Agency Partnerships Corporations Corporate Creation and Liability Corporate Purpose Fiduciary Duties Derivative Actions General Securities Regulation, Insider Info Corporate Governance, Proxy Issues Closely Held Businesses
STATUTES USED: Restatement of the Law (Third) Agency (R3A)
Agency in General
Agency: The fiduciary relationship that arises when a principal manifests assent to 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. §1.01 R3A o Manifestation: Assent or intention is manifested through written or spoken words or other conduct. §1.02 R3A Three Requirements of Agency: o Principal’s manifestation of assent for the agent to act o Principal’s control of the agent’s actions on behalf of principal o Agent’s manifestation of assent to act on principal’s behalf
Creation of an Agency; Scope of Agency
Agencies can be created in several ways, some of which do not require an express or even intended creation. o Parties labeling not controlling: The “principal” and “agent’s” characterization of the relationship is not controlling; the relationship has legal effect only when the above requirements are met. Courts examine the totality of the circumstances to determine whether an agency relationship exists. §1.02 R3A
Actual Authority: An agent acts with actual authority when he reasonably believes, based on the principal’s manifestations to the agent, that the principal wishes the agent to act. §2.01 R3A (see §3.01 R3A). o Scope of actual authority: An agent may act to fulfill express or implied objectives in the principal’s manifestations, as well as acts necessary or incidental to fulfilling such objectives, that the agent reasonably believes is required. §2.02(1) R3A. Implied Authority: An agent has implied authority when it can be circumstantially proven that the principal actually intended the agent to posses such powers, and such powers are practically necessary to fulfill the principal’s manifested objectives. Mill Street Church of Christ v. Hogan. Considerations: The past conduct principal had allowed, the necessity of the agent’s actions, the reasonability of the agent’s actions. Inherent Agency Power: An agent acting within the scope of their agency has inherent authority to commit torts. See below. o Employer-Employee relationship: An employee is an agent whose principal has the right to control the manner and means of the agent’s performance of work. §7.07(3)(a) R3A. Scope of employment: An employee acts within the scope of employment when performing work assigned to them by the employer, or engaging in a course of conduct subject to the employer’s control. §7.07 R3A. The employee does not necessarily have to be acting to specifically further the employer’s interests. Acts that are the result of the employee’s tendencies and habits in relation to that employee’s fulfillment of obligations are within the scope of employment. Ira S. Bushey & Sons, Inc. v. United States. Independent Contractors held to be Employees: If a party holds substantial control over an “independent contractor’s” operations, then the independent contractor can be considered an employee for torts purposes. Humble Oil & Refining Co. v. Martin If the independent contractor retains significant control over the inventory operations, they are treated as an independent contractor. Hoover v. Sun Oil Company. Assumed Control by Creditor: A creditor who assumes control of his debtor’s business may become liable as a principal for the acts of the debtor in connection with that business. Gay Jenson Farms Co. v. Cargill, Inc. o Not merely a veto power over the debtor, but an active attempt to control the actions of the debtor. Id. 2
Fenwick. an agency relationship exists between a franchisor and a franchisee if the franchisor retains significant control over the operations of the franchisee (such as by requiring certain standards for operation) AND the 3
. Watteau v. §2.03 R3A. §7. o Agent was Negligently Selected or Controlled: the agent was negligently selected. v. or the actions are ratified by the principal. Principal’s Vicarious Liability: A principal is subject to vicarious liability for the actions of their agent in the following situations: o Agent Acts with Apparent Authority: Agent was acting with apparent authority in dealing with third party on or purportedly on behalf of the principal.
Liability of Agency Relationship
Generally: A principal can be held liable for the acts of their agent that harm a third party. §2. supervised.-
Apparent Authority: The power of an agent or actor to affect the principal’s legal relations with third parties. §2. and that belief is traceable to the principal’s manifestations/actions.07(1) R3A. o Employee Acts within Scope of Employment: Employee was acting within the scope of employment and committed a tort.05 R3A. Three-Seventy Leasing Corp. §7. If the tort was committed to allow the employee to further their duty as an employee.06(2) R3A. §7. §7. See independent contractor issue above. Ampex Corp.01 R3A. retained. The agent can also be held liable. the principal would be subject to tort liability. A principal can be held liable to a third party in contract if the agent acted in a way that would make the third party believe that a contract had been executed. then the tort was within the scope of employment.04(2) R3A. This power arises when the third party reasonably believes the agent/actor has the authority to act on behalf of the principal. Watteau v. §7. Principal’s Direct Liability: A principal is subject to direct liability for the actions of their agent in the following situations: o Agent Acts with Actual Authority: The agent acts with actual authority. and: Agents actions are tortious. even if acting as an agent. §7.08 R3A. Grimsley. or otherwise controlled. Apparent Agency: For purposes of tort liability. OR If the principal had acted instead of the agent. trained. Undisclosed Principal Liability: If the undisclosed principal has notice of the agent’s conduct and that it might conduce others to change their position. Manning v. the principal is liable to third parties who are justifiably induced to change their position by an agent acting on the principal’s “behalf” without actual authority.04(1) R3A. Fenwick.06(1) R3A. o Undisclosed directions don’t count: A principal cannot rely on undisclosed limitations on the agent’s power.
even if it is unlikely.02 R3A. and to comply with all lawful instruction of the principal. Acting Within Scope of Actual Authority: An agent has a duty to only act within the scope of their authority.standards are designed to create an appearance of uniformity meant to cause the public to think the franchisee is part of the franchisor’s business.10 R3A. Use of Property and Information: An agent has a duty to not use property for the agent’s own purposes. v. §8. General Automotive Manufacturing Co. Regem.07 R3A. §8. §8. or should know.01 R3A.
