Corporations 11/11/12 1:24 PM

AGENCY

Reciprocal Duties of Agent and Principal (20-39)

Community Counseling Service

o Need for non-competition clause in contract – but must be careful not to violate

public policy

o What is the duty of a party to the firm when he is planning to leave but hasn’t yet

left?

You cannot seek out firm’s clients while you are still working there

Hamburger

o Did not solicit clients’ business while he was still their employ

o Anderson Rule: categorical – fiduciary duty obliges the fiduciary to act in the best

interests of his client or beneficiary and to refrain from self-interested behavior not

specifically allowed by the employment contract.

o Easterbrook and Fischel Rule: difficult to apply in practice – socially optimal fiduciary

rules approximate the bargain that investors and agent would strike if they were

able to dicker at no cost. (not a great rule because there are always transaction

costs)

o Limitations on the right to discharge

Foley

o Must decide what the relationship between the parties is: independent contractor,

employee, etc?

Cannot be fired for irrational reasons or for certain protected reasons (if

employee)

o Employees invest and rely, therefore they need protection

o Alleged public policy: employees doing the right thing for their employer

Court says there is no public interest in helping a private employer

Employer’s interest ≠ public interest

o Employer handbook can be used as evidence to prove it is not at-will employment

o Tortious breach of good faith and fair dealing – Court says no, there would be no

duty to mitigate for contract breaches, therefore it’s not a good idea

Duty to Creditors (39-49)

Blackburn

o 3P reasonably believed A was acting with the authority of P, P did nothing to

discourage her belief

Sennot

o All partners are agents for the principal, by default

PARTNERSHIP

Partnerships and other Non-Corporate Forms

GPs

o An association of two or more people to carry on, as co-owners of a business for

profit

A lot of litigation is decided on whether or not the parties were co-owners

o Intent that counts is not the creation of a partnership, but the intent to carry on a

business for profit as co-owner

o Evidence of whether or not there is a partnership:

Control

Sharing of profits and losses

JVs

o Partnership for a limited time and limited purpose

LPs

o Limited partners are very much like stockholders – they are just investing their

money, they don’t have management rights/ powers and are not liable for

partnership debts

Generally, only one general partner and multiple limited partners/ passive

investors

Cannot accidentally fall into a limited partnership because LPs must be

registered with the government (gen. state)

LLCs

o Form of a business organization for a small number of people with a relatively close

relationship but who don’t want to be personally liable for business expenses

o As similar as possible to a corporation without being taxed like a corporation

o Interests are not freely transferrable like in a corporation

LLPs

o Same as general partnership except creditors cannot go after partners personal

wealth for partnership debt

LLLPs

o The general partner is no longer liable for partnership debts

o Same can be achieve if the GP is a company (or some other non-human)

Characterizing the Relationship

Byker v. Mannes

o The definitive way to ensure your relationship is not characterized as a general

partnership is to become a different type of business organization

o You can always leave a partnership, at any time

o You can fall into GPship

Hynansky v. Vietri

o H never filed a partnership tax return and treated the losses as his own

o Pretty iron-clad rule: you have a to have a right to profits to be considered a partner

Sharing Profits and losses

Kovacik v. Reed

o Didn’t talk about who was going to share losses

o One gave money, the other gave only labor

o Default rule is that losses follow profits

o Lost opportunity costs for both parties

Fiduciary Duty (75-87)

Duty of Loyalty

Meinhard v. Salmon

o Question of fiduciary duty

o Meinhard claims Salmon should have told him about the new deal

o Salmon got the opportunity through being a partner, therefore he owes Meinhard,

at least, the duty to disclose

o Salmon has a duty to Meinhard in their common business – what is their common

business?

o Revised Partnership Act

§403: Duty of care

§404: Duty of loyalty

§103(b): Set of default rules, subject to limitations – (3) duty of loyalty

cannot be taken away

Self-dealing

Vigneau v. Storch Engineers

o Managing partner refused to pay out his partnership interest because he violated

his fiduciary duty

o It is clear he breached his duty, but what are the damages?

He is not allowed to keep his gains from the illicit, fiduciary-duty breaching

business

o Ended up with a worse deal from the court than from Storch

o Breaching party has the duty to prove by clear and convincing evidence that they

acted fairly/ fiduciarily

Management (87-98)

Covalt v. High

o Conflict of interest is always known: Covalt gains more on the lease; High loses more

on the lease

o Court says it doesn’t want to second guess the business decisions

o Partnership decisions must be made my majority; if no decision can be made, then

the status quo continues – the dissenting partner can withdraw and dissolve the

partnership

Dissolution is always the remedy for the oppressed party – you have to

liquidate the partnership and split the assets

Assets put up at auction if the partners cannot agree on value

Contracting for Absolute Discretion

Starr v. Fordham

o To what extent should courts be paternalistic and save people from the

consequences of their contracts?

o When there is self dealing in the fiduciary context, it is on those preaching to prove

fairness by clear and convincing evidence

o The partners gave themselves completely unfettered discretion

o The partners can’t come up with criteria that disfavor P, they must have some

criteria that favor him

Duty of Care

Ferguson v. Williams

o Very few cases in partnerships because you are closely associating with them,

therefore you ought to know if they are not good with partner with and you should

get out.

Be aware if your partners are incompetent

o Must be grossly and recklessly incompetent

o Courts do not like to be called in for monitoring duty

Dissolution and Dissociation: Basic Framework (98-109)

McCormick v. Brevig

o Revised UPA (1997)

Art. 6: Dissociation – something the partners do

Effects:

Might or might not result in dissolution

If dissolution, collect all assets, pay creditors, liquidate,

anything left goes to partners (winding up and dissolution)

Art. 8: Dissolution – something that happens to the partnership

Events causing dissolution:

An at-will partner expresses his not wrongful will to

dissociate, the default is dissolution, but it can be stopped.

Wrongfully dissociating partners cannot force dissolution

Art. 7: Not dissolution

Provides for a buyout – figure out a way to value the interest of the

dissociating partner and pay him that

Deciding value is difficult

If litigating value, you must issue a partial payment up front

Departing partners tend to want market value, which

usually means an auction

o Brother/ sister partnership in the family ranch

o What is the best way to value the partnership?

If total value is know, how to distribute the value to the partners?

Auction:

Issues of institutional competence when the court gives a valuation

If there is an auction, there’s no need to prove any valuation to the

court

Wrongful Dissociation (109-119)

Drashner v. Sorenson

o They ask the court to expel Drashner for them: §601(5) allows you to apply to the

court to expel a partner.

o §602(b)(1): there are strict limits on wrongful dissociation – it purports to be an

exhaustive list

o “good will” is the value of the business that can’t be accounting for in its physical

assets (an accounting term)

o Under UPA (1997) a wrongfully dissociating partner gets his interest back but must

pay for any damages he caused – you don’t get market value for your interest, the

court values it.

McCormick v. Brevig

o §601(5): expulsion

Only wrongful under UPA if it was partnership for a term

o §801(5): judicial determination of dissociation, it causes immediate dissolution

o §601(5) and §801(5) may or may not cause the same result.

o You don’t need partner’s consent to continue on if they wrongfully dissociate

o Partnership for a term: if a partner wrongfully dissociates, she doesn’t have to be

paid until the end of the agreed-upon term

o §801(2)(i): the death of a partner opens up a window for dissolution

Page v. Page

o Purported term: until they pay off their debts

o How much are you bound? IF you see a better business opportunity, you can’t

necessarily just leave, but you aren’t forced to stay forever

o UPA (1997) limits the fiduciary duty owed to people

Fiduciary Limits on Expulsion (119-135)

Bohatch v. Butler & Binion

o Partner alleges managing partner is overbilling the main client; after some

investigation, they decide there is no merit to her accusation. They expel her from

the partnership.

o They still owed her a fiduciary duty, which they breached by not giving her proper

notice of her firing and not giving her her bonus.

Contracting to Prevent Opportunistic Withdrawal

Meehan v. Shaughnessy

o Some partners prepare to leave a law firm, but they repeatedly lied about leaving

and sent letters to clients that were misleading about the old firm

o Duty to talk was in the agreement as part of the fiduciary duties owed – disclose on

demand.

o Their letters to the clients damaged the firm.

Allocating Risk of Loss in Transactions with Third Parties (135-151)

P.A. Properties

o UA hired PAP and never mentioned their partnership

o PAP was unaware of Moss until after UA had gone bankrupt and failed to pay its

debts

o Not everything the agent does binds the partnership

o Actual authority?

Is UA a partner? Yes.

In the absence of an agreement to the contrary, he has the actual authority

to bind the partnership for the purpose of its business. §301(1)

Is there an agreement to the contrary? Moss says yes.

o Apparent authority?

PAP didn’t know Moss existed – there cannot be apparent authority on

behalf of an undisclosed principal.

o Inherent authority?

Yes. Inherent authority is very broad.

o UA’s intent was to benefit the JV, not just itself and the outcome was a benefit to

the JV

o UA’s action was very much within the scope of what managers do.

