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Relevant statutes: R3A 1.01, 2.01-2.07, 3.01-3.11, 4.01-4.02, 7.07, 8.01-8.03, 8.06 Agency law is essential because it allows for hierarchical organization and delegation which facilitates large scale enterprise Agency defined o R3A 1.01: Agency defined: Agency is the fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act. o Test for agency 1: Did alleged principal manifest assent to the alleged agent that the agent shall 2: Act on the principal’s behalf, and 3: Subject to the principal’s control, and 4: Did the agent manifest assent or otherwise consents so to act? Terms o Agents may be Employee/servant: when P has a right under his deal w/A to control the details of the way in which the agent goes about her task Independent contractor: when P’s rights of control are less extensive – no control of details, but right to fire Special agents (agency limited to a single act or transaction) General agents (agency contemplates a series of acts or transactions) o Principals may be Disclosed 3rd parties transacting with agent understand agent is acting on behalf of a particular principal Undisclosed 3rd parties unaware of principal & believe agent is principal Partially disclosed 3rd parties aware they are dealing w/an agent but don’t know identity of principal Termination o Principal or agent can terminate an agency at any time o In no event will an agency continue over the objection of one of the parties Forming an agency relationship o Formed by offer and acceptance o Parties’ characterization/subjective intent does not control Agency relations may be implied when the parties have not explicitly agreed to an agency relationship Cargill, Inc. (seedco. gets loan w/lots of oversight and control from Cargill) Rule: An agency relationship may be proved by circumstantial evidence which shows a course of dealing between the two parties Cargill argues it’s a debtor-creditor relationship as opposed to agency relationship because it’s common for creditors to impose conditions; but perhaps not so many conditions 1
Authority of Agent o Actual Authority: R3A 2.01 Based on the words and actions of the principal, the agent reasonably believed that the principal gave the agent the authority What reasonable person in agent’s position would infer from principal’s conduct Not what the principal subjectively intended Includes incidental/implied Authority to take the steps ordinarily done in connection with facilitating the authorized act o Apparent Authority: R3A 2.03 3rd party reasonably believes by relying on acts of principal that agent has authority Agent cannot ordinarily establish his own authority by asserting it; it must be based on reasonable manifestation by principal White v. Thomas (Simpson bought 217 acres on behalf of D, sold 45 to P) D’s secretary did not have express, implied or apparent authority to sell 45 acres Rule: declarations of an alleged agent may be used to corroborate other evidence of the scope of agency, but agency cannot be shown solely by his own declarations or actions in the absence of the principal o Inherent Authority Not conferred on agents by principals but represents consequences imposed on principals by law Gallant Ins. Co. v. Isaac (insurance agent agrees by phone to change car covered) Inherent agency power derives not from authority, apparent, or estoppel, but from the agency relation itself. Rule: An agent has the inherent authority to bind the principal if 1) act usually accompanies/is incidental to the tasks it is authorized to perform 2) the third party reasonably believes the agent had authority to perform the act in question due to the agent’s direct and indirect manifestations, and 3) 3rd party not on notice that agent does not have authority to perform the act Tends to be applied when it would be unjust/inequitable to do otherwise Liability o Agency by Estoppel R3A 2.05: person can be held liable despite not making any manifestation that an actor has authority as an agent, if a third party justifiably makes a detrimental change in position because a transaction is believed to be on the person’s account and 1) the person carelessly caused the belief, or 2) having notice of the belief, the person did not take reasonable steps to notify the third party of the facts o Undisclosed Principal R3A 2.06: Undisclosed principal liable to 3d party for agent’s actions without actual authority if he knows of agent’s actions and their likelihood to induce others to change their positions, but fails to try to prevent them o Agency by Ratification R3A 4.01: accepting benefits under an unauthorized contract will constitute acceptance of its obligations as well as its benefits
o In Tort In general, principals are Liable for torts committed by employees Not liable for torts committed by independent contractors Only the employer-employee relationship ordinarily triggers vicarious liability for all torts committed within the agent’s scope of employment. R3A 2.04 Respondeat Superior An employer is subject to liability for torts committed by employees while acting within the scope of their employment Humble Oil (car rolls out of a gas station and strikes P and 3 kids) Holding: court finds employer-employee relationship, thus D is liable How to distinguish employee from independent contractor o Control and supervision over the contractor/employee’s actions Governance of Agency Relationships o Agency Cost Monitoring cost: expenditures on monitoring the actions of the agent Bonding cost: expenditures by agent to reduce agency costs Residual losses: the costs incurred from divergent principal and agent interests despite the use of monitoring and bonding o Fiduciary Duties Obedience: to the documents creating the relationship Duty of loyalty: to exercise legal power over the subject of the relationship in a manner that the holder of the power believes in good faith is best to advance the interest or purposes of the principal or beneficiary (most important duty in agency) Duty of care: duty to act in good faith, as one believes a reasonable person would act o R3A 8.01: agent has a duty to act loyally for the principal’s benefit in all matters connected with the agency relationship o R3A 8.03: an agent has a duty not to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship o R3A 8.06: Principal’s consent o Tarnowski v. Resop (agent misrepresents the nature of a jukebox route) Rule: all profits made by an agent in the course of an agency belong to principal Rationale: don’t want to create incentives for agents to seek their own profits In addition, under RA 407(2), fees and expenses directly traceable to harm caused by D’s wrongful acts are also recoverable This is a fiduciary duty case; were it a tort case, P would have to have been injured to recover in tort o Gleeson (lessee of 160 acres also the trustee) Trustee cannot deal with trust property for his own benefit When testatrix died, D had a choice: tenant or trustee? Rule in agency is different Agent can deal with property in his own self interest if Good faith, disclosure, and fair dealing Partnership Basics o Relevant statutes
The Law of Partnership
40(h)-(i) RUPA: 201-203. 501-503. 301. 9) o Opportunities that arise because of the partnership belong to the partnership Meinhard v. 36. 18-303 o Definition: UPA 6: association of two or more persons to carry on as a business as co-owners o Default contractual form that can be contracted around o Characteristics Share control and profits Each partner votes on partnership matters (18e) Each contributes capital as need w/other partners (18a) New partners added only w/unanimous vote (18g) J&S liability for business debts caused by wrongful acts (15a) Joint liability for other debts (15b) At will or for a set term Subject to dissolution by any P and when any P dies or withdraws RUPA fixes somewhat in holding that GP need not be reorganized with each partner change more stable form Each partner is the other’s agent (9) o Entity status of Partnership UPA § 25: Tenancy in partnership Quasi-entity. 307 o Partnership vs. 807(a). corporation Higher transaction costs Less stable (not infinite) Personal liability Difficult to transfer partnership interest o Central Problem of Partnership: conflict between owners Contrast with central problem of agency (agent-principal) Partners are fiduciaries/agents of the partnership (UPA 21. creates some degree of stability RUPA § 201: Partnership is entity distinct from partners See also RUPA §§ 303. 1002 LLCA: 18-201. UPA: 6-9. not just honesty. 31. while their enterprise continues. 306. 1001. 403. the duty of the finest loyalty. but the punctilio of an honor the most sensitive… Holding: Salmon should have disclosed the opportunity Meinhard Rationale: Salmon got the info about the 2nd contract b/c of the partnership o Either partner can bind the partnership 9(1): Every partner is an agent of the partnership and binds the partnership for normal activities unless that partner has no authority in that matter. 25-27. Salmon (leased property in at 42nd and went into partnership) Salmon’s duty to Meinhard in practical terms: Duty to disclose the business opportunity? Duty to give him first right of refusal? Rule: Partners owe to each other. 18. and the recipient knows it 4 . 12-16. 404.
part ownership. the other doesn’t) Purchase of bread an “ordinary matter connected with the partnership business. consideration for the sale of goodwill or other property o Factors to help determine if there’s a partnership Interest in net profits – suggests interest in management – suggests partnership Contribution of labor and skill. partners cannot perform unusual. wages of employee/rent to landlord. contribution of capital is not controlling Voluntary contract Intention / consent to do the acts that constitute a partnership But don’t need the intent to establish a partnership o Vohland v. Partnership Governance & Issues of Authority o Mostly UPA – default. joint for other debts 16: estoppel: if outsider reps himself as partner and anyone relies on it. he is liable to that person 36: withdrawing partner liable for liabilities at time of withdrawal and during windup Partnership Creditor’s Rights o Jingle Rule (UPA § 40(h) & (i)) old rule Partnership creditors 5 . regardless of how they may later characterize the relationship. National Biscuit (2 grocers. there was profit sharing here It can be inferred that the parties intended to do the things which amount to the formation of a partnership. nonoperational activities Authority to bind firm unless 3rd party knows of limitation on authority Partnership Formation o UPA 7: determination of whether a partnership exists 1: persons not partners to each other are not partners as to third persons 2: joint tenancy or property. annuity.” thus Stroud could not restrict Freeman’s authority to purchase bread and thus bind the partnership in liability for those purchases 9-2: w/o authorization from other partners (unanimous?). interest on a loan. one wants to buy bread. an act requiring a modification of p-ship contract requires unanimous consent o Liability 9: partners liable for acts done by each other in the course of business 9-2: not liable for acts outside scope of partnership 13: p-ship bound by partner’s wrongful act in the ordinary course of p-ship business 15: J&S for debts caused by wrongful acts. etc does not by itself establish p-ship 3: sharing of revenues does not of itself establish p-ship 4: receipt of a share of profits is prima facie evidence of a p-ship unless payment is:installment payment of debt. Sweet (man works in a nursery) Cites 7-4 as prima facie evidence of a p-ship. not mandatory o Control/Governance 18a: equal sharing of profits and losses 18e: all partners have equal rights in management and conduct of p-ship business 18g: unanimous consent required to admit a new partner to p-ship 18h: majority vote on disagreements about matters connected with the p-ship.
Page (partners in a linen supply business wind down) Partnership found to be terminable at will o No implied agreement to continue business for term long enough to recoup investment. may be subject to damages if wrongful) Causes of Dissolution (§ 31) Not wrongful End of specified term or particular undertaking Express withdrawal when no definite term or particular undertaking Unanimous consent of all non-assignee partners Expulsion of any partner in accordance with granted power Illegality going forward Partner/partnership bankruptcy Wrongful Withdrawal where express term prohibits dissolution Withdrawal in violation of fiduciary duties. w/o specific condition. Note: Most contracts say that withdrawal doesn’t. at most only a hope of that. Limited Liability Forms o Limited Liability: business creditors cannot proceed against personal assets of investors o Rationale: Creditors need only rely on partnership credit. assignee entitled to his assignor’s interest Withdrawal Partner always has the power to withdraw at any time.e. not personal assets (unless they secure a guarantee) 6 . so more valuable to clients and creditors Page v. lead to dissolution Gives each partner less power Partnership is more stable.40) Dissolution (§ 29) Change in the relation of the partners caused by any partner ceasing to be associated w/ partnership in carrying on of the business (except by assignment) Assignment (§ 27) Does not of itself dissolve the partnership If dissolution occurs. but not always the right (i. Have priority over partnership assets Do not have priority over individual assets Personal creditors Have priority over individual assets of including partnership profits Do not have any right to partnership assets (UPA § 25(c). RUPA § 501) o Modern Rule (Bankruptcy Amendments of 1978 & RUPA § 807(a)) Partnership creditors Have priority over partnership assets and equal claim to individual assets Personal creditors Have equal claim to individual assets and no right to partnership assets The difference: personal creditors and partnership creditors have equal rights to the personal assets of the partners modern rule is more friendly to partnership creditors Dissolution and Disassociation o Under the UPA (§§ 26.
torts (i.g. rather than min. such as through torts. o Limited Liability Partnership (LLP) Creates limited partner liability w/r/t professional liability. this limits what a 3d party can go after Seems to create no issue w/r/t parties that have notice.e. no personal liability General partner: manager Has unlimited liability. cap. partners liable only after the whole firm has been so held Can contract around fiduciary duties to some degree Can elect to have pass-through taxation Members pay the tax.o Limited Partnership (LP) Limited partner: investor Contributes capital No management role.) “Check the box” taxation Can’t do this if shares are publically traded 7 . but torts? Perhaps should require these LPs to have insurance. just like a regular partner Can have a general partner that is a corporation without much capital. like for a corp. maybe rights to appoint/remove a general partner Liability limited to the amount contributed. not the company (no double-taxation. e. malpractice) o Limited Liability Company (LLC) Most contractual freedom Dominant form when the company is not publicly traded Creates limited liability w/r/t partnership liability.
141. 111. including governance rights Incentivizes managers to act efficiently Permits development of large capital markets Specialization/centralization of investors and management Investors can contribute capital without knowledge Management can contribute knowledge without contributing capital Possibility of capital markets Limited liability → cheaper capital → more investors → more investment opportunities + possibility of diversification → markets for capital o Types of corporations Public corporations Funded through capital markets Rational passivity (Collective Action Problem) Most investors don’t have incentive to research the firm b/c the number of shares each has isn’t enough to make a big difference Close corporations Few shareholders Incorporate for tax or liability purposes.The Corporate Form Relevant Statutes o DGCL: 101. distinct from investors and managers. 242 General o Economic Reasons for A legal personality. 121. 106-109. corporation has less contractual freedom But corporation necessary if you need public capital Free transferability of shares Can transfer the whole interest. that has indefinite life Stability (as against partnerships) Limited liability for investors (investors have limited liability. 102(b)(6). not capital-raising Differences from public corporations Not subject to SEC regulations Less collective action problem Also: Controlled vs. 102. 211. since value is only based on PV of income stream Allows managers to take more risk by facilitating portfolio diversification As against LLC LLC more dynamic. 122. 142. attracts investors Reduces monitoring costs. In the Market General Structure o Internal affairs Relationship between managers. board. and shareholders Internal Affairs Rule: IAs governed by law of the state of incorporation o Charter / certificate of incorporation / articles of incorporation DGCL § 102(b)(1)-(7) Director’s liability for duty of care can be eliminated or limited – 102(b)(7) 8 . 160(c). 151(a). no personal liability Makes capital cheaper. corporations unlimited) Investors can only lose what they invest. w/r/t managers and other shareholders Makes shares fungible.
not for a bare majority of the shareholders. This is the reaction to Van Gorkom Enabling – can create structure best for that business Amendments to DGCL § 242 Board initiates Requires shareholder vote (default: simple majority) o Bylaws DGCL § 109 Operating rules Shareholders have power to adopt – DGCL § 109(b) Can also give the power to the board (see Blasius) Otherwise.§ 219 Non-objecting beneficial owners if proper purpose . who appoint management Criticism: Directors factually don’t have time to devote to job. except by extraordinary resolution of 75% vote Board refuses to sell assets Court says this is a board decision. or if they are initial directors named in charter o Shareholder rights Right to sell Right to sue Right to vote Right to dividends when issued Information Rights State law generally mandates little disclosure Theory is market will require it But see SEC ’34 § 14 List of shareholders unless company proves improper purpose . but the company as a whole o Obligated to obey legal documents creating its authority b/c of Duty of Obedience o Boards increasingly active in last decade. should be full-time o Exclusive legal right to manage business affairs – DGCL § 141(a) Initiates all important action (including initiating committees) Designates management Automatic Self-Cleansing v. shareholders elect board. maybe too much 9 . it doesn’t have to listen to shareholders if not in corporation’s best interest. Nature of agency relationship: directors are agents. Cunninghame (55% of voters want to sell assets) Shareholders passed a resolution to sell company’s assets w/55% vote Charter said “management of the business” vested in the board. board can adopt bylaws only prior to corporation’s receipt of any payment for stock. only hold shares of stock Board of Directors o Rationale and Criticism Rationale: Response to rational passivity.§ 219 Books & records if proper purpose – DGCL § 220 Court will tailor access to the purpose shown BUT. do not own the corporation.
