends accumulate so that when dividends are finally paid, they must cover previous unpaid years as well (protects preferred shareholders from common shareholders overdividending to themselves). 9. Corporate Powers (and Purpose) a. Historically: Corporations initially developed to serve public and private profit purposes, but the latter became the chief aim and was enshrined as the sole purpose in 19th century common law. Other actions were considered ultra vires. i. Ultra Vires: A transaction that is beyond the purposes and powers of the corporation and thus not binding on the corporation (unenforceable). ii. Dodge v. Ford (1919): A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. . . . it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefitting others. 1. To avoid Dodge rule, just use the right words (i.e. a corporate economic decision) a. Ford used the wrong language: My ambition . . . is to employ still more men, to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes. 2. Dodge wont ever happen again ruled dividend should be paid out only b/c of above testimony by Ford. iii. Dividends: a refusal to declare and pay further dividends appears to be not an exercise of discretion on the part of the directors, but an arbitrary refusal to do what the circumstances required to be done. (Dodge) b. Modern Rule: In 20th century, judges have interpreted common law liberally to shield any corporate actions (even those in the interests of other constituencies, e.g. charitable donations) with the BJR that reasonably relate to corporate interest (A.P. Smith Mfg.). i. Only normal rules for not applying BJR (fraud, illegality, conflict of interest, waste, gross negligence) will invalidate corporate decision (Shlensky v. Wrigley). ii. Charitable contributions: Legal as long as reasonable and in corps interest (which it usually is, just cant amount to waste) (A.P. Smith)


iii. Dividends: the question of whether or not a dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the Board of Directors. (Kamin v. AmEx)

1. Overview a. When issuing securities, corporations are required by both state blue sky laws and, more crucially, federal securities laws (1933 and 1934 Acts) to disclose certain supposedly relevant information with the SEC. 2. Definition of a Security - broad a. For the 1933 and 1934 Acts, a security is defined very broadly to include stock, bonds, debentures, investment contracts, and any instrument commonly known as a security, which pretty much includes and obscure security. i. Investment Contract: a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party. (p. 417) 3. 1933 Securities Act (federal law) a. Overview: Mandates initial disclosure requirements for companies issuing securities for the first time (primary market / IPOs). Because disclosure is timely and costly, companies strive to fall within safe harbor protections of 4. Due diligence is much stricter in federal law where you must make a reasonable investigation and cannot rely on others like under state law (cf. Caremark) b. 5 Disclosure Requirements: A security may not be issued unless a registration statement has (1) been filed and (2) become effective, and (3) the prospectus has been delivered to the purchaser. i. Form S-1: Consists of Registration Statement (several hundred pages) and a Prospectus (10-15 page summary of company). 1. Ramseyers Take: These disclosures are not very useful because they are written by corporate insiders and thus paint a biased picture of the company. The more useful disclosure comes from external audits, which companies pay for to entice investors (and which, therefore, would occur with or without the federal disclosure laws). There is thus a significant question about the cost-effectiveness of federal disclosure requirements. c. 4 Safe Harbors from 5 Requirements: i. Secondary Markets: Transactions by any person other than an issuer, underwriter, or dealer ii. Nonpublic (Private): Transactions by an issuer not involving any public offering. d. 11 Rules on Registration Statement Misstatements and Omissions (Escott): i. Who can Sue 11(a): Anybody who owns a security with a registration statement can sue if there is a material omission or misstatement (unless the person knew at the time of acquiring the security that an omission or misstatement existed), even if the person did not rely on the statement at all when purchasing the security, or purchased on secondary market






1. Material = information required to those matters as to which an average prudent investor ought reasonably to be informed before purchasing the security registered (would they take it into account in decision?) Who can be sued? 11(a): 1. The issuer (company) itself 2. Every signer of the registration statement 3. Every director of the issuer 4. Every expert who helped prepare or certify the statement (only liable for expertised portion) 5. Every underwriter of the security Affirmative defenses 11(b): available to everyone except the company itself (issuer): 1. Expertised Portion: a. Experts: 11(b)(3)(B): no liability if i. He had reasonable grounds after reasonable investigation to believe and did believe that the statements were true with no material omission; or ii. The statement did not fairly represent his statement (i.e. miscopied or taken out of context) b. Non-Experts: 11(b)(3)(C) no liability if no reasonable ground to believe and did not believe that statements were inaccurate i. [easier standard, no investigation required] 2. Non-Expertised Portion (written by nonexperts, including lawyers): a. Experts: 11(a)(4) no liability at all. b. Non-Experts: 11(b)(3)(A) no liability if after reasonable investigation had reasonable grounds to believe and did believe that statements were true with no material omission 3. Registration Statement Drafter: Registration statements drafter (often an officer/director) has a higher standard of due diligence, even though not technically an expert, because he is in effect an expert on the subject of the registration statement. (Escott) 4. If all affirmative defenses are met, only issuer is liable Reasonable Investigation Standard (11(c)): The standard of reasonableness shall be that required of a prudent man in the management of his own property. 1. This standard is high and does not allow for a lower standard for those less well educated (Escott) or otherwise unable to comply (cf. Francis): there must be a reasonable investigation, or you should not be a director/officer (those unable to investigate themselves can hire lawyers to conduct investigation for them). Remedies 11(e): difference between what you paid for the stock and what it is actually worth now (assuming the defense cant show it fell for other reasons).


4. 1934 Securities Exchange Act a. Overview: Mandates continuing quarterly disclosure requirements for public companies and also restricts certain types of security transactions on a stock market (secondary market). b. Much more broad than 33 Act. Covers insider trading, proxy rules, tender offer rules, etc.

