BUSINESS ORGANIZATIONS II - Shaffer Karl Bekeny/Spring 2001

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I. INTRODUCTION TO CORPORATIONS............................................................................................................5 1. Course Goals......................................................................................................................................................5 2. Applicable Rules.................................................................................................................................................5 A. INTRODUCTION TO CORPORATIONS. [1-15]......................................................................................................................................5 1. Historical Sketch of the Corporation.................................................................................................................5 2. Regulating the Modern Corporation: The Search for Accountability................................................................6 B. INTRODUCTION TO THE ECONOMICS OF THE FIRM. [16-26]{SKIM}......................................................................................................6 C. INTRODUCTION TO THE LAW OF CORPORATIONS: CORPORATE ACTORS AND FIDUCIARY PRINCIPLES. [18-46]..........................................7 1. Basic Terms and Concepts.................................................................................................................................7 2. Fiduciary Principles.........................................................................................................................................10 PROBLEM: CHESAPEAKE MARINE SERVICES [PART I] [37]..................................................................................................................11 D. THE SCHNELL DOCTRINE. EQUITABLE LIMITATIONS ON LEGAL POSSIBILITIES. [46-52]........................................................................12 PROBLEM: CHESAPEAKE MARINE SERVICES [PART II] [46]................................................................................................................13 E. CONSTITUTIONAL CONCEPTIONS OF THE CORPORATION: REGULATING THE CORPORATION’S INTERNAL AFFAIRS; STATE TAKEOVER STATUTES. [53-87]........................................................................................................................................................................................14 1. Corporation as a Person..................................................................................................................................14 2. The First Amendment.......................................................................................................................................15 3. Regulating Corporations’ Internal Affairs.......................................................................................................15 F. AMBIGUITY OF CORPORATE PURPOSE: CHARITY GIVING. [88-107]..................................................................................................17 1. The Doctrine of Ultra Vires..............................................................................................................................17 2. Modern Limitations on Corporate Charitable Giving.....................................................................................18 G. AMBIGUITY OF CORPORATE PURPOSE: SOCIAL RESPONSIBILITY. [107-126]......................................................................................21 1. Corporate Social Responsibility Trends...........................................................................................................21 2. Judicial Approaches.........................................................................................................................................21 3. What is Corporate Responsibility?...................................................................................................................22 II. AUTHORIZING, EMPOWERING AND CONSTRAINING THE CORPORATE ACTOR: STATE LAW REGULATION...........................................................................................................................................................24 A. INTRODUCTION TO BASIC FINANCIAL ACCOUNTING.[187-206] (SEE THE SPREAD SHEETS WITHIN THE NOTES FOR MORE INFO ON ACCOUNTING).................................................................................................................................................................................24 1. Financial Terminology and important concepts:.............................................................................................25 2. Introduction to Financial Analysis...................................................................................................................25 PROBLEM: PRECISION TOOLS [PART III] [187].................................................................................................................................26 B. INTRODUCTION TO CORPORATE SECURITIES. AUTHORIZATION OF STOCK.[220-237]...........................................................................26 1. Types of Financing...........................................................................................................................................26 2. Authorization and Issuance of Equity Securities (stock)..................................................................................27 PROBLEM: PRECISION TOOLS [PART V] [220]..................................................................................................................................28

BUSINESS ORGANIZATIONS II - Shaffer Page 2 of 131 Karl Bekeny/Spring 2001 C. REGULATION OF LEGAL CAPITAL. PAR VALUE.[242-252]..............................................................................................................29 PROBLEM: PRECISION TOOLS [PART VI] [243].................................................................................................................................30 D. PAYMENT OF DIVIDENDS AND OTHER DISTRIBUTIONS.[252-258, 263-278].....................................................................................31 1. Delaware Corporation -- Dividend Rules.......................................................................................................31 2. RMBCA Corporation – Dividend Rules...........................................................................................................31 1. Public Corporations.........................................................................................................................................31 PROBLEM: PRECISION TOOLS [PART VII] [252]................................................................................................................................32 MICHAEL JENSEN: ECLIPSE OF THE PUBLIC CORP..............................................................................................................................33 E. EMPOWERING OFFICERS; ISSUES OF AGENCY.[347-363]..................................................................................................................33 1. The Relationship Model:..................................................................................................................................34 Fiduciary.............................................................................................................................................................34 Owners Dividends..........................................................................................................................................34

Fiduciary..........................................................................................................................................................34 Agency............................................................................................................................................................34 Contracts.......................................................................................................................................................34 2. Action by Executives: Agency Principles and the Authority of the Corporate Officer....................................34 F. FORMAL REQUIREMENTS FOR BOARD ACTIONS.[363-368]..............................................................................................................36 G. CORPORATE COMBINATIONS; SHAREHOLDER VETO AND EXIT RIGHTS.[368-386]..............................................................................37 1. Shareholders’ Veto and Exit Rights.................................................................................................................37 Note: A and B Shareholders are covered under statutory merger rules............................................................43 2. De Facto and De Jure (by-law) Approaches...................................................................................................43 H. SHAREHOLDERS’ RIGHTS OVER BOARD ACTIONS; ASSET SALES.[386-391]......................................................................................44 1. Approval of Corporate Transactions................................................................................................................44 PROBLEM: LAFRANCE COSMETICS [PART II] [386]...........................................................................................................................45 I. SHAREHOLDERS’ POWER TO INITIATE ACTIONS & SHAREHOLDERS RIGHTS TO INFORMATION.[391-416]................................................46 1. Shareholder Meetings; Procedural Concerns..................................................................................................46 2. What Actions Can Shareholders Initiate?........................................................................................................48 3. Board Responses to Shareholder Initiatives.....................................................................................................49 4. Shareholder’s Right of Inspection....................................................................................................................51 J. DRAFTING AND OTHER ISSUES RELATING TO CLOSELY HELD CORPORATIONS, INCLUDING LARGE JOINT VENTURES: CUMULATIVE VOTING , SUPRA-MAJORITY VOTING, QUORUM REQUIREMENTS, SHARE TRANSFER RESTRICTIONS, DEADLOCK & DISSOLUTION.[417-424, 437-440, 449-451, 452-457, 465-467, 490-492].......................................................................................................................................53 1. Control Devices Relating to Shareholder Voting.............................................................................................54 2. Dealing with Dissension, Deadlock, Oppression and Dissolution. [p.466]....................................................57 III. FEDERAL LAW I. SHAREHOLDING VOTING CONTROLS. [P.515-618]..............................................57 A. ROLE OF SHAREHOLDERS IN CORPORATE GOVERNANCE. THEORIES OF THE FIRM; INTRODUCTION TO SECURITIES & EXCHANGE ACT.[515539].............................................................................................................................................................................................58

BUSINESS ORGANIZATIONS II - Shaffer Page 3 of 131 Karl Bekeny/Spring 2001 1. Theories of the Firm. [p.516]...........................................................................................................................58 2. Introduction to the Securities and Exchange Act.............................................................................................58 B. DYNAMICS OF SHAREHOLDER VOTING.[540-561]..........................................................................................................................59 1. The Collective Action Problem. .......................................................................................................................60 2. An illustrative case: Dual Class Recapitalizations. [p. 549]...........................................................................60 C. FEDERAL REGULATION OF PROXY SOLICITATIONS.[561-573]..........................................................................................................61 1. Proxy Rules as they Apply to Management. [p. 562].......................................................................................62 2. Proxy Rules as they Apply to Shareholders.[p. 568]........................................................................................64 D. THE ROLE OF INSTITUTIONAL INVESTORS.[573-594].....................................................................................................................65 1. Constraints on Institutional Investors..............................................................................................................65 2. Institutional Investors and Monitoring.............................................................................................................66 E. FEDERAL REGULATION. SHAREHOLDER PROPOSALS[594-618].........................................................................................................67 1. Evolution of The Shareholder Proposal Rule...................................................................................................67 2. The Rule in Operation......................................................................................................................................68 IV. STATE LAW FIDUCIARY DUTIES: LITIGATION BEFORE STATE COURTS.[P. 619-826]...............72 A. THE ROLE OF OUTSIDE DIRECTORS IN CORPORATE GOVERNANCE.[619-657]...................................................................................73 1. How Boards of Directors Operate [p.622]......................................................................................................73 2. Do Independent Boards Matter? [p.635].........................................................................................................74 WHAT CAN OUTSIDE DIRECTORS CONTRIBUTE? PG 619....................................................................................................................75 B. DIRECTORS’ DUTY OF CARE.[658-684].......................................................................................................................................76 1. The General Standard of Care.........................................................................................................................76 C. THE BUSINESS JUDGMENT RULE.[685-705].................................................................................................................................80 D. THE BUSINESS JUDGMENT RULE AND ILLEGAL CONDUCT.[718-721]...............................................................................................86 E. LIMITATION OF DIRECTORS’ LIABILITY.[P. 721-732, & 740-746]..................................................................................................87 FASHION, INC. PART III [PG. 721]..................................................................................................................................................90 F. INTRODUCTION TO CONFLICTS OF INTEREST AND THE DIRECTORS’ DUTY OF LOYALTY. [P. 747-767]....................................................91 STARCREST CORP. PART I [PG 753]................................................................................................................................................93 G. DUTY OF LOYALTY AND FAIRNESS DOCTRINE. [P. 767-782]..........................................................................................................94 H. DUTY OF LOYALTY AND EXECUTIVE COMPENSATION. [P. 782-796].................................................................................................96 1. Interested Director and Conflict of Interest Transactions...............................................................................97 2. Fairness............................................................................................................................................................97 3. Judicial Review.................................................................................................................................................97 4. Executive Compensation..................................................................................................................................97 I. CORPORATE OPPORTUNITY DOCTRINE. [P. 796-817].......................................................................................................................98 1. Traditional Corporate Opportunity Doctrine..................................................................................................98 2. What is Corporate Opportunity?......................................................................................................................99 3. When May a Corporate Manager Take An Opportunity for Herself?...........................................................100

................... FEDERAL REGULATION OF INSIDER TRADING : RULE 10B-5.............. Materiality................................. THE AFFIRMATIVE DUTY TO DISCLOSE.....984-987 & 989-999]{SKIM 999-1007}.................................... FEDERAL REGULATION........ Causation..... FEDERAL LAW II...................................... [P. DUTY OF DISCLOSURE TO SHAREHOLDERS...106 1.............119 D.....................109 D. 827-838]...............................................................................................................................130 ...................... [P...101 J............................................. FEDERAL LAW III............878-893]....................................................................................103 A.......................... State Law Duty of Disclosure..............................852-878].........112 VI...............................................................111 2................................... 817-826] NOTE: THIS IS ALL COURT GENERATED.115 Court rules for widow who came to director and asked if there was going to be a dividend.............................................. TIPPING.................119 1..................................... REGULATION OF AND OPERATION OF SECURITY MARKETS: INSIDER TRADING........................................................... LIABILITY FOR FAILURE TO DISCLOSE................. [P................................................................................................................ [P...........116 B.......... Remedies for the Taking of a Corporate Opportunity.......106 2........................... 114 A......... [896-905 &909-927].......................... [P....... Regulation of Trading on Non-Public Information.............................................................................121 E............................................ [P................................................................................................................. 1007] (Not Assigned).......................... Fault............................. [Kansas Rule]................................................................ Economic Theory................ [P.......................................................................................BUSINESS ORGANIZATIONS II .................................................. DUTY OF MAJORITY SHAREHOLDERS............................... DISCLOSURE AND SATE LAW REMEDIES... [P............................................................. [P.111 3.................................................... 838-852]............ Securities Markets and Securities Transactions...........114 2........ O’HAGAN................ Informational vs.................109 1............................................................................... Elements of a 10b-5 Action for Disclosure Fraud.................. 969-984]...... Federal Regulation – Section 16 [p......................................... Constructive Fraud........................... The Common Law Background to Insider Trading..................................124 2.......... DUTY OF DISCLOSURE...................................................103 1......... INSIDER TRADING (CONTINUED).............................. Implied Private Rights of Action Under the Proxy Rules......................................................111 1....118 C............. INTRODUCTION TO SECURITIES TRANSACTIONS.............................................. Court holds that because an officer acts in a relation of scrupulous trust and confidence that his behavior is therefore also subject to the closest scrutiny...............127 3......117 1..... RULE 10B-5 CONTINUED............................... LIMITS TO LIABILITY..........................................105 B.................................................................................................................................................................. Disclosure Duties of Corporations.......................................................................102 V..................Shaffer Page 4 of 131 Karl Bekeny/Spring 2001 4......................................... The Scope of the Rule........................... 927-947]............................................................... 947-969]........................ Lost State Remedies...................................................................................108 C.....................124 1.........114 1........................................... FEDERAL REGULATION.............................

Separate. Centralized Management. (5) Look at Ethical Issues. (2) Learn Applicable Rules. Churches and charities were often granted a corporate charter.Shaffer Karl Bekeny/Spring 2001 Page 5 of 131 I. Introduction to Corporations. (4) Look at Public Policy.  What is a Corporation? Four Basic Characteristics: 1. Then with the development of trading of joint stocks in the 16th century corporate charters were granted to other types of businesses. TODAY Corporations Still Receive Their Charter Form The Sovereign (The State Of Their Incorporation). What does the Securities & Exchange Act Authorize? What Can States do?  A. Traditionally corporate existence could only be granted by the king (sovereign). Introduction to Corporations. [1-15] 1. Limited Liability (up to value of capital contributions) 3. Perpetual Entity. Transferability. . 4. 2. Code) (2) Common Law (Tort Law) [Fiduciary Duty.BUSINESS ORGANIZATIONS II . (1) State Law (RMBCA/Del. and (6) Learn Practical Skills. 1. Course Goals. Duty of Loyalty. (1) Learn Technical Terms/Concepts. (3) Look at Economic Theory. 2. The East India Company is an example of one of the first corporations. Federalism Issues. Most corporations incorporate in the State of Delaware because of its advantageous corporate statutory law. Applicable Rules. Duty of Care] (3) Federal Law (1934 Securities & Exchange Act).  What are the problems with Corporate Governance? Division between Ownership & Control. State corporation statutes are referred to as enabling statutes (in general the statutes set up a default framework). Historical Sketch of the Corporation.

Voice [If shareholder democracy is encouraged shareholders can voice their concerns rather than being forced to exit]. and strong fiduciary protection. Enabling Statutes.Shaffer Karl Bekeny/Spring 2001 Page 6 of 131 2. a) Economic Theory. [Traditionalists believe that managers control shareholders and that the law should encourage shareholder voting power. Market Based. (a) Hirschman. Regulating the Modern Corporation: The Search for Accountability. Looks at Multiple Constituencies. this separation between ownership/shareholders and control/managers makes the corporation a breeding ground for opportunism. “Exit. Concession Theories. [16-26]{skim} The corporation is an investment vehicle for raising large amounts of capital and operating large enterprises. broad disclosure rights. Voice and Loyalty” Exit [If managers self-deal then shareholders can sell their shares]. Komesar. Introduction to the Economics of the Firm. [Contractarians believe that corporate law embodies the terms the parties have chosen] (a) Social Enterprise Approach (Social Entity): State/King gives Commission and authorizes what one can do. B. (a) Buy or Sell Shares. Chancellor Allen. 1. (b) 2. “Our Schizophrenic Conception of the Business Corporation” and “Ambiguity in Corporation Law” Private Contractarian Approach (Private Property): Nexus of Contracts. .BUSINESS ORGANIZATIONS II . (c) b) Alternative Theory 1. (b) Loyalty [If over time there is some loyalty in the relationship then you are more likely to maximize some of the welfare]. However. Corporate law allocates risks between shareholders and managers in an attempt to minimize shareholder-manager conflict and maximize the overall success of the corporation.

Stock options. Managers and employees who do not have as large and economic stake in a corporation as an owner would may shirk their responsibilities (shirking refers to not working hard) or self-deal. Basic Terms and Concepts. A corporation arises when articles of incorporation are filed with a state official.Shaffer Karl Bekeny/Spring 2001 Page 7 of 131 a) Risk The division between ownership and control creates Agency Costs. from surplus or earnings. Distributions.03. In a planning context a lawyer needs to thinks about the different parties risk preferences and plan accordingly. Financial rights are allocated according to shares.01. bonuses based on sales or performance. regardless of what happens to shareholders. [18-46] 1.). eg. Corporate existence is perpetual .40.  Financial Rights – Claims on Assets and Income Stream. Buy Insurance. .. The corporation has a centralized management structure. salary based on performance.  Allocate risk to the employee/management: Give employee a stake in the company.BUSINESS ORGANIZATIONS II . RMBCA § 6. Of course there are other types of risks that are out of the hands of the parties (weather.  Life Span – Formation and Duration. Its business is under the management and supervision of the board of directors.. RMBCA § 8. except as fixed by contract.  Allocate risk to the employer/owner: Supervise. Directors and officers have no right to remuneration. etc. b) Allocating Risk Allocating risk may reduce cost of shirking and stealing. or officers. (Note: this may help to prevent some of the shirking). Contract. must be approved by the board of directors.  Firm Governance – Authority to Bind and Control. C. directors. (a) Corporation.01. RMBCA § 2. RMBCA § 6. war. Introduction to the Law of Corporations: Corporate Actors and Fiduciary Principles.

[p. Contents of Certificate of Incorporation.06 Bylaws.03. (b) what you may include: contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with the law . RMBCA § 6.  Sources of Law. (b) what you may include: purpose for which the corporation is organized. RMBCA § 6. RMBCA § 8. RMBCA § 2. (4) purpose for which the corporation is organized. (3) Corporation’s address. Shareholders have limited liability for corporate obligations.BUSINESS ORGANIZATIONS II . This is also true for directors and officers acting on behalf of the corporation. 21] DGCL § 109. large creditors of small corporations will demand that corporate participants personally guarantee the corporation’s obligations.02 Articles of Incorporation. 305] . indemnification provision. (2) Corporation’s address. 299] (a) Must include: (1) name of corporation. Corporate shares are freely transferable unless there are specific written restrictions.41. Revised Model Business Code (RMBCA). and decide specified fundamental matters.” Often. and (4) Name & Address of Each Incorporator.  Transferability of Ownership Interests. they cannot bind the corporation. [p. [p. DGCL § 102. RMBCA § 2. By-Laws.Shaffer Karl Bekeny/Spring 2001 Page 8 of 131 Officers carry out the policies formulated by the board. and (3) Name & Address of Each Incorporator. (2) Number of Shares corporation is authorized to issue. [p. Shareholders elect the board. provision limiting liability of shareholders. Delaware General Corporation Law (DGCL).27. Liability to Outsiders. Corporate participants can lose only what they have invested unless there is fraud or an inequity justifies “piercing the corporate veil. RMBCA § 8. limit duration. (5) Number of shares the corporation is authorized to issue. thus reducing the significance of corporate limited liability. 18] (a) Must include: (1) name of corporation.22.  (b)Corporate Statutes.

The power to adopt. What is the difference between issued and outstanding shares? Issued: Shares that have been sold. [p. (b) The by-laws may regulate the business in anyway so long as they do not conflict with either the AIC or the Law.  Authorized. Issued: Shares that have been sold. but this does not take away the shareholders rights. Outstanding Shares. is in a “lawful business. Why have outstanding shares? Issuing shares is a way to raise capital.” otherwise. amend or repeal may also be given to the BOD through the CIC. RMBCA § 3. Page 9 of 131 (a) Before the stock is paid for BOD can revoke. Issued. Outstanding: Issued shares less what the board has bought back from the market. DGCL § 102(a)(3). What is the difference between authorized and issued shares? Authorized: Shares board is authorized to sell. elected by shareholders.  Stockholders/Shareholders “own” the corporation in that they own its stock. but once paid only a vote of the shareholders has this power.Shaffer Karl Bekeny/Spring 2001 (a) must have bylaws. They are responsible for managing or supervising the corporation’s business. (c) Organic Documents. 298] The purpose of the corp must only be that it is behaving lawfully.  The Articles of Incorporation and The By-laws.BUSINESS ORGANIZATIONS II . 22] (a) Only requisite purpose is that the Corp. directly control the corporation. By setting out in the Articles of Incorporation the number of shares that the board is authorized to sell share dilution can be prevented. Shareholder approval must be obtained before a corporation can engage in certain fundamental transactions (merger or the sale of all its assets). they AIC can specify even more. (b) Bylaws may contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with the law or the articles of incorporation. (e) Corporate Securities.01 Purpose.  Board of Directors. (d)The Corporate Actors. [p. .

. Corporation’s president’s wife sings on the program.  Breach of Loyalty..BUSINESS ORGANIZATIONS II . What rights are inherent in shares? Right to Dividends. [p. Common Shares no preference with dividends. Corporation may have right to buy back shares or bonds at a set price. Court found no breach because wife did not get paid much and the board voted before they knew that president’s wife would be singing. there are limits to applying BJR (Can’t be a dummy or a figure head). Conversion Redemption Rights. 2. Breach of Fiduciary Duty.. [Was there self-dealing? Burden is on board. it creates a presumption in favor of the board. (protects against takeovers) Residual Rights.39] FACTS: Board votes on radio advertising campaign (opera program/sponsor). Equity Shareholder Equity = Shares Debt Secured bonds that can be traded on the market. Debt. Business Judgment Rule is a shield that protects the Board.] HOLDING: Court holds that this decision was within the board’s discretion (Business Judgment Rule). Preferred Shares gets preference with dividends. There is such a thing as Preferred no voting right stock. Right to Vote.  Fiduciary Duty. Fiduciary Principles. Breach of Duty by Shareholders: .?  Equity v. Classes of Shares. When corporation is liquidated then .. Beran (1944). Shareholders bring a derivative suit (meaning a suit on behalf of the corporation) because of what they perceive as a breach of fiduciary duty for choosing to sponsor an opera program versus a variety show.Shaffer Karl Bekeny/Spring 2001 Page 10 of 131  Categories of Rights. Common Shares always must have a right to vote. Breach of Duty by the Board: Bayer v. However.

(e) Note: Conditions from BOD in 10. Apple can block the proposed method for raising capital because he own 1/3 of the common stock and it would take 2/3 vote for a change of the AIC. Note. basically having to operate within the law and the AIC.27. RMBCA §§ 2. Note this case highlights the distinction in roles and duties between shareholders and directors. For the Court to Act a case must be made that the majority shareholder’s action so far opposed the corporations interest that no one would have acted in this manner. subject to limitations of the AIC or shareholder agreement under §7.25 Voting Requirement: (a) A majority of votes entitled to be cast constitutes a majority (b) there are special rules for amending the AIC. 7.BUSINESS ORGANIZATIONS II . HOLDING: Court holds that shareholder can vote as he pleases (Vote his Shares). IF THEY ARE GREATER.27 Greater Quorum or Voting Requirements. therefore. Problem: Chesapeake Marine Services [Part I] [37]  BJR-This shields the management from ex post facto judicial review for their managerial actions. want to protect their sanctity. RMBCA §10.01(b) BOD governs the corp and they have great discretion. Note. The result would be different if we were looking at a majority shareholder. (b) must meet the same quorum requirements and be adopted by the same vote and voting groups already required or proposed to be adopted. Note. Queens County Water Co. OR MERGE. there is a desire to dampen this type of vote because the AIC are like the constitution of the corporation. or potentially the by-laws.  How can you retrieve capital? (1) issue equity. limitations. Note. 8. [p.01(a) AIC must describe the class of shares and # each class authorized to issue. which must be identical to those of the same class and described in the AIC. essentially this is the legal minimum. 6. mortgage property. §7. and relative rights of each class of shares. any restriction can only be larger. Yet.  Note. Shareholder then sells this to Corporation he is a shareholder of (votes in favor of the transaction). (b) what AIC may set forth.  Voting Law: RMBCA §7. 44] FACTS: Shareholder builds a water system on his own.32.02 (a) tells what must be in the AIC. in this case we were dealing with a minority shareholder.k. set forth preference.03 Amendment by BOD and Shareholders (c) allows the BOD to condition their submitted amendment on anything.01(b) The BOD shall manage the corporation. there may be two exceptions to the BJR in this context: (1) if the majority was fraudulent and only out to harm the minority shareholders. sell property. (1890).  RMBCA §8. . (2) the majority was simply oppressive to the minority. so long as the requirement is greater than the default. must be at LEAST a majority of those who are allowed (Shares) to vote for quorum. debt.03(c) is o.Shaffer Karl Bekeny/Spring 2001 Page 11 of 131 Gamble v.

. 10. This type of behavior goes against shareholder democracy. Board knows that they will not get a unanimous vote from the preferred class shareholders to go . 242(b)(1)-the BOD shall propose an amendment that shall be set forth for majority approval and therefore acceptance by the shareholders. What options are available to Shareholders? Exit (sell shares on market) or Exercise Voice(vote). 141(a) The corporation shall be managed by the BODs. Court orders an injunction because “inequitable action does not become permissible because it is legally possible.Shaffer Karl Bekeny/Spring 2001 Page 12 of 131 10. held the meeting in the boondocks. Code §§ 102(a)(4) Tells what the AIC should set forth. no # quorum requirement shall be under 1/3.03(a) the proposed amendment must be adopted by the BODs. §109(a) would allow the director to confer. Community Hotel Corp. D. lease. (b) shareholders never have a vested property right in the corporation. of Newport.02(a) “A sale. or other disposition of assets. and did not release a list of shareholders (Federal Law) in order to prevent shareholders from electing a new board of directors. Equitable limitations on legal possibilities. majority is good enough for approval. Code/yes). Yet. [p.BUSINESS ORGANIZATIONS II . 49] FACTS: Preferred Class of Shares w/right to dividends for 24 years. HOLDING: Board of Directors did nothing to technically violate Delaware law. (3) directors shall be elected by a plurality.” Del. adopt.01 (usual course of business stuff) requires approval of the corporation’s shareholders if the disposition would leave the corporation without a significant continuing business activity. 216 The CIC or By-laws determine quorum and those votes required for corporate transaction approval.” Court was bothered by the board of directors self-dealing in trying to perpetuate their existence. Bove v. RI (1969) [p. exchange. (2) in all votes other than election of BOD. other than a disposition described in 12. 11. repeal or amend the by-laws.01(a) corporation can add or delete any provision it may wish from AIC.03 Share exchange. ABSENCE OF CIC OR BY-LAW SPECIFICATION (1) majority unless CIC at shareholder meetings is quorum. except as provided in the CIC. 12. Inc. Chris-Craft Industries. There is a process here that does include a BOD recommendation and brief description of the proposed changes. (1971). [46-52] Schnell v. The Schnell Doctrine. 47] FACTS: Board of Directors moved annual shareholder meeting up a month(Del.

Merger only requires 2/3 vote from the shareholders. Inc. each share has a real value of $150 ($525.500 shares at $100 per share). not themselves. 2. The second claim is whether the BOD action was “unfair.000) compared to the Lamberts for their investment ($75. However. Here the members of the board can refer to the BJR in defense of their actions.000/3. and the BOD is seeking to act in the benefit of the corporation.” That is.000 investment. You are told that both the corp and the lamberts invested in the new subsidiary.BUSINESS ORGANIZATIONS II . here are the math calculations: a. What is the value of total assets of Shipyard? Shipyard will have assets of $525.000 investment. HOLDING: Court refuses to enjoin the merger. What is FMV of each Shipyard share? Since 3. Board creates a new corporation and proposed to merge the old corporation into the new one and get rid of the preferred stock . What is FMV of Lambert’s shares? Value of Lambert ownership=$122.500 shares issued. you can do x.Shaffer Karl Bekeny/Spring 2001 Page 13 of 131 through w/amendment which will terminate the preferred shareholders rights. merger in the interest of 2/3 of shareholders (why enjoin to protect 1/3 minority). you must do some simple math.000. Court cites the BJR. How do we reconcile Schnell and Bove? To start with there is a difference in the significance from recapitalization and reorganization. there is also no threat of injuring “corporate democracy” in Bove.000 cash (subscription price of 1.  Doctrine of Independent Legal Significance If one provision of state corporate code says that you can do x but somewhere else in the code it says that you can’t do x.000=$375. .000 in cash). The bottom line is to compare the number of shares that the Lambert’s received for $375. court does not want to create exceptions that will interfere with M&A deals. The issue is whether the corporation received a fair number of shares in Shipyard for its investment (a division with a fair market value of $375.500 value.” That is. What investment made by Lamberts? Lamberts get 750 shares at $100 per share=$75.000 ($375. b.500 (or 750 shares x $150 per share). did the BOD breach a duty of loyalty to the corporation and it shareholders. did the board breach its duty of due care to the corporation (“Chesapeake”) and its shareholders. Board wants to eliminate the preferred shareholders right to dividends so that the board can raise capital by selling shares (people will not buy shares if they won’t get any dividends because of the preferred shares). d.500) c. (“Shipyard”). The First claim is whether the was “unwise. they receive $112. so for 75. To make this determination.000 FMV of Shipyard)+$150. named CMS Shipyard.  Problem: Chesapeake Marine Services [Part II] [46]  Evaluating three potential claims by Apple: 1.

4. What is investment made by Chesapeake? Chesapeake contributed the assets of its Shipyard division with a FMV of $375.47. there are equitable limits as to what actions the board can take. [53-87] 1. Corporate personality makes possible the aggregation of capital and the convenience of a business entity capable of contracting. owning property suing. Corporation as a Person. even if technically legal under a provision of the state corporate statute. . There are two lines of applicable cases. 3. The third claim is whether the transaction is unlawful because Chesapeake is doing indirectly (raising capital through the issuance of new shares) what it can’t do directly.000 and (ii) require a 2/3rds vote to amend the AIC. should Schnell or Bove apply?  Derivative Suit Is an action in equity brought by a shareholder on behalf of the corporation. This exception applies in order to preserve “corporate democracy. State Takeover Statutes.000. It can’t do this directly because of the provisions in its AIC that (i) limit the number of authorized shares to 1. management of affairs. individuality. 2. 3. The action is brought against the corporation for failure to bring an action in law against some third party. f. and being sued.Shaffer Page 14 of 131 Karl Bekeny/Spring 2001 e. E. Woodward (1819) The State could not amend the charter because the charter was within the constitution which constituted a K between the state and the college) The charter may provide for 1. a board can accomplish actions that otherwise would be prohibited through a reorganization or recapitalization that is authorized by a separate provision of the state corporate statute.BUSINESS ORGANIZATIONS II . but FMV of division was $375. Holding of property. What is FMV of Chesapeake shares? Chesapeake gets 2000 shares whose value is $300.000. Constitutional Conceptions of the Corporation: Regulating the Corporation’s Internal Affairs. In the Chesapeake case. Under Schnell.40-7. most often an unfaithful or careless manager. (Trustee’s of Dartmouth College v. Clearly the current structure is “unfair” to Chesapeake and needs to be changed to protect the Lamberts from a claim that they have breach their duty of loyalty. For commercial purposes. The corporation is the real party in interest is a nominal defendant and the plaintiff-shareholder controls the suit. RMBCA §§ 7.” Under Bove and the doctrine of independent significance. state and federal law largely respects the corporation-as-person metaphor. Immortality.000 (or $150 per share value x 2000).

Internal Affairs Doctrine. 58] HOLDING: Supreme Court held that a state cannot forbid a corporation from expressing its views on a state referendum. Louis Railway Co.  Internal Affairs refer to the rights of shareholders.Shaffer Karl Bekeny/Spring 2001 Page 15 of 131 Commerce Clause. due process (life and liberty). v. 2. Regulating Corporations’ Internal Affairs. Bellotti. even when the referendum does not materially affect the corporation’s business. (Hale v. Choice of law rule which permits the parties though the incorporation process to fix the law that applies to their corporate relationship. Henkel (1906) protects the corp from illegal searches and seizures under the 4th Amendment. NO PROTECTION or limited rights: Self-incrimination. political (noncommercial) speech. Corporations are protected against state restrictions that burden interstate commerce. the law of the state of incorporation governs the internal affairs of the corporation. (1978) [p. wherever litigation is brought. Southern Pacific Railroad (1886) Corp entitle to EP under the 14th Amendment). the fiduciary duties of directors. Corporations have a limited First Amendment First Amendment right to express themselves as to commercial matters – such as advertising their products. Some states (CA) regulate the internal affairs of corporations that have substantial operations in the state but are incorporated elsewhere. (Minneapolis & St. Due Process Clause (property interests). Thus.BUSINESS ORGANIZATIONS II . 3. Beckwith (1888) corp is also entitled to the due process of law. (Santa Clara County v. The First Amendment. State Anti-Takeover Statutes. (These are basically regulating Tender Offers)  . unreasonable searches and seizures. but there are no 5th Amendment incrimination protections. Corporate property is protected against governmental deprivation under the Due Process Clauses of the Fifth and Fourteenth Amendments. and the procedures for corporate actions among others. First National Bank of Boston v.