Prior dealings establish apparent authority only if these dealings o 1) have a measure of similarity to the act in question. subject to the fiduciary duty of agents Subject to apparent authority rules Jennings v. Mercantile refused to pay Jennings his commission. Rule: An agent cannot by his own words invest himself with apparent authority. not Board’s. Pittsburg Mercantile (real estate broker gets stiffed) Mercantile officers (agents) asked Jennings to solicit offers for a sale and leaseback w/ no actual authority from Mercantile board to . Jennings sued. 4 terms in NY Corporate officers o Appointed by board resolution o Agents of the corporation. such authority emanates from the actions of the principal and not the agent. o Default: elected for 1 year terms o Staggered board Limits the removal power 3 terms in Del. and o 2) have a degree of repetitiveness Holding a corporate office cannot establish apparent authority o Not by itself 10 . No apparent authority b/c Jennings relied on agent’s actions.
which varies risk and price Disadvantages Cash-flow drain – the stated interest rate must be paid May be more expensive to refinance Possible default if company doesn’t pay.60 PV of $100 at 4% = $96. privilege.10 100 x 1. or limitation Typically has preference over common stock for liquidation and dividends Usually doesn’t vote when dividend is current. which means company might go into bankruptcy or have to borrow from another creditor at higher rate of interest o Equity Features Indefinite commitment – no maturity date Residual interest on corporation’s assets and income (unlimited upside) Right to dividends when and only when declared by the board No right to declare default/participate in bankruptcy distribution if not paid Advantages for Managers At a certain point.10 = 110 110/100 = 1.10 Present value (PV) is the value today of the money to be paid at a future point Discount rate (r): base rate earned from renting money in market Discount factor (1 + r) Future value (FV) NPV: PV of amounts received minus amounts invested Rate of return: % earned if you invest Relationship between PV and discount rate is inverse.Raising Capital Capital Structure o Leverage = the ratio between debt and equity More debt means higher leverage o Debt Features Holder has the right to declare default when The principal isn’t paid on maturity date The interest isn’t paid and there’s an acceleration clause Stated interest rate or zero-coupon bond (no interest rate. just payout) Can be customized by covenants Can have different seniority levels. Preferred Stock Common: default Preferred Def: Equity security on which charter confers special right. debt is too expensive Common vs. if not current.15 o Risk and Return 11 . can have vote Valuation Concepts o Time value of money Why? The use of money is valuable PV = (FV) / (1 + r) PV * (1 + r) = FV FV/PV = 1 + r 100 = 110 / 1. higher DR lower PV PV of 100 at 8% = $92.
5% chance of receiving 0 Risk free rate: 6.735m NPV if risk neutral: -10m + 10.5% + 2% = 8. Risk: volatility of expected returns Expected Return: weighted average of the value of the investment ER = (Returns Success)x(Probability Success) + (Returns Failure)x(Probability Failure) Then: Discount the expected return to present value Appetites for Risk Risk neutral: concern only for expected return of investment Risk averse (majority position) Systematic vs. so investor demands lower risk premium Problem Risk free rate: 6% Mets and Yankees both have 50% chance of winning world series If Mets win.06 = $70.5% Nominal interest rate paid on the loan: 13% ER = $11.065 = ~-106k o Diversification Can eliminate unsystematic risks through diversification Diversified portfolio has less total risk than individual components. compensation for unpleasantness of volatility Risk adjusted rate: risk free rate plus the risk premium The higher the risk higher the risk premium higher the risk adjusted rate Risk premium = risk adjusted rate – risk free rate Most investors are risk averse. Unsystematic Systematic – risks for the whole system Unsystematic – risks for individual firms Risk premium Def.: additional amount risk-averse investors demand for accepting higher-risk investments in the capital markets.735m/1.75 Valuation of Assets: Discounted Cash Flow Approach (DCF) o Estimate all future cash flows Use a terminal value to calculate for finite number of years NPV = C0 + (C1/1+r) + (C2/(1+r)2) + … + (Cn/(1+r)n) o Calculate the discount rate Weighted-average cost of capital (WACC) 12 .0.05 = $10.3 x . stock worth $50 ER of both investments is $75 These investments are perfectly diversifiable because they offset each other o Therefore the discount rate is the risk free rate o Therefore PV is $75/1. offers to repay $11.3m Bank’s risk assessment: 95% chance paid in full. so demand a risk premium Problem Hotel wants to borrow $10m.065 = ~80k NPV if risk averse: -10m + 1.95 + 0 x . stock worth $50 If Yanks win.5% Risk premium: 2% Risk adjusted rate: 6. if Mets lose. if Yanks lose. stock worth $100.735/1. stock worth $100.
5 + 1100 x . 50% chance of $1100 payoff Risk free rate: 5% Risk premium on this project: 5% Risk adjusted rate: 10% ER = 1500 x .10 = $1182 NPV = -$1000 + $1182 = $182 Investor invests $1000 at T0 and wants to sell the equity at T0. Treasury bond rate Equity Premium: historical amount that equity returns on investments above the risk free rate Beta: based on the amount that the company’s stock varies with the market o If the stock is as risky as the market. Beta > 1 o Efficient capital market hypothesis (ECMH) Stock market rapidly reflects all public information bearing on expected value of stocks (semi-strong form) o Problem from Corporate Finance Notes Investment opportunity: $1000 investment today In one year: 50% chance of $1500 payoff. Beta = 1 o If the stock is more volatile than the market.5 = $1300 PV = $1300/1. Value of equity = $1182 (discounted?) Return on equity if strong economy: (1500-1182)/1182 = 27% Return on equity if weak economy: (1100-1182)/1182 = -7% Investor borrows $400 to pay for part of the $1000 initial investment Borrows at 5% rate Debt is riskless b/c creditors have first claim & guaranteed cash flows of 1100 Cash flows for debt holders: -$400 at T0. $420 at T1 Cash flows for equity holders: 1500 – 420 = 1080 or 1100 – 420 = 680 EV of cash flows = (1080 + 680)/2 = 880 Equity value = 1182 – 400 = 782 Return on equity if strong economy (1080 – 782)/782 = 38% Return on equity if weak economy (680 – 782)/782 = -13% Levered equity is riskier than unlevered 13 .WACC = weighted average cost of debt + weighted average cost of equity Cost of debt calculated using current yields o The interest rate firm would pay today. not the historical interest rate of existing debt Cost of equity calculated using one of the methods below o Cost of equity Capital asset pricing model (CAPM) Links the asset’s risk to the volatility of the asset’s price Cost of equity = risk free rate + (equity premium)(Beta) Risk free rate: traditionally the U.S.
accounts receivable.g. excess goes to capital surplus Reducing stated capital requires charter amendment to reduce par value No Par Value Stock Discretionary portion of sale price set aside as stated capital – DGCL § 154 o Two: Retained Earnings Def: Profits not distributed to shareholders Managers may put money into retained earnings when it has better investment options than the stockholders or to protect themselves o Three: Capital Surplus Def: Difference between Total Equity and (Stated Capital + Retained Earnings) Assets = Liabilities + Equity 14 . machinery.Balance Sheet Assets o Current assets E. land.g. inventories o Fixed assets E. cash. buildings Liabilities o Debt Stockholders Equity (difference between assets and liabilities) is divided into three accounts o One: Stated Capital/Legal Capital/Capital Stock Def: All or portion of value that shareholders transferred to the corporation at the time of the original sale of the company’s stock to original shareholders Par Value Stock Par Value: Arbitrary dollar amount stated in charter and stock certificate Stated Capital = Par Value x # of issued & outstanding shares If stock price > par value.
default terms give assurance o Financial Statements See balance sheet above Typically reflect historical costs instead of current economic (market) values Book value may differ a lot from current market value o Distribution Constraints Can pay dividends out of NYBCL 510: dividends may be paid only out of surplus. may not be paid out of stated capital DGCL 170: dividends may be paid out of capital surplus.S.The Protection of Creditors Relevant Statutes o DGCL §§ 154. or. then no dividends can be paid until deficiency eliminated . state law rarely uses mandatory disclosure to protect creditors of closely held corporations Capital Regulation o Largely obsolete these days. 170.DGCL § 170 o Minimum Capitalization Restrictions In U.. but must disclose the revaluation Preferred stock Right to receive dividends If dividends aren’t paid as scheduled. 7 General o Types of creditors Commercial creditors Mostly protected by contract and disclosure Involuntary creditors Tort victims Have to rely on insurance o Rationale for Creditor Protections Effect of limited liability exacerbates problems of debtor-creditor relationship Three Primary Strategies to Protect Creditors Mandatory Disclosure Disclosure offers some promise of controlling debtor opportunism through misrepresentation Governed by federal securities law. if no capital surplus. have been removed for corporations Rationale: Normal business activity can easily dissipate capital Standard-Based Duties 15 . net profits in current or preceding fiscal year (nimble dividend test) Revaluation surplus – DGCL § 154 Def: market value of assets may be more than historical value on balance sheet – reevaluate the assets to reflect the higher value Add increase to capital surplus. not doing the work of creditor protection o Rationale: Contractual terms expensive to achieve. UFTA §§ 2-5. they accumulate Have to pay dividends to preferred stock before common stock Right against dividend distribution If Total Capital < Value of All Preferred Stock.
their claims will be subordinated to those of general unsecured creditors o Fraud and mismanagement are not necessary preconditions to equitable subordination. not just shareholders o Protection against Fraud: Uniform Fraudulent Transfers Act (UFTA) Remains important today Present or future creditors may void transfers when… (UFTA § 4) One: debtor had actual intent to delay.” interests may diverge In such a case.o Director Liability Traditionally. OR Two: (1) no fair consideration and (2)(i) debtor is left with remaining assets unreasonably small in relation to its business. or defraud creditors. in most states of world. believed.. when firm is w/in a “zone of insolvency. or (2)(ii) debtor intended. directors should consider the welfare of the community of interests that constitute the corporation. against fiduciary) Legal remedies are inadequate Usually done when there’s a wrongful act and an abuse of the corporate form by one or small group of shareholders Equitable Subordination Definition: When fairness requires that debt owed by a corporation to controlling shareholders be characterized as equity “A means of protecting unaffiliated creditors by giving them rights to corporate assets superior to those of other creditors who happen to also be significant shareholders of the firm. Fazio (partners issued notes & lowered the working capital) Prior to transition to corporation.g. Piercing the Corporate Veil 16 . directors’ obligations to corporation. Rule: when partners convert their capital contribution into loans. or reasonably should have believed he would incur debts beyond his ability to pay as they became due Fair Consideration: bargained for consideration close to what a reasonable person would expect (courts reluctant to question when close) o Shareholder Liability to Corporate Creditors Available when… P has an equitable right (e. thereby leaving the corporation grossly undercapitalized to the detriment of creditors. advancing interests of corporation also advances creditors’ interests But. hinder. partners significantly depleted their capital in the company by writing loans to themselves.” Test/Requirements Creditor is equity holder (typically company officer). and Insider creditor must have behaved unfairly or wrongly toward the corporation and its outside creditors Costello v.
Kinney subleased to Industrial. bank or other lending institution) to do diligence on the corporation. Industrial had no assets – a shell to protect Polan from liability. etc Voting 17 . one corporation treating the assets of another corporation as its own AND. appellate court did not) o Bubb thinks Kinney should have known what was going on Cases – Involuntary Creditors Walkovszky v. Pepper Source – this case is pro-D o Marchese owned 5 businesses. Carlton (2 cabs per corporation) – this case is pro-D o Court is unwilling to pierce the veil: owner had observed the corporate formalities. and both this disregard and gross undercapitalization harmed Kinney o West Virgina test Unity of interest such that separate personalites no longer exist Would result be inequitable if acts treated as those of the corp. parent corp that caused sub’s liabilities and its inability to pay for those liabilities would escape them (more on bottom p. but with insurance (and the legislature) o Perverse incentives To simply observe corporate formalities while skimping on repairs. o Court says unsatisfied judgment is not enough to establish “fraud or promotion of injustice.” there must be a wrong additional to that. 155) Kinney Shoe v.g. (e. respected distinctions between corporate asset pools o Dissent argues that this is abuse. Sea Land tried to pierce corporate veil to get judgment satisfied by Marchese / sibling companies.g. commingling of funds. Industrial subleased part to Polan Industries. Polan – this case is pro-P o Polan formed Polan Industries and Industrial. alone Optional third prong: when reasonable for a third party. it will be charged with the knowledge that a reasonable credit investigation would disclose. Industrial didn’t pay rent. holding the minimum insurance. Definition: Equitable power of court to set aside entity status of corporation to hold shareholders liable on contract or tort obligations Rationale: the corporate form can’t be used to commit fraud Test/Requirements Such unity of interest and ownership that separate personalities of corporation and individual no longer exist o Factors: Disregard of corporate formalities. but something less than an affirmative showing of fraud E. Commingled and misused funds. and that state policy can’t be allowed to leave victims uncompensated o Remedy lies not with the court. Sea Land had judgment against PS. (DC applied this prong. including PS. failure to pierce the veil would sanction fraud or promote injustice Cases – Voluntary Creditors Sea-Land v. undercapitalization. o Court allowed Kinney to pierce corporate veil because Polan disregarded corporate formalities.
