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Choice of Entity1. Background

a. Why do people need lawyers if they can incorporate their business for $10-$20 (ads)i. Customized Service- Forming the corporation is the beginning, not the end of

the story. Once these co’s incorporate they don’t tell you what to do.ii. They are just order takers- maybe a corporation form isn’t the best choice for

youb. Different Entities

i. Sole proprietorship (SP)ii. General Partnership (GP)iii. Limited Partnership (LP)iv. Limited Liability Partnership (LLP)v. Limited Liability Corporation (LLC)vi. Corporation (C or S corp- tax designation)

c. Which form is best for your client- 6 factors that we need to think about i. Who is liable for the debts of the business if the business cannot pay?ii. Who controls or manages the business?iii. How easily can ownership interests be transferred?iv. What is the businesses continuity of existence? (i.e. how long can it last?)v. How is the entity taxed?

1. Entity level2. Flow thru taxes

vi. How easily can this business form raise additional capital (money) later on?2. Sole Proprietorship (SP)

a. Most common type of business entityb. Need only 2 things to form SP:

i. A personii. A business

c. SOLE MEANS SOLE- cannot have more than 1 owner- if more than 1 owner it will be a partnership, BUT can have employees.

d. If not stated otherwise, the name of the SP is your own personal namee. DBA’s- (doing business as)- fictitious business name- file at the county level- gener-

ally no other filings for SP’sf. Six Factors

i. Who is liable for the debts of the SP if the SP cannot pay?1. The owner is responsible if the business can’t pay its debts b/c there is

NO distinction between the business and the sole proprietor. 2. Owner has unlimited personal liability (UPL)

a. To help limit liability the owner can buy insuranceb. Can also limit debt recourse solely to the assets that have been

purchased from the proceeds. c. Personals creditors can go after all business assets and

business creditors can go after all personal assetsd. NO distinction between personal or business assets- ALL as-

sets are exposed! ii. Who controls or manages the SP?

1. The sole proprietor (owner) controls and manages the businessiii. How easily can the SP ownership interest be transferred?

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1. sole proprietor can sell or transfer her business to someone else by selling all the assets that she used in the business including IP rights and also might have the buyer assume some liabilities (Asset deal).

2. No stock certificate that you could sell to someone iv. What is the SP’s continuity of existence?

1. SP dies when the owner dies2. SP can also terminate at the discretion of the owner, or owner can sell

the business or file for personal bankruptcyv. How is the SP taxed?

1. NO separation between business and owner so personal tax return will reflect how the SP does

a. Owner must file Schedule C- tax form- indicates whether there was net income or loss- transfer directly to Form 1040.

i. Income shows up above adjusted gross income- doesn’t get watered down so every dollar of profit gets taxed and every loss gets deducted!

ii. More money you make the less you get to deduct. vi. How easily can the SP raise additional capital later on?

1. If the sole proprietor wants to remain an SP he can’t bring in other in-vestors, because then it becomes a partnership, so only way that an SP can expand is by getting loans.

2. SP ability to expand is limited! 3. General Partnerships (GP)

a. Usually governed by partnership agreement, but if don’t have a partnership agreement or if an issue isn’t governed by the agreement then fall back to statutory law.

b. Depending on what jurisdiction you are in there are 2 potential statutory provisions:i. Uniform Partnership Act (UPA)ii. Revised Uniform Partnership Act (RUPA)

c. UPA and RUPA are default or supplemental regimes in the absence or anything oth-erwise you would look to these provisions to fill in the gaps. If no partnership agree-ment you will look solely at UPA or RUPA to govern your GP. Otherwise what you have in your partnership agreement trumps UPA or RUPA.

d. There are some provisions in UPA and RUPA that CANNOT be trumped (WAIVED) by your partnership agreements

i. RUPA § 103b2, b10 - Nonwaivable Provisions1. The partnership agreement CANNOT limit a partners liability

e. A partnership is an association of 2 or more persons to carry on as co-owners a busi-ness or property (UPA 6(1) definition).

i. Association denotes the consensual nature of a partnership- people have to want to do something together HOWEVER

ii. The fact that the people did not intend to become partners does NOT control- the key factor is not the parties subjective intent of whether they intended to form a partnership

1. MUST look at surrounding circumstances, objective 2. Hilco Property Services, Inc. v. United States (29)- Whether or not

you are operating a partnership is a question of fact. a. “It is immaterial that the parties do not call their relationship,

or believe it to be, a partnership, especially where the rights of third parties are concerned.”

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3. Martin v. Peyton (31)- Martin isn’t owed any money by Peyton or Other D’s but by the KNK partnership. Partnership has no money so Martin claims that Peyton and other D’s created a partnership when loaning money to KNK, so they are liable. Martin is trying to create deep pocketed D’s.

a. Issue- Were in fact the D’s partners of KNK- if so then they owe money (liable), if not then they don’t.

b. D’s became involved in the partnership:i. Hall (partner) asked to borrow money from friend the

D’s b/c GP needed more money ii. Hall borrowed ½ million of liberty bonds from Peyton.

Bonds are a safer type of loan for Peyton because could be used as collateral and Hall can borrow against them

iii. KNK needs more money so it asks the D’s to become partners but the D’s refuse, probably because they don’t want to be held jointly and severally liable.

iv. D’s loaned Hall 2 million in liquid securities (ease of saleability b/c can be easily & quickly converted into $. In return for loans D’s received 40% of profits until the loans were repaid (profit couldn’t exceed 500,000 and be less than 100,000) and partnership option

c. D’s didn’t intend to become partners when they entered into this agreement- signed statement that no partnership was formed- NOT conclusive, some evidence but not dispositive

d. What people put in the agreement is not controlling. Even if there is a K with another party that states specifically that this relationship is not a partnership, it is not dispositive! (Not con-trolling)

e. “Statements that no partnership is intended are not conclu-sive. If as a whole a K contract contemplates an association of 2 or more persons to carry on as co-owners a business for profit a partnership there is.”

i. Court says that in deciding whether partnership was formed we must look at the statutory definition of part-nership and look at facts and see if they meet this defi-nition. must look at everything (parties agreements, relationship, interactions, relations with 3rd parties).

f. Fact finder will decide. g. Under RUPA sharing of profits is important evidence but not

conclusive that a partnership existsh. Under UPA, receipt by a person of profits is prima facie evi-

dence of a partnership, but not when its made in repayment of a loan. Will presume that you are a partner unless you can prove otherwise.

i. Many other detailed agreements are contained in the papers…are they here to protect the lenders or to make them co-owners? Answer depends on an analysis of the various provisions (33)

i. Peyton and Freemen were trustees so were kept in-formed of what was happened to the loaned securities

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and the income generated by these securities Court says that this doesn’t make them partners, says its typi-cal for lenders to have control over collateral and for lenders to receive income generated by the securities.

ii. Provision that required Hall to run the partnership alone- doesn’t mean that they are interfering with run-ning the business because provision is not unusual to see in a credit or loan agreement. This doesn’t make them partners. They believe in Hall and what he can do so its important that he run the business and not some-one they don’t know.

iii. Requirement that the trustees be given veto power over any partnership action that they believe would be highly speculative and injurious These types of provisions are very typical in lending agreements b/c the lender wants you to operate in a certain manner, so can’t do certain things without approval.

j. Taken as a whole the court finds that the D’s are NOT partners, so not liable.

f. Joint venture- partnership from a legal perspective, but the business purpose differs. Business purpose that is either of very short duration or for a very specific purpose. Unique- getting together solely for the purpose of X.

g. Don’t need a formal partnership agreement to form a partnership, but it is advisablei. There are a number of very large partnerships that do not have partnership

agreements, but b/c they make so much money there is nothing to fight aboutii. Partnership agreement can be oral, written, or implied.

h. Six Factorsi. Who is liable for the debts of the GP if the GP can’t pay?

1. The partners are liable if the GP can’t pay b/c there is joint and sev-eral liability for all GP debts, even if debt was incurred by another partner.

a. UPA §17., RUPA 306b Liability of Incoming Partner (104)- A person admitted as a partner into an existing partnership is li-able for all the obligations of the partnership arising before his admission as though he had been a partner when such obliga-tions were incurred, except that this liability shall be satisfied only out of partnership property (Only to the extent of the new partners investment)

b. Can buy insurance to limit liabilityc. Can limit creditors recourse to specific assetsd. Partnership agreement itself can limit the authority of certain

partners to certain kinds of debt (certain partners don’t have the authority to bind the partnership to certain K’s)

e. A personal creditor CANNOT go after the assets of the partner-ship, but they can go after your partnership stake in the partner-ship because that is a share that you own.

2. Get legal malpractice is example of limit liability of partnership. a. Under 303 RUPA- can be filed with state and limit partnership

to third parti’s in particular RE.

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3. Martin v. Peyton (31)- Issue- Were in fact the D’s partners of KNK- if so then they owe money (liable), if not then they don’t. Since taken as a whole the court finds that the D’s are NOT partners, so not li-able.

4. the receipt of the share of the profits of the business is not enough to prove partnership.

ii. Who controls or manages the GP?1. UPA § 18e (default provision)(105)- All partners have equal rights in

the management and conduct of the partnership business, unless the partnership agreement specifies otherwise.

2. partnership agreement may create classes of partners with different voting and financial rights.

3. many law firms utilize classes of partners in this fashion to ensure that the senior partners have power to govern the affairs of the partnership.

4. Lupien v. Malsbenden (35)- P wants to buy a Bradley car and goes to Cragin, DBA as York motor mart. P never received his Bradley and Cragin flees the country. P sues Malsbenden under the theory that D is a partner of York motor Mart.

a. P thinks that Malsbenden is a partner because:i. P dealt with Malsbenden not Craginii. Malsbenden says that P has to turn in his car as part of

the deal, so gives him a loaner car, but the loaner car turned out to belong to someone else and was at York for sale. Malsbenden bought the car from the 3rd party and gives it to P.

b. Malbenden doesn’t agree that he is a partner, he says that he is a banker, b/c loaned Cragin $5,000 and wanted to be paid back proceeds from the car. If he is a banker than York is a SP, which makes Cragin the only one liable.

c. Malsbenden opened up the business daily, made deals for the business, paid salaries of the employees with a personal check, bought supplies (NEVER pay with a personal check, b/c then creditors will start to look to you as the obligor to pay debts).

d. Malsbenden had complete physical control of the business once Cragin left the country.

e. Court finds that Malsbenden was a partner b/c he had a lot of control. There is no difference if there was a partnership agrmt.

5. How does control merge with the notion of co-ownership? a. Don’t have to have joint-title in all assets to be co-ownersb. Co-ownership could mean joint title, but doesn’t have to bec. The right to participate and control the business is the essence

of co-ownershipd. Most important feature in Lupien was that Malsbenden had a

lot of control.6. Factual distinction between Martin v. Peyton and Lupien v. Malsben-

dena. In Martin, Hall was always in charge and the D’s only had con-

trol akin to the kind that lenders usually demand.

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b. In Lupien, Malsbenden had complete control so his argument that he is only a banker fails

7. Summers v. Dooley (41)- Trash business partnership. Summer sug-gests to Dooley that an additional worker be hired to help operate the business, Dooley refuses, but Summer hires a new employee on his own and pays for him out of own pocket. Dooley refuses to pay for ½ so Summer sues for ½.

a. Summer argues that although Dooley didn’t agree to hire this employee, he still benefited through increased profits and less workload, so he should be estopped from denying the need for the employee (unjust enrichment argument).

b. Issue- Can 1 partner make a decision against the will of another partner and then attempt to get paid for ½ (notion of control and making managerial decisions)

i. Idaho statute- Any difference may (MUST) be decided by a majority of the partners, provided that no other agreement exists. So in a 2 person partnership, both partners must make the decision (unanimous)- each partner has a complete veto power.

8. Problem- 43- A, B, and C form a partnership. A contributes 90% of the capital, and by agreement is entitled to 90% of any profits and is responsible for 90% of any losses. B and C each contribute 5% of the capital and by agreement each is entitled to 5% of any profits, and re-sponsible for 5% of any losses. Nothing is said in the agreement con-cerning how decisions will be made. If A votes one way on an ordi-nary matter connected with the partnership, and B and C vote another way, who prevails?

a. Under UPA § 18h (105)- Any difference arising as to ordinary matters, connected with the partnership may be decided by a majority of the partners, but no act in contravention of any agreement between partners may be done rightfully without the consent of all the partners.

b. So B & C get to dictate what the partnership doesc. If A wanted more power, need to put in partnership agreement

that A gets 90% of the vote. 9. Hypo- James and Susan are equal partners and lacks partnership agree-

ment. Both partners must provide financial statement to bank in order to get loan. Susan says no since invasion of privacy and james sues Su-san for breach of fiduciary duty. What result? Sanchez v. Saylor, if partnership doesn’t get loan it could go under but its Susan’s right and her essentially voting No get bank loan and thus no fiduciary duty is owed when comes to managing the business.

a. James can sue to dissolve partnership- remedy….thus always important to have management provision and have a process when partners don’t agree

10. Relationship between partners- Meinhard v. Salmon (65) – involved 2 partners and 1 partner was presented with a business opportunity which could have been pursued by the partnership, but instead usurps the opportunity for himself

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a. CJ Cardozo says that while the partnership continues partners owe the duty of finest loyalty- rule of undivided loyalty is re-lentless and supreme! MUST put partnership ahead of your own personal financial needs.

11. Dissolution can carry consequences a. Among the partners

i. If a partner, W, wrongfully causes dissolution, under UPA §38 (2)(b) provides that although the partnership is dissolved, the remaining partners can continue the partnership business. To do so the remaining partners must either, 1 pay W the value of her partnership inter-est, minus any damages caused by the dissolution, or 2 put up a bond to secure such a payment, and indemnify W against present and future partnership liabilities.

b. Between the partners as a group and third persons, such as indi-viduals or firms with whom the partnership has contracted

i. Ex. title insurance co has policy with A,B,C,D. A,B,C transferred their partnership interest to E. E and D ap-parently continue the business. However the court nev-ertheless held that title insurance co. was not bound un-der its policy because the partnership to which it had is-sued the policy had been legally dissolved.

c. For tax purposesi. Internal Revenue CCode §708 provides that a partner-

ship existence does not terminate for tax purposes until either no part of any business, financial operation, or venture of the partnership continues to be carried on by any of the partners in a partnership, or within 12 month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

d. UPA and RUPA require that a partner hold in trust anything that is for the benefit of the partnership and then remit it to the partnership

i. UPA § 20 (106)- Duty to Render information- Part-ners shall render on demand true and full info of all things affecting the partnership to any partner or the le-gal representative of any deceased partner or partner under legal disability.

ii. UPA § 21 (106)- Partner accountable as a fiduciary1. Every partner must account to the partnership

for any benefit, and hold as trustee for it any profits derived by him without consent of the other partners from any transaction connected with the formation, conduct or liquidation of the partnership or from any use by him of its prop-erty

2. This section applies also to the reps of a de-ceased partner engaged in the liquidation of af-

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fairs of the partnership as the personal rep of the last surviving partner.

iii. RUPA § 103(b)(3) (125)- the partnership agreement may not eliminate the duty of loyalty

iv. RUPA § 403 (153)- Partner’s rights and duties with respect to info

1. Must keep books and records at chief executive office. Info must be made available to all part-ners.

v. RUPA § 404(b)(1) (154)- General standards of part-ners conduct- A partner’s duty of loyalty to the part-nership and the other partners is limited to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, in-cluding the appropriation of a partnership opportunity.

1. Under RUPA, a partnership agreement can de-fine what fiduciary duty means, but can’t elimi-nate the duty

iii. How easily can GP ownership interests be transferred?1. in the absence of an agreement about how profits are to be shared, the

default provision of the UPA is that partners share profits equally. 2. Since a GP is consensual in nature the partnership agreement can say

what ever it wants about transferability of partnership interest, but if it doesn’t or if there is no agreement then must look to statutes

3. UPA § 27(1) (107) & RUPA § 503(a)(b) (160)- A partner can transfer his or her interest, but the transfer itself only entitles the transferee to the financial aspects of that partnership interest (under RUPA, finan-cial aspects are viewed as personal property). It is only if ALL the partners consent then the transferee will be considered a partner and allowed to take part in managerial aspects

a. Transferor = Financial Aspect + Management and Control as-pect

b. Transferee= ONLY financial aspect NOT management and control

i. When the transferee receives the financial aspects the M & C remain with the transferor until the new party is admitted as a full-fledged partner. If the transferor is dead then M & C dissolves and is spread throughout the other members. Transferee might requires that the transferor vote the way he would (proxy)

ii. Joint and Several liability remains with the M &C ele-ment (transferor) b/c can control debts etc. Very often what the transferor will do to get out of that problem is withdraw or disassociate as a partner immediately after the transfer so no more voting power and no more lia-bility.

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c. Under UPA §18(g) (105) can change voting threshold from unanimous to another requirement for admitting a new partner.

iv. What is the GP’s continuity of existence?1. GP lasts until 1 of certain specified events listed in the partnership

agreement occurs:a. Death of a partnerb. Completion of a business project (joint venture)c. End of a specified date (expiration date)- partners can always

amend the agreement to extend that date.2. If there is no partnership agreement then UPA and RUPA specify the

eventsa. Dissolution v. Termination

i. Dissolution happens automatically on the happening of a certain event. It is not the end of the partnership, just a change in the relationship of the partners.

ii. Partnership agreement typically provides that the re-maining partners can vote to continue on the happening of that event or choose not to continue and head to winding up and then termination,

b. Step 1- Dissolution (vote to continue or not to) if no then move to Step 2- Winding up (pay off all creditors, liquidate assets, distribute remaining profits), then move to Step 3- Termination

c. ex. partner would die and there is 4 partners, 3 are left, and partnership are consensual and thus the 3 must decide if they want to continue on without the fourth, partnership Agreement may have provisions that says move ahead or upon event of dissolution there is termination (call quits, and liquidate assets, pay off creditors, and whatever left allocate).

v. How is the GP taxed?1. GP’s are flow thru tax entities (desirable), so no firm or entity level in-

come tax, instead individual partners are taxed based on their allocated share of profit or loss. Entity itself doesn’t pay tax on any profit it makes. (not subject to double taxation like corps)

2. Partners must file Form 1065 (informational only)- tells the govt what to look for on the individual partners personal tax return. K-1- your personal share

3. Problem with investing in partnerships/LLC’s/S-corp is that you have to pay tax on your allocated share, but you might not get any cash that year b/c the partnership is preserving the money to finance the partner-ship. To avoid this problem can try to put in the agreement that the partnership will distribute enough money to partners so can at least pay tax bill.

vi. How easily can the GP raise additional capital?1. Can take in additional partners by selling additional equity (ownership

stakes)- will result in dilution of the ownership interests of the original partners

a. Process is governed by the partnership agreement (typical pro-vision delineated in PA), but if no provision fall back to UPA or RUPA (allow new partners with approval)

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2. Can borrow money, loansi. Biggest drawback of GP is joint and several liability, so other similar entities were

formed to deal with thisGENERAL RULE- Corps, LPs,, LLPs, LLCs can be organized only if certain formalities are complied with and a filing is made with the state vs. GPs can be organized with no formalities and no filing

4. Limited Partnership (LP)a. Way to bring investors ($) into business without exposing them to joint and several li-

abilityb. Must have 2 types of partners (at least 1 of each)

i. Limited Partnersii. General Partners

c. Governed by Old ULPA- Revised Uniform Limited Partnership act (RULPA) or New ULPA- Uniform Limited Partnership Act (ULPA).

d. Under RULPA § 201 (233)- in order to form a LP must file a certificate of LP with the sec of state

i. File in LP and not GP, b/c want to put creditors on notice that certain individ-uals DO NOT have joint and several liability (limited partners)

e. Must specify LP at the end of co name to put people on notice (i.e. XYZ Limited Partnership (LP))

f. Main distinction between GP and LP is in liability and management and controlg. Continues today even though the LLC is the logical candidate to replace it. h. Six Factors

i. Who is liable for the debts of the LP if the LP can’t pay?1. General Partner has joint and several liability2. Limited partner is only liable to the extent of the amount invested in

LPa. Will only lose amount invested, not responsible for unpaid

debts of LPii. Who controls or manages the LP?

1. GP has management and control over the LP in exchange for accepting liability.

2. LP is essentially a silent partner, in return for having only their invest-ment at risk they have limited control.

3. In return for limited liability, LP gives up management and control, but in all states, if the LP engages in too much M & C, then LP will become a de facto GP.

a. Control rule- if you want to be an LP, then act like one, b/c oth-erwise you will lose limited liability.

b. Under New ULPA- ULPA §303 (281) (not yet adopted by any state)- the control rule is eliminated in its entirety- No liability as limited partner for limited partnership obligations

i. An obligation of a limited partnership, whether arising in contract, tort, or otherwise, is not the obligation of a limited partner. A limited partner is not personally li-able, directly or indirectly, by way of contribution or otherwise, for an obligation of the LP solely by reason of being a limited partner, even if the limited partner

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participates in the management and control of the lim-ited partnership.

1. Why would this provision when traditionally it was otherwise?

a. If GP not managed well, the LP’s can step in

b. LLC is becoming the entity of choice and it is an attempt to change the rules of LP to make it competitive with the LLC form

4. Difficulty of determining when LP’s become de facto GPs- Gateway Potato Sales v. GB Investment Co. (482)-Gateway, a creditor of Sunworth Packing LP brought suit to recover payment for goods it had supplied to the LP. General Partner is Sunworth Corp and Limited partner is GB investment Co (GBIC). Gateway doesn’t sue the GP b/c has no money.

a. Normally the extent of LP liability is the amount invested. b. Gateway’s theory is that GBIC’s conduct makes it a de facto

general partner and therefore has joint and several liability. GBIC managed/controlled in a manner antithetical to LP status. (See footnote 1 p. 483) (Suspicious actions!)

i. All trends and important business decisions had to be approved by GBIC

ii. Employees of GBIC were at the office daily and di-rected changes of business operations

iii. Accounting involvementiv. Equipment selection; Packaging modification; con-

trolled advertisingv. Obtained loans vi. Signed checks <sometimes> (certain checks paid di-

rectly by GBIC) c. Arizona Statute § 29-319 (a)- A limited partner is not liable for

the obligations of an LP unless he is also a GP or in addition to the exercise of his rights and powers as a LP he takes part in the control of the business (Sentence one same as RULPA 303 (a) (p. 237)).

i. GP can also make an investment in a LP as a limited partner- ultimately his liability doesn’t change b/c can lose all his LP investment and be liable for the whole co (just an easy accounting method).

ii. An LP doesn’t have to be totally silent. Clearly has rights under RULPA 303(b) (238):

1. Can be a contractor or even an employee of the LP, even president.

2. Can consult and advise the GP with respect to the business of the LP

3. Can request or attend meetings of partners.

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4. BUT, can’t go too far!!! If you go too far in ex-ercising your power you can lose your limited liability. Can be held J & S liable if act like GP.

iii. Sentence 2 of RULPA differs significantly: RULPA 303(a) (237)- If the limited partner participates in the control of the business, he [or she] is liable only to per-sons who transact business with the LP reasonably be-lieving, based on the limited partners conduct, that the limited partner is a general partner

1. Lessens the impact of 1st sentence that says you can go too far.

2. Gateway court sees 2 dangers with 2nd sentence RULPA 303 (a) (237)

a. Indirect knowledge problem- Must have direct contact with the limited partner or else you are out of luck, so cant learn of conduct via 3rd party.

b. Incentive for lack of transparency (clan-destine problem)- a limited partner can completely control a LP and not fear the loss of limited liability so long as she does everything in hiding. If a creditor never sees the LP doing this, then the creditor is out of luck.

