Goshen - Corporations - F 13

Corporations
Goshen, Fall 2013

Outline

Table of Contents
Attack Sheet of the Standards of Review ................................................................................... 2
I. Entire fairness rule ................................................................................................................................. 2
II. Entire fairness + shift of burden ...................................................................................................... 2
III. Blasius standard .................................................................................................................................... 2
IV. Revlon standard ..................................................................................................................................... 2
V. Unocal standard ...................................................................................................................................... 3
VI. Negligence or Gross negligence ...................................................................................................... 3
VII. Business judgment rule .................................................................................................................... 3
Overview of Corporate Law and Corporate Finance ............................................................. 5
VIII. The Separate Legal Entity .............................................................................................................. 5
IX. Agency problems: ................................................................................................................................. 5
X. The Corporate Form .............................................................................................................................. 6
XI. The Capital Structure .......................................................................................................................... 8
XII. Introduction to Finance: Expected Return and Risk ............................................................ 9
XIII. Limited Liability .............................................................................................................................. 11
Creditor-Shareholder Agency Problem .................................................................................. 13
I. Protections of Creditors ..................................................................................................................... 13
Shareholders-Management Agency Problem ....................................................................... 15
I. Fiduciary Duties .................................................................................................................................... 15
II. Duty of care ............................................................................................................................................ 16
III. Duty of Loyalty .................................................................................................................................... 18
Shareholders-Controlling Owners Agency Problem .......................................................... 21
I. Duty of Loyalty of Controlling Owners ........................................................................................ 21
II. Shareholder Voting & the Board ................................................................................................... 23
III. Shareholder Voting & Proxy ......................................................................................................... 26
IV. Transactions in Control ................................................................................................................... 27
V. Mergers & Acquisitions: Structure .............................................................................................. 29
VI. Mergers & Acquisitions: Appraisal Rights .............................................................................. 34
VII. Mergers & Acquisitions: Hostile Takeovers ......................................................................... 36
Securities Regulation .................................................................................................................... 41
I. Efficient Markets ................................................................................................................................... 41
II. Securities Exchange Act 10(b) and SEC Rule 10b-5 ......................................................... 42
III. Insider trading .................................................................................................................................... 42

Legend:
From Class or From Reading & Discussed in Class
From Reading Only

Corporations Goshen, Fall 2013

Outline

Attack Sheet of the Standards of Review

From strictest standard to least
I. Entire fairness rule
a. Triggered by conflicted transaction
b. Triggered by Kahn v. Lynch exception: even if independent committee or
disinterested shareholders approve, if controlling owner still controlled the
terms/bargaining, then the burden does not shift
c. Requirements: conflicted party must establish all 3 to pass the standard
1. Fair dealing
2. Fair price
3. Transaction was in the interest of the corporation
II. Entire fairness + shift of burden
a. Triggered by a conflicted transaction by a corporation with a controlling
owner, but the transaction was accompanied by disclosure and approval by
the disinterested directors
b. Triggered by a conflicted transaction by a corporation with a controlling
owner, but the transaction was accompanied by disclosure and approval by
the disinterested shareholders
c. Exception: Kahn v. Lynch
d. Standard of review: The burden of establishing breach of entire fairness
shifts to the plaintiff
1. Its basically BJR, considering its quite hard for a plaintiff to try to prove
entire fairness
III. Blasius standard
a. 2 views of when Blasius standard is triggered:
1. Whenever the Board attempts to affect voting rights (easier to establish
compelling justification)
2. Whenever the Board unilaterally effectuating a change to the detriment of
the shareholders (virtually impossible to establish a compelling
justification)
b. Standard of review: Compelling justification
1. Requirement: At the very least, the justification in Blasius itself wasnt
enough
IV. Revlon standard
a. Triggered by a sale of control: When the break-up of a corporation is
inevitable, the duty of the corporations board of directors changes from
maintaining the company as a viable corporate entity to maximizing the
shareholders benefit when the company is eventually and inevitably sold
b. Triggered by stock-for-stock sale of control, depending on the circumstances:

Outline

1. If the resulting merger is a dispersely owned corporation, meaning that
the shareholders of the target end up being dispersed shareholders in the
acquiring corp, then Revlon doesnt apply (Paramount v. Time Warner)
2. But if the target ends up as minority shareholders, then Revlon does
apply because this is a sale of control because theres no guarantee that
the hidden value, future gains, etc. will be recognized (Paramount
Communications Inc. v. QVC)
c. Standard of review: negligence, i.e. whether the corporations actions were
reasonable
V. Unocal standard
a. Triggered by: If you meet the Unocal 2-prong test, then BJR applies to the
Boards action
1. Directors must show that they had reasonable grounds for believing that
a danger to corporate policy and effectiveness existed
i. Satisfied by demonstrating good faith and reasonable investigation
2. Demonstrate that their defensive response was reasonable in relation to
the threat posed
i. Evaluation: the defensive response cannot be preclusive or coercive
(Unitrin, Inc. v. American General Corp.)
A. Preclusive: Measure precludes acquisition
B. Coercive: forces managements preferred alternative on
stockholders
VI. Negligence or Gross negligence
a. Triggered by failing (i)-(ii) of the BJR requirements
b. Triggered by claim of omission
1. If subjective bad faith involved: 102(b)(7) unavailable
2. If no subjective bad faith: 102(b)(7) available
VII. Business judgment rule
a. Triggered by: If you meet all 4, the BJR applies
1. Action
2. Informed
3. Good faith
4. No conflicts
b. Failure of the above factors
1. If you fail (i)-(ii): Standard shifts to gross negligence, and 102(b)(7)
exempt provision is still available
2. If you fail (iii): Standard depends on how you failed (iii)
i. If via subjective bad faith, then you are subject to duty of loyalty and
102(b)(7) is unavailable
ii. If via conscious disregard of duty (Chancerys definition), then you
lose 102(b)(7) protection
3. If you fail (iv): It takes you away from duty of care and you will be judged
by duty of loyalty, which also means you dont get 102(b)(7)