231. 211-214. (k). (b). [See below . your vote doesn’t matter When do shareholders vote? o At shareholder meetings – DGCL § 211 Special (§ 211(d)) or annual – required. 225. not clear where limit is. 216. 151(a). date set in accordance w/bylaws Can bring an action to force a meeting if one hasn’t been called in 13 months – DGCL § 211(c) Require quorum – DGCL § 211 Notice must be between 10 and 60 days before meeting – DGCL § 222-b o By written consent DGCL § 228 Can do anything you can do at a meeting Setting record date in such a situation o Voting by giving proxies to vote to “agent” (usually management) – DGCL § 212(b) Usually empowered to vote on any matter that may come before the meeting.DGCL § 225 (also empowers directors) o Extraordinary transactions Mergers – DGCL § 251(c) Target company always votes Acquiring company sometimes votes (see below p. Relevant Statutes o DGCL 141(a).§ 14(a) of 1934 Act and Rule 14a] What do shareholders vote on? o Amendment of charter – DGCL § 242(b)(1) Class always has the right to vote on an amendment if the action is adverse to the class – DGCL § 242(b) Del. 222-223. however o Directors Election of directors – DGCL § 211 Removal of directors – DGCL § 141(k) Default: can remove director with or w/out cause 141(k)(1): unless board is classified. 45) Class voting in mergers 18 . 228. then (unless provided for in the certificate of incorporation) you must show cause. which gives Board power to supervise business and affairs of the corporation. (d). Revocable at any time Content of proxy materials subject of federal regulation. 242 General o Shareholders have three basic rights Right to vote: most important Right to sell (if disappointed w/company’s performance) Right to sue (if there’s a breach of fiduciary duty) o Basic problem with shareholder voting Collective action problem: incentives for any individual shareholder to free ride far outweigh incentives to actively monitor the company. court interpreted this to only protect changes to things in the stock certificate o Bylaws – DGCL § 109(a)-(b) Limited by DGCL § 141(a). 218-220. otherwise the purpose of classified boards is defeated Action for contested election .
How are votes counted o Straight vs.DGCL § 271(b) Dissolution . or a director can only be removed if the amount of votes to remove him is ≥ the amount of votes needed to elect him – DGCL § 141(k)(1) o Plurality vs. With cumulative voting. Cumulative Voting Straight Voting 51% shareholder can elect all board members Cumulative Voting: each shareholder casts total # of votes equal to the # of directors he can vote for. multiplied by # of voting shares Ensures minority representation BUT. board can still abandon unilaterally . 3 directors With straight voting. asking what’s best for business 19 . With cumulative voting. can expand Board as a way to dilute voting power of minority block Example: A owns 199 shares. Each can divide up their votes among any directors. in some circumstances “belong to” corp. it violates its spirit: chancery courts are policy oriented. Majority Voting Plurality wins a director election unless changed by bylaw – DGCL § 216 Majority of outstanding shares needed to vote on mergers (if they require a vote) and charter amendments Separating Control from Cash Flow Rights o Law places restrictions on this for the sensible reason that we want to keep the residual claimants in control so that the controllers of the firm have incentives to maximize the total value of the firm o Circular Control Structures DGCL 160(c) A corporation cannot vote shares of the corporation that belong to it A corporation (1) cannot vote shares that belong to another corporation (2) if (1) holds a majority of the voting shares in (2) Speiser v.g. and thus be prohibited from voting. “Stop doing business in South Africa” in 1970s Note: advance notice bylaws require early submission to the company of any shareholder-originated agenda item for annual meeting.DGCL § 275 o Precatory Resolutions (when permitted to enter company proxy materials) E. which limits the time when proxy contests can be mounted. 1 held by a corporate subsidiary may. either the whole board has to be removed. even if the issuer does not hold a majority of shares entitled to vote for the election of directors of the subsidiary. B owns 101 shares. B definitely gets to pick one director. B casts 303 votes (101 x 3) and A cast 597 (199 x 3). Even though the structure does not violate the letter of the law. Default: all classes of stock vote on a merger unless charter states otherwise – DGCL § 212(a) Sale of all assets . A votes for all 3 directors. 1. Baker (complicated ownership structure gave Speiser control) Rule: Stock in corp.DGCL § 271(a) After approval.
Google.g. not in the US because of tax on intercorporate dividends Cross ownership ties Common in Asia with many family owned conglomerates Collective Action Problem and Voting o Collective Action Problem and Voting Rational Passivity: Costs of voting (time. NYTimes Permitted at founding. of independent shareholders. Carney (35% shareholder loaned money to approve merger) Texas International loaned Jet Capital funds to exercise warrants in order to prevent Jet’s voting against (effectively vetoing) TI’s merger with Texas Air. and agents of shareholder organization have lowered collective action costs Cure for the problem: Mutual funds? Pozen suggest they have little incentive to monitor because they just take a management fee Hedge funds? Kahan argues that they do have proper incentives since they get a proportion of each year’s returns in addition to the fee System responses to collective action problem. etc. info costs. voidable transaction subject to entire fairness review Maj. whereby stockholder divorces his discretionary voting power and votes as directed by offeror Old rule: buying votes is illegal per se Modern rule: voidable but look at the process Schreiber v. which reduce costs of voting Voting by proxy SEC mandated disclosure by issuer in connection with votes Reduces information costs Evolution of “agents” of institutional investors who contract with institutional investors to study company proposals and make recommendations Institutional Shareholders Service Reimbursements of reasonable costs in connection with proxy fight 20 . Test for vote buying: does vote buying agreement have object and purpose to further shareholder welfare? o If yes. but SEC prohibits NYSE and NASDAQ from listing shares with unequal voting rights unless initially offered to the market in that structure Stock pyramids Most popular worldwide. Jet received a low-interest loan in exchange for approving merger. subject to business judgment rule o Controlling Minority Structures Three main types: each type intended to entrench minority control Dual class share structures Rationale: beneficial for companies owned/controlled by founders Common in the US. o Vote Buying Definition: a voting agreement supported by consideration personal to the stockholder.) outweigh benefit However. and approved by The board. institutional shareholders and cheaper communication costs. e.
Must be ratified by shareholder (always is) Rosenfeld v. Fairchild o Rule: Directors acting in good faith may incur reasonable and proper expenses for solicitation of proxies and in defense of corporate policies Stockholders can also vote to reimburse successful insurgents ex post 21 .
it can stick proxy solicitor with the tab DGCL § 219: yes. withholding or revocation of a proxy Exemption under 14a-2-b-1? Solicitation is interpreted very broadly by the SEC. furnished with a proxy statement containing the information specified in schedule 14a o “Solicitation” has been interpreted very broadly by the SEC. such that investors risk legal action if they say almost anything about an upcoming election w/out filing a 14A Sometimes exacerbates the agency problem because it can make it more difficult for shareholders to communicate about management o Exemptions – DGCL 14a-2(b) Exempts solicitations to less than 10 shareholders TarPERS problem: wants to wage a proxy campaign by circulating a memo 14a-3: before soliciting a proxy. not the legislative process o 14-a-3 contains the central regulatory requirement of the proxy rules No one may be solicited for a proxy unless they are. you can’t solicit a proxy later in that season Access to shareholder list? 14a-7: no. but even if determined not to be a solicitation.Proxy Rules General o Federal rules originate with Securities Exchange Act of 1934. must put together a preliminary proxy statement and file it with the SEC Is this memo a solicitation? 14a-1-l-iii: the term “solicitation” includes: furnishing of a form of proxy or other communication to security holder under circumstances reasonably calculated to result in the procurement. chiefly 14(a)-(c) o Four major elements One: disclosure requirements & mandatory vetting regime to allow the SEC to assure the disclosure of relevant information Two: substantive regulation of the process of soliciting proxies from shareholders Three: specialized town meeting provision that permits shareholders to gain access to the corporation’s proxy materials and to thus gain a low cost way to promote certain kinds of shareholder resolutions. company can furnish the list or mail materials to shareholders itself If it chooses the latter. or have been. SEC says as soon as you use the b-1 exemption. and Four: general anti-fraud provision that allows courts to imply a private shareholder remedy for false or misleading proxy materials o 14(a) states that the SEC will promulgate rules Thus the rules are a byproduct of the administrative. if you can show a reasonable purpose 14a-8: Shareholder Proposals on Proxy Statements o Shareholders are entitled to include certain proposals in the company’s proxy materials Excluded: non-management nominations for director Advantage: low cost Don’t have to file with the SEC Don’t have to mail materials to shareholders o Grounds for exclusion of shareholder proposals from corporation’s proxy materials 22 .
under which such proposals would be considered on a case by case basis 23 . there are thirteen grounds of exclusion E. under majority system. withholding votes has no power. but always an option o Corporate Governance Proposals HP Example Pension fund wants director election to be based on majority vote.g.Shareholder proposals must satisfy certain formal criteria: Must state shareholder’s identity. if not procedurally Majority voting rules have swept the nation’s charters CA v. approval of proposal would be improper under state law. which board can accept or reject SEC declines HP’s no-action letter (14a-8-j). AFSCME (proposal to allow successful proxy fighters to be reimbursed) Holding one: such a proposal was a proper action by shareholders under DE law 109a vests power in shareholders to adopt amend or repeal bylaws Must be read in conjunction with 141a: the business of every corporation shall be managed by or under the direction of a board of directors o Court finds that bylaws must regulate the process by which decisions are made but not substantive business decisions o This bylaw was about process. it does HP adopts policy in response that if a director doesn’t receive a majority. it’s expensive. the proposal relates to a matter of ordinary business (which are the province of the board) If management gets a no-action letter from SEC saying they can exclude X proposal. the length of supporting statement. and the subject matter of proposal In addition. then what? Can still wage a proxy battle on your own. and replaced it with the prior rule. saying HP’s policy did not substantially implement the carpenters’ proposal Carpenters’ proposal narrowly lost at the shareholder meeting DE legislature amended the DGCL to make majority voting work better DGCL 141-b now provides that a resignation conditioned upon the director failing to receive a specified vote for reelection can be irrevocable o This functionally implements the carpenter’s proposal. the number of proposals. although it appeared to be about substance Holding two: the proposal if adopted would cause the corp. under DGCL it’s plurality Rationale: under plurality system. to violate DE law Does not violate DGCL or CA’s articles But it does violate common law o If it allowed a proxy fighter with bad motivations to loot the company it would cause the directors to violate their fiduciary duties if they reimbursed such a person’s proxy costs o Bubb: court could allow the bylaw but read in a “fiduciary out” o Corporate Social Responsibility Proposals SEC has withdrawn the bright line rule from Cracker Barrel which allowed employment-related CSR proposals to be categorically excluded from proxy statements. he has to tender his resignation to the board.
” Materiality Ds argue conclusory statements cannot be material w/in meaning of 14a-9 Rule: knowingly false statements that are conclusory may nevertheless satisfy the “materiality” prong if they can be proved false by available evidence Causation Can it be shown by minority shareholders whose votes are not required by law or corporate bylaw to authorize the corporate action subject to the proxy solicitation? P makes two arguments for causation One: acquirer wouldn’t have gone through with transaction w/o minority shareholder approval. rescission. agrees with dissent Dissent No authority demonstrates that 14a protects only minority shareholders whose numerical strength would permit them to vote down a proposal 24 . look at the big picture: SEC adopted this rule to ensure proxy solicitations are not fraudulent or misleading. except in such case as the proposal focuses on significant social policy issues Two: the degree to which the proposal seeks to micromanage the company on issues that shareholders would not be qualified to make an informed judgment on Might apply when the proposal is super specific or imposes timeframes. New test: two considerations in making the determination One: Subject matter of the proposal Management of the workforce would generally be excludable. for PR reasons Two: proxy statement was a means to satisfy a state statutory requirement of minority shareholder approval as a condition of making the merger unvoidable Court rejects one (too speculative) and two (no indication that minority shareholder approval would render the merger invulnerable to later attack) Bubb: court got it wrong here on causation. monetary damages o Virginia Bankshares (VBI owns 85% of Bank. etc Balance sought between allowing shareholders to assert their will over management w/o letting management be overwhelmed by crazy. solicits proxies 4 freeze-out cash merger) Proxy statement contained conclusory statements that merger presented opportunity to achieve “high” value for company’s shares and that price “fair.) Causation and Reliance: Causation of injury presumed if misrepresentation is material and proxy solicitation was “essential link in the accomplishment of the transaction” Remedies: Injunctive relief. expensive proposals with no chance of passing 14a-9: The Anti-Fraud Rule for Proxy Statements o Implied Private Right of Action A private right of action exists under SEC ’34 § 14(a) and Rule 14a-9 allowing investors hurt by a fraudulent statement to sue for damages o Elements Materiality: a fact is material if there is a substantial likelihood that a reasonable shareholder would consider the fact important in deciding how to vote – Bankshares Culpability: Negligence (2d & 3d Cir’s) or intentionality/recklessness (6th Cir.
