Business OrganizationsAgencyPartnershipsCorporations Corporate Creation and Liability Corporate Purpose Fiduciary Duties Derivative Actions General Securities Regulation, Insider Info Corporate Governance, Proxy IssuesClosely Held Businesses

AgencySTATUTES USED: Restatement of the Law (Third) Agency (R3A)

Agency in General- Agency: The fiduciary relationship that arises when a principal manifests assent to an

agent that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act. §1.01 R3A

o Manifestation: Assent or intention is manifested through written or spoken words or other conduct. §1.02 R3A

- Three Requirements of Agency:o Principal’s manifestation of assent for the agent to acto Principal’s control of the agent’s actions on behalf of principalo Agent’s manifestation of assent to act on principal’s behalf

Creation of an Agency; Scope of Agency- Agencies can be created in several ways, some of which do not require an express or

even intended creation. o Parties labeling not controlling: The “principal” and “agent’s” characterization

of the relationship is not controlling; the relationship has legal effect only when the above requirements are met. Courts examine the totality of the circumstances to determine whether an agency relationship exists. §1.02 R3A

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- Actual Authority: An agent acts with actual authority when he reasonably believes, based on the principal’s manifestations to the agent, that the principal wishes the agent to act. §2.01 R3A (see §3.01 R3A).

o Scope of actual authority: An agent may act to fulfill express or implied objectives in the principal’s manifestations, as well as acts necessary or incidental to fulfilling such objectives, that the agent reasonably believes is required. §2.02(1) R3A.

Implied Authority: An agent has implied authority when it can be circumstantially proven that the principal actually intended the agent to posses such powers, and such powers are practically necessary to fulfill the principal’s manifested objectives. Mill Street Church of Christ v. Hogan.

Considerations: The past conduct principal had allowed, the necessity of the agent’s actions, the reasonability of the agent’s actions.

Inherent Agency Power: An agent acting within the scope of their agency has inherent authority to commit torts. See below.

o Employer-Employee relationship: An employee is an agent whose principal has the right to control the manner and means of the agent’s performance of work. §7.07(3)(a) R3A.

Scope of employment: An employee acts within the scope of employment when performing work assigned to them by the employer, or engaging in a course of conduct subject to the employer’s control. §7.07 R3A.

The employee does not necessarily have to be acting to specifically further the employer’s interests. Acts that are the result of the employee’s tendencies and habits in relation to that employee’s fulfillment of obligations are within the scope of employment. Ira S. Bushey & Sons, Inc. v. United States.

Independent Contractors held to be Employees: If a party holds substantial control over an “independent contractor’s” operations, then the independent contractor can be considered an employee for torts purposes. Humble Oil & Refining Co. v. Martin

If the independent contractor retains significant control over the inventory operations, they are treated as an independent contractor. Hoover v. Sun Oil Company.

- Assumed Control by Creditor: A creditor who assumes control of his debtor’s business may become liable as a principal for the acts of the debtor in connection with that business. Gay Jenson Farms Co. v. Cargill, Inc.

o Not merely a veto power over the debtor, but an active attempt to control the actions of the debtor. Id.

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- Apparent Authority: The power of an agent or actor to affect the principal’s legal relations with third parties. This power arises when the third party reasonably believes the agent/actor has the authority to act on behalf of the principal, and that belief is traceable to the principal’s manifestations/actions. §2.03 R3A.

Liability of Agency Relationship- Generally: A principal can be held liable for the acts of their agent that harm a third

party. The agent can also be held liable, even if acting as an agent. §7.01 R3A.- Principal’s Direct Liability: A principal is subject to direct liability for the actions of

their agent in the following situations:o Agent Acts with Actual Authority: The agent acts with actual authority, or the

actions are ratified by the principal, and: Agents actions are tortious, §7.04(1) R3A; OR If the principal had acted instead of the agent, the principal would be

subject to tort liability. §7.04(2) R3A.o Agent was Negligently Selected or Controlled: the agent was negligently

selected, trained, retained, supervised, or otherwise controlled. §7.05 R3A.- Principal’s Vicarious Liability : A principal is subject to vicarious liability for the

actions of their agent in the following situations:o Agent Acts with Apparent Authority: Agent was acting with apparent

authority in dealing with third party on or purportedly on behalf of the principal. §7.08 R3A.

A principal can be held liable to a third party in contract if the agent acted in a way that would make the third party believe that a contract had been executed. Three-Seventy Leasing Corp. v. Ampex Corp.

o Employee Acts within Scope of Employment: Employee was acting within the scope of employment and committed a tort. §7.07(1) R3A.

If the tort was committed to allow the employee to further their duty as an employee, then the tort was within the scope of employment. Manning v. Grimsley.

See independent contractor issue above.- Undisclosed Principal Liability: If the undisclosed principal has notice of the agent’s

conduct and that it might conduce others to change their position, the principal is liable to third parties who are justifiably induced to change their position by an agent acting on the principal’s “behalf” without actual authority. §2.06(1) R3A; Watteau v. Fenwick.

o Undisclosed directions don’t count: A principal cannot rely on undisclosed limitations on the agent’s power. §2.06(2) R3A; Watteau v. Fenwick.

- Apparent Agency : For purposes of tort liability, an agency relationship exists between a franchisor and a franchisee if the franchisor retains significant control over the operations

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of the franchisee (such as by requiring certain standards for operation) AND the standards are designed to create an appearance of uniformity meant to cause the public to think the franchisee is part of the franchisor’s business. Miller v. McDonald’s Corp.

Fiduciary Obligations of Agents- Agent’s to Principal

o Duty of Loyalty: An agent has a duty to act loyally for the principal’s benefit in all matters connected with the agency relationship. §8.01 R3A.

All of the rules below can be understood in terms of a duty of loyalty. Material Benefit from Agency: An agent has a duty not to gain material

benefits from a third party in connection with transactions made on behalf of the principal, or through other uses of the agent’s position. §8.02 R3A.

An agent is liable to his principal if he takes advantage of his agency to make a profit for himself. Reading v. Regem; General Automotive Manufacturing Co. v. Singer.

Acting on Behalf of an Adverse Party: An agent has a duty to not deal with the principal on behalf of an adverse party in a transaction connected with the agency relationship. §8.03 R3A.