1. Overview a. Under 10(b) of the 1934 Act, SEC bars insider trading, while under 16(b), it bars short swing profits. b. Purpose: Insider trading essentially allow management to earn a secret profit as to which shareholders have neither knowledge nor control, which creates perverse managerial incentives and misaligns management and shareholder interests. i. On the other hand, nobody is clearly harmed by insider trading, and, indeed, insider trading could be used as a form of employee compensation 2. Rule 10b-5 a. Overview: Under 10b-5, persons who have fiduciary duties as a result of their relation to a corporation (i.e. insiders, namely officers, directors, or controlling shareholderssee Fiduciary Duties above), have an affirmative duty to disclose material nonpublic information before trading or otherwise abstain from trading. This abstain or disclose duty has been extended through case law and rulemaking to temporary insiders, tippees, and persons in relations of trust and confidence. It has also been applied to persons without any underlying fiduciary duties through misappropriation. Corporations can likewise be liable for disclosing misleading information that causes shareholders to buy or sell shares. i. Insider: Someone who, by virtue of her relationship (i.e. employment) with a company, has access to confidential information intended to be used for a corporate purpose. Namely, directors, officers, employees and controlling shareholders. An insider who uses this information to her own advantage through trading a security deceives the outside buyer or seller. 1. Note: An insider who uses inside information to buy stock from a shareholder is deceiving someone to whom she owes a fiduciary duty (directorshareholder). Theoretically, however, an insider who uses inside information to sell stock to someone who previously did not own shares is deceiving someone to whom she owes no fiduciary duty (directornon-shareholder). Nonetheless, Rule 10b-5 makes no such distinction and would hold the insider liable in either case. 2. Corporate Buybacks: Count as insiders for purposes of purchasing back stock to themselvesi.e. the corporation must disclose material information to shareholders from whom it is buying back stock. (Zahn; Jordan v. Duff and Phelps) b. Abstain or Disclose Rule (Cady): anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled


from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed. c. Text of Law: It is unlawful for any person, in connection with the purchase or sale of any security, (1) to employ any device, scheme, or artifice to defraud, (2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of tune circumstances under which they were made, not misleading, or (3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. i. Security: Courts have interpreted security broadly for 10b-5 purposes such that almost any security from any corporation (even privately-held) is covered. But, for instance, a general partnership interest is not a security. d. SEC Enforcement: SEC, under 21(d) of the 1934 Act, can seek a civil penalty against an insider of triple damages. SEC can also pursue criminal liability. e. Elements: i. Trade or Make Material Misstatement Inducing Trade by Others: Must buy or sell a security or make a misstatement that makes others do so 1. Abstention from trading usually precludes liability unless the defendant (person or corporation) made material misstatements that caused reasonable persons to rely on the misrepresentations and trade securities (Texas Gulf Sulphur). 2. Material omissions (w/o trading for self) are acceptable because the decision to disclose is a business judgment protected by BJR (Texas Gulf Sulphur) ii. Material Information: The basic test of materiality . . . is whether a reasonable man would attach importance . . . in determining his choice of action in the transaction in question. . . . Thus material facts include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the companys securities. (Texas Gulf Sulphur) 1. Texas Gulf Sulphur found materiality because the information incited insiders to trade. a. Ramseyers Take: This reasoning, however, makes the element collapse into the trading element if you trade, its material iii. Non-public: interpreted broadly even if a few reporters know, still nonpublic. Must wait until investing public as a whole have learned iv. Scienter: Was D aware it was material, nonpublic info? 1. For misstatement - an intent to deceive, to mislead, or to convey a false impression also includes recklessness v. Breach of Abstain or Disclose Duty: 10b-5 requires abstain or disclose only when the information is inside information (i.e. possessed through a fiduciary relationship), wrongfully acquired (misappropriation), or otherwise violates an SEC rule (10b5-2; 14e-3). 6 violations:


1. Breach of insider fiduciary duty (Cady; Texas Gulf Sulphur; Zahn; Jordan v. Duff and Phelps) 2. Breach of temporary insider duty (Dirks n.14) a. But no duty or violation arising from an arms length transaction (Dirks n.22) 3. Breach of tippee duty (Dirks) a. If tippee is liable, so is tipper 4. Misappropriation: breach of duty to source of information (OHagan), possibly through violation of sources internal rules (Carpenter; but rejected in Martha Stewart case) a. Misappropriation applies even when source is complete stranger to the traded securities i. No need for tipper to have breached a fiduciary duty for personal benefits. b. Misappropriation does not occur when trader discloses intention to trade to source of information (OHagan) c. Ok to trade in competitors stock, unless co. has a rule against it 5. Violation of Rule 10b5-2 for trading on or disclosing information obtained from a statutorily defined relationship of trust and confidence extension of misappropriation theory 6. Violation of Rule 14e-3 for trading on insider information related to a tender offer f. Texas Gulf Sulphur (2d Cir. 1968): Applied 10b-5 to find both insiders liable for trading on nonpublic information (valuable ore site found) and the corporation itself liable for issuing misleading press releases to the public about valuable corporate opportunities (defeating rumors of the ore site) i. Corporate Disclosure of Material Information: Corporations need not disclose material information immediatelythe timing of the disclosure is a business judgment of the officers and BoD (n.12) ii. Reasonable Waiting Period Post-Disclosure: Court also held one insider liable for trading after a public announcement was made but before the information could have been disseminated. Insiders must give a reasonable waiting period (cf. n.18) before trading post-disclosure. g. Chiarella (SCOTUS, 1980): Found that worker at printing compnay who was printing tender offer documents for a law firm hired by the acquirer did not violate 10b-5 by purchasing stock in the target company. The worker did not owe a fiduciary duty and thus 10b-5 could not apply (Court ruled that although law firm, printing company, and worker might have owed fiduciary duties to acquirer, they did not owe them to the target of the takeover). The copy store did have a rule against using the information it copied (which could create misappropriation liability). i. Bergers Dissent: First raises specter of misappropriation as source of 10b-5 liability, but because the argument was not made to the court, it could not be accepted or rejected. Bergers dissent spurred lower court (especially 2d Circuit) acceptance of misappropriation.