Haymond v. Lundy

o Between partners

o Lundy promises 3P ~$300,000, negotiates it down to $150,000. Partnership

agreement states he cannot make an agreement to pay more than $10k to a 3P.

o Does not deal with the rights of 3P, it just deals with the what the partners actually

agreed to – actual authority

o The contingency fee is a material asset; Lundy says they did not customarily agree to

treat those fees as material assets – insufficient evidence that that is true.

o Partnership Agency

No reasonableness requirement, but you can say it as not the apparent

carrying on of the ordinary course of the partnership business

When you’re a partner, you’re automatically an agent

Dow v. Jones

o Even if the partnership is dissolved, the partnership can still be held liable under two

theories:

The party’s action is a continuing matter

Power to bind the partnership under ordinary circumstances continues

because party did not receive proper notice of the dissolution

Partner can lose this authority through agreement to the contrary

or majority vote (to take it away)

THE CORPORATE FORM

Introduction and General Principles (153-166)

Shareholders elect board; board appoints management

Shareholders always have the power to amend the bylaws

The board of directors can sometimes amend the bylaws

Shareholders have the power to elect the board, but it can sometimes be very difficult to

exercise their control over the corporation

o Too much shareholder power can result in paralysis

Almost nothing requires a unanimous vote, only waste requires it, so, in reality, nothing

does

Default rule: shares are readily transferrable, partly because the shareholders do not have a

lot of say in management

Shareholders ≠ agents of the corporation and they are NOT direct owners

DGCL §141

MBCA §8.01

DGCL §151: very flexible, can issue claims in the company and design them any way you

want

MBCA §6.01: there must be some class with unlimited voting rights and must be able to

identify who gets the residual (common stock), but can have other types of shareholders

You want a large number of authorized shares

There needs to be cushion between issued shares and authorized shares because you have

to go back to the shareholders to authorize more shares

Must always have common stock

Preferred stock is something between common stock and pure debt – in the event of

liquidation, they get paid before common stock, there is a fixed return except they may not

get it every year; they often have no voting rights; no right to the residual.

Pure debt is when someone makes a loan to the company, they get a fixed return with very

limited downside but they don’t benefit from the company’s success.

Voting Rights (166-175)

Normally shareholders vote their percentage holdings on each vacant director seat (you don’t divide

your votes), if you’re the majority shareholder, you can choose every seat.

Cumulative voting is designed to avoid giving the majority all of the seats – it is designed to give,

roughly, the percentage of seats equal to your percentage of shares.

It is decided in the certificate of incorporation whether there will be straight or cumulative voting.

N > Sx / (D+1) --- S = n. of voting shares; D = directors to be elected; X = number of directors you want to

elect

Hoschett v. TSI

o Del. Courts are big on process

o Tried to elect BoD consistently through written consents but they are forced to have

shareholders meetings annually anyway –even though they are pretty much a

formality.

Removing Directors (176-195)

Basic Rules:

Generally, whoever was responsible for electing the director, they get to make the decision

to remove them – same applies to cumulative voting, same for a classified board – whatever

the scheme for electing was, the same applies for removal, otherwise the majority could just

vote him out.

But, in Delaware, a majority can always remove a director for cause (there is a list of “for

cause” reasons)

o This can sometimes be changed in the certificate of incorporation, sometimes it

can’t, it depends on MBCA or Delaware rules.

o In Delaware, you don’t care about different classes of shares, when it comes to

removal for cause, it is one share, one vote. In MBCA, the different classes are

perfectly insulated.

o The certificate of incorporation cannot have a different rule than the general rules,

unless it is specifically allowed by statute.

May director be removed by

action of majority of shares

entitled to vote at election of

directors?

DE MBCA

Ordinary board

With cause Yes; immutable Yes; immutable

w/o cause Yes; immutable YES, UNLESS COI SAYS

OTHERWISE

Classified (staggered) board

With cause Yes; immutable Same as ordinary board;

immutable

w/o cause NO, UNLESS COI SAYS

OTHERWISE

Same as ordinary board (i.e.,

unless COI says otherwise)

Cumulative voting

With cause Yes; immutable Yes, but must use rules of cum.

Voting; immutable

w/o cause Yes, but must use rules of cum.

Voting (unless board is being

removed, in which case revert to

regular voting);immutable

Yes, unless COI says otherwise,

but must use rules of cum.

Voting.

Sub-class

With cause Yes; immutable Yes, subject to above rules

applied only within sub-class;

immutable

w/o cause Yes, subject to above rules applied

only within sub-class; immutable

Yes, subject to above rules

applied only within sub-class;

immutable

Adlerstein v. Wertheimer

o Alderstein’s business went downhill, two other directors try to oust him and replace

him with a new investor/ majority shareholder

o Question of whether the board meeting was appropriately held, and therefore if

they really got rid of Alderstein as CEO and director for cause

o They kept it a secret from him because he could have removed them because of his

majority shareholder position.

o Question of loyalty: should the directors be loyal to the company or to the CEO?

If you’re a creditor, you want them to be loyal to the company rather than

to another director who is hurting the company.

Centaur Partners

o A board structure that sets up a barrier to outsiders coming in and taking over

o Centaur wants to take over the board by adding directors – changing from nine to

fifteen because the board is staggered.

o To get rid of the staggered board, they need to change the bylaws (the certificate of

incorporation is at the director’s discretion) – bylaw amendment is, by default, at

shareholder discretion.

o They want to put a protection around the staggered board – the court says you can

protect it with a few layers.

§242: amendment by majority

§102(b): anything not contrary to the laws of the state

§216: quorum (a minimum number of people who are present at the vote

for you to actually be able to conduct business)

o It is okay, in the bylaws, to have an 80% vote for overriding a staggered board even

though the Delaware Corporations law doesn’t really seem to allow it – definitely

not in the certificate of incorporation, but that’s okay because the board’s

cooperation is needed to amend the certificate and that cooperation would not be

forthcoming.

Governance in Publicly-Held Corporations

Present value analysis: Discount rate: what you could do with the money in some alternative project of

equal risk – the higher your discount rate, the more valuable the stock is up front, less valuable in the far

future. How much money would you have to put in the bank today to get the return you want based on

your discount rate – if your discount rate is 0%, that means that $1 today has the exact same value as $1

three years from now, which is never true. PV=FV/(1+r)n (r = discount rate/ interest rate; n = number of

years; FV = future value; PV = present value)

Valuation: 1.) Look at the corporation’s assets. 2.) How much is corporation likely to earn in the future?

3.) What do other people think it’s going to be worth?

Corporation securities are, by default, liquid and easily transferrable without the permission of fellow

shareholders.

Efficient Capital Market Hypothesis (208-222): the current market price incorporates

information about the stock

o Weak form: current stock prices incorporate info about past stock prices – that

means you cannot use past stock proves to predict future prices because that’s

already calculated in – strongly empirically supported

o Semi-strong form: stock prices reflect all public information, anything that is

reasonable known to the public – so if everybody knows, the information, you can’t

use it as a predictive tool – pretty good empirical support

o Strong form: current stock prices reflect all information that could be known,

including inside information. Probably wrong because corporate insiders make

better returns than the average investor, even when it doesn’t rise to the level of

insider trading.

Proxy Solicitations; Shareholder Proposals; Governance-Related Proposals; Shareholder

Communications (222-251)

o Proxy solicitations occur when you want shareholders to vote for something you

favor

o Rule 14(a)(8): shareholder proposals – they want to piggyback on the company’s

proxy statement. Shareholder must be eligible and follow certain procedures.

Corporate management is not happy with that and generally oppose it, so the SEC

has come up with rules about when the corporation can exclude or must include

your statement.

Lovenheim

o Company tries to claim the foie gras cruelty statement Lovenheim wants to include

is not economically relevant because it is less than 5% of the company’s business.

o Lovenheim claims it is “otherwise related” and the court sides with him.

o “Ordinary business operations” claim loses.

o The shareholder’s proposal has to pass all of the tests. Ethical and social issues can

be “sufficiently related” to the business so that it cannot be excluded.

CA v. AFSCME

o Causes the company to pay for successful board elections

o Is this a proper subject for shareholder action and would this cause the company to

violate Delaware law?

The court really answers “could this cause the board of directors to violate

their fiduciary duties?”

o Does this conflict with §141(a), which leaves management to the board?

o Delaware is protective of board prerogative; they don’t give it all away to the board,

but they do favor them.

Business Roundtable

o They have been the plaintiffs in a few cases fighting against the SEC regulations that

titled the balance in favor of shareholders

o The Dodd-Frank Act basically requires the SEC to send out minority shareholder

nominations with the management’s proxy materials. SEC has established a

requirement of holding 3% of the voting power for at least 3 years and the minority

shareholder can’t be fighting for the majority of the board.

o SEC and DC Circuit disagree, the court doesn’t seem to be giving Chevron deference;

DC Circuit believes the SEC has gone too far.

o Under the 1933 and 1934 Securities Acts, disclosure has been a main theme. Since

Sarbanes-Oxley, listed companies are being more federally regulated in terms of

corporate governance.

o Jurisdiction hook is the commerce clause and the public stock exchange

Director’s Duties & Business Judgment Rule (265-276)

Only the equity stockholders are owed special duty because all other parties can protect themselves by

contract, whereas stockholders depend on management.