3. Arizona Statute 2nd sentence- However if the limited partners participation in the control of the business is not substantially the same as the exercise of the powers of a GP, he is only liable to persons who transact business with the LP with actual knowledge of his participation and control.

a. Doesn’t solve the direct knowledge problem b/c still need actual knowledge

b. Solves the transparency problem b/c you will be held J & S liable even if someone doesn’t see you, so long as LP participa-tion is same as GP. If not substantially the same need actual knowledge!

4. So these statutes show a relaxation of strict no management and control as LP- modifying LP’s chances of losing limited liability. (ex. LP as key employee, like president, making key deci-sions, but still not have liability). GP might want to do this for monetary reasons.

iii. Next 4 factors are same as in GP (see pg. 5-6 of outline)iv. Biggest drawback of LP form is Joint and several liability so GP can limit lia-

bility by interposing another corp entity or LLC between the limited partner-ship and themselves and make that limited liability entity the GP.

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1. You will be the shareholder, director and officer of the corporation (GP) and a limited partner in the LP.

2. Since corp is the GP, creditors will go after the corporation and if you don’t put a lot of money into the corp then creditors will hold the bag, will have to get assets of corp.

3. IF you are the shareholder, then you will more often then not qualify for S-corp status and get flow-thru taxation

4. tort victims are involuntary creditors5. Employee wages- same outcome as creditor liability6. LP and GP owe each other the duty of finest loyalty, so what if the LP

wants to sue the corporate GP for breach of loyalty? Does the corp form protect these people who were in essence disloyal? Is this an added benefit of having a corp GP?

a. In re USACafes, L.P, Litigation - “Not me- it’s the corpora-tion argument!

i. You are the one being disloyal, if the corp you are in charge of is being disloyal.

ii. SO, you can be sued for any disloyalty because you have a duty!

iii. Interposed corporation regarding creditors = safety, BUT interposed corporation regarding disloyal con-duct= open to suit from other partners.

iv. IF a limited partnership has a corporate general partner, its officers (including directors) owe fiduciary duties to the limited partners.

5. Limited Liability Partnership (LLP)a. GP’s that have limited to some degree the joint and several liability of some of the

partners <via statute> b. LLP, professional corp, used almost exclusively by professionals- lawyers, doctors,

accountants- to limit malpractice liability. (any vocation that can be sued for mal-practice).

c. Under most LLP statutes each partner is liable for general obligations (i.e. lease of of-fice space, if can’t pay, landlord can go after entire firm), BUT each partner is liable for THEIR OWN acts of malpractice, and not on the hook for acts of malpractice of other partners in the partnership.

d. Statute specifies the minimum amount of malpractice insurance to be in play at all times, so will collect under insurance and then from partner as necessary.

e. Must file a certificate to put people on notice that an LLP has been formed. f. Governed by RUPA § 1001 (196)- Partnership must end with LLP or equivalent to

create notice. g. In the absence of a provision in the partnership agreement, all partners are entitled to

participate in the management of the business itself. 6. Limited Liability Company (LLC)

a. Wyoming- first to form LLC statutes. b. Designed to take advantage of the best of what the partnership has to offer and the

best of the corporate form c. Formed by filing articles of organization in a designed state. The articles must include

the name of the LLC, the address of its principal place of business or registered office in the state, and the name and address of its agent for service of process.

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d. Noncorporate entities,but entities created by statute, can hold property and be sued. e. Started off slowly because of tax problem because wasn’t clear whether it would get

flow thru taxation due to corporate attributes, but now taxed like partnership. How-ever, can choose double taxation- useful when the LLC will grow quickly and soon convert to corp form.

f. In deciding which entity to choose, most people are concerned with taxes and exis-tence of developed case law interpreting statutes for certainty.

i. LLC concerns about taxes abolishedii. People understand LLC’s better than before.

g. Six Factorsi. Who is liable for the debts of the LLC if the LLC can’t pay?

1. provides investors with limited liability like corporation each in-vestor can lose ONLY their investment. Creditors can NOT go after owners if/when they cannot pay.

a. Owners are called members, formation of LLC is statutory in nature; Must file articles of organization similar to certificate of LP.

b. However, members may become liable if the conditions for piercing an LLC veil are satisfied.

ii. Who controls or manages the LLC?1. Provides tremendous flexibility- like a GP all members can participate

in the management of the LLC, unless the operating agreement says something to the contrary.

a. Members who engage in management are called managers and other members are just members. Operating agreement will specify the difference

b. LLC’s can be member managed or manager managedi. Member managed- no select people- everyone man-

ages and can bind the LLCii. Manager managed- select few manage (typical)

1. Agency relationships/Laws important when members act on behalf of LLC especially when not a manager.

2. Members can bind the LLC only if member managed (apparent authority) , otherwise man-agers must act

3. like shareholders have no apparent authority to bind corp., members of manager managed LLC cant bind.

iii. How easily can LLC ownership interests be transferred?1. LLC interest can be transferred UNLESS operating agreement speci-

fies otherwise (which it often does)a. Can limit transfers to people you know, understand, etc.

2. Transferees do NOT become members without approval, until then will only get the financial aspects of ownership, but since always have limited liability, no issue, but still no Management & Control)

iv. What is the LLC’s continuity of existence?

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1. Events of DisAssociation, Similar to GP- Operating agreement will list certain events that if occur will give choice to continue LLC or wind up and terminate. (similar to event of dissolution in LP )

v. How is the LLC taxed?1. Flow-thru taxation (like GP)- members are taxed at their personal tax

rates based on share of profit/loss and LLC itself not taxed. 2. Must fill out an informational return

a. Members of LLC will get a schedule K-1, which will then have to report on 1040.

vi. How easily can the LLC raise additional capital?1. Additional members can be brought in to the extent allowed by the op-

erating agreement if not prohibited by statute (like GP). a. Ex. can have class A-complete voting rights and class B where

get no voting rights. 2. Capital Structure is flexible (can make your own rules)

a. Tiered b. Voting rights or non-voting interestc. Pro Rata etc

i. Flexibility is important because preferred choice even over an S-corp (b/c in S-corp can only issue 1 class of share)

ii. Everyone has limited liability, regardless of what class of ownership, but not possible with S-corp.

3. Since corp is the only entity that can sell ownership stakes to public to raise capital, a lot of LLCs as they grow and want access to public funds convert to corp form before going public.

h. LLP’s, LLC’s and LP’s are statutory entities so can sue and be sued7. Corporation

a. Basic featuresi. Export of England- needed charter from the crown (explicit approval from the

King or Queen)1. Document filed to create is charter- certificate/articles of incorporation

ii. After U.S. independence businesses needed a way to incorporate so turned to state legislatures for authority to operate corporate entities

1. Typically, charter was valid for only specified type of business and getting the charter took political influence (bribery)

2. Needed better ways to incorporate business so general incorporation laws were developed

a. 1811- NY first state, but only designed for manufacturing enti-ties. Certain businesses needed additional approval from other state organizations

iii. Corporations are separate legal entities- artificial persons- separate and dis-tinct from the legal personalities that own/control them

1. Ownership claimants of the corporation are called shareholders/stock-holders (depending on jurisdiction

a. New York- shareholderb. DE- uses both shareholder and stockholder interchangeably

2. Board of directors, chosen by the shareholders, are overseers of the corporation

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3. Officers and managers operate business daily and carry out the board’s decisions.ex. hire employees.

a. Officers:i. CEO- Chief executive officerii. CFO- Chief financial officer- invest, raise capital, divi-

dends- big picture personiii. COO- Chief Operating Officeriv. Comptroller- Chief Accounting Officer- lesser officerv. Presidentvi. Vice-President- can have manyvii. Corporate Secretary- Very important role- keeps track

of board of directors meetings, notices, and statutory compliance

viii. General Counsel b. Some officers can hold more than one office (i.e. CEO & Presi-

dent; General Counsel & Corporate Secretary)c. Officers can also be directors (i.e. Chairman of the board and

CEO)i. But pressure via investors, media, SEC for companies

to split Chairman and CEO titles (Ex. Walt Disney CEO and Chairman- Michael Eisner pressured to yield chairman title)

ii. Amount of power that Chairman has on the board de-pends on the person and CEO.

d. Board of directors hires CEO and officers of corp, not share-holders (1 of the most important thing the Board does). Only board can fire CEO!

iv. 6 factors1. Who is liable for the debts of the corp if the corp can’t pay?

a. Owners have limited liability, so generally shareholders are not personally liable for the debts of the corporation, BUT can lose initial investment

b. Corporations are separate legal entities i. Power to contract, sue and be suedii. Can commit crimesiii. Subject to income and other taxesiv. Corps have constitutional rights (i.e. due process and

equal protection rights)v. Attorney-client privilege can be invokedvi. Corporation cannot take 5th amendment, BUT 4th

amendment protections against unreasonable search and seizures

vii. Corps can sue for defamation (Famous British case- McDonalds sues couple)

viii. Corporations do not have a right to privacyix. Generally corps have very expansive 1st amendment

rights, but corporation speech is regulated regarding de-frauding consumers.

2. Who controls or manages the corporation?

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a. Separation between ownership AND controli. Direct management removed from shareholders

b. Under DGCL 141 (a) (550)- Corporations shall be managed by or under the direction of a board of directors

i. Shareholders can also be on the board (gives share-holder some control)

c. Closely held corps- common to have shareholders that are also directors and officers- often no separation. Ex. guy who owns subway franchise store.

3. How easily can corporation ownership interests be transferred?a. General rule is that you are free to transfer your shares to

whomever you please. However, when dealing with a pri-vately held corp shareholders are few in number and not public so transferability is often limited by contractual shareholder agreement. Alternatively, also have to be concerned about who is going to buy your shares, especially if you invest in a very small local business, b/c there might not be a liquid secondary market!

b. Privately held co’s v. Publicly traded corpi. Publicly traded co- all shares of stock are sold to the

public through IPO; whenever shares are offered to the public must register shares through the SEC and com-ply with the Securities Act of 1933.

1. Ease of transferability b/c shares are listed on the stock exchange and individuals can sell them freely with mkt generated price.

2. Transparency- Securities Exchange Act of 1934 requires after IPO that the co become a report-ing co. Required to make periodic disclosures about business, employees and financial condi-tion to the SEC (public docs- competitors can look, so might not be great thing for all co’s)

3. has lower cost of capital, liquidity, but can be subject to hostile takeover and info is public “glass house.”

c. Private co’s- Shares are sold only to a select few, privately (no IPO)

i. Transferability- no liquid secondary mkt; top 2 candi-dates to buy shares are existing shareholders or the company.

ii. Transparency- co info is proprietary so only co. insiders will have this info.

4. What is the corporation’s continuity of existence?a. Termination date to be specified in charter, if none then can

have perpetual existence. Termination date can always be amended.

5. How is the corporation taxed?

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a. Double taxation (firm tax and flow through taxation) (unless S-corp) – C Corp- Co gets taxed and shareholders get taxed on dividends

b. Subject to both local and fed taxc. Co might qualify as an S-Corp; if elects to do so then the co

will be treated as a flow-thru tax entity. Must make election in timely manner. (not all co qualify)- S-corp requirements:

i. 75 (100??) shareholders or fewerii. Shareholder must either be individual (US resident or

alien) or qualified estate or trust, or another S-corpiii. If a C corp or foreigner buys stock in an S corp than the

S corp designation immediately become C and then have double taxation.

iv. Capital structure- co can only issue 1 class of stock if it wants to be an S corp

v. S corp can own shares in a subsidiary co and it doesn’t matter if that subsidiary is an S or C corp.

1. Policy behind S corp is to encourage small busi-ness growth and development but b/c the LLC does everything all at once the S- corp is be-coming more obsolete.

d. If s-corp then profits and losses are allocated to shareholders, see 1120S-only info tax return then K1- receive in mail which allocates your profit or lose and then report this on first page of 140 of line 17 (above the line and thus above to offset day in-come)

6. How easily can a corporation raise additional capital?a. Co’s have tremendous flexibility to raise additional capital b/c

just sell securitiesi. Caveat- S-corp has limited flexibility b/c can only issue

1 class of stockb. 3 types of securities a co will issue: (can have diff categories

within each of 3 classes)i. Debt securitiesii. Preferred stock iii. Common stock

v. Chain of payments: (1) Creditors (secured, senior, subordinated (higher yield to be last in line of creditors- junk bonds)); (2) Preferred stock holders; (3) Common stock holders

vi. par value- is the legally allowable, minimum amount of consideration that a corporation can accept from an investor for a share of its common or preferred stock. Number is decided by board. Smaller number is smaller creditor cush-ion and thus proshareholder.

vii. legal capital and par value is designed to protect the creditors of the co. This cant sell stock for less then par value since defrauding the creditors since they are not getting cushion.

1. ex. if the par value of a share of a company’s common stock is 1.00, then a potential investor must pay at least 1.00 per share for the stock he buys

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2. 2. companies try to sell their shares of stock at prices significantly higher than par value

3. any consideration that the investors pay in excess of par value is in-cluded in the “additional paid-in-capital account” (APIC) on the com-pany balance sheet

4. lower par value hurts creditors because they minimize the size of the capital cushion designed to protect creditors

viii. can issue “no par” stock1. this means no predetermined amount and board decides how much of

the consideration received should be allocated towards common stock acct. and how much should be toward APIC.

ix. Debt securities- Co IOU’s issued to investors. Co will pay interest and prin-ciple upon maturity. (ex. Bonds (generally secured by assets of the co. and if co cant repay then the lender will seize the property), debentures, notes (shorter term obligations that may be secured or unsecured).

1. Contract claimants on co – contractual right to interest (can sue if they don’t pay)

2. Upside potential is capped at the interest rate- less risk but less oppor-tunity for upside.

3. bonds and the indenture need to be conceptually distinguished a. bonds set out a promise to pay that runs to the holders of the

bondsb. indenture is a bundle of additional promises (including a

backup promise to pay) that run to the trusteex. Preferred stock- Hybrid securities (mix of stock and debt)

1. Most common form of equity ownership in a co., but K claimants, not equity

2. S corp cannot issue preferred stock because need at least 1 class of common stock at all time (need 1 owner) and can only have 1 class of stock. If an S corp issues preferred stock, then loses status.

3. Contractual obligations voted on by board4. Certificate of designation is filed with the state and becomes part of

co’s charter (no actual K) (DGCL 102(a)(4) (537), NYBCL 402(a)(6) 1124

a. Terms of preferred stock are rarely put into the charter, b/c can’t determine mkt conditions in advance, instead blank check authority given to directors-statutory ability to issue 1 or more series of preferred stock at boards discretion, with terms figured out then. Board will negotiate terms for series and when adopted those resolutions will become part of char-ter.

5. Traditionally issued by co’s in 1 or more series (1st series A, then b etc)- terms will vary btw series b/c like debt need to yield different in-terest rates based on interest rates at the time.

6. Dividend preference- must receive/pay all their dividends of preferred stock prior to the time that the company can pay any dividends to com-mon stock holders. CS holders will receive nothing if PS holders are in arrears. (DE statutorily based- DGCL 151(c) (559); NY- K based, need for demand of PS)

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a. Legal Capital rules must still be met before paying dividendsi. DGCL 170(a) (569)- surplus (net assets-

capital<CS+PS>) or from net profits this year or last year

ii. NYBCL § 510 (1133)- equity insolvency test & net as-sets test (net assets remaining after paying dividend = stated capital)

b. PS more risky than debt b/c dividends only paid at discretion of the board and then ONLY if legal cap rules satisfied, Debt must always be paid, or can lead to bankruptcy

7. Liquidation preference- PS holders will get a stated dollar amount at liquidation before CS holders get anything (typically the amount of money the PS holders paid for the stock in first place- par value (debt like feature))

8. Dividend = Annual Dividend Yield (%) * Par Valuea. May be paid in cash, property, or in shares of corp’s capital

stock. And payable at board’s discretion. 9. Annual Dividend Yield (%) = Dividend / Par Value10. Preferred stock has a higher interest rate then the markets interest rate11. Dividend payments of preferred stock are payable at the discretion of

the boarda. Can only pay it out of funds that are legally available

12. Cumulative v. non-cumulativea. Cumulative PS (contractual right)- if board declines to pay div-

idend in a quarter, it accumulates, and can’t pay CS dividend until they pay all dividends past and present. Even if dividend is prevented b/c of legal capital rules it accrues

b. Non-cumulative- if the co decides not to pay dividend it is lost forever and it would be illegal for the co to pay a past missed dividend b/c like a undeserved gift. This type often used by venture capitalists in the form of non-cumulative convertible stock b/c get the chance to convert into CS, but if the co fails get paid right after debt.

13. 2 types of voting rightsa. Voting rights (entitled by law)

i. Vote w/cs holders, but since usually more cs, they ruleii. If the amendment of charter would adversely affect the

preferred shareholders than the preferred shareholders must also approve the amendment as a separate class (DGCL 242(a) (598) NYBCL 501(a) (1126))

b. Contractual Voting Rightsi. Cumulative Preferred Stock- If the co has missed 6

quarterly dividend payments then the preferred stock-holders can elect 1 or more directors to the board who will stay on board until the arrearage is paid off, but then get kicked off! Those who get elected have a fidu-ciary duty to ALL shareholders. K provision can pro-vide that missed dividends need not be consecutive

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14. Conversion rights- can negotiate for option to convert PS to CS (resid-ual claimants) so can capture upside if co is doing well. Usually must accept lower dividend yield for this right.

15. Participation Rights- negotiate to receive both PS and CS dividend. Only works well when a co wants to pay CS dividends (cash cow)

16. Redemption Rights- DGCL 151b, the co buys back the PS b/c rates change (useful b/c when interests rate decline, can buy back and reis-sue at a lower dividend yield, shareholders will demand a premium for selling their above market dividend yield stock) There will typically be a period of time when the co is prohibited from redeeming the stock (call protection), but the co will buy at a premium price, b/c if not will have to wait maybe 5-10 years until can buy w/out prem

xi. Common Stock- ownership equity claim or interest in co 1. Ownership claimants not contract claimants (Residual claimants) – get

everything left over so upside is NOT capped. (get paid last at liquida-tion)

2. Board decides how much CS will cost, but cannot sell for less than par value b/c would be watered stock. Questions used to decide:

a. How much money are we looking to raiseb. What % of ownership are we willing to give up for that amount

of money (very early on owners are willing to give larger pieces for less $, until get closer to going public)

c. What is the entire co worth? Based on comparable valuations and discounted cash flow from investment banks….

d. How much of the co are you willing to give up to go public? (a very strong family might not want to give up control!)

i. Ex. Assume want to sell 49% of co that is worth $100 m ($49 m)

1. Want good float and liquidity (lots of shares) and don’t want share price looking cheap try getting at least $10.

3. Votinga. Typically common stock receives 1 vote per shares, but can is-

sue stock with NO voting rights (DGCL 151(a) (558), NY-BCL 501(a) (1126)), but MUST have voting class so will have 2 classes. (if S-corp and want voting and non-voting shares will lose designation).

i. Non-voting CS- Still need to get shareholder approval over certain things, but means that won’t get to vote for directors. A lot of investors don’t care about voting but want the financial benefits of being an investor.

1. Stock exchanges WILL NOT LIST NON-VOT-ING SHARES- didn’t want these stocks b/c didn’t think it was fair, so instead co’s decided to issue super voting stock (i.e. family members will get 10 votes per share, public shareholders will get 1 vote per share)

b. CS holders can vote on charter amendments (including how many shares the co is allowed to issue, so if limit reached and

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want to issue more need shareholder approval), mergers, sale of all or substantially all of the co’s assets, election of directors (if not non-voting stock which can exist in non-public co’s), termination of the co.

4. Dividends- CS holders are not automatically entitled to dividends b/c directors discretion, but in rare circumstances a court could compel a co that has so much money in bank to pay a dividend (Microsoft). Dividends do NOT have to be in cash. Dividend can be shares of co stock, shares of another co the co owns, excess inventory, IOU’s.

a. Spin off- Parent co w/2 shareholders owns all the shares of its subsidiary and parent co takes the shares of the subsidiary and give it to the 2 shareholders. 2 shareholders will now directly own the shares of the subsidiary. Important b/c now sharehold-ers can sell stock of subsidiary, but couldn’t before b/c pro-tected by parent co.

5. Redemption rights- Under DGCL 160(a) (565), a corporation is em-powered to repurchase its securities, including common stock. How-ever, via contract (more common with closely-held corporations) you can force common shareholders to sell their shares back to the corp.