h. Rule 14e-3: Passed as a result of Chiarella - prohibits any trading on undisclosed material information relating to a tender offer, regardless of whether the trader has underlying fiduciary duties or not. i. In essence, because SCOTUS ruled that 10b required a fiduciary duty to give rise to abstain or disclose duties, SEC turned to 14e and defined fraud differently to create a duty not premised on fiduciary duties in the tender offer context. ii. OHagan upheld Rule 14e-3. i. Dirks v. SEC (SCOTUS, 1983): i. Tippee Duties: A tippee assumes a derivate fiduciary duty to shareholders (so may not trade/disclose material nonpublic info) when, and only when: 1. A tipper with a fiduciary duty to the shareholders improperly discloses material nonpublic information to the tippee in violation of Cady 2. The tipper benefits, directly or indirectly, from the disclosure 3. The tippee knows or should know that tipper breached a fiduciary duty by disclosing a. 10b5-2 relationships create a rebuttable presumption that tippee knew this ii. If Tippee is liable, so is tipper iii. Tipper is liable if 1. He knowingly breaches a fiduciary duty by tipping info 2. He benefits, directly or indirectly, from disclosure 3. Tippee trades iv. No Duties for Arms Length Transaction (n.22): When a firm receives information in arms-length negotiations, the absence of any fiduciary relationship [precludes] imposing tippee liability. v. Temporary Insider Duties (n.14): Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is . . . that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes. . . . For such a duty to be imposed, however, the corporation must expect the outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply such a duty. vi. No Duties Simply for Trading on an Informational Advantage (n.17): Court noted that there are significant benefits from incentivizing investors to seek out nonpublic information, so long as such information is attainable equally by all (i.e. not attained through fiduciary duty breach). The ability to make profits from the possession of information is the principal spur to create the information, which the parties and the market as a whole may find valuable. (Jordan v. Duff and Phelps) j. Carpenter: (SCOTUS, 1987): Court splits 4-4 as to whether to adopt misappropriation theory for WSJ stock reporter who told his friends prior to


publication of his columns which stocks he was touting (which had a market affect), despite WSJ rule that pre-publication columns were confidential. k. Chestman (2d Cir., 1991): The court adopted the misappropriation theory, but found that it did not apply down a series of familiar divulgences of insider info. l. OHagan (SCOTUS, 1997): Court adopts the misappropriation theory for conviction under 10(b): i. Misappropriation theory holds that a person . . . violates 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciarys undisclosed, self-serving use of a principals information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information . . . . the misappropriation theory premises liability on a fiduciary-turned-traders deception of those who entrusted him with access to confidential information. ii. No Misappropriation if Disclosure to Source (n.9): the textual requirement of deception precludes 10(b) liability when a person trading on the basis of nonpublic information has disclosed his trading plans to, or obtained authorization from, the principaleven though such conduct may affect the securities markets in the same manner as the conduct reached by the misappropriation theory . . . . [O]nce a disloyal agent discloses his imminent breach of duty, his principal may seek appropriate equitable relied under state law. 1. Full Disclosure to Only 1 of 2 Sources (n.7): Where, however, a person trading on the basis of material, nonpublic information owes a duty of loyalty and confidentiality to two entities or persons . . . but makes disclosure to only one, the trader may still be liable under the misappropriation theory. iii. Court also upheld Rule 14e-3. m. Rule 10b5-2: SEC addresses Chestman problem A recipient of material, non-public information is deemed to owe a duty of trust of confidence to the source for misappropriation liability if: i. Whenever someone agrees to maintain information in confidence ii. Whenever two people have a pattern or practice of sharing confidences such that the recipient knows or reasonably should know that the speaker expects the recipient to maintain the informations confidentiality iii. Spouses, parents, children, or siblings. 3. Short Swing Profits (Rule 16b) a. Rule 16b (p. 511): A prophylactic strictly applied rule, Rule 16b prohibits officers, directors, and beneficial owners (>10%) of a corporation from buying and selling that corporations stock within a six month period. Any profits made through such transactions are owed to the corporation. b. Elements: i. Company: Large public company registered under 1934 Act. ii. Trader: Officer, Director, or Beneficial Owner of company 1. Officer, Director at first transaction (not necessarily 2nd)