Fiduciary Obligations of Agents
Agent’s to Principal o Duty of Loyalty: An agent has a duty to act loyally for the principal’s benefit in all matters connected with the agency relationship. Competition: An agent has a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal’s competitors. and to not use or communicate the principal’s confidential information for the agent’s or third party’s purposes. Singer.04 R3A. Singer.11 R3A. 4
. v. Acting on Behalf of an Adverse Party: An agent has a duty to not deal with the principal on behalf of an adverse party in a transaction connected with the agency relationship. Good Conduct: An agent has a duty to act reasonably and refrain from conduct likely to damage the principal’s enterprise. and the information can be provided without violating a superior duty. §8. §8.05 R3A.03 R3A. When information may provide some benefit to the principal. the agent has a duty to report it – especially if the agent wishes to act on the information for himself. §8. Miller v. the principal would want to know. Material Benefit from Agency: An agent has a duty not to gain material benefits from a third party in connection with transactions made on behalf of the principal. or through other uses of the agent’s position. §8. Reading v. McDonald’s Corp. An agent is liable to his principal if he takes advantage of his agency to make a profit for himself. §8. §8. All of the rules below can be understood in terms of a duty of loyalty. Providing Information: An agent has a duty to reasonably try and provide information that the agent knows. General Automotive Manufacturing Co. Contract Duties: An agent has a duty to act in accordance with the express and implied terms of a contract with the principal.09 R3A.
o No intent needed: No requirement of any intent of parties to form a partnership. o Limited Liability Partnerships: A partnership that has filed with the State to form an LLP is still governed by the default rules. tenancy in common. competence.15 R3A. However. Ex: Parties who supplied securities as collateral to an existing partnership expressly declined becoming partners. §202(b) UPA. Martin v. §202(a) UPA. o Default rules govern: Absent a written partnership agreement. tenancy by entirities. common property. or part ownership does not by itself establish a partnership. §8. as co-owners. only the above elements need to be met. §8. the court held that this did not preclude the parties being considered partners. §202(c)(3) UPA: A debt by installments or otherwise For services as an independent contractor or of compensation as an employee Rent An annuity to a representative of a retired partner 5
. §202(c)(2) UPA. even if there is a common interest. o Specific Formation Rules: Joint tenancy. the parties would be partners. a business for profit. absent a written partnership agreement. Sharing returns of property does not by itself establish a partnership. as well as to deal fairly and in good faith. and diligence normally exercised by agents in similar circumstances. §202(c)(1) UPA.14.08 R3A. Presumption: A person who receives a share of the profits of a business is presumed to be a partner.-
o Duty of Care: An agent has a duty to act with care. and that if there was a showing of the parties’ intention to form an association to carry on as co-owners of a business for profit. unless the profits were received in payment of.
General Partnership: A partnership is formed whenever there is an association of two or more persons to carry on. Peyton.
STATUTES USED: Uniform Partnership Act (1997) (UPA). Principal’s Duties to Agent: A principal has a duty to indemnify an agent suffers a loss on behalf of the principal. §8. the statutory rules of partnership govern the partnership. even if profit was made.
Not governed by partnership agreement: There are a few areas of partnership law that cannot be altered by the partnership agreement: Information: a partner’s right to information regarding partnership affairs cannot be varied. Disagreements about ordinary business matters are settled by majority rule of the partners. §401(c) UPA. §401(b) UPA. Liability: the principle of joint and several personal liability cannot be varied. §401(e) UPA. §401(j) UPA. o Management Right: To have an equal right in the management and conduct of business.Interest or other charge on a loan – even if it varies with the profits and earnings of the business For the sale of the goodwill of a business or other property o Partnership agreements: If there is a written partnership agreement. Right: To gain interest on payments (b. Partner’s Enumerated Rights and Duties o Payments Right: To have an equal proportional share in the partnership profits. and d). Right: To be reimbursed and indemnified for actions in the ordinary course of business or for preservation of business and property. §401(d) UPA. not the statutory rules. and property. §202(b) UPA. c. 6
Partnership Rights and Duties
The rights and duties discussed in this section are the default rules that are applied absent a written partnership agreement. Dissociation: a partner’s right to dissociate from the partnership cannot be varied. Partnership agreements may determine the standards for satisfying the fiduciary duties. losses. then the partnership is governed by the rules within the agreement. Good faith: a partner’s duty to act in good faith and fair dealing cannot be eliminated. Right: To be reimbursed for advances made beyond agreed upon capital infusions. §401(f) UPA. Duties among partners: the duties owed between partners cannot be eliminated.
§401(h) UPA. Right: To have access to books and records. The court held that the firm acted in good faith since there was no “predatory purpose” in their action. Disclosure Ex. Ex. Meinhard v. Lawlis v. Right: To get reasonable compensation for services rendered in winding up the business of the partnership. Good Faith: Partners have an obligation of good faith and fair dealing in the discharge of all their partnership duties. and non-competition. The court held that the duty of loyalty only applies to accounting of profits. acquiring partnership assets. Broad Duties of a Partnership o The rights and duties discussed above are derived from the three duties that partners owe to each other: Duty of Loyalty: Partners have a duty that prohibits them from misappropriation of partnership property. Duty of care only applies to the business aspects and use of property of the partnership.
. §401(g) UPA. Duty of Care: Partners have a duty to not be grossly negligent in carrying out their duties and obligations. Salmon. and having an interest adverse to the partnership or competing with the partnership. Opportunity Ex. usurpation of partnership opportunities. since the opportunity was a result of the partnership.: Partner in a law firm was involuntarily expelled from partnership under a “no cause” clause. and had nothing to do with disclosures about internal structure.-
Duty of Loyalty: To only use partnership property on behalf of partnership. §403(b) UPA. Day v. Duty of loyalty between partners only applies to the business aspects and use of property of the partnership.: One partner in a partnership was presented an opportunity and offer of a new adventure beyond the duration of the partnership. Kightlinger & Gray.: Partner in a law firm claimed a breach of duty of loyalty because the partners did not disclose changes to internal structure that would occur after a merger. Sidley & Austin. The court held that he had a duty to inform the other partner of the opportunity before pursuing the opportunity for himself.
if taken.01(4). the partner has the right to disassociate from the partnership. §801(1) UPA. and they can seek damages for breach.01(5)(i)-(iii). or it is otherwise unreasonably impracticable to carry on the partnership. o Expiration of Term: The expiration of the term or the completion of the agreed upon undertaking.Partnership Dissolution
Unless otherwise provided in the partnership agreement. §8. o Occurrence of Specified Event: The occurrence of an event that partners agreed would trigger termination of the partnership. However. Pav-Saver v. o Judicial Decree of Impracticability: A determination by the court that either: the economic purpose is likely frustrated. can be considered a term. §8. Page. What is a term: There must be a substantially certain term or agreement for there to be a “term. Vasso Corp. the actions by a partner make it unreasonable to carry on the partnership.” A simple hope of profit is not a term. §8.01(6)(i)-(ii). §8. the following events can result in dissolution: o Partner’s Will to Terminate: When a partner receives notice of an associated partner’s will to withdraw as partner. The disassociating partner is released from liability and can receive the value of his partnership interest (minus damages) in cash or bond.01(3). §801(2)(iii) UPA. Page v. o Judicial Decree of Equity: On application by the transferee. or at a later date specified. Existence of a term: Even if there is a term for the partnership.