. have enacted anti-takeover statues. Appraisal Statutes. not unreasonable. Pro: protect local communities. shirk. It was held unconstitutional (1) Violation of “policy of neutrality” within the Williams Act. It does not prohibit any entity. Business Combination Statutes. or from purchasing shares in Indiana corporations..76]} The Ill statute set up timetables and requirements for outside tender offers. Second Generation. Delaware Statue. or from thereby attempting to gain control.Shaffer Karl Bekeny/Spring 2001 Page 16 of 131 Today most states. The statute does not interfere with the bidding process . why: Williams Act-not a problem because (1) Not necessarily any delay. if Congress wants different. the bidder’s “control shares” would not carry voting rights. required disinterested shareholders (excluding the bidder and management) collectively vote to approve the voting rights of any bidder who sought to acquire a controlling interest in the corporation. It only provides better regulatory procedures designed to protect the corporation’s shareholders.BUSINESS ORGANIZATIONS II . (2) even if delay. Dynamics Corp. Con: allows management to be lazy. MITE Corp. [p. part of the Security and Exchange Act and (2) ICC prevents state laws which regulate interstate commerce. §8. and shareholders. That is. then let them say so explicitly.. v. First Generation. 1989 Control Share Statutes. Fair Price Statutes. (3) State reg.77] {second-generation antitakeover statute} FACTS: Dynamics contends that the Indiana Anti-takeover statute is unconstitutional because it discriminates against out-of-state entities. prevent stripping of corporate assets. Amanda Acquisition 7th Cir. until the body of shareholders voted to enfranchise. The policy behind this is that hostile takeovers hurt the local economy and tax base. HOLDING: Statute is constitutional and not inconsistent with the Williams Act. The statute. of America. US [p. {Edgar v. including Delaware. “Indiana need not define these commodities as other states do. There are Three Generations of anti-takeover statutes. CTS Corp. which applied only to corporations incorporated in Indiana with significant Indiana shareholdings. resident or non-resident. it need only provide that residents and non residents have equal access to them. from offering to purchase . Commerce Clause Violation Art I.” Third Generation. tax base. CTS US 1987 Supremes uphold. etc. There are pros and cons to these statues.

F. [Corporate Democracy] Market forces. HOLDING: Statute is constitutional.BUSINESS ORGANIZATIONS II . (2) Dodd believed that corporations should serve the community (social service) as well as its shareholders (profit making). [88-107] Corporations represent independent concentrations of economic power. Amanda wanted to merge with Universal and strip Universal of its assets.83] {Third Generation Business Combination Statue} FACTS: Amanda was a shell (debt and junk bonds) with a corporate purpose to takeover Universal. Delaware has enacted anti-takeover statutes and seems to be doing just fine. v.Shaffer Karl Bekeny/Spring 2001 Page 17 of 131 and comports with the traditional power of states to regulate the internal affairs of domestic corporations. Under Wisconsin statute the existing board has to approve the deal otherwise the bidder has to wait 3 years after buying shares to merge with the target or acquire more than 5% of its assets. Note: this does not seem to be the case. . Judge Easterbrook thinks it is a foolish statute because corporations will leave Wisconsin. The Doctrine of Ultra Vires. and the mechanics of corporate governance constrain managers’ discretion. Universal Foods Corp. Inc. Ambiguity of Corporate Purpose: Charity Giving. [Managerialism]  Berkshire Hathaway. [p. [p.  Whose interests should the corporation seek to serve? Two views: (1) Berle believed that corporations should serve shareholders at all times (profit making). Some argue that corporations represent social and political power as well.. Mason and others argue that the corporation lacks legitimacy because managers are accountable to no one. permits each shareholder to direct the corporation to donate a certain amount per share to the charity of the shareholders choice. government regulation. 107] 1. Amanda Acquisition Corp.

is a common law doctrine from the nineteenth century. DGCL § 101 (b).01 Purposes.” Under the Ultra Vires Doctrine a corporation may not engage in activities outside the scope of its powers as stated in the corporation’s charter.. Richie. except as may otherwise be provided by the constitution or other laws of this state. Today the doctrine of ultra vires has little life left in it. Thus.04 Ultra Vires.. v. HOLDING: House of Lords holds that a corporation whose charter authorized it to “sell or lend all kinds of railway plant. Modern Limitations on Corporate Charitable Giving. RMBCA § 3.. except as provided in subsections: (b)(1) which allows shareholders to bring suit and enjoin the corporation from entering into or continuing unauthorized action. a corporation has the power to (5) . etc. Ashbury Railway Carriage & Iron Co.. A corporation may be incorporated or organized under this chapter to conduct or promise any lawful business or purposes.02 General Powers.. and (b)(2) which allows the corporation to bring suit on its own or by another on its behalf [derivative suit] to enjoin the corporation from entering into or continuing unauthorized action. It literally means “beyond the power. State enabling statutes authorize “general purpose” clauses and virtually unlimited powers. (1875) [p. a corporation “has the purpose of engaging in any lawful business” unless the articles of incorporation provide for a more limited purpose.” exceeded its purposes in purchasing a concession to build and operate a railroad in Belgium. RMBCA § 3. to carry on the business of mechanical engineers and general contractors. 91] FACTS: Railway hires Richie to construct a railway line in Belgium. when applied the doctrine invalidated actions that went beyond the corporations purpose as stated in the corporation’s charter.BUSINESS ORGANIZATIONS II .the validity of a corporate action may not be challenged on the ground that the corporation lacks or lacked power to act . DGCL § 102 (a)(3) Contents of Certificate of Incorporation. RMBCA § 3..Purposes. .Shaffer Karl Bekeny/Spring 2001 Page 18 of 131 Ultra Vires. The corporation repudiates the contract after Richie had done some of the work on the ground that it lacked the power to hire Richie. 2. Richie brings suit.

. or otherwise dispose of all or any of its property. or (2) the corporation engages in activities not directly related to profit seeking. a board member. challenging that the gift Alexander Dawson.P. The factors to consider are there going to be any short-term (this is deductible and has no big effect.and share option plans. such as charitable giving.” (6) “purchase .BUSINESS ORGANIZATIONS II . Note that the company argued and the court accepted the argument that the gift advanced the company’s long-run business interests.any other entity. Smith.). Make donations for the public welfare or for charitable.. Thus. Inc... [ Background.P..” (13) “make donations for the public welfare or for charitable. family controlled company. scientific.] HOLDING: Applies A. made to the Alexander Dawson Foundation (camp for underprivileged boys). mortgage ... v. today the ultra vires doctrine only applies when: (1) a corporation acts in a manner restricted by the corporation’s articles of incorporation. 95] FACTS: Theodora holding company brings suit against Henderson and other individuals. so as to constitute a “waste” of corporate assets. and in time of other national emergency in aid thereof. Note: “WASTE” is really what is left of the Ultra Vires doctrine. supported. A. Henderson. holding that the gift in question is valid because it was within reasonable limits as to amount and purpose (cost shareholders less than 80K and went to benefit troubled youth). Theodora Holding Corp. v. (1953) [p. scientific or educational purposes.” The purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under Delaware Corporation Law except if the articles of incorporation state otherwise DGCL § 122 (9) Specific Powers.” (12) “pay pensions. Smith Manufacturing Co. look it helps balance the corporate balance sheet) or long-term benefits (this would include social welfare etc. family fighting... Theodora sought an accounting and appointment of a liquidating receiver for Alexander Dawes. .or otherwise acquire. or educational purposes. (1969) [p.Shaffer Karl Bekeny/Spring 2001 Page 19 of 131 “sell.89] Court upholds the validity of a corporate gift to Princeton University. This may include golden parachutes or heavy compensation programs for company executives. Barlow. ex-wife wanted money to go to a charitable foundation she and her daughter.

its findings of fact are supported by the record.A. there appears to be no “self-dealing. corporate law treats it as a reasonable exercise of corporate powers [BUSINESS JUDGMENT RULE] See Kahn v.97] FACTS: This is an appeal from the approval of the settlement of one of three civil actions brought be shareholders. Per the holding in Theodora Holding Corp.” breaking the fiduciary duty of loyalty. § 170 (deduction for corporate giving limited to 10 percent of the corporation’s taxable income).BUSINESS ORGANIZATIONS II . the court of chancery applied a reasonableness test. a fiduciary breach of care. its annual net income before taxes. The board investigated and hired a law firm to prepare a memorandum regarding the relevant issues the board should consider regarding the proposal. Such corporate altruism may also constitute corporate waste. Not every charitable gift constitutes a valid corporate action but here given the net worth of Occidental.  If corporate largesse is demonstrably unrelated to corporate benefits (e. See Theodora Holding Corp. Special Committee decides to establish museum next to corporate offices and notes that museum would create a new cultural landmark in L. Hammond made the proposal to the board. if the gift is tax deductible. Note: (1) By using a BOD committee of “outside” directors. {Public Recognition/advertisement argument} [Lawyers made a lot of money in negotiating the settlement]. courts generally have accepted that corporations have implicit powers to make charitable gifts that in the long run may benefit the corporation. Art museum was built in Los Angeles. Sullivan. the gift was within reason. Each civil action alleged corporate wasting of assets and challenged a decision by Occidental’s board through a special committee of Occidental’s outside directors to make a charitable donation to construct and fund an art museum to house the now deceased Occidental CEO’s.C. Dr. Armand Hammer. Sullivan and I. HOLDING: The court of chancery did not abuse its discretion in approving the settlement. when the gift is excessive) the transaction may be attacked as ultra vires. if the money is then .Shaffer Karl Bekeny/Spring 2001  Page 20 of 131 Thus.g. (300-400 million dollar collection). and the tax benefits to Occidental. However.  Kahn v. Before he died. Occidental is headquartered in Los Angeles. (2) There doesn’t appear to be any waste because the entire deal seems reasonable. (1991) [p. Dr. Moreover.R. The museum was to be named the Armand Hammer museum and Occidental’s name would be placed in various places throughout the museum.

G. Judicial Approaches. to enjoin construction of the River Rouge plant. (1968) [p. To do this we are putting the greatest share of our profits back into the business. to help them build up their lives and their homes. 110] FACTS: Action brought by Dodge brothers. Defendant argued that baseball is a daytime sport and that night games will deteriorate the surrounding neighborhood and in turn the value of the stadium. and for other relief. Dodge v. to provide the public with cars at a fair price. More and more corporations are attempting to take a stance and act on social issues (the environment. Corporate Social Responsibility Trends. against Ford Motor Company.. . Ford Motor Co. This policy ended up bringing Ford enormous success. However. Ford appealed. Henry Ford stated: “My ambition is to employ still more men. and not to make an awful profit. Ambiguity of Corporate Purpose: Social Responsibility. The lower courts order of dismissal is affirmed.” Ford wanted to build more cars and sell them at a lower price so more people could enjoy the benefits of a car.115] FACTS: Plaintiff sought damages and an order that defendants cause the installation of lights in Wrigley Filed and the scheduling of night baseball games. The lower courts ordering of payment of the dividend is upheld. HOLDING: A business corporation is organized and carried on primarily for the profit of the stockholders. the plant may be built. such as in self-dealing. to compel payment of a dividend. and other members of the board of directors. Wrigley.Shaffer Karl Bekeny/Spring 2001 Page 21 of 131 only used for the managers. Henry Ford.BUSINESS ORGANIZATIONS II . HOLDING: Court holds that it is within the Board of Directors’ business judgment to make this kind of decision. two minority shareholders. to spread the benefits of this industrial system to the greatest possible number. [BJR] Shlensky v. (1919) [p. The lower court ruled for the Dodge brother and ordered the Ford Corporation to pay a 19 million dollar dividend and enjoined it from building the River Rouge plant. workers rights – but only after pressure from shareholders or public at large) 2. [107-126] 1. The proposed expansion of the Ford Company is within the province of the board. then this would be a breach of the duty of loyalty. His goal was to employ a large amount of people at good wages.

2. “principles of Corporate Governance: Analysis and Recommendations” (A Conglomerate of all the Ideas) The corporation’s purpose is to enhance corporate profit and shareholder gain but do so by not breaking the law and optionally taking into consideration ethical considerations and optionally making a reasonable amount of money to philanthropic purposes. What is Corporate Responsibility? Milton Friedman. A lawyer in rendering advice to a client should exercise independent professional judgment and render candid . “Capitalism and Freedom” (Shareholder Capitalism) 1. “Social Regulation of Business Activity: Reforming the Corporate Governance System to Resolve an Institutional Impasse” (Altruistic Capitalism) Corporations are creations of law. no matter the costs involved to the lawyer. today corporations must promote social welfare through “altruistic capitalism. Elliot Weiss. 3. transactions which the lawyer believe is unlawful. “Lawyers. Norman Redlich. and have as their ultimate purpose the welfare of society.BUSINESS ORGANIZATIONS II .” [make decisions as if corporation bore all the transactions costs] He purposes the national directors corps. members appointed by the president. or participate in. In early days corporations could achieve this goal by promoting their financial wellbeing. There is one and only one social responsibility of a corporation – to use its resources and engage in activities designed to increase profits so long as it does not break the law. Would require large corporations to draw 2/3 of its directors from the corps. The Temple. 4. and the Market Place” Lawyers have a professional duty to refuse to approve of. (2) is Weiss. However.01 (1) is Friedman. ALI §2.Shaffer Karl Bekeny/Spring 2001 Page 22 of 131 3. and (3) is Theodora Holding.

Shaffer Karl Bekeny/Spring 2001 Page 23 of 131 advice – including unpleasant facts and alternatives a client may be disinclined to confront. These typically were applied together with anti-take over statutes. this would include how can management keep its job.  Constituency Statutes-These state laws allow for the BOD to consider other things than shareholders when making their management decisions.BUSINESS ORGANIZATIONS II . .

The two basic financial statements are the balance sheet and the income statement.Shaffer Karl Bekeny/Spring 2001 Page 24 of 131 Authorizing. II.[187-206] (See the spread sheets within the notes for more info on accounting) When you look at a balance sheet you want to find out about the profitability of the corporation’s operations. money that customers owe the corporation. and whether the corporation will be able to meet its financial obligations as they come due. the value of its assets. They are divided into current and long-term. Accounts Receivable. plant. Empowering and Constraining the Corporate Actor: State Law Regulation. Equity represents the owner’s interest in the firm ($ they put into it) . equity and cash flow. Look at the corporation’s liquidity. debt coverage.BUSINESS ORGANIZATIONS II . When you are faced with a balance sheet look at the current assets and the fixed assets (left side) and the liabilities and equity (right side). Liabilities represent money the corporation owes.  Some Basic Terms: Assets = liabilities + equity. and equipment. A. Fixed Assets sometimes referred to as property. Introduction to Basic Financial Accounting. Assets are both tangible and intangible property owned by the corporation and will be listed in terms of decreasing liquidity (the ability to be converted into cash on the balance sheet) Current Assets include cash and other assets which in the normal course of business will be converted into cash within a year of the date of the balance sheet. are the assets a firm uses to conduct its operations (as opposed to those it holds for sale).

b) Retained Earnings. Debt: Equity Ratio = divide long-term debt by the book value of its equity.” (1)Revenue Recognition-The revenue is recognized when it is earned. . (2)Expense Recognition-“Matching. and what exists. Current Ratio = divide current assets by current liabilities. b) Debt Coverage Analysis. a) Liquidity Analysis.Shaffer Karl Bekeny/Spring 2001 Page 25 of 131 1. Financial Terminology and important concepts: a) Accrual Accounting-This is verse “Cash Accounting. ** Liquidity Ratio = divide quick assets (things with high liquidity) by current liabilities. Also.” This forces a match up between paying out salaries. Does the firm have sufficient money or convertible assets that can be used to meet financial obligations as they come due? Working Capital = the difference between current assets and current liabilities. c) Equity Analysis In valuing a firm analysts tend to focus on equity accounts and income statement. ***Analysts prefer current assets to be at least twice as large as current liabilities. Introduction to Financial Analysis. Creditors are interested in a corporation’s ability to pay its debt on time. look for trends in revenues and earnings.BUSINESS ORGANIZATIONS II .(Retained Earnings=Net Income – Dividends) c) Working Capital-(Current Assets-Current Liabilities) d) Operating Income-(Before interest + Taxes) 2. etc. A ratio of 1:1 indicates that the firm is relying principally on borrowed capital. utilities.

[220237]  Someone investing money in a corporation either wants to get their money and exercise some control of how things go in the corp. the BOD has a fiduciary duty to you.BUSINESS ORGANIZATIONS II . what does your client want?] 1. Compare a corporation’s income and cash flow statement. Authorization of Stock. The corporation provides a structure for financing business operation and defining the financial rights to the firm’s income stream. Control Income Voting Rights Dividends (Equity) Interest Payment (Debt) Rights Upon Liquidation 1. (2) What is the income. so long as one class of stock has voting rights. Corporate financing comes form three sources: (1) (2) Equity financing which can be in the form of either common stock (voting rights) or preferred stock (preference with dividends). See also RMBCA § 6. While DGCL § 151 allows corporations to issue stock with no voting rights. . [planning perspective. not so with debt. Equity (Subordinate) Note: Different duties apply to equity. (3) What are your rights on liquidation. Note: Length of the debt is 10-20 years and then it ends. Introduction to Corporate Securities. The Difference here is the level of risk. Concern of Financing: Same As Always (1) Who has control. Debt (preferential) 2. Debt financing (corporation owes a 3rd party money – bonds are secured debt and debentures are unsecured debt). Types of Financing.Shaffer Karl Bekeny/Spring 2001 Page 26 of 131 d) Cash Flow Analysis. DGCL § 221 allows corporations to issue debt securities that have voting rights. (Equity can go to perpetuity. Problem: Precision Tools [Part III] [187] (See attached printout of spread sheet) B. (3) Corporate Earnings (reinvest inside $).01.

An amendment must be recommended by the board of directors and approved by holders of at least a majority of its outstanding (issued) stock. This stock is once again unissued because it was purchased back by the corporation.Shaffer Karl Bekeny/Spring 2001 Page 27 of 131 “Potential” Rights of Preferred Shareholders with Dividends 1.  If there is no more stock left to issue you have to amend the articles to authorize more. Redeemable-You want out of investment. or redemption rights. See RMBCA § 10. Convertible-Turn into common stock at 2. Authorized Shares = shares of stock corporation may authorize as specified in the articles of incorporation. it must amend the articles to authorize additional shares before it can issue more stock.31(a). Authorization and Issuance of Equity Securities (stock) Debt Security 1.03 Issued and Outstanding Stock Treasury Shares = share that are authorized but have not been issued. no treasury stock. 2. 5. Cumulative 2. No voting. Negative-No dividend. or company wants back for resale. Protection comes from Covenants: a. participation. The company may have to keep certain ratios. RMBCA § 2. . 3.  # of authorized shares is stated in the Articles. If a corporation issues all the shares authorized in its articles of incorporation. Authorized and Issued or Outstanding = authorized and sold. but they could potentially be incorporated under K. §6. pro rata.03 and DGCL § 242. §6. and DGCL § 102(a)(4) require that the articles of incorporation include the number of shares that a corporation is authorized to issue and describe certain characteristics of those shares(what class with what rights).” Authorized but Unissued = authorized shares that have not been sold to shareholders. Participation-could get paid along with common stock. 4.02(a)(2). §2.BUSINESS ORGANIZATIONS II . conversion. Voting Rights-These may exist when dividends are not paid.02(a)(2)-“the number of shares the corporation is authorized to issue.

B may be able to get a good deal. Making the cost of purchase extremely high.”  (1) a. then “approval of the amendment requires the approval of the shareholders at a meeting at which a quorum consists of at least a majority of the votes entitled to be cast on the amendment exists…” Official Comment 3 “If a quorum exists. On the other hand. hence their heightened control of the corporation. They may also put in quite a bit of protections. although there may be allowed some voting privileges under the preferred stock for major votes (mergers. M and J will be paid back through several ways. but also the greatest chance for success. On the other hand.30 “The Shareholders of a corporation do not have a preemptive right to acquire the corporation’s unissued shares except to the extent the AIC so provide. 1. they want to have as much control of the corporation. He will get paid out on his debt securities the principal and likely some interest.25 and 7. and increased value in their stock. B and Stern and Star will get paid at regular intervals (in accordance with the K) and with interest. dividends on their common stock. B has a mixed bag.000 immediately due it PTC defaults on any payment. along with any kind of payment puts more leverage on PTC to get the job done. therefore. However. or have a “sinking fund” so some of the money is paid out continually. b. to prevent dilution of your shares value. like a right to force bankruptcy. and with a certain amount of interest. the stock may carry redemption rights for either the Problem: Precision Tools [Part V] [220] . The preferred stock or debt security aspect of B’s invest give him likely no control. As a result. Yet. etc.  Preemptive Rights: Allows shareholders right to purchase a percentage of new issue.). These are the protections. but they also have the greatest risk. Preferred stock may be good for B in that it allows him to receive (a dividend preference and a liquidation preference).BUSINESS ORGANIZATIONS II . 3. having the greatest amount of risk. Works in one of two ways: §6. is dependent on the K.” Poison Pill Plans hinge on having a class of stock that in a merger context of which the board does not approve the shares may only be redeemed at (a really high price). Stern are Star are the safest here with 12% interest and the $750. Note: That Bernie (B) still has the trump vote on any major BOD action because M and J cannot get above 50% alone.03(e)-Unless provided “GREATER” requirement in the AIC. as is possible. Note: that the more debt the “leveraged” that PTC becomes. plus with the potential for voting rights. B has a difficult decision.Shaffer Karl Bekeny/Spring 2001 Page 28 of 131 RMBCA § 10. have the principal come do. he is fairly diversified. Note: these bonds while difficult for the corp aren’t all bad in that they are tax deductible. then under sections 7. The timing and how much the interest really is. he would not have the hands on with the day to day business that M and J would. so that it might make money. so he wants to see the corp do well. but on the other hand with a conversion ratio he can jump in at anytime if the corp is doing well or he wants more control . The Star and Stern plus the bank likely only want their money and may look for Bonds (secured debt) to get paid of with. a salary for running the corp. he wants the security of having a secured payment. However.26 the amendment will be approved if more votes are cast in favor of the amendment than against it by the voting group or separate voting groups entitled to vote on the plan. because part of his money is in common stock. M and j have the potential to recover the most capital. c. 2. Michael (M) and Jessica (J) are the largest voting common stock shareholders. but he may also may make a little more if the company does well and his common stock soars. (2) a.

While the note does allow for the payment of Stern. Note: §10. Par Value. Under §10. or a promissory note. Official Comment 3. stated value.02(b)(2)(iv)-This deals with the problem of watered stock.03(a) adopt by the BOD. . The consideration could be tangible. Of course.03 M and J could amend the AIC to allow for more shares. §7. Star. C. c.BUSINESS ORGANIZATIONS II . If for the corp.000 just to pay off their interest. then preferred stock may be a happy medium between common stock and debt securities. Requiring profits of at least $110. (4) a.[242-252] The concepts of par value. and legal capital are concepts which only apply in Delaware. Unless B had a conversion right that would give him the voting power to change the authorized shares. They are the ones who are taking the risk. Par value-is a made up figure that represents the amount that must be paid so the shares can be issued as fully paid and nonassesable. secured by a “sinking fund” which allows the corp to assure their ability to pay off their debt. intangible.03(c) the BOD may condition their recommendation on any basis. the stock may be bought out from underneath B if the stock becomes to expensive.000 a year to Stern and Star in interest on their required investment. DGCL § 152 provide that the board’s judgment as to the value of property exchanged for stock is conclusive.. if B can get redemption rights.30(b)(4) holders of shares without general voting rights may not have preemptive rights with respect to any class of shares. the debt is also tax deductible which is beneficial to PTC. but limits on distributions to shareholders continue to apply. Without-Par Stock: §2. and therefore have nothing for B and whoever else. Bank. and the bank. This figure was originally created to protect creditors from investors who would use fraud to create things like watered stock. §7. §10. absent fraud (future services is invalid consideration) (The reasoning behind this par value was that “Watered Stock” could be issued.21(b) The mention of shares does not necessarily include shares with par value.000 in interest a year. Regulation of Legal Capital. there is the concern that PTC will have earnings over the $50. On the other hand. but to add the new $400. To prevent watered stock: DGCL § 162 provides that shareholders are liable for the sum necessary to complete the amount of an unpaid balance of the consideration for which shares were issued. shares issued for property whose value is overstated.25Simple majority is o. and B first. and they could get the quorum and the majority vote. B could not include a preemptive right provision because under §6. but the right would have to be in the AIC. b. but then that they will not be able to pay off Stern. B therefore could probably not get the requisite amount of votes necessary to limit the amount of shares. RMBCA Today: RMBCA §25 requires that “the full consideration for which such shares were…to be issued.k.03(b) the shareholders must then approve. Under Delaware §102(b)(3) this would likely be allowed.Shaffer Page 29 of 131 Karl Bekeny/Spring 2001 corp or B.” §6. future service. §10. but they may have a conversion right so that you could enter into equity. The debt securities will likely not have any participating rights. (3) If PTC is already paying $ would force PTC to pay another $20. This scenario was difficult for creditors. The benefit M and J have is their control of the group so it is unclear why they would give that up.

Question 2a. 1.000 in cash & PTC can allocate the value of the note to surplus (permissible under DGCL 152(2)). can have no par stock-see DGCL §151(a) and §102(a)(4). Shareholder liability is limited to the payment of the consideration for which the shares were issued. See RMBCA § 6. or all will be considered stated capital under DGCL §154.Shaffer Karl Bekeny/Spring 2001 Page 30 of 131 Liability: RMBCA §6. Problem: Precision Tools [Part VI] [243] . then net assets (assets-liabilities)=$410.5 million and the equity account of $500K-what now doing is driving the equity account into 2 items: stated capital and surplus. need chose a par value less than $100/share. If must value real property at book value so net equity =$10. No problem if par value of 1 because Michael pays $100. Can consideration b for future services? For an executory K? -Not under DGCL 152 because must receive a binding obligation to pay balance of purchase price.” Liability: DGCL §162(a): You have to pay the “unpaid balance” for whatever the shares were issued. BUT SUBJECT TO THE FOLLOWING CAVEATS: 1. See RMBCA § 6.000. If issue no par stock in Del. 4.” Note: Under the RMBCA there is no par value or stated capital. does not include $400. c. Consideration Without Par Value: DGCL §153(b) “Shares of stock without par value may be issued for such consideration as may be determined from time to time by the BOD.000 of goodwill in assets. total liabilities of $5.000 from the accounting at fair market value of the building and the land). OK for cash. DGCL Today: DGCL §151(a) “…any or all of which classes may be of stock with par value or stock without par value.BUSINESS ORGANIZATIONS II . Question 2c. (This does not include notes). 2.000 shares. 2. 3. a. if issue 5. Is it necessary for PTC to assign par value in Del? -No not necessary.21 (b). or by the stockholders if the certificate of incorporation so provides. Question 2b. 2. In Delaware what consideration can PTC receive? Can PTC accept Michael’s Note? 1. property.e.000 shares x $100 par value)  Consequence of $1 par value? Stated capital of $5k & Surplus of 495K  Note: PTC balance sheet: total assets of $6 million. there can be no watered liability. any further action of BOD? a. Note: Definition of “stated capital” under DGCL §154 as amount of consideration so determined to be capital in respect of any shares without par value.22(a): Shareholders are liable for “the consideration for which the shares were authorized to be issued…or specified in their subscription agreement. which is totally up to the BODs. Can issue no par stock under DGCL §102(a)(4). can’t have par value greater than $2/share.000 shares. Stock can also be sold for the promise of future services. FREE TO CHOSE. but BOD need act at date of issuance (if for cash) or within 60 days (if for property other than cash) to allocate some of the consideration to capital and the rest to surplus. If can’t include $90. services rendered (sweat equity) under DGCL §152(1). the capital stock is not deemed “fully paid and nonassessable” if the amount of consideration received in such form listed under (1) is less than the stated capital. BUT would have a problem for the note if par value set at less than 100-prob is that under DGCL §152.000 (i. b. so if issue 5.21(c). §6. Question 2d. Consequence of $100 par value in Del? Stated capital of 500K (have 5.22.

(Distributions<shareholder equityliquidation Preferences) Note: §8. is it necessary to set par value?-RMBCA eliminates concepts of states capital. interest. note & future services good consideration under RMBCA 6.[252-258. Dividends may be paid out when there is surplus also nimble dividends may be paid out of current earnings even when surplus (capital or earned) is unavailable. and/or the the balance sheet test You have to meet both tests if the 154 is: (1) total assets – total liabilities Note: assets (2) corporation wants to issue a dividend. Reducing par value reduces than the sum Note: Reducing legal capital effect the corporation’s total assets would be lesslegal capital. c. (3)stock redemptions. b. if it cannot pay off debt. or would become impaired.000 note will go on the left hand side as assets and the $200.5 million (Capital. can PTC accept a promissory note or future services?-yes. (2)capital/liquidating distributions.000 total consideration will go on the right hand side as equity.40(c)(1) [Equity Insolvency Test] prohibits distributions if after giving it . you can do these even when insolvent.Shaffer Page 31 of 131 Karl Bekeny/Spring 2001 5. or stock split. or Net Insolvency Test] Prohibits distributions if after giving it increases surplus. §244(4) Transferring to Surplus. legal) $6 million $5. = net §1. subtract capital from equal stock surplus.40 (c). A shareholder cannot usually compel the payment of dividends (Dodge they were able to).40(6) Surplus as defined by DGCL § distribution.000 cash and $100. This is a ASSETS corporation wouldLIABILITIESto pay its debts as they come Paid in surplus EQUITY liquidity test!!! Has nothing to do with ownership stated. ** No Cushion is required. Payment of Dividends and Other Distributions.30(b) In making their decisions BODs may rely on opinions. DGCL § 170. A corporation can distribute its assets to shareholders in a variety of ways: (1)dividends. . SURPLUS NO SURPLUS §170(a)(2)-“in case there shall be no such surplus. Dividends or reinvestment??? Many different scholars give their spin on how to allocate capital.21(b). Under RMBCA. D. However. Delaware Corporation -. par value & Surplus. RMBCA § 6. How account for sale of stock to Michael on balance sheet?-the $100. Question 3?a. under RMBCA. 1. 2. RMBCA Corporation – Dividend Rules of its total liabilities plus the amount that would be needed if the corporation were dissolved at the time of distribution to satisfy the preferential rights of shareholders whose preferences are superior to those receiving the distribution. Dividends forces a corp to be more efficient but also puts it at risk in bad times. (4) corporate repurchases. Dividends can take the form of a stock dividend. does not net assets =dividends. statement. Retained earnings (Surplus) RMBCA § 6. can §154 Surplus Calculation: 1. Public Corporations. a shareholder can bring suit when dividends were paid that should not have been paid out. 263-278]  Problem on page 252.BUSINESS ORGANIZATIONS II . reports.” of § 6. cash dividend.Dividend Rules Legal Capital = par value x outstanding shares Redemption: §160(a)(1) Cannot redeem when the capital of the corporation is Stated Capital = par value x outstanding shares impaired. Too much debt is dangerous.Capital Stock = Capital Surplus effect the not be able = due. out of its net profits for the fiscal change the AIC so that you may get more year in which the dividend is declared Under the RMBCA you apply the equity/insolvency and preceding fiscal year.40(c)(2) [Balance Sheet Test.

Legal Capital=$500.000 available. a. thought that a dividend would look good to the market and liquidation would have adversely affected the company’s net income figures. there would be no surplus to pay out of because the required capital alone is $500. NOT including reacquisition or indebtedness is the DATE OF AUTHORIZATION. and the Balance Sheet Provides for $600. there is $495. Warren Buffet: Letter to Shareholders. c.000.000. Legal Capital=$5.BUSINESS ORGANIZATIONS II .000. Legal Capital=$500. 263] FACTS: The directors of American Express faced the choice of liquidating a bad stock investment at the corporate level (take a corporate tax deduction or distributing the stock to shareholders as a special dividend (taxable event for shareholders). so in Delaware under §160 (a)(1)-paying $500. although there is $100. While under §170(a)(2) allows payment out of the net profits. Under both tests $200. Under RMBCA there would be no problem because there is still $600.000 would deplete all the surplus $100. b. (NY 1976)[p.000 dollars in capital left over which under §244(4) (for par value change go to §242(3)-reduce in AIC then get a BOD resolution) may then be transferred to surplus to be paid out as a divided. IF PAYMENT OCCURS WITHIN 120 DAYS AFTER AUTHORIZATION.40 A distribution would include a stock redemption so the same rules apply. and without the ability under §244(4) to transfer any stated capital because the par value is $100. When there has been allowed this demand it is with generally “closely held” corporations. Although.00 will clearly not be a problem. Inc. Problem: Precision Tools [Part VII] [252] 1.Shaffer Karl Bekeny/Spring 2001 Page 32 of 131 Time of Measurement: §6.” The BODs are fiduciaries to their stockholders. this would generally be considered a business decision which should be left up to the BOD. Kamin v.000 in retained earnings. which would then NOT cause impairment of the capital under §160(a)(1). so they are simply even. Berkshire Hathaway. In Gottfried the court would not hear the argument but delineated the suggestion of a “Bad Faith” test. that only equals $90. It would appear that even with a $1 par value that there would be $595. a. the choice seemed obvious the board opted for the stock dividend option. 2. If after 120.000 Therefore. c.000 available.000.000 would be needed to pay off the aggregate par value under §244(4).000.00 before the liabilities would exceed the assets. and shareholders sued. THEN THE DATE OF PAYMENT MUST BE USED! Stock Redemption: §1. Ford. American Express. which it is important to note is a form of distribution under the law. (Bd. such as in Dodge v. Which they say “The essential test of bad faith is to determine whether the policy of the BOD is dictated by their personal interests rather than corporate welfare. b. 3. under this stock redemption. It is unlikely that the shareholders may compel payment of dividends. Since. because there is plenty of cash to pay the debts. HOLDING: Court applies the BJR and finds that the board’s concerns were sufficient. therefore.40(e)(3)-all distribution tests. . therefore. only $5.

when appropriate. at least one dollar of market value will be created for owners. by a thoughtful analysis of the future-that for every dollar retained by the corporation. James Surowiecki: The Taming of the Barbarians: How a rapacious leveraged-buyout firm became a positive force in the corporate economy “One familiar interpretation of KKR’s success is that it illustrates the disciplining power of debt. Becoming highly leveraged has forced managers to think seriously about costs.BUSINESS ORGANIZATIONS II . Alfred Rappapport: The Staying Power of the Public Corp. He feels the public corp as we know it is on its way out.40(b) a corporation can designate the officers it will have (you don’t have to have a secretary of you don’t want to). Issues of Agency. Empowering officers. Goizueta: You cannot serve the public interest if you are continually paying down debt. Millstein: BOD and competitive product markets should deal with Jensen’s problems in the public corp. Without the old conflict these new corps are more (1) efficient.41 (duties are those set forth in bylaws). That is good in his view because instead of pitting management against the shareholder there are now going to be institutions and entrepreneurs financing these corps. Michael Jensen: Eclipse of the Public Corp. Under RMBCA § 8. and . (2) more employee productivity. [352] (Do for exam prep.[347-363] Problems. (2)with the care an ordinarily prudent person in a like position would exercise under similar circumstances. and (3) in a manner he reasonably believes to be in the best interests of the corporation).” E. The public corp is resilient and will be around for a while. Also see: RMBCA § 8. the daily stock price. Not to mention. but not included in my materials) RMBCA § 8. (a) (1) act in good faith. and the business affairs of a corporation shall be managed under the direction of its board of directors. Letters to the Editor of the Harvard Business Review Norris: LBO companies won’t be competitive in the long run. (3) more shareholder value.42 Standards of conduct of officers.01(b) provides that “all corporate powers shall be exercised by or under the authority of.Shaffer Page 33 of 131 Karl Bekeny/Spring 2001 Unrestricted earnings should be retained only when there is a reasonable prospect-backed preferably by historical evidence or. RMBCA § 8. the Leverage Buyout stifles flexibility with the burden of debt. and improve productivity. and takes away the best marker of progress. trim overhead. Agency Relations.