§8.30: the duty is owed to the corporation (the corporation is the enterprise and the shareholders).

Standard of care is reasonable director, which allows courts to apply the BJR. Corporate management is

more risk-taking than the average tortfeasor, so you cannot use the same language.

§1715 (Penn. BCC): modifies the common law rules and says that directors can consider the effect on all

groups – means there is no way of holding directors accountable in PA because they can consider

anything in their decision-making process.

Business Judgment Rule

o Protects directors from liability to shareholders but does not protect them from

liability to 3Ps who are injured (the tort victims who do not have the alternative

remedies available to shareholders)

o The shareholders have the burden to rebut the presumption of good business

decision making

Really it’s a gross negligence rule

It works as a gate keeper

Shlensky v. Wrigley

o Wrigley won’t install lights on the field to the Cubs can have night games. Wrigley is

alleged to have said that baseball is a daytime sport and he doesn’t care about

profits but is worried about the effect lights would have on the neighborhood.

o Plaintiff must show fraud, illegality or conflict of interest to rebut the presumption

of the BJR.

o P doesn’t prove that preserving the neighborhood is not in the best interests of the

Cubs.

Dodge v. Ford Motor Co.

o Dodge wanted the company to pay a dividend, but Ford wanted to reinvest in the

company

o Ford lost on the dividend even though it’s something they’d normally win, because

instead of saying it was a business decision, he said he wanted to benefit the

community.

o Court basically told Ford to be charitable with his own money rather than the

company’s dividends.

o If management says they aren’t issuing dividends because they need the money, the

shareholder should ask why they can’t raise that money on the open market.

Fiduciary Duty

Loyalty & Corporate Opportunities (277-300)

o Northeast Harbor Golf Club

Nancy Harris, president of the Golf Club, bought up real estate surrounding

the club – initially not a problem, but years later she starts to develop it

Club wants to enjoin her and set up a constructive trust (saying her profits

are theirs)

Line of Business Test (Guth Test): If there is presented to an officer or

director a business opportunity which the corporation is financially able to

take that is, from its nature, in the line of the corp’s business, of practical

advantage to it, and is one in which the corp has an interest or reasonable

expectancy and, by embracing the opportunity, the self-interest of the

officer or director will be brought into conflict with that of his corp, the law

will not permit him to seize the opportunity for himself.

He may not take the opportunity for himself if:

The corporation is financially able to exploit the opportunity

The opportunity is within the corp’s line of business

The corp has an interest or expectation in the opportunity,

and

By taking the opportunity for himself, the corp fiduciary will

thereby be placed in a position inimicable to his duties to

the corporation

He may take the opportunity for himself if:

The opportunity is presented to the director or officer in his

individual and not his corporate capacity

The opportunity is not essential to the corporation

The corporation holds no interest or expectancy in the

opportunity

The director or officer has not wrongfully employed the

resources of the corporation in pursuing or exploiting the

opportunity.

Fairness Test (Durfee Test): rests on the unfairness in the particular

circumstances of a director whose relation to the corporation is fiduciary,

taking advantage of an opportunity for his personal gain when the interest

of the corporation calls for protection. This calls for application of ethical

standards of what is fair and equitable in a particular set of facts.

ALI Test (§5.05):

Definition of corporate opportunity

Source of info: “any opportunity” in connection with your

performance of your duties in the corporation (no subject

matter limitation) – or – even if not learned in connection

with your business position, if you think the person

expected it to be offered to the corporation (a bit of subject

matter limitation)

Type of info: (only applies directors and senior execs) source

does not matter, if the exec comes across any info that is of

interest to the corporation, no matter how, you must

disclose.

Did the director or senior exec first offer the opportunity to the

corporation?

If not, there is very little opportunity to cure. (e) is the only

way and it’s unlikely – must offer the opportunity to the

corp and they must deny it.

If there is no disclosure, there are questions of adequacy.

MBCA §8.70(h): not a substantive rule, basically just provides a safe harbor

– but it doesn’t say what happens if you don’t follow the rules. Looks at

actions by qualified directors.

o Broz

Uses the line of business (Guth) test

Financial ability test: CIS and Pricellular do not meet that test

Loyalty & Conflicting Interest Transactions (300-323): most of the time, they are talking

about directors being on both sides of the transaction (sometimes major shareholders); it’s

okay with safe harbors: full disclosure and approval by disinterested parties.

o The standard is fairness and the burden is on the party who had the conflict

Reverses the presumption of BJR.

If you have the decision/ transaction properly cleansed by disinterested

directors (or shareholders) and disclosure, it’s a much smoother process.

o Globe Woolen

Wool factory with its president also on the board of the gas and electric

company – made a very self-dealing k, he didn’t vote on it. He remained

silent while they discussed the financial implications of the contract, but did

not disclose the possibility of it becoming a losing contract for the gas and

electric company.

The board relied on his silence in approval the k. Silence is not

enough when you are a fiduciary.

o Sinclair Oil

Sinclair owns 97% of SinVen. P is a minority shareholder of SinVen. He

complains of excessive dividends, wasted corporate opportunities, and that

Sinclair caused another sub to breach its k with SinVen.

Sinclair wins on the first two and loses on the last.

Excessive dividends: P complains the dividends made it impossible for

SinVen to expand and the reason for declaring them was to give Sinclair

cash.

Falls under BJR

Wanting money is NOT an improper reason for declaring dividends –

that is the purpose of the corporation.

Not self-dealing because all shareholders benefited from the

dividend – Sinclair was just the majority and therefore got the most

benefit

o Shapiro

Closely held corporation comes up with a plan to redevelop their ailing

shopping center. They don’t believe they have the wherewithal to do it

themselves, so they enter into a joint venture with others.

The question is whether the project was appropriately raitified

All laws say directors must be disinterested, but they vary as to whether the

shareholders have to be disinterested (they can cleanse a transaction)

If Joan had resigned her directorship right before the vote, the

entire problem could have been avoided (MD statute)

MBCA §8.63(c): qualifying shares – shares don’t if they are a relative of a

director

MBCA §8.60: a sibling is, per se, a related person and is therefore an

interested vote.

Conflict of interest can be cured ex post

Duty of Care (323-350)

o Joy v. North

Sets forth the justifications for BJR

Shareholders volunteer to take risks (or at least to undertake the

risk of bad business judgment)

The market is a better incentive/ mechanism for enforcement of

institutional competence

Management should be encouraged to take risks (or at least should

not be discouraged) – the company gets all the upside, you can’t

stick management with the downside

o Smith v. Van Gorkom

§102(b)(7): Exculpation provision – corporations can put in their certificates

of incorporation that directors cannot be sued for negligence

TransUnion had more tax credits than taxable income. They acquired

companies in order to get more taxable income, but then they decided to

be acquired instead (they basically represented a tax break to whoever

acquired them). Shareholders are offered $55/ share when the market

values it at $38/share

The shareholders claim:

Breach of duty of care

Breach of duty of candor: management did not give shareholders

proper information on the deal. It only becomes relevant when

there is a shareholder vote

Standard of care:

Gross negligence – concrete manifestation of the BJR

Did not have the CFO or any outside analyst assess the

value of the company

Outside directors are allowed to rely on what inside directors tell

them if they have good reason to believe them

They eventually settled for .40 more per share than the original $55 offer

from Pritzker

Exculpation (350-375): allows corps to limit or eliminate the directors liability for breach of

duty of care (MBCA §2.02; DGCA §102)

o Malpiede v. Townson

Without an exculpation provision, you apply a gross negligence standard

when there is a breach of duty of care.

You cite the exculpation provision as an affirmative defense

Directors want it thrown out in the pleading stage: that’s what BJR

and exculpation is for

In pleadings, you are assuming all P’s claims are true

Duty to Monitor and Good Faith (375-393)

o Caremark

The directors put in place a system to ensure they knew what was going on

in the day to day business.

It’s a claim for negligence on the board’s behalf – they are not seeking

money damages, they are seeking a structural remedy

Exculpation clause

BJR (but the Ps are arguing that decisions WEREN”T made, rather

than that they were made poorly)

Violation of the duty of care

Directors do have a duty to monitor:

Corporate compliance with the law

Business performance

The board did implement procedures to ensure the employees knew how to

behave and how to stay on the right side of the law.

If you don’t take measures to inform yourself of the behavior of your

employees, you have violated the duty of good faith/ loyalty

That cannot be exculpated

o Disney 1.0 (Brehm v. Eisner)

Derivative suits have to meet a higher burden than direct suits.

Two different boards are being sued for two different things

Old Board: making the original deal with Ovitz

New Board: paying out the severance package to Ovitz on the basis

of a “no fault” termination

Old Board claim: even if the advice was crap, they relied on the advice of an

expert. Claim is tossed out

Substantive due care:

Board should have realized this was a bad idea

Court says this concept is “foreign” to the BJR. Courts do not

look at the substance of the decision; they only look at the

process by which the decision was reached.

Ps claim this decision rises to the level of waste – the court

disagrees.