Any article of a corporate charter inconsistent with 145(a)’s good faith requirement is unenforceable. a shareholder cannot state a claim based on mismanagement Rationale: If the rule were otherwise.” counts as success for the purposes of 145(c) 25 . Conticommodity (P corners silver mkt. In other words. boards would not undertake any risky projects even if in the best interests of shareholders Statutory techniques for limiting D&O risk exposure o Indemnification – DGCL § 145(a)-(f) Corporation can indemnify (i. sued) o P was employed by D Conticommodity at the time of actions in question. unless he’s held liable in a judgment and Ct.The Duty of Care Duty of care o ALI § 4. Expenses incurred in advance of action (assuming agent not liable) – 145(e) Mandatory indemnification if director is successful on the merits – 145(c) Waltuch (again) Rule: Escape from an adverse judgment (including settlement). and 3) with the care that an ordinarily prudent person would reasonably be expected to exercise in a like position and under similar circumstances o Litigated less than loyalty. pay the expenses of X) for Losses from actions done on behalf of corporation in good faith – 145(a) Losses resulting from criminal liability if agent had no reason to believe he committed a crime – 145(a) Legal fees in derivative lawsuits when director acted in good faith.145(d) Other rights to indemnification under bylaws. doesn’t approve indemnification – 145(b) Indemnification under (a) or (b) must be by independent actors .01(a) A corporate director or officer is required to perform his or her functions 1) in good faith.e. Ch. etc. – 145(f) Court interprets this to include a good faith requirement due to 145(a) Waltuch v. a corporate officer or director is not legally responsible to the corporation for losses that may be suffered as a result of a decision that an officer made/directors authorized in good faith. because the law insulates officers and directors from liability based on negligence in order to avoid inducing risk averse management of the firm The Need to Mitigate Director Risk Aversion Reasonable person negligence standard can’t be applied in determining liability It would make directors prohibitively risk averse In shareholders’ interest to offer sufficient protection to directors from liability o Gagliardi v. as opposed to “winning. suit to recover losses due to mismanagement) Rule: w/o facts showing self-dealing or improper motive. 2) in a manner that he or she reasonably believes to be in the best interests of the corporation. Trifoods (shareholder deriv. notwithstanding 145(f)’s permission to grant indemnification rights outside the limits of 145(a). wants indemnification from Conti for legal expenses o Rule: 145(a) does not permit indemnification of officers if the officer failed to act in good faith.
min. sues) 26 . result matters. errors of judgment are not sufficient as grounds for interference. would’ve gotten tax savings. look at process instead Shareholders benefit – Directors shouldn’t be so risk averse o Kamin v. an injunction Technicolor on breaches of duty of care o Cede v. P says if D sold DLJ instead. appraisal less than price paid by acquirer. Success includes anything besides an adverse judgment.g. CEO wants to retire) TransUnion sells itself to Pritzker for a price that was never negotiated or discussed. thus directors’ duty of care can still be the basis for an equitable order. P must allege gross negligence (failure of directors to avail themselves of all material and reasonably available information) or allege interestedness or disloyalty to the corp. Board gave shareholders shares of DLJ in kind. e. ABA Definition: a decision constitutes a valid business judgment when It is made by financially disinterested directors or officers Who are duly informed before exercising judgment Who exercise their judgment in a good faith effort to advance corporate interests Rationale Procedural: Converts factual question into legal one.. insulates D&O’s from jury Substantive: Courts don’t trust their judgment on subst. Van Gorkom (TransUnion has valuable NOL. which declined in value. self-dealing. American Express D Amex bought DLJ shares. or bad faith. P’s theory of liability: corporate waste Court: no fraud. not why No indemnification for breach of duty of loyalty or gross negligence o D&O Insurance – 145(g) Corporations can pay the premiums on D&O liability insurance Judicial protection of D&Os from liability for breaches of the duty of care o Business Judgment Rule Definition from Citigroup: The BJR is a presumption that in making a business decision the directors of a corporation acted on an informed basis. in good faith and in the honest belief that the action was taken in the best interest of the company Burden is on P to rebut the presumption: To rebut. Technicolor (takeover. Price was far above market but shareholder sues alleging breach of duty of care Holding: grossly negligent behavior (in context of merger) by disinterested directors didn’t merit business judgment protection First DE case to hold directors liable for breach of duty of care in which the board made a business decision Best interpreted as the first stab at articulating a corporate law of takeovers. more than imprudence or mistaken judgment must be shown Duty of Care in Takeover Cases: Smith v. rather than the duty of care having bite o 102(b)(7) Validated charter amendments that provide that a director has no liability for losses caused by transactions in which the director had no conflicting financial interest and had not otherwise breached the duty of loyalty 102(b)(7) waivers directed to damages. Van Gorkom o Smith v.
directors are entitled to trust their subordinates and need not take affirmative action (e. e.healthcare business. has 102(b)(7) . Technicolor expands it At pleading stage. Pritchard’s duties extended beyond objection and resignation to reasonable attempts to prevent the misappropriation of the trust funds” o Unclear if the standard is different for sophisticated directors. Allis-Chalmers (non-directors indicted for antitrust. Two: A breach of the duty of care or the duty of loyalty requires directors to prove the transaction was entirely fair Takeaways: Duty of care violation does not require P to show injury Damages can be calculated in different ways.Malpiede Board’s Duty to Monitor: Losses “Caused” by Board Passivity o Sins of omission rather than commission Incentives less likely to be distorted by liability imposed for passive violations. derivative suit) Rule: Directors are entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on notice something is wrong BUT. lawyers and i-bankers o Red Flag Doctrine Absent cause for suspicion. questions about patient referrals) 27 . e. -. rescissory damages Gross negligence w/r/t decision making process is sufficient to put burden on directors to show entire fairness But: gross negligence doesn’t necessarily mean that the substance was unfair – even with gross negligence the transaction can be entirely fair 102(b)(7) aims to limit director liability. Lower Court: absent proof of self-interest. P must allege duty of loyalty violation with particularized facts if corp. install and operate a corporate system of espionage) Graham v. presumed to concur in actions taken unless dissent filed Read and review financial statements Directors generally immune from liability if they rely on the opinion of counsel or independent auditors or the officer responsible for them Usually directors absolved from liability by informing other directors of impropriety But: “Mrs. is sufficient to rebut the business judgment presumption. Ch. there is an oversight duty: board must make good faith judgment that there’s system in place that is adequate to assure timely delivery to Board of appropriate info Caremark (Del.g. Thus less of a need for business judgment deference by courts o Basic rule: Directors personally liable if they (1) breach their duty to monitor that (2) proximately causes loss o Director duties (from Francis – mom director negligently lets sons loot company) Know the company’s business Not day to day. but in general Attend meetings If absent. a shareholder plaintiff must prove by a preponderance of the evidence that director negligence did cause some injury Like a tort principle.g. damages must be shown for recovery DSC rejects tort analogy One: Breach of the duty of care.g. w/o proof of injury.
but what if it’s uncertain? Does this prevent directors from taking any risk of violating the law? 28 . or 2) having implemented such a system or controls. you must plead and argue bad faith and duty of loyalty Citigroup (suit following 08 crash alleging failure to monitor and manage risks) Twist on Caremark: that standard is about failure to monitor employee misconduct. and requires bad faith (more than gross negligence) for a duty of care violation Disney tells us what is needed to find bad faith: o Bad faith Motivated by actual intent to do harm Intentional dereliction of duty. AT&T (donations to the DNC in violation of campaign finance laws) Rule: BJR cannot insulate D directors from liability if they did in fact breach a campaign finance law. bad faith must be alleged Test for director oversight liability: 1) directors utterly failed to implement any reporting or information system or controls. Ritter (DSC) (see also p. Holding: 102(b)(7). Caremark. 34) Endorses Caremark approach to duty of monitor. conscious disregard for responsibilities o Not bad faith Gross negligence Departs from Allis-Chalmers standard in imposing a duty (red flags no longer necessary). duty structure Makes sense for knowing violations of the law. and BJR place extremely high burden on P to state a claim for personal director liability for failing to see business risk Board’s duty to obey positive law o No business judgment protection for director authorization of an illegal act o Miller v. even if it was an exercise of sound business judgment. but high standard for finding a breach Stone v. show bad faith o Director consciously disregarded an obligation to be reasonably informed about the business o Director consciously disregarded the duty to monitor/oversee the biz. only a sustained or systematic failure of the board to exercise oversight will establish the lack of good faith that is a necessary condition to liability 102(b)(7) came into being as a result of Van Gorkom. Rule: Where a claim of directorial liability for corporate loss is predicated upon ignorance of liability-creating activities within the corporation. consciously failed to monitor or oversee its operations Court notes bad faith conduct by fiduciaries is a violation of the duty of loyalty Bubb: if you have a duty to monitor case or a duty of care case when there’s a 102(b)(7) waiver. here it’s failure to monitor business risk Rule: Under both Caremark and 102(b)(7) for oversight liability. o Duty to obey the law can be seen as a judge-created overlay on the fid.
(3) Controlling Shareholders Controlling shareholders: Formal Test (≥50%) or Practical Test Duty owed to whom? o Technically. Board approved Hayes’s plan to sell oyster beds to Keypoint.’s disinterested representatives and (2) deal on intrinsically fair terms o Evolution of the law of trusts Old rule: trustee can’t deal with trust property or with trust beneficiary Modern rule: trustee can deal with the beneficiary w/r/t the trust property if: (1) The beneficiary is competent (2) Full disclosure to the beneficiary (3) The transaction is fair By 1910. (2) Officers. or in the MBCA o Court defers to directors when they justify actions based on long-term corporate benefits Smith v. this was applied to corporation law o Disclosure Requirement Full disclosure allows the corporation to exercise independent judgment Hayes Oyster Hayes is director and CEO of Coast Oyster. Ford) Corporate form exists to maximize shareholder welfare (which may be argued to maximize welfare of other constituencies in process) Corporate Constituencies Corporations exist only b/c states created them to advance public interest by protecting all corporate constituencies (after all. but that doesn’t always settle it… o Issue most important in context of (1) insolvency and (2) terminal transactions o Two views Shareholder Primacy (traditional American norm: Dodge v. Barlow (Corporation gave charitable grant to Princeton) Court affirms charitable corporate gift Rationale: Modern conditions (wealth has shifted from private to corporate hands) require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities in which they operate Self-Dealing o General Fiduciaries who transact with corporation may not benefit at its expense Fiduciaries who transact with corporation must (1) fully disclose all material facts to corp. can’t get limited liability by contract) Constituency Statutes Directors have the (but not the obligation) power to balance interests of shareholder and non-shareholder constituents (in order to advance long-term shareholder interests?) Not adopted in Del. duty is owed to the corporation.The Duty of Loyalty General o Definition: Duty to exercise institutional power over corporate processes or property in a good faith effort to advance the company’s interests o Applies to (1) Directors. Hayes didn’t disclose his interest in Keypoint 29 .
of disinterested directors. transactions still voidable) because it involved self-dealing if Disclosure to board & good faith approval by maj.. of shareholders. 48): special committees of independent directors to simulate arm’s length negotiations o Kahn (p. Rationale: We don’t want courts making these decisions as to whether it’s fair in a particular situation. fully informed boards should Injury to corp. requiring fairness in addition to disinterested board approval seems to strain the language However. but nondisclosure by an interested director is inherently unfair. or intent to defraud not nec. conventional interpretation is that disinterested board approval only authorizes the transaction but does not foreclose judicial review for fairness 30 . director must establish that One: one of the following three o Disclosure to board and approval by a maj. Shareholders) o Safe Harbor Statutes DGCL § 144 No transaction voidable solely (solely is the key word. even if conditions below are met. business judgment rule applies Approval by a Disinterested Party (Board. honesty and fairness. fidelity in the agent is what matters Extent of disclosure requirement Recall Meinhard: some forms of behavior open to traders in the market not available to fiduciaries DE standard for disclosure is DGCL 144: all material information relevant But courts have formed their own tests o Weinberger (p. of disinterested directors or Disclosure to shareholders and good faith approval by maj. Court orders H’s interest in beds returned to Coast (effectively rescinding) Rule: Not every interested transaction is voidable. AND Two: The director has acted in good faith. Independent Committee. 48): fiduciary not required to state best price he’d pay or accept o Controlling Shareholders and the Fairness Standard Sinclair v. o Approval by disinterested members of the board Under the terms of the statute in Cookies and DGCL 144. Levien (Oil company paying dividends out of subsidiary it controls 97%) Intrinsic fairness test: burden on D to prove its transaction was objectively fair Rule: to invoke the intrinsic fairness standard when the situation involves a parent and a subsidiary 1) the parent must have received a benefit at the expense of the subsidiary 2) the fiduciary duty must be accompanied by self-dealing Holding: no self-dealing here b/c minority shareholders also received dividends. or o Disclosure to shareholders and approval by a majority of shareholders. or Transaction is entirely fair Quorum: Interested directors can count toward quorum – 144(b) Cookies (D-controlled bbq sauce company contracts with D-owned distributor) Iowa statute w/r/t self-dealing transactions has roughly same reqs as DGCL 144 Rule: For a self-dealing transaction not to be void. or o Transaction is fair and reasonable.
but shift the burden of proof to the plaintiff Two types of ratification decisions give rise to duty of loyalty claims o If vote involves interested controlling shareholder.Eisenberg: two reasons the fairness test should apply to interested transactions even w/ board approval One: directors are unlikely to treat one of their number with the degree of wariness with which they would approach a transaction with a 3rd party Two: it is difficult if not impossible to utilize a legal definition of disinterestedness in corporate law that corresponds with factual disinterestedness Cooke v. Bubb: not realistic way to look at actual incentives but a sound legal doctrine in that it keeps courts out of the boardroom o Approval by a special committee of independent directors Most common technique for assuring the appearance as well as the reality of a fair deal in controlled transactions between a subsidiary corporation and its parent Operation of the committee Requirements in Delaware Independent members Real bargaining power Vested w/ sufficient resources (retain outside bankers and lawyers for advice) Understanding that goal is to obtain not only fair but best available deal Effects of the Committee (if well executed) Shifts the burden of proving fairness from D to P (P must show unfairness) o Shareholder ratification of conflicted transactions Requirements for valid shareholder ratification Lewis v. or o Leave “entire fairness” as the review standard. Vogelstein (generous stock option plan put to shareholder vote) Rule: Shareholder ratification invalid if: o A majority of affirmative shareholder votes had conflict of interest. 5 mos later Ds pick loan 2 that’s best for Ds) Rule: The court will presume that the vote of a disinterested director signals that the interested transaction furthers the best interests of the corporation despite the interest of one or more directors Rationale: the disinterested directors have no incentive to act disloyally and should be only concerned with advancing the interests of the corporation.: exchange of corporate assets for consideration so small that no reasonable person would be willing to make the trade Effect of valid shareholder ratification Wheelabrator (disinterested shareholders approved acquisition of WTI by WM) Rule: The operative effect of shareholder ratification in duty of loyalty cases has been either o To change the standard of review to the business judgment rule. P must prove fairness Normally parent-subsidiary mergers o If vote involves interested directors. or o The transaction is a corporate waste Corporate waste is OK if the vote is unanimous Corporate waste def. business judgment rule applies 31 . Oolie (Ds make loan to TNN.