6. Preemptive Rights- (Private Co’s only)- Contractual in nature and guarantee a shareholder the ability, but not the obligation to maintain his ownership % if gets watered down. Traditionally, all shareholders had these rights (statutorily), but now must be specified in charter. (DGCL § 102(b)(3) (538), NYBCL § 622(b)(3) (1151). Need share-holder approval to amend the charter to add a preemptive rights provi-sion, accordingly, the prospective shareholder would have to have a lot of clout (or be offering to invest a large sum of money) for that to hap-pen.

a. Preemptive rights wouldn’t make sense in a case where co A acquired co B, and “used existing stock to do that”- When you use authorized but unissued shares of common stock to buy an-other co, those shares are issued to the selling shareholders of that other co (Company B). If some of the stock being issued in connection with the acquisition had to be offered up first to company A’s stockholders due to a preemptive rights provi-sion, it could endanger the whole acquisition. (could lead to chicken/egg problem). For example, if co A offered a 35% ag-gregate interest it Company A to Company B’s shareholders in exchange for B’s stock, and then A’s shareholders sought to enforce their preemptive rights, a 35% stake could never be is-sued to B’s shareholders. Thus, virtually all preemptive rights provisions in charters carve out issuances of shares in certain cases (e.g. in connection with acquisitions and in connection with the exercise of employee stock options).

b. Public co’s won’t have this right, if it’s in the charter existing shareholders will take out before going public. A company that has a preemptive rights provision isn’t a good candidate for going public. It would make the raising of capital in the fu-ture (even in the IPO itself) too complicated and uncertain.

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Therefore, the investment bankers who are going to underwrite the IPO tell existing shareholders that they will not take them public unless they remove the preemptive rights provision. Since going public is a way for existing shareholders to make a lot of money, they acquiesce.

7. Stock can have no par value- stock that allows the board to specify the amount allocated to the common stock account at the time stock is is-sued. (Par value stock has a predetermined amount that will be allo-cated to the common stock account). In the case of “no par” stock, the amount allocated to the CSA can be different (or the same) each time common stock is issued.

b. Legal capital rulesi. Designed to protect shareholders- CANNOT pay a dividend if it will reduce

the capital cushion, but even in the leanest of times there is tremendous pres-sure on the board to pay a dividend to shareholders.

ii. DE Legal Capital Rules – DGCL § 170(a)- Directors may declare and pay dividends on common stock either:

1. Out of surplus a. Surplus is the excess of any of the corporations net assets over

the amount determined to be capital. Surplus = (Total Assets-Total Liabilities)-capital (DGCL § 154)

i. Surplus= Additional paid in capital, Retained Earnings and other comprehensive income

b. Capital- the amount that is sitting in the common stock account and preferred stock account

c. Net assets- the amount by which total assets exceed total liabil-ities of the corporation

2. OR, if there is no surplus then out of net profits for the current fiscal year and/or the preceding fiscal year

a. A prime example of DE being a management friendly state- tells us even though there is no capital cushion to protect credi-tors, can still pay common stock holders if the co was lucky enough to make money this year or last year- to the detriment of shareholders b/c less left for them.

i. Management gets to keep their job by keeping share-holders happy by paying them dividends, but at the ex-pense of creditors.

Surplus = (TA-TL) – Capital (CSA + PSA)

HYPO- assume corp has 100,000shares of common stock outstanding (in hands of shareholders),

par value is $2 per share and thus CSA= 200,000- assume total assets = 3 million dollars and TL = 2.6mill and Net Loss= (400,000k) but

last yr. had net profit of 100,000k- can we pay dividend legally based on these facts? If yes how much?

1. do we have surplus?a. Surplus= TA-TL-Capital

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i. 3mill-2.6-(200,000)=200,000 so yes have surplus…if have any surplus never go to second prong or next step****and thus can pay max. of 200,000k in dividends

1. s 200,000/100,000 which equals a max of $2 per share…HYPO 2

- assume corp has TL= 2.9 mill instead of 2.6

1. surplus= TA-TL-Capa. 3mill-2.9-200,000= (100,000) and thus no surplus but in Delaware still can pay

dividend if made profit this yr. or last current fiscal yr. i. This yr no (lost 100,00)ii. Last yr made 100,000

1. thus can ignore Net liability of (400,000k)2. can pay 100,000/100,000= $1 dividend per share3. and thus reduces capital cushion (since comes out of CSA)

so if had 200,000 NL….AND/OR******iii. Under DGCL § 174(a)- Those who vote in favor of a dividend that would not

be legal are jointly and severally liable to the corporation or creditors in the amount of overpayment. Directors will be held liable if they did so willfully

1. Knowing shareholder exception- Directors who are held liable for an illegal dividend can sue any shareholder who took the dividend with knowledge that it was illegal,

2. Under DGCL 172(a) (569)- Directors are entitled to rely reasonably on outside advisors. Due Care Exception.

iv. NY Legal Capital rules- NYBCL § 510 - 2 parts to NY’s legal capital test- BOTH must be met: More pro creditor.

1. Equity insolvency test (510(a))- a corporation cannot legally pay a div-idend if the co is insolvent or would be rendered insolvent as a result of a payment of dividends AND

a. Insolvent- unable to pay its debts as they become due in the or-dinary course of business.

i. Can tell this by looking at the statement of cash flows or looking at the balance sheet and comparing total as-sets to total liabilities (if far exceed most likely wont be able to pay.) Also, current assets v. current liabilities

ii. Wouldn’t want to just ask a creditor if they have been paid in time b/c co might be paying late as part of its cash flow management, or there could be a dispute over the bill etc, many other reasons not to pay besides not having cash.

2. 2nd Prong- Net assets test (510(b))- (balance sheet surplus test)a. The board can only declare and pay dividends out of surplus so

long as the assets remaining after paying at least equal the amount of stated capital.

i. Stated capital = common stock account + preferred stock account

1. shares outstanding * par value.

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ii. Maximum dividends payable = net assets (which is TA-TL) – stated capital (same as DE’s surplus formula)

HYPO-NY Corp- current on paying its bills and has 500,000 common stock outstanding and par value is $1 per share and thus amount in CSA $500,000…assume TA is 5.1mill. and TL is 3.2mill.

- can NY corp pay dividend and if so what amount?o Good evidence that it is solvent since current on bills or could look at TA-TL and

if positive then good indicator solvent since can pay of liabilities or can look at CASh v. Current Liabilities (if cash greater then good indictor)

So assume we are solvent- first formula

o TA-TL has to be > stated capital 5.1mill- 3.2 mill is greater than 500,000 1.9mill > then 500,000 so yes can pay dividend

· So what is the max dividend payable?o 1.9-500,000=1.4 mill if want to figure out on per share ba-

sis then 1.4mill/500,000 which equals $2.8 per a share

HYPO 2- assume TA is 3.6 mill. as opposed to 5.1 mill. and assume the co. earned net profits

(NP)equal to $250,000 and last yr. had net loss of ($150,000)- assume other facts above and so can we pay dividend and if so what is max?- still solvent see facts above but what about second prong

o TA-TL> stated capital 3.6-3.2 must be greater or equal to 500,000K

· 400,000 is LESS than 500,000k and thus cant pay any dividend so next question is can we pay dividend up to 250k since made money of 250,000 this yr? NY does not have second prong of Delaware test-----******NY only cares if solvent AND TA-TL is greater then stated capital

In theory the 250,000 is still in the account available to creditors but who cares since co is still paying credits on time…..

v. NYBCL § 719(a)(1) (1169)- Those who vote in favor of a dividend that would not be legal are jointly and severally liable to the corporation or credi-tors in the amount of overpayment. Directors will be held liable if they did so willfully

1. Exception- Relying on faulty info and knowing shareholder exception (See § 719(d)(1))

c. Where to Incorporate? Delaware’s Preeminencei. Governance of a co is controlled by the co law in the state in which the co is

incorporated, no matter where the business is actually located- so where to in-corporate is an important decision

ii. elements of the doing business and franchise taxes may overlap, so that if a corporation is doing business mainly on one state, its total tax bill usually will be lower if it is incorporated in that state.

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iii. More than 50% of publicly traded co’s are incorporated in DE and many co’s reincorporate in DE to take advantage of DE law (form a fully owned DE in-corporated subsidiary and then merge the 2 co’s into 1 DE co)

iv. 3 reasons for why DE1. Statutorily liberal- Management friendly- places minimal restrictions

on corporate manager when running their business. Managers can treat the business as their own instead of being ruled by shareholders

a. DE allows the adoption of certain takeover defensesi. Ex. Poison Pill defense- makes it expensive for one co.

to take over another co. b. Allow manager to keep their jobs- don’t want shareholders

willy nilly throwing them out of officec. Minimizes the need for shareholder approval on a number of

things2. Large established body of case law in the DE Chancery court (a lot of

high profile corporate disputes) so has expertise that can’t find in other courts around the country.

a. Stability b/c people can always rely on DE case law3. DE chancery is very efficient when it comes to large co disputes (often

gets a case heard in a matter of weeks and sometimes even quicker).v. Can Reincorporate

1. make subsidiary and then merge into subsidiary and change the name to the old corp. Thus all assets flow into the corp by operation of law.

SEE SUPPLEMENT HYPO PG 2 d. Corporate Governing Documents and the Interplay with Corporate Finance

i. 3 main documents that govern the internal corporate governance of the co:1. Certificate or articles of incorporation….some times called charter and

most supreme2. By-laws (contain more detailed day to day corporate governance pro-

visions)3. Board of Directors resolutions (often taken at board of directors meet-

ings) ii. Charter or certificate of incorporation

1. DGCL § 102 (536) and NYBCL § 402 (1124)- Specify what needs to be in the corp charter at a minimum

a. Namei. NYBCL §402(a)(1) – Cannot mislead people with the

corp name and certain terms can only be used in the name if you get pre-approval from a particular NY state Dept – certain words are off limits

1. ex. savings or loan can if approved. ii. NYCBL § 301(a)(5)(a) (Stat II- 20)- list of words that

cannot be used in name 1. ex. police

iii. NYCBL § 301(a)(1) (Stat II- 19)- Name must include corporation, limited, incorporated or any abbreviation of those.

iv. If someone else has the same name as you have to find a new name, file and pay again.

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v. Under both DCGL § 102 (536) and NYBCL § 303 (Stat- II- 22)- Can reserve a name for up to 60 days with 2 extensions allowed.

b. Business purpose- must be included in charter. Can state a spe-cific or generic purpose or both (Generic- any lawful activity allowed under law). Most co’s just put in a generic purpose, but some risk either way.

c. # of authorized shares- 403a4, Must include the class or classes of stock that the co can issue and also the par value for each class. To change that # (amend the carter) need shareholder approval. Shareholders will only allow change if it is reason-able.

i. Under DGCL 102(a)(4) (537) and NYBCL 402(a)(5) (1125) if the co decides to issue separate stocks into dif-ferent classes they must describe how they differ (typi-cally differ only in voting rights)

1. NYBCL § 502 (1127)- blank check EXCEP-TION for preferred stock- can designate board the right to later decide rights, preferences and privileges of different series at the time of issu-ing, w/no shareholder approval b/c pre-ap-proved.

d. Duration of the corporation- can specify a termination date, but if you don’t then life of the corporation is perpetual.

e. DGCL § 102(b)(7) (539) and NYBCL 402(b) (1125) allows co to assert in charter a provision that limits a directors per-sonal liability for breaches related to fiduciary duty other than those taken in bad faith or involved in petulant conduct. Most charters include this provision. (DE case law Smith v. Van Gorkan said that directors can be liable for breaches of fidu-ciary duty, but DE law changed this)

f. Can put anything else in your charter as long as it’s not illegal! g. If want to change charter

i. Ex. increase number of shares Del 241, 242 or NY 803- majority of stock holders and the board have to approve amendment, if it adversely effects a specific group, that group can vote and veto it.

h. If charter proves to be problematic and you need to amend the charter NYBCL § 803(a) (Stat II 105)- tell us that (1) if there are no shares outstanding, so no shareholders, the sole incorpo-rator can make any amendments he wants; (2) if there are shares outstanding, need approval from a majority of share-holders to make amendment.

i. EXCEPTIONS to rule of needing shareholder approval:1. NYBCL § 803(a) (Stat II 105)- No shareholders2. NYBCL § 105 (Stat II – 9) – correcting all ty-

pos EXCEPT typos in the namea. DE doesn’t provide typo exception so

need shareholder approval

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iii. By-laws1. Nuts and bolts of co- Mechanics behind calling and holding meetings,

meetings of shareholders, typically will specify the number of direc-tors that will sit on the board, discuss how to fill vacancies on the board if director dies or resigns

2. Amending the Bylaws (depends)- DGCL § 109 (a) (544) and NYBCL § 601 (1139)- Shareholders through a vote can always amend the by-laws. However, if they choose they can put in their charter a provision that shares the power to amend the bylaws with the directors (w/out shareholder approval). If directors change the bylaws so they are ad-verse to shareholders the shareholders can change it back b/c share-holders are the owners of the co, while the directors are agents of the owners; shareholders have preemptive power over the bylaws and their amendments take precedent.

iv. Board of Directors resolutions1. Co’s are entities (artificial people) and they themselves can take ac-

tions in their own right. 2. Since co can only act through its officers and directors it makes sense

that when they resolve to do something to memorialize resolution in writing.

3. There is no bright line test over what an officer can do without the board’s approval- when it’s a material decision the officer needs to get board approval.

e. Ultra Vires Doctrinei. Beyond the corporations power and thus enforceable since lack of mutuality. ii. Asbury Railway v. Riche (126) held that any K of a co found to be ultra vires

is void even if there is shareholder approval of the K after the fact, so the co can’t enforce it against the party and the other party cannot enforce it against the co.

iii. Theory behind this doctrine is that shareholders should be able to rely on the charter and we want to prohibit unsanctioned corporate activity. Protect Public

iv. In the US we have the competing policy of certainty in commercial dealings b/c we want to promote economic growth and development, thus in state where the co lacked the explicit power to do xyz the courts often found im-plied power.

1. Ex. Charter is silent over whether the co can become a limited partner in a partnership.

a. In the UK this would be ultra vires b. In the US under common law this would be ultra vires as well c. However under DGCL 122(11) (547) and NYBCL 202(a)(15)

(1123) Specifically authorizes a co to participate in partner-ships of any kind (Statute gives you implicit (implied) power that you will have even if it isn’t stated in your corporate char-ter)

v. Ultra Vires v. illegal or unauthorized acts- Just because something is in the corporate charter doesn’t mean that it’s legal and just because something is ul-tra vires doesn’t mean it’s illegal. Also, something can not be ultra vires, but can be unauthorized because not previously approved by the directors, but a

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co will be bound to 3rd parties based on officer’s actions, b/c didn’t know that directors didn’t approve

vi. Goodman v. Ladd Estate Co. (129)- Wheatley (Director of Westover Co) wants to get a loan from Citizens bank and needs an endorsement from an-other entity so asks Ladd Estate Co. Ladd wont do it without guarantee from Westover. So if Wheatley can’t pay back loan Ladd Estate must pay and if Ladd doesn’t pay then Westover will have to pay. Wheatley defaults on the note, so Ladd estate is required to pay the bank loan, and Ladd looks to West-over for reimbursement, but Westover wont pay, so Ladd sues Westover. P’s in this case are the Goodmans (purchased all common shares of Westover) seeking to enjoin Ladd from enforcing the guarantee from Westover.

1. P’s knew about the guarantee when they purchased the shares (thought it was unenforceable), but think they deserve an enjoinment b/c it was ultra vires b/c co cant guarantee a debt. Ultra Vires b/c the guarantee wasn’t made to benefit Westover, but for Wheatley personal purposes

2. Everyone concedes that the guarantee was in fact ultra vires, so would think that the court will enjoin the enforcement of the guarantee, but court will only enjoin an ultra vires act if doing so is equitable.

3. Court instead decides that despite the fact that it was ultra vires, b/c the stock owner approved the guarantee at the time, and could have ap-proved a charter amendment that would have allowed this type of guarantee to exist (which would have made this act not ultra vires) and the Goodman’s knew all this, they step into his shoes and must guaran-tee.

vii. US courts have an aversion to throwing out corporate actions based on ultra vires doctrine.

viii. If the primary shareholder in a corp, participates in an ultra vires agree-ment, he or his successors cannot later attach the agreement as ultra vires.

ix. DGCL § 124 says that ultra vires can be asserted in 3 situations 1. Proceedings brought by a shareholder to enjoin the doing of any act or

acts or the transfer of real or personal property by or to the corpora-tion.

2. In a proceeding brought by a co or the representative against an incum-bent or former officer or director due to damage caused by an autho-rized act (not really ultra vires because something within the power of the co, but this person didn’t have the authority to do so)

3. Proceedings brought by the Attorney General to dissolve a corporation or to enjoin it from doing any act deemed to be ultra vires.

f. Objective and Conduct of the Corporation i. Financial credo of corporations is generally the maximization of shareholder

wealth. Problem with this is that sometimes it diminishes the benefits to oth-ers (ex. Employees, creditors or local community)

ii. Role that co should have in society Shareholders probably want the co to be also thinking about employees, local communities and charities.

iii. Dodge v. Ford Motor Co. (139)- At formation, Ford Motor was privately held w/ Henry Ford owning 58% and 10% owned by Dodge bros. Ford was so profitable that it had a very rich history of paying dividends and also declared special dividends (happens when co is so profitable and has no other use for $). Ford decided that he will no longer give out special dividends and instead

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redistribute that $ to the employees. Also plows back $ into the community by employing more men and reduces price of cars to make it more affordable. $52.5 million lying around the co at the time of this decision.

1. Purpose of the co. in this decision tends to be a little old school2. P’s contend that Ford’s plan is focused on other people and not the

shareholders of the co – running Ford as a charitable institution, not a business institution. Dodge bro’s want to compel the payment of a div-idend, despite the general rule that shareholders are not entitled to a dividend.

3. Ford defends his actions by saying that the charity is incidental to the primary business purpose of the co, which is designed to provide a profit for shareholders.

4. Trial court forces the co to pay a dividend and Michigan Sct doesn’t buy Henry Fords argument. Sct agrees that co’s can engage in inci-dental charity, but CANNOT make charity your primary purpose and business purpose incidental.

5. Although this case suggests that a court can force a co to pay a divi-dend under the most extreme circumstance, most courts won’t do so! Very very difficult thing to get court to do.

iv. A.P, Smith Mfg. Co. v. Barlow (141)- Co made valves, fire hydrants and other special equipment and throughout the years made charitable contribu-tions to the community and to the local colleges. One year it wanted to make a large gift of $1,500 to Princeton University and some of the stockholders challenged this gift. Co in turn seeks a declaratory judgment about the valid-ity of a contribution like this.

1. Lower court finds that this contribution is valid and the D’s appeal the decision to the NJ Supreme crt

a. Testimony of variety of co executive shows that the greater co purpose is promoting wealth in the industry through higher ed-ucation. Giving to education is essential for the communities and the co itself b/c ensures a supply of educated employees in future.

2. D’s aren’t debating the benefits of co charitable giving, but the charter doesn’t expressly authorize this type of contribution, therefore ultra vires act. Also, the statute that authorizes these types of gifts was cre-ated after the co’s creation so shouldn’t apply retroactively to the co’s formed before.

3. Court held that the common law rule on co giving if private profit is the goal of the co is that charitable giving must be incidental, so CAN-NOT give a corp gift that doesn’t benefit your co in any form. Also, gift is subject to reasonable limits.

4. Court based its decision on the NJ statue- Can give reasonable amounts to charity so long as

a. the recipient doesn’t own more than 10% of the stock of the donor corporation and

b. any contribution cannot exceed 1 percent of the capital and sur-plus of the co unless the excess is authorized by stockholders. (don’t want gifts so large that they endanger capital cushion of co)

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5. The common law rule that a co cannot give charity unless this would benefit the co has been watered down so now the benefit can be indi-rect, but court believes that the case would come out same way under common law and under the statute. Court states that the statutory pro-visions simply constitute helpful and confirmatory declarations of the power of the co to make charitable contributions under common law. Since co charters are a gift from the legislatures, court has no problem finding that the statutes applied retroactively to the co’s formed earlier.

6. Court believes that the biggest danger of charitable contributions by co’s is that the CEO often gives $ to his/her pet charity in order to ben-efit themselves,

v. DE and NY give statutory authority for co’s to make charitable gifts1. DGCL § 122(9) (547)- Power to “make donations for the public wel-

fare or for charitable, scientific or educational purposes, and in time of war or other national emergency in aid thereof”

a. Doesn’t mention anything about how contribution must be in furtherance of its corporate welfare, so must look at DE case law to see how DE courts decided this issue.

2. NYBCL § 202(a)(12) (1123)- Power to in furtherance of its corporate purposes: “make donations, irrespective of corporate benefit, for the public welfare or for community fund, hospital, charitable, educa-tional, scientific, civic or similar purposes, and in time of war or other national emergency in aid thereof.

a. Most charters are silent as to specific purpose vi. Alternative to corporate charitable giving is to give $ to shareholders and let

them choose their own charities, BUT some people wouldn’t give and wouldn’t get the corp benefit of giving the gift. So corporate giving might be better for shareholders b/c of the repercussions of the gift. Gift will be large than individual gift, so more impact on the community which may help profit the co (can be considered an investment. Also, tax benefits for co to give charity.

vii. What if a corporation that you own shares in donates to a charity in which you do not believe in - such as for abortion right?

1. sell your stock - not worth the money to fight it2. proxy fight - try to replace existing board members with new nominees

who shares the same beliefs as youviii. Extent to which NY or DE law allow directors to consider constituencies

other than shareholders when making business decisions:1. NYBCL § 717 (b) (1169)- When board makes decisions it can con-

sider many different things: Shareholders, employees, retired employ-ees, creditors, consumers, community,

a. Most of these statutes are a relatively recent phenomenon adopted by legislatures to deal with hostile takeovers where many people were fired etc. So passed this statute in an attempt to protect local co’s.

b. Typically, the hostile co will pay a premium price for the stock so when a board adopts a takeover defense it does so to pre-serve the enterprise, but at the same time prevents the share-holders from getting a premium price.

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2. DE does NOT have a statute on point, but generally puts the priority of constituents in this order: (1) Management (2) Shareholders. Accord-ing to case law relating to hostile takeovers, Board can consider other constituents provided that they have a reasonable relationship with shareholders. (employees, retired employees, creditors, consumers, community)

a. In some states the constituency statute only applies to decisions by boards relating to mergers and acquisition transactions. In other states their statutes don’t have this limitation. Thus, tech-nically a board could consider a company’s creditors when it decides whether or not to manufacture a new product. (Now, it wouldn’t make sense to do this, but the statute would allow for this). In practice, constituency statutes usually are implicated only in the takeover context.

g. Pre-Incorporation Transactions by Promoters - #8i. Promoters are individuals who (without incorporating) come up with a busi-

ness idea, do a feasibility report, and come up with the necessary funding to create the business and get it up and running. Once the co is formed they hope to receive cash or stock for putting the co together (expect compensation for services).

ii. Issue whether the services of a promoter constitute consideration for stock (must give consideration to receive stock) b/c services done before the co is even born. Statutory law says that it constitutes consideration.