Because of Disney’s exculpation clause, everything must be phrased

in terms of waste, violation of loyalty and violation of good faith

New Board claim: they could have fired Ovitz for cause and not paid out

$140m to someone who did a poor job

Court finds the “cause” is arguable so it falls well within the BJR –

does not rise to the level of bad faith.

Court says the complaint was poorly drafted and allows Ps the

opportunity to redraft . . .

o Disney 2.0

New complaint survives summary judgment

P says that no one made any judgments so BJR does not apply

Board didn’t even meet to discuss the pay out

Court finds that would support a conclusion that the board just

doesn’t care – a breach of loyalty and good faith (Lesson: conscious

indifference/ waste allows shareholders to make it past summary

judgment with a well pleaded complaint; then they just have to

prove it was more than gross negligence)

At trial, Ps did not prove all the facts they alleged

Directors did not quite meet the standard for waste (deliberately ignoring

the duty of loyalty)

Gross negligence, by itself, does not amount to bad faith – that would make

exculpation clauses useless

Derivative Suits: basically, those who control the corp sometimes commit a wrong against it; they won’t

pursue themselves, so it may be appropriate to allow others to pursue the claim. Typically on

shareholders get the opportunity to pursue the claim because they get the residual.

There might be good business reasons for not bringing a claim – subject to BJR

o You don’t apply BJR when there is: (same as when the shareholders can challenge

the board’s rejection of their demand)

Bad process

Conflict of interest

Lack of independence

Delaware

Step One: Determine Composition of Board

o Same or different? Three ways to be different:

Majority of T1 directors gone

Not a business decision

Made by board of different company

If different – Rales

o Go to T2 and look at whether the board had conflict in deciding not to move

forward with suit

Only look at t1 to the extent that it is relevant

o The board has a conflict if:

Particularized factual allegations can be alleged by the plaintiff that raise a

reasonable doubt that, as of the time the complaint is filed, the current

board could not have properly exercised independence and disinterested

business judgment in responding.

Basically, can the board, as comprised at T2, be impartial in deciding if the

suit should go forward

o If successful in alleging particularized facts then the demand on the board at T2 is

futile

If same – Aronson

o Two prongs

Independence/disinterested

Independence: Conflict of Interest at T1 (looking at the relationship

between disinterested and interest parties)

Disinterested: No material financial interest in challenged

transaction at T1

Challenged acts were product of BJR

o Look at T1 when board made the challenged decision

Apply BJR in context of challenged transaction.

If covered then shareholder can’t bring derivative suit

o Not covered by BJR if particularized facts of complaint allege either board not

independent at T1 (Conflict of Interest) or lack of due care (gross negligence) at T1

Grimes

o Look at T2 (wrongful refusal to let suit not move forward)

Whether or not their decision was tainted Board gets presumption of BJR

Up to shareholder to allege facts with particularity that BOD not

entitled to BJR

o Shareholders have given up right to declare demand futility by making a demand to

the BOD, but that is all they’ve given up (one arrow in the quiver)

o Does T2 board have the ability to say suit may not proceed?

Were they right in saying suit could not go forward?

Basic understanding in American English:

File suit with court. Corp files MTD saying, “You didn’t go through us.” Plaintiff says couldn’t

have gone through BOD because demand would be futile. To determine if demand is futile,

the court looks to Aronson and Rales. If the court finds that it would be futile, then the suit

continues on merits.

Plaintiff demands to BOD (we want to sue you!). BOD refuses to allow suit to proceed.

Plaintiff then files in court. BOD files MTD saying we already refused plaintiff’s demand.

Plaintiff says wrongful refusal and court looks to Grimes

MBCA

7.44 Grimes – decision to reject demand (let us sue you!) must be made in good faith and

after reasonable inquiry

No such thing as demand futility. Have to always make demand. Always start with Grimes in

essence and that makes fucking sense

Demand Requirement (398-411)

o Aronson v. Lewis

Derivative suit claiming that the deal between the company and Leo Fink

amounted to waste

Board loves Fink, they offer him a complete sweetheart deal

Apply BJR

No conflict on interest

Acting with requisite care

Duty to be informed

Shareholders claimed demand futility

Del. Ct looks at BJR in the context of the challenged transaction (T1) – if BJR

applied then, the shareholders can’t bring suit

Standard of pleadings (more than notice pleading):

Particularized facts that show

The board was not independent at T1 or

There was a lack of due care

If Ps create reasonable doubt in regards to:

Director independence, or

Bad process – something to knock out BJR

The court is trying to have a mini-trial on the merits – deciding if the

substance of the claim is meritorious

The decision whether or not to engage in a suit is a considered a business

decision

o Board Response (411-428)

In re The Limited

Company has the Children’s Trust with put and call options

Put option: the right to make someone buy something from

you – implication: forcing a minimum price

Call option: the right to make someone sell something to

you – implication: creating a stated max price, less than

market value

The company has to keep $350m always available in case the

Children’s Trust wants to exercise its option.

Shareholders claim the self tender was a smokescreen to get rid of

the Children’s Trust

Put/ call options do not have the same value

Company wants to free up the $350m

Shareholders say the board created the need for cash in

order to justify getting rid of the trust

Claims: waste, breach of duty of loyalty, breach of duty of care

Court looks to Aronson Test

Ryan v. Gifford

Companies often issue stock options as a form of compensation for

executives

The exercise price has to be the market price when you

grant the option – the option needs to be $0 when you

grant it

Shareholders claim that the board is backdating the stock options

(they require shareholder approval) in order to compensate

executives (which doesn’t require shareholder approval)

Stock options are passed by the compensation committee

rather than the whole board

Court found Rales does not apply because as long as half the old

board remains at T2, it is considered the T1 board.

But the violations of a shareholder approved plan are NOT covered

by BJR.

Demand Futility and Dismissal by Committee (428-440)

o Stone v. Ritter

Bank did not adequately supervise some employees and they ended up

being used as part of a Ponzi scheme. USG fined them $40m.

Bank employees didn’t file a suspicious activity report and the Ponzi

scheme continued for longer because of their inaction.

Exact same idea as Caremark – the board should have put in a policy to

ensure the employees would file suspicious activity reports

Demand futility:

Instead of applying Aronson, because Ps are complaining about the

lack of a transaction, rather than a challenged transaction, they

apply Rales

Under Rales, you look at T2 and only look at T1 to the

extent that it is relevant.

Really, the court seems to look at T1 and says, if we were

deciding on the merits, P doesn’t prove anything rising to

bad faith (really looks more like Aronson)

Standard applied to directors’ lack of activity: because there is an

exculpation clause, you have to prove bad faith

Court relies on the KPMG report to show that they had made some efforts.

o Zapata Corp v. Maldonado

Establishes Del’s rule for special litigation subcommittees of the board:

Two prong test:

Burden on the subcommittee to prove independence and

good faith – limited discovery; this is more intense/ bigger

than the mini-trial)

Court applies its own business judgment to the decision of

whether or not the suit should move forward.

o Step Two is to try to avoid structural bias of boards;

but they can also look at public interest and matters

of law in deciding

o Court can say that it agrees that it doesn’t serve the

best interests of the company, but that it is an

important, unresolved question and would serve

the public interest so they are going to let it go

forward.

Leaves a lot of leeway for the Del court’s decision.

New York’s Rule: Apply BJR (requires good process and disinterest) – the

question of whether or not to proceed with a lawsuit is just another

business decision

There is concern about structural bias – a mutually protective

philosophy with the rest of the board.

Iowa’s Rule: They don’t give any deference to the decision of the litigation

subcommittee

o Indemnification and Insurance (438-440)

MBCA §8.50 – 8.59 (does not require indemnification for partial success)

DGCL §102(b)(1), §145 (requires indemnification for even partial success “on

the merits or otherwise in defense of any action, suit or proceeding”)

Corporations traditionally indemnify directors against possible liability for

serving the corporation

Since the 1950s, insurance has been available to cover many of the litigation

costs.

Under general agency principles, a principal is required to indemnify and

agent either

Pursuant to the terms of their indemnity agreement, if any, or

Whenever the agent suffers a loss that, because of the relation,

should be fairly borne by the principal.

Close Corporations

Businesses without many shareholders.

Sometimes has a particular legal meaning

In a close corp, there is not a big market for the shares, so shareholders don’t really have the easy exit

option and they may not have much of a voice either.