Ch.. AND o Terms of deal not sufficiently egregious to raise suspicions o see Cooke v. Oolie fairness (P) 144(a)(1) §5. majority shareholder). business judgment rule applies If P succeeds. (see Cookies Food Products).02 (Burden of Proof) Neither board nor Entire Fairness (D) Entire Fairness (D) Shareholder approval 144(a)(3) Disinterested directors BJR (P) Reasonable belief in authorize Cooke v.g.02 (Burden of Proof) Neither board nor Entire Fairness (D) ? Shareholder approval Sinclair (board approval. parent on both sides of parent-sub dealings If P fails.g. burden shifts to Ds to prove by a preponderance of the evidence that the challenged transactions were entirely fair to the corporation..02a-2-b Shareholders ratify BJR / Waste (P) Waste (P) Wheelabrator 144(a)(2) Controlling Shareholder Transactions (usually parent-sub) Standard of Review DGCL 144 ALI 5.o Fairness Requirement: Burden Issues P has initial burden to establish (1) fiduciary duty and (2) self-dealing e. approach)… Business Judgment if o Low risk that fiduciary dominated the board. but not disinterested) Disinterested directors Entire Fairness (P) ? authorize (SC/IC) Kahn Shareholders ratify Entire Fairness (P) ? (majority of minority) Wheelabrator/Kahn Disney: “if Ps succeed in rebutting the presumption of the BJR.” ?? 32 . burden shifts to D to prove entire fairness of transaction With approval by majority of disinterested 3d party (Ct. Oolie P must prove lack of entire fairness if… o High risk of fiduciary dominance (e. then With no approval by majority of disinterested 3d party. OR o Egregious terms (or perhaps burden on D here) Interested Director Transactions Standard of Review DGCL 144 ALI 5.
but are too dispersed Fixed. salary) Reduce amount that manager has at risk at any moment But not enough to make manager accept risky projects of long-term value Performance-based Compensation helps solve risk-averse problem o Requirements / Standards for Compensation in General Common Law Rule on Compensation Grants Disney (Ovitz turns out not to be a good CEO. CEO and CFO must give any bonuses. and/or trading profits realized in the 12 months after the incorrect information was publicly disclosed Dodd-Frank Say on pay rule which requires a nonbinding shareholder resolution every 1. $140m NFT payment) Charter had a 102(b)(7) waiver. company might give CEO new options) Stock price can be poor indication of performance (except perhaps CEO) 33 . negligence o Disjuncture between the standards of conduct announced by the court and those enforced by the court in terms of liability SEC Disclosure Rules Disclosure of pay of top 5 officers Sarbanes-Oxley § 302 If a company has to restate financials as a result of misconduct. self-dealing transaction Goal of Compensation: align the incentives/economic interests of the director/officer and the company by Recruiting talented people & motivating them to work hard for company’s benefit BUT. 2. Ps had to show the board acted in bad faith Definition of bad faith announced by court o Bad faith Motivated by actual intent to do harm Intentional dereliction of duty. a conscious disregard for one’s responsibilities o Not bad faith Gross negligence Eisner’s actions don’t rise to bad faith. at most. short-term compensation claims (e.. or 3 years on whether the pay at the company is approved by shareholders o Stock Options and Grants Thereof Rationale for Stock Option Compensation Performance: Incentive to increase stock price and take risks (no downside) Mergers: Clause that causes vesting when the company merges and isn’t the surviving company – incentive for M&A Tax Law: Corporation can’t deduct employee compensation above $1 mil for top 5 employees unless the compensation is related to productivity Disadvantages of Stock Option Compensation Performance: When the stock declines below option price. incentive based pay.g. CEO loses incentive to get it back up (as solution. Executive Compensation o General D&O Compensation is a necessary. agency Problems Shareholders want risk-neutral managers.
Ritter The fiduciary duty violated by failing to act in good faith is the duty of loyalty Thus the duty of loyalty is not limited to cases of conflict of interest. Vogelstein o Rejects D’s motion to dismiss on waste grounds. and conscious disregard for one’s responsibilities (see Disney p. waivable if charter contains § 102(b)(7) provision Breach of Duty of Loyalty Liability not waivable under 102(b)(7) for breach of duty of loyalty and actions done in bad faith Bad faith includes intent to harm intentional dereliction of duty. Van Gorkom) However. but her level of inattention went beyond negligence) Gross Negligence Liability possible for gross negligence (see Smith v. but grounds and participates in all fiduciary duties Del. esp. but says institutional shareholders now strong enough that shareholder assent is a more rational means to monitor compensation than judicial determinations of the fairness or sufficiency of consideration (Business Judgment) Good faith determination by disinterested board or committee. entails BJR o Policy question: Is CEO compensation out of control? Arguments that it is Multiples of shop-floor wages Arguments that it isn’t Parallel growth of the American economy (correlation w/ mkt. (see p. cap and DOW) Higher CEO turnover CEO skill Worth it to the shareholders Response to shop-floor multiples divergence Globalization constrains shop-floor worker’s pay Duty of good faith and 102(b)(7) o Is there a “Duty of Good Faith” Not a separate duty. 33) 34 . if ratified by disinterested shareholder vote. 28) o Director Liability and DGCL § 102(b)(7) Negligence: No liability for negligent director action (see Gagliardi) However. Alternative metrics Relative performance: how is company doing relative to its industrial peers? Product development innovations Development of the next generation of management / succession plan Rule for Validating Option Grants: Waste/Business Judgment (Waste) Validation requires judicial finding that reasonable board could conclude that corporation could reasonably expect to receive a proportionate benefit Lewis v. says there’s no separate duty of good faith – Stone v. it encompasses cases where the fiduciary fails to act in good faith. liability possible for inaction (see Francis.
Cellular Information Disclosure is a safe harbor. (3) whether corp. info used to recognize/exploit opportunity Fairness Test How fiduciary learned of opportunity Whether corporate assets used to exploit Other fact-specific indicia of good faith and loyalty to corporation Company’s line of business Bubb: tests bleed into each other and are not entirely distinguishable o When a fiduciary may take a corporate opportunity Disclosure and Rejection Did the fiduciary disclose the opportunity to board? Was the decision the business judgment of a disinterested decision maker? Burden of showing this is on the fiduciary who took the opportunity Non-disclosure Possible in Del. partners have exit options Not necessarily the case in closely held corporations Donahue (minority shareholder sues retiring controlling dir. 35 . Corporate Opportunities o Fiduciary cannot… Wrongfully take an opportunity that equitably belongs to the corporation Compete w/ corporation w/o full disclosure and proper permission from the board o Determining what constitutes a “corporate opportunity” Expectancy or Interest Test Whether opportunity w/in firm’s legal/practical business expectancy or interest Line of Business Test Whether the corporation could be reasonably expected to exploit opportunity Consider: (1) how opportunity came to attention of fiduciary. not a requirement o Waiving corporate opportunity constraints DGCL § 122(17) – Corporation may waive corporate opportunity constraints in charter increasingly common for tech companies with interconnected boards o Duty of Loyalty in Close Corporations Treated differently than public corporations Minorities can be at mercy of controlling shareholders Like partnerships: Small number of shareholders/partners Illiquid market for shares/partnership interest Shareholders/partners often run the company Not like partnerships: Partnerships at will. (2) how far removed from “core economic activities” opportunity is. under Broz v. the corporation has a duty to offer an equal price to minority shareholders. who sold shares back) Equal opportunities rule: if a controlling shareholder causes the corporation to buy his shares.
when Ps may cease to be shareholders because the corporation in which they own shares disappears Bubb: these are not particularly meaningful. the underlying substantive claim Advantages Bring claims of fiduciary breach to court on behalf of disaggregated shareholders Encourage monitoring Disadvantage maybe too many lawsuits. adopts similar rules o Standing One: Must be a shareholder at all times during the suit Rationale: assure right interests Two: Must have been a shareholder at the time of the wrong unless you acquired the shares through the operation of law (e..Shareholder Lawsuits Types of Shareholder Suits o Direct Claims/Class Actions under FRCP 23(b)(3) Claim to recover damages suffered by individuals directly because they are shareholders o Derivative Suits General Assertion of claim on behalf of corporation against officer or director charging them with wrong to corporation 2 suits in one Suit against the directors for failing to sue the third party Suit against the third party.1. or wrong type of lawsuits o Distinguishing between direct actions and derivative suits Test from Tooley Who suffered the alleged harm? The corporation got hurt derivative suit Suing shareholders individually got hurt class action Who would receive the benefit of the remedy? The corporation derivative suit Shareholders class action Derivative Suits: Requirements o See FRCP 23. Del. demand requirement is what matters o Demand Requirement Two options Make demand of the board to bring the suit itself which must then be reviewed for wrongfulness under business judgment standard (rare in DE) OR Plead futility: i. that the board would not be able to consider the demand in an independent and disinterested fashion.g.e. and therefore demand is excused Futility of Demand Test (Aronson/Levine Test) 36 . you inherited the stock) Rationale: bias against buying up lawsuits Three: P must be able to fairly and adequately represent shareholder interests Chiefly has bite in the context of mergers/dissolutions.
In what circumstances does a board lose its authority under 141(a) to decide whether or not to prosecute a suit? Two prong test for demand futility (PLEADING stage) One: does complaint rebut with well-pleaded facts the threshold presumption of director independence or disinterest by raising a reasonable doubt that a majority of the board o Had a financial interest in challenged transaction. or o Lacked independence (i. board buys his stock to shut him up) Committee of outside directors negotiated. approved buyback Court said Ps failed to raise reasonable doubts of independence. ALI Universal demand rule: ALI: P must demand that the directors file suit. Rales v. she can then bring suit Universal non-demand rule: DSC assumes that if you make demand. as here. you concede that the board is independent. board dominated by transaction proponent). but court doesn’t spell this out.e. suit is not a bus. the decision being challenged was made by the board of a different corporation Test for demand futility in a double derivative suit: prong 1 only o Does complaint create.. or o Otherwise failed to exert due care o NB: Court is focused on the challenged transaction. Bubb says inquiry should be about whether board could properly consider the demand The two are related. a reasonable doubt that. only the second prong of the Aronson-Levine test is open to you o Special Case: If a company merges with another company Cash Merger P is no longer a shareholder. does complaint plead particularized facts sufficient to create reasonable doubt that the challenged transaction was the product of a valid exercise of business judgment? o Was the board grossly negligent? Was there bad faith? Levine v. sound BJ Delaware vs. decision of the board o 3) where. with particularized factual allegations. it should OR Two: if P cannot show directors are interested. Blasband (Ds sold company to Aqu. issued bonds. if this is conceded. so no standing Stock Merger (Parent-Subsidiary) Double Derivative Suit definition: P shareholder of parent corporation seeks recovery for cause of action belonging to subsidiary corporation. bought junk bonds) Prong 2 of the Aronson test challenging the actual transaction does not apply: o 1) where a business decision was made by a company’s board but a majority of the directors making the decision have been replaced o 2) where the subject of the deriv. the board could have properly exercised its independent and disinterested business judgment in responding to the demand? 37 . as of the time the complaint was filed. if rejected. Smith (Perot: GM sells shitty cars.
remedy is new board) Rule: governance changes resulting through a settlement. Court will not adopt a universal demand requirement or require that P demonstrate a reasonable probability of success on the merits o Requiring reasonable probability too onerous pre-discovery Court found demand excused b/c there was reasonable doubt that majority of Danaher board could act independently. Industries (suit alleges board domination. o Calculation of Attorney’s Fees Percentage of award rule Incentives for premature settlement May create incentives for attorneys not to seek nonmonetary relief # of hours worked rule Incentives for lawyers to run up hours Ways to deal with a derivative suit o Motion to Dismiss Failure to state a claim – FRCP 12(b)(6) Failure to make a demand (but see above on demand futility) – FRCP 23.1 38 . Bubb: this is the 1st prong of Aronson. A. properly applied to the demand. b/c beholden to Rales bros NB: must plead futility on BOTH boards. attorneys fees can be taken out of that Substantial benefit rule Definition: attorneys who prosecute a lawsuit can be awarded attorneys fees if the lawsuit gives the corporation a substantial benefit. can be enough of a benefit to have the corporation pay attorneys fees Dissent: substantial benefit rule may force corporations to liquidate assets Substantial benefit is good from a policy perspective because it creates incentives for plaintiffs’ lawyers to not only seek monetary damages but equitable remedies when they are more appropriate. instead of the transaction: “more satisfying analysis b/c the point of demand futility is plead that board couldn’t respond to the demand.J. as well as avoidance of litigation costs through settlement. or o Two prevented an abuse which would prejudice corporate rights & interests Fletcher v. this case only about the parent board Incentive Issues / Attorney’s Fees o Attorneys are the solution to the collective action problem w/r/t shareholder suits Typically receive 20-25% of any monetary recovery Point of allowing these lawsuits is to create incentives for corporate officers to abide by their fiduciary duties o When attorneys fees are awardable Common fund doctrine Definition: When a lawsuit creates a common fund for claimants. even if the benefits were not pecuniary and the action did not produce a fund from which fees might be paid Sufficient to find substantial benefit: (from Fletcher) o One action helped maintain the health of the corporation and raise standards of fiduciary relationships.