1. DGCL § 152 (562) – Services rendered to the co constitute valid con-sideration for stock- case law holds that promoter services before the co is born constitutes valid consideration

2. NYBCL § 504(a) (1129)- Services in connection with the formation of the co constitute consideration for stock

iii. Liability of the promoter- Goodman v. DDS Associates (115)- Goodman ne-gotiated to renovate apts for DDS and notified them that he would be forming a co to limit his personal liability. The renovation work didn’t pan out like it was supposed to and Goodman defaulted on the K prior to the time he formed the co. Thus, DDS seeks to hold Goodman personally liable on the K. Good-man defends himself by saying that he personally wasn’t a party to the K b/c Goodman signed the check as President of Building Design Inc. On the peri-odic payment checks he received which said BD co and Goodman, Goodman crossed out his name and made sure it said Building Design- Goodman “pres-ident” and instructed DDS to make out the future checks to the co,

1. General rule for promoter liability is that where a co is contemplated, but has not yet been organized, the promoter is personally liable on the K, even though the K will benefit the co once it is formed. EXCEP-TION- if the contracting party knew that the co was not yet in exis-tence at the time of contracting, but nevertheless agreed to look only at the co once formed the promoter is off the hook.

2. Goodman has the burden of showing that DDS knew that it was deal-ing with a not yet formed co and agreed to look only at the co.

3. Goodman is held liable, b/c court thinks that DDS intended to make him a party (based on their checks) and only at his request did they agree to take his name off.

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iv. 3 related concepts as to whether the co itself once formed can be bound by pre-incorporation K’s made by the promoter

1. Ratification - NO relevance here, involves agency law. One of the types of authority that can be given to officers or directors. Board will adopt as their own a K made by agent, after the fact. Since no co ex-isted, promoter not an agent for co, so this principle cant be used w/pre-incorporation K.

a. R(S)A -3262. Adoption - Board will adopt a K once its formed, but a co does NOT

have to adopt a pre-incorporation K. However, to adopt the K the board does not need to take formal actions, it can merely adopt by their own actions- accepting the benefits of the K. BUT once adopted for-mally or informally, the promoter is NOT off the hook. BOTH the promoter and the co are jointly and severally liable for the K. (Illinois Controls, Inc. v. Langham (116)) To get the promoter off the hook need a formal Novation

3. Novation - 3rd party lets the promoter off the hook. Separate agreement that mirrors the original K is made but this one only has the co’s name on it and not the promoters. Most 3rd parties won’t want the promoter off the hook, so might make him pay for this.

v. To avoid all these issues it’s better to form the corp first and then enter into K’s

h. Consequences of Defective Incorporationi. People who never incorporate or who do so defectively can still nevertheless

get the benefit of co (limited liability) ii. De Jure Corp (this is what u want)

1. is a corp. organized in compliance with the requirements of the state of incorporation

2. cannot be attacked by either private parties or the state3. need substantial compliance

iii. De Facto Corp – provides limited liability to promoter 1. insufficient compliance to constitute a de jure corp. vis a visa a chal-

lenge by the state, but the steps taken toward formation of a corp. are sufficient to treat the enterprise as a corp with respect to third parties. In such a case, the corp state can be invalidated by the state through quo warranto proceedings, but not by creditors or other persons who have had dealings with the enterprise.

3 requirements:i. Execute certificate of incorporation ii. Bonafide effort to file certificateiii. Actual exercise corporate power

iv. Cantor v. Sunshine Greenery, Inc. (117)- Cantor drew up a lease for Sun-shine as tenant. Brunetti (President of Sunshine) signed the lease on behalf of sunshine. Despite the fact that Sunshine was a newly formed co, Cantor did not request a personal guaranty from Brunetti, nor did he make inquiry as to his financial status background. Cantor relied solely on the ability of the Co to pay the rent. At the lease signing (Dec 16) Cantor insisted on receiving a check covering the 1st months rent and a security deposit, but Brunetti claimed he had none with him. So Cantor furnished a blank check which was filled out

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for requisite amount, with the name of Brunetti’s bank, and signed by Brunetti as President of Sunshine. The lease was repudiated by legal counsel for Sun-shine, and Cantor responded that he would hold Brunetti responsible for all losses. The check was not honored b/c Brunetti stopped payment and b/c Sun-shine didn’t have an account in the bank.

1. The certificate of incorporation for Sunshine was signed by Brunetti and Sharyn as incorporators on Dec 3rd and mailed with the appropri-ate fee to the Secretary of State, but deemed to be filed on Dec 18th. The lease was entered into between Dec 3rd and 18. So the lease was signed before there was a legally formed (“de jure”) corporation.

2. Being a de facto corporation will provide limited liability (presupposes a corp statute)

3. 3 requirements for being a de facto corporationa. Execution of a certificate of corporation (signing)b. Bonafide attempt to file the certificate of incorporation with the

secretary of states officei. NOT enough to draw up the certificate of incorporation,

MUST sign and send it inii. It is a bonafide attempt if it is sent in with the fee, but

gets lost in the system b/c no follow up requirement for a de facto corporation.

iii. Not an attempt if don’t send in fee. c. Exercise of corporate power

4. If 3 requirements are met, the corp will be treated as a corp. with re-spect to third parties and there would be limited liability to the pro-moter.

5. The lower court didn’t find a de facto corp and held Brunetti liable b/c didn’t think they exercised corp power b/c no board meeting, issuing of stock etc.

6. Higher court found a de facto corp, so Brunetti not liable under the lease. Held that there was no need for formal meetings, board resolu-tions or issuance of stock. Acting in the name of the co is enough to form a de facto co.

7. This result is different than a pre-incorporation K followed by adop-tion of the K, where the promoter is still on the hook, b/c actual actions were taken to form this co.

v. Doctrine of Estoppel (123)1. While concept of de facto co depends entirely on what the incorporator

does, estoppel is based on 3rd parties actions- 3rd party never expected to look beyond the co for payment, so why should it be allowed to do so now.

2. Does not shield you from 3rd parties who have not dealt with you as a business

3. Under estoppel doctrine, the 3rd party has to have dealt with a business as though it were a co….does not matter if attempt to file certificate.

4. De facto defense is a better defense than estoppel. One thing that the estoppel defense won’t protect you against, where de facto might, is when dealing with tort victims. If someone slips in front of your store, and it turns out you didn’t really incorporate, estoppel won’t work be-

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cause never dealt with you as a corp, but de facto corp defense will work.

a. In Cantor, the P did in fact deal with Sunshine as it was a co, but Brunetti attempted to use co powers.

8. Courts are split on holding shareholders personally liable for debts incurred in the corp’s name when the corp is neither de jure nor de facto nor a corp by estoppel.

a. Piercing the Corporate Veili. A shareholder has no liability for corporate obligation and shareholders risk is

limited to her investment (amount paid for her shares) See DGCL § 102(b)(6) (538).

ii. Managers are not liable for the corporation based on agency principles1. in the case of a K that is made by an agent within his authority, the

agent is not liable as long as she purported to act in that capacity and the identity of her principle was disclosed

2. In the case of a tort by a corporate employee, the manager would nor-mally not be vicariously liable.

iii. HOWEVER, there are times when people for a de jure corporation will be de-nied limited liability. Piercing of the corporate veil will occur if there is abuse of the corporate form. – lose your limited liability as a stockholder(can lose your personal assets)

iv. Corporate veil refers to shielding from personal liability a corporation’s offi-cers, directors, or shareholders for unlawful conduct engaged in by the corpo-ration.

v. Kaycee Land and Livestock v. Flahive1. when determing whether LLC pierced the corporate veil, look at com-

mingling of funds, treatment of corporate assets as its own, the failure to issue stock, the holding out by individual as being responsible for corp. debts, and the use of the corp. as a shell to evade creditors.

2. Wyoming said it is possible to pierce LLC veil. Same factors. vi. Fletcher v. Atex, Inc, (220)- Atex (D) was a wholly owned subsidiary of Ko-

dak (D) until 1992, when Atex sold substantially all of its assets to another party. Atex then changed its name to 805 Middlesex Corp. Kodak continued as the sole shareholder of Middlesex. Fletcher (P) and other claimants brought suit against Atex and Kodak to recover for stress injuries they in-curred from utilizing keyboards produced by Atex.

1. Fletcher argued that Kodak exercised undue control over Atex by us-ing a cash management system, exerting control over Atex’s major ex-penditures, and by dominating Atex’s board of directors.

2. Under applicable state law (DE), the court may pierce the corporate veil of a company and hold shareholders personally liable only in cases involving fraud, or where the company is a mere instrumentality or alter ego of its parent company.

3. NY state law looks to the law of the state of incorporation to determine whether a court will disregard the corporate form and hold sharehold-ers individually liable for the actions of the corporation. B/c Atex is a DE co, the law of DE applies.

4. Under DE law, an alter ego is demonstrated by showing that a. The parent and subsidiary acted as a single economic entity and

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b. It would be unjust or inequitable to treat them as distinct from one another.

i. A showing of fraud or wrongdoing is not necessary un-der an alter ego theory, but the plaintiff must demon-strate an overall statement of injustice or unfairness.

5. Factors that a court may consider in its determination of alter ego:a. Adequacy of capitalization

i. Did Kodak put enough money into Atex when it was formed

ii. Does subsidiary have enough money to run its business or pay off creditors

b. The corporate solvency- can it pay its debts in usual course of bus.

c. Payment of dividendsd. Observation of corporate formalities

i. Does the subsidiary have director meetings, shareholder meetings (corporate housekeeping) vs. LLC don’t need.

e. Intermingling/ Siphoning of fundsi. Did the subsidiary treat the corporation like its personal

atm.6. Evidence of alter ego in this case

a. Inclusion of the Kodak log on Apex’s productsb. Apex described as a division of Kodakc. Interlocking directorate (shared directors)d. Apex had to get approval for major decisions from Kodake. Centralized cash management system- single economic theory-

Kodak can take money from Atex’s pockets. 7. Argument that Atex is a mere façade for Kodak is that Atex needed

approval from Kodak for its decisions, but its common for parent com-panies to control decisions of their subsidiaries. Hard to prove as an evidentiary matter. Atex was referred to as a division (instrumentality) in a brochure. Court holds that is not sufficient to pierce the corp veil, b/c unreliable source

8. Court held that an implementation of a cash management system, standing alone, does not rise to the level of intermingling contemplated by the statute, neither does the overlap of the board of directors. The fact that a parent and subsidiary have common officers and directors does not necessarily demonstrate that a parent dominates the activities of a subsidiary.

vii. Walkovsky v. Carlton (226)- Walkovsky (P) was run down by a taxicab owned by Seon Cab Corp (D). In his complaint, P alleged that Seon was one of the 10 cab co’s of which Carlton was a shareholder, and that each corpo-ration had only 2 cabs registered to its name. He implied that each cab corp carried only the minimum automobile insurance required by law, $10,000. It was further alleged that these corps were operated as a single entity with re-gards to financing, supplies, repairs, employees, and garaging. Each corp and its shareholders were named as defendants because the multiple corpo-rate structure, according to P, constituted an unlawful attempt to defraud

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members of the general public. He wanted to get at the personal assets of Carlton, including his stock in other cab co’s.

1. P argues that Carlton operated the 10 corporations as a single eco-nomic entity. He does this so to compartmentalize the limited liability each co took out the minimum insurance required by law.

2. Whenever anyone uses control of a corporation to further his own rather than the corporation’s business, he will be personally liable for the corporation’s acts. Under respondeat superior the liability ex-tends to negligent acts as well as commercial dealings. However, where a corporation is a fragment of a larger corporate combine which actually conducts the business, a court will not pierce the corporate veil to hold individual shareholders liable.

3. In NY, courts will disregard the corporate form (pierce the corporate veil) to prevent fraud or achieve equity. It MUST be shown that the stockholder was conducting the corporations business in his indi-vidual capacity (alter ego notion).Must plead that the co was in-equitable, dummy corporation. When look to see if a corp is treated as a dummy we look at a few things:

a. Whether the shareholder treats the co as her personal agent and not a separate entity

b. Whether there is any co-mingling of personal and corp assets4. Majority held that can’t pierce the corp veil just b/c the co didn’t carry

enough insurance or have enough assets to pay the P’s claim. 5. Dissent felt that the attempt to do corporate business without providing

any sufficient basis of financial responsibility to creditors, here through under capitalization and minimum insurance liabilities, is an abuse of the corporate entity.

viii. To avoid getting veil pierced NEED to maintain corporate formalities1. Do your corporate housekeeping

a. Maintain minutes of meetingsb. Be prepared with board resolutions and document c. Treat corp. as a separate and distinct equity

2. Co mingling problemsa. Have to keep personal funds away from co funds EVEN if you

are 100% shareholder. b. Always let the co write the checkc. Keep a separate bank accountd. DON’T write personal checks

3. When taking money out of the co must be appropriately documented as a dividend, salary or bonus and keep records of everything.

4. Have to give the co the minimal amount of capital customary to run that type of business, so if the business fails then you personally feel it- “When nothing is invested in the co, the co provides no protection to its owners!”

a. Adhering to the relatively simple formalities, creating and b. for maintaining corp liability (249).

ix. Repercussions of veil piercing are a little different when dealing with parent co’s and individual shareholders b/c courts are more sympathetic to individual shareholder, so slightly more reluctant.

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x. Berle, The Theory of Enterprise Entity (231)- Large scale businesses today (conglomerate- conducts multiple businesses typically through multiple sub-sidiaries.  These subsidiaries are all owned, directly or indirectly, by an ulti-mate parent company) are usually conducted not by a single co, but a constel-lation of different co’s.

1. Formed less for business reasons then they are for tax and liability rea-sons

2. Could simply operate the business as mere divisions of the corporation itself rather than as subsidiaries

3. Argues therefore that if a particular subsidiary incurs a liability the as-sets of the entire conglomerate should be liable if the subsidiary in question cannot pay.

xi. According to Professor Eisenberg, a corp that puts some of its business into co form is likely to treat the same exact way as they treat unincorporated busi-nesses, the only difference is that a lawyer will spend time each year writing fictitious minutes, notes, etc of fictitious boards (meant to defraud creditors)

xii. Minton v. Cavaney (238) – In 1954, P’s daughter drowned in a public swim-ming pool owned by Seminole Corporation. P’s sued Seminole and got a judgment but weren’t able to collect from Seminole. So P’s went after the as-sets of one of the directors Cavaney (who died, so now wife is dealing w/case). Seminole had no assets, only thing they had was a swimming pool lease. Never issued shares of stock and had NO capital (owners never put $ into the co).

1. Essentially, all we have here is the paper shield (certificate of incorpo-ration)

2. Cavaney gets sued b/c he is a director, secretary and treasurer. Ca-vaney claims that he is merely a lawyer who was acting as those things merely as an accommodation to his clients until they figured out who will hold these positions. He also allowed Seminole to use his office to hold records and receive mail (put address of his office when filing as co (typical for lawyers), so mail came to him) P sues Caveney b/c he has the deepest pockets and is the only person that can be identified. P’s argue that Caveney is the alter-ego of Seminole, so should be per-sonally liable.

3. According to the CA Supreme Court there are several facts that sup-port veil piercing:

a. Inadequate Capitalization (saw this in Atex case-DE)b. Adding or withdrawing capital from the co at will (Haas says

that’s ok as long as documented)c. Treating the co’s assets as the ownersd. Using personal checkse. Officer and director of the co have to be actively participating

in the conduct of the co (important thing to remember when you are in the gray area)

i. Gray area- from the time you incorporate until the time you issue stock- who is responsible?

f. No capitalization here “ Capital is inadequate when it is tri-fling compared to the business to be done and the loss”

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i. `In CA state law inadequate capitalization alone is not enough to pierce the veil (Arnold v. Browne (240)), but 9th circuit Federal Court has held that under capital-ization is enough under its interpretation of CA law

ii. In NY, under capitalization is NOT enough, but an im-portant fact.

g. Piercing the co veil gets to the assets of shareholders, but here we have NO shareholders b/c in gray area, so Court looks for a nexus between individuals and the corp. Who was actively in-volved in the co during this gray area? Notion of an equitable owner, not a true stockowner b/c no stock issued, but someone who has a strong nexus to the co. Cavaney is a deep pocket, held director position etc (mere accommodation to clients).

h. Court holds that it doesn’t matter what Cavaney’s intent was b/c CANNOT separate real directors and real officers from ac-commodation directors and accommodation officers. Also, ac-commodation has lasted for 8 months, long time to merely help clients.

i. Lawyer should try to say no to clients and if not indem-nification.

i. P’s don’t end up winning the case b/c seeking to enforce a judgment against Cavaney, but he wasn’t a party in the original lawsuit, and so he couldn’t adequately defend himself.

xiii. Limited liability is not the same thing as risk free investing, b/c your in-vestment is exposed, but if the co goes under all you will lose is that initial in-vestment.

xiv. Shareholders do not have a legal responsibility to invest more money in the co after it runs smoothly for a few years and then starts to experience problems.

1. No need to put money into a failing business2. The capitalization requirement incurs at the inception of the co, BUT

not later3. This is a business decision, so NO duty.

Equitable Subordination1. deep rock doctrine2. the claims of creditors/stockholders should be treated as equity or stock investments3. Benjamin v. Diamond Case

a. 3 conditions for ES1. claimant (owner/shareholder/creditor) must engage in some type of inequitable conduct. He has the burden of proof2. misconduct in question must result in injury to creditors of corp. or result in un-fair benefit to the claimant3. ES must not be inconsistent with the provisions of the Bankruptcy Code.

4. Costello v. Fazioa. 3 partners converted partnership to corp. b. court held that the IOUs were dressed up as a creditor claim and the court looks at two test of ES

1. Deep Rock Doctrine- whether within bonds of reason of fairness, was there a plan where stockholder get x and creditor get Z

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2. Pepper v. Linten Test- when claim is against fiduciary (in this case yes, stock-holders), could a third party ask for the same deal? Here NO****fraud is not essential.

c. partners F and A were guilty of ES and trying to cut in line in the food chain…

Corporate Structure1. Corporate Governance- Directors are agents of the stockholders and are charged with rep-

resenting their interests. Directors, in turn, often delegate the day to day managerial responsi-bilities to the corporation’s senior officers. This is especially true when the corporation in question is publicly traded

2. part of the power of stockholders lies in their ability to elect directors. Stockholders typi-cally elect directors at the annual meeting of stockholders. Each stockholder’s voting power is directly tied to the amount of her capital contribution, as votes are allocated on a per share basis.

3. Distribution of Corporate Powers (Between shareholders, directors and officers)a. Power is statutorily based:

i. DGCL § 141(a) (550)- The business and affairs of every organization shall be managed by or under supervision by the board of directors (unless otherwise directed by this section)

ii. NYBCL § 701 (1160)- Subject to any provision in the certificate of incorpora-tion, the business of a corporation shall be managed under the direction of its board of directors, each of whom shall be at least eighteen years old. The cer-tificate of incorporation or the by-laws may prescribe other qualifications for directors. (Also must be at least 18 years old to be a sole incorporator).

b. ALI Principles of Corporate Governance i. § 3.01 (1308)- The management of a business of a publicly held corporation

should be conducted by or under the supervision of the senior executives. 1. Alters the formulation of DE and NY b/c it is trying to reflect the real-

ity of the situation. Members of the board are not there every day to run the business, so have more of a supervisory role (Board could manage if it wanted to)

ii. § 3.02 (1308)- Board has the power to manage, but its not expected to. 1. In instances where there are scandals the board will often step in and

manage. c. Case law is more in tune with the ALI principles of corporate governance and not the

statutes. So, in some ways undermine the statutory provisions at least when it comes to publicly traded co’s.

d. Executives who do in fact manage the business are the CEO, CFO, President, Vice-President etc.

e. Powers that are left to the shareholders (What they can typically vote on)i. Election and removal of directors, BUT they DON’T vote on vacated seat.ii. Amending the by laws (power can be shared with directors if charter provides

so)iii. Fundamental corporate transactions

1. Mergers2. Consolidation (merger involving 3+ companies)

iv. Sale of all or substantially all of co. assets1. DE looks at the % of income that the assets produce and the % of as-

sets being sold

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2. Cases with certain %v. Corporate dissolution (since they are owners they should vote on termination) vi. Amendments to the certificate of incorporation

1. Once shares have been issued need to get shareholder approval to in-crease the number of shares that can be listed

2. Once additional shares have been authorized it is up to the board to de-cide to list or not.

f. Removal of existing directors from the board- Comes into play whenever doing M & A work, particularly hostile takeovers. Hostile co will try to oust the board of direc-tors b/c don’t want to deal. How to get rid of directors in the middle of things:

i. In NY, shareholders can remove directors for cause (but what constitutes cause? Conviction of a felony is usually a cause). See NYBCL § 706 (1162)- Removal of Directors

1. Directors can also be removed for NO cause, if a provision that allows shareholders to do so exists in the certificate of incorporation or by-laws. NYBCL § 706(b).

a. Makes co. harder takeover target.ii. In DE, any director or the entire board of directors may be removed with or

with out cause, by the holders of a majority of the shares then entitled to vote at an election of directors UNLESS charter provides otherwise. See DGCL § 141(k) (553)-

1. If co has cumulative voting (shareholders can put all votes on 1 per-son) if less than the entire board is to be removed, no director may be removed w/out cause, if the votes cast against removal would be suffi-cient to elect him to the board. DGCL § 141(k)(ii)

g. Charlestown Boot and Shoe Co v. Dunsmore (1880)i. Shareholders allege Dunsmore, director’s negligence, lost co several thou-

sands of dollars in bad debt by not insuring the property but court found the director not to be negligent.

ii. Shareholder have no power over the management of the corp. and cannot or-der directors to take particular actions in managing the business of the corp., They may remove the directors though.

h. Schnell v. Chris-Craft Industries, Inc. (169)- P sought to enjoin management from moving up the date of the shareholder meeting. Management wanted to move up the meeting date so shareholders wouldn’t have enough time to wage a hostile proxy fight so they could elect their own choices for board of directors. Earlier meeting would give shareholders less time to get their act together and make it more likely that management won’t lose their jobs. Management amended the by laws to move the meeting up by 1 month

i. Amending the bylaws was proper under DGCL § 109 (so long as power is in charter), so what directors did was statutorily legal!

ii. However, this action is forbidden by equity! (Just because something is legal, DOESN’T make it equitable).

iii. This wasn’t a legally permissible reason to bump up the meeting date b/c di-rectors owe a fiduciary duty to the shareholders and have to look out for the needs of the shareholders and put their needs in front of their own.

i. Blasius Industries, Inc. v. Atlas Corp. (171) (created the Blasius standard of con-duct for directors)- Blasius was Atlas’ biggest shareholder and was very unhappy with the current management. Blasius starts to accumulate shares of Atlas and once

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it acquired more than 5% of Atlas shares it was required under Securities Law to file a schedule 13-D with the SEC and state its intentions. Stated that it wants to encour-age Atlas management to have a restructuring or other type of strategic transaction to enhance shareholder value.

i. Purpose of the disclosure schedule that must be filed according to S & E Act of 1934 is to alert the mkt place of what your intentions are (trying to take over co or investment purposes?) Traditionally in a takeover the person buy-ing the co pays a premium price for the shares b/c control of co is valuable (control premium). By alerting the mkt place it tells the shareholders to keep their shares b/c maybe they will get a premium price for shares.