. a determination by the court that after the transfer of a partner’s interest it is equitable to wind up the partnership either after the expiration of a term (if term) or at any time (if at will). However. o Unlawful Continuation: The occurrence of an event that would make it unlawful for the partnership or a substantial portion of it to continue. the remaining partner/s may continue the endeavor with the use of all of the partnership property. the amount of time it takes to repay a loan or debt.
§2. §2.02(b)(1) Purpose: Purpose of the corporation §2.02(b)(2)(iv) MBCA Liability: Any imposition of personal liability on the shareholders for debts of corporation in certain situations. Delaware General Corporation Law (DGCL). §6. loan and borrow money. Requirements and Effects
Requirements for Creation o Registration with State: A corporation is formed when an incorporator successfully files articles of incorporation with the states.02(a)(1)-(4) MBCA. and shareholders. Effects of Incorporation – Separate Entity.Corporations
STATUTES USED: Model Business Corporation Act (1984) (MBCA).
Corporation Creation and Liability
Creating a Corporations. not the shareholders.22(a) MBCA.02 MBCA. §2. make contracts. §2. Affairs: The manner in which the affairs of the corporation are managed and regulated. and the name and address of each incorporator.02(b)(2)(i) MBCA. §2. sue and be sued.02(b)(2)(v)MBCA Bylaws: The corporation is required to adopt bylaws for management of the corporation. §2. incur liabilities. o Limited Liability: The debts and liabilities of the corporation belong to the corporation. Limiting Liability o Separate Entity: A corporation is a separate entity from its creators. §2. o Powers: A corporation generally has the ability to act in any way an individual could act in business. Powers. Securities Exchange Act of 1934 (’34 Act). engage in a partnership. Securities Act of 1933 (’33 Act). §2. the location of the corporate office and name of registered agent. Powers: Definitions and limitations of the powers of the corporation. §3.03 MBCA. Articles of Incorporation: The articles of incorporation must include a corporate name. It can own and use property.02(b)(2)(iii) MBCA.02(b)(2)(ii) MBCA. employ individuals. The articles may also include provisions consistent with other laws about: Directors: Names and addresses of initial directors. the number of shares the corporation can issue. and donate. Par value: Par value of all types of shares.06 MBCA. own other companies. There are exceptions to this 9
. directors. and those bylaws can regulate any aspect of the corporation not inconsistent with the laws of the state.
since piercing is an equitable remedy.
Piercing the Corporate Veil. o Commingling: When a controlling shareholder’s funds are excessively commingled with the corporation’s funds.” The issue of piercing typically arises when there are less than 9 shareholders of a corporation. The question is whether the circumstances of the case show that the corporate structure was being used to defraud creditors or third parties. Shareholders are still liable for their personal actions under the principles of tort and agency law. Such insolvency is making excessive payments. o Fraud or Deception: This factor permeates the other factors. there are factors that are commonly considered by courts as evidence of abuse and alter ego: o Undercapitalization: Inadequate capitalization of a corporation can be evidence that a corporation was purposefully insolvent. o Alter Ego: A part of abuse. discussed below. salaries. Personal Liability. it can be evidence that the corporation 10
. Piercing the corporate veil is an equitable remedy. and is applied when the court feels that there has been an abuse of the privilege of the corporate structure. which is also evidence of inequity. Courts characterize this as whether there is a unity of interest and ownership between the corporation and individual shareholder. §6. The court does this by looking a variety of factors. o Abuse: Courts typically look for some form of abuse of the corporate structure. o Two typical situations of piercing: Courts will consider the corporate veil in two general situations: (1) to provide a remedy to a creditor who is owed a debt by an insolvent corporation. None of the factors by themselves are conclusive proof that a corporation should be pierced. Although publicly held corporations can be held liable when they are the controlling shareholders of a subsidiary that is “pierced.22(b) MBCA.” Factors commonly considered in piercing cases: There is no absolute set of factors for piercing. (2) to provide a remedy to a party injured by the tort of an insolvent corporation. Courts characterize this as whether adhering to the fiction of a separate corporate existence would promote fraud and injustice. However.discussed below. o Importance of equity: It is important that there is an equitable need to pierce the corporate veil. and dividends instead of purchasing insurance or leaving assets to secure debts for creditors. o Only in closely held corporations: Publicly corporations are almost never “pierced. courts will look to see if the corporation was essentially acting as an “alter ego” of the controlling shareholder. the course may “pierce the corporate veil” and hold shareholders of the corporation personally liable for the actions of the corporation. and Subsidiaries
Generally: In certain circumstances. Think inequity. which would be evidence of abuse.
Sea-Land Services. the court held that where a parent corporation controls several subsidiaries. can support the decision to pierce. Pepper Source. Factors particular to parent-subsidiary corporations: The issue of piercing commonly arises in issues of a parent corporation’s use of a subsidiary corporation. v. and that the corporations were being operated from the same office. Specific Rules for Parent-Subsidiary Piercing Cases: o No showing of fraud required in torts cases: In a tort case about breast implants. o Whether the parent does not allow the parent to have adequate capital. the court stated that many times in tort cases there is no requirement of a showing of fraud. control in itself is not dispositive. In re Silicone Gel Breast Implants Products Liability Litigation. Essentially.