o Special Litigation Committee General SLC is initiated by the board under DGCL 141(c), investigates (generally with the help of an outside law firm), and suggests dismissal or settlement Usually composed of 2 directors not on Board at the time of the transaction. Delaware’s Two Step Test for analyzing SLC recommendations to dismiss Zapata v. Maldonado (derivative action; two new board members SLC) One: first, the Court should inquire into o the independence of the committee o the good faith of the committee and o the bases supporting its conclusion o (burden is on the corporation to show these things) Two: the court should determine, applying its own independent business judgment, whether the motion should be granted. o Kaplan held that whether to proceed to step two was in court’s discretion Question: why can a court second-guess the board’s evaluation of a derivative action when demand is excused a la Zapata but cannot do the same when demand was made and the board rejected suit? Different approaches to determining director independence Oracle (D appoints two Stanford profs to its board, then to SLC) o Test for director independence Focuses on impartiality and objectivity Broad notion of independence and what motivates people In addition to greed: love, friendship, collegiality Beam ex rel. Martha Stewart (not an SLC!! A demand-futility case) o Distinction between SLC context and demand futility context Demand futility board presumed independent SLC burden on SLC to establish its own independence Different approaches to business judgment review of SLC recommendations This is about step two of the test from Zapata Zapata: court should consider matters of law and public policy in addition to corporation’s best interest Joy v. North: cost benefit approach: where the court determines that the likely recoverable damages discounted by the probability of a finding of liability are less than the costs to the corporation in continuing the action, it should dismiss the case New York’s Test One step: if committee well informed and independent BJR Settlement o Most cases are settled prior to judgment on the merits Usually lead to an award of attorneys’ fees About half of settlements result in monetary recovery D&O insurance generally pays for the settlement fund D&Os indemnifiable under DGCL § 145(b) Officers and directors almost never face out of pocket costs Still, directors don’t like being sued
Reputational issues, etc, help preserve the deterrence function of derivative suits o Settlement by Special Committee Carlton Investments v. TLC Beatrice (SLC recommends settlement) Court determined that the settlement was fair and approves over P’s objection Notes than normally in evaluating a proposed settlement the court does not make substantive determinations, but since this settlement was negotiation by an SLC “uncomfortably” applies step two of Zapata; result not irrational or egregious When are derivative suits in a corporation’s interest o May confer something of value on the corporation Compensation for past harms Forcing a governance change o Can deter wrongdoing that might happen in the future
Transactions in Control
Why do buyers pay a premium for control? Different theories: o One: premium for the private benefits of control The power to capture salary, perks, the prestige of being the boss o Two: premium paid by buyers who have a superior business plan Technical definition of control premium: o The amount above the current market price of the stock that the control block is traded at o Control premium = K x (Vb/N) + PBCb – K x (Va/N) o Where A = current controller B = prospective purchaser of control N = the number of outstanding shares K = # of shares owned by A Va = the value of the company under A’s control Vb = the value of the company under B’s control PBCa = the private benefits of control in A’s eyes (irrelevant for this calculation) PBCb = the private benefits of control in B’s eyes Regulation of Control Premia o Zetlin (owner of 44% of stock w/control of corp sells for $15/share over $7 market price) Market rule: a controlling shareholder is free to sell, and a purchaser is free to buy, the controlling interest at a premium price unless there is Looting of corporate assets Conversion of a corporate opportunity Fraud or other acts of bad faith o Perlman v. Feldman (D sells control of Newport Steel to Wilport during Korean War) Holding: Feldmann converted a corporate opportunity to raise the price of steel into a private benefit for the buyer and extracted that value in the sales price and thereby violated his fiduciary duty to minority shareholders o Easterbrook on the market rule Market rule (good) Sale of control can lead to new offers, plans, and arrangements that create gains Premium price rec’d by seller of control block amounts to ≠ distribution of gains Reduces cost to purchasers of control more efficient Equal opportunity rule (bad) Minority shareholders entitled to sell their shares on the same terms as controller Increased cost to bidders may cause them to drop out On Perlman Court’s holding makes a questionable assumption: that the gain resulting from the Feldman plan was not reflected in Newports price, although the stock was publicly traded and the plan was known to investors Wilport could not profit from the deal unless The sale of control resulted in an increase in Newport’s value, or Wilports control of Newport was the equivalent of looting o But there’s no evidence of looting; Newport’s stock price actually went up. So sale must have resulted in an increase in Newport’s value Sale of Corporate Office 41
and fraudulent. Muscat (board appointed new dir’s as part of transaction selling 10% of stock) Holding: Court upholds the reelection of the new directors at the annual meeting Looks like a controlling block of stock was sold o Brecher (D gets 35% premium selling 4% block for appointing buyers candidate to CEO) Holding: Paying a premium for control while purchasing 4% of a company’s outstanding shares is contrary to public policy and illegal Looks like the 4% was not a controlling block of stock Looting o A holder of controlling shares may not knowingly. M loots A. A minority shareholders sue D) Rule: when transferring control of a corporation to another. relatively weak duty Controlling shareholder has a fiduciary duty toward the corp. sell his shares to one who intends to loot the corporation by unlawful activity o Harris v. subject company’s board has to recommend to shareholders whether to accept or reject offer – 14e-2 Anti-fraud Provision – §14(e) Prohibits misrepresentations. or perhaps negligently. if circumstances would alert a reasonably prudent person to a risk that his buyer is dishonest or in some material respect not truthful. recklessly. it’s likely that reasonable investigation wouldn’t have discovered M’s plot. no insider trading – 14e-3 Regulation of substantive terms Tender offer has to stay open for a period of at least 20 days – 14e-1 Bidders must open their tender offers to all shareholders and pay all who tender the same best price – 14d-10 Shareholders who tender can withdraw while tender offer is open – 14d-7 42 . sells A to M. or misrepresentative practices Once the tender offer is commenced. Carter (D controls A. a duty devolves upon the seller to inquire into the bona fides of the buyer Like a tort principle: each person owes a duty to those who may foreseeably be harmed by her action to take such steps as a reasonably prudent person would take in similar circumstances Looks like red flags doctrine from Alice-Chalmers. o Carter v. D’s incentives were aligned with Ps in that sense Tender offers o Large public companies in the US generally do not have a controlling shareholder o Someone wishing to purchase control can Buy shares in the market Make a tender offer open to all shareholders o Williams Act Rationale: give shareholders time and info to make informed decision about tendering Four principal elements Early warning to public and management: §13(d) Investor must file a 13D report within 10 days of acquiring 5%+ beneficial ownership – 13d-1(a) Mandated Disclosure: §14(d)(1) Tender offeror must disclose identity. deceptive. and future plans – 14d-3 Within 10 days of offer. financing. nondisclosures. like a director has Bubb: since D seller of control got fleeced.
vote. P sues alleging Williams Act violation) Holding: D’s failure to announce its share purchases was not a violation of 14(e) of the Williams Act or Rule 10b-5 Rationale: bringing such transactions within the scope of the Williams Act would be to be rule that no large scale acquisition program may be lawfully accomplished except in the manner of a conventional tender offer SEC/Wellman 8-factor test for determining a tender offer *Active and widespread solicitation of public shareholders Solicitation is made for a substantial % of the issuer’s stock *Premium over the prevailing market price Terms of the offer are firm. or sell stock – 13d-5(b)(1) Each group member deemed to beneficially own each member’s stock Brascan (D purchases 24% of P over 2 days. not negotiable The offer is contingent on the tender of a fixed # of shares The offer is open for a limited period of time The offerees are subjected to pressure to sell their stock Public announcements of a purchasing program precede or accompany a rapid accumulation 43 . Key Definitions Beneficial: means power to vote or dispose of stock – 13d-3(a) Group: is anyone acts together to buy.
g.g. form matters a lot in M&A Stuff to be familiar with o Statutory merger under 251 o Short form merger under 253 o Asset acquisitions under 271 o Reverse and forward triangular mergers Motives o Efficiency Economies of scale: reducing average cost of production by spreading it over larger output load. Ways to Acquire Control of a Business o One: A can buy all or substantially all of T’s assets o Two: A can buy all of T’s stock o Three: A can merge itself or a subsidiary with T on terms that ensure A’s control One: asset acquisition / sale of substantially all assets – §271 o Shareholder vote on a sale of substantially all assets A’s shareholders have no statutory right to vote T’s shareholders vote when selling all or substantially all assets Majority vote of outstanding stock o Definition of “substantially all” Unclear under §271 Katz v. Bregman (D CEO sells Canadian sub constituting 51% of overall assets) Rule: 51% of a company’s assets can constitute substantially all of its assets 44 . two under-producing factories merge into one and lower costs Economies of scope: spreading costs across broader range of related business activities. e. sales of firm o Complete managerial authority not optimal. One: who has the best information? Mgmt. almost always has best information Two: who has the best incentives? Mgmt. vertical integration Replace management o Redistributive gains Tax considerations (NOLs valuable but cannot be sold – take from gov’t LBOs (take from creditors Monopolization (take from consumers o Bad Empire building Hubris Allocation of Power in Fundamental Transactions o Two considerations should determine allocation of decision-making power w/in orgs.Mergers and Acquisitions NB: corporate acquisition can take many legal forms. e.. e. not business decisions.g. incentives may be misaligned with shareholders on. but complete shareholder consent on every transaction is unworkable o Optimal: shareholders reserve power to veto matters that are most economically significant and in which they can exercise informed judgment Investment-like decisions.
becomes compulsory for all shareholders Result: acquisition receives tax treatment of a tender offer w/o the holdup problems of a true tender offer or awkward residue of minority of public shareholders But now the shareholders of the target are shareholders in the acquirer?? o Two-step merger (Delaware) Step one: A makes a tender offer for most of T’s shares at an agreed price. which follows the tender offer and removes minority shareholders who failed to tender shares Often the second step consideration is cash rather than stock in A Three: mergers o Statutory Mergers – DGCL 251 Acquirer and Target boards negotiate a merger in which A will be the surviving corporation and each board votes to approve merger agreement A acquires all of the assets and liabilities of T Not necessarily the case in an acquisition (see above) T shareholders give up their stock in T and get stock in A (or other consideration) per merger agreement Each board must approve and recommend merger to shareholders – 251(b) If a majority of shares outstanding vote. certificate of merger filed Shareholder Voting on Mergers T’s shareholders always vote A’s shareholders presumed to have the right to vote. company’s stock o Full legal control requires ownership of 100% of shares Problem: minority shareholders can create holdout Solution: share exchange and two-step mergers (also DGCL 253 w/90%+ ownership) o Share exchange A tender offer negotiated with the target board. or a majority of. that. but need not vote when A issues < 20% new stock to finance the acquisition – 251(f)(3). court here is stretching the definition of substantially all to reach the result it thinks is fair. successor liability doctrine w/r/t tort victims and environmental cleanup Disadvantages: costly and time consuming Two: stock acquisition o Purchase of all. and 45 . NB: there was another bidder that the seller rebuffed. board of T promises to recommend to its shareholders Step two: merger between the target and a subsidiary of A. after approval by a majority of shareholders. incentivizing competitive bidding to get the highest price for shareholders (Revlonesque) Hollinger (sale of Telegraph newspapers) Rule: 57% ≠ substantially all of its assets Thorpe (cont. sh-holders want to block sale of sub. sell their control block to parent) Rule: Need for shareholder approval depends not only on size of transaction but its affect on the corporation If the transaction is out of the ordinary course and substantially affects the existence and purpose of the corporation shareholder vote o Advantages and Disadvantages Advantage: A retains T’s liability shield But.
shareholder files a petition in Chancery Court within 120 days after merger becomes effective demanding appraisal – (e) Court holds valuation proceeding to “determine [the shares’] fair value exclusive of any element of value arising from the accomplishment or expectation of the merger.” (h) No class action device available. or 46 . and Merger agreement does not amend A’s charter in any respect – 251(f)(1) Rationale: mergers satisfying these conditions have too little impact on the surviving corporation’s shareholders to justify the delay and expense of a shareholder vote Dissenting shareholders may have appraisal rights under 263 Advantages and Disadvantages Advantage: A acquires everything Disadvantage: A gives up liability shield w/r/t T Known liabilities are priced in. Shareholders can get appraisal for fair value by Court of Chancery – 253(d) o Triangular Mergers (a form of the two-step merger above. vote and markets illiquid (NA now) Possibility of getting cheated (more likely in conflict transaction w/domination) Appraisal Process – 262 Shareholders get notice of appraisal right 20 days before shareholder vote – (d)(1) Shareholder submits written demand for appraisal before shareholder vote – (d)(1) If merger is approved. no shareholder vote is needed for a merger. but Chancery Court can apportion fees among plaintiffs as equity may require – (j) Market-out rule – 262(b)(1)-(2) Appraisal denied when (b)(1) T’s shares are traded on a national security exchange. capitalizes it with cash/stock of A Sub negotiates friendly tender offer to acquire majority of T’s shares Two: subsidiary merges with T Sub pays cash or stock to T’s shareholders at tender If sub survives forward triangular merger If T survives reverse triangular merger Voting provisions – 251 (NB: get comfortable with 251(f)) Advantages Retains T’s liability shield Relatively quick Appraisal Rights o General Rationale Liquidity when mergers required < unan. Security held by surviving corporation’s shareholders will not be exchanged or modified – 251(f)(2). but still a problem of unknown liabilities Short-form mergers – 253 When a shareholder owns 90% stock. more of an asset acquisition?) Two steps One: A creates a subsidiary.
Appraisal rights are not granted to shareholders under asset sales (271). Excludes: value attributed to the merger. T’s shares are held by ≥ 2. i.e. or Shares in a 3rd company traded on a national security exchange or with >2000 shareholders. but only under proper mergers (251) Duty of loyalty in controlled mergers o Tension between controlling shareholder’s exercise of voting rights and exercise of control over the corporation Controlling shareholders have a fiduciary duty of loyalty when exercising control over corporate actions and decisions 47 .e. T dissolves. or Any combination of the above o Valuation technique – 262(h) What is to be valued – three options: Value as a pro rata claim on going concern value (DE approach) Includes: all elements of future value.000 registered holders. or Cash. gives A’s stock to shareholders) Rule: The doctrine of de facto merger will not be applied to an asset sale. unless market-out exception (262) Asset Acquisition (271) Yes if all or substantially all assets are being sold (271-a) No (stock exchange rules might require vote to issue new shares) No unless provided in charter (262-c) De Facto Mergers o Is it better to treat mergers as a functional concept or a formal/technical concept? o DE courts take the formalist side w/r/t the range of statutory protections available to shareholders in a corporate combination i. they treat asset acquisitions that turn out like mergers as asset acquisitions o Hariton (T sells assets to A for stock in A. including benefits of the deal How claims measured DCF technique T voting rights A voting rights Appraisal rights Statutory merger (251) Yes – need majority of shares outstanding (251-c) Yes unless <20% shares being issued and other conditions (251-f) Yes if T shareholders vote. or Shareholder approval not required for the merger Unless merger consideration is other than (b)(2) Stock in the surviving corporation. Value as minority shares. apply a minority discount Value as a pro rata claim on going concern value. including the fact that the company may have been a target company in another merger.