DGCL § 142 sets forth general info 142(a)-Officers. (a) appointment does not create contract rights. A corporation can only act through its employees (agency). or any failure to take action. The Relationship Model: Fiduciary BO D Fiduciary Sharehol ders Owners Common. (c) an officer is not liable for any action taken as an officer.  For major transactions like mergers or a sale of substantially all of the corporations assets the board must approval of the majority of the shareholders entitled to vote. 142(e) Fill vacancies through the by-laws.Shaffer Karl Bekeny/Spring 2001 Page 34 of 131 (b)(2) a officer is entitled to rely on information. or statements. Dividends Corporation (under BOD) Agency 3rd Officer Contracts Parties s 2. reports. 142(b) by-law or BOD for time in office. . [p. 142(d) Having no officers. (b) however if there are contract rights removal or resignation does not affect the officer or the corporation. Action by Executives: Agency Principles and the Authority of the Corporate Officer. and (b) the board of directors may remove any officer at any time with or without cause. (2) legal counsel or public accountants whom the officer feels are competent.BUSINESS ORGANIZATIONS II . RMBCA § 8.44. 1. RMBCA § 8. if prepared or presented by (1) one or more officers who the director feels are competent and reliable. opinions. manner of resign or removal.43 (a) an officer may resign by delivering notice. if he performed the duties of his office in compliance with this section. 316] does not dissolve the corp. Note: an officer is not acting in good faith if he has knowledge concerning a matter which makes reliance questionable. The agents must put the corporations interests above their own.142(c) could require bond. one must be secretary.

if the BOD just lets the agent continue on with the deal. First National Bank of Jefferson.355] FACTS: Lee sued Jenkins bothers to recover pension payments due to him under an oral contract with Yardley the corporation’s president.BUSINESS ORGANIZATIONS II . FNJ refused to purchase the bonds on the grounds that Boyd had no authority to sign. 1991)[p. Note: ratification can be either expressed or implied. Lee v. (5th Cir. Thus. (from words or conduct taken in the context of the relations between the corporation and the agent). HOLDING: A president under their general authority [inherent authority] has the power to hire and fire employees. Finally. 1959)[p. Boyd a vice president with FNJ after a discussion with FNJ’s president was under the impression that execution of the agreement was acceptable so he signed. (Note: There must be principal to third party contact). this would be implied. Under respondeat superior a corporation will be liable for torts committed by its agents. There is also inherent agency power-This is a policy in which the individual who is binding the corp would generally be understood to have the power to act as the corps agent. The court affirmed dismissal because this is a question of fact and minds will differ on it. An agent may also bind the corporation through apparent authority. a corporation can ratify an agents actions by affirming prior acts or not speaking up against them. and (2) the third party reasonably relies on the agent’s purported authority as a result of the manifestation. HOLDING: A corporation will be liable to a third party under the doctrine of apparent authority if (1) the corporation manifests the agent’s authority to the third party. such as the President. for example. Of course Lee has to get around S of F [contract is oral and is for more than one year]. Agency by Estoppel-The 3rd party changes their position on a basis of reliance.Shaffer Karl Bekeny/Spring 2001 Page 35 of 131 The corporation may give the agent actual authority [agent believes that the corporation wants him to do something] which may be either express (growing out of explicit words or conduct granting the agent power to do the act) or implied. . (2nd Cir. under the theory of apparent authority Jenkins Bothers is bound. Jenkins Brothers. (it looks to outsiders that the agent has the power to do what they are doing). First Interstate Bank of Texas v. 359] FACTS: The banks are in negotiations in which FI would buy bonds from FNJ.

The by-laws may provide for quorum less than a majority. (b)A designated committee may run the corp. RMBCA § 8.21 allows action to be taken without a meeting on the unanimous written consent of the directors. the first initial problem is that under §8. RMBCA § 8.22(b) requires that two days notice be given as to date and time. 1. but the committee may not amend the AIC.23(a) [Unless AIC or By-laws hold otherwise] Does NOT require notice for “regular meetings.BUSINESS ORGANIZATIONS II . A quorum is usually the majority of the total number of directors unless the AIC provide otherwise (HAS TO BE GREATER).25(e). (c) Provides for the confines on the scope of the directors abilities. A director can waive notice in writing or at the special meeting under RMBCA § 8.[363-368] Unless the articles of incorporation or by-laws state otherwise (HAS TO BE GREATER). For special meetings. RMBCA § 8.24(a) the quorum must be a majority of the members or greater. DGCL § 141 states that the majority of the shares entitled to vote will constitute a quorum.” Directors' may waive notice of regular meetings under RMBCA § 8.23(a). but in no case shall this be less than 1/3 of the total directors. However. Widget Corporation [363] . RMBCA §8. See RMBCA § 8. they may also have committees. RMBCA § 8.23(b). unless the article of by-laws state otherwise.Shaffer Karl Bekeny/Spring 2001 Page 36 of 131  A party to a transaction that doubts the authority of the official with whom she is dealing can request a copy of the resolution delegating such authority and the minutes of the board meeting at which the resolution is adopted. See RMBCA § 8. the vote of a majority of directors present at a board meeting at which there is a quorum are necessary to pass a resolution. Action taken in the absence of a quorum is invalid.20(b) permits board action to be taken by a conference call.25 authorizes committees of the board.30(b) recognizes the expanding use of committees and permits a director to rely on the reports or actions of a committee on which he does not serve as long as the committee merits his confidence.24(a). RMBCA § 8. F. While a unanimous vote of four directors would not constitute quorum anyway. Declaration of a dividend or a merger cannot be delegated to a committee under RMBCA § 8. but there Problem.24(c). Formal Requirements for Board Actions.

Attendance is mandatory.22(b).02 Yes §13. G. 3. §8. Clearly two days of notice would be required in this case because this deals with the sale of the company’s plant and is therefore a special meeting. 1. (3) the notice may be waived under §8.05. §8.BUSINESS ORGANIZATIONS II .25. Most statutes require more that simple majority approval for certain transactions but rather require a majority of all shares entitled to vote for example in the context of a merger.02 NO Shareholder Rts of T (Acquired Corporation) Vote Dissent Rts Yes § 11. 8.25(d).03 Yes § 13.Shaffer Page 37 of 131 Karl Bekeny/Spring 2001 is also an issue of notice.02 Yes § 11.02 Yes § 13. Why not conference call? §8. Corporate Combinations.[368386] Shareholders elect directors annually unless the articles of incorporation provide for staggered terms. See RMBCA § 8.06. §8.03 Yes § 11. in which event the shareholders elect the directors every two or three years. unlike a shareholder who can have a proxy there is a sense among BODs that they must be present for the body to make the important decisions. The time period for the notice could be made to almost nothing.10. (4) the BOD may hand some of this power over to a committee §8. 2.03 Yes § 12. Make clear that quorum consists of at most a majority of the BOD §8.02 Yes § 13. RMBCA: Shareholder Rts of P (surviving Corporation) Vote Dissent Rts Yes § 11. Other alternatives for sale would be (1) the meeting could be over the phone §8.22(b). §8. See RMBCA §§ 8.24(a).02 NO No § 11.03 Yes § 13.03 NO NO No § 13.23. The shareholders have the power to elect directors exclusively unless there is a vacant seat that needs to be filled. Shareholder Veto and Exit Rights.03(e).20(b). See RMBCA § 11.20(a). Shareholders’ Veto and Exit Rights.21(a). 4. Create a committee which can carry on the general business of the Corp.02 Statutory Merger Triangular Merger Statutory Share Exchange Stock for Assets . (2) there may be a unanimous written consent.

(c) These voting and appraisal rights are subject to exceptions in Delaware and 2 exceptions under the RMBCA. [appraisal rights].Shaffer Karl Bekeny/Spring 2001 Page 38 of 131 DGCL: Shareholder Rts of P (surviving Corporation) Statutory Merger Triangular Merger Vote Yes § 251 NO Dissent Rts Yes § 262 NO Shareholder Rts of T (Acquired Corporation) Vote Yes § 251 Yes § 251 Dissent Rts Yes § 262 Yes § 262.02 a shareholder can dissent from a transaction and require the corporation to pay her in cash the value of her shares as determined by a court in an appraisal proceeding. if the transaction which the shareholder voted against is approved by the majority. (1) Statutory Merger. Statutory Share Exchange Stock for Assets NA NO NA NO NA Yes § 271 NA NO a) Background Shareholders have no power to initiate fundamental changes. (b) P and T shareholders have voting rights and appraisal rights. under RMBCA § 13. Dissenter’s rights are not available for every type of transaction but usually only apply in situations that involve fundamental changes. For example.BUSINESS ORGANIZATIONS II . Statutory Merger: P T shhs T (a) Note T shareholders could receive cash or other property instead of P shares. P shhs P shhs/Former T shhs P + T assets . The power they have consists largely of veto rights. unless 262(b)(1) applies Delaware Public Market Exception To which there may be another exception depending on the type of consideration.

02 and DGCL § 262(b)(1). §253(a). There are no vote or appraisal rights for P. the transaction can proceed as a short form merger and no vote by P or T’s shareholders is required. Public Market Exception-§262(b)(1) appraisal rights or consideration other than Subsidiary get no voting rights. T assets P shhs/former T P Corp. See RMBCA § 11.06 and DGCL § 259. no vote of P’s shareholders is required.000 shareholders on record. A majority of the shares of both P & T that are entitled to vote must vote in favor of the merger. one that does not increase by more than 20% P’s outstanding stock.05(a). many §262(b)(2) corporation. See RMBCA § 11. See RMBCA § 13.Shaffer Karl Bekeny/Spring 2001 Page 39 of 131 EXCEPTIONS: RMBCA=2 DGCL=3 Small Scale-This is a merger that does not increase P’s shares by more than 20% (outstanding). corporate statutes allow merger without shareholder approval of eitherThe target shareholder you receive cash §11. Former shareholders of T become shareholders of P and lose all rights they had as shareholders of T unless they dissent and get appraisal rights.03(g).04 and DGCL § 253. The boards get together and decide which one will merge into the other. The boards make a plan outlining this and submit it to the shareholders of both P & T.02 and DGCL § 262.BUSINESS ORGANIZATIONS II .01 and DGCL § 251(a) If the transaction qualifies as a “small scale merger”. §11. §251(f). Assets/P-T shares . Shareholder of P retain their rights as shareholders of P but they too have dissenter’s rights. Because likely the feeling is that if you don’t like the merger sell your STATUTORY MERGER: P & T are two separate legal entities. P shhs P Corp. Parent gets no voting rights. Exception a the Exception Short Form Merger-When a parent company owns more than 90% of tosubsidiary. but YES APPRAISAL. are not available if the shares are publicly traded or has shares of P or a 3rd party. No dissenter's rights for P shareholders if the merger is small scale or short form. more than 2. See RMBCA § 11. See RMBCA § 11. See RMBCA § 13.03(g) and DGCL § 251(f). Assets/P and S shhs (2) Triangular Merger (Forward) T shhs T Corp. T shareholders get voting and appraisal rights. but YES APPRAISAL for dissenters. (1) Short Form Merger IF P owns at least 90% of T prior to merger.

more descriptive name like P-T. Merger Sub issued all its shares to P. Note: T shareholders have the same rights they did under the statutory merger. 3.Shaffer Karl Bekeny/Spring 2001 T-PS Merger Plan Page 40 of 131 P Sub Holds P shares or consideratio T merges into PS P-T Corp. P sets up a new wholly owned sub-S. P capitalizes Merger Sub with its shares or other assets (such as cash). The shareholder of S does. Inc. P’s board can eliminate its shareholders right to vote on the merger. YES Appraisal If General Statutory-YES Vote.BUSINESS ORGANIZATIONS II . Note: P shareholders do not have any rights. Assets/all Sub Shares + Former minority shhs-cash Short Form-NO Vote. 4. After the merger. and T’s shareholders receive as consideration the assets that Merger Sub received when P capitalized it. P continues as the sole shareholder of the surviving Merger Sub. Assets/T shares T Corp. 2. Thus. T assets PS merges into T P shhs/former T P Corp. (P Sub) Former T Assets 1. P can exercise dissenter rights. Assets/P and S shhs (3) Triangular Merger (Reverse) T shhs T Corp. YES Appraisal . as part of the merger plan. P shhs P Corp. Assets/Major SH of Sub Minority Subsidiary Subsidia P shhs P Corp. Cash-Out. Inc. T merges into Merger Sub. the shareholder is P (The BOD). Inc. Merger Sub enters into a merger plan with T under which Merger Sub is the surviving corporation. (P Sub) T Assets PS-T Merger Plan P Sub Holds P shares or consideratio (4) Upstream/Downstream Mergers (Squeeze-Out Merger. In return. which typically adopts a new. Freeze-Out) Parent Shhs P Corp.

2d 701 (Del. P shareholders have NO voting or Appraisal rights. UOP. P can either keep T as a Sub.06) 4. 457 A. 3. Inc. it can then (1) dissolve T.Shaffer Karl Bekeny/Spring 2001 Page 41 of 131 1. then T shareholders become shareholders of P. 5. Shareholders of T must approve the plan. 2. Under this form the shareholders of T get shares of P in exchange for their shares of T. but wishes to end with precisely the same structure as would result from a stat merger. They have no further rights as T shareholders unless they dissent (11. just as in a triangular merger. If P mergers into the Sub then it is a Downstream merger. Targ et Targe t Similar to statutory merger except that here shareholders of T must approve the plan. . shares of P are issued to T. or if the Sub mergers into P then the merger is Upstream. If P does not want to operate T as a sub. T becomes a subsidiary of P.03) 3. 4. (§11. Weinberger v. The parent receives the surviving subs stock while the remaining shareholders receive other consideration. 1. (2) distribute all of its assets to P and having P assume all of its liabilities. Allows a majority shareholder to squeeze out its minority shareholders. like cash or non-voting debt securities. If the minority shareholders receive cash then it may be referred to as a cash out merger.02) 2.. T shareholders have voting and appraisal rights. P’s shareholders are unaffected and have not rights. NOT Delaware) P shhs. Once approved. a. Former T Pare T Parent a.BUSINESS ORGANIZATIONS II . P and T boars must put together a plan of exchange agreement. 6. b. or cash. (§ 11. In Delaware these mergers are subject to an “entire fairness” test that requires fair dealing and fair price. P (5) Exchange of Shares (ONLY RMBCA. or (3) merging T into P in a “short form” merger. 1983). The status of P shareholders is unchanged.

The T company can then dissolve after paying off its liabilities and distributing the remaining proceeds to the shareholders pro rata. T could receive cash P shares T SHs T assets T T Corp. Assets P Corp. Assets T Corp. The shareholders of T must approve the sale and have dissenter rights. T SHs have voting rights. 2. but no in Del. T SHs have appraisal rights ONLY in RMBCA.Shaffer Karl Bekeny/Spring 2001 Page 42 of 131 (6) Exchange of Stock for Assets P P Corp. Assets P P Corp. Assets/T assets P shares T SHs T assets T T Corp.BUSINESS ORGANIZATIONS II . 3. giving T. Assets/T assets P SHs/Former T SHs P Corp. P SHs have no voting or appraisal rights. §262 3. P SHs P uses its stock to buy the assets of T. 1. P P Corp. 2. P stock as consideration. Assets/T assets P 1. T then becomes a shell or a holding company with its only assets the sales proceeds to shareholders pro rata. P purchases all of T assets. P SHs Dissolution (T SHs receive P P (7) Tender Offers (Share Acquisition) Paren t T Targe t P and T SHs Paren . shhs) Assets T Corp.

(Del. Arco Electronics. A corporation has the right to sell all of its assets for stock of another corporation under DGCL § 271.379] FACTS: Shareholder argues that the purchase of all Arco’s assets was unfair to stockholders and that the transaction constituted a de facto merger.BUSINESS ORGANIZATIONS II . Farris v.. ** Context could be the sale of all a companies assets. The shareholder argues that they have appraisal rights.Shaffer Karl Bekeny/Spring 2001 Targ et Page 43 of 131 Note: Y shareholders could receive cash or other property instead of P shares. . Hence there are no appraisal rights. Note: This could be a “friendly acquisition” or a “hostile” tender offer. De Facto and De Jure (by-law) Approaches. 2. Hariton v. Where the structure of a corporate combination does not provide for appraisal or voting rights a shareholder needs to argue that there was a de facto or de jure merger. (9) Consolidation Former A and B Comp C A SHs Comp A Comp B B SHs Note: A and B Shareholders are covered under statutory merger rules. If it has sufficient stock then P does not have to get approval from its shareholders. 1963)[p. either for P stock or property. HOLDING: This was not a de facto merger. if the legislature does not like what is going on then let them go ahead and change the law. P can also purchase T’s shares directly from shareholders. Glen Alden Corp. there are no voting or appraisal issues. (Sounds like doctrine of independent legal significance) Furthermore. (PA 1958) This case applies the de facto merger doctrine and is applied in both of the cases bellow. T shareholders sell T shares to P only if they so choose. Inc. thus. Note: Not covered by statute. T’s shareholders don’t vote they either accept the offer or they don’t.

. Asset Sales.. Once again.02 §251(c) §271(a) §275(a) RMBCA § 12. 138] requires shareholder approval for sales of substantial all the assets if the sale was not in the ordinary course of business.. HOLDING: The critical factor in determining the character of a sale of assets is generally considered not the amount of property sold but whether the sale is in fact an unusual transaction or one made in the regular course of the business seller. a subsidiary of Penn... the legislatures language is fairly specific. 136] does not require shareholder approval for sales of substantially all its property in the ordinary course of business....BUSINESS ORGANIZATIONS II ..01 [p.... (Del. H. HOLDING: This is not a merger and therefore there are no dissenter’s rights.Shaffer Karl Bekeny/Spring 2001 Page 44 of 131 Terry v.03 Sale of Substantial Assets§12... 1981)[p... Approval of Corporate Transactions.... (3rd Cir.... if you don’t like it..02 [p. But PA law under §908 calls for “actual combination....388] FACTS: Shareholder brings suit seeking a preliminary injunction alleging that approval by Signal’s board for the sale of its oil division required the approval of the majority of outstanding shares because it constituted a sale of substantially all of Signals assets.. Signal..[386-391] 1.. A ..383] FACTS: Shareholder contends that a proposed merger between Colt and Holdings.. The comment to this section states that a sale of several distinct manufacturing lines while retaining one or more lines is normally not a sale of “all or substantially all” even thought the lines being sold are substantial and include a significant fraction of the corporation’s former business (Signal)..” which may not happen in a triangular merger..03 §242(b)(1) Mergers:. Shareholders’ Rights over Board Actions...02 Voluntary Dissolution. (triangular merger) constituted a de facto merger...§11.. Gimbel v. Penn Central Corp.§14. 1974) [p. then they should not be so specific..§10. Shareholders Vote on Fundamental Changes to the Corporation: RMBCA DGCL Amendment of AIC:... DGCL § 271(a) requires majority stockholder approval for the sale of “all or substantially all” of the assets of a Delaware corporation... RMBCA § 12.

the manufacture and sale of trucks. Under the RMBCA there should be no problem in making the 120 days since there is a safe harbor. Katz v.02(a) the question is whether the corp would be left without a “significant continuing business activity. “Heart of corporate existence and purpose.BUSINESS ORGANIZATIONS II . .391] Court held that the sale of assets which constituted more than 51% of its total assets and 45% of its net sales. c. In this case the oil division only represented 26% of the total assets of Signal and accounts for 15% of its revenues. But there is no further indication how this should be defined.Shaffer Karl Bekeny/Spring 2001 Page 45 of 131 sale of all or substantially all of a corporation’s assets = one which is unusual. and thus required approval from the majority of shareholders. (Del. 1. ii. Signal is now a conglomerate engaged in the aircraft and aerospace business. The sale does not constitute the sale of substantially all the assets. and that would cause the company to depart radically from its traditional line of business. 2. Problem: LaFrance Cosmetics [Part II] [386] i. only stating under §271(a) “all or substantially all” requires shareholder approval in Delaware. Bergman. Absent some statutory requirement for shareholder approval. a board is authorized to take all actions it deems necessary in managing a corporation’s business.” a. Quantitative. while as much as 45% of net assets has been held to be substantially all. and 25% of either income from continuing operations before taxes or revenues from continuing operations for that fiscal year…” b. Signal Case make clear that the test should be broken down into two parts. Qualitative. under Delaware there could be more litigation. the Sweet violet division was only responsible for 20% of LaFrance’s net income last year. this was only in connection with the second part of the test. The Gimbel v. Continuing business activity is set within the statute as “25% of total assets at the end of the most recently completed fiscal year. Note: In Delaware the test is unclear. 1981)[p. Under § 12.” In the Katz case the fundamental nature of the corp was changed. constituted a sale of substantially all the assets of the corp. and other businesses.Ch. In the present case.

Authorizes shareholders to act by written consent. a) The Call RMBCA § 7. but it has to be taken by all the shareholders to be effective.BUSINESS ORGANIZATIONS II . DGCL § 211 Meetings of Stockholders. and it must be in writing. or any person authorized by the article of incorporation or the by-laws may call a special meeting of shareholders. . Shareholder Meetings. Procedural Concerns. (b) by-laws set the date for the annual meeting. (2) owners of 10% of the shares. Note the Shareholders do not have an automatic right to call a special meeting. (1) The board of directors. Note: only majority in Delaware. (c) failure to have an annual meeting as specified in the by-laws does not invalidate corporate action. (c) the failure to have an annual meeting as specified in the by-laws does not invalidate corporate action. (a) meeting may be held in or out of state.04(a) The shareholders in Delaware may take unanimous action.01 Shareholder’s Annual Meeting. Shareholders’ Power to Initiate Actions & Shareholders Rights to Information.[391-416] 1.Shaffer Karl Bekeny/Spring 2001 Page 46 of 131 I. RMBCA §7. (a) States that a corporation’s annual meeting is usually fixed by its bylaws. (b) meeting may be held in or out of the state.02(a) Shareholder Special Meeting. RMBCA § 7. DGCL § 228 Consent of Stockholders in lieu of a Meeting. DGCL § 211 Meetings of Stockholders Only BODs (d) excludes stock ownership as a qualification for calling such a meeting.

393].BUSINESS ORGANIZATIONS II . and DGCL § 213. or more 60. discretion is totally left open to .25(a) Quorum and Voting Requirements for Voting Groups A quorum usually consists of a majority of shares entitled to vote unless the Articles of Incorporation state otherwise. See RMBCA § 7. RMBCA § 7. 222(b) no less 10 days. See RMBCA § 7. Martin Marietta was a ten percent shareholder was powerless to call a special meeting any earlier than 10 days after it became a 10 % shareholder. To satisfy the notice requirement.07. DGCL §214 Cumulative voting. A majority usually consists of a majority of shares entitled to vote unless the Articles of Incorporation state otherwise.Shaffer Karl Bekeny/Spring 2001 Page 47 of 131 b) Notice Delaware Notice: 222 Notice of Meeting. Shareholders can waive notice. for an action taken at the meeting to be effective. c) Quorum A quorum must be represented at a shareholders meeting. Only matters within the purpose described in the meeting notice may be considered at a special meeting. See RMBCA § 7.27 permits greater quorum or voting requirements.02. either in writing or by attending a meeting and not objecting to the absence of notice. Record date must be at least 70 days before the meeting. DGCL § 216 allows a majority of shares to amend a corporation’s articles of incorporation or bylaws to increase of decrease the quorum requirement.26 permits action to be taken by a single group when the articles of incorporation provide as such. necessitates that you first meet the standard now DGCL § 216 Quorum and Required Voting for Stock Corporations. any shareholder entitled to vote. either in person or by proxy. No quorm under 1/3. RMBCA § 7.06.05. In order to change or delete a greater quorum or voting requirement. ** Bendix Martin Marietta takeover attempt illustrates the importance of timing [p. A company must give written notice of an annual or special meeting to all shareholders entitles to vote at the meeting. a board must set a “record date” prior to the meeting and provide “shareholders of record” who will be entitled to the vote as of the record date notice.. RMBCA § 7. See RMBCA § 7.

RMBCA § 7. Inc. Both parties enter in to a compromise where they each have 6 representatives on the board.398] FACTS: This case involved a battle for control of Lowe’s theaters by two factions.04(a) requires the consent in writing of all shareholders entitled to vote on an action.28(b) provides for cumulative voting when voting for directors. The shareholders wanted to endorse the former administration of Auer the corporation’s past president. A neutral . 2. 1957)[p. ** If shareholders have the power to elect they should also have the power to remove.Shaffer Karl Bekeny/Spring 2001 Page 48 of 131 in place. (Del Ch. One headed by the president and one headed a shareholder. Loew’s. the shareholders.BUSINESS ORGANIZATIONS II . RMBCA § 7. unless the AIC so provide. DGCL § 228(c) allows a majority of the shareholders entitled to vote on an action to act by written consent but no advance notice is required although notice must be given to none consenting shareholders after the fact. What Actions Can Shareholders Initiate? Auer v. and remove four directors for cause. Consequently. Dressel. amend the articles of incorporation and by-laws to provide that vacancies due to removal be filled only by the shareholders. all shareholders must receive advance notice of the action to be taken. HOLDING: Shareholders could properly make a non-binding recommendation that the corporation’s former president be reinstated. d) Action by Written Consent  Shareholders are permitted to act by written consent. (NY 1954) [p. Campbell v. even thought the recommendation had no binding effect on the board. 395] FACTS: Shareholders bring a suit against the company president for not calling a special shareholder meeting pursuant to a by law provision requiring such a meeting when requested by holders of a majority of the stock. amend the by-laws to reduce the quorum required from action.

amend the by-laws to increase the number of directors. The board had time to voice its concerns to shareholders (only a compelling justification would authorize this type of action – not informing the shareholders).” 3. the court held that the President faction could use corporate funds to solicit proxies to remove directors who opposed its business policies.403] FACTS: Blasius accumulated Atlas Shares.Ch. Action designed to principally to interfere with the effectiveness of a vote creates a conflict between the board and the shareholders. §142 mentions removal and the court is satisfied that stockholders have this power. In this case the procedure behind the proxies was not valid because the accused directors were not given an opportunity to present their case to stockholders (DP rights for Corporate directors who will be removed for cause). that the by-laws be amended to expand the board size. Blasius delivered to Atlas a signed written consent with precatory resolutions recommending that the board develop and implement a restructuring proposal. ** Remember. HOLDING: Court holds that the board acted in good faith in response to what it thought would lead to a recapitalization which would harm the company. (if the proxies were only of a personal nature the expenditure would not have been proper). Board Responses to Shareholder Initiatives. 1988)[p. Inc.” the Ds in Blasius violated the law. in which tactics to impede insurgents were held to equitable limitations. The president called a special meeting to fill the director vacancies. Yet. Atlas Corp. The Court held that their actions were unintentional but applying the principle held in Schnell. Yet.Shaffer Karl Bekeny/Spring 2001 Page 49 of 131 director would be the 13 board member to prevent deadlock. The board violated its duty of loyalty to the shareholders by calling a special meeting to keep itself in power. Chris-Craft. “inequitable action does not become permissible simply because it is legally possible. even finding the action taken was taken in good faith. (Del. Campbell brought suit to enjoin the special shareholder’s meeting. shareholders are entitled to vote to replace incumbent board members. The present board viewed this as an attempt to take over the corporation and called an emergency meeting. and three other directors resigned. it . v. In July of 1957. even if it was done to “protect” the corporation – it interfered with the shareholders right to vote. and remove two directors from the other side and fill their vacancies. The Court held. HOLDING: Stockholders have the power to remove a director for cause. “inequitable action does not become permissible simply because it is legally possible. the neutral director. The court issues a preliminary injunction. However. there is nothing in Delaware statutory law which provides for the removal of a director by stockholder action. and elect the new directors. Blasius brings suit alleging that the special meeting which was voted on by phone and which nominated two new directors and amended the by-laws was self motivated in an attempt to protect the present board. Schnell v.BUSINESS ORGANIZATIONS II .. “I therefore conclude that. However. Blasius Industries.

no consummation for 90 to 100 days. therefore. 3.Shaffer Karl Bekeny/Spring 2001 Page 50 of 131 constituted an unintended violation of the duty of loyalty that the board owed to the shareholders.03 it would appear that the shareholders may not initiate an amendment as it requires BOD approval. §109 there is no problem for shareholders to amend the by-laws. Under §8. plus under §7.01 Official Comments. Therefore.04(a). that is the role of the BOD. Note that §7. in Campbell demonstrating total self-interest to bring about cause is difficult. this is no problem under §10. This specifically includes “an increase in the number of the BODs.08(a) allows for a cause requirement. the judgment of the Court of Chancery is AFFIRMED. The Quickturn case bellow will demonstrate how this flies in the face of §141(a) of the Delaware code.” In Delaware. This meeting could be call under §7. Margaret with over 10% of the shares could under §7. we hold that the Delayed Redemption Provision is invalid.10(a)(1). It is unlikely that the shareholders could actually vote to stop a sale of the Sweet Violet.” Problem. For example. v.02(c) and in accordance with the notice requirement of §7. §8. Under §10.02(a)(b) call for a special meeting of the shareholders. and the practical reality is that the BOD may need shareholder votes to approve the sale. On the other hand. (Held illegal 1998) NH=Nobody could amend plan for redemption for 6 months. December 31. as the Model demonstrates. but I am unclear what the reality is here.10(1) with someone who does. “The Delayed Redemption Provision [NO HAND] would prevent a new Quickturn BOD from managing the corporation by redeeming the Rights Plan to facilitate a transaction that would serve the stockholders’ best interests. 1998) [note book].02. it is the BOD who should nominate a new director. While really the only way to act is through a properly called meeting. Howard Shapiro (Supreme Court of Delaware.02 if no shares have been issued. Because the Delayed Redemption Provision impermissibly circumscribes the board’s statutory power under §141(a) and the director’s ability to fulfill their concomitant fiduciary duties. . If the Shareholders don’t like something their most appropriate avenue is electing new Directors.32 does apply to close corps.02(2) with the requisite amount of 10% of the shares. even under circumstances where the Board would be required to do so because of its fiduciary duty to the Quickturn stockholders. but this requirement does not seem to be easily met. Inc. then there may be a vacancy to fill which the shareholders may do under §8. 4. but they can provide their feelings to the BOD.” (Counter with doctrine of independent legal significance). Note that the redemption is of a posision pill.BUSINESS ORGANIZATIONS II .08(d) it would appear that the shareholders could call a vote to remove a director who does not oppose the sale and replace him under §8. and with a stated purpose set up and provided with notice under §7. this was to be shareholder reflection time. However. §7. On that alternative basis. The “Dead Hand” and “No Hand” concept: DH=The only people who could vote to redeem the rights plan were the current BOD’s. requiring buy back at Quickturn Design Systems. not pack from the shareholders. §12. additionally. LaFrance Cosmetics-Part III: 1. unless the AIC provide then the shareholders may not call a meeting. if the amendment goes through under §8. Under DGCL §211(d) there is no minimum percentage for a shareholder or group of shareholders to call a special meeting.03.05(c). While the shareholders may amend the AIC or even the by-laws. if there are already shares then under §10.20 the shareholders have no problem amending the by-laws.32(d) this only applies to non-publicly held corps who can achieve a unanimous vote. the shareholders can approve by a unanimous vote of the shareholders under §7. 2.