Outline

c. Triggered by conflicted transaction + approval by disinterested directors
d. Triggered by conflicted transaction + approval by disinterested shareholders
1. Adjustment: BJR based waste
2. Standard: shareholders can approve any transaction, but only if there is
no waste
3. Waste:
e. Triggered by corporation with a controlling owner who makes a transaction
but the transaction was not self-dealing
f. Triggered by meeting the 2-prong Unocal test
g. Standard of Review: Rationality
1. If you fail the BJR, meaning the action was irrational, you still must
consider bad faith
2. If no bad faith, then still no liability

Outline

Overview of Corporate Law and Corporate Finance

VIII. The Separate Legal Entity
a. Corporation components
1. Consumers
6. Managers
2. Suppliers
7. Other corporations
3. Employees
8. The public at large
4. Creditors
9. The government
5. Shareholders
b. Interaction of corporations components with the law
1. Employees: covered in theres labor law
2. Consumers: product liability law, contract law, tort law, etc.
3. Suppliers: Contract law, tort law, secured interest
4. Government: Mostly tax law, legal licenses (banks, insurance co., etc.)
5. Public: Environmental protection
6. Other corporations: Anti-trust law regulating competition, IP law
7. Management: covered in corporate law
8. Shareholders: covered in corporate law
9. Creditors
i. When the business is healthy: covered in corporate law
ii. When the business is bankrupt: covered in bankruptcy law
c. Corporation
1. A separate legal entity, separate legal personality
2. Management is doing the thing i.e. performing the actions, but its in fact
the corporation whos really doing that thing
3. Theres nothing to prevent a person from being multiple things at the
same time (i.e. 1 person can be employer, employee, shareholder,
director, and creditor) (Lee v. Lees)
4. Determining if someone is an employee
i. Writing
iii. Contract
ii. Verbal
iv. According to behavior
5. Key concept: ownership is separate from the corporation as an entity
i. The corporation, as an entity, may deal with the owner which can still
be recognized as a two-party transaction (Salomon v. Salomon, Inc.)
IX. Agency problems:
a. Three major agency cost problems in corporate law (Principal-Agent)
1. Shareholders-Management (includes directors)
2. Creditors-Shareholders
3. Shareholders-Controlling Owners
b. 3 types of solutions to the agency problems
1. Structural solutions
i. E.g. Form a Board of Directors who will monitor management, as part
of the structure of the corporation

Outline

ii. E.g. Require an external auditor to audit the reporting of the
corporation
2. Legal solutions: corporate law
i. Deals with the agency problems mostly by placing fiduciary duties
over management, directors, and controlling owners
3. Market solutions
i. 3 types of markets, each which restrain agency problems:
A. Product market: e.g. if you were Nokia and sat on your thumbs
while the iPhone came out, youre screwed
B. Capital markets: Mismanagement will affect the companys ability
to raise more money, and will impact performance
1) This market primarily controlled by securities regulation (see
Securities Regulation below)
C. Market of corporate control: If you mismanage, then someone may
come in and take over the company and run your corporation
X. The Corporate Form
a. Corporation process
1. Corporation files Charter/Articles of Incorporation/Certificate of
Incorporation
i. Essentially the constitution of the corporation
ii. Mandatory sections
A. Name of corporation
1) Limitation: Cant be misleading or already taken by someone
else
2) Otherwise, very flexible
B. Authorized shares (discussed in the second half of class today)
C. Registered agents
D. Name(s) of incorporator(s)
E. Statement of purpose
F. Grants of directors
1) 102(b)(7): Except in the case the directors are negligently
liable, they are exempt from liablity to pay compensation to the
corporation
iii. Other sections: Normally dont add much more beyond the mandatory
sections
2. Corporation sends charter to the office of the Secretary of State
3. Once the filing is complete, corporation exists
4. Corporation holds its first board of directors & shareholders meeting:
Normally, those who incorporated will appoint themselves in the first
meeting as directors
i. Corporation creates its bylaws: Very detailed document that includes
all elements regarding management of the corporation (how to hold
shareholder meetings, choosing directors, etc. etc.)
b. Changes to the charter