OR NB: In Kahn the committee was not independent o An informed majority of minority shareholders approves the transaction 48 . wants Lynch to buy Celwave. finds up to $24/share good price. structured.: power to do what other shareholders can’t. threatens hostile tender offer if rejected) Court: Alcatel. pays $21) A’s study used T’s data to make a fair price determination of $24/share that was never disclosed to T’s board or shareholders. did count as controlling shareholder Rule: Entire fairness standard is the exclusive standard of judicial review in examining the propriety of an interested cash-out merger transaction by a controlling or dominating shareholder Burden: begins with the controlling shareholder. there may be self-dealing transactions Minority shareholders can bring duty of loyalty suits Can seek safe harbor under §144 but it’s onerous Weinberger (Signal is majority shareholder of UOP. influence the board o Cash Mergers / Freeze-out Mergers Typical process Parent notifies T of going private or minority freeze out proposal Parent issues press release Proposal subject to special committee approval T sets up special committee of independent directors Generally hires bankers and lawyers Parent negotiates with special committee and hopefully agrees on price Why do freeze-outs? Public companies have to comply with SEC regulations Minority shareholders cannot influence board elections but can still assert rights When A and T are in the same business. considered holistically One: Fair dealing o How was the transaction initiated. how was the approval of stockholders and directors obtained o Includes the duty of candor Two: Fair price o What constitutes control Shareholder ratification and independent director approval can ease the burden on self-dealing fiduciaries of proving entire fairness.g. negotiated. may have breached their duty to Signal had they disclosed the $24/share price they never should have done this study in the first place Board approval or minority shareholder approval would have sufficed under 144 to ease the burden from entire fairness. which approved the transaction Two Signal directors doing the study were conflicted on both sides. doesn’t disclose to UOP board. but the conflicts require entire fairness Rule: Entire Fairness standard has two components. disclosed to directors. w/43% ownership of Lynch. Lynch declines: Alcatel offers to acquire Lynch. wants to buy out minorities. but burden shifts to the challenging shareholder plaintiff IF o An independent committee of directors approves the transaction. Control def. comm. but controlled mergers raise special issues Kahn (Alcatel has 43% stake in Lynch. e.
o Special committees of independent directors in controlled mergers Two approaches to judicial review of independent special committees One: treat the special committee decision like that of a disinterested and independent board business judgment review Not totally banished in Delaware. and Disclosing adequate information for the minority to make an informed judgment If such conditions are met business judgment review Holding: Unocal’s offer is coercive because its definition of minority includes o Stockholders who are affiliated with Unocal as directors and officers o The mgmt. court applies BJR because although A owned 46% of shares. Western National. makes exchange offer. whose incentives are skewed by their employment 49 . Pure creates special committee. it only nominated 2/8 directors pursuant to a “standstill agreement” Two: continue to apply the entire fairness test. there’s no obligation to pay a fair price business judgment review In re Pure Resources (Unocal owns 65% of Pure.Test: a showing that the action taken was as though each of the parties exerted its bargaining power against the other at arm’s length is strong evidence that the transaction meets the test of fairness. Unocal declines. even if the committee appears to have acted with integrity. goes ahead with offer) Rule: a tender offer freeze out such as this will be considered non-coercive when Part one (w/r/t the offer) o One: it is subject to a majority of the minority tender condition Minority means fully independent from the controlling stockholder o Two: the controlling stockholder promises to consummate a prompt §253 merger at the same price if it obtains more than 90% of the shares. since courts cannot easily evaluate subtle pressures and feelings of solidarity between board members Kahn approach o Controlling shareholder fiduciary duty on step one of a two-step tender offer If a controlling shareholder “offers” a transaction to the board must pay a fair price under entire fairness review a la Kahn. seeks higher offer. w/burden on P If a controlling shareholder “offers” a transaction directly to public shareholders in the form of a tender offer as long as the offer is not coercive. and o Three: the controlling stockholder has made no retributive threats Part two (w/r/t the independent committee) o The controlling stockholder must give the independent directors on the target board adequate time to react to the offer by Hiring their own advisors Giving the minority shareholders a recommendation on the offer. of Pure.
Two step test One: has management. etc. a court must not substitute its judgment for the board’s Preclusive: A response is preclusive if it deprives stockholders of the right to 50 . excludes Mesa) Rule: when a board takes defensive measures in the face of a hostile takeover bid. back end is shit bonds.e. it has an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.Public Contests for Corporate Control General o Control contests are an important constraint on manager-shareholder agency costs i. share buyback) DSC clarifies the second prong of Unocal Second prong of Unocal from above Determine whether the defensive measures adopted are reasonable in relation to the threat posed Rule: If the board’s defensive response is not draconian (preclusive or coercive) and is within a range of reasonableness. they don’t want to lose their jobs in a takeover for poor performance o Two traditional ways to initiate a hostile change in control Proxy contest: run an insurgent slate of candidates for board election Has returned with the rise of hedge funds and other institutional investors Tender offer: purchase enough stock to obtain voting control Costlier than a proxy contest. but has the advantage of capturing shareholder attention with promises of cash up front rather than promises of future performance. with reasonable investigation. nature of the deal (coercive tender offer). employees. effects on non-shareholder constituencies (creditors. o Traditional judicial approach to a board’s response to a hostile takeover attempt If the response was self interested in an immediate financial way entire fairness Otherwise business judgment review Problematic b/c although in hostile takeover situations boards are not interested in the sense of self-dealing. determined that a threat exists? o Threat: bad price/timing. in good faith. Unocal board offers to buy the backend shares for $72. they are never truly disinterested in efforts to acquire control There was a need to find a middle way o Begins to change in the 80s Van Gorkom: T board found grossly negligent when it seemed to comply with duties Unocal: articulates for the first time a standard of judicial review btwn BJR and EF Revlon: another type of heightened review short of entire fairness Defending against hostile tender offers o Unocal (Mesa makes front loaded (coercive) tender offer for Unocal’s stock at $54.) Two: is the defensive measure adopted reasonable in relation to the threat posed? Two consequences of Unocal Coercive tender offers stopped because boards could adopt defensive measures SEC adopted rules that banned discriminatory self-tenders of shares o Unitrin (Amgen hostile tender offer for Unitrin. customers. reacts w/poison pill.
However. we have to play the game. judges basically just use their fiduciary duty radar and when it goes off they set things right. and when it comes to Revlon. because there’s inherent power in the board to manage the company’s affairs Passes Unocal test One: board determined that there was a threat in the marketplace of coercive twotier tender offers Two: Boot strap and bust up takeovers were increasingly common. the board was afraid such takeover would take the form of a two-tier offer Choosing a Merger or Buyout Partner o Board’s entrenchment interest can affect not only takeover defenses but also its choice of a merger or buyout partner o Management can obtain benefits in friendly deals Place on the surviving corporation’s board 51 .’s outstanding stock Two: without first receiving target board’s blessing The person who triggered the rights cannot buy the discounted stock her holdings become extremely diluted o Moran (Household adopts poison pill triggered when >20% shares bought in the market as a preventative measure to ward off future threats) Holding: boards have authority to adopt shareholder rights plans 151-g: authorizes the issuance of stock 157: authorizes the issuance of rights 141-a is also working here. burden shifts back to plaintiffs to show that the defensive action does not satisfy business judgment review Looks a lot like business judgment review Bubb: despite the fancy complicated doctrine.g.g. 20% of the corp. bond. the structure really does matter The Poison Pill (shareholders rights plan) o General Hostile tender offers Pro and Con Pro: useful device for disciplining corporate management Con: exposes disaggregated/disorganized shareholders to abusive t-offer tactics o Description Nominally: shareholders rights plans are rights to buy a capital asset. receive tender offers or precludes a bidder from seeking control by fundamentally restricting proxy contests or otherwise Coercive: A response is coercive if it is aimed at forcing upon stockholders a management-sponsored alternative to a hostile offer Burden on D directors to show board action proportionate and reasonable If they meet their burden. share Really: alters the allocation of power between shareholders and boards How they usually work Rights plan is adopted by the board Shareholder vote not necessary if corporation has a provision in its charter allowing it to issue stock Rights to buy the company’s stock at a discount are distributed to all shareholders These rights are triggered if One: someone acquires more than e. e.
fairness demands a canvas of the marketplace to determine if higher bids may be elicited Exemption allowed in very limited circumstances When directors possess a reliable body of evidence with which to evaluate the fairness of a transaction. a long term strategic plan) can constitute a threat under the first prong of Unocal just as much as structural coercion (e. as here bad o Barkan on Revlonland: Level playing field for bidders When multiple bidders are competing for control. Van Gorkom ($50-60 good for LBO. board adopts poison pill and puts debt on balance sheet. Time (Time has strategic plan w/Warner. Consulting contracts Termination payments o Smith v. stockholder vote approving the merger does not exonerate the board b/c the board is a fiduciary. they may approve the transaction without conducting an active survey of the marketplace Pulling together Unocal and Revlon o Paramount v. a target abandons its long-term strategy and seeks an alternative strategy also involving the breakup of the company If the board’s reaction is only a defensive response and not an abandonment of the corporation’s continued existence. must focus on one thing: maximizing value for shareholders Duty of loyalty issue (end of case says board violated the duty of care) The company. Two circumstances. Paramount sues to stop the deal) Rule: Before Revlon duties attach. Time transforms merger deal into tender offer for Warner. directors’ only obligation is to shareholders (different from Unocal) Lockups not per se illegal: If the security guaranteed enhances the bidding good If the purpose is to thwart other bidders. is liable to the noteholders Implausible that directors would risk liability from noteholders Here. Paramount bids on Time. not the directors. o Revlon (P makes hostile cash tender offer for Revlon. Revlon enters agreement w/Forstmann w/lockups) Rule: When a sale/breakup of the company becomes inevitable. P raises bid. which implicate Revlon duties One: when a corporation initiates an active bidding process seeking to sell itself Two: in response to a bidder’s offer. fairness forbids directors from using defensive mechanisms to thwart an auction or to favor one over another Market check required When the board is considering a single offer and has no reliable grounds on which to judge its adequacy. without excluding others. board approves sale to Pritzker for $55) Holding: Board was grossly negligent in failing to act with informed reasonable deliberation in agreeing to the merger proposal.g. there must be substantial evidence to conclude that the dissolution of the target board is inevitable. the directors’ role changes from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders Change from Unocal: instead of focusing on other constituencies.g. Unocal duties attach o One: substantive coercion (the threat to. a two tiered tender offer) 52 . e.
control of Time here was in the market before and after merger. traditional DE concern for stockholder voting rights) which takes 2 forms One: Judicial determination regarding the adequacy of the decision making process employed by the directors Burden on the directors to show they were adequately informed Two: A judicial examination of the reasonableness of the directors’ action in light of the circumstances then existing Burden on the directors to show that they acted reasonably (not perfectly) Time did not reject the “change of control” rationale for triggering Revlon duties nor hold that a breakup of the company is essential to give rise to Revlon duties NB: the “not excluding other possibilities” language before the two part test Revlon duties under QVC In general. o Paramount v. the court drew the line at the point at which public shareholders are excluded from meaningful participation in governance in the combined company.o Two: Time’s response was not aimed at cramming down on shareholders a management sponsored alternative. by a controlling shareholder or otherwise De facto definition of control more likely than de jure since QVC’s analysis rests on policy considerations expect 30-35% control to trigger Revlon Board action in such circumstances subject to enhanced scrutiny (mandated by the threat of reduced voting power. or b) a breakup of the corporate entity (does this include simple sales. makes offer w/3 lock ups. directors have the obligation to (from QVC) Be diligent and vigilant in examining all available offers Act in good faith Get all material information reasonably available to evaluate offers Negotiate actively and in good faith with all considered parties Strategies for getting the best price for shareholders Conduct an auction – Barkan Market check – Barkan Consider whether (from QVC) o Defensive measures are reasonable If they limit directors duties to fulfill their fiduciary obligations. directors’ obligation is to seek the best value reasonably available for the stockholders. or does that fall under change in control?). QVC makes better offer. but aimed to carry forward a preexisting transaction in an altered form reasonably related to the threat This case establishes the limits of Revlon NB: change of control not the determining factor for triggering Revlon. control premium being sold. they are invalid and unenforceable o Offers in place are or will continue to be conditional o Offers in place can be improved o Offers in place reasonably likely to come to closure o Timing constraints are an issue 53 . Paramount does everything it can to not sell itself to QVC) Rule: If a corporation undertakes a transaction which will cause a) a change in corporate control. In adopting a change in control trigger. yes. QVC (Viacom wants to buy Paramount. but that’s not the test.