2. Beneficial Owner: Someone who owns more than 10% of any class of any equity security at time of sale and purchase a. Foremost-Mckesson (SCOTUS 1976): A party does not become a beneficial owner until after acquiring 10%: the transaction to first exceed 10% ownership does not itself count as a Rule 16b transaction. b. Reliance Electric (SCOTUS 1972): A beneficial owner can structure sales to get just below 10%, and any sale thereafter does not violate Rule 16b. c. Convertible Shares: For convertible shares, you calculate the percentage ownership of that class if only the owner converted all her shares. If that theoretical figure exceeds 10%, then owner is a Rule 16b beneficial owner. d. The >10% must be of a single class of stock (e.g. 7% of Class A and 4% of Class B are insufficient). e. Being a beneficial owner of one class of stock makes purchases and sales of another class of stock from the same corporation fall within the ambit of Rule 16b iii. Transaction: (1) sale and purchase or (2) purchase and sale iv. Timeframe: Within Period of less than 6 months v. Equity Security 1. Only stocks, stock options, and convertible debt (but not other bonds/debentures) vi. Remedy Construction: Maximize liability - counted by whatever means maximizes the profit received and not subtracting any losses (e.g. if an officer buys 10 shares at $20/share and 10 shares at $60/share and then sells all 20 for $30/share, even though there is a net loss, the officer is liable for $100 (10 shares at $30/share less 10 shares at $20/share). c. Enforcement: A civil remedy statute enforced either by the issuer or by shareholder through derivative actions. d. Statute of Limitations: Suit must be brought within 2 years of date of profits.

1. Proxy Fights a. Overview: Shareholders can assign their shareholder vote to others through proxies. In publicly held corporations, nearly all shareholders vote by proxy, which can lead to fights between parties attempting to gain a controlling or majority bloc of shareholder votes to use at shareholder meetings. On shareholder meetings, see Shareholder Powers. A proxy fight is about corporate control: shareholders elect the directors and thus when new management teams want in, they can engage in a proxy fight to control the shareholders to control the board. Proxy fights are expensive to wage, and thus much litigation has arisen about who can use corporate funds and who can be reimbursed. i. Tender offers became a more effective means of obtaining corporate control (hostile takeovers), see Mergers & Takeovers below, but with the


introduction of the poison pill and other defenses, proxy fights have returned in importance. ii. Taking over control must occur through voting rather than litigation because BJR blocks court examination of management competence. b. Proxy Voting: Proxy voting is not absentee balloting: rather, it is the assigning of the right to vote of one shareholder to another. i. Proxy voting is governed by 1934 Act. 2. Basic Federal Regulations a. 1934 Act 14(a): Prohibits solicitation of proxies in violation of SEC Rules. b. Rules 14a-3, 14a-4, 14a-5, 14a-11: Require people soliciting proxies to furnish shareholders with a proxy statement that discloses relevant information about the vote, e.g. conflicts of interest. Disclosure requirements are extensive. c. Rule 14a-6: Proxy solicitation material must be filed with the SEC. 3. Proxy Funding a. General Rule: So long as the proxy fight is over policy rather than merely personal, corporate funds can be used to finance proxy fights. b. Incumbent Management: Incumbent directors may use corporate funds and resources in a proxy solicitation contest if (1) the sums are not excessive (must be reasonable expenses), and (2) the shareholders are fully informed (Levin; Rosenfeld) i. Just need to follow the BJR protects directors if (1) and (2) are met. c. Losing Incumbent Reimbursement: Acceptable under the same reasonable expense standard as above. (Rosenfeld) d. Challenger Reimbursement: Shareholder ratification permits reimbursing successful challengers for reasonable expenses. (Rosenfeld) 4. Shareholder Proposals a. Rule 14a-8: Allows shareholders to submit shareholder proposals of less than 500 words that the issuer must send out in its proxy statement to the shareholders (to give opportunity for shareholders to proxy their votes to proposer). i. Proper Subject Matter: 1. Committees to Study a Matter 2. Requests About Corporate Action 3. By-Law Amendments ii. Exceptions: (BoP on company) 1. Invalid Subject Matter Under State Law: State law may bar some shareholder proposals. For instance, forming a committee to study something for shareholders sake or requesting that the corporation take an action is acceptable. It is NOT acceptable, however, to require/order the corporation to take a specific action (control is in hands of directors, not shareholders). 2. Economically Insignificant or Otherwise Not Significant, Rule 14a-8(i)(5): Issuer need not send out shareholder proposals that relate to operations of the issuer worth less than 5% of its total assets and less than 5% of its net earnings and gross sales and that is not otherwise significantly related to the issuers business.


a. Non-economically Significant Proposals: Proposals that are not economically significant but that are socially or ethically significant can satisfy the otherwise provision. (Lovenheim) 3. Ordinary Business Operations, Rule 14a-8(i)(7): If a proposal relates only to ordinary business operations and does not raise any important policy questions, then it need not be included. 4. Violates proxy rules (false /misleading proposals), Rule 14-8(i) (3) 5. Personal Grievance, Rule 14-8(i)(4): 6. Subject Matter Beyond Corporations Power, Rule 14a-8(i)(6): 7. Same Subject Matter as Previously Rejected Proposal: b. Process of Review: Issuers initially file request with SEC to not include shareholder proposals in proxy mailings. SEC can either agree or disagree categorically, or suggest a rewrite to the proposing shareholder that will make it mandatory for the issuer to include the proposal. From there, agency decisions are appealable up through the SEC and into district court. 5. Shareholder Inspection Rights (Access to Shareholder Lists and other documents) a. Generally: Shareholder lists are valuable because insurgents will want to target large shareholders to be the focus of their solicitation. Federal law says nothing about when shareholder lists have to be turned over, but state law does. i. Generally, liberal granting of shareholder lists for a proper economic purpose, but more restrictions on business documents (fear competition) b. Rule 14a-7: Permits management to choose whether to mail a rival groups proxy material to shareholders itself and then bill the group for cost or give the shareholder list to the rival group and allow it to pay for itself directly. i. Because management wants to keep the list confidential, it will usually mail the material itself and bill the rival group. ii. Does not trump certain state rights granting disclosure of the shareholder list to rival groups. c. Reasons To Grant Access: i. Generally: Any proper purpose will mandate list access. (Honeywell) ii. Tender Offers: A shareholder desiring to discuss . . . a tender offer should be granted access to the shareholder list unless it is sought for a purpose adverse to the corporation or its stockholders. (Crane) iii. Evaluate Investment Possibilities: a shareholder with a bona fide investment interest could . . . bring this suit if motivated by concern with the long-or short-term economic effects . . . . (Honeywell) d. Reasons To Not Grant Access: i. Junk Mailers ii. Competitor Seeks Trade Secrets iii. Personal Political or Social Agenda: His sole purpose was to persuade the company to adopt his social and political concerns, irrespective of any economic implications to himself or Honeywell. This purpose . . . does not entitle the petition to inspect Honeywells books and records. (Honeywell)