Competition: An agent has a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal’s competitors. §8.04 R3A.

Use of Property and Information: An agent has a duty to not use property for the agent’s own purposes, and to not use or communicate the principal’s confidential information for the agent’s or third party’s purposes. §8.05 R3A.

Contract Duties: An agent has a duty to act in accordance with the express and implied terms of a contract with the principal. §8.07 R3A.

Acting Within Scope of Actual Authority: An agent has a duty to only act within the scope of their authority, and to comply with all lawful instruction of the principal. §8.09 R3A.

Good Conduct: An agent has a duty to act reasonably and refrain from conduct likely to damage the principal’s enterprise. §8.10 R3A.

Providing Information: An agent has a duty to reasonably try and provide information that the agent knows, or should know, the principal would want to know, and the information can be provided without violating a superior duty. §8.11 R3A.

When information may provide some benefit to the principal, even if it is unlikely, the agent has a duty to report it – especially if the agent wishes to act on the information for himself. General Automotive Manufacturing Co. v. Singer.

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o Duty of Care: An agent has a duty to act with care, competence, and diligence normally exercised by agents in similar circumstances. §8.08 R3A.

- Principal’s Duties to Agent: A principal has a duty to indemnify an agent suffers a loss on behalf of the principal, §8.14, as well as to deal fairly and in good faith. §8.15 R3A.

PartnershipsSTATUTES USED: Uniform Partnership Act (1997) (UPA).

Partnership Formation- General Partnership: A partnership is formed whenever there is an association of two

or more persons to carry on, as co-owners, a business for profit. §202(a) UPA.o No intent needed: No requirement of any intent of parties to form a partnership,

only the above elements need to be met. Ex: Parties who supplied securities as collateral to an existing partnership

expressly declined becoming partners. However, the court held that this did not preclude the parties being considered partners, and that if there was a showing of the parties’ intention to form an association to carry on as co-owners of a business for profit, the parties would be partners. Martin v. Peyton.

o Default rules govern: Absent a written partnership agreement, the statutory rules of partnership govern the partnership. §202(b) UPA.

o Limited Liability Partnerships: A partnership that has filed with the State to form an LLP is still governed by the default rules, absent a written partnership agreement.

o Specific Formation Rules: Joint tenancy, tenancy in common, tenancy by entirities, common

property, or part ownership does not by itself establish a partnership, even if profit was made. §202(c)(1) UPA.

Sharing returns of property does not by itself establish a partnership, even if there is a common interest. §202(c)(2) UPA.

Presumption: A person who receives a share of the profits of a business is presumed to be a partner, unless the profits were received in payment of, §202(c)(3) UPA:

A debt by installments or otherwise For services as an independent contractor or of compensation as an

employee Rent An annuity to a representative of a retired partner

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Interest or other charge on a loan – even if it varies with the profits and earnings of the business

For the sale of the goodwill of a business or other propertyo Partnership agreements: If there is a written partnership agreement, then the

partnership is governed by the rules within the agreement, not the statutory rules. §202(b) UPA.

Not governed by partnership agreement: There are a few areas of partnership law that cannot be altered by the partnership agreement:

Information: a partner’s right to information regarding partnership affairs cannot be varied.

Good faith: a partner’s duty to act in good faith and fair dealing cannot be eliminated.

Duties among partners: the duties owed between partners cannot be eliminated.

Liability: the principle of joint and several personal liability cannot be varied.

Dissociation: a partner’s right to dissociate from the partnership cannot be varied.

Partnership agreements may determine the standards for satisfying the fiduciary duties.

Partnership Rights and Duties- The rights and duties discussed in this section are the default rules that are applied

absent a written partnership agreement. - Partner’s Enumerated Rights and Duties

o Payments Right: To have an equal proportional share in the partnership profits,

losses, and property. §401(b) UPA. Right: To be reimbursed and indemnified for actions in the ordinary

course of business or for preservation of business and property. §401(c) UPA.

Right: To be reimbursed for advances made beyond agreed upon capital infusions. §401(d) UPA.

Right: To gain interest on payments (b, c, and d). §401(e) UPA.o Management

Right: To have an equal right in the management and conduct of business. §401(f) UPA.

Disagreements about ordinary business matters are settled by majority rule of the partners. §401(j) UPA.

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Duty of Loyalty: To only use partnership property on behalf of partnership. §401(g) UPA.

Right: To get reasonable compensation for services rendered in winding up the business of the partnership. §401(h) UPA.

Right: To have access to books and records. §403(b) UPA.- Broad Duties of a Partnership

o The rights and duties discussed above are derived from the three duties that partners owe to each other:

Duty of Loyalty: Partners have a duty that prohibits them from misappropriation of partnership property, usurpation of partnership opportunities, and having an interest adverse to the partnership or competing with the partnership.

Duty of loyalty between partners only applies to the business aspects and use of property of the partnership.

Opportunity Ex.: One partner in a partnership was presented an opportunity and offer of a new adventure beyond the duration of the partnership. The court held that he had a duty to inform the other partner of the opportunity before pursuing the opportunity for himself, since the opportunity was a result of the partnership. Meinhard v. Salmon.

Disclosure Ex.: Partner in a law firm claimed a breach of duty of loyalty because the partners did not disclose changes to internal structure that would occur after a merger. The court held that the duty of loyalty only applies to accounting of profits, acquiring partnership assets, and non-competition, and had nothing to do with disclosures about internal structure. Day v. Sidley & Austin.

Duty of Care: Partners have a duty to not be grossly negligent in carrying out their duties and obligations.

Duty of care only applies to the business aspects and use of property of the partnership.

Good Faith: Partners have an obligation of good faith and fair dealing in the discharge of all their partnership duties.

Ex.: Partner in a law firm was involuntarily expelled from partnership under a “no cause” clause. The court held that the firm acted in good faith since there was no “predatory purpose” in their action. Lawlis v. Kightlinger & Gray.