. the corporate veil of one subsidiary may not be pierced to satisfy the liability of another. o Whether there is no clear distinction as to which transactions are the parent’s and which are the subsidiaries. there were no corporate formalities. Inc. Court found that defendant had several other corporations. Example of piercing the corporate veil: Defendant shareholder’s corporation did not pay for having items shipped by plaintiff. whether adhering to the fiction of a separate corporate existence would sanction fraud was not settled. such as excessive commingling. the corporations were undercapitalized. (Related to undercapitalization. self-dealing). o Can’t pierce veil through one subsidiary for the actions of another subsidiary: In a contract breach case. Defendant was sued. it can help show that the corporation was merely an alter ego of the controlling shareholder. Roman Catholic Archbishop of San Francisco v. o Control or Domination: Excessive control of the corporation by the controlling shareholder can support the decision to pierce. and therefore the case was remanded. o Whether the board of directors of the parent make decisions for the subsidiary. there was substantial commingling of funds. The basic concepts above remain the same. Commingling includes using corporate funds for personal expenses. o Self-dealing: Abusive self-dealing by the controlling shareholder. and a mixing of assets. Defendant dissolved corporation after default judgment. but there can be additional considerations: o Whether the relationship is structure so that all of the profits of the subsidiary flow to the parent corporation. but when alongside other misconduct.-
is merely an alter ego of the controlling shareholder. (A subset of alter ego). The court held that there was a unity of interest and owernship between the corporation and defendant. is evidence that the corporation is an alter ego. o Failure to follow formalities: Failure to follow formalities can substantiate evidence of commingling and self-dealing. However. It also shows who should be held liable. Sheffield. However.
” where the piercing goes horizontally to pierce “sister corporations. o Implied corporate power: Most states hold that a corporations has an implied power to do whatever is “reasonably necessary” to promote their express purposes and aid their express powers. Walkovszky v. Common considerations of the court are: o Motivation of division: Whether there was a legitimate business motivation for the division beyond a fraduldent intention to escape liability. employees. Express corporate power: Corporations have an express power to perform any act authorized by the general corporation law of the state and those acts authorized by the articles of incorporation. and was operated with the same supplies. as well as any more limited purpose stated in the articles of incorporation that is consisted with the statute. and facilities that the corporations are essentially part of the same enterprise. repairs.
Corporate Purpose and Power
Corporate purpose: Corporations have the purpose of engaging in any lawful business permitted by the State’s incorporation statutes. and that the corporate structure was being abused. o Primary purpose: The primary purpose of a corporation is to provide profits for its shareholders. as well as nine other corporations. Dodge v.
Enterprise theory is a type of “piercing. Plaintiff also sued Defendant. Sheffield. §3. o Confusion: Whether customers and creditors were justifiably confused as to who they were actually dealing with.” rather than vertically to reach the controlling shareholder. o Commingling: Whether there is enough of a commingling of assets. o Still must allege a disregard of corporate form and fraud: Must show that the corporations were being operated in an individual capacity.01 MBCA. who was the controlling shareholder in each corporation. When it applies: When multiple corporations are used to artificially divide what is essentially one business enterprise into segments in order to unreasonably limit liability or to mislead creditors or customers. and facilities. 12
. Each corporation had minimal insurance. trade names. Plaintiff sued corporation that owned cab. personnel. Ford Motor Co. Carlton: Plaintiff was injured by taxicab. UNLESS limited by statute or common law.o Mere non-satisfaction does not justify piercing: There must be a true inequity of not piercing. Roman Catholic Archbishop of San Francisco v. a mere inability to recover debt does not justify piercing the veil.
Wrigley. and other data prepared by.
Fiduciary Duties of Corporate Directors and Officers
In General: Directors.31(a)(2)(ii)(B) MBCA. Shlensky v.30(b) MBCA. officers. rather than the individual shareholders.Duty to Consider All Material Information Reasonably Available: Directors are required to consider all information that is material to the decision and is reasonably available. §8.
. financial statements. Business Judgment Rule: Courts give directors the presumption that the directors have acted as a reasonably prudent person in any decision.30(e) MBCA: o Officers or employees believed to be reasonably competent to provide the information. illegality. §8. It is important to note that they owe this duty to the corporation. or conflict of interest. Derivative Suits: Cannot use derivative suits to contest actions unless there is some element of fraud.-
Statutes Adding Corporate Purposes: States can add permissible corporate purposes and powers by statute. v. directors have a duty to discharge their duties in good faith with the care that a person in a like position would reasonably believe appropriate under similar circumstances. These statutes can be applied to corporations that are already in existence. Smith Mfg. §8. and high level employees will simply be called “directors. reports or statements. §8. o Director Decisions Procedural Due Care .30(f)(1) MBCA. This rule “shields” directors from having all of their decisions second guessed Good faith: discussed below. directors. Co.” Duty of Care o General Duty of Care: Generally. A. The duties are discussed below. and high level employees* owe substantially the same duties to the corporation. §8. actions under the duty of care can be violated if the directors did not act in good faith. o *For purposes of this section. which is an important distinction when talking about derivative actions. or lack of decision. Barlow. a director is entitled to rely on the opinions. officers.30(b) MBCA.P. Reasonable Reliance: As long as they do not have any knowledge making the reliance unwarranted.