RMBCA § 16. but that would be a violation of the duty of loyalty. Under RMBCA § 16. Proper purpose=”a purpose (2): reasonably related to such person’s But to inspect minutes of board interest as a stockholder. a shareholder must have a proper purpose and describe with reasonable particularity that purpose and the records to be inspected.” Blasius. . RMBCA § 16.” meetings. the byrequired. minutes of shareholder meetings and like documents. Shareholder’s Right of Inspection. See Schnell v. Under 16. Chris-Craft. Ch. accounting records. (Del.407] Where corporate directors exercise their legal powers for an inequitable purpose their action may be rescinded or nullified by a court at the instance of an aggrieved shareholder. 6. “even …in good faith. These answers would likely that in Delaware under §228 the shareholders can do almost anything without even a meeting.04 a corporation is liable for a shareholder’s costs and fees for refusing inspection unless the corporation can prove that it acted reasonably.02 DGCL § 220(a) Grants inspection rights to beneficial Limits inspection to stockholders of owners as well shareholders of record. thus making it difficult for record. which records must be directly connected with that purpose. or the shareholder list. The BOD could attempt to stop the shareholder vote as in both Blasius and Schnell. Stahl v. 4. Likewise. Apple Bancorp.02(b). the shareholders may remove directors under §141. §220(b)-Lays out what you can look shareholders can readily inspect the at and when. “proper purpose” is articles of incorporations. If shareholder voting is hindered there is a good chance the action is inequitable. state statutes vary considerably on this point.BUSINESS ORGANIZATIONS II . 1990)[p. Whether an action is inequitable does not require a dishonest motive or an inquire in to the directors good faith. but divides corporate records shareholders who hold their stock in into two categories: nominee accounts to exercise the (1): right. However. because there may be a situation where there is a “compelling justification.01(e) & 16. laws.Shaffer Page 51 of 131 Karl Bekeny/Spring 2001 5. A court will have to look at the facts.” but not in this case. Shareholders are entitled to a right of inspection.02(a). There is the recognition in Blasius as well that this is not a per se rule.

Petitioner brings suit. the Official Comments to §16. Note: CEDE is the depository trust company that holds on the brokerage firms shares. Honeywell. and the corporations themselves would . He requested a shareholder list in order to solicit proxies for the election of new directors and Honeywell refused. Conservative Caucus v. (MA 1946) [p. Rel. He purchased shares for the sole purpose of gaining a voice in Honeywell.” ** This case has not been followed by Delaware Courts. ** “The Power to inspect is the power to destroy. If an owner does not object then the brokerage firm can give her name to the corporation (this will be done in the form of a NOBO list).03 state that a corp will only be required to hand over a NOBO list they already have. Chevron Corp. depositary trust will prepare a list of all firms holding stock in its name. Inc. a) Proper Purpose DGCL § 220(b) defines a proper purpose as a purpose “reasonably related” to such a person’s interest in a stockholder. (MN 1971)[p.409].413] The court permits shareholders who oppose doing business with Angola to inspect the records. or to accomplish some object hostile to the corporation. Pillsbury v. Delaware require upon request (shareholder entitled to list) There are two types of lists (1)CEDE. (Del. However..Shaffer Karl Bekeny/Spring 2001 Page 52 of 131 A remedy for the shareholder would be to request a writ of mandamus from the court ordering that inspection be allowed. 1972) [p. HOLDING: The petitioner’s motivation to elect new directors is not germane to his or Honeywell’s economic interest. State Ex. There was no proper purpose in the request so Honeywell had a right to refuse the records. Generally.410] FACTS: Petitioner a member of the prominent and wealthy Pillsbury family wanted Honeywell to stop production of its anti-personnel fragmentation bombs used in Vietnam. A corporation can then contact those firms to determine the number of beneficial owners. to annoy or harass the corporation. doing business with Angola could bring sanctions and hurt the corporation financially. This type of definition provides no help at all. b) What Comprises a Stock Holder List? One cannot determine who beneficially owns stock from the corporations list of stock holder’s of record because today most stock is held in nominee accounts which are in street name (Such and such trust). Lamson & Hunnard Corp.BUSINESS ORGANIZATIONS II .” See Albee v. (2)NOBO (Non-objecting beneficial owners). From case law we know that a shareholder has no right or inspection “if his purpose be to satisfy his curiosity.

449-451. Quorum requirements. §16. reasonably related to the actual list. but in the event that they are not then they don’t have to get them as that would difficult. 437-440.BUSINESS ORGANIZATIONS II . 490492] Problems associated with the division of management and control can be dealt with through private contracting in closely held corporations. 1981) [Won’t require a corp. For what can they look? Who Can Request to Look at the Stock Ledger? §220(a) “Stockholder of record” §16.02(c)(1-3) that the demand is (1) made in good faith and Sadler v. J.02(f) “beneficial owner” §220(b) Stockholder has a right for inspection. HOLDING: The corporation must provide the NOBO lists they didn’t already have. to get a NOBO list if it doesn’t already have one].02(a) any record in §16. Supra-Majority Voting. (NOBO lists take some time to get whereas a CEDE list can be obtained instantly. Deadlock & Dissolution. and then under §16. Share Transfer Restrictions. with proper purpose. Delaware requires that corporations deliver to shareholders entitled to inspect stockholder lists both the CEDE (Trust-a list of all the firms holding stock in the name of CEDE) breakdown and the NOBO lists already within the corporation’s possession. NCR Corporation. [looks like a partnership] . provided under §16. 465-467. including large Joint Ventures: Cumulative Voting . This is no longer generally true.[417-424. (State Statutory law permits this). See RB Assoc. to obtain a CEDE list if it has not already done so. They will not require the Corp to obtain a NOBO list and hand it over to a shareholder if it does not have a NOBO list itself and does not plan to obtain one. 415] [NO LONGER GOOD LAW] FACTS: NCR was resisting a takeover bid by AT&T by refusing to redeem a poison pill that presented an obstacle to AT&T. (Del. 1991)[p. Drafting and Other Issues Relating to Closely Held Corporations. and (3) substantial majority stockholder participation in the management. They also require a corp. of NJ v. (2nd Cir. direction and operations of the corporation. AT&T sought to remove the obstacle by soliciting proxies and removing incumbent directors.Ch. (2) no ready market for corporate stock.02(b)(3) inspect record of shareholders. Gillette. What is a close corporation? It will usually be typified by: (1) a small number of stockholders. 452-457.01(e). The law and economics school like Easterbrook and Fischel love this (contracting). AT&T arrange for a NCR shareholder to obtain the shareholder list and request that it provide a NOBO list.Shaffer Karl Bekeny/Spring 2001 Page 53 of 131 hold onto the NOBO lists.

This is a device designed to assure board representation for minority shareholders. Voting Trusts-§7. The extension. S=Number of shares represented at the meeting. You use a formula: the votes a shareholder is entitled to cast multiplied by the number of directors she is entitled to vote for. Control Devices Relating to Shareholder Voting. NOTICE.BUSINESS ORGANIZATIONS II . See also RMBCA § 7. (2) Shareholders transfer some or all of their shares to the trustee. BOD Response to Cumulative Voting: (1) The board can counter this by staggering elections of directors. under RMBCA there is a presumption until it is stated otherwise. a) Cumulative Voting.422.31(b)-The voting agreement is specifically enforceable. binds only those who sign it. d=Number of directors it is desired to Example of Cumulative Voting: [Pg 421] (900) x 1 elected) (8) + 1 + 1 = 101 (This is the amount of shares that George will need to get Note: Multiply the number of votes the shareholder is entitled to cast by the Under DGCL § 214. Note: DGCL §218 eliminates the 10-year limit on the duration of the voting trust. shows on stock transfer ledger with the trustee as the registered holder. (3) The Trust Agreement specifies a term not to exceed 10years. cumulative voting exists only to the extent that it is provided for under the corporation’s articles of incorporation. (§141(d) and §8. [p. §10.06).Shaffer Karl Bekeny/Spring 2001 Page 54 of 131 1. (4) Beneficiaries and a list of shares transferred to the trust. for formula] Cumulative Voting Formula: X= S x d +1 D+1 X=Number of shares required to elect Directors. Note: 7. plus a copy of the agreement must be sent to the principal corporate office.30 (1) Shareholders enter into a written trust agreement. §10. . (2) Decrease the size of the BOD.20 and §109 (Amend By-laws) Note: §109 grants the power to amend the by-laws to the BOD if you put in the AIC. if one is desired.20 b) Devices Outside the Corporate Machinery Voting Mechanisms: 1.28(b).

(NY 19180[p. Curtis. For Director Voting-May incorporate requirements either in the AIC or the By-Laws so long as they are not inconsistent with the AIC.21(a). then it may no longer have these agreements. it is coupled with an interest sufficient in law to support an irrevocable power.24. Designated by Shareholders-Simply designated to hold the proxies pursuant to the agreement. They could also be incorporated through shareholder agreements.22(d) “An appointment of a proxy is revocable unless the appointment form or electronic transmission conspicuously states that it is irrevocable and the appointment is coupled with an interest. b. but remember the restrictions under §7. supra-majority proposal must also receive supra-majority approval. §212(c) or §7. a. §218(c). A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. c) Restriction in Shareholder Voting Agreements. Mason v. Amend of AIC. and only as long as.22(d)(5) under §7. §7. This section is not subject to the previous one.32. but as soon as the corp is to go public.32 In a close corporation shareholders can designate almost anything. In some jurisdictions. Economic Interest in Corporation-Interest in corp although not the stock itself. Appointments coupled with an interest include the appointment of…” §212(e) “A duly executed proxy shall be irrevocable if it states that it is irrevocable and if.25(a) or (c). (4).” What is the Interest? Stock-The proxy holder has an option to buy the stock or lends money to the shareholder who pledges the stock as collateral.27(b). §7.BUSINESS ORGANIZATIONS II . §8.31 Two or more shareholders who agree as to how they will vote.22(d)(1). that this ONLY applies to close corps.22(d)(3). §7. Amend of By-laws-§10.§7. 1. 2.22(f) it terminates Shareholder Agreements-§7. 3. Voting Agreement (Voting Pool Agreements)-§7. Assists in close corp governance. (2). Supra Majority Provisions-Requires either supramajority approval by the shareholders or the BODs.Shaffer Karl Bekeny/Spring 2001 Page 55 of 131 2.437] . Irrevocable Proxy-§7. For Shareholders-Come about either when AIC originally drafted or by amendment.

Supermajority voting requirements for specified matters.439] The court holds an agreement invalid. consecutively. [p. or simultaneously) an opportunity to acquire the restricted shares. 449] See Benintendi v.Shaffer Karl Bekeny/Spring 2001 Page 56 of 131 The court holds that an agreement between shareholders was invalid because the powers delegated to shareholders were too broad (one of the parties was to act a general manager for a year and shape the corps. Clark v. e) Types of Transfer Restrictions §6. some courts have held that these are invalid. Kenton Hotel.439] Court validates a similar agreement as the one in McQuade but distinguishes it on the grounds that in the present case there was no attempt to sterilize the board as in Mason and McQuade.  A court will not go for an agreement that in effect provides for a sterilized Board. Buy-Sell Agreement-(Death. and competent. high vote requirements in the articles or by-laws. See RMBCA §§ 2. Dodge (NY 1936)[p.25(c) and 8.” Note: Different than a “Right of first refusal” in that in a right of first refusal the option comes at the same price and with the same restrictions and conditions as the offer from the 3rd party. §6.02. withdrawal. The agreement stated that Dodge would vote for Clark as Director and general manager as long as he proved faithful. d) High Voting or Quorum Requirements. A high quorum requirement for either shareholder meetings or board meetings can serve many of the same functions as a supermajority requirement.27(d)(1) and §202(c)(1) First Option Provision-“Obligates the shareholder first to offer the corporation or other persons (separately. 7. efficient.BUSINESS ORGANIZATIONS II . McQuade v.27 Restrictions on Transfer or Registration of Shares and Other Securities §6. policies). The terms of the agreement stated that the parties would use their best efforts to keep one another in office as directors and officers and salaries were not to be changed unless there was unanimous consent. However. specifically or by implication. but with the First Option Provision the deal comes at the agreed upon terms. This agreements imposes an obligation to .24(c). (NY 1945) on the grounds that such a provision was against public policy as it promoted dead-lock and hindered the making of business decisions. A great many legislatures have enacted statutory provisions that authorize.27(d)(3) and §202(c)(3) May Require Conditional Approval-Of shareholder disposition of stock from the BOD or the other shareholders. Stoneham (NY 1934) [p. or deadlock requires the corp to buy and shareholders to sell at a given price).

Federal Law I. The rules governing proxy statements make it impractical for share holders to nominate or solicit support for candidates. Deadlock.30(2) attempt to deal with this.” III. authorizes a court to allow any close corporation or one of its shareholders to “purchase all the shares owned by the petitioning shareholder at the fair value of the shares. 2. [p. Shareholders rarely play a meaningful role in selecting directors. These agreements are typically funded through life-insurance policies taken out on the lives of the principal stockholders. or (b) the shareholders have been deadlocked and have not been able to elect directors for two years. these agreements then provide liquidity to the estate. Section 14. RMBCA §§ 14. Shareholding Voting Controls. (Shareholder action) grants a court power to dissolve a corporation if a shareholder establishes that (a) the directors are deadlocked. and the deadlock is injuring the corporation or impairing the conduct of its business. [p. . such as “freezing out” a minority shareholder by cutting them off from both salary a dividends. When one shareholder or group of shareholders use liquidity rights all the time to frustrate all actions preferred by some other shareholder or group of shareholders. or (c) corporate assets are being wasted. When those who control the corporation pursue a course of action that other shareholders find oppressive.515-618] State corporate statues divorce ownership from control. Most public corporations are firmly controlled by self-perpetuating boards of directors or by senior corporate officials that those boards have elected. just holding liquidity stock with current income.Shaffer Karl Bekeny/Spring 2001 Page 57 of 131 purchase. commonly found attached to deceased stockholders estate. the shareholders can not break the deadlock. Dealing with Dissension.34 and 14. Courts will respond by applying the law of partnership to address these problems.BUSINESS ORGANIZATIONS II .466] There are two main types of situations that create problems of oppression and deadlock: 1. Oppression and Dissolution. Section 14.34.30(2). 2.

2. but there are basic aspects of corporate governance. because these institutions were made weak due to our decentralized political system. Investment is a voluntary activity and that consequently relationships between shareholders and management should be viewed as essentially contractual in nature. Role of Shareholders in Corporate Governance. Roe wants to reexamine the evolutionary structure of our corporations. Brudney.Shaffer Karl Bekeny/Spring 2001 Page 58 of 131 A. Easterbrook and Fischel. The Contractual Theory. Introduction to Securities & Exchange Act.[515-539] 1. These guys are for corporate laws that govern the relationship between management and shareholders. Theories of the Firm. bargaining for rules has its problems and its benefits. Additionally. economics. Roe.516] Bearle and Means. Recognized the separation of management and control. Theories of the Firm. Clark. These guys would get rid of a laws that act as a constraint on management. On the other hand. The Corporation and Private Property. instead shareholders exercise the Wall Street Rule and sell their shares rather than get involved in the internal affairs of the corporation. relating specifically to securities that come directly from the company. [p.BUSINESS ORGANIZATIONS II . Introduction to the Securities and Exchange Act. . Another Way To Look at the Modern Corporation. largely management controls public corporations. Fiduciary Duties-address the obligations of the fiduciary to serve the beneficiary. For example. The American system which did not allow for the control from financial intermediaries.focuses on the party’s right to benefit themselves. Bearle and Means believe that shareholders do not play a major role in monitoring management. and therefore relationships among shareholders and between shareholders and managers should be viewed as essentially contractual in nature. such as fiduciary duties that may not be bargained around. and the resulting disability from benefiting himself except as specified expressly. someone who agrees with Bearle and Means points out the contractarian approach is silly because the average investor lacks sufficient information about the stock he is buying. The Economic Structure of Corporate Law. Brudney thinks there is a difference from simply random contractual rules and those of the fiduciaries. Today. agency costs are reduced when contractual terms are agreed upon in the face of market and legal constraints. and the limits of that entitlement. They believe that the market will respond and protect shareholders. that they are not one in the same. The general belief that investment is a voluntary activity. Butler. the Contractual Relationship. and politics. the modern corporation lies in technology. Securities Can be Traded in 2 Ways: (1) The 1933 Act.

No 12(g)(1) filing requirement if… a. Under Section 15(d): Section 15(d) Imposes Obligations Comparable to §12 for “Public Offerings” under the 1933 Act 1.Shaffer Karl Bekeny/Spring 2001 Page 59 of 131 (2) The 1934 Act. who is identified as the owner of a particular security. (Basically any security being traded on national exchange). “Application of Section 12(g)” Jurisdiction 12 Registration Requirements for Securities: Section 12(a) of the 1934 act [p. 2. basically anyone $10. 3(a)(11). (Examples would be the NYSE and the NASDAQ. however. an over-the-counter market). and two of them are regional. there is a reserve authority for the SEC. Section 12(b) Procedure for Registration. Note: The Stock Broker must be registered with the NASD (National Association of Securities Dealers). The latter is usually done at the required annual meeting. relating to securities that are secondary. Exemption From Section 12(g) does include convertible 1. and with the SEC.000. State statutes such as RMBCA § . OR b. Shareholders can also amend corporate by-laws. suspend registration. Dynamics of Shareholder Voting. the Security and Exchange Commission). 2. The Registration requirement only applies to EQUITY securities. Last day of most recent fiscal year. Also.[540-561] What Shareholders can do: Shareholders must approve certain transactions that affect the structure of the corporation such as amendments to the articles of incorporation. Note: There are 9-stock exchanges in the US. Class of securities Held of Record is LESS than 300. and sales of assets. SEE HANDOUT.000 on the last day for the last three years. 12g-4 Certification of Termination of Registration Under Section 12(g) The termination shall take effect after 90 days or when the commission says so.000. unless year of actual registration. Most shareholders votes are cast by proxy (Rule 14a-9 governs proxies). Total Assets do NOT exceed $10. or traded through markets. mergers. a. LESS than 500 persons where the total assets of the issuer (corp) have not exceed Held of Record. securities. if security class is held by less B.000. 12g5-1.BUSINESS ORGANIZATIONS II . This is an SRO (Self-Regulating Organization. 937] sets forth the requirements for what type of securities need to be registered and when they need to be registered. IF. Under Section 12(g) (Exemptions to the General Rule): Equity security Note: 1. Information-The security may be issued for the exchange after an application is filed with the exchange itself. The Duties under this section are suspended if the security is registered under section 12.

BUSINESS ORGANIZATIONS II . (D. the fact remains that shareholders use their franchise as a monitoring device only infrequently. as well as the federal system of proxy regulation. The Collective Action Problem.Shaffer Karl Bekeny/Spring 2001 Page 60 of 131 7. [p. while state law validates the process of proxy voting Federal law governs it. An illustrative case: Dual Class Recapitalizations. a) Business Roundtable v. Securities and Exchange Commission.22 authorize shareholders to vote by proxy. The rule identifies situations in which shareholders are disenfranchised and prohibits companies from continued access to the national securities exchanges if they take such action. assume that shareholder voting plays a central role in corporate governance. But SRO’s like NYSE have implemented similar self governing rules. 2. getting information to shareholders. 1. Corporate Law. Proxies [p. Most theories of corporate law . [p.545] When shareholder vote they engage in collective action. 49] The statute permits shareholders to vote in person or by proxy. The Roundtable contends that the SEC exceeded its authority and did not have the power to create a new rule. Thus. 553] FACTS: The Business Roundtable is a group of businessmen that get together and talk about business and corporate law. it limits the validity of the proxy to a period of 11 months from the date of its execution unless the appointment specifies a longer period. the Roundtable files suit against the SEC for implementing Rule 19c-4. Self Regulating Organizations (SROs) like the NYSE and NASDAQ also play a role in fair corporate suffrage. The SEC responded by enacting Rule 19c-4. (Court held SEC did not have power to do this – NO LONGER VALID).C. . Cir.” Investors are unlikely to spend the time reading proposals sent to them (rational apathy) and are likely to rely on someone else to read it and act for them (free ride).” The only problem is that don’t have anything to support this. 549] Shareholders gave proxies for recapitalizations that were not in their best interest by changing their voting rights by adopting amendments. Anyway. Yet. RMBCA § 7. 1990) [p.22. Clark. The SEC argued that it had authority under section 19(c) language that states that the SEC has the authority to promulgate rules“ otherwise in furtherance of the purposes of the exchange act. Collection action is saddled with the problems of “Rational Apathy” and the temptation of shareholders to take a “Free Ride.

The corp must attempt to communicate with the beneficial owners. b) How the Proxy Process Works. Filing Proxy Materials: Management files proxy materials with the SEC. While generally speaking the shareholders will tend to be rationally apathetic. so maybe there really is no research involved in which case they just vote NO. Identifying the Shareholders: Street Names: NOBO (non-objecting-beneficial-owner) lists. and with 55% of the outstanding shares of the UNI company they may have a greater risk which would warrant the research. Once filed with the SEC. however. Universal Netware. No where in the legislative history is there support for the creation of a rule that protects one vote per one share. Federal Regulation of Proxy Solicitations.Shaffer Karl Bekeny/Spring 2001 Page 61 of 131 they argue section 14 power to regulate the proxy process but the court does not buy this. HOLDING: This type of rule is for state corporate governance law to determine. the SEC staff will review the materials. The company will wait for comments before sending anything to shareholders. because it does not make sense for them to actual do the research to potentially benefit the company.[561-573] Section 14(a) and Rules 14a-1 through 14a-7 of the 1934 act govern proxy solicitations. . Objections to the proxy: If a shareholder wants to counter a proxy solicitation they have to duplicate the process for their own proxy materials. C.” However. they actually save more by doing nothing or simply voting for the statute quo. Shareholder Voting: Usually done in the form of a proxy which generally states that the shareholder will vote with the board’s recommendations. because the stock option is an incentive to do better work for the company. Counting the Proxies: At the meeting proxies must be counted and votes recorded (usually handled by an outside firm). Inc.BUSINESS ORGANIZATIONS II . having nothing to lose. This generally is known of as the “prisoners dilemma. may see the present situation as a threat to their investment. A. The Board then sets a record date to determine which shareholders are entitled to receive notice of the meeting. The institutional shareholders.558] The Annual Meeting: The Board of Directors selects a meeting date (usually fixed in the by-laws). B. D C. Part I. in this case this problem is not quite as glaring because the institutional directors are known for acting collectively.[p. A.

564] . or to revoke a proxy. even through the newspaper is o. or revocation of a proxy. this would not include a “solicitation in opposition. the requesting security holder has the option to either receive the list or have the info mailed out if. Rule 14a-6 requires management to file preliminary copies of its proxy statement and form of proxies with the SEC at least 10 days prior to disseminating those materials to shareholders. or §14a-1(l)(1)(iii) the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement.k. which is 14a-3(a) “concurrently furnished.  What is a solicitation? Rule 14a-1 defines solicitation to include: §14a-1(l)(1)(i) any requests for a proxy whether or not accompanied by or included in a form proxy. (g). 14a-3(c) 7 copies of the report that went to security holders must also be sent to the Commission.” 14a-3(b) If the proxy concerns electing directors then an annual report must also be included. Rule 14a-4 regulates the form of the proxy.000. 562] Rule 14a-9 prohibits inclusion of materially false or misleading statements in proxy solicitations. Gittlin. withholding. 1966)[p. (2nd Cir. Rule 14a-3 requires that every proxy “solicitation” by management be accompanied or preceded by a definitive proxy statement. [p.BUSINESS ORGANIZATIONS II . approval of accounts. an election of directors. Proxy Rules as they Apply to Management. Studebaker Corp. v. Note: That the mailing of the proxy solicitation materials is at the solicitor’s expense.000. [like an ad or a letter] Note: 14a-1(l)(iv)(A) Stating how and why a security holder intends to vote. However. See § 12(b). etc. 14a-7(2)(i)-generally speaking the preferred choice would be to mail the list so that the solicitors would not be able to know whom the names and addresses of the security holders. 1. Note: Under 14a-6(a) there are some exceptions for the preliminary filing requirement for what appear to be regular or annual meetings or security holder meetings that might include . Has to be sent to the commission no later than when it was sent to the security holders. the request is in response to a going private move by the registrant under 13e-3.Shaffer Karl Bekeny/Spring 2001 Page 62 of 131 These rules apply to every company that has a class of securities listed on a stock exchange or has a class of securities owned by 500 or more holders of record and assets of at least $10. 14a-7(b)(1)(i). §14a-1(l)(1)(ii) any request to execute or not to execute.” 14a-7-The registrant must provide either a list or actually mail the proxy solicitation materials to any record or beneficial holders of a security.

Ill. 1964)[p. Smallwood v. receive staff clearance. Union Pacific RR v. The proxy rules do cover this type of communication. A group which supported the politician. . (Rock Island 2) (N. Chicago. and television scripts be filed with the SEC. ** For the group to have published the add without violating the proxy rules at that time.565] Court rules that report distributed to shareholders was reasonably calculated to influence a shareholder’s decision whether to grant a proxy or not constituted a solicitation and therefore constituted a violation of the proxy rules. The court held that this was a violation of the proxy rules. ** The SEC relaxed its rules because it was concerned that the requirements were discouraging shareholder participation. 1943) [p. Barbash. Long Island Lighting Company v. published a newspaper article accusing LILCO of mismanagement and passes onto taxpayers the costs of the construction of a new nuclear power plant.D. The ad was addressed to the public and concerned a local political issue. Pearl Brewing Company. Dissent by Judge Winter: Points out this is a first amendment issue. 566] FACTS: LILCO was the focus of a local political campaign in which the candidate urged public ownership of the utility. (no filing done).(Rock Island 1) (7th Cir. it was reasonable calculated to influence the shareholders votes. The court held that the letter was not a communication reasonably calculated to result in the procurement of a proxy (nothing in the letter mentioned the proxy). LILCO complained that the ad constituted an unfiled proxy solicitation. they would have needed to file a proxy statement with the SEC.565] Two months before soliciting proxies a company advised its shareholders of a merger. Okin (2nd Cir. Proxy solicitation had begun and nothing was filed with the SEC. no one had started to solicit proxies at this point. Citizens to Replace LILCO.BUSINESS ORGANIZATIONS II . Brown v. 1964) [p. and circulate copies of that statement to all shareholders. No violation of the Rules. 1985)[p.Shaffer Karl Bekeny/Spring 2001 Page 63 of 131 Gittlin obtained support from 42 other shareholders for permission to inspect corporate records in preparation of an attempt to take over the board of directors. 1974)[p. The politician acquired sufficient shares to demand a special shareholder’s meeting to consider his proposal. SEC v. press releases. (2nd Cir. and file the add with the SEC at least 10 days before publishing it.564] A letter which was a part of a continuous plan intended to end in solicitation was a violation of the proxy rules (no filing done). 565] Ad which informed the public about an issue pending before a government agency served a independent purpose to inform the public rather than influence Rock Island Shareholders. Chicago. HOLDING: Rule 14a-6(g) requires that solicitations in the form of speeches. (5th Cir.

14a-2(b)(1). 14a-8 and 14a-10 (These are the Anti-Fraud provisions): a. Solicitations by persons not seeking proxy authority and without a substantial interest in the matter. 1131 b. c. Note: There are exceptions to the exemptions: 14a2(b)(1)(i-x). b. sometimes these groups are subject to the more stringent proxy rules that apply to management. disclosure. Under Rule 14a-1 a shareholder can make an announcement of how she intends to vote her shares with an explanation of why. (labor unions. BUT NOT INCLUDING. Proxy Rules as they Apply to Shareholders. Nonmanagement solicitations to less than 10 persons. 1400-6(g).BUSINESS ORGANIZATIONS II . or disseminated to the media without limitation by the rules. Advice by financial advisors in the ordinary course of their business. Rule 14a-2 There are several exemptions to the filing. broadcast. News paper advertisements that identify the proposal and tell shareholders how to obtain proxy documents Rule 14a-9 (This section basically allows you to sue the issuer or anyone else who violated these rules) prohibitions still apply to prohibit material false and misleading statements. (2) Exemptions from all the proxy solicitation rules: a. i. Pg.Shaffer Karl Bekeny/Spring 2001 Page 64 of 131 2. and religious groups have become more vocal). Requests by beneficial owners to obtain proxy cards and other information from brokers that hold their shares. provided they disclose any interest in the proxy contest and receive no special fees from others for giving the advice. The revised proxy rules have encouraged shareholder activism. Communications by brokers to beneficial owners seeking instructions on how to vote the owner’s shares. Not deemed a solicitation so this type of information can be published. and distribution requirements. However. c. 14a-2(a)(1).” There are two major categories of exemptions: (1) Exemption to Rules 14a-3 to 14a-6 to 14a-15. Rule 14a2(b)(2).[p. . 14a-2(a) (2). political. 568] The rules have been relaxed so that a shareholder can request that management include a shareholder proposal in a proxy. Rule 14(b)-Requires brokers and dealers to pass on proxy information to their clients. 14a2(b)(2). the exemption exists under the “proxy solicitations.

” This of course. A shareholder shoe owns a large percentage of stock is .” GAF Corp. is the exact opposite of the Barbash case.” Legal standard: “The letter was not a communication reasonably calculated to result in the procurement of a proxy. 14a-1(l)(iv)(A) Herbert Rogers could express his views through the media. may also directly approach the institutional shareholders in this case. or disposing of security interests. like pension funds. therefore. it need not be disclosed as a plan or proposal under item 4 of schedule 13D. B. The Role of Institutional Investors. A. Herbet. He could likely achieve some of his goals be going after institutional shareholders for help. (2d Cir. Universal Netware. 1971)[p. or are you simply providing them with information? Linch is a Security Holder and so may himself say his mind under 14a-1(l)(iv)(A) speak his mind. holding. are starting to play a larger role in corporate governance. explaining why he felt that the plan was not a smart one and it would never be considered a solicitation. v. voting.BUSINESS ORGANIZATIONS II . As a security holder. exempting Herbet from 14a-3 to 14a-5. Page 1013-1014 of the code book. The court held that under § 13D there is no requirement to make predictions of future behavior or to disclose tentative or inchoate plans. (2nd Cir.Shaffer Karl Bekeny/Spring 2001 Page 65 of 131 Rule 14(c)-What info you must provide before an annual or other meeting. The situation was held to not be “totally innocuous was not overwhelmingly prejudicial either. 1995)[p.. Constraints on Institutional Investors. Unless a course of action is decided upon or intended. not running afoul of the exceptions to the exemptions under 14a-2(b)(1)(i-x). Azurite Corp. Institutional Investors. as it is more just information of a plan and not a solicitation. Are you contacting the record shareholders before you are allowed to. Rule 13(d)-5(b)(1) defines person to include a group and a group will be deemed to have acquired the shares of its members when two or more persons “agree to act together for the purpose of acquiring. Ltd. C. B.[573-594] 1. unless you have already initiated one. Inc. but in this case the BOD is speaking. V. basically the same as solicitation.573] Defendants were not liable for announcing their proxy contest plans at an earlier date (they eventually filed schedule 13D). D D. Amster & Co. C. Section 13(d) requires any person who becomes an owner of 5 percent of the stock of a registrant to file a schedule 13D within 10 business days of acquisition. The real question here is when do you have to file a proxy solicitation? You would have a failure to file under 14a-6. Pearl Brewing Company there would appear to be in problem with the statement. Milstein. Under Smallwood v. Part I. 572] Four members of the Milstein family who together owned excess of 10% of the corporation’s stock were held to be in violation of section 13(d) by failing to timely file schedule 13D. and a failure to provide a proxy statement and form under 14a-3.

Bernard Black. Capital. Black argues for reform that focuses on the process of voting rather than substantive governance rules. Labor. Meliven Eisenberg. they are not equipped to oversee management.which gives them less incentive to worry about company specific concerns.Shaffer Karl Bekeny/Spring 2001 Page 66 of 131 more likely to engage in monitoring. collective action problems plague institutional investors making them less effective as they could be at monitoring. Corporate Control. many government regulations also hinder their activity. including different types of institutions to join forces to exercise influence. Owning a 10% (Beneficial owner) or BOD or officer stake can trigger shortswing profits which need to be forfeited under section16(b). 577] Product. [p. Also money managers of institutional funds diversify -.575] An active shareholder or shareholder group. See Black. (2) requiring a number of institutions. Institutional Investors and Monitoring. However. owning a 5% stake in an issuers stock triggers filing requirements under section 13(d). But. Furthermore. . He feels that the primary duty of an institutional investor is to protect the interests of its own beneficiaries. 2.BUSINESS ORGANIZATIONS II . [p. do they also owe an obligation to their fellow shareholders? Eisenberg argues no. active shareholder must report its holdings and plans on schedule 13D (a passive shareholder can file the much shorter schedule 13(g)-(under 13(d)-5(b)(1) this would include groups of people too)-in order for this to apply they would have to allege that they are not seeking control of the company).581] Institutional Investors have taken the position that their primary obligation is to their own beneficiaries. Agents Watching Agents: The Promise of Institutional Investor Voice. [p. The Structure of the Corporation: A Legal Analysis. and (3) corporate managers can watch there watchers (pension funds). Agents Watching Agents: The Promise of Institutional Investor Voice. the division between management and control is not as wide as when Bearle and Means did their famous study. Problems: Institutional Voice means: (1) asking one set of agents to watch another set of agents. Thus. Shares owned by pension funds are voted by employees who often share the same views as management.