1. Ramseyers Take: As with Dodge v. Ford, if the political or social agenda is simply phrased in different rhetoric to appear like a business agenda, then the desired access will be granted. e. Burden of Proof: When a shareholder is denied access to a list of stockholders, the corporation bears the burden of proving that the shareholders purpose in seeking the list is improper. (Honeywell) For other records, the shareholder bears the burden of proving proper economic purpose to prevent corporate warfare of companies continually seeking business records from competitors. (Honeywell)

1. Shareholder Voting Arrangements a. Generally: Shareholder voting arrangements, which pool voting rights of numerous shareholders, are valid so long as they are limited to shareholder voting. Shareholders cannot combine to determine future BoD actions. b. Purpose: Useful for securing loans or securing individuals to join a firm. c. Types of Shareholder Arrangements: i. Unequal Voting Rights: Corporations can sell different classes of stock: 1. Non-voting shares of stock, or if a state does not allow that (e.g. Illinois) 2. Extra voting shares very cheaply to certain parties and/or shares with no dividend rights (Stroh non-economic stock) ii. Voting Trust: Shareholders get together and put shares in a trust to be voted by the trustee according to the rules of the trust, though shareholders still get dividends (splits economic and voting rights of stock) iii. Vote Pooling Arrangement: Shareholders contract agreeing to combine votes (valid Ringling), with any disagreements settled by an arbitrator, which makes the pool like a trust when there is a disagreement 1. Ringling agreement interpreted like irrevocable proxy, so violating agreement voids your vote, doesnt give arbitrator final decision power. 2. Post-Ringling, many states created statutes to give effect to arbitrators final decision (like a voting trust) [Rams view] 3. Most states limit VPAs to 10 years by statute. 4. Shareholder agreements to vote shares in accordance with the will of the majority are also valid (Ramos v. Estrada) iv. Irrevocable Proxy: Proxies are usually revocable, but can be created otherwise. 1. Usually coupled with an interest (i.e. during employment, while loan outstanding). 2. Shareholder Arrangements Binding Directors (in Closely Held Corporations) a. Generally: Shareholder agreements binding directors are not valid b. Rationale: They seem to breach a fiduciary duty to minority shareholders who are not privy to the agreement (McQuade) i. McQuade v. Stoneham (NY 1934): Rule: a contract is illegal and void so far as it precludes the board of directors, at the risk of incurring legal liability, from changing officers, salaries, or policies or retaining


individuals in office, except by consent of the contracting parties because Directors may not by agreements entered into as stockholders abrogate their independent judgment in management of corporate affairs. 1. Employment Contract: The solution to the McQuade problem is to draft the terms of the shareholder agreement in an employment agreement between the corporation and the employee. c. Exceptions: Agreements binding directors allowed if (1) no prejudice to creditors (2) does not violate public policy, and: i. Unanimous shareholder agreement (Clark v. Dodge - NY 1936) no harm to minority (i.e. directors are only shareholders); or ii. Strong majority agreement and no complaining minority (Galler v. Galler Ill. 1964). 1. Incentivizes consenting shareholder who wants to breach to make it worth the minority shareholders while to complain. iii. Although some cases limit these exceptions to closely held corporations, some cases suggest that they apply to small corporations that are similar to but not technically closely held (Ramos) iv. Ramos v. Estrada (Cal 1992): Seems to apply the letter of the McQuadeClark-Galler law (the agreement is only about how to vote shares [in concurrence with majority] not about director duties), but not its spirit by upholding shareholder agreement that gives corporate control to shareholder who only controls 50% of the group that controls 50.1% of corporation and who uses that control to out officers and directors who disagree with him. 1. Example of court allowing an implicit agreement to elect officers (that comes from voting for BoD) even though it would have been illegal were it made explicit. 2. This agreement is doing an end run around McQuade, but court okay with that. d. Rationale for Exceptions: we want people in closely held corporations to be able to protect themselves 3. Abuse of Control (Freeze Outs) a. Freeze Out: Effort by majority shareholders in a closely held corporation to take away financial interests / rights of minority shareholder, who is then unable to recover fair value for his investment because, unlikely publicly traded corporations, there is no ready market for his shares. Ex: i. Fire them as employee and/or no dividends ii. Trying to get them to sell shares to majority for below-market price b. Solutions: i. Advanced Planning: Advanced planning and contract design mechanisms can often mitigate freeze out problems (though not always): 1. Restrictions on Transfer of Stock: To avoid being forced to work with strangers who may disagree with you, place transfer restrictions on sale of stock i.e. consent / right of first refusal (see below)