Instead they have contracts – make a shareholder agreement

Statutory Provisions:

MBCA §7.32: designed to tell the courts not to apply pre-existing common law of corps

(eliminating BoD or restricting the board’s authority); creates a unanimity requirement;

disclosure requirement: must always disclose the existence of the shareholder agreement to

anyone entering the close corp or he can rescind his purchase of shares.

o Failure to reach unanimous agreement does not render the agreement invalid, it

just means you don’t get the safe harbor.

o The agreements are rendered void if the company becomes publically traded

Del: Subchapter 14 creates the legal category of close corps.

o §342: Various things MUST be in the certificate

o §343: Must be specifically labeled a close corporation

o §350: Does not require unanimity, but majority agreement

Only parties who agree are bound

Specifically states this is not against public policy

o §351: Shareholders can manage the corp rather than the board

Contracting Around Law (447-472)

o McQuade v. Stoneham

Court found that the agreement took away control from the board and was

therefore bad, even though no one was harmed by the agreement

o Clark v. Dodge

Clark is guaranteed ¼ share of dividends, no unreasonable salary to others

Court says Clark can enforce the agreement because the invasion of the

powers of directors

Holds that McQuade is not binding law

o Zion v. Kurtz

Zion negotiates for veto power even though he is a minority shareholder

Del sort of allows you to do this with §350 but the question is whether this

is really a close corp under Del law

Majority finds the company can do it even though it is not legally a close

corp because no 3Ps were harmed

Dissent says the legislature created the rules for close corps for a reason

and the majority has eviscerated those rules by allowing a non-designated

close corp to benefit.

Under the MBCA, there is no reason to define the company as a close corp is

3Ps aren’t buying the shares

o Blount v. Taft

What is a shareholder agreement? Unlike a certificate of incorporation or

bylaws, it is a contract

Blounts basically want veto power for employment decisions

They put it in the bylaws – then the Tafts and the McGowans decide

they don’t like it anymore and change it by majority vote

Court finds this is a shareholder agreement with an amendment provision

that allows for majority change

Lesson: must make it very clear that something is subject to unanimous

consent because there is a strong presumption toward majority rule.

o Ramos v. Estrada

S corporation – means there is no taxation at the corp level – but you have

to have human shareholders (rather than LLCs or other corporations)

It’s a creation of federal tax law

Partnership Analogy, Enhanced Duty (473-494)

o Zidell

Family company: two brothers; first brother brings his son in, other brother

quits and wants dividends

Application of BJR

Conflict of interest? (self-dealing)

Lack of due care?

Bad faith – question of fact

P has the same burden of showing there is no good faith

explanation – v. difficult to prove

Court found no bad faith therefore they did not overcome BJR and cannot

force dividends

o Wilkes v. Springside Nursing Home

Four friends invest equally and each draw equal weekly salaries – they own

and operate a nursing home.

The other started disliking Wilkes because he negotiated a higher selling

price of real estate to another of the original members

Damages: asking for the salary he would have been paid

Duty: strict duty of good faith – Mass. Court finds as matter of law that close

corporation are to be treated as a partnership for intra-shareholder disputes

Majority (D) has burden to show a legitimate business purpose

without much deference (not Meinhard v. Salmon)

P has burden to show he was harmed and must show it’s a close

corp to be treated as a partnership

P can show there was another option less harmful to him

Breach of contract – Wilkes’ back up claim, even though it was unwritten

Who pays the damages? Supposed to be the corporation but it’s really the

shareholder – he should only be paid 75% of any damages because Wilkes is

a 25% shareholder, so his net has always been 75%, so the other three are

bearing Wilkes’ share.

Involuntary Dissolution, Buyouts (504-519)

o Kemp & Beatley

Prior to the time of the shareholders leaving, compensation was done by

salary with a dividend-like thing distributed according to shares

After Dissin and Gardstein left they changed the policy to give bonuses

based on work done

Substantive rule: frustration by the majority of the legitimate and

reasonable expectations of the minority that were central expectations of

their participation

Burden on D to show that something other than dissolution is the right

remedy

Remedy is similar to partnership – but you threaten the majority with

dissolution unless they come up with a reasonable buy out proposal

o Gimpel v. Bolstein

Robert Gimpel embezzled from the family company, was caught, promptly

fired and cut off from the business. He wanted participation, access to

books, and to get dividends – so he alleged oppression and asked for

dissolution

Court finds there was not oppression to result in dissolution

Expectations test doesn’t work

Fair dealing test

Robert should be allowed access to books and records

Company has to buy out Robert or change the company

policy on dividends

Share Repurchases (519-533)

o Concord Auto Auction

Death provision for stock buyback

There was a set price – but they could agree to change the price each year

at the annual meeting

Buyout/ repurchase agreements give minority shareholders a floor to get

out of the arrangement

Court interprets the k as written

o Gallagher v. Lambert

Gallagher is an employer/ officer/ director and he purchased shares subject

to a mandatory buyback agreement

If terminated or resigned by Jan 31, he gets books value, after that

he gets market value (though not often the case, book value can be

higher than market value)

They wanted to shares to stay within the company

Gallagher fired, not wrongly, on Jan 10

He claims they fired him because they wanted to pay the lower

book value for his shares – he really wants market value

He claims they wronged him by causing the trigger event to occur

Court found that Lambert had no fiduciary duty not to fire Gallagher

pre-Jan 31. They all agreed to the terms of the buyback provision

o Pedro v. Pedro

Three brothers with the same duties and equal shares

Buyback agreement – 75% of the book value (all agree)

Alfred discovers a bookkeeping discrepancy that causes discord between

the brothers

The other brothers fired him and told the employees he’d had a nervous

breakdown

Alfred brings a motion for dissolution; brothers move to convert it to a

buyout proceeding

Alfred alleges breach of fiduciary duty and bad faith therefore the buyback

is not his sole remedy – he wants fair market value for his shares

Court looks at the k to decide whether it was intended to be the sole

remedy – the low price might indicate that it was the only option – no one

would choose it if there was a choice

Alfred wins: he gets the stock retirement account and he gets extra

damages for breach of fiduciary duty (they owed him a duty not to engage

in triggering events to this extent) and lost wages

Ds claim the lost wages are a double recovery because the wages

are really a substitute for dividends

Court did not really entertain this objection.

LLCs

Del. LLCA §402: Default rule on management looks more like a corporation; management is in

proportion to the interest in profits of the members.

Del. LLCA §503: Default rule on profit shares looks more like a corporation; allocated on the agreed

values of the members’ investments.

Del. LLCA §804: Default rule on liquidation: (a)(3) first return any contributions, then any extra is

distributed according to interest sharing (profit shares) – more like a partnership.

Uniform LLCA §404(a): any distributions must be in equal shares (more like partnership)

ULLCA §407: each member has equal rights in management (more like partnership)

ULLCA §*** on distribution/ liquidation is the same as Delaware (more like partnership)

Planning and Contracting (535-556)

o Elf Atochem

o Olson v. Halvorsen

Fiduciary Duty and Contracting Around (556-571)

o DLLCA §1101: (c) duties may be expanded, restricted, or eliminated except the

implied covenant of good faith and fair dealing. (d), (e) cannot eliminate or restrict

liability for bad faith.

o ULLCA §110: (c) cannot (4) (5) (d) may do – as long as not manifestly unreasonable

(5)

o Which is more limiting?

ULLCA allows you to spell out conflicts you foresee and deal with them as

you wish

DLLCA gives you more scope to make blanket conflict statements, but it is

less certain that the courts will follow your contract.

o Bay Center Apartments

The only relationship Bay Center had with anyone was the LLC agreement

for management of PKI. But they’d really like to sue ETI because that’s who

they think failed.

They use a claim based on break of the implied covenant of good faith and

fair dealing – PKI had the power and authority to compel ETI to act and

therefore had the duty to compel ETI.

Ps charge that Nevis had a conflict of interest with the bank loan that he

personally guaranteed – he wants the bank paid first rather than Emery Bay.

They also charge that he had a duty to make PKI sue ETI for breach of

contract.

Question of fiduciary duty: possibly conflicting statements in the k. They

incorporate Del Code by reference then say there are no fiduciary duties

between parties except as otherwise written.

Court found there was a reasonable interpretation finding fiduciary

duties between parties.

o Kahn v. Portnoy

They modified their fiduciary duties by contract, by they did a very poor job

of it.

The claim is that Portnoy’s influence caused the board to make a bad deal

for the company to benefit him (he gains on the HPT deal and doesn’t lose

on the RMR deal)

Contract defines a certain class of transactions and says how to deal with

them

Including that the person bringing the claim has the burden of

proving by clear and convincing evidence (high standard) – not the

normal BJR. Clear and convincing evidence standard doesn’t matter

in the pleadings.

Definition of class of transactions:

Shareholders (and/or affiliate); directors (and/or affiliate); company

There are multiple plausible readings of the clause

Judicial Dissolution and Other Remedies (571-591)

o Fisk Ventures

Shares are in a corporation; interest is in an LLC.

Fisk got a put right (DEFINE**) from Genitrix as part of his investment

As part of an exit strategy, if Genitrix didn’t have the cash to buy his

interest, he got to replace one of Segal’s board members, which

really means he gets to take over (important decisions need 75% of

the board, which he would then have)

Standard for judicial dissolution: not reasonably practicable to carry on the

business of the LLC

Simply because the board has failed to vote unanimously is not a deadlock,

there must be something more

Possibly continuous inability to reach decisions – more than just the

normal, expected exercise of a party’s veto right.

Segal says instead of judicial dissolution, Johnson should exercise his put

right

Court says Johnson cannot be forced to exercise his option – Clarke

does not like this reasoning, dissolution is the last resort for people

with no other options.

o R&R Capital

Russet brothers (money men) on one side and Merritt on the other (though

not a named P – she’s appointed the manager)

Russets on some claims have no standing to petition for dissolution because

they are not members or managers

Del. §109(d): waiver – may not waive rights to a proceeding in Delaware.