Kamin v. and therefore is protected by the business judgment rule. o Director Inaction In general: The following principles apply specifically to instances where there was no action or decision by the directors. or other people retained as experts that are believed to be reasonably competent to provide the information. o Interested Director Transactions 14
. Shlensky v. Many different considerations can be considered a rational basis. Where there is no action by the directors. §8.30(f)(1)-(3) persons that the board has formally or informally delegated a function of the board that is delegable under applicable law. American Express Co. Substantive Due Care – Corporate Waste: The decision itself can be challenged only if no reasonable business person could have made the decision. In re Caremark Litig. public accountants. Relying on Information from Others: The principle discussed above permits directors to rely on the information given by others. Ordinarily whether a dividend is declared is a matter of business judgment. or has caused them to take a corporate opportunity away from the corporation for himself. Duty of Loyalty o In General: Duty of loyalty issues involve situations where a director has a conflict of interest that has impacted their action or lack of action. Extremely high standard: This standard will almost never be satisfied.-
o Legal counsel. o A committee of the board of directors which the director is not a member if it is reasonably believed to be competent to provide the information. The concepts above still apply.30(d) MBCA. Relying On Performance of Others: As long as they do not have knowledge making reliance unwarranted. Monitoring System: Case law has suggested that directors have a duty to install a monitoring system to enable it to better discharge its oversight obligation. and is largely considered a gross negligence standard. a director can rely on the performance by any other the §8. the directors must still be aware of information that would have caused it to take action if action was necessary. §8. then it will not violate due care.30(f)(3) MBCA.30(f)(2) MBCA. The decision must be unconscionable to the point where directors squandered corporate assets. even if the decision was wrong. If there was a rational basis for the decision. §8. Wrigley.
etc. Red Flags: When a director is on both sides of a transaction. Lewis v. (2) is in the line of business of the corporation. he will not have to disclose it. o Usurpation of Corporate Opportunity General rule: A director may not take a corporate opportunity for himself if the opportunity. fairness test. & E. If the above requirements are met. If the opportunity came from the director’s individual/personal capacity. If it came from his director capacity. or the director is dominated or controlled by an individual with a material interest at stake in the challenged conduct. the directors can avoid liability for a transaction involving a conflict of interest if either there was: Disclosure and disinterested voting: the director disclosed his conflict of interest to the directors/shareholders and either: (1) a majority of disinterested directors approved the transaction. Inc. Broz v. S. Where opportunity comes from: Whether or not a director should disclose depends in part on where the opportunity came from. §144(a)(1) DGCL. §8. No Business Judgment Rule: The business judgment rule does not protect the decisions of interested directors. AND the director can show that the transaction was fair. or the shareholders. However. 15
. OR Transaction was fair: the transaction was approved by the board of directors. he most likely should disclose it. AND (4) is one in which the corporation has and interest or expectation. Disinterested Majority/Fairness Rule: With the directors bearing the burden of proof. Inc. a committee.Interested Director: a director is interested in a transaction if they have a financial or familial interest at stake outside of role as director. when he receives financial gain outside of his position as director. §144(a)(3) DGCL. Cellular Information Sys.: (1) is one which the corporation is financially able to undertake. (3) is of practical advantage to it.L. §144(a)(2) DGCL. the director can pursue it. No formal requirement of disclosure: There is no formal requirement that the director disclose the opportunity to the board. line of business test. Other approaches: The general rule above is the Delaware court’s approach.. and the two-step test (interest + fairness). disclosure can create a safe haven down the road.31(iii) MBCA.. Other tests include: interest and expectancy test. or (2) shareholders approve transaction in good faith.
o Subset of Loyalty: Good faith is a condition of loyalty. o Connecting Care and Loyalty: Questions of the duty of loyalty are traditionally limited to cases of conflicts of interest and usurpation of corporate opportunity. Actions that are not per se disloyal. Dealings Between Parent and a Subsidiary: A corporation that has a controlling interest in a subsidiary has a duty in any transaction where there is self-dealing between the parent and the subsidiary. Ritter. o Scope of “bad faith”: There is a range of what constitutes “bad faith. good faith allows plaintiffs to recover against directors for disloyal duty of care violations. The parent controlling shareholder violates the duty if 16
“Good Faith” o Good faith is not a separate fiduciary duty that has the same grounds of liability as care and loyalty. Examples: intentional failure to act in face of duty to act. Stone v. a director cannot fulfill their duty of loyalty if they fail their duty of care in bad faith. intentional act to violate law. Essentially. intentional action with purposes other than those advancing corporate interests. but they CANNOT be limited for duty of loyalty violations.. see §102(b)(7) DGCL. but it is a duty that can impose indirect liability. Ritter. Therefore. Controlling Shareholder: Controlling shareholders are shareholders that have de facto control over the board of directors. Derivative Litigation: Subjective bad faith: This is classic bad faith – fiduciary conduct motivated by an actual intent to do harm. Intentional Dereliction of Duty: This is above gross negligence but below subjective bad faith – it is a conscious disregard for one’s fiduciary responsibilities. The range was described in In re the Walt Disney Co. which usually comes from being a majority shareholder. “Good faith” brings events that would ordinarily only be under the duty of care into play with the duty of loyalty. Controlling Shareholder’s Duties: Controlling shareholders owe a duty to the corporation and the minority shareholders. but are the result of more than a simple inattention or failure to be informed. Stone v. o Why does it matter: Damages for liability for duty of care violations can be limited by corporate provision.” but what is important to remember is that it does NOT include simple gross negligence. but rather are circumstance-specific. and therefore actions that are in bad faith can be thought of as questions of loyalty.
Fiduciary Duties of Controlling Shareholders
Shareholders’ Duties in General: Shareholders in general do not owe any duty to the corporation or other shareholders. These duties are not parallel to the director’s duties.
the courts have developed the derivative suit process in which the shareholders can compel the corporation to sue the directors. Derivative suit: A derivative suit is an equitable procedural process in which a single shareholder can sue on behalf of the corporation. dividends. Board Complies: If the board complies to the demand. When a corporation is injured by those directors. Derivative Suits in General
The Dilemma: Directors control the actions of a corporation. o Suit within a suit: Conceptually. the recovery from such a suit belongs to the corporation. Derivative Actions: A direct suit is when the shareholder is suing the corporation to enforce their right as a shareholder. where the court allows the shareholder to enforce the right not being enforced by the directors. o Essence of Claim Determines Nature: The distinction relies on the essence of the claim – whether it is based on harm to the corporation (derivative). essentially compelling the corporation to enforce its right to sue the directors. either individually or as a representative of a class of shareholders.Derivative Actions
The Governance Dilemma. the derivative process its own law suit within the law suit against the directors. then they will file suit and therefore there is no need for a derivative action. rather. not directly to the shareholder Direct v.