1. 10 day grace period to file the 13D gives 10 more days to keep buying shares w/out the control premium

ii. Restructuring can enhance value to the shareholder by selling of businesses that are dragging down performance. Involves a realignment of the right side of the co’s balance sheet (liabilities and owners equity) that allow rejuggling of debt to equity mix in a way that enhances shareholder value.

iii. Blasius proposes a leveraged recapitalization (restructuring- realigning dif-ferent assets on the balance sheet)- Suggesting that Atlas borrow significantly against its assets. Huge amount of debt on the right side of the balance sheet would increase cash and Blasius wants Atlas to pay out the increased cash in the form of special dividends. BUT a leveraged recap makes the financial via-bility of the co more precarious b/c it is a huge amount of additional debt that must be paid back. Not the best thing for a co to be so highly leveraged b/c the best case scenario has to happen at all times for the co to survive.

iv. Blasius Proposal1. Special cash dividend in the amount of 35 million plus proceeds from

the exercise of stock options, plus proceeds from sale of certain busi-nesses.

2. Sell off all the assets that don’t relate to mining operations because they are under performing.

3. Special non-cash dividend (shareholder IOU)- turns the shareholders into creditors as well (highly specialized type of IOU)

a. This may be beneficial to shareholders b/c some of their invest-ment is taken out and if the co doesn’t do well it doesn’t matter to them and if it does do well it is better for them.

v. Atlas Management doesn’t react well to the proposal and weren’t happy that the shareholders were telling them what to do b/c directors manage the busi-ness. So Blasius decides to try to get rid of the directors who don’t like the idea. The problem is that under the co charter doesn’t allow for getting rid of directors mid stream, so instead try to take action through written consent of shareholders. (2 ways to take shareholder action (1) shareholder meeting, or (2) in between meetings in action by written consent)

1. DGCL § 228 (592)- Action can be taken without meeting by the writ-ten consent of that action by the shareholders by the same # of votes that would be required to approve this action at a meeting. Quorum (critical mass of shares) requirement don’t come into play). Have 60 days to get enough other votes in writing for that to be effective.

2. See NYBCL § 615 (1146)

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vi. Blasius’ written consent demands the adoption of a precatory (prayer like, wish or desire, not a demand) recommendation that the board engage in a leveraged recap. The shareholders don’t have the authority to demand that the board engage in a leveraged recap b/c statutes give the directors the authority to manage the business. So if the board won’t act the way you want them to your only option is to get rid of the board of directors.

1. Also demanding an increase of # of board members from 7 to 15 (max # allowed by charter).

2. Also request to appoint 8 new specific people to those additional seats. vii. To defeat Blasius’ consent solicitation the board amends the bylaws to in-

crease the size of the board from 7 to 9 and to appoint two people who are fa-vorable to them making it impossible for Blasius to control the board through the consent solicitation.

viii. Blasius alleges that the Atlas board actions constituted a breach of their fiduciary duty and care and the directors actions were designed to entrench the directors in their positions. (3 Rules)

1. The directors defend themselves by saying their actions were taken in good faith. Also the 1. business judgment rule “mere rationality” (le-gal presumption in favor of directions that so long as they act without a conflict of interest they are presumed to have acted in good faith, due care, and in the shareholders best interest) so presumed to have satis-fied their fiduciary duties and up to shareholder to prove otherwise.

a. Mere rationality rule- shareholder can challenge BJR by show-ing that there was no rational bus. Purpose for the board to do what they did.

2. Directors believed that the Blasius proposal if fulfilled would be a huge detriment to the co so they were taking action against a hostile threat (Unocal defense).

a. 2. Unocal standard (defensive measure standard)- the board can take defensive action even against shareholders if there is a real threat or perceived threat so long as the de-fense is reasonable or proportionate to the threat posed.

b. While the board is normally afforded the presumptive BJR, it is not the case when the decision involves the implementation of takeover defenses. The board must first satisfy 2 burdens be-fore apply BJR

i. Demonstrate reasonable grounds for believing that a danger to corporate policy and

ii. Board must demonstrate that the defensive response was responsible in relation (proportionality test)

ix. Court throws out the Unocal standard, b/c not a defensive strategy case, and instead says that this case is whether the board can act for the principle pur-pose of preventing the election of a new majority of directors. This issue de-serves even closer scrutiny than Unocal (requires strict scrutiny). Also, the business judgment rule doesn’t apply b/c this DOESN’T deal with the power of the board over the co’s assets and what they want to. This is a case dealing with the allocation between the directors and the shareholders of corporate power (power struggle).

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x. In order to protect the shareholders right to vote the court adopts the 3. com-pelling justification standard/ blasius rule.- Board CANNOT take unilat-eral action the primary purpose of which is to interfere or to impede the shareholders voting franchise unless they have a compelling reason to do so (no case in which the board has satisfied this burden).

1. When the board takes action w/out a compelling justification there are breaches of two fiduciary duties of the board – (1) duty of care and (2) duty of loyalty (put the needs of shareholders above yours).

xi. Blasius standard is a pro shareholder test, but the tricky part is getting the DE court to use it, very often when Blasius appears to be implicated, the DE Court will go for the Unocal test, Revlon test, or business judgment rule.

j. MM Companies v. Liquid Audioi. MM owns 7% of liquid Audio and sought to gain control by purchasing it for

$3 per share. Audio rejected and thus MM intended to propose amendment to bylaws at annual meeting to expand board to 9 from 5 (staggered or classified board) Tough for hostile takeovers in single meeting.. P filed a proxy state-ment with SEC at its intention to expand board. D first expanded board from 5 to 7 and thus after P established that primary purpose for board action was to impede or interfere with the effectiveness of shareholders’ vote, the burden shifts to the board to prove a compelling justification for the board action.

ii. D, board failed to meet the threshold burden of the Unocal and Blasius Stan-dard. Rule of thumb- if have burden prob. Will lose.

1. Board must first demonstrate compelling justification. If one of the primary purpose is to interfere with shareholder purpose to vote, must satisfy Blasius standard and then Unocal Standard. If cant come up with compelling interest don’t go to Unocal, game over (which was this case)> If motive is not to prevent shareholders from getting seats then do it to protect co then go to second tier, Unocal standard.

k. Stroud v. Grace (181) – (case that people point to say that DE Sct has embraced the Blasius standard given by Chancery Court). Privately held co. (Milliken family). After a member of the family dies 17% of stock passes to the Stroud family. Since its such a large amount of stock, they could potentially nominate someone members to the board and the Milliken family didn’t want this. So wanted to amend the by laws so that there are certain criteria that must be met to become a director (co’s often do this). Problem here is that these director qualifications are being inserted at the same time that the stock was transferred to Stroud family, so looks like it is designed to pre-vent Stroud family from nominating their own candidate. Amendments contained a provision that said that a candidate can be disqualified at any time for not meeting qualifications.

i. Court is concerned less here than in Blasius mainly b/c this isn’t a unilateral action taken by the board, yes the board approved the action, but then they sought shareholder approval to ratify these amendments and 78% of share-holders approved it.

ii. Shareholder ratification after FULL DISCLOSURE sterilizes even void-able actions by the board, burden is shifted to Stroud family to prove that these actions were unfair. (Often will see arguments about the quality of dis-closure).

iii. If the people who are adversely affected by amendment approve it and they are given full and fair disclosure, then court will keep it approved.

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l. Williams v. Geier (SCM 84) (DE Sct 1996)- Dispute occurred during 1985, during the height of a hostile takeover boom. One of the D’s is a publicly head co Milicron, controlling shareholder is the Geier family. Milicron had 10 board of directors (3 in-siders own 12.6%, 7 outsiders own 1%). Milcron developed a recapitalization plan that greatly offended the P Tenure voting plan similar to Smuckers co. plan.

i. Under the tender voting plan, Milcron’s certificate of incorporation would be amended so that all stocks will be deemed to have 10 votes per share rather than just one. If sold your shares of common stock the transferee will only be deemed to have 1 vote per share and only after that transferee has held on to the shares for 3 consecutive years will the shares revert back to 10 votes per share. If Milicron issued new shares, new buyers of shares would have to wait 3 years to get 10 votes.

ii. Recap plan has a number of different objectives. 1. Takeover defense- if a corporate raider purchased the share he couldn’t

get control b/c would have to acquire many more shares than 50% so long as other shares retained their 10 vote per share power. Raiders will have to stick around for 3 years to get super voting power and raiders are usually short term profit artists who have no interest in sticking around for 3 years.

2. Creates incentive for people to be long term stock holders and turns at-tention to the long term.

3. Increase power of majority power, Geier family is less likely to trade4. deter hostile party to tender offers

a. tender offers are always made at a price higher at what stock is trading at and thus incentive to buy co always above what the stock is trading at.

iii. Tender Offers must comply with Securities Exchange Act and Williams Act- need full and adequate disclosure.

iv. Geier family owns over 50% of the co pre-voting plan, so for raider it means that the family MUST sell, for him to gain control. Raider must negotiate with family. So hostile successful could NOT be successful already, what is the purpose of the tenure voting plan?

1. Stealth Objective- Geier family wants to sell some stock, BUT retain control over the co that has been in their family for years. (also com-mon when family bus. Goes public)

a. P. 88 Footnote 10- if 30% of shares in the minority shares, then the Geier family could sell 30% of their shares and still retain over 50% voting power.

b. So, objective is to protect the Geier family, NOT to protect the company, encourage people to be long term shareholders, or discourage hostile takeovers.

v. Basic principles of equity tells us that the majority should be able to ACT like the majority

vi. To implant a tenure voting plan need to amend the certificate of incorporation 1. DGCL § 242(b)(1) (598)- Board must consider the issues, vote to ap-

prove it and advise shareholders that it is in their best interest. Share-holders must vote to approve. Once approved by shareholders the amendment has to be filed with the sec of state.

vii. Milicron follows steps perfectly (Issues- shareholder vote)

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1. Information is given to shareholders regarding the upcoming vote via the mail.

a. Publicly traded co’s must adhere to Federal Proxy Rules. i. Don’t have to be at the meeting to vote, you can let

someone vote for you, but must get a proxy statement that complies with federal rules of disclosure.

2. Milicron gives 2 pieces of info to shareholders dealing with recap plan approval

a. It was going to pass NO matter what b/c the Geier family owns majority

b. If don’t get 66 2/3% approval, then will be delisted from NYSE. Since Geier family doesn’t have that much, the other shareholders need to approve.

viii. Information given to shareholders is coercive b/c people don’t want to be delisted from NYSE, b/c would lose liquidity, so will vote yes.

ix. Lower court applied the Unocal standard, but Sct doesn’t agree with the appli-cation of this standard b/c that only applies to unilateral board action, here we have an action that REQUIRES shareholder approval.(b/c amendment). P’s argue that Blasius requirement of compelling justification applies, but the court rejects this argument. So P’s focus on full and fair disclosure, claiming that the board did not give enough info. P’s attack the vote itself, if successful then essentially there is no vote, and then we can get back to Unocal or Bla-sius.

x. DE Sct applies the business judgment rule (bad for P’s b/c 9/10 times that it is applied and shareholders challenge, they will lose).

xi. Business judgment rule is a rebuttable presumption that directors fulfilled their fiduciary duties when they took a particular action- directors acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interest of the co.

1. To rebut presumption can sow that there was a conflict of interest, so maybe can show lack of due care.

2. No evidence here to overcome presumption via due care failure- Board hired 3 legal advisors to explain and compare the plan, and met 3 times to discuss, voted in favor at 3 meetings.

3. When bjr applies can’t attack decision based on it being bad w/20/20 hindsight-so long as there is a rational business purpose, even if there were better ways to achieve it, you cannot question

xii. Court held that the board acted in good faith, tipped its hat to outside direc-tors.

xiii. Controlling shareholders also have fiduciary duties running to minority shareholders, they CANNOT use their power or dominance over co to garner a benefit that is NOT available to anyone else. (ex. Cant give dividend just for themselves). Geier and tenure voting plan didn’t breach their fiduciary duty to minority shareholders because the minority gets the same benefit they did- 10 votes per share.

xiv. It is irrelevant that less than 50% of minority voted to approve the plan b/c no requirement under DGCL that you need a majority of the minority to ap-prove the plan.

xv. Del is promanagement over stockholder and pro stockholder over creditor.

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m. Inside v. Outside directorsi. Inside directors are employees or officers of the coii. Outside advisors (lawyers or accountants) insiders or outsiders? Question is

whether they are independent or aligned with the co. Can make the argument that these people are inside directors b/c would like to keep that account or business so they are not likely to rock the boat and most likely wouldn’t rock the boat. May want to look at the size of the relationship (major client or not?), Typically considered inside. Important because DE courts give high deference to what independent directors do b/c feel they have no reason not to trust independent directors who thoroughly thought of problem.

iii. Outside directors have no financial nexus to the co other than sitting on the board.

n. Tender offers- offer that a party makes to all the public shareholders of a certain com-pany at a stated price (price usually higher than mkt price b/c of control premium).

i. Need to comply with federal securities law (Williams Act- SE act of 1934) Purpose behind fed regulation started in the 60’s because people were coming out with offers called Saturday night specials that gave co’s 3 days to accept offers, making co’s feel coerced into agreeing. So Fed gov gave framework- every offer has to be open for 20 days, mandatory disclosure, so people know whether to tender or not.

ii. Tender offer is a reverse IPO b/c takes shares from public and makes them private again.

iii. Hostile tender offer- Tender offer made to all shareholders without the bless-ing of the target co’s management. Management not consulted at all and usu-ally fired after the deal is done.

4. Authority in General a. Directors and Officers as agentsb. 3 parties in an agency law issue:

i. Agent1. General agents- authorized to engage in a series of actions over a wide

spectrum that involves a continuity of service (ex. Corporate officer who works daily for the company in actions over a wide spectrum for benefit of company).

2. Special Agent- authorized typically to conduct a single transaction or a series of related transactions that do NOT involve a continuity of ser-vice.

ii. Principal (3 types)1. Disclosed principle- 3rd party transacting business with agent is

AWARE that there IS a principal and know the identity of that princi-pal.

2. Partially disclosed principle- 3rd party knows that the agent is acting on behalf of principal BUT does not know the identity of the principle. (ex. World Disney and Disney World Story)

3. Undisclosed Principal- 3rd party does NOT know that the agent is act-ing on behalf of a principal, 3rd party believes that agent is acting for him/herself.

iii. 3rd Partyc. 5 types of Authority (agent can only act for a principle within the authority that was

given to her)- Principle should be bound by agents actions if she gave authority

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i. Actual authority1. Focus is on the agent- what would a person in the agent shoes believe

that the principal has told him to do. 2. Can be either express or implied3. Incidental authority (ex. Tell someone to sell your car, give them au-

thority to advertise b/c need to advertise to achieve the goal)4. If an agent has actual authority, the principal is bound even if the third

person did not know that the agent had actual authority. ii. Apparent Authority

1. Focus is on the 3rd party- entails if someone in the shoes of the 3rd party would think that the agent had the authority from principal to do cer-tain act.

2. Example- Power of position (reasonable for 3rd party to assume that the co treasurer has the power to sign a check on behalf of the co).

3. Often goes hand in hand with actual authority, BUT sometimes don’t (ex. Maybe CEO says he is the only one who can sign checks- diver-gence from what 3rd party might think) VS. a treasurer who signs and reasonable for 3rd party to think so thus has apparent authority.

4. HYPO: P owns a granary and employs A to manage it. A’s employ-ment agreement with P states that A’s authority to purchase grain is limited too transactions that do not exceed 5000; larger purchases re-quire P’s express approval. This limit is unusual in the granary busi-ness. P directs A to tell T, a seller of grain, that A’s unilaterial author-ity to purchase is unlimited because P believes this will induce T to give priority to orders placed by A. A represents to T that A’s author-ity to purchase is unlimited and enters into a k on P’s behalf with T to buy 10,000 of grain. P is bound by the contract with T. A has actual authority to make the representation to T. A has apparent authority to enter into the contract with T because T reasonably believes A has au-thority to bind P to a contract to buy the grain.

iii. Agency by estoppel (a little like promissory estoppel)1. Focus is on the 3rd party and principal 2. 3rd party deals with someone who isn’t an agent (purported agent) and

the principal has done some conduct to lead the 3rd party to reasonably believe that this person is the agent and the 3rd party changes his posi-tion relying on the purported agent and the principal hasn’t taken any action to remedy this belief.

iv. Inherent authority1. Focus in on the principle- would a person in the principles shoes in

fact think that the agent would take these actions despite the fact that it’s in violation of instruction and the principle was in fact aware of this possibility, so reasonable chance this might happen.

2. Principle must bear the risk of the agent harms the 3rd party. (ex. Neg-ligent or overzealous agent- Dominoes Pizza- less than 30 minutes promise- foreseeable that drivers would drive crazy, even if not told to do so). Ex. when bind the principal when agent had no actual or appar-ent authority.

v. Ratification

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1. After the fact approval of what the agent has done- principle affirms the agents conduct or engaging in conduct that is justifiable only if he had such intention (can be implicit or explicit)

2. Remember in promoter context can’t say that the co has ratified what the promoter has done b/c no co at the time, so have to say that the co adopted what the promoter has done.

d. Liability i. Principle to a 3rd party- If an agent engages in action with a 3rd party and had

any of the 5 types of authority, the principle is bound to the third party.ii. 3rd party to principle (after agent forms some k with him)- If the principle is

bound to the 3rd party under 1 of 5 types of authority then the 3rd party is bound to principle, BUT 1 EXCEPTION

1. Exception- undisclosed principle- 3rd party doesn’t have to complete the transaction with the principle if the agent or principle knew that the 3rd party wouldn’t complete the transaction if he knew who the princi-ple actually was. (makes sense b/c reflects the consensual nature of K- shouldn’t be forced to deal with people you don’ t want to deal with).

2. 3rd party is able to get out when its an undisclosed principle, but not a partially disclosed principle b/c in partially disclosed principle case the 3rd party is put on notice and could have taken the time o find out who the principle was and if agent refuses to disclose can refuse to go through with the transaction.

iii. Agent to a 3rd party- IF the agent has one of 5 types of authority then she is not bound to a 3rd party unless the principle was undisclosed or partially disclosed. When the agent DOESN”T have 1 of the 5 types of authority then the agent has just entered into a transaction on their own account.

iv. Agent to Principle (agent gets the principle into trouble when dealing with 3rd party)

1. If the agent has actual authority then she is not liable to the principle at all.

2. If the agent has apparent authority then she is liable to the principle for resulting damage (if based on principles actions, why should agent pay? Maybe b/c the agent should have known)

3. Agents liability stemming from inherent authority is unsettled. 4. If a co ratifies after the fact, the agent should no longer be responsible

to the co because the co has ratified as its own something that the agent has done.

5. Restatement 2nd Agency- if the agent has breached a duty to the prin-ciple he is liable.

6. If the agent acted within her actual authority, the principle has to in-demnify for any damages the agent pays (ex. Expenses incurred by agent for any costs incurred in defending against 3rd parties).

e. Restatement 2nd of Agency § 387 - § 390 (30-33)- Focus on the duty of the agent to act solely for the benefit of the agent. Issue is one of trust. (ex. Director must put the needs of shareholders above himself)

5. Action by Directors (Agents of shareholders, should be working on shareholders behalf)a. Formal notice is not required for a regular board meeting. b. Two models of corporate governance

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i. Traditional- the board of directors manages the business and affairs of the coii. Modern- Directors don’t manage, but just act as watchdogs and overlook.

1. Modern world has led to the modern model- constraints on the modern directors time, info,

a. Most boards of publicly traded co’s meet 6-12 times for about 2 hours, so approx 60 hours a year. Senior officers who work at the co are there every day of the work week so have more time to manage.

b. Generally the board will approve things based on info the offi-cer send them, which they often don’t get in timely manner, so also constraints on info and ability to look at it. Directors don’t ask for the info in timely manner b/c:

i. some directors don’t want to be bogged down by extra work

ii. May be subject to more liability the more they knowiii. Bad manners- certain etiquette that comes along with

being a directoriv. Board of directors usually consists of insiders, luminar-

ies, friends of CEO’s, close investment bankers etc, so unless there is a major shareholder, no one is likely to rock the boat. Most looking to appease the CEO. CEO doesn’t want all outsiders, b/c often feels like this is own co. Also another problem is that independent di-rectors will change to be insiders over time.

1. DGCL § 141(e) (552) and NYBCL § 717 (a)- tells us that directors can rely on reports pre-pared by officers and also opinions and reports by outside advisors.

a. UK has professional directors (outsiders) who are independent with an office in the co and is there daily

b. Must rely in good faith to those who are competent in giving the advice.

c. Staggered or Classified Board- rolling election process- ability to take your board of directors and break them down into different classes (typically 3). Each class comes up for re-election in different successive years, SO typically only 1 class of directors comes up for re-election in a given year.

i. Ex. Assume have 9 directors in 3 classes, year 1- directors 1,2,3, next year di-rectors 4,5,6 and so on

ii. Politically correct reason for this is continuity of knowledge and info b/c won’t have 9 new directors in one year, maybe 3 new directors, but 6 old in any given year. BUT real reason is that it hinders hostile takeovers b/c pre-vents the hostile part from replacing a majority of shareholders in 1 year, will have to wait for the next annual meeting to try to replace the next 3 and so on if more, if achieve this will be successful.