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Partnership Dissolution- Unless otherwise provided in the partnership agreement, the following events can result

in dissolution:o Partner’s Will to Terminate: When a partner receives notice of an associated

partner’s will to withdraw as partner, or at a later date specified. §801(1) UPA. Existence of a term: Even if there is a term for the partnership, the

partner has the right to disassociate from the partnership. However, the remaining partner/s may continue the endeavor with the use of all of the partnership property, and they can seek damages for breach. The disassociating partner is released from liability and can receive the value of his partnership interest (minus damages) in cash or bond. Pav-Saver v. Vasso Corp.

o Expiration of Term: The expiration of the term or the completion of the agreed upon undertaking. §801(2)(iii) UPA.

What is a term: There must be a substantially certain term or agreement for there to be a “term.” A simple hope of profit is not a term. However, the amount of time it takes to repay a loan or debt, if taken, can be considered a term. Page v. Page.

o Occurrence of Specified Event: The occurrence of an event that partners agreed would trigger termination of the partnership. §8.01(3).

o Unlawful Continuation: The occurrence of an event that would make it unlawful for the partnership or a substantial portion of it to continue. §8.01(4).

o Judicial Decree of Impracticability: A determination by the court that either: the economic purpose is likely frustrated; the actions by a partner make it unreasonable to carry on the partnership; or it is otherwise unreasonably impracticable to carry on the partnership. §8.01(5)(i)-(iii).

o Judicial Decree of Equity: On application by the transferee, a determination by the court that after the transfer of a partner’s interest it is equitable to wind up the partnership either after the expiration of a term (if term) or at any time (if at will). §8.01(6)(i)-(ii).

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CorporationsSTATUTES USED: Model Business Corporation Act (1984) (MBCA); Delaware General Corporation Law (DGCL), Securities Act of 1933 (’33 Act); Securities Exchange Act of 1934 (’34 Act).

Corporation Creation and Liability

Creating a Corporations, Requirements and Effects- Requirements for Creation

o Registration with State: A corporation is formed when an incorporator successfully files articles of incorporation with the states. §2.03 MBCA.

Articles of Incorporation: The articles of incorporation must include a corporate name, the number of shares the corporation can issue, the location of the corporate office and name of registered agent, and the name and address of each incorporator. §2.02(a)(1)-(4) MBCA. The articles may also include provisions consistent with other laws about:

Directors: Names and addresses of initial directors. §2.02(b)(1) Purpose: Purpose of the corporation §2.02(b)(2)(i) MBCA. Affairs: The manner in which the affairs of the corporation are

managed and regulated. §2.02(b)(2)(ii) MBCA. Powers: Definitions and limitations of the powers of the

corporation, directors, and shareholders. §2.02(b)(2)(iii) MBCA. Par value: Par value of all types of shares. §2.02(b)(2)(iv) MBCA Liability: Any imposition of personal liability on the shareholders

for debts of corporation in certain situations. §2.02(b)(2)(v)MBCA Bylaws: The corporation is required to adopt bylaws for management of

the corporation, and those bylaws can regulate any aspect of the corporation not inconsistent with the laws of the state. §2.06 MBCA.

- Effects of Incorporation – Separate Entity, Powers, Limiting Liabilityo Separate Entity: A corporation is a separate entity from its creators.o Powers: A corporation generally has the ability to act in any way an individual

could act in business. It can own and use property, sue and be sued, make contracts, incur liabilities, loan and borrow money, engage in a partnership, employ individuals, own other companies, and donate. §3.02 MBCA.

o Limited Liability: The debts and liabilities of the corporation belong to the corporation, not the shareholders. §6.22(a) MBCA. There are exceptions to this

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discussed below. Shareholders are still liable for their personal actions under the principles of tort and agency law. §6.22(b) MBCA.

Piercing the Corporate Veil, Personal Liability, and Subsidiaries- Generally: In certain circumstances, the course may “pierce the corporate veil” and hold

shareholders of the corporation personally liable for the actions of the corporation. Piercing the corporate veil is an equitable remedy, and is applied when the court feels that there has been an abuse of the privilege of the corporate structure.

o Importance of equity: It is important that there is an equitable need to pierce the corporate veil, since piercing is an equitable remedy. Courts characterize this as whether adhering to the fiction of a separate corporate existence would promote fraud and injustice.

o Abuse: Courts typically look for some form of abuse of the corporate structure. The court does this by looking a variety of factors, discussed below.

o Alter Ego: A part of abuse, courts will look to see if the corporation was essentially acting as an “alter ego” of the controlling shareholder. Courts characterize this as whether there is a unity of interest and ownership between the corporation and individual shareholder.

o Two typical situations of piercing: Courts will consider the corporate veil in two general situations: (1) to provide a remedy to a creditor who is owed a debt by an insolvent corporation; (2) to provide a remedy to a party injured by the tort of an insolvent corporation.

o Only in closely held corporations: Publicly corporations are almost never “pierced.” The issue of piercing typically arises when there are less than 9 shareholders of a corporation. Although publicly held corporations can be held liable when they are the controlling shareholders of a subsidiary that is “pierced.”

- Factors commonly considered in piercing cases: There is no absolute set of factors for piercing. None of the factors by themselves are conclusive proof that a corporation should be pierced. However, there are factors that are commonly considered by courts as evidence of abuse and alter ego:

o Undercapitalization: Inadequate capitalization of a corporation can be evidence that a corporation was purposefully insolvent, which would be evidence of abuse. Such insolvency is making excessive payments, salaries, and dividends instead of purchasing insurance or leaving assets to secure debts for creditors, which is also evidence of inequity.

o Fraud or Deception: This factor permeates the other factors. The question is whether the circumstances of the case show that the corporate structure was being used to defraud creditors or third parties. Think inequity.

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o Commingling: When a controlling shareholder’s funds are excessively commingled with the corporation’s funds, it can be evidence that the corporation is merely an alter ego of the controlling shareholder. Commingling includes using corporate funds for personal expenses, and a mixing of assets.

o Self-dealing: Abusive self-dealing by the controlling shareholder, such as excessive commingling, is evidence that the corporation is an alter ego.

o Control or Domination: Excessive control of the corporation by the controlling shareholder can support the decision to pierce. However, control in itself is not dispositive, but when alongside other misconduct, can support the decision to pierce. It also shows who should be held liable.

o Failure to follow formalities: Failure to follow formalities can substantiate evidence of commingling and self-dealing. Essentially, it can help show that the corporation was merely an alter ego of the controlling shareholder.