Court finds this cannot mean what R&R says it means because that

would mean LLCs can’t waive any rights – it proves too much

R&R claims the language in some clauses is ambiguous and that

means they aren’t waivable

The goes against Delaware’s purpose

R&R claims it’s against public policy

Delaware wants freedom of k to the fullest extent allowable

Court says their remedy is a claim of bad faith against Merritt – good faith

and fair dealing is definitely not waivable

Delaware will let you waive the right to dissolution. ULLCA does NOT allow

you to wait that right.

o VGS v. Castiel

Similar to Alderstein: Castiel has control of the LLC because he appointed

two of the three member board, but his appointee went against him and

worked clandestinely with Sahagen to wrest control from him.

Merger means that all interest from the LLC goes away and they must issue

stock – Sahagen gives a $10M promissory note so that he can get the

controlling stake in the new corporation.

Court finds they acted in bad faith and the merger is void.

Outsiders: Corporations as a Device for Allocation of Risk

Statutory Rules Governing the Equity Cushion

o Uniform Fraudulent Transfer Act: if you have creditors, you can’t just give money

away if it’s going to injure the creditor – isn’t really about corporate law.

o Del. §170: basically an accounting limitation on how much money you can give out –

you can only give dividends out of the surplus.

o MBCA §6.40: (c) no distribution can be make if they make the corporation unable to

pay their debts when they come due.

Look at the definition of distribution §1.40(6) – a direct or indirect transfer

of money or property in relation to shares (dividend, share repurchase, etc)

o Equity cushions, the money the original investors put into the corporation –

minimum capitalization requirement, are no longer needed

It didn’t really do very much to protect creditors.

Minimum Initial Capitalization Requirements

o Del. G.C.L. §§ 153, 154

o MBCA § 6.21

Quality and Valuation of Consideration Paid for Shares

o MBCA § 6.21

o Del. G.C.L. § 152

Limits on Distributions to Shareholders

o MBCA § 6.40

o Del. G.C.L. §§ 154, 170, 244

Dividends and Distributions (593-608)

o Klang

Self-tender and merger

P is a shareholder, not a creditor – these rules were not designed to protect

shareholders

Klang says the corporation violated the rules because, post-merger, the

company had a negative net worth

It is not apparent how Klang has been injured, which makes the case difficult

to prove

Court says they can value their net worth however they want, so long as it’s

reasonable.

o Balance sheets: it must be equal on both sides – you use equity to ensure balance

Retained earnings – where you throw in all the extra money

Capital – par value

Surplus – anything extra you get from selling above par value

Current liabilities – those debts due within the year

Long-term debt – due in more than a year

Piercing the Veil

o Three elements must be present:

D dominated and controlled the corporation (corp had no mind of its own)

Control was used to perpetrate a wrong

It was the proximate cause of the injury to P

o Contract (608-625)

Consumers Co-op v. Olson

Olson starts ECO with $7,000, then it ends up $190,000 in debt.

Trial court found that ECO was inadequately capitalizes and Chris

had control of the corp, therefore they pieced the veil.

Appeals court says not do not pierce the veil:

Corporate formalities were heavily relied upon- used to

protect shareholders

Chris completely separated corporate and personal

expenses

He also kept putting his own money in the corp to prop it up

Court finds Co-op waived its rights to claim inadequate

capitalization – they are estopped because they continued to give

credit after non-payment.

K.C. Roofing

Russell paid secured creditors and not anyone else; he paid himself

and his wife $100k salaries and $100k in rent – these are disguised

dividends

Court allowed the veil pierced because Russell satisfied the three

prong test – he was misappropriating the corporate form to escape

creditors

o Tort (625-634)

Respondeat superior – the employer is liable for the torts of the employee –

Parents are NOT liable for their subs under respondeat superior

Western Rock v. Davis

Fuller (money man) and Stroud (everyday activities) operate

together to do blasting in TX. Western Rock is basically a shell corp

and is extremely asset poor. When they learn of the blasting

problems, they continue doing the same thing. Ps sued W.R. but it

had no assets, so they want to pierce the veil.

They satisfy the three prongs: In control of the corp? Yes.

Perpetuating a fraud or wrong? Yes, they kept blasting even after

being notified of the problems. Proximate cause? Yes.

Assuming they are not allowed to pierce the corporate veil, it is

possible that Fuller and Stroud could be held directly liable for the

torts, corporation or not.

Baatz v. Arrow Bar

McBride was served alcohol at Arrow Bar while intoxicated, then he

hit the Baatzs with his car.

McBride was judgment proof, so they sued the bar and its owners

under a state statute making it illegal to serve someone who is

visible intoxicated.

The employer is the corporate entity, not any inviduals.

Factors that indicate injustices and inequitable consequences that

would allow a court to pierce the veil:

Fraudulent representation by corporation directors

Undercapitalization

Failure to observe corporate formalities

Absence of corporate records

Payment by the corporation of individual obligations

Use of the corporation to promote fraud, injustice, or

illegalities

The legislature decided that corporations have limited liability for

torts and contracts

If the corporation has insurance, you don’t bother trying to pierce

the veil – you only need to when the corp does not have enough

assets to cover the damages.

o Parent/Sub and LLC (634-657)

Craig

Three part test for piercing the veil

100% ownership/ control is not enough to pierce but total, actual

control is

Charter claims is had potential but not actual control over Cape

Trying to avoid liability is not a reason to pierce the veil

In this case they are just trying to pierce the veil to get to another

corp

Bestfoods

Can the parent company be held liable for its sub’s actions?

Veil piercing theory; or

Direct liability of the owner/ operator

Court looked at the parent/ sub relationship because if an

employee/ supervisor works for both the parent and the sub, the

default presumption is that he was working for the sub.

Find someone who only works for one company – better for

P if it’s the parent

The question is not whether parent operates the sub, it’s whether

they’re operating the facility for direct liability – dominate/ control

the sub is for veil piercing

Kaycee

De Facto Incorporation (658-669)

o Graziano

Graziano signs k with RKO prior to actually incorporating but with the

provision that all liabilities shift to the corp prior to closing

Creditor without a remedy, under D’s interpretation – the corp has an

option to accept liability or not and they are covered from personal liability

Court found the parties needed to make a new agreement

(novation) to create this option

Remedies:

Pierce the veil: but they need to find the three elements.

o Timberline

Timberline rented to Aero-Fabb Corporation and didn’t get paid – but Aero-

Fabb was a de facto, not de jure corporation

Bennett (Aero-Fabb shareholder) denies liability even though the corp was

defectively incorporated and not legal during the time the rental agreement

was made.

Theories:

Corporation by estoppel: this is decided completely case by case

All about fairness, typically based on things the estopped

party did – in these circumstances, this particular party

cannot argue that the other is not a corp

Bennett did not meet the burden of showing P even

believed it was dealing with a corp; definitely did not show

any faulty actions

De facto corporation (not all jx accept this theory, including this one

because it is now very easy to incorporate)

Intention: the parties must intend to incorporate

Action: the parties did prep work for incorporation

Davenport, the promoter, who signed on behalf of the non-existent corp

does not get off the liability hook unless the corp expressly undertakes the

obligation by novation

Who is liable?

The party has to have purported to act for the corporation

Bennett and his partner were engaged in a business for profit – a

partnership

If it’s found to be a partnership, Bennett is liable; if it’s a

partnership then Davenport is an agent = liability

MBCA §2.04 is more exculpatory, requires knowledge that there was no

corporation, but might be liable under some other theory.

Mergers

Requires approval of both boards of directors and shareholders

MBCA: majority of shareholders – a quorum

Del.: a majority of ALL shareholders

Exceptions: (where the shareholders don’t get to vote)

Whale-minnow mergers: > 20% threshold counts as a minnow (if A’s entire shares will comprise less

than 20% of the merged corporation)

Parent-sub mergers: If the parent owns at least 90% of the sub, you just need the board of the parent to

approve.

Del.

§251(c)

§262(b) – gives you appraisal, but its subsections might take it away

MBCA

§11.04

§13.02 – if you don’t get appraisal under (a) you don’t go any further; if you do, move to (b)

which might take it away

Appraisal rights:

Not everyone gets an appraisal right – if it’s the kind of deal where you get a vote, you tend

to get appraisal rights (except with parent-sub**)

Market out: if there is an active market for the stock that you retain or give up, then you

don’t get appraisal because the value is easy to determine.

MBCA has a special provision – if it’s a merger being carried out by the controlling

shareholder then you get an appraisal right – you don’t have to show any wrong (like breach

of fiduciary duty) – NOT true in Delaware

Introduction and Dissenters’ Rights (689-707)

o Hewlett

§225(d) action to invalidate the vote

The board met many times and really examined the deal

Standard applied: knowing misrepresentation by management

ISS = institutional shareholder services – tells them how they ought to vote

Requires a “substantial likelihood” the info would have been relevant to the

shareholder’s decision.