1. Necessary for hostile party to replace the board in order to get rid of poison pill (adopted and redeemed unilaterally by the board). Can ei-ther replace the board or raise your offer price to a point they can’t refuse to get rid of the poison pill.

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iii. Poison pill and staggered board makes the co impervious to take overd. Directors can generally take action in 1 of 2 ways

i. Action by unanimous written consent (series of board resolutions prepared in advance by a law firm)- DGCL § 141(f) (553) and NYBCL § 708(b) (1163)- allows directors to take action out of meeting of directors through unanimous written consent. Saves time and expense of a meeting, BUT MUST be unani-mous. If there are vacancies on the board, can still take action by written con-sent, but all existing directors must sign.

ii. Action at a board meeting- can either have a regular meeting or can call a spe-cial meeting.

1. To take action at a board meeting need 2 things: a. Quorum of directors- before the board can take binding ac-

tion on the co needs to have a critical mass of directors show-ing up at the meeting.

i. Typical quorum is a majority of the entire authorized board, not merely those then in the office. (Ex. 9 direc-tors, need 5 for quorum, even if 2 vacancies)

ii. DGCL 141 (b) (550) & NYBCL § 707- Certificate of incorporation can change the quorum requirement to be greater (super majority) or less than the majority, but can’t have less than 1/3.

b. Appropriate vote to get the matter passed- typical vote needed is majority vote of directors present at the meeting. (DGCL § 141(b) (553) and NYBCL § 708(d) (1164)

i. Ex. 9 directors and 5 people show up (quorum), 3 out of 5 need to vote yes to pass something

ii. Generally speaking you can raise the voteiii. Both NY and DE don’t let you lower it to less than a

majority.1. Can have a situation where 2 people take action

that binds the whole board. Ex. If your quorum is 1/3 of the board, w/9 people on the board, and 3 people show up to meeting that is a quorum and so 2 is a majority.

6. Leveraged Recapitalizationa. Goal is to put substantial amount of cash into the hands of a co. common stockholders

by leveraging the co assets. To achieve this goal, the co. will borrow large amounts of debt and then distribute the proceeds to its stockholders in the form of an extraordi-nary dividend. A stockholder vote is not required to effect a leveraged recap.

b. Stockholders receive a large amount of cash, but their shares of stock become less valuable. They now own shares in a co. weighted down with debt

7. Action by Shareholdersa. Election of board of directors (plurality vote needed to elect)

i. Ex.10 nominees and 5 open spots, assume that every nominee gets a few votes, the top5 vote getters will get the job.

1. DGCL § 216(iii) (583)- unless the certificate of incorporation or by-laws state otherwise the board will be nominated by a plurality of shares made by shareholders by proxy or at meeting.

a. If charter says can be less than majority then ok

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b. A person who doesn’t vote but there for quorum is considered a No for the vote.

2. NYBCL § 614(a) (1146)- unless the certificate of incorporation states otherwise the board will be nominated by a plurality of shares made by shareholders by proxy or at meeting.

a. An absent vote don’t count as a vote at all. Hypo: 500 shares rep. at meeting and assume satisfies quorum, Assume 200 vote yes, 175 vote no and the other 125 are abstentions

- In Del the matter is not approved since 175+ 125 (count abstentions as no)= 300 which is more than 200yes.

- In NY- it would pass since 200 vs. 175 and therefore yes wins. o Need majority of yes + no noteso Ex. have 200 of 375 which is thus a majority

b. Manner in shareholders vote for directorsi. Traditional or straight method (applies virtually to all co’s)

1. Assume 5 open spots and 7 candidates (top 5 vote-getters will be elected), assume we have 300 shares- get to cast 300 votes for up to 5 people, don’t split up 300 among 5!!! If you only like 3 candidates, then you can give 300 to only 3 and abstain for other 2.

2. if own more than 50% then have power to elect all directors. ii. Cumulative voting (uncommon) (ONLY APPLIES FOR ELECTION OF DI-

RECTORS)1. allows a shareholder to cast a number of votes equal to the following

formula Shareholder cumulative votes = # of shares a shareholder holds * # of votes per share* # of open slots.

a. Can cast these votes all in favor of just 1 nominee or spread them out evenly or unevenly for other nominees.

b. Ex. You have 100 shares and 2 nominees running for board. # of cumulative votes= 100*1(# of votes per share)* 10(number of slots open) = 1000 votes. If you feel very strongly that 1 person will be elected you can put all 1000 of your votes on that one person (contrast that with 100 that you could ordinar-ily put on that person if you had straight voting).

2. Purpose behind cumulative voting is that it is designed to help ensure that minority shareholders will have at least 1 representative on the board of directors. Minority shareholders by cumulating their votes and putting it all on 1 person can help defeat a majority nominee.

3. DGCL § 214 (583) & NYBCL § 618 (STAT II-68)- Both say that shareholders can accumulate their shares only IF the certificate of in-corporation says, SO better get it in before there is a controlling shareholder b/c after the fact no majority shareholder will vote to amend the charter to have this. Majority shareholder cant change pro-vision alone!

4. As a shareholder of a co that has cumulative voting you might want to find out if you own enough shares to choose a director of your choos-ing:

a. N= (X * (D + 1)/S i. X= # of shares you own

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ii. D= number of directors to be elected (seats open)iii. S= total number of outstanding shares that can be

elected (not the cumulative votes)b. Formula assumes 1 vote per share. Have to assume worst case

scenario that everyone votes, but some people don’t vote so it makes votes more important.

c. Must round down whatever number you get. IF don’t have enough votes can get together with 1 or 2 minority sharehold-ers and pool your votes.

d. Hypo- 5 person board and all up for reelection, you own 100 out of 1000 stocks outstanding

i. N= .6 which means elect zero people. 5. If we were to buy shares in this co that has X shares outstanding (as-

sume 1000), what would be the fewest shares we could buy and still elect the director of our choosing? Formula must equal 1.0. Stick with the old formula but work it in reverse.(D=5, S=1000, N=1)

a. N = X (D +1)/Sb. 1= X (5+1)/1000 c. X=166.67 have to round up – Need 167 votes to elect exactly

1 director6. Without cumulative voting majority shareholder gets to elect ALL

board members. Majority shareholder of a co being formed wont want to put cumulative voting in charter b/c doesn’t work in his favor. Typ-ically see cumulative voting when a group of people get together and form a co, but wouldn’t even raise the point with 1 person forming the co.

c. Shareholder Meetingi. Need a quorum to take legally binding action, if not vote will be ineffective

1. DGCL § 216 (1) (583)- Certificate of incorporation or bylaws can specify a quorum, but it can’t be less than 1/3, default provision- ma-jority of shares entitled to vote at that meeting.

2. NYBCL § 608 (1143)- Certificate of incorporation or bylaws may pro-vide for a lesser quorum (than majority of shares), but not less than 1/3 of votes and ONLY the certificate of incorporation can provide for a greater quorum.

a. In NY, once a quorum is reached, it is not broken by subse-quent withdrawal. This motivates people not to leave, b/c if they do it will be up to others decisions. For vote will need a majority of people present, not majority of the quorum. Proxy card filled out in the beginning won’t be valid if you leave.

ii. Proxy card- nominate someone to be your proxy (vote the way you want them to). Proxy’s legitimately filled out and sent in counts as a quorum. (most shareholders vote by proxy)

iii. Quorum is measured at the start of the meeting. iv. Vote needed to approve an action (ex. merger or charter amendment)

1. DGCL § 216 (2) (583)- Unless the DGCL species a contrary threshold or the bylaws or certificate of incorporation states otherwise a majority of shares present at the meeting or by proxy is needed. (NOT plurality of shares, that is only for election of directors!!!)

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a. Minimum number of shares needed to approve something in worst case scenario- 26% of shares voting in favor of some-thing can bind the whole co if 51% of shares are represented and of those 51% say yes.

b. Abstentions count as NO votes 2. NYBCL § 614 (b) (1146)- NYBCL, certificate of incorporation or by-

laws can provide for a different votes, but if it doesn’t then the default requirement is a majority of votes cast in action.

a. Abstentions DO NOT count as votes in NY- huge distinction between NY and DE. Count for quorum purposes but don’t count in determining whether a specific action is approved. So measure majority approval by comparing majority yes votes with no votes- so long as 1 more yes vote there is shareholder approval. In DE NEED a majority vote in favor of action, (ex. out of 500 need 251 yes). If have 200 yes votes and 175 no votes, essentially have 300 no votes, but in NY action would be passed b/c abstentions don’t count.

v. Proxy Voting – ability to vote shares even though cant attend meeting in per-son

1. NYBCL § 609 (a) (1144)- Shareholders can authorize another person to vote their shares

a. Typically the designated person to appoint is one of the officers of the co (preprinted appointee). Appointee gets to vote as you see fit, but there are circumstances where you essentially give someone carte blanche to vote how they see fit.

b. When you give someone your proxy it generally lasts for that meeting.

2. NYBCL § 609(b) (1144)- proxy lasts as long as the proxy specifies, but in any event no more than 11 months (basically will last for this meeting, but not the next).

3. If you give your proxy to someone, but end up coming to vote, your vote controls, not the proxy (proxy will be discarded, even if you don’t let them know)

4. NYBCL § 609 (f-h) (1144)- Proxy’s are normally revocable at the pleasure of the shareholders executing them. Can also change your vote at your pleasure. However, can also make a proxy irrevocable, so you can’t change your mind if the following things occur:

a. On its face, the proxy says its irrevocable b. Has to be given to one of the following entities

i. Pledgee- ex. if you pledge your shares to a bank and the bank will require you to give it an irrevocable proxy, so it can vote as it sees fit for the duration of the irrevoca-ble proxy.

ii. Someone who has purchased or has yet to purchase your shares- designed to get at the record date problem (co’s have to choose a date and time where everyone who owns shares after this time will only be able to vote at next meeting, not this 1).

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iii. Someone designated under a valid shareholders agree-ment- essentially an agreement amongst shareholders that may decide a number of thing about their relation-ship with one another. (other shareholders may agree to vote as this other person, so give irrevocable proxy to that person to ensure that it happens)

5. DGCL § 212(B) (580)- The duration of the proxy last as long as 3 years unless a longer time period is specified in the proxy (shows DE’s management friendliness, not seen in NY)

a. DGCL 212(e) (581)- Irrevocable proxy exception- Proxy can be irrevocable if it says its irrevocable on its face, but it also has to be coupled with an interest. So people who receive the irrevocable proxy must have some interest in either the shares or the co.

6. Vast majority of all shares at public co’s are voted by proxy. This may lead to a problem b/c may be tough to get people’s attention. So many shareholders all around the country w/out large stakes, so don’t really care. Still need quorum, so have trouble taking action.

7. Oral expressions of a proxy do not constitute a proxy, MUST be in writing.

Corporate Fiduciary Duties: The Duty of Care1. Basic Standard

a. Fiduciary duties are essential the same for officers and directorsi. Duty of careii. Duty of good faithiii. Duty of loyalty

b. Concerned about harm coming to the co itself through actions of directors which hurts shareholders and even creditors. (Caused by sloppy decision making by direc-tors, or even inaction)

c. Need a duty of care when it comes to common shareholders b/c they may be ignorant about the co (negligence), while creditors and preferred stockholders go in on a trans-action basis so have a K. No K protection for common shareholders, most transac-tions aren’t even documented, so can’t say you did x and this K says you cant do this, so we are suing you.

d. Francis v. United Jersey Bank (520)- Pritchard & Beard Intermediaries Co was a reinsurance broker (reinsurance is process by which an insurance co will share risk with other insurance co to limit own exposure- through reinsurance brokers find rein-surer who will take risk from a few co’s for premium). P & B was heavily involved with the flow of money, $ that didn’t belong to itself. Family owned co 3/5 directors were Charles Pritchard Senior, Lillian Pritchard, and Charles Jr. Eventually 2 Pritchard bros and Lillian were the only directors left- Charles as president and William as Vice President. When the bros took over they began to engage in un-scrupulous conduct. Took money out of the co for personal use under guise of share-holder loans, but never paid loans back. Also, co-mingled $ held on behalf of insur-ance co’s with P& B’s $, so taking loans from $ that didn’t belong to them.

i. Both re-insurance co’s and insurance co’s were severely hurt b/c bro’s took money. Co went into bankruptcy.

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ii. Trustees of P&B (try to find people that owe co money so can pay back credi-tors) find the mother as a defendant

iii. Directors actions at meetings- Very perfunctory actions- election of officers, adoption of banking resolutions (almost comical), adoption of a retirement plan. Minutes do not reflect anything about the loans or the financial condi-tion of P& B. Upon instruction of Charles Jr. financial statement were not to be given to anyone but himself.

iv. Court condemns Lillian Pritchard as a director- Not active in the business and knew virtually nothing of its corporate affairs; visited the office only on one occasion; unfamiliar with the rudiments of insurance; made no effort to ensure that the co complied with industry standards.

v. Ms. Pritchard’s defenses: Senile defense; after her husband died she became incapacitated, grief stricken, too much alcohol, psychologically overborne by her sons.

1. Court rejects this defense and finds her competent. She didn’t know what her sons were doing only because she made no effort to know what they were doing.

vi. NJ Supreme Court- “Directors are NOT ornaments, they are essential to corporate governance!”

vii. NJ Business Incorporation Act (14(a)(6-14)- Directors must discharge their duties in good faith and with that due care and diligence that…

e. NYBCL § 717(a) (1168)- Duty of Directors- A director shall perform his duties as a director in good faith and with that degree of care that a ordinary prudent person in a like position would use under similar circumstances. (notions of diligence and skill are subsumed within the word care)

f. Revised Model Business Corporation Act- RMBCA § 8.30 – Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation.

g. DGCL- statutory standard doest exist, duty of care in DE is common law based. h. Under NY, NJ and RMBCA, the test for whether a director has fulfilled duty is both

objective and subjective i. Objective component- compare what the director has done with that of an or-

dinary prudent person. ii. Subjective components- Look at an ordinarily prudent person in a like posi-

tion- so must look at the same skill set as director at hand. Also, under similar circumstances- practical import of this is that hindsight has no place in the analysis- the fact that the action proved to be incorrect is irrelevant.

i. Directors have a duty to:i. Have at least a rudimentary understanding of the business ii. Keep informed of developments of the co. iii. General monitoring function (don’t have to be there daily to operate busi-

ness)iv. Directors don’t need to go in and do an audit of financial records, but

have to have familiarity with the financial status of the co which comes from periodically reviewing the financial statements. (If Ms. Pritchard had looked at the financial statements should be tipped off about son’s shareholder loans)

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j. If directors finds something fishy, have duty to investigate, and if directors uncovers some misfeasance must:

i. Object to the conduct (say you MUST stop now)ii. If conduct doesn’t stop, need to seek out legal counsel (in house or outside)

and discuss with them what the appropriate action should be (ex. can sue) iii. Another alternative- Noisy exit- director resigns under protest and sends a de-

tailed letter stating why he or she is resigning, detailing the misfeasance. If the co is publicly traded co it has a disclosure obligation on form 8-K and the co must disclose that a director has resigned due to a disagreement with man-agement and if the director sent in a letter stating why he/she resigned.

k. Even if the directors have been negligent or engaged in misfeasance, they will NOT be held responsible UNLESS THEY CAUSED THE LOSS. (Proximate cause)

i. NJ Court in Francis adopts the substantial factor test- misfeasance or non-fea-sance must have a substantial link to the loss. Court has to think about what caused the loss. In Francis, court had to ask whether Ms. Pritchard’s inaction caused the harm. Court points to 3 problems that led to the loss: (1) commin-gling of funds, (2) Brother’s stealing, (3) Mrs. Pritchard’s dereliction of duty (substantial factor b/c the sons spawned their fraud from the backwater of her neglect)- her failure to supervise allowed them to continue their malfeasance.

ii. There has to be a nexus between the injury caused and the directors actions, must be substantial factor

l. NOT a defense for directors to say that they were induced to become a director by be-ing told they wouldn’t have to do anything, b/c this analogous to ignorance of the law and doesn’t help!

m. In Re Emergency Communications Casei. Director of co. relied on outside advisor in good faith in which the advisor

gave opinions based on his own expertise. However director Mudo had the ex-pertise and thus held to a higher standard then compared to other directors who didn’t know.

ii. Directors must review financial statements, have fundamental standings about the business

n. In re Caremark International Inc. Derivative Litigation (569) (gets to heart of di-rectors duty to monitor)- Healthcare Co. committed multiple violations of the law, es-sentially bribing doctors and had to pay a lot of fines for its conduct. Shareholders sued the directors to recover losses as a result of the litigation. P’s claim, that the di-rectors neglect in their duty to monitor led to the co’s losses, b/c didn’t realize what the co was doing. Weren’t being careful!

i. Court states that the breach of the director in not exercising appropriate atten-tion can be attributed to 2 different sets of facts

1. Typical claim- made ill advised decision that turned out to be disas-trous

2. Unconsidered inaction- the board failed to take action to prevent a loss b/c the board was never aware that there was a loss in the first place.

a. Directors generally talk about the big picture items while the underlings operating the co are the ones that can take actions that cause big losses with no concern for upper level directors, SO directors MUST have in place an info system to ensure that they have a reasonable ability to find out what the un-

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derlings are doing. Info at the grassroots level must flow up-stream.

b. Board MUST make a good faith judgment that its info re-porting system in both concept and design is adequate to upstream info. (standard used by court)

c. To show lack of good faith on the part of the board P’s must look at the system and see how it operates and essentially show a “sustained and systematic” failure to show that an info sys-tem was in place

ii. Court says that the directors would have no problem showing that they had a good faith belief that their info system was adequate, yet still approved the settlement b/c the settlement called for them to tweak the info system to make it more effective.

2. Business Judgment Rulea. Normally courts, especially DE courts, give great deference to board room decisionsb. 2 judicial developments that watered down the duty of care for directors (Aronson v.

Lewis (532))i. Gross negligence is the standard used for director liability in duty of care ii. Business judgment rule is a presumption that in making a business deci-

sion the board acted on an informed basis, in good faith and in the honest belief that the action was in the best interests of the co. Up to the P’s to overcome this presumption- can rebut by showing conflict of interest or gross negligence, waste of assets or disloyal conduct

c. Elements of the business judgment rule (545)i. Need a business decision, includes a decision not to act and a decision to take

action (decision to expand the board is NOT a business decision (Blasius))ii. Decision needs to be made on an informed basis (duty of care concept)- focus

is on the decision making process- did the board hold meetings, read docu-ments, hear people’s opinions?

iii. Decision was made in good faith (carries with it a notions of loyalty)iv. Decision has to honestly be made in the best interests of the co.

d. Smith v. Van Gorkom (549)- Transunion Co had valuable investment tax credits, but couldn’t use them b/c didn’t have taxable income, so rather than waste these credits it wanted to find a way to help a 3rd party to use these credits. Decided to find a 3rd party that had a lot of taxable income so it could acquire transunion and use these tax credits (concept of synergy) To buy all the outstanding shares of TU on the open mkt would cost a lot of money so any co would need to borrow money (lever-aged buy out). Co never figured out how much the shares of the co are worth, only figured out how much debt would be required to buy all the shares. Considered man-agement buy out but vetoed idea b/c it would cause a tremendous conflict of interest and didn’t want to deal with it (Putting their own needs ahead of shareholders, b/c making an offer with inside info- obviously want a good deal for themselves at the ex-pense but might be at expense of principle). Van Gorkom expressed his willingness to sell his 75,000 shares at the right price ($55). Came up with number basically out of no where (Roman’s, CFO, just using # in leveraged buy out hypos; represented a 45% premium over current mkt price, so sounded good) VG decided it was time to sell the co. VG meets with Pritzker, takeover specialist, and makes a detailed pro-posal about buying Transunion for $55 per share and demonstrates that the LBO debt can be paid off w/transunions cash flow within first 5 years. Pritzker agrees to $55

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dollars per share. VG says that they should make sure that $55 is the best price for the co, so until the deal is closed should be allowed to accept other offers. Pritzker isn’t happy about that b/c he doesn’t want his co to serve as the stalking horse for an auction (doesn’t want to put up time and effort into the deal and then lose). So as a compromise they agree that Transunion will give him an option to buy 1 million shares of stock at the current price b/c if he loses the auction he can take the shares and sell them to the highest bidder. Pritzker also demands that transunion act on his merger proposal over the weekend (3 days to decide). VG calls a special meeting (Sept 20) 1 day in advance, but doesn’t tell the board what the meeting was about and doesn’t invite their investment banker, also no proposals were given, b/c not yet drawn up. Senior management reacts negatively to this whole proposal. Romans says that $55 is too low a price, VG rejects this counsel. VG doesn’t tell the board how he arrived at $55 per share, but does tell them there is 90 day period where someone can come in and make another offer if felt that it was under priced, but couldn’t solicit bids. Attorney at meeting stated that a fairness opinion was not re-quired by law before the transaction went through. Traditionally, investment bank will give opinion about price. Attorney also tells them that they might get sued by shareholders if they reject the offer. Romans tells the board that while $55 is not an unfair price, it is at the lower end of a fair price, board agrees. Merger agreement is executed at a social event, VG doesn’t read it just signs it. No director actually reads the agreement. Big release comes out trumpeting the deal. Senior manage-ment of TU revolted, particularly didn’t like restraints on soliciting other offers. Pritzker agrees to amend the merger agreement to keep management happy b/c doesn’t want to lose them (Oct). Amendments approved sight unseen based on VG’s representations, but when read there are variations. Pritzker obtains financing for deal, so satisfies contingency of the deal, also purchases million shares at mkt price. As part of the amendment, transunion can actively seek other offers, but must be done with deal before Feb. 1. Investment bank generates interest from other firms.

i. KKR expresses interest and sends a formal offer to purchase all the assets and assume liabilities for $60 a share. VG reacts poorly to this offer and was es-pecially upset that it contained a financing contingency. No press release was put out about this offer b/c VG thought it might chill other bidders. Ulti-mately KKR withdraws its bid when a key supporter withdraws his support when VG talks to him privately.

ii. GE capital also expressed an interest but it needed more time to make an offer (60-90 days) but VG refuses, ultimately puts in an offer but somehow fades away.

iii. Action is commenced by shareholders claiming that the board failed to reach an informed decision in accepting Pritzkers offer.

iv. In DE, breaches of duty of care are predicated on concepts of gross negligence b/c the business judgment rule is the presumption. Have the directors in-formed themselves prior to making a business decision of all the material info that is reasonably available to them?

v. Lower court says that the TU directors fulfilled their duty of care b/c acted on an informed basis- discussed transaction on 3 diff occasions, so falls within the BJR; P’s have to come up with particularized evidence to show that there is gross negligence.

vi. Directors argues that the court should look at what they knew on and after Sept 20, and reapproved it after learning more, met 3 separate times. Also, cut

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a great deal b/c getting $55 per share (mkt price $38), 48% gain. Also, mkt test period, so if price was too low, others would make a deal. Court should defer to them, b/c have so much experience. Finally they relied on legal coun-sel, and could have been sued if didn’t accept this deal. (Suggests a breach of duty of loyalty, b/c shouldn’t be concerned about being sued personally, putting their own interests ahead of shareholders; also have liability insurance, so not paying out of pocket anyway).