582] Institutional Investors have many reasons to remain rational apathetic. He feels investors have become more active because voice has become less expensive with relaxation of federal laws. The Logic and (Uncertain) Significance of Institutional Shareholder Activism.Shaffer Karl Bekeny/Spring 2001 Page 67 of 131 John Coffee. Liquidity versus Control: The Institutional investor as Corporate Monitor. [2].585] Bock argues that competition amongst money managers acts to prod managers into acting (investors may feel betrayed or that the manager is shirking their duties by not checking out the companies he is investing in for the investors). C. (1) While the statement itself may be exempt under the proxy solicitation rules section 14a-2(b)(1). Since not deputizing directors. Shareholder Proposals[594-618]. Investors that want liquidity may hesitate to accept control. Individual shareholders are likely to be rationally apathetic.BUSINESS ORGANIZATIONS II . because they would have had to have filed a 13D. D D [1]. E. There are several potential problems in this case. Evolution of The Shareholder Proposal Rule. That to assume the duties of a board member would be to place them in conflict with their duties to their beneficiaries. The group pushed through a proposal asking GM to set up a shareholder committee for corporate responsibility. [3]. The institutional investors would likely also have to give up liquidity for control. [4]. they may be exempt from solicitation rules since they could be contacting under 10. and therefore they may have real interest in getting the vote done correctly. Other scholars argue that institutional investors will come to dominate corporate management. but institutional shareholders. and therefore the only concern is 14a-3 to 14a-6 violations. Campaign GM in 1970 was the first major successful effort in this respect. 1. The fiduciary duties to the beneficiaries is likely to be fine so long as she thinks that her decision is likely in their best interest. [p. Federal Regulation. Coffee disagrees for the latter reasons. B. A. 14a2(b)(2). In the 1970’s shareholders became more concerned with social issues such as the environment and diversity. Their desire to execute an informed vote grows exponentially. there will probably be no 16(b) duty. Likewise. Inc. since they own more of a stake. The proposal got . [p. Coffee feels that the law needs to intervene to give the institutional investors incentive to monitor. They became less concerned with corporate governance. may have more interest. NOT 14a-2(b)(1)(vi)-since there are more than 5% of corps shares within the BOD. Part I. something that they would likely not want to do. Universal Netware. The main criticism would be that institutional investors are not proper for management. Edward Bock.

a proposal that mandates certain action by the Board of Directors may not be a proper subject matter for shareholder action. etc. the shareholder advancing the proposal must be a record or beneficial owner of at least 1% or $2. however.000 in market value of the securities entitled to vote and have held the securities for at least one year. address. (2) The proposal asks the board to do something illegal.. (3) (Violation of Proxy Rules) the proposal is contrary to SEC proxy rules and regulations. A proper subject is one that a shareholder may properly bring to vote under the law of a company’s state of incorporation. number of shares he owns. (4) If the proposal relates to the redress of a personal claim or grievance or if it is designed to benefit the claimant and this interest is not shared by the security holders at large. while a proposal recommending or requesting action may be proper..Shaffer Karl Bekeny/Spring 2001 Page 68 of 131 only 2. However.597] Set forth the standard for what is a proper purpose under Rule 14a-8(i)(1). .E. Under R. this is better dealt with because it is precatory in nature (advisory). 2.BUSINESS ORGANIZATIONS II . NOTE: this will depend on state law. Rule 14a-8. Yet. Cir. 14a-8(i)(1) sets forth exceptions which allow a issuer/corporation to omit a proposal from its proxy statement and form proxy under any of the following circumstances: (1) (Improper Under State Law) if the proposal is not the proper subject for action by security holders. 14a-8(1). changing procedures to amend the companied by-laws. (3rd.. like a violation of Rule 14a-9 (a material false or misleading statement). R. v. Dressel.73% of the votes at the meeting but GM changed its policies and shortly thereafter nominated its first black director. 1947)[p.C. Transamerica Corp. when and how shareholders can bring a shareholder proposal that the board of directors is forced to include in a proxy statement it is sending out to shareholders. the Court did uphold the propriety of elections of independent auditors.1062] sets forth the requirements for what. Proposals by Security Holders [p. In this case.14-8(2) the shareholder must provide his name. and requiring a report of the annual meeting be sent to shareholders. note this is similar to Auer v. (3) the proposal should be submitted timely. Under R. (4) only one proposal may be submitted and (b)(1) it must include a supporting statement not exceeding 500 words and (b) (2) should identify the proponent. S. The Rule in Operation. For example.

(10) (Substantially Implemented) the proposal has been rendered moot. Iroquis a report on forced geese feeding was found to be important even though it was less than 5%. then under 14a-8(m) it must be included but the registrant may include the reasons that it feels it is a bad idea. however in 1998 the SEC announced its return to a case-by-case analysis. SEC (1995) (The case that codified Cracker). without shareholder initiative or approval. If there is no proper exclusion above for one of the reasons. that the BOD has the discretion to declare dividends. mainly because the company is already doing what the shareholder asks. (12) (Resubmissions) the proposal deals “with substantially the same subject matter” of a proposal that was submitted to security holders in the last five years that failed to get 3 percent on its first try. (11) (Duplication) the proposal is substantial duplicative of a proposal previously submitted to the registrant by another proponent and the proposal will be include in the materials. New York City Employee’s Retirement System v. (8) The proposal relates to the election of an officer. (13) (Specific amount of dividends) the proposal relates to specific amounts of cash or stock dividends. that employment practices such as EE or Affirm Action could be excluded as “ordinary course. or 6 percent on its second try. or 10 percent after three tries. Allowing for no exceptions when social policy.BUSINESS ORGANIZATIONS II . Medical Committee For Human Rights v.Shaffer Karl Bekeny/Spring 2001 Page 69 of 131 (5) (Relevance) the proposal relates to operations which account for less than 5 % of the registrant’s total assets and for less than 5 % of its net earnings and gross sales. Then the SEC changes course and said in Cracker Barrel Old Country Store. SEC (1992) NO Action Letter. which held that management could not exclude a initiative to force Dow Chemicals not to consider the use of napalm. . This is a fundamental part of corporate law. (9) The proposal is counter to a proposal to be submitted by the registrant at the meeting. Lovenheim v. this prevents dissidents from clogging the company’s proxy statement with their own candidates.” This was upheld by the 2nd circuit. (6) The proposal deals with matters beyond the boards power to effectuate (ultra vires). and is otherwise not significantly related to the registrant’s business. SEC. (7) (Management Functions) the proposal relates to matters relating to the conduct of ordinary business operations or the registrant.

Dressel. Thus.I. Cir. under 14a-8(i)(7). or (7) involves “ordinary business operations. Auer v. like the individual shareholder right above. technically. Du Pont de Nemours & CO.601] FACTS. If the company decides to omit a proposal it will request a no action letter from the SEC. (5) not significantly related to the company’s business.[p. HOLDING: The court held that the meeting had to be called because it involved significant matters even if the shareholders vote would not bind the board.. Then. the SEC then can also bring an injunction seeking a court order that the proxy statement must be included.[p. Transamerica-Since the time of this case the companies have traditionally acquiesced to the decision of the SEC because it is not worth litigating the issue. E. even is the proposal relates to ordinary business it cannot be excluded if it relates to public policy.600] A shareholder has an implied right of action under Rule 14a-8 to challenge an omission in court. and ask for enforcement from the federal court.602] . (SDNY 1993)[p. b) Substantive Grounds for Omission.. 1992)[p. mandatory resolutions do not have to be included while recommendations should be included (Note to paragraph (i)(1).BUSINESS ORGANIZATIONS II .C. Roosevelt v. you need to ask what is the subject matter of the proposal. However. (D. The antithesis of ordinary business is public policy.601] Most often registrants will omit proposals under the grounds of Rule 14a-8(i) (1) not a proper subject.” Both (i)(1) and (i) (7) depend on application of the law of the issuer’s state of incorporation. Amalgamated Clothing and Textile Workers Union v.599] Rule 14a-8(j) provides that the registrant/issuer must send materials to the SEC if it decides to omit a proposal (Basis for a No Action Letter). if it involves ordinary business it may be omitted under Rule 14a-8(i)(7). (NY 1954)[p. Wal-Mart Stores.Shaffer Karl Bekeny/Spring 2001 Page 70 of 131 The shareholder may also use 14a-8(k) to have the SEC determine that a violation is occurring. a) No Action Letters. Inc. Under Rule 14a-8(i)(1). (the meeting concerned the rehiring the president). Whether the president of a company was required to call a shareholders’ meeting that had been demanded by a shareholder who held sufficient stock to satisfy the statutory requirement.

** AS of 1997 the SEC reversed its position on EEO programs.BUSINESS ORGANIZATIONS II . Portland General Electric. Wal-Mart contends that these are ordinary business matters which may be excluded under 14a-8(i)(7).616] The court affirmed management’s refusal to include in the proxy statement a shareholder statement in opposition to management plans for construction of a .000 the last year. Medical Committee for Human Rights v. [Court looks at no action letters as a sort of common law on this issue to reach its result]. A shareholder. (D. but is now again likely the law. the court modifies the proposal so that it can be submitted to the shareholders. Lovenheim. in Delaware § 141(a) leaves the conduct of ordinary business in the hands of corporate directors and officers. HOLDING: The meaning of significantly related to issuer’s business does not solely hinge on Economic significance. Ltd.614] A proposal against the use of Napalm submitted to Dow Chemical could not be omitted even though it related to less than 1% of Dow’s overall business. SEC. in this case and on this particular topic. Court focused on the fact that board was not manufacturing Napalm for business reasons but for patriotic ones 14a-8(i)(7). (D. The proposal dealt with equal opportunity and affirmative action policies. Lovenheim v. (OR 1961)[p.Shaffer Karl Bekeny/Spring 2001 Page 71 of 131 FACTS: Shareholders challenge Wal-Mart for omitting their proposal from the proxy statement and form sent to shareholders for matters to be voted on at the annual meeting. 1972)[p. submits a proposal to Iroquois in the form of a resolution regarding the force feeding of geese to make pate that Iroquois imports and distributes. 1985)[p. 611\ FACTS: This is an animal right case addressing the force feeding of geese to make pate. The court granted Lovenheim’s request for a preliminary injunction.000 in assets are related to pate. and it appears that these proposals will no longer be considered ordinary business matter [p. Iroquois Brands. Note that this was kind of overturned by Cracker Barrel. During the 1970’s proposals relating to only 1% of a company’s were not allowed to be omitted because the proposals raised important policy questions to be considered important enough to be considered significantly related to the issuer’s business. Cir. However.617].C. Carter v.. Iroquois omits the proposal on the grounds that it does not significantly relate to Iroquois’ business under Rule 14a-8(c)(5) [its annual revenues are $141 million and pate sales were only $79.C. HOLDING: Proposals which deal with significant public policy concerns although the also deal with ordinary business matters (a power plant operating a nuclear power plant) may not be omitted under Rule 14a-8(i)(7).D. and only $34. the SEC has found that they are excludable as involving ordinary business because they relate to employment policies. Note. EEO programs. the resolution recommended the forming of a committee to look at the issue.

the group may run afoul of 14a-(i)(5) since they do not affect 5% of the companies total assets. [p. The court held that the proposal was not a proper subject for shareholders under Rule 14a-8(i)(1). then they are eligible to submit a proposal. (2) Disinterested shareholders or directors must be fully informed in a conflict of interest transaction in order to validate the transaction or to shift the burden of proof in litigation challenging the transaction. and therefore in violation of 14a-8(i)(1) of the SEC’s proxy code. in violation of 14a-9. Note: There are also some statements. then it would not be as likely to violate 14a-8(i)(1). because not all states do not allow a shareholder by-law proposal. which has been held for over a year. the SFSJ may violate DGCL 141(a) and therefore 14a-8(i)(1). such as when they say. seeing as they have $3. because the SFSJ would essentially be interfering with the management function. Inc. Furthermore. to under 14a-8(i)(7) to examine the social policy of all proposals. 619-826] IV. It would appear that the plan would be a problem because it would likely violate Delaware code 141(a). that could be construed as fraudulent. Iroquis that the policy is significantly related as it will help prevent the Lay Off of 1. B  A. SEC takes the position that NJ law does not prohibit this kind of shareholder action but held the opposite in a case involving Delaware law and possibly NY (will depend on state law). “company disregard for EEs. or arguably is not “significantly related to the company’s business.Shaffer Karl Bekeny/Spring 2001 Page 72 of 131 dam.200.000 UNI employees.” it is not determinative as of the SEC’s 1998 decision.” However.618]. Universal Netware. they may make the argument under Lovenheim v. [p. Part II. However. Fiduciary duties are one of the critical elements in the relationship between shareholders and management.” they need some proof. because an employment decision would appear to be part of a companies “ordinary business operations. while Cracker Barrel letter may have some influence. . For example: (1) A director must be fully informed in order to gain the protection of the business judgment rule. B. Be on the look out for proposals to amend the by-laws of a corporation (depends on the state law and the provisions in the by-law. if this case is going on in Delaware.BUSINESS ORGANIZATIONS II . (3) A director may be guilty of appropriating a corporate opportunity if she does not disclose the opportunity to the board before taking it for herself. State Law Fiduciary Duties: Litigation before State Courts. However. Likewise. Disclosure lies at the heart of much of the law of fiduciary duties. A. a situation which the Delaware Supreme Court held in Quickturn made the “NO Hand” or “Dead Hand Provision” unlawful. like is it made unamendable by BOD) that could be a 141(a) violation and therefore a 14a-8(i)(1) violation. 14a-8(b). if the statement were more of a recommendation. and some of the other statutory provisions.

However.BUSINESS ORGANIZATIONS II . fiduciary breaches are usually are challenged by shareholders in derivative litigation brought on behalf of the corporation (management is unlikely to bring a suit against itself). 251] “The business and affairs of every corporation . State statutes give the BOD wide latitude in how they can operate.75] “(b) All corporate powers shall be exercised by or under the authority of. (2) ownership issues such as initiating a merger or constructing takeover defenses.. [p.[619-657] 1. etc. outside directors usual lack the expertise that management does in the company. Powers. Yet. one thing a board can’t delegate is the decision to issue a dividend or not. 2.. Most Directors lack experience in the business of the company on which they sit. Number.Shaffer Karl Bekeny/Spring 2001 Page 73 of 131 Fiduciary duties are owed to the corporation. Weiss. 623] Four factors that constrain outside Directors to carry out their job: 1. “The Board of Directors. Management. However. Most Directors hold demanding jobs elsewhere.shall be managed by or under the direction of a board of directors.. “outside directors” are usually directors or high level management of other corporations – they do not really have the time or incentive to monitor.  . its Board of Directors. Elliot J. RMBCA § 8. and (3) oversight such as reviewing senior executives’ performance and ensuring corporate compliance with legal norms.. How Boards of Directors Operate [p. A. Directors are often not willing to question and second guess each other (collegial atmosphere). Moreover.” As of late there has been much discussion concerning the use of “outside directors” to assist in the monitoring of management in general. and the business affairs of the corporation managed under the direction of. and Corporate Takeovers: Opportunities and Pitfalls” [p. The Role of Outside Directors in Corporate Governance. thus reducing agency costs.622] Management has three principal functions: (1) enterprise decisions concerning operational and business matters.01 Requirements for and Duties of Board of Directors[p.” DGCL § 141(a) Board of Directors.

such as employees. Actions at the meetings are usually by consensus. reports. 4. Outside directors. How Manning Thinks the BOD Should Operate Their Managing Powers 2 Exceptions To Agenda Setting 1. especially those that are executives of other corporations. 2. have a “structural bias” against taking actions that conflict with the interests or preferences of a corporation’s managers. 2. Bayless Manning. However. and updates (often committees of the board). Others argue that directors should be drawn .Shaffer Karl Bekeny/Spring 2001 Page 74 of 131 3.625]  Outside directors (meaning not management of the corporation) are part-time people. there is this corporate culture that wants the statue quo anyway.635] Directors who are independent of management can act to reduce agency costs within a large corporation by checking management overreaching and vetoing unwise management proposals. They rely on company executives to provide the information. (Note: To not do this may cause BOD liability). Do Independent Boards Matter? [p. Some scholars argue that boards should have directors that represent the interests of constituencies other than shareholders. but this will typically be set by management. Internal Information System-Auditing system put in place so management officers and the BOD are getting clear and accurate info. Directors have little in the way of financial incentives and face little in the way of legal pressures to perform effectively. Plus as Weiss points out. Agenda Setting is very important. often outside directors do not want to rock the boat – they usually defer to a CEO who stands behind her proposals and prefer to resign quietly rather than challenge the CEO publicly. They simply do not have the time or the incentive to stay on top of everything when they only meet on a one-and-a-half-day-a-monthbasis. Functional Management-This is the BOD’s ability to hire and fire the CEO and other top management. “The Business Judgment Rule and the Director’s Duty of Attention: Time for Reality” [p. The board only has limited time so only some things are put on the agenda. The directors must rely on others for information.BUSINESS ORGANIZATIONS II .

The Outside directors. in fact. preventing them from voting against their CEO and acting independently.000 or more with the corp. • National Association of Corp Dir. not relative of anyone in company. What Can Outside Directors Contribute? Pg 619 1. the ALI §3A. However. transaction of $200. the obvious pitfall is that they would lack experience and training. The committee should be made up of disinterested individuals. Section ALI 3A. is not EE of firm providing major service to company. but who would also care a great deal about the corp. (e) Constituency Directors? • This would include groups such as EEs.BUSINESS ORGANIZATIONS II . you provide no service to company.000 shareholders and $100 million have an audit committee. working for a firm employed by the corp. receive no comp other than dir fees. with their experience can act as a check which keeps the managers in line and .23 looks to a Dir without a “significant financial” interest in the transaction.Shaffer Karl Bekeny/Spring 2001 Page 75 of 131 from groups that are not part of the traditional corporate establishment.05(Comment C) recommends that all companies with at least 2. (c) How Do we Define “Independent” • ALI §1. This may be beneficial. and clearly the statute looks favorably upon it. They do have their constraints. but it is still unclear how much of an affect outside or independent directors actually have on the corp. 2. While outside directors are supposed to oversee the company. etc. (b) Who are the Outside Directors? • Most of the directors on major corps are outside directors. you are independent if: o Never EE of the corp. and are forced to rely on inside directors and other corporate managers. and who does not have a “significant relationship” with a senior executive. o Such as working for the firm. they will typically review financial statement and reports. Should provide proper incentives for management but avoid over compensation.. (a) Note: With oversight and disclosure is also the push for an audit committee. (d) Structural Bias? • This is when a “mind set” exists that prevents outside directors from breaking with the CEO or managers view of the situation. however. part of interlocking directorate in which corp CEO sits on BOD of another corp who EEs the director. who would be disinterested. • The Council of Institutional Investors add someone who is EE by foundation or University who receives substantial funds.01 suggests publicly held corporations should have a majority of outside directors.

there is also the problem that the inside dirs here are outside dirs at your independent dirs company. while totally independent they are likely to lack either the knowledge in general. it may be difficult for these dirs to know what is the best option and the preferred practice in a particular area. (3) they depend in inside dirs for their information. then as well for professional and constituency dirs. Directors’ Duty of Care. -Clearly the benefit of the BODs is their ability to step in and keep the corp managers in check when they feel that they are behaving in a manner which might be detrimental to the corporation. (2) Discharge his duties in a manner he reasonably believes to be in the best interests of the corporation. The business judgment rule presumes that directors and officers carry out their functions in good faith. (1) the dirs don’t have time. after sufficient investigation. (2) they often lack experience in the specific business which they are overseeing.C 4. Of course. . and the reality is that if the CEO is the largest shareholder etc. be honest. and (3) Become informed in performing his decision-making and oversight functions with the care an ordinarily prudent person in like position would reasonably believe Common Law Standards: The Delaware Supreme Court has stated that a party challenging a business decision must show either the directors failed to act: (1) in good faith.Shaffer Page 76 of 131 Karl Bekeny/Spring 2001 the company focused on the shareholders best interest. (4) there is no real incentive for these dirs to step up and do what is best for the company and reign in the inside directors. The duty of care addresses the attentiveness and prudence of managers in performing their decision making and supervisory functions.B. A. principally for the benefit of the shareholders. Unless. Aronson v. officers. or the practical knowledge of the real business world. Of course. as Manning points out. this presumption is overcome. (2) in the honest belief that the action taken was in the best interests of the company. On the other hand. and so do these independent dirs really want to cause turmoil when they may be attempting a similar move at their own company. Of course. The General Standard of Care. and for acceptable reasons. and controlling shareholders are obligated to act in the corporation’s best interests. they are likely to receive a lot of deference. B. a director must: If These Actions Are Done The BOD did NOT Breach Duty of Care (1) Discharge his duties in good faith.BUSINESS ORGANIZATIONS II . and not approve or condone illegal activity. 3. 1. not have a conflict of interest. with highly technical and diversified companies. The people who serve as dirs may also be diverse. Statutory Standards: Under MBCA § 8.30. courts abstain from second-guessing well-meaning business decisions even when they are flops. and in this case how independent are these outside dirs. Lewis 1984  Facets of Duty of Care: (1) Good Faith. and (3) on an informed basis. the real problem is as Weiss points out.[658-684] Directors.

(NJ.” Duty of Inquiry An offshoot of the business judgment presumption entitles directors to rely on information and advice from other directors. officers. Pritchard liable for failing to become informed and make inquiries. Pritchard’s laxity proximately caused the losses to the corporation. HOLDING: Court held Mrs. and outside experts. a closely held reinsurance brokerage business. United Jersey Bank. which revealed that her sons were taking client funds in the guise of “shareholder loans. or refuse to serve as a director.. However. (1963)[p. She never read the firm’s annual financial statements. If one feels that he does not have sufficient business experience to qualify him to perform the duties of a director. Allis-Chalmers Manufacturing Co. See RMBCA § 8.” RMBCA §8. in imposing a standard of ordinary care on all directors. he should either acquire the knowledge by inquiry. (The desire to add the estate to the bankruptcy pool may explain the court’s duty of care analysis. After her husbands death Mrs. Graham v. There Must Also Be at Least A Basic Dir Understanding: “The NJ Business Corporation Act.30(a)-Refers to care that “an ordinarily prudent person in a like position would exercise.” Suit was brought by a bankruptcy trustee against the widow and her two sons. Pritchard was listless and started drinking. After her husband’s death she became a director. directors cannot hide their head in the sand and claim reliance if they have knowledge or suspicions that make reliance unwarranted. and (3) Reasonable Care. confirms that dummy. Pritchard was the widow of the founder of Pritchard & Baird. 1981)[p.661] FACTS: Mrs.30(e)(1-3). Directors must be informed in making decisions (possess minimal levels of skill and expertise).BUSINESS ORGANIZATIONS II . She could have brought her sons’ illegal misappropriations to the attention of insurance officials. employees. [Mrs.] As a general rule a director should acquire at least a rudimentary understanding of the business or the corporation.667] . but was inactive and knew virtually nothing about the business. Francis v. she died during the proceedings and her sons stood to benefit from her estate. board decision’s must be related to furthering the corporation’s interests. figurehead and accommodation directors are anachronisms with no place in New Jersey Law. That means that management directors with greater familiarity with the corporation have a greater duty to independently verify information.Shaffer Karl Bekeny/Spring 2001 Page 77 of 131 (2) Reasonable Belief.

 Under RMBCA § 8. The board considered a compliance system but decides against it because it seemed unwarranted. (1996)[p. and .  Board inaction (failure to implement a monitoring system) is protected only if the failure was a conscious exercise of BJ. absent knowledge or notice to the contrary. Notice That Delaware Had What Appeared to Be Straight Negligence Standard For a plaintiff to establish that a director breached their duty of care they would need to show that: (1) The directors knew. (3) That the directors took no steps in a good faith effort to prevent or remedy that situation. The shareholders want to recover this money. official comment.  More recent Delaware cases suggest that a board may have a duty to install corporate information and reporting systems to detect illegal conduct. Good faith inaction is protected by the BJR. directors are not liable for failing to institute a antitrust compliance program because there were no grounds to suspect it was needed (Where is the Red Flag)(“obvious signs”). or (2) Should have known that violations of law were occurring and. Derivative Litigation. Unless the director knew of or suspected bid-rigging.30(b). they were not obligated to install a monitoring system. (Note however. that management was pushing for an increase in profits at a time when there was a down turn in the market – perhaps influencing mid-level management’s illegal actions). (stricter federal sentencing guidelines for companies who fail to implement compliance programs now days encourage boards to implement programs or else proceed at their own peril) In re Caremark International Inc. the parties agree into settlement negotiations. below. in matters of legal compliance a director may depend on the presumption of regularity. HOLDING: Under the BJR. Caremark was under criminal investigation and entered an agreement in which it would pay $250 million to the government.BUSINESS ORGANIZATIONS II .672] FACTS: Suit involves claims that the members of Caremark’s board of directors breached their fiduciary duty of care to Caremark in connection with alleged violations by Caremark employees of federal and state laws and regulations applicable to health care providers. in either event. Court approves the settlement.Shaffer Karl Bekeny/Spring 2001 Page 78 of 131 FACTS: Shareholders bring a derivative action on behalf of Allis-Chalmers against its board of directors and four non-director employees to recover damages which the corporation had to pay because of an antitrust suit for price fixing. See Caremark International.

is to then (1) object.Shaffer Karl Bekeny/Spring 2001 Page 79 of 131 (4) That such failure proximately caused the losses complained of. Compliance programs instituted because of the sentencing guidelines which are insufficient to mitigate a corporation’s criminal liability will often be used in a derivative suit to show that a director did not act reasonably in carrying out her oversight duties. Do you really want courts to make business decisions? a) Due Care and Criminal Liability [p. and if not may request that one be instituted. and while this does not require indepth analysis. 2. Fashion.” therefore requiring at least a minimal amount of knowledge in overseeing the company. The shareholders are the ones who actually take the risk. exists.30(b) refers to the duty of care as through the eyes of the “ordinary prudent person in a like position. render a director liable for losses caused by non-compliance with applicable legal standards.BUSINESS ORGANIZATIONS II . Under Francis Peter’s duty. experts told them that the payments to physicians for referrals while questionable were legal. (2) and if the conduct is not corrected to then resign. fashion designer. and she could also be then protected under the BJR from the Caremark decision. The monitoring system would provide that much more protection. the Dir does have to properly inform themselves about the on goings of the corp unlike the woman in Francis. and that failure to do so under some circumstances may.” Peters would also want to determine if a monitoring system were in place. then they will not be held liable even if the systems fail to prevent wrongdoing. Three cases in book. and that she can look at financial statement and see when the corporation is taking a terrible turn. I mean you may rely even upon your fellow dirs. No evidence of bad faith. she cannot behave as a “dummy” or “figurehead dir. if she finds some illegal activity. 682] The business judgment rule does not protect corporate illegality. or Joe off the street. or managers of the corporation. Note: Peters should also request an indemnification agreement that would protect her from personal liability. Under the facts of this case the directors had set up a system. HOLDING: A director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system. Inc. Problem. this merely requires that she take the time to solicit their advice.  There is a policy for BJR: 1. all involve environmental or food and drug violations. which the board concludes is adequate.  If directors set up some type of monitoring system (BJR). they had a right to rely. While it is unclear whether the ordinary person is a CEO. . Part I RMBCA 8.

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C. The Business Judgment Rule.[685-705] The BJR is a rebut table presumption that directors in performing their functions are honest and well-meaning, and that their decisions are informed and rationally undertaken. (Does not apply when self-dealing or illegality).
BJR Presumption (1) That the BOD acted in “Good Faith,” (2) that they reasonably believed that they were acting on behalf of the corp, (3) they used reasonable diligence in their monitoring and inquiry.

BJR shields directors from personal liability and insulates board decisions from review. PP why Presumption is Good: BJR encourages people to serve as directors, take business risks, and avoids judicial meddling. Delaware Supreme Court has suggested that the BJR involves both procedural and substantive due care.  Procedural Due Care = implicates the process used in reaching a decision.  Substantive Due Care = raises the question of whether the complaint states a claim of waste of assets (no person of ordinary sound business judgment would deem the transaction worth what the corporation paid or received). Neither DGCL § 141 nor RMBCA § 8. 30(d) specifically adopt the BJR. BJR is a creature of common law. a) The Scope of the Business Judgment Rule Joy v. North, (2nd Cir. 1982)[p.687] FACTS: Book does not give facts – in book to talk about BJR. HOLDING: Under the BJR, a corporate officer who makes a mistake in judgment as to economic conditions, consumer tastes or production line efficiency will rarely, if ever, be found liable for damages suffered by the corporation. The policy behind this is: (1) shareholders voluntarily undertake the risk of bad business judgment when they invest in a corporation, (2) courts recognize that after-the-fact litigation is an imperfect device to evaluate a corporate business decisions, and (3) it is in the interest of shareholders that directors take risks and that the law not create incentives for overly cautious corporate decisions.

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BJR does not apply in situations in which the corporate decision lacks a business purpose, is tainted by a conflict of interest, or results from an obvious and prolonged failure to exercise oversight or supervision. Smith v. Van Gorkom, (1985) (This is the Transunion case) [p. 688] Standard of Care to Rebut Presumption is Gross Negligence. The court held should respect the BOD role under §141(a), cites Aronson v. Lewis. FACTS: Context is a friendly cash-out merger. Van Gorkom, Trans Union’s CEO, initiated, negotiated and advocated a merger agreement whose terms may have favored the acquirer, Pritzker. Shareholders brought a class action challenging the board’s failure to become sufficiently informed. The board failed to: (1) inquire about Van Gorkom’s role in setting the merger terms, (2) review merger documents, (3) inquire in to the fairness of the price being offered for the shares and the value of the unused tax credits, (4) inquire the view as to fairness of price of the CFO, Romans, (5) seek an outside opinion from an investment banker as to price fairness, and (6) to postpone the decision which was made at a two-hour meeting without prior notice and without there being an emergency. The board argued that they had a right to rely on Van Gorkom’s oral presentation outlining the merger terms and Roman’s opinion at the meeting. The Court disagreed. (Odd for the court to intervene, no allegations of bad faith or self-dealing [self-dealing overtones for Van Gorkam who was retiring and stood to make money on the stock he owned]). HOLDING: Directors of Trans Union Corporation are liable for not informing themselves adequately when they approved and recommended the sale of the company in a negotiated merger to shareholders (also violated a duty of disclosure). The BJR cannot be applied to shield the directors. NOTE: What if the board had done all these things? There is little to suggest that the board might have extracted a better deal. However, now boards of directors who receive unsolicited offers for their companies can put off an unwanted buyer on the ground that Delaware law requires them to take their time to first become fully informed.
Smith v. Van Gorkom, (The Trans Union Case)
1. Only 2 hour meeting, rubber stamping. 1. Experience, not dummies or figureheads (Francis) 2. Never actually read the proposal, (Should have exec summary). 2. Time sensitive issue. 3. CEO, CFO, Blind reliance, not 141(e) protection. 3. Good faith no self-dealing. 4. Cash-Out merger->end of the day someone else is taking over. 4. Reasonable belief transaction was in SHHs interest. 5. They did not get any further valuation. 5. Shhs did not approve the agreement. 6. The BODs could have asked for more time. 6. $17 dollars above the market value, 15% premium. 7. The BODs should have looked at “cash flow statement.” 7. Rely on 141(e) independent council, CFO, Gorkon. 8. Really pressure on self-dealing. 8. They met 3 times over multiple

Why This is a Good Decision

Why Bad Decision

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Problem, Fashion, Inc. Part II [p. 685]
Reliance1. Notice may not be sufficient in this case as under RMBCA § 8.22(b) requires that two days notice be given as to date and time. 2. The reports are not from private investors. a. The CEO. b. Accountants (Financial Statements, prepared by the targets accountants), but under what principles are these being analyzed? c. CFO, who knows if he is disinterested.  Loren can likely rely on both the CFO and CEO, but of course under §8.30(e)(1), Loren has to believe that they are reasonably competent. There may be some question in this case not as to competence, but rather as to if Lane was behaving in good faith. Note: Loren’s knowledge of the relationship between Lane and the United’s CEO may be the “red flag” which should require Loren to greater question the choice and seek further inquiry. i. Loren needs to assure that some proper form of due diligence has been done. Independence Why is this a special meeting? The relationship between Lane and the CEO of United should raise some serious questions as to the decisions being made here. Once again, this may be the red flag that Loren could be held responsible under Francis for. Negotiates-Likewise, it was Lane who negotiated the deal and it is simply being sprung on Fashions BOD. Timing-Was this really an emergency, something that had to be decided that day? Isn’t United the corporation who should be begging for the deal with Fashion, without the infusion of cash they are going to go bankrupt, therefore, it would appear that a well dickered deal would allow Fashion some time to consider a drastic action. The target company, however, in this is in distress. This case does seem a lot like Van Gorkom, like Loren and the rest of the BODs could be held liable for a failure to properly inform themselves if this deal does not go through. Consider what the BOD’s did not due in Van Gorkom and it seems similar to this case, The board failed to: (1) inquire about Van Gorkom’s role in setting the merger terms, (2) review merger documents, (3) inquire in to the fairness of the price being offered for the shares and the value of the unused tax credits, (4) inquire the view as to fairness of price of the CFO, Romans, (5) seek an outside opinion from an investment banker as to price fairness, and (6) to postpone the decision which was made at a two-hour meeting without prior notice and without there being an emergency. What about Loren’s Liabilities?  Loren could express her concern by voting NO, also by voicing her concern during the meeting, should could then finally resign, but without taking such drastic steps, Loren could also abstain, which would mean that she would not approve the merger under §8.24(d)(2). An abstention is not approving of the BOD action.  The fact that Loren is an outside director probably does not matter, as Manning would suggest.

the directors do not exercise reasonable care in supervising the effects of the decision.708] the court held that the BJR does not protect director’s who fail to inform themselves of all material information reasonably available to make their decision and that failure to provide adequate supervision of the manager who was hedging was a breach of their duty of care. of course. Roth (Ind.1992). The analysis changes process to substance. In Brane v. Often courts will mix the analysis of the two. “The BJR. (2) Obligation of deliberative decision making on issues of fundamental corporate concern.” Feels Only 2 Elements Are Legitimate for Realistic Standard of Care: (1) Alertness to potentially significant corporate problems.App.  . a grain hedging case [p. Both require the director to be informed however duty of care cases apply an ordinary negligence standard while BJR cases apply a gross negligence standard. Stuart R. The Burden of proof also changes from the P to the D. Page 83 of 131 b) Due Care and the Business Judgment Rule [705-721] Bayless Manning “The Business Judgment Rule and the Director’s Duty of Attention: Time for Reality” The relationship between the business judgment rule and the duty of care is complex.” Courts often have difficulty distinguishing between the duty of care and the BJR.Shaffer Karl Bekeny/Spring 2001 If the BJR presumption is overturned: 1. seems to be dumb cases. but both the BJR and the duty of care can involve judicial examination of the director’s process. 2. after the decision. exceptions Caremark and Brane suggest that directors may lose protection of the BJR with respect to transactions that are both part of on-going monitoring and a specific business decision if. NO BJR rule applies.Ct.BUSINESS ORGANIZATIONS II . Cohn “Demise of the Director’s Duty of Care: Judicial Avoidance of Standards and Sanctions Through the Business Judgment Rule. is intended to remove courts from scrutinizing the substance of specific decisions.

and by delegating excessive authority to his son. opinion. Some courts require that the challenger show that the director’s action or in action proximately caused damage to the corporation.30(b)(3) permits directors to rely on a committee if the director “reasonably believes the committee merits confidence.” RMBCA § 8.BUSINESS ORGANIZATIONS II .Shaffer Karl Bekeny/Spring 2001 Page 84 of 131 In Hoye v. the director must have read the report or statement in question. in order to rely on a report. 711] (Tort Action. Meek (10th Cir.Y. c) Reliance Under RMBCA § 8. there is a minimum intelligence requirement. NOT controlling for fiduciary duty). and (2) transactional cases [Van Gorkom] the idea being that if the directors had not approved some specific transaction a loss to the corporation could have been avoided.” d) Causation There are two types of breach of duty of care cases: (1) nonfeasance cases[Francis & Graham] the idea being that if the directors had carried out their duties with more diligence that they would have been able to prevent the loss. Not every care breach creates liability. you cannot use ignorance as justification. For a director to be liable the plaintiff will have to show causation. or other matter. However.” RMBCA §8. -The director must be “diligent and careful” to get BJR in performing his duties. The extent of the director’s involvement is speaking with his friend about what is going on with the . Andrews (S. statement.” -The holding surrounds a failure to make the basic inquiries.30(b) “Inherent in the concept of good faith is the requirement that. because as the court in Francis held. or have been present at a meeting at which it was orally presented. even good faith would not be enough for this case. or have taken other steps to become generally familiar with its contents.D. 1924) [p. the trial court held that Meek had breached his duty of care by failing to curb the extent of the investment and to monitor the company’s investment decisions and results.30(b) official comment.N. 1986) “In a suit by the trustee in bankruptcy. FACTS: A director is the friend of the president of a corporation. Barnes v. a director must make “ a judgment as to the reliability and competence of the source of information upon which he proposes to rely.

directors had breached their duty of care by failing to inquire about negotiation and terms of a merger. 1993) [p.K. the bad business judgment of the president would have still lead the corporation into financial trouble.714] (CEDE II) HOLDING: A breach of either the duty of loyalty or the duty of care rebuts the presumption that the directors have acted in the best interest of the shareholders. Court’s are less likely to find proximate cause when directors are inattentive to mere mismanagement. illegality. Technicolor.  When directors disregard management abuse courts readily find proximate cause. (Del.. v. or conflict of interest. In this case. which requires the directors to prove that the transaction was entirely fair.Shaffer Karl Bekeny/Spring 2001 Page 85 of 131 corporation when they are out together socially. e) Rebutting the Presumption of the Business Judgment Rule To overcome the BJR a plaintiff has to prove either: (1) Fraud. The corporation goes into bankruptcy. [It doesn’t make sense to hold a director liable for business mistakes that are themselves protected by the BJR]. or (2) Lack of a rational business purpose.BUSINESS ORGANIZATIONS II . IF NOTliability may be possible. Proximate cause becomes an affirmative defense if the directors can prove that the transaction was fair. Cede & Co. because if fair. O. Inc. Inc. 1995) [p. Technicolor. HOLDING: The director is not liable because even if he had been involved. or (3) Gross negligence. . how would they be the cause of the damages then? Cinerama. BJRis presumption rebuffed. (Del. Chain of Questions 1.. The court required the defendants to prove the challenged transaction’s entire fairness as to price and process. 715] (CEDE IV) “To require proof of injury as a component of the proof necessary to rebut the BJ presumption would be to convert the burden shifting process from a threshold determination of the appropriate standard of review to a dispositive adjudication on the merits.” IF YES 2. “gross negligence. Is the transaction “entirely fair?” IF YES 3.”  Thus the injury or damages analysis (based upon causation) does not enter into play until after a determination that the transaction was not entirely fair.

Executive Compensation: Compensation exceeds fair value of Director’s services. or in a merger context forcing minority shareholders to accept an unfair price for their shares.718] . opportunities. or (2) A decision the director did not reasonably believe to be in the corporation’s best interests. Corporate fiduciaries breach their duty of loyalty when they divert corporate assets..    Selling Out: accepting a bribe Entrenchment: Uses corporate machinery to protect his incumbency. = Once the BJR presumption has been rebutted defendant directors need to prove that the transaction was fair (fair dealing and fair price).  Usurping Corporate Opportunity: Fiduciary takes what could have been a corporate opportunity for herself.[718-721] The duty of loyalty addresses fiduciaries’ conflicts of interests and prohibits fiduciaries from putting their own interests ahead of the corporation’s. or (5) A sustained failure to be informed in discharging the director’s oversight functions. or (4) Action resulting from the director’s lack of objectivity or independence. (3rd Cir. or information for personal gain.Shaffer Karl Bekeny/Spring 2001 Page 86 of 131 Under RMBCA § 8. or (3) A decision as to which the director was not adequately informed.  Trading on Inside Information: Fiduciary buys or sells on material inside information. Weinberger v. Miller v. a director can become liable for: (only if the corp’s charter does not limit liability) (1) An action not in good faith. 1974)[p.   Flagrant Diversion: Stealing Self-Dealing: Fiduciary enters into a deal with corp. or (6) Receipt of an improper financial benefit.31. UOP D. on unfair terms. American Telephone & Telegraph. The Business Judgment Rule and Illegal Conduct. Entire fairness test as applied in Cede.BUSINESS ORGANIZATIONS II .

RMBCA § 8. what was done may have violated a federal statute for whom shareholders are a protected class. permit complete exculpation of directors.02(b)(4).19 approval) Prin. Under. Indemnification clauses in employment contracts. Limitation of Directors’ Liability. In response to the decision in Smith v. D&O insurance premiums went up and many directors declined to serve for fear of liability.24(d). 721-732.5 million which the Democratic National Committee owed them for services provided during the 1968 national convention. The y argued that this amounted to AT&T making an illegal contribution to the DNC in violation of federal law.[p. Note: These standards are NOT self-executing (Both require shareholder ALI §7. & 740-746]  D&O insurance. HOLDING: Directors cannot be insulated from liability under the BJR on the ground that the contribution was made in the exercise of sound business judgment. the corporation can never reduce the amount for which directors can be held liable to less than the director’s annual compensation. or failed to object to it becomes jointly and severally liable for all damage that the decision proximately caused the corporation. 2. a director who attends a meeting is presumed to have agreed to the action. unless the minutes of the meeting reflect the director’s dissent or abstention. acquiesced in it. E. of RMBCA § 2. To address this many states.Shaffer Karl Bekeny/Spring 2001 Page 87 of 131 FACTS: Shareholders bring a suit against AT&T for failing to collect an outstanding debt of $1. Courts have held that in breach of duty cases each director who voted for an action. Van Gorkom. and Statutes which limit liability. such as Delaware. now allow charter amendments the shield directors for breaching their duty of care. Reversed and remanded to see if the director’s violated the statute.02(b)(5) DGCL § 102(b)(7) Corporate 3rd party indemnification Contents of the Governance Articles of Incorporation Certificate of The ALI does not Incorporation. .BUSINESS ORGANIZATIONS II .

Statute Variances Among States for Liability 1. Officers. No exceptions for breached of the duty of loyalty or acts or omissions not in good faith. or $100. except liability for: 1. 3.” 2. was justified in her actions. (C) a violation of section 8. the person must have been acting in good faith and believed that they were acting in the best interest of the corporation. then they must report this indemnification to the shareholders in writing. (c) Indemnification required if person successful on the merits of a suit against him. Obtaining a personal benefit (such as by insider trading). (b) Applies to derivative suits but only permits reimbursement of attorney fees.21(a)-If a corp indemnifies a director. and 4. Indiana-Even if there is a breach of care.Shaffer Karl Bekeny/Spring 2001 Page 88 of 131 “(4) a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken. and Employees. (B) an intentional infliction of harm on the corporation or the shareholders. EXCEPT liability for (A) the amount of a financial benefit received by a director to which he is not entitled. 2. or (D) an intentional violation of criminal law. Most States-Allow for “private K” within limits of the statute. Whether the Director was successful in defending the action.BUSINESS ORGANIZATIONS II .” No Liability for Money Damages to corporation or shareholders. or any failure to take any action. An intentional violation of criminal law. Approval of illegal distributions. and 2. Acts or omissions not in good faith or that involve intentional misconduct or knowing illegality. DGCL §145: (a) Provides for indemnification of Directors. 3. Whether the Director. the greater of either the year’s salary. “A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. Breaches of duty of loyalty. as a director. 3. provided that such provision shall not eliminate or limit the liability of a director… No personal liability for breaches of duty. Approving illegal distributions. .000. Indemnification: §16. though director remains liable for: 1. Virginia-The Director damages have a ceiling. or provides them an advance. Moreover.33. Only applies in third party actions not derivative suits and only reimburses attorney fees and judgments. Intentional infliction of harm on the corporation or its shareholders. the BOD would not be held liable unless their actions were “willful misconduct. or 4. Two Factors in Seeking Indemnification 1. Financial benefits he received to which he is not entitled. though unsuccessful in her defense. 2.

2. Del §145(c)).Shaffer Karl Bekeny/Spring 2001 Page 89 of 131 Good Practice in Seeking Indemnification 1.52. seeks indemnification of his legal expenses from his former employer. 3. (2nd Cir. Conticommodity Services. DGCL §145(a)). (RMBCA §8. and then you would also ask for D & O insurance. DGCL §145(a)). Mandatory Indemnification If a Director is sued because of her corporate position and she defends successfully.54(a)(3). Silver market crash case. could be done through private K with the BOD. either procedurally. HOLDING: Under § 145 (c) mere success is vindication enough. Third Party Actions  A director must be deserving to be entitled to indemnification in an action brought by a third party-such as when the EPA sues for illegal dumping or investors claim securities fraud.52. However.” Waltuch v.BUSINESS ORGANIZATIONS II .51(a)(1). Put the indemnification in the AIC.732] FACTS: Waltuch. including attorney’s fees. The articles of incorporation require his employer to indemnify him for his expenses in both private and federal actions. DGCL §145(a)). Merritt-Chapman & Scott Corp. 1. or on the merits. §145(c). a silver trader. a. 2. What Does It Mean to be Successful on the Merits? This would include basically anyway in which a suit is dismissed. Wolfson (1974).  The Director in a criminal proceeding had no reasonable cause to believe that her actions were unlawful-a standard that goes beyond whether she acted in good faith. Also argues that he was successful on the merits under section 145(c). (RMBCA §8. DGCL 145(c)).52 requires that you be “wholly successful. . Waltuch should be reimbursed it does not matter that he won because of a settlement which dismissed the suit against him. the corp is obliged under all state statutes to indemnify the director for litigation expenses. o Indemnification Criteria:  The Director must have acted in Good Faith (§8.  There was a reasonable belief by the Director that her actions were in good faith (§8. v. 1996) [p. (requires success on the merits).51(a)(3). Permissive Indemnification Indemnification to the extent successful-Delaware looks to the extent in which the Director is able to be successful. Note: This rule may create a plea bargaining problem. for this reason. See RMBCA § 8. Cal §317(d).51(a)(2). Inc. the RMBCA §8. Could get a shareholder vote that would place the indemnification in the AIC. (§8.

or Committee of BOD) (§8. corp. In Delaware. (6) Other willful misconduct.52 and determined that did not meet standards under 8.51(e). (5) Knowing violations of law. or private K. Inc. or a contract. 1 abstention. only nonInterpretation of the of litigation expenses in the Note: Most statutes allow for the payment Indemnification Statutes form of an advancement.53(a) that the director is entitled to permissive indemnification. (4) libel or slander. case-by-case determination RMBCA §8. Procedure: Court Ordered may determine if the director meets the criteria for Statutes tell us who Indemnification COURT ORDER 1. i. (4) the imposition of penalties or fines. Even Though Not in Statute: Some states allow indemnification without it being found within the state statute.54(2) you may only provide director’s shares.58. (2) The Director must take to repay the advancement if he is not entitled to it. (2) Bad faith. the by-laws.” DGCL §145(b). RMBCA §8. §8. Directors not party §8. just good faith statement.53.55 (1) Director must affirm entitlement to permissive indemnification. (3) an out of court settlement. §8. “Is fairly and reasonably entitled to indemnification in view of all the relevant permissive indemnification. indemnify for (1) litigation expenses. a. RMBCA §8.53 requires: (1) written affirmation of good faith belief that has met 8. No security needed. shareholder brings derivative suit. DGCL §145(e) The By-laws orrequire a case-by-case determination. §145(f) required in the articles. 145(g). Court Order. theory is that the director could have gone out and gotten the insurance themselves anyway. (1) circumstances. RMBCA §8. only can determine if he meets the criteria.53(b). and (2) written undertaking to repay funds if not entitled under 8. (2) Shareholders §8. some. but §8. 721] Facts: This was a final vote regarding the acquisition. have been Note: Although this seems to be indemnification when there should not (RMBCA §8. §145(d)(2). the vote was 10 yes. if the action was brought by the corp or its shareholders (derivative). .55(b).BUSINESS ORGANIZATIONS II . if the director meets the criteria for a permissive indemnification. b. Actions By premiums comes the Corporation DERIVATIVE Note: D & O Insuranceor On Behalf offrom the compensation of the directors. Procedure: Delaware requires an undertaking to repay. (3) Illegal What does it can pay (1) litigation personal to a director who settles the case. (RMBCA does not include BOD’s 2. (Expenses and liability). DGCL any shareholder may vote. and advances can be made if (1) Do not Contract Indemnify.54 & 8. but not required.Shaffer Karl Bekeny/Spring 2001 Page 90 of 131 Coverage: Director sued by 3rd party. you may still get indemnity even if ineligible or liable to the corp.55(b)(1). (4) A special Ind Counsel appointed by the BOD (including interested. InvalidThose who move forward to get him payment of the advancement must not know (3) of Inconsistent: Some statutes may be inconsistent with indemnification provisionsanything that the by-laws. statutes may not apply.02(b)(4). May BOD authorize: A board may authorize permissively under Del code §145(e) and RMBCA 8. §145(b)(4). Case-by-Case procedure: Many statutes require a specific. DGCL §145(b)). Note: Could condition on providing security. expenses. RMBCA 8. decline in share price of 50%. compensation. If unsuccessful.57. in which case these indemnification of found within would preclude indemnification. required $750 million capital infusion.51 standards or is protected under 2.55.55(b). AIC.51(d)(1). 1. §145(d). Part III [pg. Advancement of Litigation Expenses Note: Most statutes do not allow corps to indemnify directors “adjudged liable” to the §8. (2) personal liability. don’t want to discriminate against directors who don’t have so much money. 145(e).53. Note: The corp cover? out Improper expensesbenefit. §8.55(b)(3). The standard is the same as Delaware above. The BOD can advance expenses of $100K a. (3) Committee of non-party directors. Insurance Fashion.

i. may indemnify for expenses (including attorney fees) if acts in good faith & reasonable belief re corporation’s interests. Key Issues re expenses? (1) whether amount is reasonable. Subchapter F to the RMBCA recognizes that self-dealing transactions can be both fair and beneficial to a corporation.51(a)-permissive indemnification-may indemnify if (1) in good faith & reasonable belief that in the best interests of corporation.54 -why?-to protect minority or dissident directors. good faith & reasonable belied in corporation’s best interests) (Unless ordered by the court under 8. Indemnification? a.51(d)-cannot indemnify in derivative proceeding. RMBCA 8.02(b)(5). d. e. Who is special counsel? -must have no prior professional relationship. Can Directors otherwise receive up-front coverage of expenses if BOD does not wish to grant in circumstances? Yes-by court order if (1) put in articles. Court-ordered indemnification? RMBCA 8. amount in facts: (1) of expenses of $1 million. -Note: does not require to meet due care standard under 8. The duty of loyalty requires a manager to place the corporation’s best interests and those of the stockholders above her own. Delaware has no express provision regarding expenses-DGCL 145(d) covers indemnification. May the corporation make payment under Del Law? i.BUSINESS ORGANIZATIONS II .54(a)(3)). [p. 2. by-laws.30(b). a.51(a)(2)(d) (1). (i. May corporation make payment under RMBCA? i. (3) shareholders. (2) if not so covered.e. and this is important in that it helps reign in the BOD and Officers. 747-767] Be on the look out for self dealing transaction both direct and indirect.Shaffer Page 91 of 131 Karl Bekeny/Spring 2001 c. -But. whether on the merits or otherwise. (2) settlement for $15 million to corp. Note: cannot cover amounts paid in settlement other than expenses (i. DGCL 145(b)-permissive. (2) whether met appropriate standards of good faith and reasonable belief in corporate interests. b. See RMBCA § 8. The Real Question: As Robert Clark stated: “The principal difficulty in this area of the law is establishing appropriate criteria for measuring the validity of the transaction. c. d. Appropriate Decision-maker? RMBCA 8. resolution or indemnification agreement. F.60(1)(i) and (ii) [subchapter F -definitions. ii. including as selected by directors where don’t have 2 disinterested ones. except for expenses where the director has met relevant standard under 8.e. even though they . RMBCA 8. (2) special legal counsel. (3) $10 million paid by D&O insurance. can only receive indemnification after the suit is successful.55-determination of indemnification must be authorized by (1) disinterested directors. ii. the $5 million)-but query if Delaware court will not award if believes reasonable in circumstances (treat damages and settlement expenses similarly).” Victor Brudney. Contract Law and Fiduciary Duty in Corporate Law: There has been a dilution from the CL duties of fiduciaries. where act in official capacity or (2) permitted under 2. DGCL 145(d)-similar to RMBCA. i. Introduction to Conflicts of Interest and the Directors’ Duty of Loyalty. Procedures? Same as above for RMBCA.

partner. 2d.Shaffer Karl Bekeny/Spring 2001 Page 92 of 131 have found multiple ways to get around. The directors who would sustain the challenged transaction have the burden of overcoming the presumption against the validity of the §144(a)(3) transaction by showing fairness. How Do we Define Self-Dealing? Direct and Indirect Self Interest: Direct Interest: The Classic example of the corp and the director being parties to the same transaction. child. (Ill.60(1)(i)-Sales and purchase of property. which defines “related person” to include the spouse. whether there is a disinterested majority of the board or not who approves the transaction – today courts review the transaction and look for unfairness to the corporation before invalidating the transaction. sibling. . but this he feels is an unlikely place to find real control. contract doctrine is not strong enough and does not provide the needed protections. or family trust.. a) The Common Law Standard. etc. and low rent to corporation that directors owned or were connected with). approved or ratified.60(1)(i). (1) Corp transaction with director’s close relatives. 1960)[p.BUSINESS ORGANIZATIONS II . §8. No transaction of a corporation between itself and any of its directors is automatically void able at the suit of a shareholder. §8. loans to and from the corp. HOLDING: Transactions between corporations with common directors may be avoided only if unfair. §8. grandchild. (2) Significant Financial Interest. Indirect Interest: When corp action in connected with another person or entity that the director has a strong personal or financial tie with. agent. but if there were concerns about their actions they could receive control through consent that would be readily agreed to by the shareholders. They don’t have any of these real concerns. Brudney points out that modern law justifies its position on modern market tendencies and the reputation of the corporate directors. But on thing is clear. a committee thereof. (ii) (Another entity in which director has a significant financial interest or in which he is a director. the furnishing of service by a nonmanagement director (like outside counsel). to the or transaction IS FAIR as to the corporation as of the time it is authorized. by the BODs. (3). or EE). parent.60(1)(i).60(1)(ii) The BODs have different Shlensky v. (3) Between Companies With Interlocking Directors. South parkway Building Corp. or the b) The Statutory Approach [“fairness tests”] Note: Similar to RMBCA ratification.756] FACTS: Shareholders sue to recover money lost through self-dealing transactions approved by an interested majority of the board of directors (fixture purchases at low prices. The directors in this case breached their duty of “The loyaltycontract corporation. §8..

Shaffer Karl Bekeny/Spring 2001 Page 93 of 131 DGCL § 144(a). Diamond=IP (probably. and that through the sales corporation. Remillard-Dandini Co. and if you are disinterested you are also going to be applied There is NO BJR Presumption for Self-Dealing Cases: Starcrest Corp. it simply shifts the burden to plaintiff to prove unfairness. Marciano v.. 1952)[p. Grey=ID 3. Part I [pg 753]. so that the manufacturing companies were stripped of their sales function. 1976) [p. the directors realized profits which should have gone to the corporation. Sup. 7 member BOD: (1) Elizabeth Adams CEO The Committee: 1. or (2) The material facts are disclosed to the shareholders. even though section §144 does not contain such language. even though they lack quorum.5 . While a transaction is not voidable simply because an interested director participated. (Del.” Cinerama.761] FACTS: Plaintiff. Brown=ID 2. Fliegler v. However. it will not be upheld if it is unfair to the minority stockholders. but open for debate). HOLDING: The directors used their majority power to their own advantage.765] (Notice the Significance of This Case!!!) HOLDING: It would require disinterested shareholder approval of an interested director transaction before shifting the burden of proof from the interested director to the challenging shareholder. 1991) “The key to upholding an interested transaction is the Shlensky-“neither disclosure body. (plaintiff must prove unfairness). App. compliance with the terms of section 144 does not restore to the BOD the presumption of the business judgment rule. Note: Grey dissents from the committee vote. the court found this to be a “fair transaction. v. (Cal.” approval of some neutral decision-makingnor shareholder assent can convert a dishonest transaction into a fair one. Kirby. in response to this problem the legislature has made a sharp distinction between interested and disinterested directors. and the shareholders vote to approve the transaction. Remillard Brick Co. alleged that the majority directors of the manufacturing companies used their power to have the manufacturing companies enter into contracts with the sales corporation.” Once there is the demonstration of “conflicting interest. (Del. a minority shareholder. or (Note: this does not state disinterested shareholders). Nakash.BUSINESS ORGANIZATIONS II . citing Kahn. Lawrence.” Oberly v. 1987) Case of a deadlock at both shareholder and the director level. a transaction shall not be void solely because it involves an interested director if: (1) The material facts are disclosed to Board or a Committee. and a majority of disinterested directors authorized the transaction. “as construed by our SC recently. (Del. Committee recommends $6. Chancellor Allen sums up what is likely the modern rule.” then the BJR presumption has been rebutted and the new issue surrounds the fairness of the transaction.

Delaware requires “entire fairness. DGCL §144Under the case law. Yes (5) Brown. but that an assessment of “FAIRNESS” is still required. 3. Questions to ask when determining if the director is independent include (1. Under §8. 767-782] “Fairness” Test You need to prove both substantive and procedural fairness to meet the entire fairness test.60(1)(i) there is no doubt that Elizabeth has a conflict of interest. it is likely she is interested and therefore 144(a)(1) committee approval fails. Arguably there was also not a majority of disinterested directors voting in favor at the BOD meeting. since Grey voted NO and White did not attend. likely there has been a breach of the duty of loyalty in this case. and here relation and dependency on Elizabeth. do they have a financial interest. even though. or familial or financial interest. However. Yes (6) White. but the shareholders did approve the vote.” it is for this reason that there are only 3 disinterested dirs) a qualified director would suffice. Yes (4) Linda Diamond GC. Lawrence case the court held that the shareholder approval had to have been by a majority of the disinterested shareholders. this has been held. Note: That there are questions as to whether Elizabeth really “Material disclosure. however.62 or §8. In the Fliegler v. While the other side would say there was a 5-1 BOD approval of the transaction. which include .” also required by 144(a)(1).61(b)(1-3) to Lewis.Shaffer Karl Bekeny/Spring 2001 (2) Paul Baker CFO. other courts like Marciano hold that the burden of proving unfairness now shifts to the challenger. but of the 54% that approved. The BOD’s are allowed to rely on the committee. then transfer to the BJR.62(a). Under 8.62thefairness based upon That of Loyalty and the Different approach to of BJR procedure. this is unclear in Delaware.63get BJR.k.62(d) means not part of transaction. how were they appointed. which likely requires that then you RMBCA §8. or are they being dominated. there is neither committee or BOD ratification. 2. if comply with §8. it is important to note that this language is not in the statute. only shift burden to P to prove G. as she will receive the benefit of her deal with the corp. Cleveland Browns) with the company. UOP (1983). but there are not two in this case because Grey votes no and White does not appear at the meeting.) (b) §8. are there family ties. but they must be “qualified. there has been no disclosure that the facts tell us regarding the shareholder vote under §8.63. Cinerama citing Kahn. Yes (3) Robert Crown VP Sales. Here. be applied. [p. because it she is then the committee could have approved the transaction by 2-1. see how it applies. on shifting the burden to the challenger.” Weinberger v. Official Comment §8. Duty of Loyalty and Fairness Doctrine. after ratification a fairnessattach. consideration then becomes waste. Note: Dutywhen there is a finding in RMBCA under §8. therefore failing 144(a)(1).61 and §8.” which would not include under §8. as this outline identifies that (Remillard and Fliegler) the transaction may still be o. but the committee has to be disinterested. given her EE position (likely dominated by Elizabeth.63(c) Elizabeth or her family’s 40% share. one side would say you are relying on a 1 to 1 vote.BUSINESS ORGANIZATIONS II . The only are immune from test still See §8. Yet. Yes (Does not appear at the meeting) (7) Grey.62(a) a BOD vote of two “qualified” (§8. Therefore..62 Under §8. or “EE Relationship. Therefore.63(a) shareholders may also ratify. NO Page 94 of 131 (a) §144 Well the question here is whether Diamond is disinterested or not.61(i). Plus while there may have been adequate disclosure of “material facts” under §8. only 14% were likely not from the Adams family. (1) Nonvoidability Statutes-§144(a) interested transaction shall “not be void or voidable solely for the reason” that a director is interested.63(a)(3). 4.

if you are procedurally cool. RMBCA Subchapter F. the burden switches to the P to demonstrate: (1) There was waste (Aronoff. Who is Disinterested? i. (2) Composition of BOD or Committee Approval: a. (2) the shareholders were NOT informed. and they are not dominated by interested parties. • Note: RMBCA §8. He is not directly or indirectly interested in the transaction (NO money or relations). Puma upheld disinterested directors development and approval of deal with company’s main family. Cleveland Browns.” §8. Substantive Fairness Has Two Aspects: Objective Test-The self-dealing transaction must replicate an arm’s length transaction by falling into a range of reasonableness. it is often much easier to palate if there does exist some procedural safeguards. b. Ratification by Shareholder Majority-When a majority of disinterested shareholders ratify a decision. burden placed on challenger). many statutes permit a majority of shares held by disinterested shareholders to constitute a quorum. ALI §1. Oyster. ALI-applies modified fairness and burden-shift.” NOT party to Note: In Delaware. (Remillard and Fliegler cases in which required.18 disinterested director is one that is not party to transaction or indirectly interested. then you shift the burden to the P to demonstrate Substantive unfairness!! Ratification Courts will give significant deference to a corporate decision. Page 95 of 131 Procedural Fairness Substantive Fairness This would generally surround the issue of BOD approval. some times just the conflict of interest. which has been ratified. Corporate Value-The transaction must be of particular value to the corporation. §8. this is conclusive. Both of these tests involve significant meddling into business judgment matters. He is not DOMINATED by the interested director. Unanimous Ratification-If self-dealing is ratified unanimously by all the shareholders or by a sole . Courts will carefully scrutinize the terms.” Rather. (Some have held merely presumption when approval of disinterest. especially the price. (3) transaction was illegal.BUSINESS ORGANIZATIONS II . • Courts remain suspicious if ratifying majority is interested. Shlensky Factors for Fairness: (1) Did the corporation receive full value for it purchase? (2) Corporations need for the property. iii.Shaffer Karl Bekeny/Spring 2001 This is an acceptance by the court of the transaction if it was in the corporation’s best interest. as judged by the corporation’s needs and the scope of its business. (4) The transaction was ultra vires because of a limit found in the AIC. but the fairer test seems to look to all “material facts” that might affect the BOD or committee decisions. c. A director is dominated when he acts as requested without independent judgment. Note: When it is difficult to determine whether the agreement is substantively fair.63(b)-vote by an interested shareholder is not counted for shareholder ratification.60 “qualified director.62(a) Qualified BOD ratification. • Note: RMBCA §8. The examination of this question has several components: (1) Disclosure-This means different things to different people. ii.63(c)-Nonetheless. (3) Corps ability to finance the purchase. then generally the defendant does not have to show “fairness. “intrinsic fairness.

See Waste Doctrine. meant to be a bright line test]: RMBCA § 8. Subchapter F of the RMBCA and the ALI principles of corporate governance adopt a safe harbor test meant to assure the validity of self-dealing transactions if properly approved. Informed.” entails an exchange of corporate assets for consideration disproportionately small as to lie beyond the range at which any reasonable person would trade.1997)[p. Inc. RMBCA Subchapter F [only 6 states have adopted. 782-796] Note: To avoid the uncertainty of the judicial determinations of self-dealing. Vogelstein. disinterested shareholder ratification of a transaction in which corporate directors have a material conflict of interest has the effect of protecting the transaction from judicial review except on the basis of waste.BUSINESS ORGANIZATIONS II . HOLDING: The effect of informed ratification is to validate or affirm the act of the agent as the act of the principal. However. 1979)-The action was “improvident beyond explanation. H.Shaffer Karl Bekeny/Spring 2001 Page 96 of 131 Delaware Waste Standard = (Michelson v. Lewis v. Duty of Loyalty and Executive Compensation. (Del.Ch. uncoerced. which was approved or ratified by the shareholders of the company at its 1996 annual shareholder meeting. (1) Disclosure Procedural fairness requires full disclosure of the existence of a conflict and of other material information concerning the substance of the transaction. if there is any substantial consideration and if there is a good faith judgment that under the circumstances the transaction is worthwhile there should be no finding of waste.776] (Chancellor Allen) FACTS: Shareholder suit challenges a stock option compensation plan for the directors of Mattel. Most often the claim is associated with a transfer which serves no corporate purpose or for which no consideration is received at all (in effect a gift to the recipient). [p.. above.61(b) validates a director’s conflict of interest transaction if: . The court concluded that the shareholders complaint should not be dismissed because the one time option grants which were approved were unusual enough to require a waste analysis. Duncan (Del.

or (3) Established to be fair. pension plans. and then looks for specific facts to rebut the presumption. as the Court found. Executive Compensation One of the most common forms of corporate self-dealing. because they were merely friends. 1. The Court begins with the application of the BJR. The Ps must demonstrate that (1) Eisner was personally interested because of his relationship. 1998) The facts of this case deal with the duty of loyalty. stock options. 2. (2) now look at the domination of the other directors: Disney.30. but the reality is that Disney is such a major shareholder he just couldn’t be dominated.BUSINESS ORGANIZATIONS II . and or course regular salary.61 “Terms of the Transaction. Could see on exam in the form of bonuses..61(b) states that judicial review of an informed decision by disinterested directors is limited to the “care. 4. or (2) Disclosed to an approved by a majority of qualified shareholders. options. and good faith criteria” of RMBCA § 8. but court will not find business relationships alone make Eisner interested. Sections 8.Shaffer Karl Bekeny/Spring 2001 Page 97 of 131 (1) The transaction is disclosed to and approved by a majority of qualified (but not less than two) of qualified directors/disinterested directors.60 define who interested persons are. and Nunis-They are all EEs so they may or may not be dominated by Eisner. whether disclosed or not. When executive compensation is approved by disinterested directors then it is subject to business judgment review. and repurchases require board approval under RMBCA § 6. . best interests. acquaintances. Litvack. In Re Walt Disney Corp Derivate Litigation (Del. Interested Director and Conflict of Interest Transactions.61(a)& (b) and 8. there was not even an issue because Eisner himself was not interested. following a normal arm’s length business negotiation..” 3.” See comments to § 8. RMBCA § 8.25. In this case. Stock grants. in light of the knowledge that would have been reasonably acquired in the course of such negotiations. Fairness “A fair price is any price in that broad range which an unrelated party might have been willing to pay or willing to accept . Reviewing and approving executive compensation can be delegated to a committee of outside directors. and whether this was breached by Eisner in approving a Presidential spot in Disney with an incredible severance package.24. Judicial Review Official comment to RMBCA § 8.

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Gold-Disney’s personal attorney, so he is NOT dominated by Eisner. Stern-Interested architect because he receives a great deal of money from Eisner. O’Donovan-A priest who is the President of Georgetown Univ. his only problem is that his school got money, but he did not, this is a large enough distinction for the court from the Kahn case, where the directors actually received money. Bowers-No doubt makes more money on the board than as an elementary school teacher, but it may be important to remember that PP says we want more poor people on boards so she is not interested. Russell-This man is Eisner’s attorney so he is obviously interested. Note: At the end of the day, since Eisner himself is not interested, the BJR will apply and the deal is o.k. this does not foreclose an examination based upon waste or care breaches, but not loyalty. Lewis v. Vogelstein, (Del.Ch. 1997) [p.793] FACTS: Involved shareholder ratification of a one-time stock option for corporate officers and directors. HOLDING: Applies the waste standard in the context of a shareholder ratified stock option for officers and directors. I. Corporate Opportunity Doctrine. [p. 796-817] The corporate opportunity doctrine is a subset of the duty of loyalty doctrine, it balances the corporation’s expansion potential and the managers’ entrepreneurial interests. A corporate fiduciary cannot take a business opportunity for herself if it is one that the corporation can financially undertake; is within the line of the corporation’s business and is advantageous to the corporation, and is one in which the corporation has an interest or a reasonable expectancy. See Guth v. Loft (Del. 1939)[p.796]. The problem on the exam will be separating which opportunities should be turned over to the corporation and which can remain with the manager to be exploited. 1. Traditional Corporate Opportunity Doctrine A corporate manager cannot usurp corporate opportunities for his own benefit unless the corporation consents. The plaintiff ahs the burden of proving the existence of a corporate opportunity. Farber v. Servan Land Company Inc., (5th Cir. 1981)[p.798] FACTS: Majority shareholders buy land adjacent to land the corporation owns and runs as a golf course. Minority shareholder brings suit saying that the shareholders who bought the adjacent land usurped a corporate opportunity.

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HOLDING: There was a corporate opportunity in this case and shareholders did not decline it. Attempted ratification by interested shareholders does not prevent a derivative suit. The corporation is entitled to the profits the majority shareholder’s realized. Court goes through 4 step analysis: (1) Did a corporate opportunity exist?, (2) Did the stockholders decline the opportunity by failing to act?, (3) Did the shareholders ratify the transaction?, and (4) Did the corporation receive a benefit in selling its assets in conjunction with the land the majority shareholders purchased? 2. What is Corporate Opportunity? Look for diverted corporate assets, existing corporate interests, line-of-business test. Also, watch out for a problem in which the director is involved with many corporations (to whom is the duty owed?, brings in the BJR. See Johnston v. Greene (Del. 1956)) [p.806] This older Delaware case points out that it is up to the director to decide where the opportunity goes, which would include himself. Interest or Expectancy: the fact that directors had undertaken to negotiate in the field on behalf of the corporation, or that the directors had knowledge the corporation was in need of the particular business opportunity, or that the business opportunity was seized and developed at the corporation’s expense with the facilities of the corporation. (Thorpe v. CERBO, Inc., Del 1996). • One analysis is whether the opportunity came to the corporate manager in his individual or his corporate director role? If receive info as an individual, may be evidence that this was not a corporate opportunity. Broz v. Cellular Information Systems (Del 1996). (In this case a director purchased a cellular phone license and the other directors did not seem interested. Note: There was no financing in this particular case, but the discussion with the BOD’s was found to be sufficient inquiry, a move which Clark and Brudney DO NOT like, because they question how anyone can know if financing is available without full disclosure to the BOD first? Note: That the ALI §5.05(a)(1) requires full disclosure to the corporation and reveals the conflict of interest and the opportunity that exists. Line of Business: the opportunity falls within the corporations line of business, applies beyond a corporation’s existing operations. The court compares the new business with the existing operations to determine if the new project is functionally related to the corporations existing or anticipated business, the manager must obtain corporate consent before exploiting it. • A functional relation exists if there is a competitive or synergistic overlap that suggests that the corporation would have been interested in taking the opportunity itself. Example, Miller v. Miller Minn 1974. Fairness: is it fair and equitable that the corp. did not get the opportunity. (Durfee v. Durfee (Mass 1948))-whether fair for director to take transaction.

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Miller v. Miller (MN 1974)[p.805] [Combines Line of Business with Fairness], applied the following factors in determining fairness: (1) The nature of the officer’s relationship to the management and control of the corporation, (2) Whether the opportunity was presented to him in his official or individual capacity, (3) His prior disclosure of the opportunity to the board of directors or shareholders and their response , (4) Whether or not he used or exploited corporate facilities, assets, or personal in acquiring the opportunity, (5) Whether the acquisition harmed or benefited the corporation, (6) All other factors bearing on the director’s good faith in acting toward the corporation which ordinarily prudent men would exercise under similar circumstances. The Eclectic Approach The combination by some modern courts of a narrower expectancy test and a broader line-of-business test. • ALI Principles §5.05 How do we define a corporate opportunity? • A business opportunity that1. A director or senior executive becomes aware of in his corporate capacity; 2. A director or senior executive should know the outside party is offering to the corporation; 3. A director or senior executive, who became aware of it through the use of corporate information; should know the corporation would be interested in; 4. The senior executive knows is closely related to the corporation’s current or expected business. Therefore, under the ALI Principles corporate executives are subject to line-ofbusiness and expectancy restrictions, while outside directors are subject only to expectancy restrictions. Lewis v. Fuqua Del 1985-Some courts apply a fairness test on top of the expectancy/line-of-business tests. Note: The question of fairness surrounds, how fair is it to hold the manager accountable for his outside activities. 3. When May a Corporate Manager Take An Opportunity for Herself? Burg v. Horn, (2nd. Cir. 1967)[p.807] FACTS: Part-time managers of a closely held real estate business acquired other properties with the tacit consent of their co-shareholder. The co-shareholder knew from the start that the managers held and managed other similar properties. The properties acquired by the managers although in the same line of business of the business had not been offered to it or sought by the business. [crazy case where the defendants buy slum apartments with money from the partnership] HOLDING: The co-shareholder’s informal acquiesce to the managers’ outside entrepreneurialism led the court to conclude they had not usurped a corporate opportunity. [Schaffer agrees with the dissent, that this was a taking of a corporate

The ALI. Arguably this deal was a corporate opportunity. however. (2) They were not fulltime EEs. that the Ds were merely shareholders. 797] Traditionally the Farber case laid out an analysis of whether there was a corporate opportunity in this case and whether it was improperly taken from the starcrest company. It may be that White got the deal in his private capacity. while starcrest is not presently in the casino business. §5.BUSINESS ORGANIZATIONS II . but Petro Inc. this may provide some of the problem. . (2) Did the stockholders decline the opportunity by failing to act?. and that it may be himself.05(b)(1)(B). that this is an older Delaware case. For example. and (3) Imposition of a constructive trust on the new business or the subject matter of the opportunity such as land. (2) Profits taken from the corporation. which Brudney and Clark would support point to the Pre-disclosure and rejection of the corporate opportunity. iii. but it was a profit. Remedies for the Taking of a Corporate Opportunity. While there was no prior disclosure. a company he may even owe more of a duty to since he is the CEO of the company.05(a) White did not offer the deal to the Board. whether it was as a director. The factors to consider are (1) Did a corporate opportunity exist?. Greene case has held that the director can chose who gets to receive the corporate opportunity. which when considered demonstrate that i. the company had specifically spoken about opening a casino. while the casino is in the Bahamas. (a) Interest or Expectancy. He did not use any of starcrest resources. but that the Petro company did. (b) Line of Business. and he did not use corporate means to come across the deal. on the other hand. there are several ways to look at corporate opportunity. §5. there was some indication that they were planning to be in the casino business.05(b)(2). the defendants bought the slum apartments with partnership money and the partnership was in the business of slum housing] Note: However. the deal did not harm starcrest. and this would be good enough for the line of business. Remedies include: (1) Lost profits. is this really a corporate opportunity: (1) White did not become aware of the deal through work. However. that White’s best defense may be that he never did take advantage of the corporate opportunity under §5. Factors: (1) They were already in the business. In this type of situation the Johnston v. 4. this is best examined through the Miller v. Problem Starcrest Corporation-Part II [pg. (c) Fairness Starcrest did not Get Opportunity. Note: However. v.05. and (4) Did the corporation receive a benefit that would have righted any wrong? First.Shaffer Karl Bekeny/Spring 2001 Page 101 of 131 opportunity. Also note. Miller factors. ii. White did know that casinos were an area of interest that the BOD was interested in §5.05(a). would it matter if we knew that White was Petro’s largest shareholder? Maybe. where Starcrest was looking. let it be rejected. but it may be important to note that White did not receive the benefit in this case. did. iv. a place outside the US. under §5. He is a new and independent director. or in his own personal circles. or allow for ratification.05(b)(1)(A). (3) Did the shareholders ratify the transaction?. However. §5. Note: The Broz case held that it might be relevant how White came across the deal. that they were not directors or managers.

v. anyone of the subsidiaries should have the opportunity. (Ford v. did not enforce. (3) Dividends Payments. pay out of too many dividends. which is satisfied when: §5. issuance (only to the majority ay an unfair price). (Del. Duty of Majority Shareholders. share exchanges.10(a)(1)-(2) (1) The transaction is fair to the corporation when entered into. this is known as the intrinsic fairness standard. HOLDING: Court assumes the propriety of parent-subsidiary dealings. how is this so if the only real duty of the shareholder is to make a lot of money? There are several situations in which the majority shareholders have a duty to their minority counter parts: (1) Business transactions-parent-sub (been set up on unfair terms) (2) Freeze-out mergers. approval by a majority of disinterested directors will not affect the standard by which the transaction is reviewed. The burden is on the minority shareholder to show the dealings were not those that might be expected in an arm’s length relationship. Note: “Unlike interested director transactions. Yet. Be on the look out for parent-subsidiary dealings. (Weinberger v. or (Sinclair v. challenged three sets of parent-subsidiary dealings: (1) Siven’s high-dividend policy. the court will not now question that. How Does the ALI Deal With This Situation? The ALI imposes a duty of loyalty. (1) Dividend claim: BJR. .Shaffer Karl Bekeny/Spring 2001 Page 102 of 131 J. (2) Sinclair’s allocation of projects to other affiliates. no self-dealing because minority shareholders are also getting paid on the dividend. Levin. and (3) Sinven’s failure to enforce contracts with other Sinclair affiliates. [p. Levein). 817-826] Note: This is all court generated. (2) Denial of expansion Opportunity. Courts impose fiduciary duties on controlling shareholders that parallel those of directors and officers. UOP) Here you will have to set up a fairness standard. 819] (Note: This is a “squeeze-out merger”) FACTS: Minority shareholders of Sinven. (majority could change their old shares for new ones). payout of too few. Dodge). this really was a breach of K. (3) Breach of K: Allowed late payments. 1971)[p. redemption (Zahn).BUSINESS ORGANIZATIONS II . but it will shift the burden of proof to a shareholder challenging the Sinclair Oil Corp. (4) Share transactions. OR (2) The Transaction is authorized in advance or ratified by disinterested shareholders following disclosure concerning the conflict of interest and the transaction does not constitute waste of corporate assets at the time of the shareholder action. a partially owned (97 percent) Venezuelan subsidiary of Sinclair Oil.

residence and citizenship of the purchaser. 827838] Corporations registered pursuant to the 1934 Securities Act get information to the public/shareholders through various filing requirements. (B) The source and amount of funds or other consideration used in making the purchases. and the corporation whose stock they bought (issuer).  Section 13 applies to every issuer of a security registered pursuant to section 12 of the 1934 Act.. Inc.1977)[p. Such persons must file a statement with the SEC.. (Del.. It also applies to persons who indirectly or directly acquire more than five per cent of any security registered under section 12. then any plans or proposals related to this.. Court held that the transaction between the parent and subsidiary was not fair and cost minority shareholders money. .. it is necessary to examine how that duty has developed under both federal and state law and how those two bodies of law interrelate. A. (2) If material changes occur then an amendment must be filed. Securities Exchange Act requires corporations to file certain documents with the SEC. Duty of Disclosure. The statement must include the: (A) Background. (E) Information as to contracts (JV. V.Ch. 825] FACTS: Hughes owns all the stock of Toolco.. See § 13 [p. Federal Regulation. (D). put or call options). v. Toolco could not obtain financing for quite some time. When considering the duty of disclosure owed to the shareholder as a decision-maker.. identity. transfer of the securities.BUSINESS ORGANIZATIONS II . TWA wanted to purchase new planes but was forced to go through Toolco. [p. Duty of Disclosure to Shareholders. Toolco was unable to prove that it did not cause damage to TWA. 943]. TWA sought an accounting and damages for the delay. Toolco owned 78% of TWA.. See § 13(d). loans. HOLDING: Court applies the intrinsic fairness rule. Federal Law II. Summa Corp..Shaffer Karl Bekeny/Spring 2001 Page 103 of 131 Trans World Airlines. (C) If the purpose of the purchases is to acquire control of the business of the issuer. Claims of inadequate disclosure in violation of the proxy rules have become a vehicle for plaintiff’s obtaining federal jurisdiction rather than attempting to establish a breach of fiduciary duty under state law.

 There are a line of cases addressing questionable illegal corporate payments and practices.Shaffer Karl Bekeny/Spring 2001 Page 104 of 131 (3)When two or more persons act as a partnership.S. 13a-Ongoing reporting requirements. identity and background.BUSINESS ORGANIZATIONS II . Form 8-K. or other group [INSTITUTIONAL INVESTORS] for the purpose of acquiring. It was the pattern of the company’s behavior combined with its attitude toward the environmental violations that caused the SEC to charge disclosure violations. holding or disposing of securities of the issuer. Steel had violated the reporting requirements of § 13(a) when it failed to disclose the company’s frequent violations of environmental requirements. 1038].  FORM 8-K [p. 1202] . which resulted in fines to the company. (3) Management 13e-They must disclose their background. etc. 843] Disclosure about management integrity is limited to situations where the rules specifically mandate disclosure or where the conduct has had a materially adverse economic impact on the corporation. quarterly reports on form 10-Q (Rule 13a-13)[p. 842] HOLDING: The SEC found that U. The More Important Question is Now How do you Enforce These Duties? (1) The SEC can enforce these rules themselves. Who Has to Make Disclosure? (1) Issuer 14a (14a-3 proxy statement) 14b-Requires bank and broker to deliver a statement 14c-Even if you didn’t solicit proxies you still have to offer comparable information. current reports on Form 8-K (Rule 13a-11) [p. [p. (2) Will there be a private right of action? In re Matter of United States Steel Corporation.1038]. 10-Q (2) Shareholders 13d-5% or more. 13g-once you are a 13d shareholder then you have ongoing requirements. but if not seeking control you can file on this (short form) only having to disclose your identity and background. Registered Corporations must file annual reports on Form 10-K (Rule 13a-1) [p. such group shall be deemed a “person” for purposes of this subsection. 10-K. syndicate. (SEC 1979) [p. 1037]. limited partnership.

I.1237] Reports on management’s discussion and analysis of financial condition and results of operation as well as executive compensation.BUSINESS ORGANIZATIONS II . submission of matters to vote of security holders. Also. is false or misleading with respect to any material fact. must include submission of matters to a vote of shareholders if the matter was submitted during the fourth quarter of the fiscal year. Includes Financial information. (3) bankruptcy or receivership.Shaffer Karl Bekeny/Spring 2001 Page 105 of 131 Must file Form 8-K when: (1) change in control of registrant. legal proceedings [furnish info as required by Regulation S-K].I.. exhibits and reports on Form 8-K.  J. Case Company charging deprivation of the pre-emptive rights of respondent and other shareholders by reason of a merger .   Regulation S-K [p.1208] Must file Form 10-Q within 45 days after the end of each of the first three fiscal quarters of each fiscal year. or which omits to state any material fact necessary in order to make the statement therein not false or misleading.  Regulation S-X [Shaffer mentioned but not in book] 1. Section 14(a) declares it “unlawful” to solicit proxies in contravention of Commission rules. other information (discretional). [p.  Federal Courts have inferred a private cause of action for shareholders to seek relief for violations of the SEC proxy rules. As to business. 1205] Must file annual report with in 90 days of the close of the fiscal year end. Case Co. 829] FACTS: A stockholder brought suit against J. v. [4-6 file within 5 days]. changes in securities. defaults upon senior securities. (6) Resignations of registrant’s directors. May file Form 8-K when: (5) other events. [1-3 file within 15 days of occurrence of event] (4) changes in registrants certifying accountant. Borak. and SEC Rule 14a9 prohibits solicitations “containing any statement which .. properties. (2) acquisition or disposition of assets. FORM 10-Q [p. Implied Private Rights of Action Under the Proxy Rules. legal proceedings.  FORM 10-K [p.

BUSINESS ORGANIZATIONS II . What attorney’s fees are available? Cort v. The stockholder brought two claims: (1) breach of director’s fiduciary duty to the stockholders. Ash US 1975 (The Court begins to curtail the private right under federal law). The biggest problem with this section is notice the complexity of requirements. HOLDING: A right of action exists as to both derivative and direct causes under section 14(a). It is alleged that the merger was effected through circulation of a false and misleading proxy statement. and (2) violation of § 14(a). Frame work for Analysis 1. Note: §14 purpose is to protect investors. Was it material? 3. Note: §27 provides “exclusive jurisdiction” to the federal courts for violating the statute. Note: This case does not overturn Borak but it does begin to provide some standards. Did damages occur. The right is judicially implied. Liability for Failure to Disclose. [p. explicit or implicit. NOTE: nothing in 14(a) provides for an express cause of action and the court did not look at legislative intent.Shaffer Karl Bekeny/Spring 2001 Page 106 of 131 between Case and the American Tractor Corporation. either to create or deny the private remedy? 3. 838-852] 1. Is there a Misrep? 2. Is there any indication of legislative intent. Note: The problem is that §18 of the code already creates liability for misleading statements. 5. it is found on pg. The main issue in the case was whether the stockholder could bring a private suit under section 14(a). . Materiality. there are several questions which I will want to answer: 1. Is the plaintiff one of the class for whose special benefit the statute was enacted? 2. Is their Causation between lie and result? 4. Refused a private right of action under the Federal Election Campaign Law. Is it consistent with the underlying purposes of the legislative scheme to imply such a remedy? B.  If I get a problem where I need to determine whether an implied private right of action exists.

Watch out for what should be a state claim for breach of fiduciary duty. Cooke v. The shareholder claimed that the proxy statement failed to state that the purchase of 34% of the stock (which was disclosed) gave it control of TSC. [p. 1988). (general quality and integrity of management). Teleprompter F.BUSINESS ORGANIZATIONS II . 1990). no matter how small had to be disclosed. 844-845] US Steel 1979-The SEC found disclosure violations for a “pattern” of environmental violations. . (8th Cir. v. 1978).supp. A shareholder of TSC sued for violation of Section 14(a) and Rule 14a-9. (5th Cir. Justin Industries.  Remember not every misstatement or omission is material. Northway. Inc. SEC v. Wallerstein v. court using steel case found that this would generally be true.Shaffer Karl Bekeny/Spring 2001 Page 107 of 131 TSC Industries. Klavex 1975-Kicks backs arranged by candidate for director. 1971-Material that it was not disclosed that a candidate for BOD had been convicted of bribing public officials.” “…There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available. SEC v.N.” Court finds that the omitted facts were immaterial because the disclosures that were given revealed the nature of National’s relationship with TSC and alerted a reasonable shareholder to the fact that national exercised a degree of influence over TSC. Levine v.838] [Rule 14a-9] FACTS: National Industries acquired 34% of TSC Industries Stock by purchase from the founding family. Primerica Corp. and then placed five of its nominees on TSC’s board of directors. NL Industries 2nd 1991-Court held that failure to disclose costs of environmental violations under 10b-5.D. inc.Y. HOLDING: “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. however. inc. [p. See Golub v. v. Joe Schlitz-13a court found failure to disclose illegal or improper payments made to induce the sale of the company’s products was material because of the bearing it had on the integrity of management. Choctaw Securities. in this context there was indemnification from the government. The corp has a right to know of the potential integrity of the director. The two companies agreed to a sale of TSC’s assets to National in exchange for stock and warrants of National.. A joint proxy was issued by the two companies. which the company showed an indifference to. (E. PPD Corp.

The shareholders alleged that the proxy statements used in a merger of Electric and American Manufacturing Corp. However. 1981-Emphasis of disclosure is on quantitatively significant data. a shareholder must establish that the defect was of such a character that it would have a significant propensity to affect the voting process.”  The concept of causation has been separated into two tests: (1) Loss Causation = the transaction caused harm to the plaintiff (relatively easy to demonstrate) e. “Where there has been a finding of Materiality. 1978-There is a difference between disclosure and state law fiduciary violations. PPD 8th Cir. as here. HOLDING: There is an implied private right of action for violation of § 14(a) [Borak].Shaffer Karl Bekeny/Spring 2001 Page 108 of 131 Note: The courts now tend to limit disclosure about management integrity to those situations where the rules specifically mandate disclosure or where the conduct has had a material adverse economic impact on the corporation. If the facts of a merger are disclosed and the shareholders go ahead and vote for what is an unfair transaction. then an action under Rule 14a-9 cannot be maintained. a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress. you cannot make an individual disclose their perhaps improper characterization of motives. [p. he proves that the proxy solicitation itself. Material will not include alleged violations of the law. Gould v.” The shareholders have showed enough to sustain their cause of action.. in Borak.846] FACTS: Shareholders bring suit against Electric Auto-Lite Company under Rule 14a9 and § 14(a).BUSINESS ORGANIZATIONS II .g. Haughton 9th Cir. 2. Electric Auto-Lite Co. Causation. Note: “Where there has been a finding of materiality. was an essential link in the accomplishment of the transaction. Gaines v. a shareholder has made a sufficient showing of casual relationship between the violation and the injury for which he seeks relief if the shareholder can establish that the proxy solicitation established an essential link in effectuating the transaction. if. . were misleading in that it told Auto-lite shareholders that the board of Directors approved the merger without informing them that all of the directors were nominees of and under the control and domination of Merganthaler (Auto-lite had merged into this corp). rather than the particular defect in the solicitation materials. the shareholders got less for their shares than the shares were worth. Mills v.

852-878]. even though the parent was offering only $125 per share. Here all pertinent facts were disclosed by the person’s charged with violating § 10(b) and Rule 10b-5. there was no deception through nondisclosure to which liability under those provisions could attach. Inc. Federal Regulation. not unfair corporate transactions or breaches of fiduciary duties. (1) What was not disclosed: a. Informational vs. However. Constructive Fraud. v. and b. Rule 10b-5 regulates deception. an amount slightly higher than a valuation of the subsidiary by the parent’s investment banker.859] FACTS: Goldberg brings suit against Meridor under Rule 10b-5 challenging the sale of Meridor’s sale of essentially all its assets in exchange for stock and the assumption of its debts (two press releases were issued. [p. (2nd Cir. full disclosure forecloses liability under the misappropriation theory. Minority Shareholders .BUSINESS ORGANIZATIONS II .Shaffer Karl Bekeny/Spring 2001 Page 109 of 131 (2) Transaction Causation = requires the plaintiff to show that the defendant’s violation caused the company to engage in the transaction in question (harder to prove) e. current liability exceeds net equity. Accurate information is necessary in order to preserve the integrity of the voting process. Rule 10b-5 prohibits both false and misleading statements and fraudulent acts and practices in connection with the purchase or sale of any security.855] FACTS: A parent company merges with its majority owned subsidiary after giving minority shareholders notice of the merger and an information statement that explained their rights to a state appraisal remedy.  There 1. AND They lost their State remedy. The parent stated that the a valuation of the subsidiary’s assets indicated a $640 per share value. Limits to Liability. is a material non-disclosure. He overstated the value of the assets. Green. HOLDING: Unless the disclosure had been misleading no liability could result.g. An unfairly low price cannot amount to fraud absent deception. the press releases failed to disclose conflicts of interest). what happens when transaction does not require shareholder decision making? Then Shareholders can attempt to bring a suit under § 10(b) and Rule 10b-5. HOLDING: The complaint should be treated as if it had alleged that the press releases were materially misleading and that one of UGO’s directors was deceived or not fully informed as to the effects of the transaction. C. [p. in Mills the loss was occasioned by the merger and the merger was caused by the solicitation of proxies to secure sufficient votes for its approval. 1977) [p. Santa Fe Industries. Meridor. Thus. Goldberg v. Therefore.

. higher 2. did not. (“essential link”). Causation-There are two types: Note: It is still unclear what standard applies. Inc. Field v. because of misrep. and the statement ofthe Gould negligence(a) Material. A statement was made that the board of directors believed that $42 a share would be a fair price for the minority stock that would be purchased so the merger could be completed. 1980)-In order for the Goldberg rule to apply there must have been a “reasonable Note: probability” that had the info been proper disclosed that a There exists a state court may have granted an injunction. b. and (2) That state court would have granted relief. Sandberg. causation. Sandberg. Virginia BankShares.applies negligence standard to an outside director. 4. Accountants. Wright v. [p. Alabama Farm Bureau Mutual Casualty v. A misstatement would be material if shareholders were lulled into forgoing an injunction (state remedy) that was available under state law and necessary to prevent irreparable harm to the corporation. 1977) & Kidwell v.” and NOT simple mismanagement or breach of a fiduciary duty. 4. Catalyst (3rd Cir. Sandberg also brings state law claims for breach of fiduciary duty against First American. and (b) That it was the “essential link” in the merger BOD was standard to: a. etc. v. 1988)-They reaffirmed the Goldberg holding. Must be in Shareholder voting votes were not required by law or 2. Meikle (9th Cir. succeeded. Disbelief or undisclosed motivation.BUSINESS ORGANIZATIONS II . Wilson-While vote not necessary.873] FACTS: First American Bankshares began a freeze out merger in which First American eventually merged into Virginia Bankshares. gave up state appraisal right. Heizer (7th Cir. HOLDING: Knowingly false statements of reasons may be actionable even though conclusory in form. Culpability-Gould. Loss Causation-Is it fair? while Causation Act provides was a Merger which required Voting. Adams in fact did apply scienter. • The Court used Mills requiring them only to show that Herskowitz-extended the 3. reasonable corporate bylaw to authorize the transaction giving rise to important to shareholder in their vote. 1979)-Only need to show under §10b-5 is that in the 9th and 7th a state law claim was available. Most minority shareholders gave the proxies to First American. Trump (2nd Cir. b. Transaction§11 1993 -1. Va Bankshares v. but limited it to circumstances when there exists an intent. Mills-This for negligence. Misrep or the merger. is insufficient to satisfy the elements of fact that must be established under section 14(a). HARM. so NO transaction scienter. Investment bankers process. 1979)-(1) Insist that claim must have been available under state law. Further Requirements: 1. or “willful misconduct of a self-serving nature. Theabank’s proxy solicitation was not the essential link in Elements for 14a-9 Claim. The court found that the statement violated the “fundamental purpose” of the act. but that a possible claim existed. Healey v.Shaffer Karl Bekeny/Spring 2001 Page 110 of 131 state a cause of action when claiming that they were lulled into not seeking to enjoin a merger because of the board’s deceptive disclosures. §10b-5 of the2. Sandberg has failed to show the equitable basis required to extend the §14(a) private action. Sandberg brings suit against First American under § 14(a) and Rule 14a-9. Duty of Disclosure to Shareholders effectuating Omission (Note: the minority shareholders’ context) 1. a. w/o. not that you would have Circuits. American threshold Fidelity (5th Cir. Materiality=TSC-“substantial likelihood” that material fact would have beenthe claim. type of 1934 Act requires a Sandberg-NO need for vote. standing alone. 3. a minority shareholder. 3.

878-893] 1. Inc.Shaffer Karl Bekeny/Spring 2001 Page 111 of 131 D. Fault . 2. Great American Industries. [p. HOLDING: A minority shareholder.BUSINESS ORGANIZATIONS II . Wilson v. plaintiffs must also prove that they in fact lost state appraisal rights. Disclosure and Sate Law Remedies. who has lost his right to a state appraisal because of a materially deceptive proxy. When defendants choose to issue a proxy plaintiffs have a right to a truthful one.878] FACTS: Following the merger of Chenango industries into Great American Industries.  There can be transaction causation where a materially misleading proxy statement “causes a shareholder to forfeit his appraisal rights by voting in favor of the proposed corporate merger.. The deceptive proxy constitutes an “essential link” in accomplishing the forfeiture of this state right. Lost State Remedies. Although a finding of materiality in a proxy solicitation may satisfy the elements of loss and transaction causation for forfeited state appraisal rights. minority shareholders of Chenango sued Great American. Chenango. may make a “sufficient showing of causal relationship between the violation and the injury for which he seeks redress. The shareholders alleged that defendants violated Rule 14a-9 because of omissions and material misrepresentations in a joint proxy statement/prospectus issued in connection with the merger. and various officers and directors connected with those corporations. The case is remanded to determine this. The injury sustained by the minority shareholder powerless to effect the outcome of the merger vote is not the merger but the loss of his appraisal right. [p.

883]: Gould v. Standard Knitting Mills. even though no shareholder vote is required. State law has regulated proxy solicitations longer than the federal government. Rule 10b-5 requires the more exacting test of scienter. owe shareholders a duty of disclosure. Section 11 contains an explicit negligence standard. corporate fiduciaries are not responsible for the failures of non-fiduciaries to disclose. including at least directors and controlling shareholders. (6th Cir. [Lacos Land Del] [Stroud Del actual language of quote] Thus.BUSINESS ORGANIZATIONS II . State Law Duty of Disclosure.Shaffer Karl Bekeny/Spring 2001 Page 112 of 131 Virginia Bankshares left open the question of whether the standard of culpability to which the directors will be held in a section 14(a) action is negligence or scienter. they are referred to as the Delaware Carve Out-they are for (1) derivate claims and (2) Breach of duty to shareholder claims. a tender offer by a controlling shareholder or a tender offer by the corporation for its own shares [Lynch. 1980). (3rd Cir. Adams v. whether in a traditional merger.. Glassman. directors and controlling shareholders have a duty to disclose when they place the shareholder in a position in which she has to decide whether to sell her stock or seek appraisal rights. those not in a fiduciary relationship with shareholders do not owe them a duty of disclosure. The two principal liability provisions of the federal securities laws provide different answers. However. The duty of disclosure arises when a fiduciary asks the shareholders to act as corporate decision makers. and short-form mergers.888-889] . American –Hawaiian Steamship Co. Lower Federal courts are divided [p. [Zirn Del] Additionally. Note: While fed law might be thought to control under the supremacy clause. 3. there are fewer cases as state courts are reluctant to embroil themselves in the internal affairs of the corporation. and Eisenberg]. (a) Under What Circumstances Does the Duty Arise? Those who are in a fiduciary relationship to the shareholders. in Delaware there is the carve out from the fed regulations that provide state court options. 1976) applied the negligence standard in a section 14(a) case to an outside director. [Shell] [p. applied the scienter standard in a section 14(a) case to an outside accountant. As a general rule.