- Example of piercing the corporate veil: Defendant shareholder’s corporation did not pay for having items shipped by plaintiff. Defendant dissolved corporation after default judgment. Defendant was sued. Court found that defendant had several other corporations, there were no corporate formalities, there was substantial commingling of funds, the corporations were undercapitalized, and that the corporations were being operated from the same office. The court held that there was a unity of interest and owernship between the corporation and defendant. However, whether adhering to the fiction of a separate corporate existence would sanction fraud was not settled, and therefore the case was remanded. Sea-Land Services, Inc. v. Pepper Source.

- Factors particular to parent-subsidiary corporations: The issue of piercing commonly arises in issues of a parent corporation’s use of a subsidiary corporation. The basic concepts above remain the same, but there can be additional considerations:

o Whether the relationship is structure so that all of the profits of the subsidiary flow to the parent corporation. (Related to undercapitalization, self-dealing).

o Whether there is no clear distinction as to which transactions are the parent’s and which are the subsidiaries. (A subset of alter ego).

o Whether the parent does not allow the parent to have adequate capital.o Whether the board of directors of the parent make decisions for the subsidiary.

- Specific Rules for Parent-Subsidiary Piercing Cases: o No showing of fraud required in torts cases: In a tort case about breast

implants, the court stated that many times in tort cases there is no requirement of a showing of fraud. In re Silicone Gel Breast Implants Products Liability Litigation.

o Can’t pierce veil through one subsidiary for the actions of another subsidiary: In a contract breach case, the court held that where a parent corporation controls several subsidiaries, the corporate veil of one subsidiary may

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not be pierced to satisfy the liability of another. Roman Catholic Archbishop of San Francisco v. Sheffield.

o Mere non-satisfaction does not justify piercing: There must be a true inequity of not piercing; a mere inability to recover debt does not justify piercing the veil. Roman Catholic Archbishop of San Francisco v. Sheffield.

Enterprise Theory - Enterprise theory is a type of “piercing,” where the piercing goes horizontally to

pierce “sister corporations,” rather than vertically to reach the controlling shareholder.

- When it applies: When multiple corporations are used to artificially divide what is essentially one business enterprise into segments in order to unreasonably limit liability or to mislead creditors or customers. Common considerations of the court are:

o Motivation of division: Whether there was a legitimate business motivation for the division beyond a fraduldent intention to escape liability.

o Confusion: Whether customers and creditors were justifiably confused as to who they were actually dealing with.

o Commingling: Whether there is enough of a commingling of assets, personnel, trade names, and facilities that the corporations are essentially part of the same enterprise.

- Walkovszky v. Carlton: Plaintiff was injured by taxicab. Plaintiff sued corporation that owned cab, as well as nine other corporations. Plaintiff also sued Defendant, who was the controlling shareholder in each corporation. Each corporation had minimal insurance, and was operated with the same supplies, repairs, employees, and facilities.

o Still must allege a disregard of corporate form and fraud: Must show that the corporations were being operated in an individual capacity, and that the corporate structure was being abused.

Corporate Purpose and Power- Corporate purpose: Corporations have the purpose of engaging in any lawful business

permitted by the State’s incorporation statutes, as well as any more limited purpose stated in the articles of incorporation that is consisted with the statute. §3.01 MBCA.

o Primary purpose: The primary purpose of a corporation is to provide profits for its shareholders. Dodge v. Ford Motor Co.

- Express corporate power: Corporations have an express power to perform any act authorized by the general corporation law of the state and those acts authorized by the articles of incorporation.

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o Implied corporate power: Most states hold that a corporations has an implied power to do whatever is “reasonably necessary” to promote their express purposes and aid their express powers, UNLESS limited by statute or common law.

- Statutes Adding Corporate Purposes: States can add permissible corporate purposes and powers by statute. These statutes can be applied to corporations that are already in existence. A.P. Smith Mfg. Co. v. Barlow.

- Derivative Suits: Cannot use derivative suits to contest actions unless there is some element of fraud, illegality, or conflict of interest. Shlensky v. Wrigley.

Fiduciary Duties

Fiduciary Duties of Corporate Directors and Officers- In General: Directors, officers, and high level employees* owe substantially the same

duties to the corporation. It is important to note that they owe this duty to the corporation, rather than the individual shareholders, which is an important distinction when talking about derivative actions. The duties are discussed below.

o *For purposes of this section, directors, officers, and high level employees will simply be called “directors.”

- Duty of Careo General Duty of Care: Generally, directors have a duty to discharge their duties

in good faith with the care that a person in a like position would reasonably believe appropriate under similar circumstances. §8.30(b) MBCA.

Business Judgment Rule: Courts give directors the presumption that the directors have acted as a reasonably prudent person in any decision, or lack of decision.

This rule “shields” directors from having all of their decisions second guessed

Good faith: discussed below, actions under the duty of care can be violated if the directors did not act in good faith.

o Director Decisions Procedural Due Care - Duty to Consider All Material Information

Reasonably Available: Directors are required to consider all information that is material to the decision and is reasonably available. §8.30(b) MBCA; §8.31(a)(2)(ii)(B) MBCA.

Reasonable Reliance: As long as they do not have any knowledge making the reliance unwarranted, a director is entitled to rely on the opinions, reports or statements, financial statements, and other data prepared by, §8.30(e) MBCA:

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o Officers or employees believed to be reasonably competent to provide the information. §8.30(f)(1) MBCA.

o Legal counsel, public accountants, or other people retained as experts that are believed to be reasonably competent to provide the information. §8.30(f)(2) MBCA.

o A committee of the board of directors which the director is not a member if it is reasonably believed to be competent to provide the information. §8.30(f)(3) MBCA.

Substantive Due Care – Corporate Waste: The decision itself can be challenged only if no reasonable business person could have made the decision. The decision must be unconscionable to the point where directors squandered corporate assets.

Extremely high standard: This standard will almost never be satisfied, and is largely considered a gross negligence standard.

Ordinarily whether a dividend is declared is a matter of business judgment, and therefore is protected by the business judgment rule. Kamin v. American Express Co.