Outline

c.
d.
e.
f.
1. Consent from the board of directors

2. Shareholder approval
i. Model Business Code: Majority of those involved at the meeting
ii. DE Law: At least 51% of all shareholders
3. Re-file the change
4. The change in the charter cant be done unilaterally by only the board or
only the shareholders
Changes to the bylaws (DE Law): Changes can be changed by either of the
below
1. Shareholders
2. Board of directors, if they have authority to do so in the charter
3. If someone changes the bylaws by the directors, its up to the court to
decide abuse
4. Significance of this consideration: Becomes crucial during hostile
takeover situations
Hierarchy of authoritative documents of a corporation
1. Corporate law
2. Charter
3. Bylaws
Layers of governance
1. First layer: State law (e.g. Delaware law)
2. Second layer: Federal law, i.e. securities regulation, and relates mostly to
disclosure
i. Securities Act of 1933
ii. Securities Exchange Act of 1934
3. Third layer: Stock exchange
i. When corporations are choosing where to trade, every exchange has
rules for the means of which to trade
ii. Structure of the board, independence requirements, committee
requirements, etc.
4. Fourth layer: Private ordering
Preference for DE Incorporation
1. DE competes globally for incorporation, i.e. incorporation is its product
2. Up to 1911, NJ was formerly the dominant state of incorporation
3. Theories why DE is so successful in attracting incorporations
i. Race to the bottom: states, who are in the market of selling
corporate charters, will promote management-friendly corporate law,
and since, practically speaking, management chooses the state of
incorporation (even though its supposed to be a decision by the
shareholders; normally they just rubber stamp the decision), the
states are exacerbating the shareholders-management agency cost
ii. Race to the top: If the states law unduly favored managers,
shareholders in that states corporations would earn lower-than-
normal returns, and the states corporations therefore would have a
higher cost of capital, which would either bankrupt most of the states
7

Outline

corporations or cause the ouster of management through the market
in corporate control; therefore managers wouldnt possibly choose a
state who unduly favors managers
iii. Goshens conclusion: There is no difference between DE companies
and non-DE companies, but there certainly isnt a race to the bottom
4. Why other states dont compete with DE: the breadth of case law, the
system already ingrained on the law school curriculum, the need for
something very very wrong and costly to happen to DE in order to justify
the move
g. Authorized shares charter requirement
1. Authorized shares: the maximum number of shares the corporation can
issue
2. Shares can have some currency value to each share, or no share value
3. Importance of currency value: that specific share cannot be issued at a
price below the indicated share value
4. Board has the authority to issue the shares
i. Implications:
A. Board hypothetically has the ability to turn a dominant
shareholder into a minority shareholder, granted there are enough
remaining unissued shares
B. The larger the number of authorized shares, the bigger the
discretion youre giving the Board to control the shareholders
5. Outstanding shares:
i. Shares that are in the hands of the shareholders
ii. Only these shares that are important when thinking about the
allocation of power, votes, dividends, etc.
6. Companys process of buying back shares, i.e. treasury stock
i. Consequence: those shares bought back are now just pieces of paper,
and no longer ownership units, i.e. outstanding
ii. Basically, they go back into the pot of unissued shares
XI. The Capital Structure
a. Different classes of shares
1. Normally in charter, Board is given discretion to create different classes
2. A share represents a claim against the corporation for 3 things:
i. Claim to vote
ii. Claim for dividends
iii. Claim for final dividend, i.e. whatever remains after liquidation
3. The Board may create classes involving any mixture of those rights (e.g.
making a share thats 10x vote rights, 0x dividends rights, 5x liquidation
rights, etc its up to the Board)
b. Equity interest: sometimes thought of as residual interest, i.e. the claim to
what is left after all senior claimants have been satisfied
c. Preferred shares
1. Last in line after all the creditors, much like common shares

Outline

2. But, ahead in line to the common shares
3. 2 types of preferred shares:
i. Cumulative: every period a dividend isnt paid, its accrued, and you
cant pay common shareholders until all the accrued dividend is paid
to the preferred shareholders
ii. Noncumulative: every period a dividend isnt paid, its gone
4. 2 types of participation:
i. Participating preferred shares: After it receives its preferred dividend,
it then gets equally with what the common shares get
ii. Nonparticipating preferred shares: After it receives its preferred
dividend, thats it
5. Implication: While it seems as if cumulative participating preferred
shares is the ideal type of ownership, it will obviously be more expensive
to buy one share of that compared to one common share
d. Debt
1. A fixed claim, for fixed duration, with or without collateral or some other
contractual provision
2. Come ahead of equity
e. Options
1. Options: bets between 3rd parties that have no relationship whatsoever
to the corporation
2. Warrants: Issued by the corporation itself (instead of an unrelated 3rd
party)
3. Convertibles: Combination of a call option and a bond
4. 2 types basic option:
i. Call: Provides the option owner with the right to buy within a given
time frame
ii. Put: Provides the option owner with the right to sell within a given
time frame
5. Option components
i. Asset
ii. