Andrew Wills

Corporations Outline
10/9/2012

EXAM –
 Short Answer/Multiple Choice -- December 10
 Essay -- November

What is a firm/business organization?

 A series of Relationships between people and groups of people.
Where does agency law come from?
 Started with Story’s treatise, then Mechem’s “A Treatise on the Law of Agency,” then the
Restatements. Now, the Restatement (Third) is the leading agency law.

Terms:
 Sole proprietorship – mom and pop with a few employees. This is the biggest example of the
agency context. You have an employer and an employee.
 Partnership --
 Corporation --
 LLC – relatively new form, limited liability company with features of both of the others.
 Principal --
 Agent – works on behalf of the principal.. babysitter, gardener, etc. You don’t have to say I,
Professor Rod., trust Mrs. Franklin to be my agent. It’s automatic. Owes a duty of loyalty to the
principal. Restatement 8.01. (Ex. The duty not to use or communicate confidential information of
the principal for the agent’s own purposes or those of a third party.)
 Agency Relationship (According to Restatement (Third)) – created with the principal manifests
assent to have the agent act on the principal’s behalf and under the principal’s control and the
agent manifests assent or otherwise consents so to act. No contract is needed to form this
relationship. Has both inward and outward looking consequences.
o Inward looking – relate to the relationship between the principal and the agent and are
largely governed by the contracts between the parties and by the law of fiduciary duties
o Outward looking – relate to the relationship among the principal, the agent, and a third
party and are governed by the various “principles of attribution.” Principals can be held
liable for the torts or contracts of the agents.

Agents and Principals –

Nears v. HHFI
 Franchisor is HHFI. Holiday Inn Mt. Pleasant is the Franchisee. Holiday Inn contracts with ETEX to
do the management of that location. Mrs. Nears is the employee, and the manager threatens her,
abuses her, etc, to cause stress related injuries. She sues Marshall, ETEX, Holiday Inn, Nealy and
Brewer, and HHFI. The question is: is the franchisor liable for the harm caused to Nears by
Marshall? HHFI did nothing. So how can it be liable? If the management company were an agent
of HHFI, then they would be vicariously liable for the harm done to Mrs. Nears.
 What is the key question: Is HHFI exerting enough control on the operations of the Holiday Inn
in question so that we can say that that Holiday Inn is acting as an agent on its behalf?
 Why control? If they have control, they have the ability to stop what is going on. So isn’t HHFI
exerting some kind of control over personnel here at the Holiday Inn? Yes, but those systems are
meant to control guest satisfaction and not employee relationships.
  What if instead Marshall had cursed out a guest? Probably it would be more in control of HHFI.
This changes something; it is not direct to the consumer.
 MAIN QUESTION: HOW MUCH CONTROL DOES THE PRINCIPAL EXERT OVER KEY AREAS?
o If HHFI trains you in one area, then they have exerted control.

HYPO –
 Cloudberry example – Can the franchisor, Cloudberry, be liable for an employee’s actions? You
must ask – do they exert enough control over the employees of the business?
o Look to the training of the employees, the power the franchisor has to remove the
employee, the hiring decisions, the agreements between the parties, etc.
 To what extent can contract out of the baseline law?
o She gave example of the sign at St. Mary’s. Some or all of the health care professionals
performing services….We are not on the hook for what these guys do. So is the sign better
or is the contract better? The sign is stronger, because the third party that is affected has
notice of the relationship. In the contract, the third party has no idea. ON NOTICE. Its
harder to say, “I thought you were acting on behalf of Cloudberry!”

Duty of Loyalty –
Food Lion, Inc. v. Capital Cities/ABC, INC.
 Food Lion says you breached your fiduciary duty to us. You were an agent, and you had a duty of
loyalty, and you breached that duty. The court says these are the three so far: Breach of
confidence, Competition either on your own or with a competitor, Misappropriate profit,
property, or business. Now they want to add one! Here, the businesses interests were
adverse in a FUNDAMENTAL WAY.
 North Carolina and South Carolina said so far that employees are disloyal when their acts are
“inconsistent with promoting the best interest of their employer at a time when they were
on its payroll.”
 There is a tension between the public interest and fiduciary duty in this case.
 NOT SWEEPING – An employee doesn’t commit tort when completing one job inadequately when
having two jobs. There must be intent to act bad.

The duty of loyalty to the principal ends the day the agency relationship ends.

QUESTIONS?
 Gambrell Company out of Illinois selling faulty dialysis machines. Someone says, if you don’t stop
selling these machines, I will do whatever it takes to stop you. The next day, he goes to the FDA
and says I worked for Gambrell, and this is what they’re doing. He’s revealing confidential
information.
o Right after he gets fired, there is no more fiduciary duty. BUT what if he is still employed?
 Lets say there is no ABC, they are just working for Food Lion. They go to ABC and say we have this
footage; we want you to run a story.

o Full-Time, Part-Time and None go into business. None contributes $50,000 in cash, Part-Time
contributes $25,000 in cash and the property on which the business will operate, and Full-Time
works full-time for the business. Part-time works about 15 hours a week for the business. None
does no work, but offers occasional advice. What do None, Part-Time, and Full-Time owe or
receive if the assets of the partnership are: $0, $75,000, or $100,000?

Principles of Attribution:
The primary rationale for imposing liability is based on three things:
 1. Control
2. Benefit
3. Consent
**Control itself is NOT ENOUGH to justify a finding of liability.

Terms:
 Authority – when an agent acts with authority, her action has legal consequences for the
principal.
 Actual authority – the principal’s gives a manifestation to the agent that the principal consents to
the agent taking actions on the principal’s behalf. It is necessary to evaluate the communications
between the parties. Certain kinds of authority must be in writing (power of attorney).
 Express actual authority – may be conveyed orally or in writing. Ex. P tells A to do something. A
does X. The agent has actual express authority to do X, the P is bound.
 Implied actual authority – the power to do things necessary to fulfill the agency. For example –
run my used car business – gives authority to buy used cars, advertise the cars, hire additional
employees as necessary, etc. USE THE FACTS TO NARROWLY CONSTRUE.
 Manifestations – words from the principal by word of mouth or letter, authorized statements,
from documents, or from third persons who have heard. Restatement (Third) has a definition of
manifestation. “A person manifests consent or intention through written or spoken words or
other conduct.” Did away with “Inherent agency power.” ALSO, it can come through an
intermediary.

Apparent authority – How to find apparent authority:

o Manifestation – from principal and received by third person
o Third persons “reasonable interpretation” – like if someone goes to the doctor and
follows the advice of the nurse.
 Considers subjective and objective components
o MAYBE reliance – but look to estoppel.
 Example: You need a manifestation from the principal in order to have apparent authority. Does
not require a prior agency relationship between the parties. Lets say I tell you I am a rep of Apple,
and I tell you the new phone is coming out. I say I have a few examples of this phone I will sell.
Give me $50 now and in a week I will give you the iPhone 5. I go to Mexico with the money. You
sue Apple. Do you have a good cause of action? Am I acting with apparent authority? Was there a
manifestation of authority from the principal to the third party? No, in this case, Apple will say no!
We had nothing to do with it. If news reports circulate say that I am apple’s best rep, then will
Apple be bound? Even though if it is not directly through Apple, there is still some apparent
authority. She still has to show that she reasonably believed that I work for Apple. The
question is in my capacity, would someone likely be customarily be authorized to make
these offers?
o Arises under two situations:
 Where one acts beyond scope of actual authority
 Where persons appear to be agents but aren’t
 Example: What if Rodrigues says I am on behalf of GA Law and we are rescheduling the exam?
Probably that would be okay because she is a professor, and we don’t know if the associate dean
has to sign off on it. It wouldn’t be reasonable for the professor to ask for the social security
number. SECONDARY STEP – she’s acting with authority, but what is the scope of that
authority?! How do you know that Rodrigues is authorized to teach you at all? No one said she is
okay for a teacher but there is manifestations for authority.

Estoppel – tort-based action of reliance

  Elements:
o An unambiguous promise
o Reliance on that promise to detriment
o The reliance was reasonable and foreseeable
 Many cases treat Estoppel and AA the same, but the Restatement distinguishes them.
 DIFFERENCES BETWEEN ESTOPPEL AND AA:
o THE THIRD PARTY MUST CHANGE THEIR POSITION.
o ALSO, THE PRINCIPAL HAS NO RIGHTS AGAINST THE THIRD-PARTY.
 Example: If you know some stranger to you is out there and pretending to act on your behalf, and
I never say anything, then at a certain point I am estopped from saying that that person is not my
agent.

Bethany Pharmacal Co. v. QVC, Inc.

 QVC has a tour for the best things in America. QVC hires network trade associates to choose
people around the states. The trade associations hire people in the areas to pick people. Bethany
receives an initial expression of interest, then they receive a letter saying they have it. To have
apparent authority, you need:
o a manifestation from principal,
o that it is reasonable belief by the third party,
o and that the third party relied to his detriment.
 Bethany tries to make the case that there is apparent authority AND estoppel for reliance. What
makes her case hard to make? There was no manifestation by QVC to say that Janis is acting on our
behalf. They said you need a purchase order, and that said it repeatedly. QVC even tried to fix the
problem. They also had agents that communicated this fact. This makes the belief
UNREASONABLE. Also, they ordered too much, because they only needed $10,000 worth of
product

Partnerships
8/20 class
 Pg. 29-42
 Anna, Beth, Charlie, and Donna form an at-will pship under RUPA. Under the following
circumstances, what rights do the dissociated partners or successors in interest have a right to
demand a winding up and sale? If not? How will he dissociated partner’s interest be paid off?1:
Anna announces that she is withdrawing and she will insist the pship be liquidated2: Anna dies.
Harry is the sole heir and executor of Anna’s estate. Beth, Charlie, Donna, and Harry meet to
discuss what to do next. Beth, Charlie, and Donna want to continue the pship. They propose
Anna’s estate be paid the value of her interest over the next few years out of future profits. Harry
consents.3: Anna dies. The remaining partners desire to continue, as in #2 above, but Harry
refused to consent and demands that the business be liquidated.4: Anna dies. 4 weeks later, Beth
notifies Charlie and Donna that she is withdrawing immediately.

 Uniform Partnership Act (UPA)

o Proposed by National Conference of Commissioners on Uniform State Laws
o Want to universalize since partnerships do work in many states.
o Two Theories: Aggregate or Entity
 UPA is schizophrenic. It says aggregate but then other provisions say it is a separate
legal existence.
 Revised Uniform Partnership Act (RUPA)
 o Due to changes by Georgia and California
o The Entity Theory dominated the RUPA… distinct from its partners
o RUPA 201 – “a partnership is an entity distinct from its partners”
o Changes:
 RUPA 203 – makes partnership property the property of the entity not of the
individual partners
 Does away with the rule that departure causes dissolution
 RUPA provides for the merger or conversion of partnership into limited
partnerships
 FORMATION:
o UPA 6(1), RUPA 202(a) – an association of two or more persons to carry on as co-owners a
business for profit.
o Formation can be INADVERTENT
 One partner may be bound to third parties by the act of another partner
 Partners are personally liable for obligations of the partnership
 Must have the REQUISITE INTENT
 One indicating factor is whether the partner receives a share of the profits. (UPA
7(4))
 Business Entities –
o TAXATION:
 PARTNERSHIPS
 They are not taxed as separate business entities like that of a corporation.
Individual partners must pay the taxes on this money.
 In terms of taxes, partnerships are better. BIG NEGATIVE.
 CORPORATIONS
 Corporation as an entity pays taxes like a person. Also, the owners of the
corporation (shareholders) must pay taxes on their money (dividends). This
is the double taxation of the corporate form.
 LLC
 In LLC, you can elect for partnership tax, BUT you have liability.
o LIMITED LIABILITY
 The partnership is liable for the debts of the partnership, so each partner is
responsible.
 They could go after your personal assets in a partnership.
 BIG BANKS were once partnerships. They didn’t have to take on any risks really, so
no one had any responsibility.
 How limited is the liability for a limited liability?
 The LLC has LIMITED liability. You get the benefit of single layer of taxation,
but you have limited liability.
 You can lose everything you put in the LLC but that is all.
 How limited is the liability for corporations?
 The liability is limited because only the corporation is responsible for the
taxes it owes.
 You can lose everything you invest, but that is all. You could lose everything
you invest in the corporation.
o MANAGEMENT
 PARTNERSHIP
 All of the partners are eligible to make decisions for a partnership. Your
assets are on the hook for what you do and don’t do. Every other partner can
affect your assets because they are putting you on the line for their risky
 behavior. Ordinary matters are a majority of the partners. If it is an
extraordinary matter, then there needs to be a unanimous vote. Owner has a
strong vote in the partnership.
 CORPORATION:
 The corporation is run by the board of directors. The shareholders vote for
the BOD, and then the BOD appoint the executive officers. The board is in
charge. The executives run the day-to-day business.
o TRANSFERABILITY
 PARTNERSHIP
 It is not freely transferrable. You need the permission of the partners in
order to sell a partnership share. It is a close-knit community, and you
shouldn’t be able to force someone to be a partner if you don’t want them.
 CORPORATION
 Shares can be transferred pretty freely. The default is that you can buy a
share and sell a share as much as you want. It is easier in a public
corporation, but even in a private corporation it can be traded. Closed
corporations are usually like family businesses, and there are contractual
stipulations on who you can sell to.
 LLC
 Freely Transferrable
o LIFE/EXIT
 PARTNERSHIP
 The RUPA says you can leave without dissolution, but it isn’t clear on how. If
a partner wants to get out of a partnership, they can get out.
 CORPORATION
 The default for a corporation is perpetual life.
 LLC
 It is default perpetual.

How to Apply This:

 What issues are changed if you are a private or public corporation?
o You will say to Five Guys – these are the things that matter when you are deciding what
kind of business you want. Taxation, liability are easy. But THEN, management is more
difficult. Who do you want to control? ALSO exit/liquidity – do you want to be able to walk
away? Do you want owners to be able to walk away?

Holmes v. Lerner –
 Urban Decay was a cosmetic company that was born because two women wanted to create it. UPA
defined a partnership in 202(A) as: “an association of two or more persons to carry on as co-
owners a business for profit.” The legislature omitted the language that required that the
profit be shared to have a partnership. They changed it to be just “prima facie evidence” of a
partnership being formed.3 You don’t have to INTEND in your head that you want to be in a
PARTNERSHIP, but YOU DO HAVE TO INTEND TO CARRY ON A BUSINESS AS CO-OWNERS FOR
PROFIT. In 202(C), the code says that if someone receives profits, that can be a partnership
(unless someone is “paid out of profits”).
 The court looks at several things to determine that this is a partnership – such as their idea to do
everything together, Holmes worked for a year without any pay, she goes to board of
directors, etc. How does the court deal with the profits? They say she hasn’t drawn a salary while
others have drawn one. There were no profits! They had $431,000 in losses and only $205,000
in revenues. That’s not odd that she hasn’t gotten any profits yet!
8/21 Class

 Partners have equal rights in the management of the business (RUPA 401F)
 If partners disagree, the vote of a majority controls (RUPA 401J)
 Any extraordinary transaction requires the unanimous consent of partners. “Acts outside of the
ordinary course of business of a partnership. (RUPA 401J)

 Vechitto v. Vechitto – The defendant breached the provisions of the partnership agreement by
either transferring his interests in the partnership and/or introducing other persons into the
business of the partnership without consent required in the partnership agreement.
o The default is that you can’t transfer your partnership shares. The agreement may say
that you can but you need the consent of the other partners. The point of this case is that
the suit is out of the ordinary activities of the business, so there must be unanimous
consent of all the partners. Can Chris speak for the partnership? (Who can sue on behalf of
the corporation?)
o What is the general rule for partnership management?
 Ordinary decisions = majority vote
 Unusual or extraordinary circumstances = unanimous consent
o Make the argument that the court gets this completely wrong.
 Protecting the business, the partnership, etc. are also business of the partnership. In
this case, suing those who breach a duty to the partnership seems that it can be part
of the business.
 ALSO – The general statutes say that partnership can sue partners; If has to be
unanimous, then someone would never agree to be sued!

 National Biscuit Company v. Stroud – One of the partners says to the third party I am not going
to be liable for this if you sell it to our partnership. Nabisco sells it to the store ANYWAYS. BUT
didn’t he directly remove Stroud’s actual authority by saying He’s not authorized? No, he can’t take
away the ability! Each partner in a partnership has an equal power in management, and one can’t
take another’s power. He needs a majority, but he still doesn’t have it! 50%/50%

 Summers v. Dooley – Summers loses because partners can’t change the status quo. We have two
partners who are in disagreement. In a two person partnership, only one person is not enough!
The status quo prevails when there is a deadlock. He can’t hire someone new because it breaks
the status quo.

Problem 2-2, pg. 46 -- Two partners of the law firm told another partner not to practice law until he was
licensed. He did it anyways. Are the partners liable for this action? Think about agency law – Actual and
apparent authority.
 Might he still have apparent authority? Has the partnership done anything to indicate to the third
party that he is authorized to make these decisions or to do the transaction? He’s a partner at the
firm, so you have authorized him. He has the apparent authority to act on behalf of the law firm.
He doesn’t have actual authority, but he does have apparent authority. Always look at it from the
third-party perspective. The partnership would be liable.

Partnership Fiduciary Duties –

 The UPA provided a weak duty of loyalty for partnerships. The RUPA goes far to change this.
  RUPA 404 says that partners owe duties of loyalty and care. (PARTNERS CAN NARROW BY
CONTRACT) It limits to the following:
o An anti-theft duty that corresponds to the anti-theft duty in UPA 21, except that the word
“Formation” has been dropped to indicate that fiduciary duties arise only after the
partnership is created.
o A prohibition against self-dealing
o A prohibition against competing against the partnership
 RUPA 404(C) establishes that conduct showing GROSS NEGLIGENCE, RECKLESSNESS,
INTENTIONAL MISCONDUCT, or KNOWING VIOLATION OF THE LAW would violate the requisite
standard of care.
 RUPA also adds a duty of good faith and fair dealing (RUPA 404D)

Salmon v. Mienhardt – This is a joint venture (a mini partnership for a small project) in the form of a
hotel in New York called the Hotel Bristol. A man leases the building to Salmon. Did Salmon breach his
fiduciary duty to Mienhardt when he took the lease without permission?
 Yes – The new lease is sufficiently connected to the old lease, so by not allowing Mienhardt to get
in on this is a breach of the fiduciary duty with his partner. It’s the same real estate. Also, Salmon
was the manager so the only way for him to learn is through the joint venture. Poor Mienhardt is
depending on Salmon!
 No – Even though the property is the same property, he can start a new business because it is the
end of the lease. Also, 20 years are up, and Salmon’s name is on the lease. This new business is a
much bigger business and is a different kind of venture.
 A lot turns on how you define the business. Also, he isn’t renewing the lease on the same terms!
 RUPA –
1. to account to partnership to any profit received
2. to refrain from dealing with the partnership in the conduct or winding up of the
partnership business as or on behalf of a party
3. to refrain from competing with the partnership in the conduct of the partnership business.

What if the partnership agreement says – you can compete. Can they do this?
 NO. The partnership may not eliminate the duty of loyalty. RUPA 103(b)(5) it is NON
WAIVABLE.

Gibbs v. Breed, Abbott & Morgan – Plaintiffs are partners of a law firm, and they moved to another firm.
They are suing for monies due to them under their old partnership. They moved and took many old
clients and employees with them. Breach of loyalty/fiduciary duties.
 The members of a partnership owe each other a duty of loyalty and good faith.
 Convincing one to move to another place does not constitute a breach of fiduciary duties, but
because they prepared the memo with the confidential information on it before they had quit they
were in breach of fiduciary duty.

Partnership Accounting –
 A capital account tracks each persons ownership claim against the partnership. This is determined
by:
o Contributions made by each partner to the partnership
o Each partner’s share of profits or losses from partnership operations
o Any withdrawals of funds from the partnership
o Each partner’s gains or losses upon sale of the partnership or its assets
o Doesn’t reflect loans made by partners to the partnership (separate)... Also, labor is not a
capital contribution.
 o Partners are personally liable, so if all the money from the partnership has been paid
except someone’s debt, then they must pay it out of their own funds.
o Can get payments (like a salary) called “DRAWS.”

DEFAULT Sharing profits (RUPA 401B) – can be changed by contract.

Review–
 A/100, B/100
 Profit sharing default rule is that the profit is divided equally, but you can change this by contract.
Loss sharing is proportionate to however profits are shared. LOSSES FOLLOW PROFITS.
 Compensation for services – 401H – you work for free
 Any contributions made are credits that must be paid out when the partnership is dissolved
 Order paid:
o Third party creditors
o Partner creditors
o Capital accounts
o Profits

DIFFERENT THEORIES:
1. Kovacik Theory – labor partner
2. RUPA Theory

Kovacik v. Reed – Kovacik contributes $10,000. Reed only contributes sweat equity. He doesn’t get any
money for a year. Partnership ends with losses and Kovacik gets some losses back, but the partnership
can only pay him $1,320. He gave $10,000, so he is still out $8,680. He wants Reed to pay half of this total
amount ($4340).
 WE HAVE THE UPA, BUT HERE IS THE EXCEPTION! THIS SHOWS AN EXCEPTION FOR
SERVICES PARTNERS AND CAPITAL PARTNERS.
 Under UPA, Kovacik is right. A clean application of the rules to the facts shows that he is right. BUT
California says this is so unfair! One part contributed services, and the other contributed money.
 Under RUPA, then why wouldn’t Reed get any money? The default for a services paid is that you
don’t get any money – you get nothing. BUT the California SC doesn’t see it this way. It finds that
Kovacik loses. Why? They say that the services put up are loses.

Hypothetical –
 Full-time, part-time, and None go into the business. None contributes $50,000 in cash, Part-Time
contributes $25,000 in cash and the property on which the business will operate, and Full-Time
works full-time for the business. Part-time works about 15 hours a week for the business. None
does no work, but offers occasional advice. What do None, Part-time, and Full-time owe or receive
if the assets of the partnership are: $0, $75,000, or $100,000?
o Full Time – He is only contributing services, so he is like Reed! He has nothing in his capital
account.
 $0 in his capital account
o Part Time – She definitely has $25,000 in her capital account. She doesn’t get any for her
services. She wants to argue that there is a cost to her for the cost of the rent! Ignore the
rent amount for now… But it really is a claim that part-time would have in real life.
 See 401(d), 401(e)… talk about it as a loan.
o None -- $50,000 in capital contributions
o What if there are no assets left in the partnership? Partnership assets are $0. Who pays
what to whom?
 There is a loss of $75,000 total in UPA DEBTS. Full time has to pay his share.
$75,000 divided by THREE. So he pays out $25,000. Part-time pays out $25,000 but
receives $25,000. He pays himself. None pays out $25,000 but gets $50,000. TOTAL
None gets $25,000. So essentially Full time is the only one out.
 What about under Kovacik? Is full time off the hook?
 Courts said in Kovacik that the parties valued the services and money equal
because they agreed to split everything equally. So does that mean they are
all valued as equally?
o So what if there is $75,000 left?
o What if there are $100,000 left?
 Under the Partnership act, we go through the required payouts. $75,000 goes back
to pay back the capital accounts.
 $25,000 profits gets split THREE ways.
 Does Kovacik say that the services partner is off the hook?
o Lets say that there is a third-party creditor. There is enough money. There is a third party
creditor who has a claim for $90,000. What happens under Kovacik?
 Losses follow profits.
 Kovacik by its terms says that neither party is liable to the other for loss that is
sustained. Is Kovacik just about protecting services partners no matter what, and
part-time partners mess everything up?
 THERE ARE THREE DIFFERENT ANSWERS! THIS EXCEPTION CREATES THIS
AMBIGUITY.

In Re Keck, Mahin & Cate – Plaintiff is the plan administrator. Defendants are the partners Billaner and
Ho-Okana. Other people in the firm commit malpractice, and they have already moved on. There is also a
line of credit from the bank. All of the partners have the opportunity to settle, and then they are
discharged. They are jointly and severally liable for anything that the plaintiff thinks they need to pay.
o Administrative costs get first priority. (Lawyers GET PAID FIRST)
o They say that the judgments for the malpractice were entered after they had already left
the practice.
o The rules of the bankruptcy are controlling. It says that you can go after these people, so
you can, but even absent this, the agreement still can’t discharge this liability.

Note 4 – default rule is that they aren’t liable arising for debts arising before they get there. You assume
liability for those things you accept when you get there.
 How are they connected to this claim? The court says that the partners can’t amongst themselves
that ok you aren’t liable. The third parties still have claims! You can’t just release!

Limited Liability Partnerships –

 The same as general partnerships that have filed with the state to get limited liability.
 Authorized in all 50 states
 Can be personally liable if they have participated in or supervised the wrongful conduct of another
partner.
 Most popular among professional firms

Dissolution
  UPA: Dissolution under the UPA means any change in the relation of the partners caused by any
partner ceasing to be associated in the carrying on. This is not winding up, and this does not result
in its immediate termination UPA 30.
o The original definition represents an “aggregate theory” of partnerships. The UPA does not
distinguish a departure that triggers a winding up of the business from a departure that is
governed by a buyout or continuation agreement.
 RUPA: Does away with the UPA rule that the departure of a partner causes a dissolution of the
partnership and has different rules for continuation and winding up of the partnership.
o A partner may dissociate at any time RUPA 602(a)
o Dissociation – departure of a partner. May or may not result in winding up and
termination. RUPA Article 6. The article defines whether or not you will have a:
 Winding up/Liquidation – RUPA 801 lists all of the events that trigger a winding
up, or liquidation, of the partnership business.
 Buyout – Article 7 of the RUPA. If this happens then:
 The dissociated partner’s interest must be purchased for “the greater of the
liquidation value or the value based on a sale of the entire business as a going
concern without the dissociated partner (701c) AND
 The dissociated partner’s liability and ability to bind the partnership are
termination (702)
o Wrongful dissociation – punishes you for dissociation that normal dissociation does not.
First you go to the wrongful dissociation provision (602) and see what happens. Just
because a partner dissociates doesn’t mean that the partnership ends.
 If it is a partnership for a term, then I don’t get to dissolve the partnership. I have
wrongfully dissociated. 701(h) – In the world of buyouts. A partnership can’t get his
money until the end of the term. Unless the leaving partner can prove there is no
undue hardship, he must wait for his payout.
 There are three kinds of partnerships:
 At-will -- The default under at-will means that you have the ability to walk
away and dissolve the whole thing.
 Partnership for a particular undertaking – if a partner dissociates for this,
then they have breached the agreement between the partners and they may
be liable for damages because it is a “Wrongful termination.” The dissociating
partner is liable to the partnership and the other partners for damages.
 Partnership for a particular term – See above.

Fischer v. Fischer – A man and a son have a business together as a partnership. His business is worth
more than his son will have to pay his estate when he dies, so he attempts to dissolve the partnership.
The court says that it is for a particular purpose, and that purpose hasn’t happened yet. SO it is not at
will, but it is for a particular purpose. The court says that it shouldn’t have said AND but it should have
said OR. IT sounds like the more normal interpretation is that it was meant to buy and sell that particular
property. According to the majority, because this letter exercises his right, he’s not saying I’m dissolving
this partnership, he’s just giving up a right.
 We’re not in the buyout world… There has not been a dissolution, so all she gets in the $50,000.
 The concurrence says that they were only in the process of winding up and it had not been
terminated yet. This has been a wrongful dissolution under the UPA, so it has not been terminated.

QUESTIONS: Anna, Beth, Charlie, and Donna form an at-will pship under RUPA. Under the following
circumstances, what rights do the dissociated partners or successors in interest have a right to demand a
winding up and sale? If not? How will he dissociated partner’s interest be paid off?
 1: Anna announces that she is withdrawing and she will insist the pship be liquidated
 o She can demand liquidation. So they just have to sell? 802(b) – Anna has the right to
demand dissolution unless she waives it. You don’t want it to dissolve! They would have to
convince you to waive your right. The default under the UPA is that the partner has a
nuclear option. I don’t like what’s going on, so unless I waive the right, y’all have to sell it! If
you don’t want to dissolve, you must buy me out.
 2: Anna dies. Harry is the sole heir and executor of Anna’s estate. Beth, Charlie, Donna, and Harry
meet to discuss what to do next. Beth, Charlie, and Donna want to continue the pship. They
propose Anna’s estate be paid the value of her interest over the next few years out of future
profits. Harry consents.
o UPA 601(7)(1) – we’re in the world of a buyout. The default is that a partnership continues
after death. This is a break from common law. The estate is entitled to interest on whatever
amount that is.
 3: Anna dies. The remaining partners desire to continue, as in #2 above, but Harry refused to
consent and demands that the business be liquidated.
o One partner dies, and the heir of the estate wants to liquidate. Go to 601, then go to 701 for
death.
 4: Anna dies. 4 weeks later, Beth notifies Charlie and Donna that she is withdrawing immediately.
o Anna dies, then Beth wants to resolve. Here we have death followed by notification of
withdrawal. She wants to end the partnership – so we’re in the land of 601(1) and we have
a DISSOLUTION.

Corporations

o Delaware law – more favorable, more common law decisions, etc.

o Traditionally, at least three incorporators and three directors were required.
o Documents for incorporation – articles of incorporation, certificate of incorporation (Delaware),
or charter (generic name); see DGCL 102(a); MA 2.02(a)
o Purpose of incorporation – can be general like “to engage in any lawful purpose for which a
corporation may be organized.” DGCL 102(a)(3)
o Other clauses: Initial directors; Management provisions; Bylaw provisions; Director
liability; Indemnification
o Choice – See hypothetical: Sarah has a business and has 750 investors and other small group
investors.
1. Decentralized management decisions – everyone would have a hold-out right
2. Liability – she and all other partners would each be liable to each other
3. It would prevent dissolution problems (the Mr. Sweeny problem)
a. The partnership will dissolve if it is an at-will partnership
i. It gets too costly to contract out of this.
b. The shareholders of a corporation get money when the corporation makes
money. The board of directors make decisions.
o Board of Directors – all directors are elected by the shareholders at an annual shareholders
meeting unless their terms are staggered. There are inside directors and outside directors. After
the Enron scandal, the SEC and Congress have stressed the importance of having outside directors.
They depend on inside directors for knowledge of the inner workings of the company.
o Removal – can only be removed by shareholders for cause. MA 8.08(a); DGCL 141(K). In
Delaware, the charter can change this. Can be removed by courts in MA 8.09.
o Quorum – A majority of the board is a quorum by default, but the charter or bylaws of the
corporation may alter the quorum to specify more of less. MA 8.24(A); DGCL 141(B)
 o Committees – the board may act through committees composed of one or more director. MA
8.25(a); DGCL 141(C). Actions taken by committees of the board may carry the same weight as
actions by the whole board of directors. MA 8.25(D); DGCL 141(C).
o Shareholder Voting – Most can be altered by the corporation’s charter or bylaws
o Each share of common stock carries one vote. DGCL 212(A); MA 7.21(A)
o Shareholders vote on the election of directors and on certain fundamental transactions
(DGCL 211(B); MA 8.03):
 Amending the corporations charter
 Amending the bylaws
 Approving a merger
 Approving the sale of assets not in the ordinary course of business like selling all or
substantially all of the assets of the company
 Approving the dissolution of the company
 Ratify conflict-of-interest transactions
o Shareholders may vote at a shareholders meeting either in person or by proxy
o Majority vote wins except in directors elections when only a plurality is required.
o What Law Governs
o Internal Affairs Doctrine – The law that governs what applies to shareholders and
directors is state law. So Coke is incorporated in Delaware, so Delaware law governs it.
o Delaware (DGCL) has a very sophisticated corporate law. It also has a Court of Chancery.
Because there are so many cases, there is a greater level of predictability. Law/Economics
thinks it is crazy that people say that shareholders take lots of risks by companies moving
to Delaware – this is crazy because the market will respond and value the company at a
lower amount. Lets say you are incorporating a company, and you want to incorporate your
client in Delaware. It is not hard at all. There is a website called CTAdvantage.
o The other choice is the Model Business Corporation Act. This is the model for Georgia
and most other states except for Delaware.

How does Congress react to the stock market crash?

 1933 Securities Act – if you’re going to sell to the public, you need to tell the public lots of
information. It is a disclosure regime. This is the information that you need to provide.
 Securities and Exchange Act of 1934 – Securities must be Registered –
o UNLESS there is an exemption – intrastate offering exemption, exemption for employee
stock plans, private companies (Chic-Fil-A, Mars, Cargill, etc) You must watch whether or
not the issuance of the stock falls within an exemption.
o It’s a SECURITY – earthworms, orange groves, etc.
o Great – you have this initial information, but you have a stock exchange
 What is the basis for regulation of the securities?
o Interstate Commerce from the Constitution
 One exemption is that if you are a Georgia corporation selling only to people inside
Georgia, then you are outside of the jurisdiction for regulation of securities.
o With stocks you don’t have a tangible good – you just have a piece of paper. You can’t take it
anywhere for people to look at.

SECURITIES (A stock or a bond)

 “Investment contract” – Howie test defines the investment contract broadly.

 o DEF: An investment in a common enterprise with the expectations of profits AND expected to
arise solely or substantially from the efforts of others.” If you don’t register, then the
investors get their money back.
o Vacation in Florida, see a billboard that says invest in these orange groves! There are cases
involving payphones when you buy a share in the payphone. Also, there are cases of
earthworms. All of these cases are cases in which the promoters did not register with the
SEC. The court says that these ARE securities.
o We will start with the private corporations and then work our way into publicly traded
companies.
 Equity – power to control, usually by voting, and the right to receive profits. All equity is capital
stock, and individual units of capital stocks are called “shares.” The typical voting rights are:
dividend rights, liquidation rights, voting rights, conversion rights, redemption rights, and
preemptive rights.
o Common shares – have two fundamental characteristics: 1. Unlimited voting rights; 2. The
right to the ridual assets of the corporation after all liabilities have been paid.
o Preferred shares – shares that have preference or priority in payment over common
shares. These are Model Act 6.01(c) and DGCL 151.
 Debt – some fixed obligation of repayment independent of the success or failure of the business.
Usually in the form of “Bonds.”
o Leverage – refers to the notion that borrowers may use borrowed money to generate
returns greater than the cost of borrowing.

TAKE-OVER MECHANISMS

 Staggered Board
o This is found in MA 8.03(c) and DGCL 211(B)... refers to a board that allows for classes of
directors to be elected for multiple year terms. This is such that there is always a majority
of directors who are continuing without need for re-election. If, for instance, a nin-person
board is divided into three classes, with three-year terms, then every year, three of the
directors would be elected for a three year term, and six of the directors would remain on
the board without needing to be re-elected.
 Ex. One way to take control of a public corporation where the target corporation’s
board is unwilling to approve is to change the composition of the board through a
proxy contest. The insurgent will just purchase enough shares to get the votes. If the
board is staggered, an insurgent would be required to win two annual elections to
gain a majority of seats on the board.
o Example of Classified (Staggered) board – where you have 9 directors but they each have
three year terms. The positive spin on this is that you have continuity, each person has a
three year term, but the negative is that it is an anti-takeover measure. You have to wait to
year 2 to have majority control of the company that you own.
o Location of Clause:
 MA – must be staggered in the articles
 DCGL – 141D, says that it can be in the bylaws or articles
o Why does Google not have a staggered board? If a shareholder buys over 50% of the stock,
then they have the board for elections.

 TWO Classes of Stock

 o These two classes of stocks have one set with a lot more voting rights than those in the
public. It vests control in the directors and makes it harder for the general public to buy up
all the shares and take over the company.

CORPORATE FORM

 Venture capitalists – look for startups to invest in. They take a company like Epasys and say we
will give you $10 million and take a portion of the equity. This is preferred stock. It has special
voting rights and if there is a sale, then the preferred investors get paid off first. If there are any
dividends, they get paid first. Mitt Romney’s background is a venture capitalist. He worked at Bain
Capital. One thing they did was to act as a VC. They invested in Staples. Venture capital is a species
of private equity. Bain started like this. They go in and take a share of the company and get a stake
in the company in return.
 Private equity – an umbrella term for equity that is not publicly available. Leveraged buyout
funds (private equity funds) – not the good guys but the unclear depending on how you look at
things. These take a company that is publicly traded and buy it. Its not like a venture capitalist and
take a little bit. You take out a whole lot of debt and use as the security debt. You take out a loan
from the bank and use the company as collateral. The mortgage is actually on the company itself.
o Figuratively the managers get fat and lazy. They stop running things for the public
shareholders but for themselves. Then the people who need to pay off the company debt
come in and say we are going to make the company much smaller. Its good for everyone
because we’ve made a better company. This means selling off part of the business and
firing people.
o That’s how this gets controversial – they fire people and make it smaller!
 Incorporation – it is easy. The incorporator files the articles of incorporation.

Grant v. Mitchell – Mitchell and Meltzer are the software developers, and Grant comes along with some
money. They decide to make a company to produce their software and make lots of money. Egan is the
attorney who helps them. The money gets preferred stock (Grant). The sweat equity founders have to
earn their stock over time (Mitchell and Meltzer). This gives them incentive to work so they don’t have to
put anything down. They get stock options when they’ve worked for so long. Mitchell disagrees on what
was said. Grant says that he is the incorporator of the company and that Mitchell is NOT a director on the
board.
 There is a big problem already: It’s a he said she said. THERE IS A CONFLICT OF INTEREST HERE.
McDermott’s client is actually the company – that is who Egan is supposed to represent. He is also
counseling the founders of the company. There is a conflict of interest. It is dealt with by
waivers of conflict of interest.
 Does the corporation get formed? Articles of Incorporation are filed with the Secretary of State on
December 23, 1999. Then things fall apart.
 There can be only ONE incorporator OR there can be only ONE director. The statutes say so.
Mitchell says that she is a director. HOW?! Someone can only become a director if there is a
written consent or if the incorporator appoints you. The judge even says so! A written consent
from Grant as incorporator naming them both to the board is MISSING. He says looking at all the
evidence; it looks like Grant appointed Mitchell as director.
 How does he get to the point that convinces him that Mitchell is on the board?
 Should the Incorporator Consent ever been filed with the Secretary of State? NO. Only the articles
and amendments need to be filed with the SOS.
 Even Grant said stuff that meant that at least one of them would be on the board.
  There is a Foreign Corporation Certificate (FCC) document that was filed with the state of
Massachusetts because they were incorporating with Delaware. This document is under penalty of
perjury and it says that Mitchell is a director.
 Even the lawyers thought that she was going to be on the board. They presumed that she was on
the board and later came up with this argument that she wasn’t. EVEN THOUGH there is an
attorney client privilege, it doesn’t apply because there is a company and the parties all are
related.
 There was a directors consent form with both signature lines on it.
 The court says that this is of limited utility.
 The major question is WHAT SHARE? There is a simultaneous case that is trying to figure out how
much each party had of the company.
 Lets say the company was for sale, and Grant wants to sell. He can make a lot of money. Mitchell
says no, we’re going to keep it as private and sell down the road. DEADLOCK.
 So why does the underlying shares matter? Every year the board gets replaced. The majority
shareholder is going to control the board.
o That is why this doesn’t really matter. Relative power dynamic.

Problem 4-1
 We’re in the model act jurisdiction, and it says that if the document is delivered and conforms with
the requirements of the statute, then the Secretary of State MUST file it. What is the reason that
the SOS can refuse to file the articles? Look at 2.02. Then look at 4.01. It must be FINS CORP. or
FINS INC. The structure is important so you need to be able to distinguish them. The signal is that
there is a limited liability entity. If it is Martha Stuart Inc, then you know you can’t go after all of
her assets. You can only go after the assets of the entity. If its just Martha Stuart then you can’t go
after her.

Problem 4-2
 They wouldn’t want to fracture their interest in ownership of the company. The biggest upside is
that you can pay back the bank the loan at the little bit of interest and you take the ownership of
the company. So if you are the loan officer at the bank, then what do you do? You MUST ask for –
some security from the individuals.
 YOU MUST also ask for – certain covenants that are promises that you get to see financial
statements and you get to sign off on any expenditure that is high.
 You want security that isn’t a secured interest but comfort that you will get paid back.

Problem 4-3, pg. 214

 Josh owns Fins, but there are two people on the board – Josh and Sherrie
 Josh wants to pursue this new opportunity and ignore what Sherrie says. Can he do this?
o NO. This is a question that pertains to the management of the corporation. It is a board
level decision, and so there needs to be a majority of the board members’ approval. His vote
counts equally even though he has a majority of the shares of Fins.
 Can he remove Sherrie from the Board?
o The default is that he can remove her if he is the majority shareholder. Here, though, there
is a clause that said there must be “good cause” to remove a board member.
 Now her term is up and she’s up for reelection. Now can he take control of the board?
o YES. Lets say the elections are held every July 1, Its July 1st, so who is he going to vote for?
HIMSELF.
o There is a difference between failure to reelect and removing one from the board.
 Lets say elections are July 1, and it is August 15. He has to wait a whole year. What else may he be
able to do?
 o AMEND THE ARTICLES – 1003(a) – need board recommendation to shareholders
THEN the shareholders must vote on it. Shareholders can’t take any action on their
own without the board. She is a roadblock.
o You could try to fight the argument and say the removal is for good cause. This is not really
a good case for “good cause.”
o Can you expand the board on your own? Now the board has 4 members, and you can win!
o In this case, they amended the articles of incorporation.
o Can Josh on his own amend the bylaws?
 Under 10.20(a) – A corporation’s shareholders may amend or repeal the
corporation’s bylaws.
o He could try to amend the articles of incorporation, but he can’t do that because 1003(a)
says he needs board approval to amend the articles of incorporation.
o He can either:
 BUY HER OUT
 WAIT UNTIL THE NEXT YEAR AROUND
 TO START ANOTHER COMPANY AND TAKE ADVANTAGE OF THAT OPPORTUNITY
BY WAY OF NEW COMPANY. THERE MAY BE AN ISSUE – THE DUTY OF LOYALTY.

Adlerstein v. Wertheimer – Alderstein controls the corporation because he made loans to the
corporation and got Series B preferred stock, which gave him many voting rights. Wartimer, an
investment banker, and Mencher, a money manager, are the other members of the board.
1. Sexual harassment charges
2. Lies to the board
3. Generally doesn’t seem to have a good sense of where the company is going
 How do they get rid of him as CEO? They have a board meeting that he called and they vote at the
board meeting to have him taken out. The court found that the way the board meeting was
actually called was not correct and wasn’t a real board meeting.
 It was definitely a board meeting… But it wasn’t proper at the board meeting to fire the CEO. They
did have the power because hiring and firing the CEO is a classic board decision. It’s 2 to 1.
 In order to remove him from the board, they gave Reich Class C stocks to dilute Adlerstein’s
shares. As a majority shareholder, he voted Adlerstein out.
o It doesn’t seem like they have to have “Good cause” like there was in the FINS hypothetical.
The default is that they can remove them.
 THE COURT SAID THIS ISN’T GOING TO WORK. THIS ISN’T FAIR. What could Adlerstein have
done if he knew about the coup?
o He could have acted by written consent and removed both of them. Because there is no
good cause provision, they can just say I don’t like you. You should have been told!

Piercing the Corporate Veil Doctrine –

 You found a corporation, and it says CORP or INC. You are protected 99% of the time. You can
loose everything you have invested, but that is ALL. There are sometimes when that shields fails.
Creditors, then, can come after your assets.
 Doctrines:
o Alter Ego Doctrine
o Fraud/Injustice
o Mere Instrumentality

Soerries v. Dancause – An underage woman goes into a bar and gets drunk. She then wrecks and dies.
Soerries is the owner of the club, and he is the ONLY shareholder. He does several bad things: Pays his
mortgage payments with the corporate money, Comingling funds.
Problem 4-5
 He didn’t do anything to disrespect the corporate form. It is very unlikely that the corporate veil
would be pierced.

DERIVATIVE SUIT
Delaware Demand

 It stems from the idea that the board is the one who manages the corporation.
 Lets say that there is a CEO who works for 14 months and the he gets paid $140 million. You are a
shareholder and you say I WANT TO SUE THE BOARD, but this group is only a small group. The
board makes the decision to sue! You must make a demand on the board to sue the corporation.
 Delaware doesn’t think demand is required. You may not have to make a demand if it is:
o Excused, or
o Futile
 There will be no incentive if you have little to gain! Because of this, we allow attorneys their fees.
But now we have unmeritorious claims. We now have a sorting mechanism with procedural
obstacles. These have been embraced by Delaware (See Lewis v. Anderson) Also see
Delaware Chancery Rule 23.1. –
o Plaintiffs must have been shareholders at the time of the alleged breach of duty
o Plaintiffs must remain shareholders throughout the litigation
o Shareholders must demand that the board of directors take action before the shareholder
assumes control of the litigation
o Once a derivative claim is filed, the court must approve any settlement.
 Was it wrongful refusal? The court will use the business judgment rule as the standard of review.
o Most of the time you won’t win this wrongful refusal test, because of the business judgment
rule. There’s almost no way to get around that. A well-advised shareholder NEVER MAKES
A DEMAND BECAUSE THEY CAN’T GET AROUND THE STANDARD OF REVIEW.
 A well-advised shareholder will try to make it an excused or futile decision to sue.

In order to file a derivative suit, a party:

1. Plaintiff Must demand, but –
a. Defendant (corporation) Will REFUSE
b. Plaintiff can say there is a wrongful refusal (this almost never works) There is the
business judgment rule, so don’t even bother; instead,
2. If it is excused or futile, under Aronson v. Lewis. There must be particularized facts that give a
reasonable doubt as to the boards independence or interestedness OR the decision is otherwise
NOT a product of a valid exercise of business judgment.
a. Aronson –
i. interested/not independent (to show otherwise, the majority of the board must be
interested and not independent)
ii. Otherwise not product of valid exercise of business judgment.

Beam, Martha Stewart Living OmniMedia v. Stewart -- Beam is a shareholder of MSO, and she is mad
that Martha Stewarts Company breached their fiduciary duties of loyalty and care by illegally selling
stock.
 If you are an insider, don’t leave yourself the opportunity to buy and sell shares of the company.
They need to get the demand excused, so which prong of Aronson? –
 o The first prong – that the directors were interested and not independent. You ONLY
NEED A MAJORITY OF THE BOARD. Martha Stewart is interested.
 Interest – means you have a direct financial interest in this transaction. If this
happens then you lose money or tangible benefits. Martha Stewart and Sharon
Patrick. Why is Patrick personally interested? She is an employee of the company,
and Martha determines how much money Patrick will make. She is interested here
because she wants to make sure Stewart is not sued.
 But the other board members are also getting paid! BUT…. It isn’t their day
job. The court turns a blind eye to the compensation if it isn’t their full-time
job. “Boot-strapping.” If this is the case, then you can never have a situation
with the majority. They would always be not impartial. A plaintiff may not
“bootstrap allegations of futility” by pleading merely that “the directors
participated in the challenged transaction or that they would be reluctant to
sue themselves.
 Independence – there are some independent circumstances, such as an interested
person exerting forces on you.
o Being friends with someone isn’t enough to make you interested.

Example –
o Lets take a case where an oil company discloses that it has found new oil reserves that is worth 2
billion dollars and the stock price goes up. Later on, the oil is prohibitively expensive to recover.
They lose millions of dollars, and the stock price goes way down. The plaintiff’s attorneys sue.
o You need to prove that the board is either “interested” or “not independent.”

Model Act Demand

o How does the Model Act handle derivative suits?

o According to the Model Act, you HAVE TO MAKE A WRITTEN DEMAND. No shareholder may
commence until a written demand has been made.
o Three possible chances:
1. Accept the demand – okay lets sue this Martha Stewart. This never happens!
2. Stall – This is a bad decision! Don’t just ignore. If the board decides to stall, then the
plaintiff has 90 days to wait. IF there is irreparable damage, then you get less than 90 days.
3. Reject the demand – They can reject through a majority vote of qualified directors present
at a meeting of the board or through majority vote of a committee consisting of two or
more qualified directors appointed by majority vote.
o WHERE IS THE SORTING MECHANISM? This is pretty much crap, though, because they don’t
have a way to weed out the faulty decisions! The board may be not qualified, and that is the same
thing as not requiring a demand.

Direct cause of action –

 Smith v. Van Gorkem was not a derivative suit. It was a direct suit. If you no longer have a status as
a shareholder, then you have a direct cause of action. If your problem is just that they aren’t
paying enough for MY share, then that is a direct cause.
 Delaware makes this test (TOOLEY CASE):
1. Who suffered the alleged harm?
a. Was it the corporation or the suing shareholder individually?
2. Who would receive the benefit of the recovery?

Running HYPO:
  Grenfell bought Bank Won for a lot of money. The shareholders of Greenfell got mad because they
allege that Greenfell could have gotten a much better deal. Harrison, the current CEO of Greenfell
said I’m not ready to give up CEO, so they say you must pay more. Plaintiffs claim that they are
diluted because there is a high premium for the shares. Grenfell issues new shares and gives it to
Bank Won in return for the cost of the business.
o DILUTION: If a company worth 100 pays our 20 dollars to buy a new company and I own a
quarter of the company before, I still own a quarter of the company afterwards. Presuming
that the 20 dollar business is worth nothing, I have just lost value.
o Is this a direct cause of action or a derivative suit?
 Direct – the shareholders are being affected directly because the percentage of their
stock is going down – their stock has been diluted.
 If the value of the stock goes down it is almost always a direct cause of
action.
 Derivative – the corporation is also being affected because the value of the
corporation has gone down.

SPECIAL LITIGATION COMMITTEES

o Oracle has best example. See below.
o In cases where demand is PROPERLY excused, the company would still like to take control of the
litigation. They make an SLC and let them decide whether it is best to proceed with the litigation.
This rarely happens.
o New York said that the SLC gets a business judgment rule. Delaware said this was TOO LAX! They
can’t create a committee just to get around demand.
o The Delaware Supreme Court made a TEST:
1. The court should inquire into the independence and good faith of the committee and
the bases supporting its conclusions. Corporation has burden of proof.
2. The court should determine, applying its own independent business judgment, whether
the motion should be granted.

In Re Oracle Corp. Derivative Litigation – In this case there has been insider trading when certain
board members have traded on inside information before the company lost its value. In this case, the
CEO, CFO, director and finance and audit committee chair, and director and chairman of the
compensation committee. They sold the company on January 2001, and on March 1 the stock drops. They
know that they are not uninterested and not independent, so they bring on two new members. The new
members that are brought on board are two Stanford professors.
 The SLC decides that there is not a need to sue. They say: There is not enough information even if
they did have the information to know what would happen. There was no hockey stick effect?
They thought it would but it didn’t. There must be scienter – you must prove that they knew that
the stock would fall. They recommended that the suit be dismissed because it would be too hard to
prove. They didn’t sell that many shares – so why wouldn’t they have just sold them all?
o FIRST… The SLC must prove that they are independent! This turns on whether a director
is, for any substantial reason, incapable of making a decision with only the best interests of
impartiality and objectivity. IMPARTIALITY AND OBJECTIVITY. SLC BEARS BURDEN OF
PROOF. The test is NOT DOMINATION AND CONTROL. Look to PERSONAL relationships. “A
directors decision is based on the corporate merits of the subject before the board rather
than extraneous considerations or influences. Oracle comes first, then the Delaware
Supreme Court rules on Beam v. Stewart. They say that friendship is not enough. In this case,
they don’t even know them that much. How do you reconcile the two cases? It’s hard to tell
 where to draw the line. He talks about the two hypothetical brothers. In Stewart, the court
says that you don’t have to be more independent but the burden of proof is shifted in an
SLC case. The plaintiff must bear the burden of proof in a board of director’s case. So in the
Oracle case, the BOP is on you!
 They are? They didn’t get paid, the company doesn’t employ them, they won’t lose
their jobs, they are willing to give back their compensation, and there are no
material ties to the trading defendants. They are professors, so they should be used
to confrontation. Also, there are lots of Stanford professors – that shouldn’t be
enough!
 They aren’t? Ellison was going to put up $150 million dollars towards a University
and Stanford had close connections. Also, Boskin was a professor of Grundfest, and
they kept in touch over the years. Lucas paid Stanford Law School and that money
was used for personal research by Grundfest. Boskin recruits the guys to be on the
SLC, so it is easy to see that this may mean there was a reason to hire these guys.
o SECOND... They must prove that they acted in good faith.
o THIRD... They must prove that they had reasonable bases for their
recommendations.
 AFTER THIS ABOVE STEPS... THEN THE COURT CAN EXERCISE ITS OWN JUDICIAL BUSINESS
JUDGMENT. THIS MAKES UP THE ZAPATA FACTORS.

Burden of Proofs—
1. Board v. plaintiff – plaintiff bears the burden of proof
2. SLC v. plaintiff – the SLC bears the burden of proof

INSURANCE AND INDEMNIFICATION

Let’s say you get asked to be a director, but you remember that they may be liable in the future. You can
lean on the three-legged stool.
1. 102(b)(7) – Exculpation clause – the charter must say that directors won’t be held liable for
gross negligence.
2. Insurance – you want insurance AND indemnification because you want the company to remain
in good health and not suffer any burdensome financial blowouts because of a lawsuit.
a. Maybe the company can’t indemnify you without insurance!
b. This is another way that companies protect directors from personal liability for their
actions as directors. The actions must be in good faith.
c. This can also be called “D&O Insurance” or Director’s and Officer’s Insurance.
d. Can’t insure against intentional misconduct or dishonesty OR breaches of loyalty.
e. Typically need a declaratory judgment to show that it is an “INSURABLE EVENT.”
3. Section 145 – Indemnification – the idea that under the charter the company must pay if you
have to pay any for judgment or anything caused to be paid by the government or third-parties.
a. Mandatory if you are successful on the merits
b. Permissive if you settle or you lose.
c. DGCL 145; MA 8.51-8.57... Did they act in good faith and in a manner reasonably
anticipated to be in the corporation’s best interest?
d. The company agrees to pay the directors and officers for any losses arising out of their
service to corporation (including the costs of defending).

DOW Chemical Company –Dow wants to invest in special chemical companies, but the shareholders are
alleging that this purchase was ALL WRONG. Why? The Kuwait government has to approve at every level
the transaction, so the party seems like an unreliable one. The agreement wasn’t sufficiently binding and
was uncertain. Also, for the other deal they needed the K-Dow deal to close. It is not sufficiently secure.
There are also problems with the R&H deal. For one, it is relying on the K-Dow deal in order to close.
There is more certainty with the R&H deal. There should have been some “outs” in the business deal so in
case the K-Dow deal fell through they would have a backup. There should have been a contingency in the
contract like “If we get money from K-Dow, then I will buy.” It should have sewn the deals up airtight so
there was no way for Kuwait to walk away and left itself some leeway in case financial conditions change.
It agrees to specific performance and that it will pay $100 million for every year that it doesn’t close.
 You need to make a demand….
o Unless it is FUTILE:
 In order to get by the demand being futile, the board needs to show that SIX of the
board members are INTERESTED OR NOT INDEPENDENT. ALSO, It can’t be
protected by the business judgment rule.
 In this case, you probably don’t have six that are uninterested or
independent. It seems that all of them are not independent.
o Don’t forget about the bootstrap argument. You have to have something more than just
them being on the board.
 Did agreeing to these transactions constitute bad faith? That is the only way you can get
through in a case.

Derivative Suit—
 Demand
 Unless excused (ARONSON TEST)
o Prong 1 – the Board members must be not independent or interested
o Prong 2 – challenging the underlying business decision. The pleading must cause a
reasonable doubt that there is not a product of business judgment rule. We can challenge
the duty of care – 102(b)(7) problem. Did exercise oversight or that it lack good faith?

CLOSE CORPORATIONS
o They have special challenges because they are smaller. The default is that you can sell a share…
BUT if it isn’t publicly traded, then whom are you going to sell it to? You don’t have the right to
walk away in a closely held corporation. EXIT and LIQUIDITY.

TWO ROLES:
 Shareholder roles – vote for directors, vote if there is a merger.
 Director roles – manage corporations...but in a closely held corporation, the roles can start to feel
blurred.

SHAREHOLDER AGREEMENTS

 Vote pooling agreements – MA 7.31; DGCL 218(C)

 Generally speaking, a shareholder agreement is a simple contract among the shareholders. This
provides protection to minority shareholders. “Vote Pooling.”

McQuade v. Stoneham – The owner of the Giants signed an agreement that specified the salaries and
said they would continue being directors and officers of the company. McQuade is out. Assume the
agreement is severable – part of it is enforceable and part of it is not. The part of fixing the salaries AND
REMAINING AS OFFICERS is NOT enforceable. The part of fixing themselves as directors IS
ENFORCEABLE. Courts AREN’T suspicious of the pooling agreement saying that certain people will be
directors. When shareholders start saying things like certain people are going to be officers, this is TOO
MUCH. Directors should have the power to say who are officers!
 OLD RULE: The whole things fail because the provisions aren’t severable.
 NEW RULE: MODEL ACT 7.32 – says the agreement is still good even if there are parts that
eliminates the board of directors. In order to be okay, they have to meet 7.32(b)(1)-(3)It used to
be that shareholders can NEVER step on Directors toes. NOW, just look to Model Act 7.32.
You can, but there needs to be notice.

Ronnen v. Ajax – A family owns the majority of Ajax. Norry winds up with more shares than his sister
because his father gave him more. Norry also has the option to buy out Ronnen at an unfair price. She
wants to get rid of the option, so he says okay but I want managerial control of the company and the right
of first refusal. Does the agreement give Norry the power to vote regular shares in a meeting to vote for
directors? ARGUMENTS IN ORDER:
 Plain reading says that Norry shall have the power to make decisions. BUT it says “PARTIES” and
there are only two parties! BUT we take the first thing you said first in a contract. Contract
interpretation says you don’t want to contradict. Also, the main argument is that the parties
intended for Norry to be in charge of the day-to-day management of the corporation. Electing a
new board would not be day-to-day operations. Norry wouldn’t have given up the option to buy
without something in return. SO he gets the right to vote!
 The board delegates to officers the day-to-day operations of a firm.

TRANSFER RESTRICTIONS

o These are imposed in the charter or bylaws of the corporation. DGCL 202(B); MA 6.27(A).
o There is a concern about trying to keep things in the family, but SOMETIMES people have to leave.
Who knows how much they are worth!?
o Valid if they pass a TWO PART test:
o 1. The restrictions must comply with the formal requirements relating to adoption of the
restriction and must be conspicuously noted on the share certificates.
o 2. The restrictions must be for a proper purpose. The general test for a proper purpose Is
reasonableness.
 Ex. The shareholder must offer an option to purchase the shares (accepted), the
corporation are obligated to purchase the shares (buy/sell agreements, accepted),
the corporation must approve the share sales (accepted), the shareholder is
prohibited from transfer altogether (these complete prohibitions are very skeptical
and would be struck down).
 Buy-sell agreements – provide liquidity, determine price when it is hard to value,
allow planning... Book value? Fixed Price? Formula?

Capital Group Companies v. Armour – There is a divorce. The trust has the value of a lot of their money,
but the restrictions say that they can’t transfer. They are in California, so they are in a community
property state. They have to split things IN HALF, no matter whether it is in a trust or not. The trust has
restrictions that say that it can’t be split. The issue is whether the stock transfer restrictions may
reasonably operate to prevent the transfer to, or disposition in favor of, the wife of any legal or beneficial
interest in the stock. Arguments:
1. She says that the distribution will not give Ritter an ownership interest. The court says that the
right to receive the profits and dividends IS an ownership interest.
 2. She says that the distribution is not a transfer as that term is defined in the SRA. There is no
transfer of the stock. She just wants the proceeds of the sale. The court says that the SRA precludes
more than just transfers, but also dispositions and assignments.
3. She says that the transfer is not reasonable. CGC says it doesn’t have to be reasonable! RULE:
COURT SAYS NO, A CASE CALLED GRYNBURG SAID IT MUST BE REASONABLE.
a. CGC says it is reasonable! The burden of proof is the party contesting the validity of the
restriction (lady). They say our purpose is to keep costs of compliance down and to keep
the employees of the company reliable—they want to align the employees and owners to
give them a central purpose. Courts agree! This is reasonable.
b. Reasonable test:
i. 1. Is it reasonable to achieve a legitimate corporate purpose?
ii. 2. Is the stock transfer restriction reasonable as it applies to a particular
individual?

VOTING TRUSTS

o DGCL 218; MA 7.30

o Keep your eye on exactly what the agreement is. Shareholders get in together to vote as
shareholders.

Shareholders acting as shareholders –

o They might agree that we are going to vote for X as director. These are enforceable. What if you
breach? Then I have to go to court to enforce it – which is a big pain.
 IRREVOCABLE PROXIES – I grant you the power to vote my share forever. Courts don’t like this.
UNENFORCEABLE. Limit usually to 10 years.
 VOTING TRUSTS – You give the voting rights to a trustee. Shareholders still get to keep the
financial rights such as proceeds, but they tie up their voting rights in this voting trust.
o Must serve a legitimate purpose
o They are enforceable unless contrary to public policy

Shareholders acting as directors –

o When shareholders agree to do things that will step on toes of managers, like tell who will be CEO,
who will be officers, what the salary will be. This is BAD. These are void as a matter of public
policy. Directors must have free reign.

CLASSIFIED SHARES

 DGCL 151; MA 6.01—The purpose of this is to allocate control among the various classes of
shareholders.
 Main Classes:
o Preferred – has preferences over common stock
 Carries with it benefits like a liquidation preference. 1X preference is that they’ll get
their initial investment back. 2X means they get 2 times their initial investment
before everyone else gets paid.
 Dividend that is paid first – common can’t get anything til you get yours
 You get to appoint so many directors, you get a seat on the board, etc.
 Follow the alphabet
 Preferred Series A
 Preferred Series B
  Preferred Series C
 Preferred Series D
o Common – normal everyday stock
 Lets say your client is a VC who will be the first investors in this company, just like Benchmark.
You have $500 million, but lets say you only commit $10 million up front. WHY? You are unsure
about the investment, so you say I’ll buy myself some time with this money. You go through
rounds, like in Poker. The further you go through the alphabet the more money you need.
 What else do you ask for?
o Prevent dilution!
o Be very clear – you want to include merger in your agreement.
o Liquidation preference – you don’t want this to be diminished when a new series rolls in.
Cannot be changed. Need a supermajority or 100% of the votes of the Series A
stockholders.
o Voting power – approval of majority series A before the issuance of the next preferred
series. You want to be at the front of the line.

Benchmark v. Vague – Puts in 20$ million and gets Series A. The next rolls, they put in $5 million. CIBC
says we’ll put in $27 million but give us convertible note convertible into stock. It wants the security of a
loan on its books but then have a chance to convert into stocks if the company is doing well. Benchmark
knows what is going on. They are in Series C stock by now. In order for CBIC stocks to come in, they have
to allow them to be senior to them, but they say they get a veto on any more stock, any material change, if
they raise the number of the directors, etc. Benchmark says: Class A and B stock wants issuance of new
senior stock; Sale of assets/merge; Raise number of directors; Right to vote if the corporate action
materially adversely changes the rights, preferences and privileges. Juniper needs more money! SERIES
D! CBIC has them sign an agreement, and they get to vote if there is a material change to the rights.
Benchmark says it should be able to vote on this new issuance because it lessens Benchmarks equity,
gives them 90% voting power, less liquidation power, etc. MATERIAL ADVERSE EFFECT? YES. IS
BENCHMARK OKAY TO BE MAD? YES.
o The court says – you didn’t protect yourself adequately, Benchmark, so you lose! You need to have
words in the contract that say “by way of merger or otherwise.” CONTRACT WASN’T GOOD
ENOUGH.
o Merger didn’t adversely impact the rights of a class of shareholders enough to require a vote. There is a
presumption against creating a voting right when it is not explicitly included in the parties’
agreement.

CUMULATIVE VOTING

o If you have 51% of the vote, then you control the board. BUT there are ways to make sure the
minority has representation:
o Shareholder agreements --
o Special classes --
o Supermajority quorum
o Cumulative voting – method of counting shareholder votes in director elections in which
each shareholder is entitled to cast a number of such shareholder’s shares times the
number of directors to be elected. Unlike “straight” voting, under cumulative voting a
shareholder may cast all of his or her votes in favor of a single director rather than
allocating them among the candidates.
o Things to know:
o Know formula
o Know what it means to cumulate the votes
 o Know that it must be in the articles!
o Location of Clause –
o MA – 7.28(B) (available in the articles of incorporation)
o DCGL – 214 (certificate of incorporation)
o In order for the minority shareholders to have this right, it needs to be in the articles of
incorporation!
o Example – Ong has 6 shares, Taylor has 4 shares. There are 10 shares total. There are THREE
director positions available.
o In STRAIGHT VOTING… They get to vote their TOTAL amount on EACH director for voting.
In that situation, the minority guy NEVER WINS… He can never get one guy at all.
o In CUMULATIVE VOTING… The minority still have some power because they can put ALL
their votes on one guy and get him! You take all of your shares, multiply it by the amount of
directors up for election, and that is your total of votes! They can be put on ONE guy!
o Cumulative Voting Formula:

Number of Shares voting (X) Number of Directors desired

Number of directors to be elected + 1

= the number of votes needed

o EXAMPLE – Lets say we have 9 directors, there are 600 shares voting, and Kaval has the minority
with 200 shares.
o Can it get ONE DIRECTOR? YES
 600X 1/10 = 60
o Can it get TWO DIRECTORS? YES
 1200/10 = 120
o Can it get THREE DIRECTORS? YES
 1800/10 = 180
o Can it get FOUR DIRECTORS? NO
 2400/10 = 240

If it is in a bylaw that gives the majority the right by saying you need a 75% vote to do X, but then a
majority can amend it itself and take that right away. ???

SUPERMAJORITY REQUIREMENTS

 Protects minority shareholders by giving them veto powers over corporate decision without
offending corporate norms because corporate statutes allow high quorum and voting
requirements
 ADDING OR REMOVING Supermajority Requirement:
o Delaware: DGCL 242(B)(4), majority vote (BUT requires a supermajority vote when an
existing supermajority voting provision is to be altered, amended, or repealed)
 TO REMOVE: When supermajority voting requirements appear in the carter, they
can be amended or repealed only by the greater vote specified in the charter
provision. If it is in the bylaws, there are no restrictions. SO if it is in the bylaws, they
may be amended or repealed by a mere majority unless the bylaws themselves
dictate that such an amendment requires a greater vote.
o MBCA: MA 7.27(B), adopted by same vote as required by the proposed supermajority
  TO REMOVE: the amendment or repeal of supermajority provisions requires a
supermajority vote.
 WHERE TO PUT THE Rules:
o Delaware: DGCL 216, in charter, they can be amended or repealed only be the greater vote
specified in the charter provision or bylaws. But, there’s no statutory restriction on the
amendment or repeal of supermajority voting requirements in bylaws
o MBCA: MA 7.27, must be specified in the charter; amendment or repeal requires
supermajority vote
 Options:
o Can apply to all transactions or only certain transactions (merger or sale). If applies to all
transactions, likelihood of deadlock increases.
o Can apply to board decisions (DGCL141(B), MA 8.24)

PREEMPTIVE RIGHTS

o “Right of First Refusal” – Rights of a shareholder to subscribe to the portion of any increase in a
corporation’s capital stock necessary to maintain the shareholder’s relative voting power as
against other shareholders
o Rarely used in public companies but common in closely held corporations
o Granted/denied in Articles of Incorporation
o Types:
o Opt-Out: most frequently used by states, but becoming less popular.
o Opt-In: reflects skepticism about the value of preemptive rights and recognition that from
the corporation’s standpoint, preemptive rights simply complicate the issuance of new
shares. Default rule is against preemptive rights but a corporation may provide for
preemptive rights by including a provision in its Articles
o Can be waived as a class (Kimberlin v. Ciena)

Kimberlin v. Ciena Corporation – It used to be default that there was a right of first refusal (preemptive
right). NOW you have to “opt in.” Before they can offer the shares to new investors, you have to give old
investors a right to refuse. In a venture-backed company like Ciena, it is normal to give a preemptive
right. Venture capitalists aren’t sure whether the company is going to flourish or not. It gives some then
waits a bit.

DEADLOCK

 In a general partnership, when someone does something wrong, they can walk from the
partnership. They can say I am done with this partnership, and the default is a judicial sale. It is a
great deal of power that the general partner has.
o You contrast that with the minority shareholder in a close corporation. They don’t have
that power. They are at the mercy of the majority.
 Deadlock is when the shareholder vote is evenly divided. Some plan for this so that the business
relationship should not proceed unless there is unanimous assent. It usually leads to dissolution.
o What is the general rule for how a corporation dissolves? First, you need a board of
directors’ approval vote. (MA 1402, DCGL 275) So we have a baseline ability to dissolve a
corporation. Second, you let the shareholders vote.
o If they cannot even agree to dissolve, then the court may issue a judicial dissolution.
 Buyouts are a common remedy
Conklin v. Perdue – There is a deadlock among the board of this small corporation called CPI. The two
players in the case are the sole shareholders and directors of the company. Things eventually fall apart,
so they can’t agree on what to do. They can’t even agree on whether to dissolve the corporation.
 Massachusetts opts for a rule (pg. 281) that says that 40% or more shareholders can dissolve a
corporation. Here, neither of them has asked for dissolution. They are dysfunctional. The judge just
looks at it and says I want to dissolve it.
 Each of the owners get to split the company half and half, but because the company isn’t worth
anything nobody gets anything.
 The three claims are DERIVATIVE IN NATURE. Why don’t we have a demand derivative analysis?
Because they are both shareholders, it wouldn’t make sense to have the board of a two person
company to bring the case on itself. Often, court says they don’t need to go through the derivative
analysis.
 Day deadlock first occurred is the day of dissolution. All actions taken after that date are
independent of the former entity.

MINORITY OPPRESSION

 Will of majority shareholders governs the business, but directors have a fiduciary duty to serve all
shareholders. Freeze-Out: terminate minority shareholder’s employment, remove the minority
shareholder from the board, refuse to declare dividends, increase salaries and employment-
related perquisites to majority shareholders, buy the minority shareholder’s shares at a
discounted price (squeeze out price)
o Response:
 Judicial: fiduciary law  allows direct suits because of partnership-like duties
 Legislative: special dissolution statutes
- Broaden the grounds to include “oppression”
- Provide additional remedies for dissolution, including buyout, appointment
of a custodian, ordering a dividend, or other equitable remedy
 It is the “doctrine of minority oppression” – The classic story is this one: There are three
brothers that start out and form the business. Lets say one of the brothers is on the outs. Two and
three are embezzling, and then one gets fired because he finds out. If one gets fired, then he gets
nothing because there are no dividends to be given to him. He gets no return on his investment.
The only thing he can do to make value on this is to sell. There are two kinds of people he can sell
to: Third party or current shareholder. They froze him out, and the third party won’t want to buy!
Not a great chance.
 Pressure Points in Closely-Held Corporations:
o Benefits of stock ownership include:
 Dividends
 Participation in management
 Employment: termination may be equivalent to withholding the benefits of stock
ownership
o Why close corporations pay salaries, not dividends:
 Reasonable salaries are deductible as expenses
 Dividends are not deductible (double taxation)
 Massachusetts –
o They developed a common law of minority oppression.
o Donahue – Close corporations are like partnerships and you owe the utmost duty… the
court said that the majority shareholders owe heightened fiduciary duties comparable to a
partnership. You can’t oppress the minority in this way. Treat the minority like you would a
partner.
 o “Equal Opportunity Rule” – If the stockholder whose shares were purchased was a
member of the controlling group, the controlling stockholders must cause the corporation
to offer each stockholder an equal opportunity to sell a ratable number of his shares to the
corporation at an identical price.”
 Delaware –
o Nixon – The directors have shares of Class B of a stock. They own 30% of the shares. The
board of directors says it is going to take out life insurance on the key directors. If the
employee dies, then the proceeds of the policy are used to buy out the deceased. They want
this because they don’t want to have all of these non-employees to have shares in the
company. Also, it gives liquidity to your shares so your family can have money when you
die. The Barton heirs, the ones that own 30 % of the company, get left out because they
aren’t employees. Delaware says that the minority shareholders have other options, but the
majority shareholders shouldn’t be forced to treat them that well. They have a business
judgment whether to buy the position.
 Three mechanisms for conflict of interest–
 Votes of shareholders (disinterested, there are none)
 Votes of the directors (disinterested, there are none)
 Burden is on the directors to prove the fairness of the transaction. Is it
fair? Yes. Delaware says that fairness doesn’t mean equality. Just because all
the shareholders aren’t treated the same, it is a worthwhile treatment. It
helps everyone because it attracts employees and shareholders.
 BACK to Massachusetts –
o Wilkes – They didn’t think the Donahue decision was a great idea after all. Maybe the
majority owners can freeze one out! Can they demonstrate a legitimate business purpose
for its action? Two step analysis—
 Is there a legitimate purpose for doing this?
 Is there a better way to do it that would be less harmful to the minority?
 BACK to Delaware –
o Riblet – The Executive officer (minority shareholder) was fired in breach of the
employment contract. The Delaware court didn’t buy Wilkes... SO MINORITY
SHAREHOLDERS ARE MORE VULNERABLE IN DELAWARE THAN IN ANY OTHER
STATE. HEIGHTENED DUTY.
o We want to make parties to think by themselves, but you are frustrating that, and it is bad
policy. Delaware thinks you should take care of yourself.
 BACK to Massachusetts –
o Leslie v. Boston Software Collaborative Inc. – Three founders, each is a 1/3 shareholder.
We have a basic disequilibrium because the salaries are by way of billable hours. Leslie is a
loose cannon. He curses, he treats employees poorly, he treats customers unfairly, and he
bills at a higher level than what his work is worth. They fire him. There is a still a problem,
and their actions don’t pass muster because they owe him a higher duty than they would
owe a regular employee. He is like a partner because of their business relationship. There
are other options that would have insulated him from employee interactions and still have
achieved the purpose of the company. Leslie doesn’t want his job back. He wants a
severance package and he wants to be a director again. There is no forced buy out.
 Which of his complaints are derivative and which are direct?
 Direct – failure to pay dividends, wrongful termination, freeze-out. So any
claim for compensation would be direct, but the distribution would get
murky.
 Derivative – waste of corporate assets, breach of fiduciary duty,
mismanagement of company, they increase their own pay
  Alternative ways to get to this result:
o Breach of fiduciary duties
 Breach of duty of loyalty – Look at them and say they have duties of loyalties to the
corporation. When they fire Wilkes, they raise their own pay, so that is self-dealing.
Argue that the salary is excessive, and that is a breach of duty of loyalty.
o Agreements
 Shareholder agreement – saying that they are a manager and control the daily
activities of the corporation, etc.
 Employment agreement – saying that he got severance or shares if he is fired
without cause
 Buyout provision – if he wants to sell the corporation they have to buy out from him
at a set price or at a market price that the appraiser decides.
o LLC – it used to be you chose a partnership or a corporation, but then it shifted because of
the limits to liability. Now we have a middle ground – LLC! The ability to fashion your own
rules is now available, so we are probably less sympathetic. DGCL 341 – Subchapter 14 –
“Close corporations” – Georgia has a similar title. Some states, including Delaware, have
said that they have heard this. Sometimes close corporations are different, so we will
institute something that we identify in the statute as close corporations. You have to have
less than a certain number of shareholders. You then must say in your articles that you
want to be close corporations. It is easier to liquidate and to sue for oppression in that
situation.

Remedies for Minority Oppression

 Judicial Dissolution: based on oppressive conduct by the majority shareholder
 Buy-Out: most common alternative remedy to judicial dissolution – permits corporation or the
shareholder to purchase the shares of a shareholder petitioning for dissolution. The purpose is to
ensure that minority shareholder do not use judicial dissolution strategically
 Other Remedies:
o Canceling/altering charter, bylaws,
o Directing or prohibiting any act of the corporation, shareholders, directors, officers or
other persons
o Selling all the proper and franchises of the corporation to a single purchaser
o Paying dividends/damages
 Three attributes of an equitable remedy:
o Fair compensation for loss of employment
o Fair compensation for any amounts received by Khayter & Goulart in the nature of a
dividend
o Provision for Leslie, for so long as he remains a shareholder, to be able to monitor the
management of BSC and participate in the returns to shareholders, without interfering
unduly therein

How is an IPO supposed to work?

 Companies were selling stock, and it turned out there was nothing there. People lost millions of
dollars, and Congress is upset. How do they make sure it won’t happen again?
 The fear is that people will lie and then leave with the money. You can sue her, but you can’t find
her. She is gone. Congress says “lets put some deep pockets on the hook.” The mechanism by
which they are sold is to sell the shares to investment banks. The investment banks roll is to buy
shares and then turn around and sell the shares to the public. One of the rolls is to gauge and price.
The other is the liability function. If it turns out that the seller is lying, then you can sue the
investment banker. It puts a repeat player with a reputation at stake on the hook.
  There is a conventional 7% discount to the investment bank. That is nominally how the
investment bank makes its money because it turns around and sells the stock for 100% to the
public. There is a phenomenon where the stock is priced at X and shoots up on the first day of
trading. It is the IPO pop. It varies in amounts. Netscape was going to price at 14$ and it went up to
28$, but by the end of the day it went up to 98$. If you are an investment bank client, you can
make a lot of money if the stock pops. There is an argument that this is extremely bad for the
company because if it sells to the public at x and rises to x + 20, the company doesn’t get the
money. The investment bank should have placed it at x + 20.

Facebook Case Study –

 Dividends – how can they be a powerful tool on managerial opportunism? If they have to give out
the money, then the company won’t have to reinvest or to have corporate jets or lavish
headquarters. Startups usually don’t have a lot of free cash flow because they need to reinvest. So
why do Facebook venture capitalists want dividends? They want security so their investment
provides an adequate return. If the managers are going to get money, they will get it first. Then if
there is a liquidation, then the dividends get factored in.
 Liquidation – the boxing up and selling of a company that has not succeeded. A sale of the assets.
For preferred stock owners, they will get a set amount. The most likely other chance is when they
merge… They can get out after this! Say Google buys Youtube. This is a liquidation, so they can get
out.
 Voting rights – The Class A common stock holders get 1 share, and the Class B common stock
holders get 10 votes. Zuckerburg has majority control because he has agreements with the
shareholders giving him right to vote their shares. This gives him a majority vote before the IPO.
The preferred shareholders have protective provisions. In order to alter or change the rights of
my series of preferred stock, there needs to be a majority of votes by the preferred
shareholders. Also, the A & B preferred shareholders are able to appoint a director each. Also, in
the Protective Provision language, it has the “by amendment, merger, consolidation, or
otherwise” language like in the Delaware case.
 Redemption Rights – The idea that the company can tell the VC to give back the shares, they can’t
do that. BUT the investors can say, it has been 3 years so CASH US OUT. IT WOULD BE GOOD IF
THE COMPANY WEREN’T DOING VERY WELL. If the company isn’t doing well and they force them
to pay them, then they may go insolvent and that person would have to give money to the
bankruptcy. USUALLY, these are used more of a form of leverage. “We won’t redeem the shares if
you do X.” The Facebook preferred shareholders don’t have redemption rights. They didn’t need
anymore investors.
 Registration Rights – Entitle investors to have a share of the common stock
 Conversion Rights – Have a huge economic impact on the corporation. The preferred shares are
ALWAYS convertible into common stock. OPTIONAL or AUTOMATIC. Sometimes, they arrange so
that they VC must convert automatically when it reaches certain success.
o Automatic – the preferred shareholders HAVE to convert. The most common is on the IPO.
You don’t want all of these investors to be special rights investors that allow them to veto
transactions, etc.
 Right of First Refusal – If they want to raise more equity in another round of securities, the
preferred stock holder has the option to purchase more prorata so they have the same percentage
ownership in the company. If they don’t have the same share that they did before, so the new
owners will be glad but they will have fear that they don’t want to buy anymore.

Questions – pg. 305 – would the entrepreneurs or the investors (or both) make the following decisions:
 Expanded product offering – management level decision, entrepreneurs.. if the VC’s disagree,
they could put pressure on the entrepreneurs such as not participate in later rounds of financing,
but legally they have no option
  Merging with Microsoft – (A merger works by creating a subsidiary company. There needs to be
a vote of the board of directors, the shareholders, and the preferred shareholders by way of their
protective provisions)
 They want to sell shares by the venture capitalists – the default for corporations is that you
can sell your shares to everyone, but there are transfer restrictions in place here, so you need
prior written consent by the directors.
 Paying dividends – the decision would come from the board. Zuckerburg DOES control the board,
so he basically has control (entrepreneurs). Sometimes there will be a negative covenant against
being able to issue dividends, but what power do they have (the venture capitalists)? In order for
the common to get paid, the preferred has to get paid first.
 Expanding the size of the board – FB has to have at least 5, but they can’t have any more than 8.
Facebook has a range, so they can easily expand the board by one because they only have SEVEN.
Then the question is what if he wants to put TWO MORE. Can he do that on his own? No, he needs
the signoff of the preferred shareholders. He would need to amend the bylaws and for that he
needs the sign off on the investors.
 Replacing Mark Zuckerberg – it is the decision of the shareholders. If he were an officer, it would
be a decision of the board.

FACEBOOK IPO—
 The typical IPO has a first-day pop.
 Bad guy – they underprice their share less than what it is really worth, and then they sell these
undervalued shares to their best shareholders and make money from the transaction when it
POPS.
o There is an innocent reason that they underprice. It’s hard to value something, and they
take their best guess. Their initial pricing turns out to be where the stock is trading a year
from now.
o The bank makes a promise to sell the stocks, so if they don’t then they have to buy them.
It’s a whole bunch of banks… one with a lot of retail investors, some with pension funds,
etc. You spread the risk, but you have prestige by being a lead-underwriting bank. The bank
needs to be overcommitted to sell, and then the day before the IPO you price. The pricing
decision is made by the underwriters by the book.
 Good guy – there is a natural hype from the marketplace, and everyone wants a share.
 People want to blame NASDAQ; there was too much volume. Aside from that, Rodrigues posits
that the problem was with Morgan Stanley. Why?
o More shares went to individual investors than to large investors.
o They upped the price and the number of stocks they would sell right before the IPO went
public. CRAZY. Who does this at the last minute? They increased the price and the number
of shares by 25%.
o They wanted to drive the whole show. They didn’t have the rest of the information, which
would be very helpful.
o The large investors had information that the mom and pop investors didn’t have – that the
advertisers pulled out. Now this will probably be in front of Congress.

LIMITED LIABILITY CORPORATIONS (LLC)

Note on S Corporations –
1. Cannot have more than 100 shareholders
2. Must have only one class of stock
3. May have as individual shareholders only US citizens or resident aliens.
Note on Limited Partnerships –
 Became important for tax shelters
 Governed by RUPLA, then UPLA
 Must have a general partner and at least one limited partner

Limited Liability Corporations

 Terminology –
o articles of organization (as opposed to articles of incorporation)
o members (as opposed to shareholders)
o operating agreement (as opposed to bylaws)
o There are two different kinds of LLCs.
 Member managed – members make decisions in the company
 Manager managed – members elect managers… more centralized management like
a corporation.
o Limited Partnerships -- private equity funds, venture funds, etc. are organized as 10-year
LPs where the main guy is the GP and the other guys are LP. They just invest, and their
liability is limited to their investment. There must be a GP that is on the hook for
everything. The old rule was that if the LP tried to participate in management then she
becomes a GP with unlimited liability. That isn’t the case anymore.

 Corporate players are:

o Promoter – before the corporation is formed, this is the person that does initial
agreements, leases, etc. They do the business for the not-yet-incorporated corporation. A
promoter is liable for a lease if the corporation does not come into existence AND
continues to be on the hook in the contract even after the corporation is formed unless
there is a novation. Promoters are personally liable on all pre-incorporation contracts.
 All persons purporting to act as or on behalf of a corporation, knowing there was no
incorporation under this Act, are jointly and severally liable for all liabilities created
while so acting. MBCA §2.04
 However, if one party urges another to sign in the name of the corporation, even
though both know it does not exist, estoppel may prevail
o Incorporator – person who incorporates the company
 Novation – where the third party says YEAH you’re off the hook, it’s a new contract,
etc.
 This is dangerous – you may sign papers for this new corporation and then be on the
hook if something goes wrong.

 Formation –
o Formed through a formal filing of a Certificate of Organization or the Articles of
Incorporation. RULLCA 201(a); DLLCA 18-201(a). Agreements between members are
operating agreements.
o Conflicting Agreements: When operating agreement & articles of incorporation conflict,
the agreement controls with respect to members, dissociated members, transferees and
managers while the Articles of Incorporation controls with respect to third parties who
reasonably rely on it. RULLCA 112(d)
o Conflict Agreement and Statute: If an operating agreement or articles of incorporation
conflict with a statute, the statute controls with respect to mandatory provisions but the
agreement between the parties prevail with respect to non-mandatory provisions
 Doctrines that prevent inequality (LLCs cannot be created informally):
o De facto corporation: if a person (promoter) attempted to incorporate but failed to follow
the proper formalities, courts might conclude that the corporation existed in fact (de
facto), eve if not in law (de jure). Recognition of limited liability to protect the promoter for
personal liability
 Stone v. Jetmar Properties: voids the principle of de facto corporation.
Incorporation process is so simple that protection shouldn’t be available for those
who fail to incorporate.
- De Facto Corporation – there is no such thing, but they want to see if it will
fit. Here, though, that doesn’t work because he never made a bonafide,
colorable attempt to organize the LLC. For example, he would have to have
sent it in but it get lost in the mail. There is no more de facto corporation in
Minnesota because it is in the comments to the statute. There are some cases
that still refer to it, but it is not available due to the language of the statute.
- Corporation by Estoppel – Ortega says he treated it like a corporation so it
must be one! The court rejects that argument because it was an act under
fraud.
o Corporation by estoppel: recognition of limited liability vis-à-vis third parties who deal
with a promoter on the assumption that the promoter represents an existing corporation,
even if the corporation has not been formed.
 RULE: all persons purporting to act as or on behalf of a corporation, knowing there
was no incorporation under this Act, are jointly and severally liable for all liabilities
created while so acting. Exceptions found in MBCA §2.04.

 Management
o Management provisions are default rules that can be altered by the operating agreement.
Member managed are default. RULLCA 407(a); DLLCA 18-402
o Member-Managed LLC: (default rule) members have equal management rights & decide
all ordinary business matters by a majority of members. Runs like a partnership – ordinary
matters are decided by majority vote of members & extraordinary matters generally
require unanimous consent.
 Gottsacker v. Monnier –We start with a New Jersey LLC that is member managed
with three members. Two of the members try to perform an illegal transaction to
get one other member out of the deal. That person files suit alleging an illegal
transaction, because he only got $22,000 for his share. The brother is saying that the
vote for their shares should be voted all together because they are “collective.”
- Members with material conflicts of interest are usually allowed to vote but
are required to deal fairly with the conflicted member. No one disputes that
it is a conflicting interest, but the question is whether or not one with that
kind of dispute can still vote. They are arguing different statutes.
- Common law rule: any transaction with a conflict of interest would be
voidable
o Manager-Managed LLC: managers have exclusive management rights & decide all
ordinary business matters by a majority of managers. Members must consent to: : sell,
lease, exchange, dispose of, merger, conversion, undertake serious act, amend the
operating agreement.
 Taghipour v. Jerez: LLC can attempt to limit power of manager by operating
agreement but the manager may still be able to bind the corporation (apparent
authority issue). We have THREE LLC members, and the question is whether a
 manager can take out loans in the name of the corporation. The members of the LLC
never know about the mortgage, and the manager takes the money and runs. The
other members want to argue that the bank shouldn’t have the property.
- Does Jerez have the actual authority to make this loan? Yes because he is the
manager.
- There are COMPETING STATUTES. One says that you can’t enter into loans
without the others consent, and there is one saying that a manager can
unilaterally enter into a loan by himself. CONFLICT. The court says that the
more specific statute is always better.

 Limited Liability
o Default Rule: every member of LLC has equal management rights (member managed)
unless they provide for centralized management (manager managed) in the organizing
documents. Both structures provide limited liability
o Piercing the Corporate Veil: circumventing limited liability & holding shareholders
personally liable for the obligations of the corporation
 Designed to impose personal liability on shareholders when they have failed to treat
the corporation as a separate entity
 In corporations, courts look to formalities to determine if the corporate veil should
be pierced (board meetings, separate bank accounts, etc.). But, LLCs do not have
these formalities  harder to pierce the corporate veiling in LLCs! Direct actions
are more successful.

 Fiduciary Duties
o RULLCA
 Members don’t have any duties. RULLCA 409(g)(5)... There may be a duty to
minority members on the part of the majority member. Not just duty of care and
duty of loyalty; there are OTHER duties.
 Courts are reluctant to let you contract out these! SUBJECT TO WAIVER IF THEY
AREN’T UNREASONABLE. RULLCA 110(D)
o Delaware LLC Statute:
 The baseline Delaware LLC statute lets you contract out of fiduciary duty
altogether. What’s left? The contractual covenant of good faith… not a fiduciary
relationship because it is inherent in making a contract. Imposed on LLC managers;
owed to the LLC and individual members. Can’t oppress a minority member because
fiduciary duties are owed to each member
 Statutes impose the duties of care & loyalty on managers (Purcell v. Southern Hills)
o Types of Lawsuits:
 Derivative: enforcement of fiduciary duties in an action which shareholders of a
corporation sue on behalf of the corporation to enforce fiduciary duties against the
managers of the corporation
 Harm caused to the corporation – i.e. mismanagement or theft of corporate
funds – harm to shareholders derives from the harm to the corporation
 Harder to sustain
 Tzolis v. Wolff – The court holds that members of an LLC should be able
to bring derivative suits against other members. Why? There is no
express requirement saying that there is NO derivative suit—it is just silent
on the point. The victim shouldn’t be without a remedy. You need to be able
to sue! If you don’t let them sue on behalf of the corporation, then you have a
direct claim ONLY. You need the derivative claim to stop this. That unduly
 muddies the waters. Why not? The senate and the house have two different
versions of the bill, and they compromised by removing the derivative suit
language.
 Direct: shareholders act on their own behalf
 Harm caused to the shareholders – i.e. depriving shareholders of mandatory
dividends based on shareholder agreement
 With LLCs, sometimes direct actions allowed for matters that would
normally be considered derivative actions if a corporation was involved
o Auriga Capital Corporation – Start with William Gatz. He and his family own a large
section of farmland in Long Island, New York. They decide they are going to develop it as a
golf course. He contacts investors, and they form Peconic Bay, LLC. Gatz, through his other
LLC, is the manager of LLC. Strine says that he is essentially the main guy in charge, so he is
the one with the duty. They have built a great golf course, they give the bank a note secured
by the lease on the property, then they sublease it to American Golf Corporation.
 Delaware’s LLC statute says that you can contract out of fiduciary duty – everything
except for good faith and fair dealing as a contractual covenant.
 Gatz knows that American Golf Company is going to leave, and he wants to take
advantage of the opportunity that the golf course won’t be leased anymore. He
thinks he can run the golf course for more money, so he wants to keep it. He wants
to get rid of the other investors. He manipulates the process by: Auction; Doesn’t
hire a broker; Doesn’t do due diligence; Low ball offers; He reserved the right to
reject any offer.
 One of his STRONGEST arguments is that he doesn’t owe any fiduciary duties. They
didn’t contract for him to run a good auction! They knew they were minority
investors, so tough luck! Another justice agrees with him.
 Court says you owe a duty if you don’t contract out of it.
o DELAWARE DEFAULT: DUTY?
 Yes… (STRINE SAYS YES) These are still your investors, and part of them giving
you the money was that you would invest it and give them a return on the
investment. This is a gap filling argument. The average minority investor expects to
have some level of protection or at least not self-deal and set up a fixed auction.
Delaware’s law is starting to rule in all the states! Most states are saying that the
default is that fiduciary duties apply.
 NO? … LLC’s are seen as a more informal process and so maybe there shouldn’t be
these duties. But this isn’t really a formality! You can make this argument, but it isn’t
good.

 Dissolution
o Is it allowed?
 Dissociation is still allowed for in some states, RULLCA 601
 Other states hold that the members cannot withdraw if they haven’t provided a
clause for exit or withdrawal rights, DLLCA 18-801.
o Two mechanisms for dissolution in LLC:
 In Vallinote, the exit mechanism is honored by the court and this is what goes. You
better think carefully through the liabilities and obligations because we’re going to
honor the contract.
 In Haley v. Talcott, there is still a statutory dissolution mechanism if you can
convince the court that judicial dissolution is warranted. There are cases that go into
what it means is “reasonably practicable.”
o Valinote v. Ballis – (Negotiated Exit Rights) We have an LLC that is down on its luck and
down to two members. They are fifty/fifty members, and the bank loans the LLC $200,000
for a note, and they get personal guarantees from the two owners of the LLC in their
personal capacity. There is an “exit mechanism.” One names a price that he thinks is fair,
and the other can either sell or buy. He is incentivized to name a good price, and in this case
Ballis gives a price that makes the value of the company negative. The LLC defaults on the
loan, and the bank comes after Vallinote. Must Ballis indemnify Vallinote for the money
that he has to pay the bank? Why does the buy-sell agreement strongly apply that he
receives indemnity? The buy-sell procedure allows a member to extricate himself from the
company, and that can’t be done unless ALL financial obligations are wrapped up. In
paragraph 11 there is a resignation procedure that says you are on the hook for liability,
whereas the buy-sell agreement doesn’t say anything about it. This implies that you
wouldn’t be on the hook. According to him, there is a chance that the guarantee will need to
be paid so that is why he sold the company for a negative amount of money.
 Easterbrook evaluates these and rejects these. WHY? He says that “strongly implicit
isn’t the same thing as explicit.” He says that Vallinote could have contracted with
the bank to get him off the hook for the contractual requirement to repay the note.
They don’t stay true to the Limited liability form. He says – why else would I pay this
money up front, making a negative price? He’s buying security from having to
indemnify Ballis. It’s an odd provision because it essentially is like a veil piercing
provision.
o Haley v. Talcott – (Judicial Dissolution) Strine says this really looks like a partnership.
Why? They structured everything like a partnership. The UPA says the test of a partnership
is “that they split profits,” and here they are splitting profits. He’s technically an employee,
but it is very hard to fire him and he can’t have his position reduced. He gets 50% of the
proceeds if the business is ever sold. This case is about the LLC and what will happen if it
doesn’t work out. They disagree about the division of profits and ownership stock, and the
owner fires Haley. Talcott only has 50% of the company, so he can’t do anything with his
share. Delaware statute provides for what can happen if there is a stalemate. It provides for
dissolution, and it requires it: “Whenever it is not reasonably practicable to carry on the
business in conformity with a limited liability company agreement.”
 There is an exit mechanism, but he doesn’t want to use it. Judicial dissolution
granted to break deadlock between two 50% members of the LLC because exist
mechanism was inadequate. Exit would have left one member responsible for the
mortgage of the other with no control over the LLC
o NeoClone Biotech Case Study – Angel investors – come prior to the venture capitalists
and after the friends and family. They usually invest LESS than a venture capitalist. Their
demands are less onerous. They come up with something called convertible debt for the
angel investors – they can convert their debt into equity in certain circumstances such as
there being a great success. They have a safety of debt in case of bankruptcy BUT you get
the upside of getting to convert.
 There are FOUR things that could happen:
 ONE: In the event that they have a material default like a failure to make
principal or interest payments, the loans must be paid back with interest.
There are a list of material defaults: failure to observe a covenant
(Rep/warranty – you represent that something is true. We represent that we
have five patents and they are in this stage of development) (Covenant – a
promise to do something in the future. I promise to furnish you with reports
every six months.) If it ever happens that they fail to provide or what they
said isn’t true, that is a breach.
  TWO: Qualified financing – If there is a high investment (usually a VC), then
they can get out.
 THREE: Sale of NeoClone... So you have NeoClone and right now it has duty to
pay on the note a fixed amount to the angel investors. As long as the angels
can convert, they can get a piece of the pie. NeoClone wants to keep it as debt
so they can’t convert to equity.
 FOUR: Interim Equity Issuance – if there was going to be an additional angel
investor at more than $510,000, then they can convert similar to that under
the qualified conversion.
 Control/Financing Rights –
 Usually there are either member or manager managed LLCs. This is a
manager-managed LLC. They also have a management committee.. They
have the power to remove managers AND to approve large transactions.
 Managers have:
o ROFR
o Majority vote of management to approve additions
o Buyout
 Democracy –
o Partnership – 1 person 1 vote
o Corporations – if you own more you get more of a say
 Why did they form an LLC?
 VCs want to invest in corporations... So it’s not very clear. The reasons you
would want an LLC you can get from a corporation.

REGULATION OF DISCLOSURE, FRAUD, AND INSIDER TRADING

RULE 10B5

o Congress introduced 10B... “as the commission should articulate...”

o SEC is the commission. THEY need to regulate this. They come up with Rule 10B5 (pg. 648).
o Anytime there is fraud in the sale of equities and securities, YOU CAN SUE. Attorneys can sue
on your behalf. These are security transactions that dominate the headlines. Attorneys think that
there has been a loss so there MUST be something under 10B5 in which they can sue.

Section 10(B)
o It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce or of the mails, or of any facility of any national securities
exchange...
o (B) To use or employ, in connection with the purchase or sale of any security...any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the Commission
may prescribe as necessary or appropriate in the public interest or for the protection of investors.

10b-5 Elements:
1. Misstatement or omission: Gallager
2. Material fact on which the plaintiff: Basic
3. Scienter (intent to deceive, manipulate...Recklessness/disregard as to truth is enough. Negligence is
NOT enough)
4. Reliance/Causation – Basic
 5. Damages – Settle

Gallagher v. Abbott Laboratories – FDA sends a letter on March 17 that says HI we’re worried about
these problems. On September 29, it becomes apparent that the FDA is serious. The settlement is on
November 2. The stock keeps dropping. Plaintiffs are buyers of Abbott’s securities between March 17 and
November 2. They’re saying that the disclosure was fraudulent because it gave them a false reassurance
that everything was going to be ok. SO the stock was higher than it should have been. The real question –
whether not revealing this information or anything else that the defendant company said or didn’t
say constituted a fraudulent misstatement or omission.
o The plaintiffs failed.
o Why was there is no fraudulent misstatement or omission?
o There was no duty to correct a report (10K)
o Also it wasn’t wrong when it was made.
o What do the securities law require? They just require that you make the 10Q and 10K. You
might have to list some things on the periodic disclosures, but there is no duty for
continuous filing.

Basic v. Levinson – Basic is trading at $20, and there are talks about merging. The stock goes up.
Plaintiffs are former Basic shareholders who sold their stock after Basic’s first public statement and
before the suspension of trading. They say – you should have told the market that you’re in talks with a
merger. There is another interest. The long-term shareholders are happy and they think that if the
company had announced this merger the shares would have been diluted. Combustion may have run
away because it would have been too expensive.
 TEST FOR MATERIALITY – “Substantial likelihood that a reasonable shareholder would consider
the information important.”
o What do the defendants say should be the test—Agreement-in-principle test – “it won’t
become a material fact until there is an agreement in principle. Only then must you
disclose.” They give three rationales:
 1. An investor not be overwhelmed by excessively detailed and trivial information
 2. Needs to preserve the confidentiality of merger discussions. No! But if you say
something it must be true. This is timing v. accuracy. The company should have
made “no comment.” If you deny it and its untrue, then you are liable. SILENCE OR
NO COMMENT.
 3. Bright-line rule.
 TEST FOR RELIANCE -- Say you’re an attorney for a class for 1000 people who sold shares. If you
have to prove reliance, you’re facing a problem because there was systematic reliance on the part
of each individual on the misstatement. The court says – you don’t need to do it! We’re going to
introduce this tool – the presumption of fraud on the market. The presumption says: When
these people buy or sell, they’re relying on the fact that the market reflects all of the disclosed
information. If you sold at a point, then you’re saying I didn’t hear that statement but I’m relying
on the fact that the market took that into account. IT IS AN IMPLICATION. There are ways to
rebut it. To what extent is the market price the true price.

CHANCELLOR (GUEST SPEAKER)

 The importance of process is very important in5 Delaware law **
 Judges are experts in law. Law is about procedure and process. Judges love process.
 Courts of Chancery are courts of equity, so they are like a morality tale.
Newest case – Chevron
o Its board of directors adopted a bylaw called an “exclusive forum selection bylaw.”
o This bylaw directs all litigation filed against the company’s board of directors to be filed in
Delaware courts.
o They have been sued by shareholders (two pension funds) saying the bylaw is invalid. You can’t
adopt a bylaw like that. They have gone through discovery and are now going to ask for summary
judgment to rule in favor that the bylaw is valid.

Court of Chancery
 Very old, only three states have Courts of Chancery.
 Created in 1797, it is a pure court of equity, and it originally adopted England common laws
 If you want money damages, you went to the law courts. Most states have combined the courts so
that there is only one court.
 Delaware still has separate courts for equity and law.
 Judges will be appointed by the governed and confirmed by the Senate. They serve 12-year terms.
The courts will be balanced equally between the political parties. Political influence has been
reduced.
 Now there is a judicial screening committee who decides who will be a judge. They recommend
THREE people to fill the vacancy.

Corporations are Important in Delaware:

 It became the business court out of pure luck. Corporations law was created in Delaware in 1899.
 President Wilson proposed laws that terrified corporations, so the New Jersey corporations said
oh no what are we going to do? They went across the river to Delaware.
 Delaware makes their money on franchise fees. They also get escheat fees. They don’t have sales
tax…
 They review the laws every year to make sure they are the best.
 Delaware Division of Corporations
o You call them and say we want a name reservation. It is 24/7.
o It’s a business for Delaware!
 Delaware Enabling Statute
 Legislative Process and Bar association

IN-HOUSE AT IHG CORPORATION (GUEST SPEAKER)

o Largest legal group is in Atlanta.
o He joined in 1992
o Needed an attorney who could deal with joint ventures in the hotel arena, AND real estate
o It was originally Bass Beer, a company out of UK
o They then bought Intercontinental from a Japanese company
o Now he focuses on hotels and franchises
o Regulations are very important – FTC regulates franchising, and AG regulates franchising

General counsel –
o You better be a generalist… you need to know anything there is to know about being a business
lawyer.
o You’re a mile wide and an inch deep
o He doesn’t report to the CEO in Atlanta; he reports to the President in London
 o Business Reputation and Responsibility (BRR) –
o Legal department
o Risk management
o Internal audit
o Corporate responsibility
o This group crafts a mission for the group in the company. They have a mission of to protect
the reputation of IHG International.

What is corporate responsibility?

o It does different things for different companies, but there are different senses:
o Green
o Business
o Social Responsibility

General Points
o The legal department is the largest group within BRR.
o The goal of the legal department is “to become the world’s best hotel law firm.”
o They want to do what they need to do to fill all the blanks at the company
o If the legal department is properly functioning and properly integrating, there is no one besides
the CEO that should know more about the company than the lawyer.
o They are also company historians… they have knowledge of the history of the company that is
invaluable.
o No one hires a lawyer BUT the legal department. If the CEO wants to hire one, of course you will
listen politely. The lawyer will be the one to choose who does the best work.

Business lawyer and corporate lawyer aren’t the same thing!

o Corporate lawyers deal with mergers, corporate form, etc. They deal with audit committees, etc.
o A business lawyer is someone who is working with a particular business that understands
everything about a specific kind of business.

Don’t say YES OR NO. Yes, if. No, but.

o You have to come to a middle road of yes and no.
o Think about ways to get the business to accomplish its goals without violating the law and without
doing something stupid.

Outside counsel vs. General Counsel

o They have to understand the business! They will create something value added to what the
general counsel already owns.

What about the difference between small company and publicly traded?
o You have many disclosures, committees, formalities, etc. that come along with working at a
publicly traded company like IHG.
o Closely held corporations generally have a patriarch in that group that is the principal or the
money person, and that person’s word usually goes. It is harder to get the lawyer to get through to
them about the legal issues.

Exam Review:
 Cite statutory provisions
 Introduce rule
 Don’t need case names, just common law principles