a. Partnership Equivalent: Unanimous consent is required to add new partners 2. Forced Purchase of Stock: To avoid a problem like Wilkes or if cash is needed, shareholders can require forced purchases of their stock by either other shareholders or the corporation itself. a. Sale Price: Difficult to decide proper price when shares have no set market. i. Formula calculate based on cash flows and interest rates cheap and easy but inaccurate answer ii. Appraisals - detailed but hard to pick appraiser, possibly biased, and certainly expensive solution. iii. Book value cost less depreciation taken iv. *Buy-sell provision* - optimal (The party that wants out will name a number, and the other side has the option of selling its shares or buying the shares at that price), 1. Only works with indifferent, well-off, 2-man corps. b. Problem: Can be abused, e.g. if shareholder A is in cash crunch, shareholders B & C could threaten to exercise As forced purchase, leaving shareholder A bankrupt. c. Partnership Equivalent: Partners that leave have a right to their interest in the partnership ii. Remedy (no advanced solution): restore minority shareholder as nearly as possible to the position she would have been in had there been no wrongdoing restore benefits which she reasonably expected (Brodie v Jordan Mass 2006). 1. Damages or injunction may be proper 2. Forced buyout is improper if appraisal artificially inflates price b/c there is no market iii. Dissolution (rare): Some states allowed frozen out shareholders to demand dissolution of corporation, in which case the majority shareholders will likely negotiate with the minority shareholder to achieve a fair price to buy him out (buying out is in both parties interests because actual dissolution would result only in scrap value as opposed to the going-concern value (which includes intangible yet valuable assets, such as goodwill) of the corporation). c. Wilkes v. Springside Nursing Home (MA 1976): Majority shareholders have fiduciary duties, akin to those of partners, to minority shareholder in closely held corporation. Court sets out 3-part burden-shifting test to determine shareholder liability for freezing out minority shareholder: i. Breach of Fiduciary Duty: Did the majority breach fiduciary duties by freezing out the minority shareholder (e.g. firing or reducing salary)? ii. Legitimate Business Purpose: If so, burden shifts to defendant to show that the breach was motivated by a legitimate business purpose.


iii. Least Harmful Course of Action: If so, burden shifts back to plaintiff to show that the breach was not the least harmful means to achieve the legitimate business purpose (court must weigh ii. and iii. case-by-case) 1. Ramseyer: Overdetermined case / Unnecessary test a. Majority, as directors, had fiduciary duties to Wilkes as a shareholder (cf. Posners dissent in Jordan, below). b. Alternatively, the court could have applied Sinclair and found the majority self-dealing (acting in both official capacity and private capacity). c. By creating these shareholder duties and complicated burden-shifting test, court added needless complexity. 2. Note: Wilkes is not followed in most jurisdictions d. Smith v. Atlantic Properties (MA 1981): Applies Wilkes to find that a minority shareholder (with 25%) became ad hoc controlling interest and violated fiduciary duties by vetoing dividends (requiring 80% agreement) b/c he was rich and didnt need cash, which subjected the company to IRS tax penalties. i. Problem: Applies Wilkes, but this isnt a freeze-out. ii. Ramseyer: Unnecessary to apply Wilkes: Sinclair would have worked (controlling shareholder fiduciary duties). Also unclear why defendant is liable here as opposed to majority: both groups were controlling and both disagreed with each other and both seemed to be as self-dealing as the other. e. Jordan v. Duff and Phelps (7th Cir. 1987): Closely held corporations that (according to employment contract) buy back their own stock at book value (upon termination of employment) have duty to disclose material information or abstain. i. Ramseyers Take: Posners dissent gets the better of the argument that shareholder was an at-will employee required to sell stock as soon as his employment was terminated (thus a shareholder at will) - removed any obligation to disclose by the corporation because the corporation could have fired him at any time if it did not want the employee to gain the value of the material information and the employee could not have protested. ii. Note: Jordan does not rely on Wilkes duties to achieve outcome in favor of supposedly frozen out employee. Note also that Posners dissent would conflict with Wilkes. f. Brodie v. Jordan (Mass. 2006) proper remedy (damages or injunction) for freeze-out is to restore minority shareholder as nearly as possible to the position she would have been in had there been no wrongdoing restore benefits which she reasonably expected i. Held: Forced buyout (never agreed upon) at expert appraised price exceeded her reasonable expectations (price was artificially inflated b/c there was no market for her shares) remanded to determine remedy 4. Transfer of Control (Control Premiums) a. Control Premiums: shareholders can usually sell controlling blocks of stock for a premium above the price for minority shares. Premium allowed? i. Rationale for allowing: Disallowing will lead to hold-out problem.


ii. Take-me-along provision: If minority shareholders are given right of first refusal, but choose not to purchase majority shares, majority must offer to buy minority shares at the same price iii. General rule premiums allowed, minority not entitled to share, and no take-me-along duty (Zetlin), though individual shareholders in closely held corps can contract for a take-me-along provision so as not to get shut out of a control premium (Frandsen). Some courts have held that control premium must be shared with minority if its the result of looting the company or depriving the corp of its biz opportunities (Perlman)it flows from the general fiduciary duty of controlling shareholders to minority owners. b. Right of First Refusal: Restriction that shares offered to be sold must first be offered to a particular party for purchase. i. A merger agreement does not constitute an offer to sell shares, and thus does not trigger right of first refusal b/c the shares of the acquired firm are not bought, they are extinguished. (Frandsen) c. Forcing Director Resignation and Election of New Directors: Although it is illegal to sell corporate office or management control by itself (that is, accompanied by no stock or insufficient stock to carry voting control), it is acceptable to sell control (including forcing directors to resign) if the transaction involves the sale of a controlling block of shares (Essex).