See Stroud v. The derivative claim is only unattractive because of the procedural hurdles that stand in the way. or sale or purchase of all the assets. . Who has standing? It is only the shareholders. Inc.892]. however.Shaffer Karl Bekeny/Spring 2001 Page 113 of 131 (b) Materiality Under State Law. but the problem is the shareholders will have to re plead this claim. Getty Oil Co. The Delaware Supreme Court has indicated that a duty of full and fair disclosure arises whenever directors are either required to seek a shareholder vote or elect to do so. profits and net equity. Fiduciaries are held to a standard of strict liability for violations of the duty of disclosure: they are held liable for its breach whether or not they are acting in good faith (this type of decision is outside the scope of the BJR). Brincat (Del 1998)-The BOD in this case overstated the financial condition of mercury to the shareholders of the corp. (iii) Merger. 1989)[p.BUSINESS ORGANIZATIONS II . “Shareholders are entitled to rely upon the truthfulness of all information disseminated to them by the directors they elect…” 3. that the directors have to know there is a material mistake. Milliken Enterprises. 5.” See Rosenblatt v. There seems to have to be a requirement of scienter. merger. short form. but under 13(a) of 1934 Act. (Del. [Arnold v. (Del. Fiduciaries must disclose “all material information. 2. Delaware. Note: The class action would likely not work because it may be impossible to demonstrate reliance for each member of the class. did not fulfill 10k requirement by misstating earnings. Society Savings Corp. [p. 890] The court adopted the TSC materiality standard. (d) Malone v. So there will be no proxy solicitation required. In Delaware. Note: In this case there is some suggestion that only a derivative claim would survive that courts standards.. there are disclosure requirements whenever you (i) vote. In determining whether a fiduciary’s omission of information or false statement in a disclosure is material it is irrelevant. whatever. 1. (ii) even when shareholder voting not required. 4. the disclosure rules only covers those who have a fiduciary duty. This case would clearly have been a 10b-5 violation. a. you will be held liable if any part of it is a misrep. 1985). An issue is that there is no shareholder vote. (c) “Voluntary” Disclosures and Lost State Remedies.] Once you start a statement.

“The Law of Conservation of Securities” insider trading harms those who are unable to trade because an insider bought the shares. and traders. These individuals are preempted. Regulation of and Operation of Security Markets: Insider Trading. VI. Introduction to Securities Transactions. It also harms . Not fair to other investors to use corporate information for your own gain. 1. the lemming effect). Economic Theory. Not all securities trade at their inherent value.  Economic Theory and Insider Trading. who buy and sell for customers and themselves]. and (2) affects the market for a corporations stock and thus implicates the market’s role in the corporate governance system.BUSINESS ORGANIZATIONS II . American Stock Exchange. dealers. The market is not perfect. Securities Markets and Securities Transactions There are two types of public securities markets: (1) Stock exchanges (NYSE. [896-905 &909-927]  What does this have to do with corporations?  Regulation of Securities Transactions often: (1) involves corporate management and thus necessarily involves fiduciary duties. electronic inter-dealer quotation system]. This distorts the value of the stock and wrecks havoc on the market. it's like playing with a marked deck. people still continue to try and out perform the market and make money. Information is not complete. etc. When you look at the market you will see investors behaving rationally but most often irrationally (buying or selling with the rest. and (2) NASDAQ Market (National Association of Securities Dealers Automated Quotation System) [over-the-counter market.Shaffer Karl Bekeny/Spring 2001 Page 114 of 131 Federal Law III. Yet.) [floor with specialists. Two views: (1) Insider trading is bad. A. Wang.

Stockholder had sold his stock Note: stockholder was a sophisticated investor. Easterbrook and Fischel believe that this is away to compensate managers and thus it encourages them to take risks. which will benefit investors (everyone gets a bigger piece of the pie). MA (1933) [p.910] FACTS: Stockholder brings suit against defendant officer and directors for not disclosing to him as a stockholder their knowledge of a novel theory that would possibly permit the corporation to extract more copper from a mine. (2) Law and economics followers argue that insider trading is beneficial to the market and should not be prohibited. Goodwin v. Directors and officers owe a fiduciary duty only to the corporation and are under no affirmative obligation to disclose material non-public information when purchasing or selling securities in an impersonal market. HOLDING: Court holds that the lower court dismissal was valid. under the special facts doctrine a . Allowing insider-trading will in the markets efficiency because insiders will have an incentive to delay the release of information (disclose).Shaffer Karl Bekeny/Spring 2001 Page 115 of 131 traders who are induced to buy or sell – disclosure may protect these individuals but not those that have been preempted. Investors will take into account insider trading and allocate risk by not paying as much for the securities. The Common Law Background to Insider Trading. state law as it relates to insider trading remains relevant for two reasons: (1) federal law builds on common law concepts. which hurts the firm by reducing capital. However. Delayed Disclosure. Today the law governing the trading of securities is largely federal (§ 10 (b) and Rule 10b-5). and (2) shareholders in close corporations still rely on state law. They believe that insider trading will permit smoother changes in stock prices. 2.BUSINESS ORGANIZATIONS II . Agassiz. Portfolio Theory and the Cost of Capital. However. (a) Duty to Shareholders and Investors.

Oreamuno.the officer or director had beached their fiduciary duties to the corporation. or to declare of to pass a dividend. NY (1969) [p.  Traditional common law approach was that a corporate insider did not ordinarily violate his fiduciary duty to the corporation by dealing in the corporation’s stock. HOLDING: Court holds that officers and directors are accountable to their corporation for gains realized by them from transactions in the company’s stock as a result of their use of material inside information -. This was a computer company whose stock fell off the planet after they could not keep up with their business. profits made by him in stock transactions undertaken because of his knowledge are held in constructive trust for the principal. Repide. U. because the court had two problems with the case. (2) Privity between buyer and seller does not exist in anonymous trading. If a corporate officer has inside information that the corporation is about to purchase or sell securities. [Goodwin represents the majority rule. Court holds that because an officer acts in a relation of scrupulous trust and confidence that his behavior is therefore also subject to the closest scrutiny. (1) The duty of insiders is to the corp. [Special Facts Doctrine] Hotchkiss v. NOT individual shareholders. [Kansas Rule] (b) Duty to the Corporation. 914] Court rules for widow who came to director and asked if there was going to be a dividend. Strong v.Shaffer Karl Bekeny/Spring 2001 Page 116 of 131 plaintiff may be afforded a remedy when non-disclosure amounts to unconscionable behavior by the insider.S. unless the corporation was harmed. the transaction will be closely scrutinized and relief may be granted in appropriate instances.] Note: Under the “Special Facts Test” the D’s were not held liable.BUSINESS ORGANIZATIONS II . (1909) [p. See Strong v. Repide. Fischer.914] FACTS: Derivative action for breach of fiduciary duty for using inside information to reap large profits which rightfully belonged to the corporation. Diamond v. (1909). . KN (1932) [p. 912] Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts within his peculiar knowledge and not within reach of the stockholder.

927-947] The authority for the adoption of Rule 10b-5 is § 10(b) of the Securities Exchange Act of 1934. HOLDING: A corporation may not recover the profits of corporate officials who trade in the corporation’s securities on the basis of inside information. Follows: Schein v. 7th Circuit (1978) [p. to disclose to another (tip) material . senior executive. other employee of a public corporation. Decio.920] FACTS: Court decides whether Indiana would adopt the holding in Diamond. Kardon v. National Gypsum Co. Section 10(b) is a catchall. Court reasoned that the corporation is not harmed. it is not unlawful for a person who is not an insider. The Court also felt that there may have been harm in that the inside trading hurt the corps reputation and thus the marketability of its stock.1946). which it finds detrimental to the interests of the investor. acting in a breach of a fiduciary duty owed to corporation. nonpublic information about that corporation. [p. (Confirmed by Superintendent of Insurance v.. Chasen. since their EE should not be able to unjustly enrich themselves.D. Was the first to hold that Rule 10b-5 supported an implied private action for damages.S. or temporary insider (derivatively) to use material nonpublic information to purchase or sell that corporation’s stock. Federal Regulation of Insider Trading : Rule 10b-5. 1971)). § 10(b) and Rule 10b-5 make it unlawful for a director. that the corp has a higher claim.Pa. Bankers Life & Casualty Co.   However.BUSINESS ORGANIZATIONS II . (U.  Rule 10b-5 – Implied Private Action for Damages. B. . See Texas Gulf Sulphur and Chiarella. temporary insider. (E. it authorizes the Commission by rules and regulation to prohibit or regulate the use of any other manipulative or deceptive practice.Shaffer Karl Bekeny/Spring 2001 • Page 117 of 131 • The court answered the question of where was the harm in this case by bringing forward the point that no harm need be shown. FL (1975). Freeman v.  It is unlawful for an insider or temporary insider. or tippee (a stranger) to trade in a corporation’s stock simply because they possess information not available to other traders.

1. nonpublic corporate information has an obligation to disclose the information or abstain from trading in the corporation’s securities. or. Texas Gulf was exploring Northern Canada for mineral deposits.  Rule 10b-5 gives rise to two distinct duties: (1) A duty not to trade on inside information. The court states that (1) Anyone in possession of material information must either disclose it to the investing public. brings a 10b-5 action against Cady. An associate at Cady gives Gintel material information concerning the cutting of dividends in a company that Gintel owned shares in before the information is released to the public. HOLDINGS: (1) All transactions in TGS stock or calls by individuals apprised of the drilling results were made in violation of Rule 10b-5. 930] THIS CASE AFFECTS ANYONE WITH MATERIAL INFORMATION! FACTS: S. [outlines possible scenarios] In re Cady. or he chooses not to do so. For silence to be fraudulent there must have been a duty to disclose that information.. Holds that a corporate insider who possesses material. Roberts & Co. [p. (S. If there is no duty then it cannot be fraud to remain silent. Note: this was the rather large problem with the original 10b-5 analysis as it focused on “misrepresenting material facts.C. brings suit against Texas Gulf Sulphur for violating § 10(b) and Rule 10b-5 among other things. and Gintel.C. HOLDING: Held that Gintel violated 10b-5. The Abstain or Disclose Test The core purpose of Rule 10b-5 is to make sure that all investors have equal access to information.. Texas Gulf Sulphur Co.C. a brokerage firm. Before this information was made public the company made a public announcement downplaying the importance of the find.E.” Securities and Exchange Commission v.E. 928] FACTS: S. The Scope of the Rule. Before and after this time insiders bought stock and exercised calls and options.E.BUSINESS ORGANIZATIONS II . 1961) [p. (2)Rule 10b-5 is violated whenever assertions are made in a manner reasonably calculated to influence the investing public if such assertions are false or misleading or are so incomplete as to mislead irrespective of whether the issuance of the release was motivated by corporate officials for ulterior purposes. and (2) Duties relating to disclosure of that information.Shaffer Karl Bekeny/Spring 2001 Page 118 of 131  See page 955. (2) Must abstain from trading in or recommending the securities concerned . one of its partners. They found a huge mineral deposit. if he is disabled from disclosing it in order to protect corporate confidence.

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 Materiality. Whether information is material within Rule 10b-5 depends upon the balancing of both (1) the indicated probability that the event will occur, and (2) the anticipated magnitude of the event in light of the totality of the company activity. C. Rule 10b-5 continued. Tipping. [p. 947-969] 1. Regulation of Trading on Non-Public Information. Chiarella v. United States, (U.S. 1980) [p. 947] STRANGER (This is the framework for the “Abstain or Disclose” test). NOTE: THE 10B-5 DUTIES NO LONGER TO JUST ANYONE!


FACTS: S.E.C. investigates Chiarella, an employee at a financial printer. S.E.C. and Chiarella enter into a consent decree where Chiarella will give back money he made using inside information he got from his job. Then D.O.J. files a criminal suit against Chiarella. Chiarella is found to have violated § 10(b). Supreme Court grant certiorari and reverses conviction. HOLDING: A person who learns from the confidential documents of one corporation that it is planning an attempt to secure control of a second corporation does not violate § 10(b) when he fails to disclose the impending takeover before trading in the target company’s securities if he does not have a duty to disclose it. In this case Chiarella had no fiduciary duty to the prospective buyers. Chiarella was not a corporate insider and he received no confidential information from the target company. There can be no fraud absent a duty to speak. A duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information. Dissent, Burger: § 10(b) and Rule 10b-5 mean that a person who has misappropriated nonpublic information has an absolute duty to disclose that information or to refrain from trading. SEC’s Response, 14e-3, prohibiting during the course of a tender offer, trading by anybody (other than bidder) who has material, non-publicmaterial nonpublic that Tipper = a person who discloses info about the offer he knows was obtained information. through either bidder or target. THIS IS REALLY APPLICABLE WHEN THERE IS NO FIDUCIARY FOR MISAPROP, BECAUSE 14E-3 DOES NOT REQUIRE ONE. Tippee = a person who receives material nonpublic  Tipper = a person who discloses information from a tipper. If the tippee subsequently discloses the information, he becomes a tipper as well as a tippee and the person to whom he discloses becomes a sub-tippee. Tippees of corporate insiders have been held liable under § 10(b) because they have a duty not to profit from the use of inside information that they know is confidential and know or should know came from a corporate insider. Thus, the tippees’ liability is derivative in that it is based on the tipper’s breach of

there can be no violation by the tippee.

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Dirks v. Securities and Exchange Commission, [p.956] TIPPEE/TIPPER FACTS: Dirks, an officer at a broker-dealer firm, received material nonpublic information regarding on going fraud from Secrist, a former officer (insider) of a corporation. Dirks had no connection to the corporation. Dirks investigates the fraud and urges the Wall Street Journal to write an article. Dirks discloses the fraud information to investors who relied on it in trading in the shares of corporation (sell) before the information is made public. The SEC censures him because even though he violated 10b-5 he helped uncover fraud. HOLDING: There was no actionable violation by Dirks. In the absence of a breach of duty to shareholders by insiders, there was no derivative breach by Dirks. If an insider’s tip constituted a breach of the insider’s fiduciary duty then the tippee’s actions will be considered a derivative breach and the tippee will be liable. The test to use in determining whether the insider breached their fiduciary duty is whether the insider will benefit, directly of indirectly, from his disclosures. Thus, absent some personal gain, there has been no breach of duty to the stockholders. And absent a breach by the insider, there is no derivative breach. There must be a breach of the insider’s fiduciary duty before the tippee inherits the duty to disclose or abstain. There can be no duty to disclose where the person who has traded on inside information was not the corporation’s agent, fiduciary, derivative fiduciary, or a person in whom the sellers of the securities placed their trust and confidence. (A third party such as a lawyer or accountant may become a constructive insider and in turn a fiduciary of the shareholders when corporate information is revealed legitimately to them).

Misappropriation Theory.

Holds that a person commits fraud “in connection with” a securities transaction, and thereby violates § 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes. Chiarella and Dirks did not address whether section 10(b) or Rule 10b-5 make it unlawful for a person who has no connection to a corporation to trade that corporation’s securities on the basis of material,

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non-public information that he misappropriated from some third party. Circuit courts were divided on this issue. Three circuit courts have concluded Two circuits reject the that it is unlawful for someone misappropriation theory. outside a corporation to trade on the See United States v. Bryan (4th Cir. basis of misappropriated information. 1995), United States v. O’Hagan (8th See United States v. Newman (2nd Cir. Cir. 1996), rev’d U.S. 1997. 1981), S.E.C. v. Clark (9th Cir. 1990), S.E.C. v. Cherif (7th Cir. 1991). Rationale: That where a fiduciary has misappropriated information for the purpose of buying and selling securities, the nexus between the misappropriation and the misappropriator's’ trading satisfied the “in connection with” requirement of §10(b). Rationale: Misappropriation theory is invalid because the person injured by the misappropriator’s breach of fiduciary duty was not a participant in any relevant securities transaction. Thus, even if misappropriation somehow could be viewed as “deceptive,” the deception did not have the necessary connection to a purchase of sale of securities. Decided after Central Bank.

Decided before Central Bank. NOW,

SUPREME COURT HAS RULED THAT CRIMINAL LIABILITY § 10(B) MAY BE PREDICATED ON THE MISAPPROPRIATION THEORY. D. Insider Trading (continued). O’Hagan. [p. 969-984] Carpenter v. US (US 1987) [was divided on whether misappropriation theory was o.k., 4 / 4]. United States v. O’Hagan, U.S. 1997 [p.969] FACTS: O’Hagan, a partner at Dorsey & Whitney in MN, purchases calls and options for Pillsbury Stock. At the time O’Hagan did this Dorsey & Whitney was representing a London based company, Grand Met, in a tender offer for the common stock of Pillsbury. O’Hagan did no work on the tender offer. The SEC initiated an investigation that lead to a 57 count indictment (based on O’Hagan’s misappropriation). O’Hagan was convicted and received a 41 month federal prison term. The court of appeals for the 8th circuit reversed stating that liability under § 10(b) and Rule 10b-5 may not be grounded on the “misappropriation theory.” The U.S. Supreme court granted certiorari. HOLDING: Supreme Court reverses and holds that criminal liability under § 10(b) may be predicated on the misappropriation theory.

C.E. S. v. United States.  Benefit to Tipper. files suit arguing Switzer and his friends were liable under 10b-5.” See Chiarella. did not breach a fiduciary duty to Phoenix’s shareholders by disclosing this information since he did not personally benefit. That relationship “gives rise to a duty to disclose or to abstain from trading because of the necessity of preventing a corporate insider from taking unfair advantage of uninformed stockholders. but to the source of the information. (W. knowing of Platt’s position.980] FACTS: Switzer.980] FACTS: Employees of a magazine printer give out advanced copies of Business Week.S. accountants. This theory also applies to attorneys. Since Platt breached no duty there was no way that Switzer and his friends could have derivatively breached a duty. tell his wife that he needs to leave town because there was a possibility that Phoenix would be liquidated. directly or indirectly.BUSINESS ORGANIZATIONS II . is at a track meet and overhears Platt. The S. § 10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material nonpublic information. Libera. Note: disclosure is also to the source of info! Moreover. CEO of Phoenix Resources. . a company’s confidential information qualifies as property to which a company has a right of exclusive use. football coach for the University of Oklahoma.D. from the disclosure.E. 1987. (2nd Cir. Trading on such information is a deceptive device under § 10(b) because “a relationship of trust and confidence exists between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position within the corporation. Switzer. See Dirks. The people who received advanced copies trade on this material non-public information. made substantial investments in Phoenix. 1993) [p. U. the tipper. consultants. Traditional Theory of Insider Trading Targets a corporate insider’s breach of duty to shareholders with whom the insider transacts. United States v. Misappropriation Theory of Insider Trading Outlaws trading on the basis of nonpublic information by a corporate outsider in breach of a duty owed not to a trading party. Switzer and his friends.Okl. and others who temporarily become fiduciaries or a corporations. 1984) [p. See Carpenter v.C.Shaffer Karl Bekeny/Spring 2001 Page 122 of 131 Under the traditional theory of insider trading. Switzer and his friends were not liable as tippees because Platt. HOLDING: Under the Dirks test.

United States v. which he subsequently sold at a profit. 982] FACTS: A young attorney provided defendants with information about ongoing or contemplated transactions involving clients of the law firm that employed him. Despite the fact that he told her to keep the information confidential she told her daughter.C. S. 1991) [p. and tippees of up . HOLDING: Lund was liable as a temporary insider since the information was made available to Lund solely for corporate purposes. 1993) [p.000 Shares of P&F stock. his stockbroker.D. United States v.E.  Family Relationships. Pursuant to section 21A of the 1934 Act the SEC is authorized to seek judicially imposed penalties against insiders. In turn her daughter told her husband. Teicher. Prior to any public disclosure regarding the venture Lund purchased 10. The Tipper/employees could be found liable even if the tipper did not know that the tippee would trade on the basis of the misappropriated information.981] FACTS: Lund the CEO of Verit Industries was asked by Horowitz a board member of Verit if he wanted to contribute $600K in capital for a joint venture with P&F Industries. telling him to keep it confidential.  Tippee’s State of Mind. (2nd Cir. constructive insiders. HOLDING: Court holds that Loeb had no duty not to disclose and that therefore Chestman could not be derivatively liable as Loeb’s Tippee. CEO of Waldbaum supermarkets. (C. v. tells his sister that he had agreed to sell the Waldbaum chain to A&P. 1983) [p.Shaffer Karl Bekeny/Spring 2001 Page 123 of 131 HOLDING: As a matter of law the employer-employee relationship was sufficient to establish a duty not to disclose which the printer’s employees breached by providing advanced copies of the magazine to others. tippers. Chestman also buys Waldbaum stock for his own account.BUSINESS ORGANIZATIONS II .  Remedies for Insider Trading Violations. Loeb told Chestman about the sale. Chestman.981] FACTS: Ira Waldbaum. Keith Loeb then proceeded to place an order with Robert Chestman. Lund. Cal. HOLDING: A violation of Rule 10b-5 occurs when a trade is conducted in ‘knowing possession’ of material nonpublic information obtained in breach of a fiduciary or similar duty. Defendants were in the business in gathering rumors and public reports about publicly traded companies. (2nd Cir. Keith Loeb.  Constructive Insiders.

or tippee may be required to disgorge his profits. and pay a treble damage penalty. Also at the insistence of the SEC civil penalties of up to 1 million dollars or three times the insider’s profits (whichever is greater) may be imposed on employers pursuant to section 21A(b). the 1988 Act grants E. whether in an SEC or private action. reduced by any disgorgement obtained by the SEC under its injunctive powers.. Exchange Act §21A. etc. “Watchdog penalties”-Insider Trading and Securities Fraud Enforcement Act of 1988. Congress provides more bite by extending civil penalties to ERs who “control” insider traders. [p. The Federal Remedies for Insider Trading • • • • • • SEC Injunctions and Disgorgment-SEC v. Section 32(a) authorizes criminal penalties of up to ten years in prison and maximum fines of 1 million for individuals and 2 million for non-natural persons (corporations. An insider..Shaffer Karl Bekeny/Spring 2001 Page 124 of 131 to three times the profits gained or the losses avoided in unlawful insider trading. Civil Recovery by “defrauded” owners of confidential information-Owners of confidential information who purchase or sell securities may bring a private action under 10b-5 against inside traders and tippees. TGS Civil Recovery by Contemporaneous Traders-Securities Fraud Enforsement Act of 1988.984-987 & 989-999]{skim 999-1007} 1. Recovery is the disgorgement of the insiders actual profits realized or losses avoided. Disclosure Duties of Corporations Silence is actionable in connection with corporate disclosures when: . Civil Penalties-The act authorizes the SEC to seek a judicially imposed civil penalty against traders and tippees who violate Rule 10b-5 or Rule 14e-3 for up to three times the profits realized (or losses avoided) in insider trading. The Affirmative Duty to Disclose. “Bounty” rewards-To encourage informants. limits recovery to traders contemporaneous with insiders.). tipper.BUSINESS ORGANIZATIONS II . Informants are paid a bounty.

 Business Judgment Rule and the Duty to Disclose: Financial Industrial Fund. 1973). (10th Cir. Rumors began to circulate that Fluor had gotten a large contract and analysts made inquires. (2nd Cir. corporations are encouraged to make prompt disclosure of material events. HOLDING: A company has no duty to correct or verify rumors in the market place unless those rumors can be attributed to the company. [p. or (2) the company knows that insiders are trading based on information not available to the public. See Elkind v.Shaffer Karl Bekeny/Spring 2001 Page 125 of 131 (1) the company fails to correct misinformation it created and that it is actively circulating in the market. Before this time the pension fund sold shares in Fluor. State Teachers Retirement Board v. Corporations subject to the reporting requirements of the 1934 Act are required to file annual reports 120 days after the end of their fiscal years. There is no evidence that the rumors can be attributed to Fluor. Inc. Fluor responded with no comment statements. a pension fund. Fluor used its business judgment in deciding when to act (this happened shortly after the rumors started. 1981) [p. and current reports within 10 days after the end of the month in which a reportable event occurred. (2nd Cir. McDonnell Douglas Corp. a large engineering and construction firm. Unless adequate and accurate information is available to the public a corporation and its insiders may not trade in the corporations securities without running a risk of violating § 10(b) and Rule 10b-5. Generally. v. for alleged violations of Rule 10b-5 and of the NYSE listing agreement and company manual. seminal reports within 45 days after the end of the 6month period.984].BUSINESS ORGANIZATIONS II . A company will not be held liable so long as its management exercises reasonable business judgment in deciding on the timing of disclosure. South Africa had them sign a confidentiality agreement. once Fluor was aware of the relationship between the change in market activity and the contract they were negotiating). On the facts of this . sued Fluor Corporation. South Africa was working on getting financing through the French government. Fluor did nothing until the NYSE asked them to suspend trading. Liggett & Myers. Fluor Corp. HOLDING: Material information must be “available and ripe for publication” before a duty to disclose arises. NYSE states that if unusual market activity should arise before important corporate action or development then the corporation should be prepared to make an immediate public announcement of the matter. 1980).987] FACTS: State Teachers. Fluor had entered into contract negotiations with the South African government. Inc.

There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available). Thus.” Whether merger discussions in any particular case are material will depend on the facts of the case. the court rejects the proposition that information becomes material by virtue of a public statement denying it. (U. The court specifically adopted the TSC Industries. 1976) materiality standard for 10b-5 actions (an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Basic asked the NYSE to suspend trading and made a public announcement confirming the merger. to become a merger agreement in principle). (U. “Materiality will depend at any given time upon the balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity. Materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.S. Furthermore. 1980) [p. HOLDING: A fact is material for purposes of Rule 10b-5 if there is a substantial likelihood that a reasonable investor would consider it as altering the “total mix” of information in deciding whether to buy or sell. Former shareholders bring a class action suit against Basic and its directors.  Silence absent a duty to disclose is not misleading under 10b-5. During negotiations Basic made Three Public Announcements denying that it was engaged in merger negotiations. A no comment statement is the equivalent of silence. if disclosure of the information would affect the price of the company’s stock. with reasonable certainty. Basic. Inc. The court also applied the Texas Gulf Sulphur probability/magnitude test for materiality. asserting that the defendants issued three false or misleading public statements in violation of § 10(b) and Rule 10b-5. Eventually. The court rejected the “agreement-in-principle as to price and structure” as the bright-line test for materiality (mergers discussions can not be a material fact if negotiations were not destined. Incorporated v.Shaffer Karl Bekeny/Spring 2001 Page 126 of 131 case management did not have reliable specific figures prior to disclosure.1003] FACTS: The case requires the court to apply the materiality requirement of § 10(b) and Rule 10b-5 in the context of preliminary corporate merger discussions. the information is material. . Inc. Levinson.BUSINESS ORGANIZATIONS II .S. During this period shareholders sold stock. Northway. [footnote 17 page 996]. Combustion Engineering expressed interest in acquiring Basic when regulation opened up in the mid-seventies (Basic manufactures chemical refractories for the steel industry). v.

the company has no duty to “update” the statement. a person acting on behalf of an issuer.  § 21E of 1934 Act provides a safe harbor for forwardlooking statements. Section 21E(c)(1) provides that an issuer. or (ii) immaterial. 1995). was (I) made by or with the approval of an executive officer of that entity.Shaffer Karl Bekeny/Spring 2001 Page 127 of 131 However. or committed a material fact that made his statement misleading.BUSINESS ORGANIZATIONS II . or (ii) if made by a business entity. within a reasonable time. Materiality standard is TSC (substantial likelihood that the disclosure of the omitted fact would have been viewed by . was made with actual knowledge that the statement was false or misleading. Inc. and certain other persons shall not be liable in any private action under the 1934 Act with respect to any forward looking statement if and to the extent that (A) the forward-looking statement is (i) identified as a forward looking statement. or remained silent in the face of a fiduciary duty to disclose a material fact. a historical statement that the company believed was true when making it but subsequently discovers was false or misleading. Yet. 2. or (B) the plaintiff fails to prove that the forward-looking statement (i) if made by a natural person. The defendant affirmatively misrepresented a material fact. [p. when subsequent events render inaccurate a forward-looking statement that a company believed was true when made and for which the company had a reasonable basis.. 997]. a corporation has a duty to correct. Elements of a 10b-5 Action for Disclosure Fraud (a) Material Misinformation. Bespeaks Caution Doctrine: A mechanism by which a court can rule as a matter of law that defendants’ forward-looking representations contained enough cautionary language or risk disclosure to protect the defendant against claims of security fraud. (7th Cir. See Stransky v. and is accompanied by meaningful cautionary statements that identify which portions could change. and (II) made or approved by such an officer with actual knowledge by that officer that the statement was false or misleading. Cummins Engine Co.

(1975) [p. Hochfelder (U. The defendant knew or was reckless in not knowing of the misrepresentation and intended that the plaintiff rely on the misinformation. Blue Chip Stamps v.S. 1980) Ernst & Ernst v. (c) Scienter.999] HOLDING: Court held that a private action for damages under Rule 10b-5 can only be maintained by a person who actually purchased or sold securities. The court justified its holding in large part by pointing to the speculative nature of a claim brought by a person who can only allege that. an accounting firm retained by First Securities Company of Chicago. Manor Drugs. and (2) Whether scienter is required in an S.BUSINESS ORGANIZATIONS II .S. no matter who the plaintiff is or what remedy is being sought.Shaffer Karl Bekeny/Spring 2001 Page 128 of 131 the reasonable investor as having significantly altered the ‘total mix’ of information made available) and TGS (probability/magnitude test). manipulate or defraud. 1976) [p. SEC (U.S. . U. she would have purchased or sold securities. Section 10(b) was intended to proscribe knowing or intentional misconduct.S. HOLDING: To succeed in a 10b-5 action a plaintiff must prove that defendant acted with scienter –an intent to deceive.  Only applies to shareholders who traded shares between the time the misrepresentations were made and the time the truth was revealed. had not followed appropriate auditing procedures and thus had failed to discover a scheme by which First Securities president had induced Hochfelder to invest in non-existent accounts.  Hochfelder left open two important questions: (1) Whether reckless misconduct satisfies the scienter requirement.C. 1980) which held that scienter is a required element of a Rule 10b-5 offense. injunctive action as well as a private damage action. had she known the truth. United States (U. Chiarella v. (b) Standing. This last question was answered in Aaron v.1000] FACTS: Hochfelder argued that Ernst & Ernst. and to the vexatious potential of litigation based on such a claim.E.

supported by the fraud-on-the –market theory? A: We adopt the fraud-on-the-market theory. Sun Chemical Corp. courts infer reliance from dissemination of misinformation in the trading market. 1977)(gave definition of recklessness. (7th Cir. the Supreme Court has not addressed it.BUSINESS ORGANIZATIONS II . The plaintiff relied on the misrepresentation. Causation. v. The Supreme Court Adopted the Fraud-On-The-Market Theory to address the problem of proving reliance in openmarket transactions. ideally transmits information to the investor in the processed form of a market price.. Sundstrand Corp. In 10b-5 cases involving transactions on impersonal trading markets. Levinson (U. . courts dispense with reliance if the undisclosed information was material. The plaintiff suffered actual losses as a result of his reliance. Reliance. an extreme departure from the standards of ordinary care. the plaintiff would not have entered the transaction or would have entered under different terms – a restated reliance requirement. Titan Capital Corp. Incorporated v. Thus. In 10b-5 cases of a duty to speak.  (e) . Basic. 1990). which presents a danger of misleading buyers and sellers that is either known to the defendant or is so obvious that the actor must have been aware of it”). “A highly unreasonable omission. See Hollinger v. (d) Privity.. (9th Cir. Requires the plaintiff show that “but for” the defendant’s fraud.S. the market is acting as an unpaid agent of the investor. The market is interposed between buyer and seller and. Transaction Causation. federal courts of appeal have uniformly held that reckless misconduct will satisfy the scienter requirement. giving her information to make her decision (it is like a face to face transaction in this sense). 1988) [p 1003] QP: Whether it was proper for the courts below to apply a rebuttable presumption of reliance. However.Shaffer Karl Bekeny/Spring 2001 Page 129 of 131 We still do not know the answer to question one.

Officer includes executive officers. The plaintiff suffered damages.BUSINESS ORGANIZATIONS II . Punitive damages are not available. Damages. the corporation = the issuer). Courts use various theories to measure damages under Rule 10b-5. Requires the plaintiff show that the fraud produced the claimed losses to the plaintiff – a proximate cause requirement.Shaffer Karl Bekeny/Spring 2001  Page 130 of 131 Loss Causation. 1007] (Not Assigned) Under § 16 it is conclusively presumed that. Federal Regulation – Section 16 [p. See Rule 16a-1(f). when a director. (f) . 3. officer or 10% shareholder buys and sells securities of his corporation within a sixth-month period. chief financial or accounting officers as well as any person who performs significant policy-making functions. he is trading on inside information and must disgorge himself of the profits (goes to issuer.

is there an you file proxy Exception in this case? 14a-2. and When Do You Have to File With SEC Then Comply: 1. 14a-3 Proxy 2. What does the case law say. statement with the are you receiving less than 5% of shareholder SEC. Whose Jurisdictional rules apply. for example. then you get BJR. 14a-6 Require that 4.Shaffer Karl Bekeny/Spring 2001 Page 131 of 131 Exam Prep Suggestions to Approach Solicitation Question.30(a) “an ordinarily prudent person in a like position would exercise. control? How To Exam the Duty of Care There is a basic standard of knowledge which directors are to Have (That you would as Dir exercise care that under §8.BUSINESS ORGANIZATIONS II . requires “gross negligence” to rebut the presumption) .”) Graham v. that includes within it an auditing system. Allis-Chalmers (“reasonable person” or Negligence standard for noticing the red flags) Caremark International Derivative Litigation (If you set up the compliance system. Barbash or the Railroad Case. Is solicitation really taking place? 14a-1 Statement 3. Even if there is a solicitation.

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