1. Key to all breach of fiduciary duty cases is getting beyond motion to dismiss and into land of discovery. Often, D’s will settle b/c not worth time and effort past the motion to dismiss. This is why the P’s need to offer particularized facts suggesting breach of fiduciary duty- so high standard to get passed motion to dismiss.

vii. The standard of care- mere negligence is not enough to hold directors liable they need to be grossly negligent and stockholders must show particularized facts to overcome the presumption

viii. DE Supreme Court says there are 2 issues: (1) whether the board made an informed judgment on Sept 20 (2) Assuming that they didn’t make an in-formed decision on Sept 20, were the actions taken after adequate to cure the infirmity on Sept 20?

1. Court concludes that on Sept 20 the directors didn’t make an informed business decision. Didn’t have any documents and took the word of VG. Under DGCL § 141(e)- directors may reasonably rely on the re-ports of officers and outside advisors, BUT MUST rely in good faith. Suspicious circumstances here caused them to have a duty to make further inquiry (everything happened so quickly). Would have found w/ a little inquiry that the info provided wasn’t enough to make an in-formed business decision.

ix. Under the business judgment rule, there is no protection for directors who have made an unintelligent or unadvised judgment if their decision making is grossly negligent.** Based on your process towards decision will be determi-nate if acted informed or uninformed.

x. Directors failed to inform themselves about the intrinsic value of their co, a premium alone is not enough to suggest that it’s a fair price. Need to show that premium was sufficient. Can get a valuation from internal or external opinion.

xi. Court finds the mkt test period unduly restrictive b/c didn’t allow for solicita-tion of bids and when revised wasn’t amended based on the representations to the board. It wasn’t a mkt test period designed to provide a level playing field for other players. Created an auction that continually favored Pritzker. Ac-cording to Revlon, need to have an auction. Court says if u are so wise why did you approve this deal.

xii. Court found that what they did after Sept 20, didn’t correct the infirmities. Court didn’t believe the amendments did what the directors claimed they did (didn’t create level playing field). Anyone buying the co would have to pay off Pritzker b/c he exercised the option to buy the shares. Another deal would have to be completed by Dec and couldn’t have a financing contingency. Process that led to the amendments was flawed- directors didn’t ensure that the right action was taken.

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1. Don’t have to read every word of the merger agreement, but have to have some ability to ensure that the action you authorized was effec-tive (follow-up required).

2. Directors were grossly negligentxiii. Remedy-Chancery will determine the fair value of the co and award dam-

ages based on the difference between fair price and $55. If worth same or less, directors get lucky, but still negligent.

xiv.Ultimately there was a settlement before Chancery gave valuation. P class got $23 ½ million- 10 million is paid by directors liability insurance and the re-maining amount is paid by Pritzker (indicates that he thought he got a good deal after taking advantage of them).

xv. Van Gorkam created absolute havoc in the financial world b/c many directors resigned b/c didn’t want to be held liable for anything, many nominees de-clined to be nominated and insurance premiums for directors and officers sky-rocketed. So DE and NY passed legislation that severely dampened the VG decision b/c didn’t want to deter people from being on boards. Passed legisla-tion that limited the directors personal liability for breaches of fiduciary duty, particularly duty of care (Exculpatory Charter Provisions)

xvi.DGCL § 102(b)(7) (538)- Certificate of incorporation can contain a provision eliminating or limiting the personal liability of a director for breaches of duty to the co or the stockholders.

1. Today, this language is often put in automatically, existing co’s need to get shareholder approval to put this in.

2. Provision limits directors exposure to monetary damages with respect to breaches of fiduciary duty (essentially covers directors carelessness or gross negligence)

3. Provision CANNOT limit:a. Breaches of duty of loyalty to the co or shareholdersb. Acts or omissions not taken in good faith or involving inten-

tional misconduct or knowing violation of the law.c. Cannot get a director off the hook for unlawful payment of div-

idends or stock repurchases in violation of legal capital rules. d. Will not cover transactions from which directors derived an

improper personal benefitxvii. NYBCL § 402(b) (1125)- Substantially similar to DE provision- must be

put into the charter and essentially shields you from breach of duty of care. xviii. Many argue that today the duty of is basically dead, b/c of these statutory

changes, especially since P’s must overcome the business judgment rule. Nevertheless, often DE courts will go through the whole trial, just to find that there was no breach of duty and even if there was there is an exculpatory pro-vision.

xix.RULE: Under the business judgment rule, there is no protection for directors who have made an unintelligent or unadvised judgment if their decision-mak-ing process is grossly negligent.

e. Malpiede v. Townsoni. Fredrick’s of Hollywood announced it had retained an investment bank to

conduct a search for a suitable buyer and approved a merger with Knights-bridge. There was a no shop and no talk provisions in the merger agreement with Knights. Before the merger closed, Fredrick shareholders filed a class ac-

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tion and moved for preliminary injunction against the merger and alleged a breach of fiduciary duties and recover damages caused by the rejection of higher bids.

ii. P adequately alleged a claim of breach of duty of care. However. Corporate charter exculpates the directors for any breach of duty of care (allows direc-tors to take risks in good faith). P failed to meet the burden to prove breach of loyalty (conflict of interest)

iii. The exculpatory provision does not bar duty of care but is an affirmative de-fense. .

3. Limits on Liability; Directors’ and Officers’ (“D&O”) Insurance (sometimes E & O ins.- errors and omissions)

a. These policies are extremely difficult to read and understand, and insurance co’s will try to do anything not to pay claims.

b. D & O usually kicks in when the co goes into bankruptcyc. 2 components that relate to indemnification (Very typical to have charter provision

stating that the directors will be indemnified for attorney fees etc.)i. Corporation reimbursement policy- If the co pays the directors, the insurance

co will pay the co for out of pocket expensesii. If a claim against the director is not covered by the corporate reimbursement

policy, then the insurance co will pay the director directly for any expenses in-curred. (important that policy requires the insurance co to pay as cost are in-curred, b/c don’t want to wait until the end to get paid).

d. D & O, like malpractice insurance is a claims made policy- Insurance only covers claims that both arise and are actually brought during the term of the insurance

i. Ex. If something occurs before the insurance kicks in, but file claim when have insurance, won’t be covered.

ii. Ex. Something happens during the period of insurance, but the claim is not made until after the insurance expires, won’t be covered.

iii. Result is that directors MUST always think about the statute of limitations- if a claim arises when is the last possible date it can be brought against you? So if director retires he can purchase a tail- doesn’t cover future conduct, but any-thing that might have occurred during the original insurance period. Can last for as long as the statutory period and typically cheaper than other types of in-surance.

e. Generally speaking this covers directors for acts of negligence (gross negligence)- al-though there are exculpatory provisions at least this will cover the expenses of going to court when the P wants to prove that you are grossly negligent. BUT, everything that the exculpatory provision doesn’t cover, D & O WILL NOT cover also. Will be covered for accidentally violating security laws and defending unmeritorious claims

Corporate Fiduciary Duties: The Duty of Loyalty1. Duty of loyalty is typically implicated in 5 recurring factual scenarios

a. Transactions between a director and her corporationi. Self dealing transactions (implicated b/c in making a deal on their own behalf,

but still need to keep the best interests of the co. in mind)b. Interlocking Directorships- transactions between 2 entities typically corporations that

have common directors. (implicate duty b/c of the concern of lopsided transactions in favor of co A over co B- maybe if director has a greater financial stake in co A than B.)

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c. Use of Corporate opportunities (Usurption)- When a director learns of a possible co opportunity and without offering it to the co takes it for himself (concern is that direc-tor will put personal business interest ahead of those of the co)

d. Entrenchment Actions- actions entrench the directors in their positions (typically arises in takeover battles)- directors putting their interest of keeping their jobs as di-rectors and officers ahead of the shareholders’ interests. (May turn away potential takeover offers just b/c they want to keep their jobs)

e. Favoritism- favoring one class of shareholder over another class of shareholders. (comes up less frequently)- Directors have a duty to all shareholders regardless of class.

i. Ex. Co has both common and preferred stock and an outsider says he will pay this amount of $ for all the shares, and up to directors to divide among the dif-ferent classes of shares. An unfair split could lead an allegation that one class was favored over the other, could be that the directors had a bigger stake in one class than the other.

2. Transactions Involving Self- Interested Directors (not always bad but have the ability to be)

a. Historically, in common law (1880), any K between the director and the co was void-able at the will of the co or will of shareholders whether the transaction was fair or unfair to the co.

i. Policies underlying this rule is that even the directors who are not involved in the transaction are unlikely to vote no. (Cumberland Coal Iron v. Parish- When a K is made with even 1 of the directors, the remaining directors are put in the embarrassing position of having to check over the transaction). Peer pressure concern- will simply rubberstamp it because dealing with friends.

ii. Wardwell court made cynical statements about human nature and why the original common law rule was very much concerned with the directors putting their own needs ahead of the co In the majority of cases the co will be the loser and directors financial interest will win b/c of human nature.

b. In 1910, the original common law rule was replaced with a new rule- A K between a co and director was in fact valid if approved by a disinterested majority of directors and not found to be unfair or fraudulent when challenged. Rule was changed b/c it goes to the essence of self dealing transactions- sometimes it might benefit the co to deal with self interested directors, so in situations when the deal is in fact good why should the co or shareholders be able to challenge it?

c. In 1960, the rule changed again- Most states created self interested director statutes which provide a mechanism to cleanse self interested director transactions

i. DGCL § 144 (a) (555)- Provides a mechanism for a transaction that is other-wise tainted to become cleansed and thus to be able to withstand shareholder challenge- No contract or transaction between a co and director, or no contract or transaction between a co and any other co with the same directors or who have a financial interest, shall be void or voidable even if the interested direc-tor is present at the meeting considering the transaction if:

1. There has been FULL disclosure plus disinterested director approval OR

a. Transaction will be cleansed of all the material facts as to the director’s relationship and interests are known to the board and the board in good faith authorizes the transaction by a majority of disinterested voters

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2. There has been FULL disclosure plus good faith shareholder approval OR

a. Transaction will be cleansed if there is full disclosure of the conflict to shareholders and shareholders vote to approve it in good faith

3. The transaction is objectively fair to the coa. Must be fair at the time that it is authorized or ratified by the

board or shareholders. i. The process WILL NOT be tainted if an interested di-

rector votes so long as the truly disinterested directors vote yes. Sometimes a director doesn’t know that he/she is interested!

ii. Fleigler v. Lawrence (634)- Allows for judicial re-view of transaction, even if it has been cleansed. So essentially, the only thing that cleansing gets you in DE is that it puts the burden on the challenger to prove that the transaction is not fair. (essentially 1 and 3 or 2 and 3 to be cleansed!)

ii. DGCL 144b says common or interested directors may be counted for quorum purposes, they can participate and vote but don’t count for purposes of clean-ing process.

iii. NYBCL § 713 (1165)-(less management friendly, so harder to get things ap-proved)- Cleansing process is substantially the same as DE- (1)Full disclosure and disinterested director approval; or (2) Full disclosure and good faith shareholder approval; or (3) Transaction is objectively fair to the co. BUT 3 wrinkles:

1. To become an interested director under § 713 the director must be a in-terlocking director OR must have a substantial interest in the other co. (DE doesn’t define it to be substantial, but case law tells us that the in-terest must be material).

2. NYBCL § 713(a)(1) requires that disinterested director approval must comply with the provisions of NYBCL § 708(d) (1164)- Requires ap-proval by a majority of directors at a meeting when a quorum is present. IF the number of disinterested directors at the meeting does not constitute a majority of such directors (708d), then the vote of the disinterested directors must be unanimous. (NEED majority of disin-terested voters).

a. Ex. Suppose have 15 directors, § 708(d) default rule requires 8 directors (majority) to be present to take action. 13 directors come to meeting, so have quorum. Under 708(d) need 7 direc-tors (majority of 13) to approve a transaction.

i. Scenario (1)- 4/13 are interested directors, so 9 disinter-ested. Under § 713(a)(1) a self interested transaction can only be approved if 7 disinterested voters vote yes. Won’t matter if other 2 disinterested vote no!

ii. Scenario (2)- 9 interested directors and 4 disinterested directors- only choice for approval of self interested transaction is if ALL (unanimous)4 disinterested direc-tors vote yes.

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1. vs. Deleware need 3 of 4 majority3. NYBCL § 713(b)- If the procedure of full disclosure is coupled with

shareholder approval or disinterested director approval, then share-holders CANNOT effectively challenge the transaction- ONCE IT HAS BEEN CLEANSED, IT IS CLEANSED!!! NOT SUBJECT TO JUDICIAL REVIEW. But, if this procedure isn’t met then the burden of proving that the conduct was fair and reasonable to co falls under to the supporters of the transaction. Great procedural mechanism in NY, b/c once cleansed can’t be challenged like in DE. BUT under § 713(b) can challenge that the transaction wasn’t cleansed properly.

d. Lewis v. S.L. & E., Inc. (602)- 2 companies: (1)LGT- (favored co)- ran a tire dealer-ship in Rochester and (2)SLE- owned the land and buildings leased to LGT. P was Donald and D’s were his brothers Allen, Leon Jr. and Richard. Co’s were linked b/c had interlocking directors- Allen, Leon and Richard were directors of both co’s and also shareholders of both. Donald and sisters were shareholders of SLE, but not at-tached or affiliated with LGT. Incentive was created for 3 bros to maximize the prof-its of LGT that is shared only between the 3 bros at the expense of SLE b/c the costs are spread out against multiple shareholders. The 3 bros treated SLE with disdain and disrespect (largely ignored SLE’s corporate existence)- held no shareholder meetings and viewed SLE as existing purely for the benefit of LGT and that viewpoint would have been fine if the identity of the shareholders were identical for both co’s. SLE leased its land and building to LGT, so LGT can run its business. Terms of the original lease expired in 1966 (1200/month rent). SLE was responsible for real es-tate taxes and all other expenses were borne by LGT. When the lease expired the lease wasn’t renewed, just continued with LGT paying the same rate, even though property taxes increased. Donald believed that the rent was severely below mkt and gross undercharging with respect to the property and building constituted a waste of SLE’s assets. Donald refuses to go through with shareholder agreement provision that said that he must sell his shares of SLE at book value to LGT, b/c owned no shares of LGT. He felt the price was artificially depressed through the actions of the brothers. Donald sues the D’s for wasting the assets of SLE and they countersue for specific performance.

i. D’s CANNOT defend on the business judgment rule (even though rent would fall under it) b/c it is dismantled by their conflict of interest (interlocutory di-rectors).

ii. District court held that P has the burden of proving that the directors are wast-ing co assets, BUT the 2nd Circuit says that interested directors have the bur-den of showing that the lease arrangement to SLE b/c NYBCL § 713 tells us that unless the transaction has been cleansed (which it hasn’t) the proponents of the transaction have the burden.

iii. IF they went through the cleansing process of 713a, they wouldn’t be able to obtain disinterested approval since the board is all interest directors

iv. D’s failed in proving that the lease was fair and equitable to the co. 1. D’s defend their action by saying that the real estate value has

dropped, but court rejects this argument b/c real estate taxes have risen to the point where it eats up the whole rent

2. D also argues that this rent is ALL LGT can afford to pay, but this ar-gument fails, b/c directors were taking excessive salaries. Also, SLE could have gotten a different tenant.

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v. D’s were held liable for wasting the co assets of SLE. Case was sent back to figure out what LGT should have been paying so D’s could pay the difference out of their own pockets. Once that is done the P’s will have to sell their shares at fair value (which will increase with payment of increased rent)

3. Corporate Opportunity Doctrine and Other Dilemmasa. Northeast Harbor Gold Club, Inc. v. Harris (673)- Club was fairly isolated. Har-

ris was the President of club and was presented with 2 opportunities to purchase land adjacent to the Club. The real estate agent contacted Harris b/c she was president of the club and it would be in the best interest of the club to purchase the property. Harris bought the Gilben Property w/out offering it to the club first. She disclosed to the board after the fact and told them that she didn’t plan on developing the land so the club will be protected. She then buys the Smallidge property after learning of its availability from the postmaster during a round of golf. Harris doesn’t offer this op-portunity to the club, but discloses to the board that she is in the process of buying the property and then at an official meeting tells them she bought it but has no interest in developing it. Later she hires people and subdivides the property into lots and gets ready to develop the lots. The board is not pleased that Harris has engaged in these actions and asks her to step down as president & brings lawsuit.

i. Actual allegation- breach of fiduciary duty and loyalty seizing the opportunity that the club thought should be provided to it and then attempting to profit out of it. Remedy they are seeking is constructive trust remedy- land will be held in trust for the benefit of the club and as soon as they pay her what she paid they will get the property.

ii. Trial court found that under existing Main law, Harris has not usurped the club property because acquisition of real estate wasn’t in the clubs business. Moreover, the court found that the club lacked the financial ability to buy the real estate in the first instance.

iii. Sct finds that the current law needs to be revamped: Provides an overview of the various schools of thought on corporate opportunity doctrine:

1. DE’s Line of Business Test (Guff v. Loft (1939))- Court will try to figure out if this opportunity is within the line of business of the co. If a business opportunity is presented to an officer or director of a co and the co can financially undertake and it is within the line of business then the officer or director CANNOT seize the opportunity for herself unless there is disclosure to the corp and the corp does not want to pur-sue it.

a. Guff tells us that the opportunity has to be so closely associated with the existing co activities that if that opportunity was seized then the officer or director would essentially be in com-petition with the co.

i. Problem with this test is that its very difficult in many instances to decide whether an opportunity is within the line of the co’s business. (Ex. Golf club was not in the business of development, but had a policy of trying to prevent development around the club). Another prob-lem is that in testing for financial ability the answer will often be no b/c club won’t know that the opportunity is available so won’t have the $ lying around, but great

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opportunity’s typically open up extra resources (ex. can get bank loan).

2. MA’s Fairness Test- Look’s at the equity and fairness of the situation and decides whether it would be fair to the co to allow the officer or director to pursue this opportunity. The problem with this test is that it doesn’t five any guidance to any existing directors and officers on what they can and cannot do.

3. Minnesota Two Step Test-a. DE Line of Business Test- If the director were to seize this op-

portunity would it put her it direct competition with the co?b. Mass Fairness Test- Once decided that it is within the line of

business, must look at all the circumstances and decide whether the transaction should be set aside b/c inequitable

i. Problem- combination of DE and MA problems. 4. Principles of Corporate Governance (court embraces this test)

a. ALI PCG § 5.05 (1324)- Director or officer cannot take a cor-porate opportunity for himself unless certain conditions are met. (ALL conditions must be met)

i. MUST offer it to the co after full disclosure of the con-flict of interest and the opportunity (if there isn’t FULL disclosure, then its always improper to seize the oppor-tunity for yourself) AND

ii. The opportunity MUST be rejected by the corporation itself AND (1 of 3)

1. Taking of the opportunity MUST be fair to the co or

2. the opportunity is rejected in advance by disin-terest directors in a matter that meets the stan-dard of the business judgment rule or

3. ratified after the fact by disinterested sharehold-ers and the rejection is not a waste of co assets (cleansing process)

b. Financial ability is a factor under § 5.05 b/c rejection can be based on the inability to get financing.

c. § 5.05(b) defines a corporate opportunity as 1 of 2 thingsi. Any opportunity to engage in a business activity (does

not need to be closely related) of which the director be-comes aware either in connection with the performance of his job or the person offering it to her expects her to offer it to the co or she learns of it through the use of co info and property if the transaction is one that is reason-ably expected to be of interest to the co.

ii. Corporate opportunity is any opportunity to engage in a business opportunity of which an officer (not director) becomes aware of other than on the job and knows that it is closely related to something the co is engaged or wants to engage, then has to offer it.

d. If the transaction was not rejected by shareholders or directors, or ratified by them, then burden falls on officer who seized the

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opportunity that it was fair. Otherwise the burden falls on the challenging shareholders,

5. There was not enough info to decide this case, now the lower court has to find additional facts to figure out if this is a corp opportunity. On appeal the court finds that these were corporate opportunities and Har-ris breached her fiduciary duties by not offering it to the board, BUT then the court found that no action could be taken b/c passed the statute of limitations.

b. Hypo- suppose that O inherits a business that is competitive with that of corporation X. Here O has not taken a corporate opportunity. However, if O runs the business without resigning from corporation X, she may be improperly competing with X. Similarly, suppose O started a business that originally was not competitive with X, but that later becomes competitive because X itself expands its geographical or prod-uct line reach, so that it begins going head to head with O’s business. Here too O has not taken a corporate opportunity, but may be improperly competing with X.