Demand Requirement In General o Demand: In general. etc. or whether it is based on a harm directly affecting the value of shares (voting. The second substantive part is the suit against the directors. Shareholder’s role: the shareholder is not suing on behalf of their own right or other shareholder’s rights. the shareholder must show that the directors have had some opportunity to file suit on behalf of the corporation before the shareholder is granted the equitable right to file suit on behalf of the corporation. they are acting as an enforcer of the corporate right. The initial derivative action is a suit in equity.
. Therefore. But since the directors are controlling the actions of the corporation. it is unreasonable to expect them to allow the corporation to sue them (they would be suing themselves).) o Decline in Share Value Not Enough: Courts have consistently held that a decline in the value of shares resulting from a harm to the corporation does not create a direct right of action in itself (can’t transform derivative into direct). Usually. the corporation can sue the directors.
Akers. and will be upheld as long as it was in good faith and made by a disinterested majority. many jurisdictions also allow a shareholder to claim that making such a demand would be futile. Universal Demand Approach o The MBCA requires that all derivative suit plaintiffs make written demand on the directors MBCA §7.44. o If demand is rejected: If the demand is rejected.-
Board Rejects: If the board rejects. and therefore the demand requirement should be excused. o Demand Excused Due to Futility: In the alternative. OR that the rejection was not in good faith. The board did not fully inform itself about the challenged deal. Directors have a material/familial interest Directors are dominated or controlled. then they have made a business judgment that the suit would not be in the best interests of the corporation. o Foundation: Corporate directors have the governance power of forming special committees to deal with particular areas of governance. OR the challenged deal was so unfair on its face that it could not have been the product of sound business judgment. the shareholder must allege particular facts that tend to show that either Grimes v. The demand will be excused if the plaintiff alleges particular facts that tend to show: A majority of the board is interested in the challenged deal. “Innocent Minority”: In response to derivative litigation. MBCA §7. Protected decision: The decision to reject the demand is protected by the business judgment rule. Grimes v. Marx v. boards can create a committee consisting of some or all of the directors not implicated in the alleged wrongdoing and 18
. New York Approach to Excusal o The NY Courts have a modified excusal test that is somewhat broader than the Delaware approach.42. OR the challenged transaction should not be protected by the business judgment rule (refers to the substantive transaction which would be contested in the derivative action). Donald: The board is not disinterested or independent (duty of loyalty). Delaware Approach to Excusal o Two-Part Test: For demand to be excused.
Special Litigation Committees
Corporations have developed a response to avoid derivative litigation and maintain control over any suits on behalf of the corporation/against the corporation. Donald. the plaintiffs must plead particular facts that show that the board was not disinterested.
detailed record of findings) Court looks to see if there is a rational basis for their recommendation. Zapata v. Fraud. o Motion to Dismiss: the corporation’s attorney will then submit a motion to dismiss on behalf of the corporation. relying on experts. Insider Info
Securities Regulation in General. and potential benefits. and focuses on their rights in regards to buying or selling stock. Court’s Treatments of Motion to Dismiss: Courts have developed rules (based of their general treatment of derivative actions) on how to deal with motions to dismiss entered by special litigation committees: o Delaware Approach: Court applies a two part test only in situations where demand has been excused. the committee’s recommendation is protected by the business judgment rule. o Securities Act of 1933: Regulates the primary market of stock (the corporation selling to investors). o Investigation: The directors. o Promulgated Regulations: Under either of the acts. investigate the merits of the case. o Composition of Committee: The committee is always composed of directors who have no connection to the contested transaction. and many times has directors who are completely new to the board. o Securities Exchange Act of 1934: Regulates the secondary market of stock (investors selling stocks to each other).
General Securities Regulation.-
gives them the power to decide if the corporation should pursue a lawsuit against the implicated directors. o Report: The committee then submits a written report to the court about its suggested action. Maldonado: (1): The defendant directors must prove the committee member’s independence and the procedural completeness of the investigation. 19
. Court examines the investigative process (regular meetings. (2): If the first prong is satisfied. along with lawyers and other experts. the court exercises its own business judgment in determining whether or not it is in the corporation’s best interest to dismiss the lawsuit. Rule 10b-5
Scope of SEC Regulation: SEC regulatory statutes protect shareholders as investors. o New York Approach: Unless the plaintiff can prove that the special litigation committee lacked independence or failed to operate on an informed basis. the SEC has promulgated a series of “rules” that regulate the stock industry. projected costs.
or omit a statement. whether part of the corporation or an individual seller. v. o Types of Lies: Many form of statements can constitute fraud. or artifice to defraud.”
Securities Fraud Cases
The basis of these cases is that there was some misrepresentation. just that a lie or misrepresentation was made with intent to lie or misrepresent. no matter how big or small. and is the most widely used tool in securities and general corporate law. To make an untrue statement. scheme. makes misrepresentations or false statements. Insider trading cases: These are cases where someone buys or sells securities based on information that is only available to an “insider. Fraud: Any of the “fraud” covered in the Rule 10b-5 provisions is sufficient. o Fraud: although the rule defines the situations it applies in. or promulgates phony documents in the purchase or sale of securities. in the connection with the purchase or sale of any security: Employ and device. OR to engage in any act. regardless if it is interstate. Opinions: “soft information” such as opinions or projections can be fraudulent if the person making the statement knew there was no rational basis for the opinion. of material fact in circumstances that would make such a making/omission misleading. can be fraudulent.-
Rule 10b-5: This rule is under the ’34 Act. but that omit a fact that is necessary to make the statement non-misleading. o A violation of the rule gives rise to a private right of action. the type of fraud that the rule applies has been determined on a case to case basis by common law. 20
. Half-truths: Statements that are true. o Rule 10b-5 makes it unlawful to. practice. There are two very common situations: Securities fraud cases: These are cases where someone lies. Jurisdictional means: Any use of mail or telephone at any time in the purchase or sale of securities will allow the courts to apply Rule 10b-5. Levinson. or course of business which operates would operate as a fraud or deceit upon any person. Lies: Making an assertive statement that is simply not true is always considered a fraudulent misrepresentation. There are common elements/requirements to all of these cases. who commits a fraudulent act in the sale of securities. discussed below. Basic Inc. o Applies to any transaction: the rule applies to any purchase or sale of securities. o Applies to any party: the rule applies to anyone. o No requirement of “evil motive”: There is no requirement that the lie or misrepresentation be made with an evil motive.
or whether the losses even happened because of the fraud. Standing: Plaintiff must have bought or sold securities. Culpability/Scienter: There must be some intent to deceive. there is a rebuttable presumption of reliance. the court balances the probability of the event occurring with the magnitude of the event if it does occur at the time of the transaction. and specific cautionary statements in good faith about the opinion. Materiality: A fact is material if there is a substantial likelihood that a reasonable investor would find the fact important in deciding whether or not to buy or sell a security o Probability x Magnitude: In regards to the materiality of whether future events would occur. The plaintiff does not have to show personal reliance on the fraudulent act. you must also examine whether there was another cause of the losses.” which means that the person spoke without qualification. Not about fiduciary duties or fairness: Case law has clarified that Rule 10b-5 is about disclosure. o Reckless is the floor: The lowest level of Scienter is “recklessness. no evil motive: Scienter does not require that there was bad faith. not about duties or fairness. and knowing that they did not know whether what they were saying was true or false. Widely traded securities: In cases where the security at issue is widely traded. Levinson. to make a material fraudulent statement/omission. Basic Inc. beyond simple negligence.
. o Transaction causation: The plaintiff relied on the fraud to enter into a transaction which then caused them harm. cannot have not bought securities Causation/Reliance: there are two general theories of causation in fraud cases. Basic Inc. Non-disclosure: Silence in the face of an affirmative duty to speak can be considered fraudulent. Damages: The goal of damages under Rule 10b-5 is compensation. evil motive. o Again. the plaintiff must show that they were aware of the fraudulent statement and that they relied on it. Levinson.-
Bespeaks caution: The person making the statement can create a safe harbor if they make detailed. Consider intervening causes: In these situations. Punitive damages are not available. Generally. o Loss causation: The fraud must have caused or materially contributed to the pecuniary losses of the plaintiff. In Connection with Trade of Securities: Fraud must be a “proximate cause” of the purchase or sale of securities. reasonable. rather it is assumed that the market price itself relies on such statements and therefore the plaintiff did to. or malice in the making/witholding the statement. v.
o Rule 10b-5: Rule 10b-5 has been applied to insider trading to prevent insiders from trading on information that is not available to the public. that will move the stock up or down). Under this doctrine. officer. that is not available to the public. Always dealing with a lack of disclosure in insider trading cases. an officer or director is under an affirmative duty to disclose special facts when buying shares from existing shareholders. if they satisfy the personal benefit test: The tipper breached a fiduciary duty 22
. Only applies to companies registered under ’34 Act. Only applies to directors or officers. Texas Gulf Sulphur Co. Any material information triggers the doctrine. Only applies to face to face transactions (privity). or an associate in a law/accounting firm for the corporation) acquires material information about the company (can be good or bad. Disclose or Abstain Rule: Anyone in possession of material non-public information has a duty to disclose that information before trading in the stock. Only applies to certain individuals. and acts upon that information (either by personally buying/selling or tipping off a third party). “Tippees”: Third parties who receive insider information (think golf buddy) can be held liable for acting on such information. Under State Law o There is no liability for insider trading except under the special facts doctrine. an employee. Rule doesn’t apply: to those who through persistent analysis dig up information. Insider trading can be dealt with under state law or under Rule 10b-5. or those who have the information come to them through luck. SEC v. or 10%+ shareholder of the company who makes a profit from a purchase/sale--sale/purchase within a six month period.Insider Trading
Insider Trading: A circumstance where an “insider” (an officer or director of a corporation. Fiduciary nexus between trader and source: Rule applies when there is a “nexus” between the inside trader and the other party to the transaction. Misappropriation: Rule applies when the inside trader vilaters a fiduciary duty owed to the source of the information. No requirement of wrongdoing or intent. Only applies to purchases or sales from existing shareholders. Under Federal Law o §16(b) ’34 Act Recovery: This section imposes strict liability on any director.
§7. who delegate certain matters to them.02 MBCA. Shareholders: shareholders own the corporation.01 MBCA. as will be discussed below. o Officers: officers perform the day to day management of the corporation. are called in response to specific issues that need shareholder approval. they can allow another person to vote their weight of shares. One important right is their ability to elect directors. §7.
Public Corporation Governance. Voting by shares: Unless the articles of incorporation provide otherwise. §7. but their ownership is separated from the control of the corporation. Proxy Issues
Basic Statutory Scheme
Board of Directors: the board of directors has been given powers by the corporate statute to make decisions and take certain actions as a body. §212 DGCL.22 MBCA.
AND the tipper tipped the tippee in the hopes of receiving some personal benefit from the tippee (can include personal relationship) Applies all the way down the chain of tippees. the concept described above is not always reality.
Publicly Held Corporations. in publicly held corporations this model is not necessarily accurate. This problem is exacerbated by the shortcomings of directors – who are supposed to be acting in the interests of the 23
Basic Mechanics of Shareholder Voting
Annual Meetings: an annual shareholder meeting at which the board of directors is elected and other regular business matters are discussed. §212 DGCL. It is loosely based on a principal-agent relationship. However. each share is entitled to one vote. They only exercise control over certain fundamental transactions. and also hire the officers who run the corporation. The shareholders elect the directors. depending on the bylaws. Voting through proxies: Shareholders are permitted to vote by proxies. and get their power from the directors. “Flow of Power” Concept: The structure is based on the notion that authority flows from ownership to officers. shareholders are very disconnected from the corporation – they cannot oversee the activities of the corporation.21 MBCA. but the management is controlled by the directors. and they have no power to manage the corporation’s affairs. §7. who manage the corporation. as well as their right to information. That is. Special meetings: meetings that. Realities of Governance
Problem with the “Flow of Power” Concept: In publicly held corporations.
(1) proxies are usually the only way to obtain a quorum. and therefore proxies important for two reasons. (2) whomever gets the most proxies should be able to control decisions. or abstain from voting. Proposals that relate to the election of directors.