1. Generally a. Mergers are usually performed pursuant to statute and require approval by majority of the directors and voting shareholders of both corporations. i. Appraisal Rights: Shareholders (of either corp) who voted against the merger are entitled to demand fair cash value of their shares. 1. Exception: Delaware does not give appraisal rights to large publicly traded companies. 2. Ramseyer: Appraisal rights do not make much sense, especially for publicly traded companies where shareholders can just sell on an open market: they create uncertainty for corporations who cannot know in advance how much cash will be needed to satisfy shareholders exercising appraisal rights. b. All-Assets purchase - Alternatively, a corporation could purchase all the assets of another corporation. Benefit: avoiding the unforeseen liabilities of the acquired company and appraisal rights (but the sale can be construed as a de facto merger giving rise to appraisal rights) 2. De Facto Mergers a. Generally: A transaction that is a merger in substance but not statutory form. Courts differ as to whether to treat such mergers as de facto mergers triggering legal rights like statutory mergers or whether to apply an equal dignity rule that considers transactions different in form differently. b. Farris v. Glen Alden (PA 1958): Sale of all of one corporations assets to another in exchange for stock is a de facto merger that gives rise to appraisal rights. 36

i. Farris Rule: A transaction is a merger if it so fundamentally changes the corporate character . . . and the interest of the . . . shareholder therein, that to refuse him the rights and remedies of a dissenting shareholder would in reality force him to give up his stock in one corporation and against his will accept shares in another. c. Equal Dignity Rule (DE): so long as a transaction conforms to a statutory designation, it is that designation and not a de facto anything because all statutes possess equal dignity. For instance, a sale of assets has its own statute different from the merger statute, thus a sale of assets is not a de facto merger (Hariton). 3. Freeze Out Mergers (Cash Out Mergers) a. Definition: Controlling shareholder forms a new corporation (or already has an interest in another corp) that buys out (with cash) the minority of the old corporation freeze-out of minority by forcing them to cash out. b. Purpose: Avoid Sinclair fiduciary duties that controlling shareholders owe to minority shareholders / avoid hold-out problem (minority refuses to sell directly to controlling shareholder) - approval of S/Hs not needed / privatize. c. Legality of Freeze-Out Mergers: i. Preliminary consideration: Controlling shareholder only has the burden to show fairness if there is a risk of self-dealing ii. Fairness (Wienberger, DE): Controlling shareholder must satisfy Sinclair duties - show intrinsic fairness in its self dealing merger: 1. Fair price and fair procedures (but NOT a business purpose). 2. Controlling shareholder has burden of proof unless there is ratification by minority shareholders after full disclosure. iii. Legitimate Business Purpose (Coggins, MA): In addition to fairness, a controlling shareholder must show a legitimate business purpose for a freeze out merger. 1. Shareholder level business purpose (i.e. securing a loan) does not qualify as a legitimate business purpose (contrary to invalid DE precedent in Tanzer). 4. De Facto Non-Mergers a. Definition: A merger in form but not in substance, often a liquidation to avoid certain contractual rights (Frandsen) or payouts to preferred shareholders (Rauch). i. Rauch v. RCA (2d Cir 1988): Delawares equal dignity rule prevents court from construing merger that complied fully with merger statute, but was in actuality a liquidation, as a de facto non-merger. 5. Hostile Takeovers a. Tender Offers: An offer by a bidder to shareholders of a target corporation. Usually the offer is above the market price to induce selling. i. Two-Tier Tender Offer: Takeover bid in which the bidder makes an offer for less than all the shares at one price (the first tier or front end) and then a lower price for the rest of the shares (the second tier or back end). Two-tiered tenders incentivize sales to make the merger go through because shareholders fear they will be stuck with lower back end price.


b. Regulations: State regulations on tender offers vary widely. There are a number of federal rules under the Williams Act: i. Must notify SEC within 10 days of acquiring 5% of stock 1. This requirement would bar Maremonts actions in Cheff 2. Parking Violations: Anybody who holds stock on behalf of the 5% owner must also be disclosed ii. Purchaser must disclose background and plans for target firm iii. Purchasing price must be uniform (any price raise during a tender offer must be made retroactive). 1. Can cap how many shares to buy at a price, but that price must be pro rata for all shares purchased. iv. Tender offer must be kept open for 20 business days 1. Bars Saturday night special defense of announcing a tender offer late Friday and closing Monday so that the corporation has no time to mount defenses. c. Defenses: (NOTE: Ts BoD can always just say no to unsolicited offer, w/o putting in defensive measure or seeking alternative deal) i. Greenmail: Potential acquirer purchases enough shares of target to threaten takeover target purchases its stock back from potential acquirer at premium over market price to buy off the acquirer. 1. IRS has made greenmail subject to 50% tax. 2. Can be legal under Cheff ii. White Knight: Have a more friendly company come in and buy company iii. No-shop Clause: Agreement that a targeted company will not seek a more favorable offer (often used to attract white knights). 1. Revlon makes no-shop agreements in the midst of a bidding war illegal. No-shop agreements are legal only when they serve to secure a pre-commitment; they cannot lock out competitive bidding that will drive the sale price up for shareholders. iv. Lock-up: Option given to a bidder (usually a white knight) to acquire selected assets at a favorable price. 1. Revlon makes lock-up agreements in the midst of a bidding war illegal. Lock-up agreements are legal only when they serve to secure a pre-commitment; they cannot lock out competitive bidding that will drive the sale price up for shareholders. v. Crown Jewels: Targeted corporation sells or gives a white knight a lockup option that covers the targets most desirable business. vi. Poison Pill (Shareholder Rights Plan): Device adopted by targeted corporation that issues a series of preferred stock or other rights that can be redeemed upon being triggered by a certain event, e.g. a takeover. These provisions thus make a takeover excessively costly. 1. Flip-in Poison Pill: All existing shareholders, other than the acquirer, can buy additional shares at a bargain price. a. Deterrent Effect: Massive dilution of target stock value 2. Flip-over Poison Pill: After target is merged into acquirer, holder can buy additional shares of the acquirer at bargain price.