Manipulation of Deutsche Bank Asset Management – possible vote buying,

but the court says it’s not proven to their standard

De Facto Mergers and Contractual Limits (708-725)

o Farris v. Glen Alden Corp

Did a sale of assets transaction rather than an out and out merger in order

to avoid giving Glen Alden shareholders voting or appraisal rights

There was majority shareholder approval, but there were minority hold outs

getting swept along and the question is whether they should get appraisal

rights.

o Applestein

Epstein/ Interstate sells its shares to United in return for shared in United

and giving Epstein control once Interstate is dissolved.

Two step transaction – substance over form

Looks like a merger: dissolution, assumption of liabilities and assets,

complete transfer, pooling of interests, joinder of officers and directors,

assumption of control (by Epstein)

o Hariton v. Arco Electronics

Arco sells its assets to Loral and effectuates a merger – Arco’s shareholders

approve the transaction, Arco liquidates and now the shareholders of Arco

are Loral shareholders.

Hariton wants his appraisal right, but you don’t get appraisal with a sale of

all assets

There is no such thing as abstract mergers – there is only what the law

allows you to do.

Business Purpose

o Tanzer

Long term debt financing is a legitimate purpose but that cannot be a

subterfuge for getting rid of minority shareholders

Odd statement because no company gets rid of minority

shareholders just to do it, they do it for an economic purpose

Business Purpose Test only applies to cash-out mergers

A certain amount of self interest is okay

Cash-out mergers need to be approve by a majority of the

shareholders and can be challenged if they were not adequately

informed.

o Coggins v. New England Patriots

Entirely dependent on the good will of those who control the majority of

the stock

He wants to use company assets for his own purposes, but there are other

shareholders, so he wants them gone.

Does not pass the BPT

o Weinberger v. UOP (728-744)

Valuation and Exclusivity (744-769)

o Cede & Co v. Technicolor

MAF/ Perelman acquires Technicolor through tender offer. Dissenting

shareholders want appraisal. But should valuation be under the

Kammerman or Perelman plan?

Court of Chancery looked at K’s plan, which was failing and had

reduced the stock price. They read Weinberger to say the expected

value increase after the merger can’t be counted because it’s

inconsistent with the statute.

Supreme Court of Del finds that is a misreading – count all the

effects of the merger on price unless it’s purely speculative.

Perelman had already begun to implement his plan, therefore the

price reflecting the Perelman plan is the correct valuation.

Perelman could argue that he would not have begun implementing his plan

but for the promise of the merger.

Acquirer takeaway: do a one step merger – this is not always

possible.

o Glassman v. Unocal

Short form mergers – completely controlled by the parent (more than 90%)

– solely on the decision of the parent’s board, no negotiation and no

shareholder vote.

Stauffer says appraisal is the exclusive remedy except in cases of fraud or

illegality

Expanded into long form merger context with Schenley

Appraisal as a remedy is a single shareholder action – they don’t get to

share costs with anyone ≠ class action remedy

Fair dealing is not required, but full disclosure is a necessity in a short form

merger

Two choices for shareholders: accept the price offered or seek appraisal

§262(j) – represents one of the only disincentives to serious undervaluation

– the court can tax the parent company for the costs

o Stringer v. Car Data Systems

Majority shareholders offer a very below market value buy out for the

minority shareholders – bad faith in coming up with the price.

There was no fraud, there was just undervaluation and mistreatment

Appraisal is the sole remedy available for plaintiffs.

The legislature has given Ps the ability to recover attorney’s fees, etc for bad

faith actions by the majority.

In Del, the test is “entire fairness” and the burden is on the D.

Hostile Takeovers (827-844)

Cannot merge companies without the approval of management

Cannot do sale of assets without the approval of management

Tender offer so that you can own the majority

Proxy battle – you don’t ask shareholders to sell you their shares, you ask them to let you vote their

shares.

Takeover is hostile to existing management, not necessarily hostile to the company

When management is faced with a hostile takeover, they can sometimes take defensive measures

Poison pill: measure put in place by management to make the company unattractive to

hostile takeovers

Triggering event might be anyone acquiring 30% of the stock. Acquirer gets a smaller

proportionate share of the pie after the shareholders get their new right to buy at a reduced

price. The triggering event doesn’t really happen – management can get rid of the pill.

Dead hand poison pills are illegal – they limit who can take away the poison pill and

therefore limit shareholders’ power to change management too much.

White knight: management looks for someone with a lot of money who can make a

competing offer and who won’t fire management.

Greenmail: someone buys a lot of stock, management gets worried and pays him above

premium price for his shares

Pac Man defense: target company tries to take over the acquirer

Self-tender: company asks the shareholders to tell it their stock – once they get it back it’s

not available to the acquirer.

“Locking up the crown jewels”: sell or contract control of the “crown jewels” of the

company (whatever it is that makes it an attractive acquisition) to someone other than the

acquirer.

Williams Act: a tender offer has to be left open for a particular period of time. There must be a lot of

disclosure in the offer. All shares tendered must be paid the same amount – if you get more than you

wanted, you pay shareholders on a pro rata basis (if you want 51% and 100% offer their shares, you buy

51% of all their shares). This gets rid of the stampede effect.

Why are there high premiums for stocks?

Company is managed poorly – acquirer believes he could/ would manage it better and make

more money

Synergy – gains to be had by cutting down on duplicate expenses

Empire building – acquirer is overpaying because they want the psychic benefits of

managing a big company – target shareholders get a great deal

Exploitation hypothesis – two tier offer (first tier: buy 51%; second tier: a merger and buy

out with a lower price)

Winner’s curse – accidental overpayment; the party with the highest bid is going to win and

he is likely to have overpaid simply by outbidding the others.

Cheff v. Mathes

o The company bought back the shares from the potential acquirer at an above

market value using corporate funds

o The company is allowed to treat some shareholders better than others (e.g. it’s

allowed to pay greenmail) if it’s for the good of the excluded shareholders.

o The burden of showing the board is acting in the best interest of the company

rather than to perpetuate the current board’s control is on the board.

o Del courts are looking at the interest of the company above and beyond the

shareholder

“corporate policy and effectiveness” – pops up relatively often but it

undefined

Enhanced Scrutiny

Unocal v. Mesa Petroleum

o Can you treat some shareholders worse for the good of the company? Disallowed

Mesa Petroleum from the better stock price.

o Front-end loaded 2 tier tender offer: the best price is in the first step of the tender

offer merger. The second step doesn’t have as good a reward therefore it’s

somewhat coercive.

The optimal route is for small shareholders to tender.

o Unocal made a self tender offer at a higher price than Mesa if Mesa’s offer succeeds

and it gains a majority – this is the Mesa Purchase Condition

o They changed their offer to get rid of the condition and simply made their higher

offer to anyone who wanted to tender. Changed the incentive to tender, but

excluded Mesa from those offered the option to tender its shares.

o The scrutiny is not BJR (because of fear of self-interest), it is heightened

There must be reasonable grounds for believing a danger existed to

corporate policy and effectiveness

Burden is on directors – they must show good faith and reasonable

investigation – sounds like duty of care

What constitutes a threat?

It’s suspicion of a breach of the duty of loyalty that triggers this standard of

review

A showing of approval by the board with a majority of the

independent directors, that goes in the board’s favor.

Remember, there cannot be money damages due to a breach of the

duty of care due to exculpation clause

You cannot exculpate breaches of the duty of loyalty

Moran

o Poison pill – the question is whether or not the company can issue this type of

security. This type of stock is not used to make money, it only operates at the

triggering event, then it becomes valuable.

o Court says it isn’t going to examine the reasoning behind the issuance of securities

because a corporation is allowed to issue securities (that is not up for judicial

review)

o Must pass BJR. Burden is on the board.

The mere possibility that the company might be broken up, per se

constitutes a threat.

No allegations of any bad faith or that these steps were taken for

entrenchment purposes.

o Courts end up approving, in principle, the poison pill, but they aren’t making a

judgment about how the board may use that pill – if it’s used for bad faith/

entrenchment purposes, the court may step in.

Carmody

o Dead hand poison pill means it cannot be removed by the directors like a poison pill

– it can only be removed by continuing directors, the acquirer can’t have a proxy

battle and put his directors on the board and have them take out the pill, like with a

normal poison pill.

o Court says this is a disenfranchisement of shareholders because they cannot elect

new directors with the same power as the others

o Goes too far and has a preclusive effect – this is not a proportional response

o The board at any time must have the power to redeem (get rid of) the poison pill for

it to be legal

Air Products

o All cash offer for all shares

o Under what conditions will the board be forced to redeem the pill?

The directors must meet some kind of standard: good faith, reasonable

investigation (duty of care) or show it was a “grossly inadequate offer”.

Their refusal is examined under this duty of care standard no matter the

offer. They can stand in the way and not redeem the pill if there is no

evidence of bad faith.

Revlon

o There is enhanced scrutiny

Reasonable grounds to believe a threat exists

Reasonable investigation

Proportional response

o Independent directors – they are independent from management; they should

stand on the side of the shareholders rather than that of management

o Defensive measures:

Lock-up

Termination fee/ break up fee – they promise the white knight a lot of

money if the deal doesn’t go through, so if someone else takes over, they

are going to find themselves very indebted to that 3P.

o Cannot say break up was a threat if it is inevitable.

o The directors are not always supposed to get the best price, sometimes their duty is

to defend the brand – but not here.

o When it becomes clear that break up or change in control is inevitable (that the

company is, essentially, up for sale), it is the board’s duty to act as an auctioneer

and get the best price for the shareholders. (Revlon Duties)

Paramount v. Time

o Proposal for a stock for stock merger

o Time wants a preservation of its culture – basically saying the officers and board

from Time get to stay on

Time culture is a cost – Time’s shareholders have to pay to preserve the

culture (changes in the ratio of stock to be exchanged)

o Paramount proposed all cash for all shares instead of doing a stock for stock merger

Time says the offer was inadequate – but the market doesn’t see that –

Time is worried the shareholders will take the offer; they need to be

protected from themselves

o Instead of a merger, Time is going to buy 51% of Warner’s stock. There is no need

for shareholder approval

Paramount responds by increasing its offer – now it’s offering 59% premium

over market

o Shareholders bring suit claiming this is a Revlon- type claim where the company is

for sale

They argue if Time is for sale, it’s the board’s duty to act as an auctioneer

Court finds Revlon duties are not indicated because the company will go on,

there is no abandonment of the company’s future plans

o Unocal claim:

Not complete deference to BJR

What is the threat? It is to Time’s shareholders who will be cheating

themselves by accepting Paramount’s offer

Paramount v. QVC

o No shop: Paramount agrees not to shop around for buyers

o Termination fee of $100m

o Court finds Revlon duties were triggered

Transfer of control – important because you can get more for a controlling

bloc than minority shares – this is their one chance for a control premium

o Unocal-mitigated BJR (enhanced scrutiny)

Look at process and substance of potential threats

o Revlon triggered by change in control

Board must be impartial and act as an auctioneer

o Paramount v. Time

The opportunity to sell a controlling bloc at a control premium

Federal Law

Securities Act of 1933: disclosures at IPO, prospectus. Deals with the primary market

Places a burden to disclose on the seller

Securities Exchange Act of 1934: General disclosures. Deals with the secondary market.

SEC does not hold itself up as quality control for shareholders

Blue Sky Laws are the state securities laws

Proxy Statements, Disclosure, Rule 14a-9 Private Action (939-955)

o Borak

Individuals can sue for a violation of federal securities laws

Misleading proxy statements

May or mat not have a private right of action under federal securities laws,

it depends on the facts of the case

Companies are federally barred from making misleading statements in their

proxy statements

Proxy Statements, Materiality, Reliance, and Causation (955-975)

o TSC Industries

More information is not always better – requiring complete disclosure

would cause companies to dump information on the shareholder, leaving

him unable to parse important from superfluous information

Companies should use their judgment to narrow it down to necessary,

material disclosures

It is material when there is a substantial likelihood a reasonable

investor would consider it important

o Virginia Bankshares

A freeze-out merger of the minority shareholders – but they didn’t need

their vote because VBI owned 85%

Minority shareholders claim the buy out price was unfair and that the

directors knew that when they sent out their proxy materials claiming it was

a good price

The court finds what directors think about the deal is material

But, court finds no causation in this case

Minority shareholders did not lose their appraisal rights if they

could show material misrepresentation under state law

In Del, if you vote for the transaction you lose your appraisal rights

o Mills

What connection must be shown between the misrepresentation and the

harm?

There needs to be causation – reliance by the shareholder on the

misrepresentation.

Minority shareholders claim they would not have voted for the merger had

they known about Mergenthaler’s majority control

They were necessary votes

SCOTUS finds that if the proxy solicitation was necessary/ material, then

there is causation

Rule 10b-5 and State Law (996-1016, 1045-1053): need “fraud” “in connection with” the

buying or selling of securities

o Birnbaum v. Newport Steel

There was a price control on steel but not on the stock price of steel

companies (creating a shadow market price) – steel users are trying to bring

steel production in-house

Shareholders claim there was fraud in the letters sent to them explaining

what had happened with the company

There is a problem with the “in connection with” prong because neither the

buyer nor the seller of the securities were defrauded

Only defrauded purchasers or sellers can make a claim under 10(b)

(5)

o Bankers Life

Who is hurt in this convoluted purchase/ sale? The creditors and policy

holders of Manhattan Casualty, because it no longer has assets

Seems like an unlawful dividend

The fraud is difficult to find – they decide MC was defrauded by its sole

shareholder, Begole, but it was not defrauded in the purchase and sale of

securities, but the court expands “in connection with” because it was all

part of the bigger securities deal.

o Blue Chip Stamps v. Manor Drug Stores

Shareholders want to expand the reach of 10b-5 so that it covers

shareholders who did not purchase stock because the prospectus was

misleadingly pessimistic

Court finds this goes too far without a congressional mandate

This would expand the class of plaintiffs too far because anyone

could say they would have bought a stock but for . . . – it would clog

the system

This case represents the beginning of the cut back on 10b-5 private action.

o Santa Fe Industries v. Green

Short form merger – minority shareholders get appraisal rights, but they

allege fraud.

Supreme Court was not willing to let 10b-5 be expanded to cover this

behavior – it’s not fraud to offer less than what shareholders want

Rule 10b-5: Reliance and Causation

o Basic, Inc. v. Levinson

Rumors of an impending merger, Basic denies the rumors – shareholders

said they believed/ relied upon Basic’s denial and got rid of their stock, they

lost out on a bigger pay day when the merger went through.

Court adopts the “fraud on the market” theory

Presumption that the shareholder relied, but it can be rebutted

Relies on the semi-strong form of ECMH

The misleading disclosure is incorporated into the stock

price – shareholders relied on this price that was reflective

of bad information

Dissent points out that integrity of the market price is an odd idea –

there is no promise of integrity of the market price, people often

feel it under- or over-values stocks

Possible rebuttals:

Testimony from experts saying no one believed Basic’s denials, so

the market price is not reflective of the misrepresentation

Show that individual shareholders had different reasons for selling

their shares.

Insider Trading (1123-1153, 1164-1181)

The notion of fraud is key

Based on 10b-5 (1934 Sec. Exch. Act) even though it doesn’t say anything about insider trading

Failure to disclose is only wrongful if there was a duty to disclose. Need 1.) Duty to disclose 2.) Failure to

disclose 3.) Fraud

This is not a prohibition on unfairly acquired information, you just cannot engage in fraud in the buying

and selling of securities.

Fiduciary Duty Theory: relies on the special relationship between the insider and the person with whom

they’re dealing (a shareholder) – there is a duty to disclose

Problem with this theory: really only applies when buying – if you sell to someone who is

not a stockholder, you don’t have a duty to disclose – however, courts have chosen to

ignore this discrepancy

Misappropriation Theory: the wrongfulness of insider trading is the misappropriation of information for

personal use, depriving the corporation from using the info on its own behalf

Cady, Roberts Theory: “disclose or abstain” you either have to disclose the insider information before

you trade or you don’t trade

It is not really grounded in fraud and therefore does not satisfy 10b-5; ignored the fact that

it is only wrong not to disclose if there was a duty.

Texas Gulf Sulphur (Second Circuit – their rule was overruled)

o They make a great discovery, they want to keep it a secret. All the officers buy up

stock at the artificially low price. The company issues a misleading press release

stating they did not make the find; finally they confirm their find.

o There was no duty to disclose to the people from whom they bought the land

o Is this inside information? Is it material? If yes, you must disclose or abstain.

o If you’ve discovered the information using corporate resources, then it is insider

information – if you learn it independently through your own resources, it is not

insider information.

Chiarella

o Low level employee of a legal printing firm who regularly bought stock in companies

before their planned tender offers

o He owed no duty to the target stockholders (other than the general duty to refrain

from positive misrepresentations)

o Found that the printer and its employees violated no duty to the seller of shares

because they had been retained by the bidder.

Dirks

o Found that the tippee violates 10b-5 only if the tipper breaches a fiduciary duty in

disclosing the information to the tippee and the tippee is aware of the breach. The

breach must be established by showing that the insider-tipper disclosed the

information for the purpose of gaining an improper benefit.

o Tipper is also liable for any unlawful insider trading by the tippee.

Misappropriation and Rule 14e-3

o SEC adopted Rule 14e-3 in response to Chiarella: it is unlawful for any person who

obtains advance information about a tender offer to use that information in

connection with a securities transaction. (Misappropriation Theory – put forth by

Justice Berger in his dissent)

o O’Hagen

Upheld the misappropriation theory, even though the court acknowledged

it might capture some instances of insider trading not involving a breach of

fiduciary duty.

Duty owed to: Why? Content Breach Fraud?

Classic Theory

(Chiarella)

Other side in

the trade

(special

relationship)

Fiduciary

relationship

Disclose or abstain

– don’t mislead by

failing to disclose

Trade without

disclosing

Yes

Misappropriation

(O’Hagan)

Source of info Relationship

of trust and

confidence

Don’t use info for

personal purposes

Use info for own

purposes & Don’t

tell the other side

Yes

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11/11/12 1:24 PM