If there was a rational basis for the decision, even if the decision was wrong, then it will not violate due care. Many different considerations can be considered a rational basis. Shlensky v. Wrigley.

o Director Inaction In general: The following principles apply specifically to instances where

there was no action or decision by the directors. The concepts above still apply. Where there is no action by the directors, the directors must still be aware of information that would have caused it to take action if action was necessary.

Relying on Information from Others: The principle discussed above permits directors to rely on the information given by others.

Monitoring System: Case law has suggested that directors have a duty to install a monitoring system to enable it to better discharge its oversight obligation. In re Caremark Litig.

Relying On Performance of Others: As long as they do not have knowledge making reliance unwarranted, a director can rely on the performance by any other the §8.30(f)(1)-(3) persons that the board has formally or informally delegated a function of the board that is delegable under applicable law. §8.30(d) MBCA.

- Duty of Loyalty

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o In General: Duty of loyalty issues involve situations where a director has a conflict of interest that has impacted their action or lack of action, or has caused them to take a corporate opportunity away from the corporation for himself.

o Interested Director Transactions Interested Director: a director is interested in a transaction if they have a

financial or familial interest at stake outside of role as director, or the director is dominated or controlled by an individual with a material interest at stake in the challenged conduct.. §8.31(iii) MBCA.

Red Flags: When a director is on both sides of a transaction, when he receives financial gain outside of his position as director, etc.

No Business Judgment Rule: The business judgment rule does not protect the decisions of interested directors. Lewis v. S.L. & E, Inc.

Disinterested Majority/Fairness Rule: With the directors bearing the burden of proof, the directors can avoid liability for a transaction involving a conflict of interest if either there was:

Disclosure and disinterested voting: the director disclosed his conflict of interest to the directors/shareholders and either: (1) a majority of disinterested directors approved the transaction, §144(a)(1) DGCL; or (2) shareholders approve transaction in good faith, §144(a)(2) DGCL.

OR Transaction was fair: the transaction was approved by the board of directors, a committee, or the shareholders, AND the director can show that the transaction was fair. §144(a)(3) DGCL.

o Usurpation of Corporate Opportunity General rule: A director may not take a corporate opportunity for himself

if the opportunity, Broz v. Cellular Information Sys., Inc.: (1) is one which the corporation is financially able to undertake; (2) is in the line of business of the corporation; (3) is of practical advantage to it, AND (4) is one in which the corporation has and interest or

expectation; No formal requirement of disclosure: There is no formal requirement

that the director disclose the opportunity to the board. If the above requirements are met, the director can pursue it. However, disclosure can create a safe haven down the road.

Where opportunity comes from: Whether or not a director should disclose depends in part on where the opportunity came from. If the opportunity came from the director’s individual/personal capacity, he will not have to disclose it. If it came from his director capacity, he most likely should disclose it.

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Other approaches: The general rule above is the Delaware court’s approach. Other tests include: interest and expectancy test, line of business test, fairness test, and the two-step test (interest + fairness).

- “Good Faith”

o Good faith is not a separate fiduciary duty that has the same grounds of liability as care and loyalty, but it is a duty that can impose indirect liability. Stone v. Ritter.

o Why does it matter: Damages for liability for duty of care violations can be limited by corporate provision, see §102(b)(7) DGCL, but they CANNOT be limited for duty of loyalty violations. Therefore, good faith allows plaintiffs to recover against directors for disloyal duty of care violations.

o Subset of Loyalty: Good faith is a condition of loyalty, and therefore actions that are in bad faith can be thought of as questions of loyalty. Stone v. Ritter.

o Connecting Care and Loyalty: Questions of the duty of loyalty are traditionally limited to cases of conflicts of interest and usurpation of corporate opportunity. “Good faith” brings events that would ordinarily only be under the duty of care into play with the duty of loyalty. Essentially, a director cannot fulfill their duty of loyalty if they fail their duty of care in bad faith.

o Scope of “bad faith”: There is a range of what constitutes “bad faith,” but what is important to remember is that it does NOT include simple gross negligence. The range was described in In re the Walt Disney Co. Derivative Litigation:

Subjective bad faith: This is classic bad faith – fiduciary conduct motivated by an actual intent to do harm.

Intentional Dereliction of Duty: This is above gross negligence but below subjective bad faith – it is a conscious disregard for one’s fiduciary responsibilities.

Actions that are not per se disloyal, but are the result of more than a simple inattention or failure to be informed.

Examples: intentional failure to act in face of duty to act, intentional act to violate law,, intentional action with purposes other than those advancing corporate interests.

Fiduciary Duties of Controlling Shareholders- Shareholders’ Duties in General: Shareholders in general do not owe any duty to the

corporation or other shareholders.- Controlling Shareholder: Controlling shareholders are shareholders that have de facto

control over the board of directors, which usually comes from being a majority shareholder.

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- Controlling Shareholder’s Duties: Controlling shareholders owe a duty to the corporation and the minority shareholders. These duties are not parallel to the director’s duties, but rather are circumstance-specific.

- Dealings Between Parent and a Subsidiary: A corporation that has a controlling interest in a subsidiary has a duty in any transaction where there is self-dealing between the parent and the subsidiary. The parent controlling shareholder violates the duty if

Derivative Actions

The Governance Dilemma, Derivative Suits in General- The Dilemma: Directors control the actions of a corporation. When a corporation is

injured by those directors, the corporation can sue the directors. But since the directors are controlling the actions of the corporation, it is unreasonable to expect them to allow the corporation to sue them (they would be suing themselves). Therefore, the courts have developed the derivative suit process in which the shareholders can compel the corporation to sue the directors.

- Derivative suit: A derivative suit is an equitable procedural process in which a single shareholder can sue on behalf of the corporation, essentially compelling the corporation to enforce its right to sue the directors.

o Suit within a suit: Conceptually, the derivative process its own law suit within the law suit against the directors. The initial derivative action is a suit in equity, where the court allows the shareholder to enforce the right not being enforced by the directors. The second substantive part is the suit against the directors.

- Shareholder’s role: the shareholder is not suing on behalf of their own right or other shareholder’s rights; rather, they are acting as an enforcer of the corporate right. Usually, the recovery from such a suit belongs to the corporation, not directly to the shareholder

- Direct v. Derivative Actions: A direct suit is when the shareholder is suing the corporation to enforce their right as a shareholder, either individually or as a representative of a class of shareholders.

o Essence of Claim Determines Nature: The distinction relies on the essence of the claim – whether it is based on harm to the corporation (derivative), or whether it is based on a harm directly affecting the value of shares (voting, dividends, etc.)

o Decline in Share Value Not Enough: Courts have consistently held that a decline in the value of shares resulting from a harm to the corporation does not create a direct right of action in itself (can’t transform derivative into direct).

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Demand Requirement- Demand Requirement In General

o Demand: In general, the shareholder must show that the directors have had some opportunity to file suit on behalf of the corporation before the shareholder is granted the equitable right to file suit on behalf of the corporation.

Board Complies: If the board complies to the demand, then they will file suit and therefore there is no need for a derivative action.

Board Rejects: If the board rejects, then they have made a business judgment that the suit would not be in the best interests of the corporation.

Protected decision: The decision to reject the demand is protected by the business judgment rule, and will be upheld as long as it was in good faith and made by a disinterested majority. Grimes v. Donald.

o Demand Excused Due to Futility: In the alternative, many jurisdictions also allow a shareholder to claim that making such a demand would be futile, and therefore the demand requirement should be excused.

- Delaware Approach to Excusalo Two-Part Test: For demand to be excused, the shareholder must allege

particular facts that tend to show that either Grimes v. Donald: The board is not disinterested or independent (duty of loyalty);

Directors have a material/familial interest Directors are dominated or controlled.

OR the challenged transaction should not be protected by the business judgment rule (refers to the substantive transaction which would be contested in the derivative action).

- New York Approach to Excusalo The NY Courts have a modified excusal test that is somewhat broader than the

Delaware approach, Marx v. Akers. The demand will be excused if the plaintiff alleges particular facts that tend to show:

A majority of the board is interested in the challenged deal; The board did not fully inform itself about the challenged deal; OR the challenged deal was so unfair on its face that it could not have

been the product of sound business judgment.- Universal Demand Approach

o The MBCA requires that all derivative suit plaintiffs make written demand on the directors MBCA §7.42.

o If demand is rejected: If the demand is rejected, the plaintiffs must plead particular facts that show that the board was not disinterested, OR that the rejection was not in good faith. MBCA §7.44.

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Special Litigation Committees- Corporations have developed a response to avoid derivative litigation and maintain

control over any suits on behalf of the corporation/against the corporation.o Foundation: Corporate directors have the governance power of forming special

committees to deal with particular areas of governance.- “Innocent Minority”: In response to derivative litigation, boards can create a committee

consisting of some or all of the directors not implicated in the alleged wrongdoing and gives them the power to decide if the corporation should pursue a lawsuit against the implicated directors.

o Composition of Committee: The committee is always composed of directors who have no connection to the contested transaction, and many times has directors who are completely new to the board.

o Investigation: The directors, along with lawyers and other experts, investigate the merits of the case, projected costs, and potential benefits.

o Report: The committee then submits a written report to the court about its suggested action.

o Motion to Dismiss: the corporation’s attorney will then submit a motion to dismiss on behalf of the corporation.

- Court’s Treatments of Motion to Dismiss: Courts have developed rules (based of their general treatment of derivative actions) on how to deal with motions to dismiss entered by special litigation committees:

o Delaware Approach: Court applies a two part test only in situations where demand has been excused. Zapata v. Maldonado:

(1): The defendant directors must prove the committee member’s independence and the procedural completeness of the investigation;

(2): If the first prong is satisfied, the court exercises its own business judgment in determining whether or not it is in the corporation’s best interest to dismiss the lawsuit.

o New York Approach: Unless the plaintiff can prove that the special litigation committee lacked independence or failed to operate on an informed basis, the committee’s recommendation is protected by the business judgment rule.

Court examines the investigative process (regular meetings, relying on experts, detailed record of findings)

Court looks to see if there is a rational basis for their recommendation.

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General Securities Regulation, Fraud, Insider Info

Securities Regulation in General, Rule 10b-5- Scope of SEC Regulation: SEC regulatory statutes protect shareholders as investors, and

focuses on their rights in regards to buying or selling stock.o Securities Act of 1933: Regulates the primary market of stock (the corporation

selling to investors).o Securities Exchange Act of 1934: Regulates the secondary market of stock

(investors selling stocks to each other).o Promulgated Regulations: Under either of the acts, the SEC has promulgated a

series of “rules” that regulate the stock industry.- Rule 10b-5: This rule is under the ’34 Act, and is the most widely used tool in securities

and general corporate law. o Rule 10b-5 makes it unlawful to, in the connection with the purchase or sale of

any security: Employ and device, scheme, or artifice to defraud; To make an untrue statement, or omit a statement, of material fact in

circumstances that would make such a making/omission misleading; OR to engage in any act, practice, or course of business which operates

would operate as a fraud or deceit upon any person.o A violation of the rule gives rise to a private right of action.o Applies to any party: the rule applies to anyone, whether part of the corporation

or an individual seller, who commits a fraudulent act in the sale of securities.o Applies to any transaction: the rule applies to any purchase or sale of securities,

no matter how big or small.o Fraud: although the rule defines the situations it applies in, the type of fraud that

the rule applies has been determined on a case to case basis by common law. There are two very common situations:

Securities fraud cases: These are cases where someone lies, makes misrepresentations or false statements, or promulgates phony documents in the purchase or sale of securities.

Insider trading cases: These are cases where someone buys or sells securities based on information that is only available to an “insider.”

Securities Fraud Cases- The basis of these cases is that there was some misrepresentation. There are common

elements/requirements to all of these cases, discussed below.

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- Jurisdictional means: Any use of mail or telephone at any time in the purchase or sale of securities will allow the courts to apply Rule 10b-5, regardless if it is interstate.

- Fraud: Any of the “fraud” covered in the Rule 10b-5 provisions is sufficient.o No requirement of “evil motive”: There is no requirement that the lie or

misrepresentation be made with an evil motive, just that a lie or misrepresentation was made with intent to lie or misrepresent. Basic Inc. v. Levinson.

o Types of Lies: Many form of statements can constitute fraud. Lies: Making an assertive statement that is simply not true is always

considered a fraudulent misrepresentation. Half-truths: Statements that are true, but that omit a fact that is necessary

to make the statement non-misleading, can be fraudulent. Opinions: “soft information” such as opinions or projections can be

fraudulent if the person making the statement knew there was no rational basis for the opinion.