a. Deterrent Effect: Impair acquirer capital structure and dilute interest of acquirers other shareholders. 3. Poison pill option can only be revoked by BoD, so acquirer can still try proxy fight to install a board that will redeem the pill a. A "dead-hand" provision allows only the directors who introduce the poison pill to remove it (for a set period after they have been replaced), so potentially delaying a new boards decision to sell a company. vii. Scorched Earth: Dividending out all the funds of a corporation to make it unattractive to acquirers d. Test for Defense Validity: For self-dealing directors (e.g. majority of directors are officers or EEs), the test is the same as always: proof of objective fairness. For independent directors, the test is less (since they have no conflict of interest). BJR protects independent directors implementing tender offer defense if (1) they had reasonable grounds to believe, as a result of good faith and reasonable investigation, that a tender offer was dangerous to the corporations policy and effectiveness (Cheff) and (2) the defense mechanism was reasonable in relation to the threat posed (Unocal). Will be reasonable in relation to threat if the goal was to carry forward a pre-existing transaction in an altered form; and incurring heavy debt to re-finance that acquisition in response to a hostile offer does not alone render the decision unreasonable (Time-Warner). e. Test (Cont): The directors duty shifts from protecting the corporation to maximizing the sale value for shareholders (Revlon) if: (1) Directors indicate company is for sale / corp initiates active bidding process (Revlon); or (2) Corp abandons long-term strategy, and seeks an alternative transaction involving the breakup of the company (Revlon/Time-Warner); or (3) transaction will cause a change in corporate control (QVC). i. Cheff v. Mathes (DE 1964): Upholds greenmail as a valid defense against a takeover offer. Establishes baseline test for independent directors: burden of proof of showing reasonable grounds to believe a danger to corporate policy and effectiveness existed by the presence of the [tender offer]. . . . the directors satisfy their burden by showing good faith and reasonable investigation; the directors will not be penalized for an honest mistake of judgment. ii. Unocal: Upholds selective stock repurchase defense as made in good faith upon reasonable investigation and reasonable in relation to threat posed by inadequate tender offer. Mesa makes two tier tender offer to buy Unocal with the same price at the front and back end, but the bank end are junk bonds. Defensive tactic: Unocal will buy back their remaining 49% of shares at a high price ($72) if Mesa gets the 51% (then later, regardless). Sort of scorched earth defense since the idea is that nothing will happen because everybody will want the high back-end price, so they wont tender to Mesa in the first place. Mesa sues contending their exclusion violates fiduciary duties owed to it by Unocal. Held: objective to defeat inadequate Mesa offer or provide remaining 49% with $72 are valid purposes reasonable in relation to the threat posed


1. Post Unicol: Counter Tender Offers (Stock Buyback): SEC Rule 13e-4(f)(8): Bans tender offers not made to all shareholders iii. Revlon: Initial bid was low, so poison pill and buyback defensive tactics were reasonable then. Interested board: intermediate scrutiny satisfied with good faith and reasonable investigation. But the Forstmann LBO deal was not acceptable, because the bid was no longer too low. The directors role at that point was not to protect the corp, but to get the highest bid. If its clear that the company is going to get busted up, you should try and get the best price that you can (and the lock-up, no-shop, cancellation fee provisions in Fortsmann deal did not do this). Managers paying too much attention to noteholders, who are protected by contract. They have to pay attention to shareholders. iv. Paramount v. Time - No substantial evidence to conclude Ts board, in negotiating with W, made the dissolution or break-up of T inevitable (as was the case in Revlon). Adoption of defense mechanisms alone does not trigger Revlon duties. 1. Also, Unocal duties were met: Reasonable threat to T (i.e. inadequate value, Ts S/H unaware of benefit T-W could have, etc.); T reasonably informed (explored all available entertainment companies originally, including P, P doesnt meet Ts need); restructuring of T-W deal (including adoptiong defensive measures) was a reasonable response to the threat goal was to carry forward a pre-existing transaction in an altered form (T incurring heavy debt to finance acquisition does not alone render the boards decision unreasonable so long as debt would not be injurious to corps well-being) v. Paramount v. QVC Paramount triggered Revlon duties to seek best value reasonably available to stockholders because the effect of the Viacom-Paramount transaction would be to shift control of Paramount from the public stockholders to a controlling shareholder (Viacom). Paramount directors process was not reasonable due to defensive measures they put into original agreement with Viacom: Stock Option Agreement had unusual and potential severe provisions; Termination Fee made P less attractive to other bidders, when couple with Stock Option Agreement; No-Shop Provision inhibited Ps Board form negotiating with other potential bidders, particularly QVC, which already expressed interest in P.