Proxy Issues and Fights
Importance of Proxies: Most shareholders do not attend the shareholder meetings. Directors cannot always manage the officers: many directors only work part time. 14a-8(i): Proposals contrary to state law (such as proposals relating to a particular management function within the directors authority).” AFSCME v. Preliminary disclosure if matter is other than director elections/shareholder proposals. o Consequence: Many times. while the corporation wants high levels of work for less compensation. There are certain requirements for solicitation. discussed below: o Proxy statement: a comprehensive disclosure document that accurately and truthfully provides all information relevant to matters to be voted upon. Proposals relating to significant ethical and social concerns. Proposals that violate the law or rules of the SEC. o Shareholder proposals: Any shareholder with $1.” Lovenheim v. o Disclosure to SEC: Definitive copies of proxy statement or proxy card must be provided to SEC at or before time they are mailed to shareholders. and has promulgated several rules (Rule 14a). and many times they are friendly with the CEO. directors may exclude certain proposals from proxy statements. and therefore give too much trust to the officer. o Proxy card: The proxy card must allow the shareholder to indicate whether they approve or disprove of a matter.shareholders. Proposals that relate to operations that account for less than 5% of the company’s business. unless it is otherwise significantly related to the corporation’s business. they in large part rely on the officers for information. or to the furtherance of the shareholder’s personal interest. Solicitation of Proxies: The SEC has the power to regulate proxy solicitation for all ’34 Act registered companies under §14(a) ’34 Act.000 worth or 1% of voting securities can call for a referendum on shareholder raised issues. 14a-4(b)(1). However. This is a problem because they have a conflicting interest – they want high levels of compensation for less work. and other non-economic concerns. the officers end up being able to de facto control the corporation. can still be considered to “otherwise significantly relate to business. Iroquois Brands 24
. Proposals that relate to the amending the bylaws to require certain shareholder director candidates be included in the proxy materials are not considered to be “related to an election. 14a-6. 14a-3. AIG Proposals that relate to personal claims or grievances.
as long as the funds are not excessive and there is full disclosure to the shareholders of the use. Governance problems: Typically problems arise in governance when individuals abuse their roles in attempting to control board decisions.” especially when the election of incumbent directors is being strongly contested by other shareholders. o Why?: Corporate fiduciary duties focus on the duties owed by the management to the corporation. in theory still applies to closely held corporations. or if it is duplicative of a current proposal. unique problems arise in closely held corporations because many times the same people fill the roles of directors. Both sides typically resort to campaigning.
Governance of Closely Held Corporations
Statutory Scheme: The statutory scheme. Therefore they have developed standards to help protect shareholders in a closely held corporation much like partners in a partnership. and it usually comes down to who can collect the most proxy votes from disinterested shareholders. Inc. officers. Proxy Fights: Gathering proxy votes can become a “fight.-
Proposals similar to proposals that have been submitted within the last 5 years and failed to receive a certain amount of votes. Levin v. However. 14a-9. some courts have created heightened standards for closely held corporations about the way that controlling shareholders treat minority shareholders in the business decisions. control voting by other shareholders. o Use of corporate funds: Incumbent directors are allowed to use corporate funds in their proxy solicitation. and shareholders.
Closely Held Corporations
Closely Held Corporations in General
Same duties: Directors. Partnership law focuses on the way partners treat each other in respect to their business. o Liability for false or misleading statements: The SEC prohibits proxy solicitation where there are false or misleading material statements. discussed above. or if it conflicts with the corporation’s proposal. and control shareholders are subject to the same traditional fiduciary duties that directors. officers. control the transfer of shares. officers. Heightened Standards: As will be discussed below. Courts have recognized that closely held corporations in many ways resemble partnerships just as much as public corporations. Metro-Goldwyn-Mayer. and control shareholders in publicly held corporations. or abuse minority shareholders. 25
BUT they cannot agree to what they will do as directors. and the minority’s reasonable expectations. There are two basic situations that this duty arises in. o Control of Shareholder voting: Agreements among shareholders about how they will vote (usually for directors) are valid. Springside Nursing. Inc. make some agreement. Smith v. Atlantic Properties. sometimes making agreements about what they will do as directors. Actual Majority: When there is an actual majority. Springside Nursing Home. Courts will expect the majority to consider certain things. o Legitimate Purpose: Majority must show that there was a legitimate business purpose for their action. such as the minority’s loss of all value of their shares. Dodge. McQuade v. o Less Harmful Means: If the majority does show a legitimate business purpose. controlling shareholders in closely held corporations owe a fiduciary duty to the minority shareholders that largely resembles the partnership duties. Inc. Wilkes v. since it would conflict with the statutory authority of the board of directors to manage the corporation. o More Why: The court recognizes that shareholders many times derive their economic benefit from salaries as officers/directors. they can agree to elect each other as directors. Brodie v. §7. the defendant can still show that there was a less harmful means that would have still achieved the legitimate business purpose. not director actions: When individuals acting shareholders. o Injunctive relief 26
.o Attempts to control board decisions: Many times shareholders of close corporations will enter into agreements about future actions. the majority is under a duty to not take action that results in “freezing out” the minority shareholders from exercising reasonable influence on control and receiving a reasonable economic benefit. and are not “disinterested” like most shareholders in public corporations. Can agree to shareholder actions. Jordan. Stoneham.
Heightened Duties for Controlling Shareholders
Specific to Closely Held Corporations: As mentioned above. Remedies: The remedies for such breaches are hard to develop. The minority shareholder can only use this power to serve a legitimate business purpose. such as when they have the veto power. and are enforceable under regular contract law. Clark v. Wilkes v.31 MBCA. Also. not through dividends. but they should only seek to restore the reasonable expectations of the disenfranchised shareholder since the court is acting in equity. not just shareholders. their initial involvement and role in organization of the company. Ad Hoc Majority: The above principles can also apply to situations where a minority shareholder is able to act as a controlling shareholder. that shareholders are typically involved in the running of the corporation.
o Involuntary dissolution §14.30 MBCA.
.o Damages (careful to only give damages to the extent of the disenfranchised shareholders reasonable expectations – don’t want to create an artificial market for the shares that would exceed their expectations.