Bespeaks caution: The person making the statement can create a safe harbor if they make detailed, reasonable, and specific cautionary statements in good faith about the opinion.

Non-disclosure: Silence in the face of an affirmative duty to speak can be considered fraudulent.

Not about fiduciary duties or fairness: Case law has clarified that Rule 10b-5 is about disclosure, not about duties or fairness.

- Materiality: A fact is material if there is a substantial likelihood that a reasonable investor would find the fact important in deciding whether or not to buy or sell a security

o Probability x Magnitude: In regards to the materiality of whether future events would occur, the court balances the probability of the event occurring with the magnitude of the event if it does occur at the time of the transaction. Basic Inc. v. Levinson.

- Culpability/Scienter: There must be some intent to deceive, beyond simple negligence, to make a material fraudulent statement/omission.

o Again, no evil motive: Scienter does not require that there was bad faith, evil motive, or malice in the making/witholding the statement.

o Reckless is the floor: The lowest level of Scienter is “recklessness,” which means that the person spoke without qualification, and knowing that they did not know whether what they were saying was true or false.

- In Connection with Trade of Securities: Fraud must be a “proximate cause” of the purchase or sale of securities.

- Standing: Plaintiff must have bought or sold securities, cannot have not bought securities- Causation/Reliance: there are two general theories of causation in fraud cases.

o Loss causation: The fraud must have caused or materially contributed to the pecuniary losses of the plaintiff.

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Consider intervening causes: In these situations, you must also examine whether there was another cause of the losses, or whether the losses even happened because of the fraud.

o Transaction causation: The plaintiff relied on the fraud to enter into a transaction which then caused them harm. Generally, the plaintiff must show that they were aware of the fraudulent statement and that they relied on it.

Widely traded securities: In cases where the security at issue is widely traded, there is a rebuttable presumption of reliance. The plaintiff does not have to show personal reliance on the fraudulent act, rather it is assumed that the market price itself relies on such statements and therefore the plaintiff did to. Basic Inc. Levinson.

- Damages: The goal of damages under Rule 10b-5 is compensation. Punitive damages are not available.

Insider Trading- Insider Trading: A circumstance where an “insider” (an officer or director of a

corporation, an employee, or an associate in a law/accounting firm for the corporation) acquires material information about the company (can be good or bad, that will move the stock up or down), that is not available to the public, and acts upon that information (either by personally buying/selling or tipping off a third party).

- Always dealing with a lack of disclosure in insider trading cases.- Insider trading can be dealt with under state law or under Rule 10b-5.- Under State Law

o There is no liability for insider trading except under the special facts doctrine. Under this doctrine, an officer or director is under an affirmative duty to disclose special facts when buying shares from existing shareholders.

Only applies to directors or officers. Only applies to purchases or sales from existing shareholders. Any material information triggers the doctrine. Only applies to face to face transactions (privity).

- Under Federal Lawo §16(b) ’34 Act Recovery: This section imposes strict liability on any director,

officer, or 10%+ shareholder of the company who makes a profit from a purchase/sale--sale/purchase within a six month period.

Only applies to companies registered under ’34 Act. Only applies to certain individuals. No requirement of wrongdoing or intent.

o Rule 10b-5: Rule 10b-5 has been applied to insider trading to prevent insiders from trading on information that is not available to the public.

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Disclose or Abstain Rule: Anyone in possession of material non-public information has a duty to disclose that information before trading in the stock. SEC v. Texas Gulf Sulphur Co.

Fiduciary nexus between trader and source: Rule applies when there is a “nexus” between the inside trader and the other party to the transaction.

Misappropriation: Rule applies when the inside trader vilaters a fiduciary duty owed to the source of the information.

Rule doesn’t apply: to those who through persistent analysis dig up information, or those who have the information come to them through luck.

“Tippees”: Third parties who receive insider information (think golf buddy) can be held liable for acting on such information, if they satisfy the personal benefit test:

The tipper breached a fiduciary duty AND the tipper tipped the tippee in the hopes of receiving some

personal benefit from the tippee (can include personal relationship) Applies all the way down the chain of tippees.

Public Corporation Governance, Proxy Issues

Basic Statutory Scheme- Board of Directors: the board of directors has been given powers by the corporate

statute to make decisions and take certain actions as a body.o Officers: officers perform the day to day management of the corporation, and get

their power from the directors, who delegate certain matters to them.- Shareholders: shareholders own the corporation, but their ownership is separated from

the control of the corporation. They only exercise control over certain fundamental transactions, but the management is controlled by the directors. One important right is their ability to elect directors, as well as their right to information.

- “Flow of Power” Concept: The structure is based on the notion that authority flows from ownership to officers. The shareholders elect the directors, who manage the corporation, and also hire the officers who run the corporation. It is loosely based on a principal-agent relationship. However, as will be discussed below, in publicly held corporations this model is not necessarily accurate.

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Basic Mechanics of Shareholder Voting- Annual Meetings: an annual shareholder meeting at which the board of directors is

elected and other regular business matters are discussed. §7.01 MBCA.- Special meetings: meetings that, depending on the bylaws, are called in response to

specific issues that need shareholder approval. §7.02 MBCA.- Voting by shares: Unless the articles of incorporation provide otherwise, each share is

entitled to one vote. §7.21 MBCA, §212 DGCL.- Voting through proxies: Shareholders are permitted to vote by proxies. That is, they

can allow another person to vote their weight of shares. §7.22 MBCA, §212 DGCL.

Publicly Held Corporations, Realities of Governance- Problem with the “Flow of Power” Concept: In publicly held corporations, the concept

described above is not always reality. First, shareholders are very disconnected from the corporation – they cannot oversee the activities of the corporation, and they have no power to manage the corporation’s affairs. This problem is exacerbated by the shortcomings of directors – who are supposed to be acting in the interests of the shareholders. Directors cannot always manage the officers: many directors only work part time, they in large part rely on the officers for information, and many times they are friendly with the CEO, and therefore give too much trust to the officer.

o Consequence: Many times, the officers end up being able to de facto control the corporation. This is a problem because they have a conflicting interest – they want high levels of compensation for less work, while the corporation wants high levels of work for less compensation.

Proxy Issues and Fights- Importance of Proxies: Most shareholders do not attend the shareholder meetings, and

therefore proxies important for two reasons. (1) proxies are usually the only way to obtain a quorum; (2) whomever gets the most proxies should be able to control decisions.

- Solicitation of Proxies: The SEC has the power to regulate proxy solicitation for all ’34 Act registered companies under §14(a) ’34 Act, and has promulgated several rules (Rule 14a). There are certain requirements for solicitation, discussed below:

o Proxy statement: a comprehensive disclosure document that accurately and truthfully provides all information relevant to matters to be voted upon. 14a-3.

o Proxy card: The proxy card must allow the shareholder to indicate whether they approve or disprove of a matter, or abstain from voting. 14a-4(b)(1).

o Disclosure to SEC: Definitive copies of proxy statement or proxy card must be provided to SEC at or before time they are mailed to shareholders. Preliminary disclosure if matter is other than director elections/shareholder proposals. 14a-6.

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o Shareholder proposals: Any shareholder with $1,000 worth or 1% of voting securities can call for a referendum on shareholder raised issues. However, directors may exclude certain proposals from proxy statements, 14a-8(i):

Proposals contrary to state law (such as proposals relating to a particular management function within the directors authority);

Proposals that violate the law or rules of the SEC; Proposals that relate to the election of directors;

Proposals that relate to the amending the bylaws to require certain shareholder director candidates be included in the proxy materials are not considered to be “related to an election.” AFSCME v. AIG

Proposals that relate to personal claims or grievances, or to the furtherance of the shareholder’s personal interest;

Proposals that relate to operations that account for less than 5% of the company’s business, unless it is otherwise significantly related to the corporation’s business;

Proposals relating to significant ethical and social concerns, and other non-economic concerns, can still be considered to “otherwise significantly relate to business.” Lovenheim v. Iroquois Brands

Proposals similar to proposals that have been submitted within the last 5 years and failed to receive a certain amount of votes; or if it is duplicative of a current proposal; or if it conflicts with the corporation’s proposal.

- Proxy Fights: Gathering proxy votes can become a “fight,” especially when the election of incumbent directors is being strongly contested by other shareholders. Both sides typically resort to campaigning, and it usually comes down to who can collect the most proxy votes from disinterested shareholders.

o Liability for false or misleading statements: The SEC prohibits proxy solicitation where there are false or misleading material statements. 14a-9.

o Use of corporate funds: Incumbent directors are allowed to use corporate funds in their proxy solicitation, as long as the funds are not excessive and there is full disclosure to the shareholders of the use. Levin v. Metro-Goldwyn-Mayer, Inc.

Closely Held Corporations

Closely Held Corporations in General- Same duties: Directors, officers, and control shareholders are subject to the same

traditional fiduciary duties that directors, officers, and control shareholders in publicly held corporations.

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- Heightened Standards: As will be discussed below, some courts have created heightened standards for closely held corporations about the way that controlling shareholders treat minority shareholders in the business decisions.

o Why?: Corporate fiduciary duties focus on the duties owed by the management to the corporation. Partnership law focuses on the way partners treat each other in respect to their business. Courts have recognized that closely held corporations in many ways resemble partnerships just as much as public corporations. Therefore they have developed standards to help protect shareholders in a closely held corporation much like partners in a partnership.

Governance of Closely Held Corporations- Statutory Scheme: The statutory scheme, discussed above, in theory still applies to

closely held corporations. However, unique problems arise in closely held corporations because many times the same people fill the roles of directors, officers, and shareholders.

- Governance problems: Typically problems arise in governance when individuals abuse their roles in attempting to control board decisions, control voting by other shareholders, control the transfer of shares, or abuse minority shareholders.

o Attempts to control board decisions: Many times shareholders of close corporations will enter into agreements about future actions, sometimes making agreements about what they will do as directors, not just shareholders.

Can agree to shareholder actions, not director actions: When individuals acting shareholders, make some agreement, they can agree to elect each other as directors, BUT they cannot agree to what they will do as directors, since it would conflict with the statutory authority of the board of directors to manage the corporation. McQuade v. Stoneham.

o Control of Shareholder voting: Agreements among shareholders about how they will vote (usually for directors) are valid, and are enforceable under regular contract law. §7.31 MBCA, Clark v. Dodge.

Heightened Duties for Controlling Shareholders- Specific to Closely Held Corporations: As mentioned above, controlling shareholders

in closely held corporations owe a fiduciary duty to the minority shareholders that largely resembles the partnership duties. There are two basic situations that this duty arises in.

o More Why: The court recognizes that shareholders many times derive their economic benefit from salaries as officers/directors, not through dividends. Also, that shareholders are typically involved in the running of the corporation, and are not “disinterested” like most shareholders in public corporations.

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- Actual Majority: When there is an actual majority, the majority is under a duty to not take action that results in “freezing out” the minority shareholders from exercising reasonable influence on control and receiving a reasonable economic benefit.

o Legitimate Purpose: Majority must show that there was a legitimate business purpose for their action. Wilkes v. Springside Nursing Home, Inc.

Courts will expect the majority to consider certain things, such as the minority’s loss of all value of their shares, their initial involvement and role in organization of the company, and the minority’s reasonable expectations.

o Less Harmful Means: If the majority does show a legitimate business purpose, the defendant can still show that there was a less harmful means that would have still achieved the legitimate business purpose. Wilkes v. Springside Nursing.

- Ad Hoc Majority: The above principles can also apply to situations where a minority shareholder is able to act as a controlling shareholder, such as when they have the veto power. The minority shareholder can only use this power to serve a legitimate business purpose. Smith v. Atlantic Properties, Inc.

- Remedies: The remedies for such breaches are hard to develop, but they should only seek to restore the reasonable expectations of the disenfranchised shareholder since the court is acting in equity. Brodie v. Jordan.

o Injunctive reliefo Damages (careful to only give damages to the extent of the disenfranchised

shareholders reasonable expectations – don’t want to create an artificial market for the shares that would exceed their expectations.

o Involuntary dissolution §14.30 MBCA.

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