4. Directorial Entrenchment- those activities that the directors engage in that lead them to make their jobs more secure (comes up most frequently in the context of takeovers

a. Unocal Corp. v. Mesa Petroleum Co. (1140)- Mesa wants to takeover Unocal in a hostile takeover (Corporate Raider- T.Boone Pickens- CEO of Mesa). Mesa makes a 2 tier front end loaded tender offer for shares of Unocal (2 stages). 1st tier- Mes of-fers to pay $54 in cash to obtain 37% of Unocal stock (Mesa already owns 13% of shares so this would give them controlling rights). 2nd tier (back end)- Mesa will ac-quire the remaining public shares through a squeeze out merger- will have enough voting force to force the merger. Will buy remaining shares with debt securities(junk bonds) reportedly worth $54. Unocal board finds this offer to be inadequate and wont recommend to shareholders, after getting 2 outside opinions. Unocal board ap-proves a defensive strategy- conditional exchange offer- If Mesa acquired enough Unocal shares to push ownership level above 50% Unocal would then offer to ex-change the remaining 49% for Unocal debt securities worth $72 per share. Mesa was excluded from participating in this offer. Mesa seeks a preliminary injunction de-signed to prohibit Unocal from completing its exchange offer.

i. Court describes this 2 tier front end loaded tender offer as coercive in nature b/c shareholders won’t want to be stuck at the back end getting junk bonds so almost forced to tender at front end so they can get cash, regardless of whether $54 is a fair price.

ii. Mesa will only pay cash to first 37%of outstanding shares, so if too many shares are tendered at the front end securities law says that everyone will get some shares purchased for cash and the rest will be returned.

iii. Purpose of the conditional exchange offer is that it would keep Mesa from getting the other 49% of shares by offering an alternative to the remaining 49%. Once that exchange offer was done and the shares repurchased by Uno-cal, the only who will have outstanding shares is Mesa. But now controlling shareholders of a co that is heavily debt laden (were only planning on issuing $54 junk bonds not $72).

iv. Mesa makes a number of arguments in support of its request for injunction1. Discriminatory treatment – Unocal is making an offer to buy every-

one’s shares but Mesa’s, why shouldn’t they get the same treatment as other shareholders. Potential duty of loyalty problem b/c directors are shareholders, and they will benefit from this offer. Unocal responds by

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saying that Mesa is the one who caused the problem with an inade-quate coercive offer, so don’t owe them any loyalty b/c they are the one’s trying to hurt the co. Also, BJR.

v. DE court decides that a DE co can selectively buy back some shares from some shareholders.

1. DGCL § 160(a) (565)- Statutory authority for selective repurchases2. Meant to defeat practice of greenmail- Corporate raider buys a signifi-

cant stake of a co and goes to the board and says they have a choice- we can launch a hostile takeover and then we will fire you or you can make us an offer to buy our block of shares at a premium price (pay us to leave you alone)

a. Court notes that T Boone Pickens and Mesa are notorious greenmailers.

b. Green mail is still legal, BUT the internal revenue code has taken steps that provides disincentives fro both parties to en-gage in a greenmail oriented transaction (can no longer deduct the spread between mkt price and premium, also greenmailer must pay substantial tax on the premium price).

c. A lot of different states have taken steps to try to prevent green mail outright

i. NYBCL § 513(c) (1136)- A co cannot repurchase 10% or more of stock form a shareholder at a premium price if the person holding the shares has held it for more than 2 year, without shareholder approval.

vi. Directors are permitted to take action in response to a perceived threat to the enterprise

1. Harm reasonably received irrespective of the source- court recognizes that the threat coild come from one of the shareholders, so it is legiti-mate to protect the co even if it means going against one of the co’s shareholders.

vii. Defensive actions that the board takes fall under the business judgment rule BUT there is an omnipresent specter that the board may be acting in its own best interests rather than those of the shareholders.

1. Co’s takeover another usually b/c management isn’t performing well, so this change may be beneficial

2. By-product of defensive actions is entrenchment of positions.viii. Court adopts Unocal standard- tells us when defensive measures of di-

rectors preserve the protection of the business judgment rule 1. Directors have demonstrate that there is an actual or perceived

threat to the corporate enterprisea. Can show this by deliberations (outside directors), looking at

facts, investigating2. Defensive actions taken must be reasonable in relation to the

threat posed. (Proportionality) a. A co doesn’t have unbridled discretion to defeat any perceived

threat by any draconian means available. However it was proper for circumstances.

ix. Holding is still true with private co’s today but With public traded co’s today, under federal law, under Williams Act (Exchange Act 13e-4 and 14d-10)

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1934, prohibit making exclusionary exchange offers like the one made in Un-ocal. Must make the offer to every stockholder.

b. Defensive measures that are put in place from time to time:i. Defensive charter amendments (staggered board or super majority voting re-

quirement)ii. Crown jewel strategy- Target co sells or gives someone the option to buy the

most important asset or business of the co at a deeply discounted price if the hostile party gets a certain % of shares.

iii. White knight strategy- Once it becomes clear that the target will not remain a stand alone co. the board will sell to someone they like better (odd b/c this is based on director makeup, not co’s likes or dislikes-so where do shareholder needs fall into this?)

iv. Pac man strategy (not common anymore)- if the hostile co launches a takeover of your co, you in turn try to takeover their co.

v. Golden parachute strategy- Once co is taken over, very lucrative severance payments will be triggered for directors who are fired. Makes takeover less appetizing for potential bidders.

1. WSJ article- Merck adopted golden parachute payment b/c of hostile takeover threat, providing some director’s w/up to 3 times previous year salary plus bonus.

c. The Unocal Standard is only used with defensive strategy and only those taken unilaterally by directors, won’t apply if shareholders approve.

i. Under federal law (Williams Act Rule 14d-10- all holders rule) public co’s can only make tender offers to ALL the shareholders regardless of who they are. (So Unocal would have been wrong in not making offer to Mesa, under federal law). But DE law still stands and Unocal standard is still alive and well. (Today’s rules)

d. Unitrin Inc. v. American General Corp Casei. Unitrin had charter with supermajority voting provision.

Corporate Fiduciary Duties: Takeovers1. Directorial Duties in the context of Corporate Takeovers.

a. Revlon, Inc. v, MacAndrews & Forbes Holdings, Inc. (1160)- Revlon was a takeover target when Mark Bergerac was CEO. Famous takeover artist Ron Pearl-man, CEO of Panty Pride was the bidder. Initially PP tried making a friendly offer, but Bergerac hated Pearlman so didn’t want to cooperate. PP board authorized it to go after Revlon on a hostile basis at a price of $45. Lazard tells Revlon that PP’s strategy is to acquire Revlon with junk bonds and then break up the co and sell off the parts at $60-$70 per share. This strategy tells us that the sum of the parts at Revlon are worth more than the whole (management not doing good job- maybe board should break up co themselves and get the $ for the shareholders b/c keeping money all together doesn’t make much sense). Wachtell Lipton, Legal counsel for Revlon recommends that Revlon repurchase up to 5 million of its own shares (price will in-crease by artificial demand, but wont matter to PP b/c will just buy less shares). Real reason for this is that Revlon can put the shares in an Employee Stock Option Plan (ESOP) and those shares will be controlled and voted by a trustee nominated by Revlon, so unlikely that the trustee will tender shares to PP or vote PP nominees to the board. (makes shares impervious to acquisition by PP). Can also use those shares to option or sell outright to a white squire (buys a chunk of your stock, unlike

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knight who buys all shares) who under a K agreement agrees not to tender those shares to a hostile co or vote w/out Revlon’s approval (putting shares into friendly hands). Wachtell also recommends that Revlon adopt a poison pill(shareholder rights plan) essentially entitles shareholders other than hostile party to purchase shares at a super cheap price if hostile party were to buy over a certain %, thereby diluting the mkt place with those shares, making the takeover really expensive. (Poi-son pill has never gone through, but good threat). Board adopts the recommenda-tions.

i. Poison pill adopted and rescinded unilaterally by the board. To get the board to redeem the poison pill must keep offering a higher price to a point where the board can’t say no more anymore. Another way is to put together a board that is hostile to the pill (Proxy fight). Shareholders CANNOT redeem a poi-son pill. (business decidsion.

1. Flip in- buy cheap stock from your co2. Flip over- if your co isn’t doing well can buy cheap stock in remaining

co. ii. PP ultimately launches its hostile bid: $47.50 per common stock and $26.67

per preferred share. Conditioned on PP receiving necessary financing and on Revlon redeeming the poison pill

iii. Revlon rejects the bid as inadequate and also launches another defective strat-egy- exchange offer of new debt securities worth a certain value for up to 10 million shares. By not using cash to buy these shares, Revlon was preserving cash, but takes 10 m shares out of the mktplace and can add to ESOP or sell to white squire.

iv. Makeup of Revlon’s board (DE always places high priority on what indepen-dent directors of co does)

1. 14 directorsa. 6 hold senior management positions (inside directors)b. 2 hold significant blocks of stock (arguably independent direc-

tors b/c most likely to be concerned with shareholdersc. 4 had various business relationships with Revlon at some point

in time (Technically outside directors b/c no current relation-ship, but probably looking out for interest of current directors so can have future relationships.

d. 2- No affiliation (independent)v. Revlon offers a new price of $42 per share- reflects the exchange program b/c

now Revlon is more highly leveraged. vi. Sept 24, Revlon board decides not to sell to PP, but up for sale to someone

else. Want to sell to White Knight- Forstmann, so treat him well! Forstmann’s initial offer was made public and note prices plummeted in value b/c reflected fact that Forstmann was borrowing to buy Revlon and that debt will be on Revlon’s books after sale, so less chance of those creditors being paid. Note holders threatened to sue Revlon for doing deal with Forstmann that undercut the credit worthiness of the notes and caused the price to fall. Forstmann comes up with new proposal

1. $57.25 per share (fits valuation of co), but must be granted a lock up option (allows them to buy 2 important divisions of Revlon, in the event that another acquirer gets more than 40% of Revlon- Crown Jewel lock up option). Revlon had to agree to no shop provision-

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couldn’t shop around actively for another bidder. Also, cancellation fee- if a 3rd party bought more than 20% of Revlon stocks, Revlon was forced to pay Forstmann a check for $25 m. Forstmann in turn agrees to support the value of Revlon notes in the mkt place, so won’t get sued. (prop up value- whenever the price of the note starts to drop, they will step into the open mkt and buy the notes, creating an artificial demand. Revlon accepts this offer.

2. the cancellation fee is not illegal but must be compensatory (like liqui-dated damges it must be reasonable and cant be punitive)

a. between 2 and 4% in DE is considered reasonable. vii. PP continues to step up its offer, but demands that Revlon repeal the defensive

strategies. Its last bid was $58, conditioned on nullification of the poison pill, waiver of debt covenants and repeal of the crown jewel lock up option.

1. The K between Revlon and note holders limits Revlons ability to incur additional debt and PP was going to borrow most of the $ it needed to buy Revlon, so with those existing notes outstanding it limited the ability of Revlon to acquire new debt, ability to sell assets and pay div-idends.

viii. PP seeks injunctive reliefix. Court grants injunction., Chancery court reasons that Revlon directors

breached their duty of loyalty by making the concessions to Forstmann, by putting their own need ahead of shareholders b/c were scared of being sued.

x. DE SCT notes that whenever directors take defensive measures there is the omnipresent specter of the directors own interests.

xi. Court uses Unocal standard to determine whether the defensive strategies are ok

1. When confronting the hostile takeover, the defense must be reasonably perceived threat and the response must be proportional (not drancon-ina, coercive, preclusive)

2. Poison Pill- the court recognizes the power to adopt it so long as the reason for it is reasonable. Finds that Revlon acted in good faith and the poison pill was reasonable in relation to the threat posed. How-ever, the court says this issue is moot, b/c once the co decided to sell itself then it had to redeem the poison pill, b/c that prevents the sale of the co. (redeemed by implication)

3. Exchange offer is proper in connection with hostile threat so long as it complies with the Unocal standard. DGCL 160a- allows co to acquire its own seucirites from stockholders.

xii. Boards duty changes once it decides to put the co up from sale- change from preservation of the co as corporate entity to someone charged with getting the max value as part of the sale process fro the shareholders

1. Defensive measures become moot- want everyone who can bid to bid so DON’T want restrictions on shareholders (existence of lock up ar-rangement deters other people from bidding). Any defensive strate-gies that are inconsistent with director’s role as auctioneer is a vio-lation of the directors duties.

2. Board members become auctioneers, charged with getting the best price for shareholders thus give everyone same info and access

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3. Board can slightly favor one offer over another higher one, if it is more solid (Mills Acquisition case, not all bids are alike)

4. Lock Up are not illegal , it would be to institute during active auction but ok if there is plateu of bids (and make lock up to get a little higher offer)…anything to slow down auction is illegal.

5. Directors have a duty to explore another offer and if its better to take it even if they have already committed to sell to another party (usually provision in K for this)

a. DE courts view cancellation fees under a liquidated damages scope (should the co who contracted to buy get paid for all their efforts if someone else swoops in with a better offer and gets to buy?) Usually the court will not allow fee if its more than 4% of purchase price.

b. Alcoa- Shares selling at $34 on open mkt, but tender offer for 5% of shares was made to buy shares at $32. This is a legal scam b/c bidder thinks that there are people out there who will sell b/c ignorant enough not to know that alcoa is trading at a higher price. Some people tender shares b/c don’t know what they’re doing.

2. Self tender offers, conditional exchange offer and repurchases-(all put more shares in the hands of the target co b/c essentially the co is buying back its own stock, key difference is the regulatory regime that must be met when conducting a given transaction.

a. Self tender offer- Repurchase that rises to the level of a “tender- offer” under the federal securities laws. This triggers a substantial disclosure obligation. Moreover, since it is a “self”-tender (meaning the company is the one tendering for its own shares), it triggers even heightened disclosure under the federal securities laws. This stems from the fact that the agents of the shareholders (i.e. the board) is offering to buy the shares from their principals (i.e. shareholders) when the board has complete access to all available info about the co and the shareholders only have limited access.

b. Conditional exchange offer- Form of “self-tender offer. However, b/c the co is of-fering to acquire additional shareholders’ shares NOT with cash, but w/ other securi-ties of the company, it is referred to as an “exchange offer.” The conditional part re-lates to specific conditions to the company’s obligations to consummate the exchange offer. In Unocal, one condition was that Mesa not get to tender its Unocal shares into the exchange offer.

c. Repurchases- Repurchasing shares is ordinarily governed by state law. See e.g. DGCL § 160(a) (565). However, if the co is a publicly traded co, the federal securi-ties laws could come into play depending on the circumstances surrounding the repur-chasing activities, thus triggering certain disclosure requirements. However, repur-chases typically do not rise to the level of a “tender offer,” and thus the disclosure (if any) mandated by federal law is more minimal.

Corporate Fiduciary Duties: Controlling Stockholders1. Duties of Controlling Stockholders (with control comes power!)

a. Majority stockholders are all controlling since owe more than 50% of stock and if don’t have commulative voting then elect entire board.

b. Controlling shareholders are no always majority stockholders. Ex. when there are millions of shares and you own 12% while everyone else owns less than 1 percent.

c. Controlling shareholder have a fiduciary duty to minority shareholders and to the corporation

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i. Must have a real life board- CANNOT control the co and use if for your own use.

ii. This is why so many co’s when they acquire another co don’t simply want a majority stake they want 100% or nothing.

1. Co will make a tender offer at a minimum of the majority of outstand-ing shares b/c if not then the co will have a large block of minority shares outstanding. If 51% is tendered, can do a 2nd step merger and force out the remaining 49% of shares outstanding. (A good defense for this is a provision in the charter that requires a super majority vote).

a. 1st and 3nd step must be the same (i.e.cash and cash, or debt and debt) if not courts will find it coercive b/c people will stampede to front so can get cash.

d. Sinclair Oil Corporation v. Levien (707)- Sinclair owns 97% if Sinven and owns 100% of Sinclair International Oil (SIO). Board of Sinvan was made up of everyone Sinclair elected (virtually all were directors or employees of Sinclair (not indepen-dent of Sinclair))P’s, minority shareholders who own 3% of Sinven alleged 2 breaches of fiduciary duties and sue Sinclair. Sinclair can’t buy remaining 3% of Sinven b/c Venezuelan govt required that any co’s operating in their country must re-tain a certain % of resident shareholders.

i. Sinclair concedes he has fidicuary dity as a controlling stockholder. ii. Because the Sinven board was dominated by people who were loyal to Sin-

clair, Sinclair owed Sinven fiduciary duties (When you don’t have 100% ownership you can’t treat Sinven as your private play toy, have fiduciary duties to shareholders and the co.

iii. 1st breach alleged is the excessive payment of dividends (exceeded their rev-enue) that drained money from the co, thus stunting its industrial growth. P’s believe that Sinclair’s motive was that they were short on cash so wanted to use Sinven as a private piggy bank.

1. The payment of dividends were in compliance with DE legal capital rules (DGCL § 170(a) (569) a dividend can be paid out of surplus (TA-TL)-Capital (PV x outstanding shares) or out of this year or last years net profits), so P’s don’t make an allegation that it violated legal capital rules.

2. Normally when it comes to paying dividends directors have a very wide latitude in deciding whether to pay dividends or not, so D’s argue that the business judgment rule applies.

a. Court says that if the BJR applies than the P’s would have to show either an improper motive or that it constituted a waste of corporate assets.

b. If can’t show improper motive or waste of corporate assets, then have to show that the dividend is not based on any reason-able objective (mere rationality test)- very tough to show.

3. Lower court refuses to apply, disables the BJR over the decision to pay dividends mainly b/c of the domination of Sinclair over Sinven. In-stead the court applies the Intrinsic Fairness Test- the burden of proof ordinarily on P to overcome the BJR, shifts to D directors to prove that the dividends and everything else was intrinsically fair to the co and shareholders.

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a. P’s will always try to get this test, and inflict the burden on the D’s- the best way to get it is to show a conflict of interest.

b. D must show they went through the cleansing process. 4. DE Sct doesn’t believe that the intrinsic fairness test was the right one

to apply b/c to make the intrinsic fairness test apply P’s must allege breach of fiduciary duty coupled with self dealing

a. Self dealing in parent-subsidiary context- parent is gaining profit for itself at the expense of the minority shareholders. If Sinclair used its domination and control to extract a benefit not also made available to the minority shareholders.

b. DE Sct doesn’t believe that self dealing was involved in this case b/c the dividends were being paid all the time to BOTH Sinclair and the minority. Had Sinclair paid a dividend solely to itself and not to the 3% minority it would have been intrinsically unfair.

5. P’s argue that they don’t really want the dividend money and Sinclair doesn’t either, just want it b/c of improper motive (cash flow), and re-sult is that they are sucking out all the $ out of it so it can’t expand

a. Sct holds that the P has the burden of showing that there were opportunities that they could have explored and that Sinclair usurped them from Sinven, but P’s couldn’t do it so these alle-gations are just speculation.

6. BJR applies to the dividend payments and the P’s lose on this issue. iv. 2nd breach of fiduciary duty allegation is claim that Sinclair prevented Sinven

from pursuing its legal rights after SIO breached its K with Sinven. (K called for Sinven to sell all its crude oil to SIO for min and max prices and SIO failed to make payments on time and buy the minimum amount of crude oil as required by the K).

1. Court applies the intrinsic or entire fairness test b/c there was self deal-ing here (100% of the benefit of the breach goes to Sinclair, while only 97% of damage goes to Sinclair).Lopsided transaction, so burden of proof is switched to D to prove that the failure to allow Sinven to sue for breach of K was intrinsically unfair to Sinven. (similar to lewis v. SLE case)

2. D was not entitled to BJR since there was substantial conflict of inter-est. However, the BJR is disabled if self dealing.

3. D’s couldn’t come up with a justification so the court finds that it was intrinsically unfair.

a. Sinclair makes a funny argument about this- SIO was buying all the oil that Siven produced, so if it turned out that we needed more than was produced what could we do? Court says they could have made Sinven produce more oil.

v. Very often minority shareholders, particularly in closely held corporations, do not have the opportunity to liquidate because no one to sell to, but the major-ity of shareholders can because someone will want to buy control. So minor-ity shareholders will sue the majority for not including them in the deal, BUT they won’t win b/c controlling shareholder DO NOT have fiduciary duties over their shares, they can do with them and vote however they want with them! Fiduciary duties ONLY apply to control and domination.

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vi. DGCL 253- Short form merger provision1. any time own more than 97% can merge subsidiary into parent (cant

merge other way) without asking minority vote2. however minority has Appraisal Rights, DGCL 262, if merged out of

existence and have no say in matter then allows to dispute the consid-eration your receiving.

e. Jones v. H.F. Ahmanson & Co (1969, Cal)i. P, Jones claims D breached fiduciary responsibility in the creation and opera-

tion of UF, DE corp which owned 87% outstanding of Association (savings, loan bank in which have depositers who conver the deposit stock into IPOs) stock.

ii. Although directors and officers of a co. are bound by fiduciary duties to act in best interest of shareholders, the shareholders themselves normally do not have such duties toward each other. However in Cal, a majority of share hold-ers of closely held corp. have a duty not to destroy the value of the shares held by the minority shareholders.

iii. From Pepper v. Litton, a director, or controlling stockholder is a fiducuary and where any engagements with the corp. are challenged the burden s on the di-rector or stockholder not only to prove the good fiath of the transaction but also yto show its inherent fairness from the viewpt. Of the corp. and those in-terested therein.

iv. Holding: here no market existed for people to buy Association stock, and thus the controlling shareholder may not use their power to control the copr. For the purpose of promoting a marketing scheme that benefits themselves through the detriment of the minority. P wins.

1. the problem was not that D transferred its shares to UF but rather of-fered debentures of Association for security. UF doesn’t own any as-sets it’s a holding co and thus the loan to UF was not guaranteed. This also caused the Assoc. board to stop paying dividends.

2. ex. like Geier Family Case- of the 85% owned sell 49% of the UF co and still maintain majority with 51% of UF

a. .85 x .51 = 43.3% and yet D’s still in control of Assoc. v. D could have caused Association to effect a stock split and create a market or

create a holding co. for Association shares and permit all stockholders to ex-change their shares before offering holding co. shares to the public. D never allowed minority shareholders exchange and be able to optain the forward stock split of the new UF corp. and thus breached fiduciary duties (like Sin-clair would be considered self dealing).

vi. Court holds that UF must hold an exchange stop split to P for 250 to 1 and re-payment of capital for IPO or allow P to cash out directly.

f. Forward Stock Splitsi. Ex. stockholder of DIM held 50shares worth 100 each (5000 total) before the

split, he will own 150 shares worth 33.33 each (a total of 5000) after the 3 to 1 split.

1. Splits are designed to make its common stock more affordable on a per share basis to broader range of investors.

2. Tends to be a positive sign. It perceives the split as a sign of manage-rial confidence that the co’s stock price will continue rising in the im-

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mediate future. Thus seeking to bring th stock down into a more af-fordable trading range.

g. Reverse Stock Spliti. Designed to increase the per share trading price of the co’s common stock and

1. Don’t want to stock to be considered penny stock or delisted for being to low. NASDAQ below dollar delisted.

2. Market refers stock split as bearish, negative. ii. can be used to eliminate minority stockholders.

1. must cash out if only own fraction of a stock