which make a board’s decision not to recommend a negotiated acquisition a trigger Rejection of the negotiated deal by a vote of T’s shareholders A later sale of assets to another firm 54 . There is only one Revlon duty: get the best price for stockholders at a sale of the company.g. the deal to shareholders in light of a better offer DGCL §146 now allows for force the vote provisions. o Viable and realistic alternatives exist Cash vs. when the target directors began negotiating the sale of the company. lockups in a merger of equals with no change in control If the sale of the company becomes inevitable. perhaps applies Unocal test (Time) Rationale: no plausible information difference between directors and shareholders when the offer is cash. the more lenient courts will be in analyzing it Triggers for lockups and termination fees Failure of the board to rec. duty of care not applicable here Holding: directors did not breach their duty of loyalty by failing to act in good faith in considering and approving the merger Test for breaching the duty of loyalty by failing to act in good faith Intentional dereliction of duty Conscious disregard for one’s responsibilities Test for complying with the duty of loyalty by acting in good faith Disinterested and independent Aware of the company’s value Considered the offer with the help of financial and legal advisors Revlon duties here did not kick when the acquirer filed a 13D in 5/10 signaling its interest. 567-568) All cash offered triggers Revlon All stock offered in a merger of equals doesn’t trigger Revlon Mixture of cash and stock continuum. stock merger (p. Protecting the Deal o Lockups Historically Options to target’s assets: virtually nonexistent since Revlon Options to target’s stock: nonexistent since FASB changed policy in 2001 Today: Termination Payments Cash payments to A if T elects to terminate merger or fails to close the deal Scrutiny Often scrutinized under Unocal (as these are a type of defensive measure) E. Revlon applies Under Revlon. but on 7/10. the later in the process the lockup happens. when it’s stock the directors potentially have an information advantage relative to shareholders Countervailing factor: agency problem boards may want to entrench themselves in office o Lyondell (chemical company sells itself to European company for $48/share) Lyondell has a 102(b)(7) waiver. court assesses board’s good faith.
corporation not privileged to do so if corporation breaches liable for damages Answer: Fiduciary out If some triggering event occurs (such as a better offer or an opinion from outside counsel that the board has a fiduciary duty to abandon the original deal). Two: within a range of reasonableness Holding: the target board did not have the authority to accede to the acquirer’s demand for an “absolute” lockup. it secures 2/3 vote from remaining shareholders and Board approval 55 . Rests more on the fiduciary issue NB: this case not comparable to Weinberger (which imposed entire fairness review) because in Weinberger the controlling shareholder was on both sides of the deal State Anti-Takeover Statutes o DGCL § 203 Corporation may not engage in a “business combination” with a subsidiary any time within 3 years of gaining ownership. because the law is not clear fiduciary outs still important Also important to signal the good faith of a board’s directors. Uncertainty in the doctrine DSC seems to have held contracts that violate fiduciary duties unenforceable Suggests damages would never be available against a corp. esp. meaning any stockholder vote was robbed of its effectiveness preclusive and coercive o Defensive measures also unenforceable b/c there was no fiduciary out and the provisions together would prevent the board from discharging its fiduciary duties to minority stockholders. o No-Shop Provisions T board cannot actively solicit other bids and sometimes is restricted from discussions if someone solicits them Board may have to submit proposed agreement to shareholders and recommend it Lockups serve a purpose by inducing bidders into the contest who might not enter without the guarantees provided by lockups Fiduciary duties in conflict with no-shop provision Van Gorkom held T’s board has no fiduciary right to breach a contract i. T board can avoid the contract without breaching it. if the whole package of lockups will be upheld or struck down together o Omnicare (A demands force the vote lockup that essentially guarantees it will acquire T) This is a stock for stock merger Revlon does not apply. unless It acquires 85% or more in the first purchase. Unocal analysis Unocal analysis of the board’s defensive measures One: threat: the possibility of losing the Genesis offer Two: is the response reasonable: two step test under Unitrin One: not preclusive or coercive o Board fails here. that abandons a transaction subject to Revlon on the grounds that a better deal is available However.e. the force the vote + voting agreements guaranteed stockholders would approve the merger. or If it acquires between 15% and 85%. even if the directors’ fiduciary duty requires them to breach.
o Not so important after the development of the poison pill and the Williams Act Hostile tender offers are not successful on their own. ITT delays meeting. restructures to block Hilton) Holding: Court applies Unocal. Blasius and Unitrin to find ITT could have found Hilton’s offer inadequate (satisfies Unocal 1?) but finds the installation of a classified board in the spinoff corporation is preclusive and coercive under Unitrin. the board must show a compelling justification “The shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests. board.” o Hilton (Hilton TO/proxy contest. Rule: The central importance of the franchise to the scheme of corporate governance requires that Unocal not be applied and that closer scrutiny be accorded to such transaction. would be takeoverers have two options Friendly option: negotiate with the board to get them to remove the pill Hostile option: tender offer + proxy contest These actions may lead to further defensive steps on part of the target o Schnell (board moves up the date of the annual meeting to screw over acquirers) Rule: Actions taken with the intent to frustrate a proxy contest are a violation of the board’s fiduciary duty o Blasius (board adds two 2 new members to prevent acquirers from adding 8) Holding: A board cannot act for the principal purpose of preventing the shareholders from electing a majority of new directors. 56 . board has to pull the poison pill Proxy Contests for Corporate Control o In a poison pill world.
Repide (P dir..Tarnowski Comes from agency law: agent may not use principal’s info for personal profit BUT. such as a vote on merger. Director Dealing with Company Shares (Modern State Law Approach) o Fiduciary/Agency Theory Corporate officials who deal in corporation’s securities on the basis inside info w/o securing informed consent breach fiduciary duty to the corporation One rationale: inside information is a corporate asset and the corp. Goodwin (D CEO buys own stock after a promising mining survey. who says nothing) Rule: Where special facts exist. P seller sues) Holding: Given that the knowledge upon which D relied in purchasing the stock was only a speculative theory. now under DE law the board has a fiduciary duty of candor to truthfully disclose all material facts relevant to shareholders’ decision Federal Statutory Law 57 . is therefore entitled to any profits made by its agents by trading on it . not widely adopted Freeman v. offers to buy shares from D dir. Decio (earnings overstated. a director has an obligation to disclose these material facts or refrain from buying corporate stock in a face to face transaction.Insider Trading Why is it bad? o Faith in the market is diminished o Incentives for managers to move the stock price up and down o Unfair to let officers use privileged information to gain an advantage over others Fraud at common law o Five elements A false statement Of material fact Made with the intention to deceive Upon which one reasonably relied and which Caused injury o Remedy generally not available solely for nondisclosure w/o overt deception o Remedy not available for losses of persons trading over stock exchanges o Director Dealing with Company Shares at Common Law Majority Rule: director’s only duty is to the corporation. CEO sells stock before truth comes out) Derivative suit: corporation is suing the directors Holding: o One: Should not expand fiduciary duties so broadly to encompass an abstract injury to the corporation Here there was no actual injury o Two: Remedies under federal securities laws are more effective o State Law Disclosure Obligations When a board is seeking some shareholder action. D had no duty to disclose it to the seller. no duty to disclose Minority Rule: (trustee/beneficiary approach) director has duty to disclose material information when trading with shareholders in a company’s stock Intermediate Rule Strong v.
or course of business which operates as a fraud or deceit upon any person In connection with the purchase or sale of any security Originally SEC was intended to bring suit Implied private right of action read in later in Kardon 2d circuit most friendly to IPRAs SCOTUS was for a time. shareholders with >10% of the corporation’s stock) to file public reports of any transactions in the corp’s securities. not federal. does §253 short form cash merger. or To engage in any act. neither present o Rationale: §10(b) did not expressly provide a private cause of action Shouldn’t be implied where unnecessary to ensure fulfillment of Congress’s purposes Fiduciary duty is traditionally a matter of state. w/in 2 days of the trade under SOX §403 A covered person who buys and sells shares within 6 months is conclusively presumed to have done so on insider information Remedy Corporation has right to disgorgement of insider’s profits Formula: look backwards and forwards 6 months (but transaction before D was an insider do not count) Pay the highest amount that this generates – inference goes against the insider Have to match the number of shares whichever direction you go What is included in “purchase or sale” Purchases and sales.o §16(b) and Rule 16: Ban on short-swing profits 16(b) requires statutory insiders (directors. it only prohibits conduct involving manipulation or deception. scheme or artifice to defraud To make any untrue statement of a material fact or omit to state a material fact in order to make the statements made…not misleading. Ps sue) o Shareholders don’t bring §262 appraisal suit. has since pulled back Santa Fe (D owns 95% of stock. obviously Derivative transactions Swaps. law Goldberg (private right of action not totally dead under Santa Fe) 58 . officers. practice. allege fraud w/derivative suit o Holding: 10b-5 does not encompass breaches of fiduciary duty. brightline approach Underinclusive: insider trading can occur over a period >6 months Overinclusive: short-swing transactions need not involve insider information o §10 and Rule 10b-5 Congress in §10 punts to the SEC to develop regulations SEC enacts 10b-5 in 1942 Unlawful for any person…by the use of…interstate commerce or a nat’l exchange To employ any device. shorts Mergers Probably: Cash mergers Probably not: Stock for stock mergers Bottom line: simple.
underinclusive o Rationale: Requirement of preexisting relationship analogizes to fraud Allows case by case review of relationships. o Rule: A derivative action can be brought under 10b-5 on the basis that the transaction between the corporation and a fiduciary or controlling shareholder was unfair. overinclusive o Rationale: Inherent unfairness of a party taking advantage of inside info o Criticism: unclear where the fraud is if there’s no deception o Texas Gulf Sulfur (drilling sample suggests large mineral deposit) Rule: Anyone in possession of material inside information must either disclose it to the investing public. Roberts: Basic duty to disclose arises from o One: the existence of a relationship affording access to inside information intended to be only for a corporate purpose. or abstain from trading in or recommending the securities concerned while such inside information remains undisclosed Rationale: 10b-5 is based on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information Fiduciary Duty Theory o Rule: A10b-5 violation requires a breach of a preexisting fiduciary relationship between the alleged violator and the affected shareholder Reaches a narrower set of insider trading activities. not from the mere possession of nonpublic market info. if the transaction involved stock and P can show A misrepresentation or nondisclosure that Caused a loss to the shareholders Elements of liability under 10b-5 False or Misleading Statement or Omission (whether there’s a duty to disclose) Cady. thus selective targeting o Criticism: Does not reach behavior like D in Chiarella Dodges question on how insider trading defrauds uninformed traders o Chiarella (D printer buys stock in corp inferred from takeover documents) Rule: The duty to disclose stems from a relationship of trust and confidence. Won’t do this without evidence of congressional intent 59 . and o Two: the unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure Equal Access Theory o Rule: Anyone with inside information must abstain from trading on that information or must publicly disclose the information Broad conception of liability. here D was not a corporate insider & received no info from the issuer of the stock he purchased (the target) Rationale: We cannot affirm D’s conviction without recognizing a general duty between all participants in market transactions to forgo transactions based on material nonpublic information.
himself. who tells broker Chestman. denying it publicly) o Holding: Materiality in the context of a merger does not require agreement-in-principle 60 . Gov’t convicted Chestman under two theories One: aiding and abetting Keith’s misappropriation Two: tippee of the misappropriated information Both required Keith to have breached his FD to the source Holding: Keith owed no fiduciary duty to his wife/her family Kinship does not establish a fiduciary duty Confidentiality agreement cannot be imposed unilaterally can be implied but only from a preexisting FD-like relationship SEC’s Response: Rule 10b-5-2 A person has a duty of trust or confidence for purposes of the misappropriation theory Whenever a person agrees to maintain info in confidence Whenever two persons have a history of sharing confidences Whenever a person receives material NPI from a spouse. child or sibling o O’Hagan (D works at law firm working on TO for Pillsbury. buys calls) Holding: Liability may be predicated on the misappropriation theory §10(b) req’s that conduct involve “deceptive device/contrivance” fiduciary’s feigned loyalty to the principal satisfies this distinguished from Santa Fe: all facts disclosed no deception §10(b) also req’s deception w/r/t purchase sale of any security does not refer to deception of an identifiable purchaser/seller Anomalous result: seems like if the fiduciary discloses his plans to the source no liability (but he’d probably be in f’d under other laws) Materiality General formulation: The significance a reasonable investor would have placed on the withheld information in deciding how to act – Basic Specific formulation: Balancing of probability that event will occur with the anticipated magnitude of the event in light of total company activity – Texas Gulf Basic v. who tells husband Keith. and clients. Misappropriation Theory o Rule: One who misappropriates nonpublic information in breach of a fiduciary duty owed to the source of the information and trades on that information to his own advantage violates 10b-5 Distinguished from fiduciary duty theory: Misappropriation theory shifts the focus from the trader and counterparties w/which he trades to the relationship between the trader and his source of information o Criticism No basis for offering recovery to anyone but the employer/client o Chestman (D and his broker buy stock based on inside info from family) Waldbaum agreed to sell his company. who tells daughter Susan. Levinson (companies negotiating merger. who buys stock for Keith. tells sister Shirley. parent.
manipulate or defraud o may be inferred from reckless or grossly negligent behavior Pleading: two approaches o 1) Simply state that D acted w/scienter (9th Cir. not SEC) Rule: Misrepresentation/omission must cause both P’s transaction and loss o Like but-for causation in tort law o Dura Pharmaceuticals: more facts needed to show causation Remedy Rule: Uninformed. D discloses) Holding: The tipper got no personal benefit from tipping D. tells D analyst about fraud. and o Test: Tipper breached FD if he benefits. not SEC) Rule: Rebuttable presumption that P relied on the integrity of the market price o Rationale: Fraud on the market Market price rapidly reflects all available information (ECMH) Misrepresentations artificially inflate/deflate market price D’s can rebut by showing o (a) misstatement did not affect the price o (b) P’s decision to trade did not rely on the market price Causation (necessary for P. not SEC) P must be a buyer or seller of stock. from tip Tippee knows or should know there’s been a breach Dirks v. not just anyone 61 .Elkind o Limited at max to insider’s profits o Rationale: Taking away profits takes away incentive for insiders to trade Tipper / Tippee cases Rule: Tippee must disclose/abstain only if Tipper breached his fiduciary duty/ReTAC by tipping.Scienter Definition: specific intent to deceive.) or o 2) Facts that give rise to strong inference of fraudulent intent (2d Cir) Standing to Sue (necessary for P. SEC (former officer of corp. so he didn’t breach his duty therefore D didn’t have a fiduciary duty D not liable o §14 and Rule 14e-3(a) SEC’s interpretation of 14e-3(a): (validated in Chestman) Anyone who obtains inside information about a tender offer that originates w/ either the offeror or target must disclose the info or abstain from trading No fiduciary duty or ReTAC required Not quite equal access theory because information has to come from offeror or target. directly or indirectly. Holding stock in reliance on false information is insufficient – Blue Chip Stamps Reliance (necessary for P. deceived investor may recover loss on stock up to reasonable time after learning of tipped info or public disclosure of it .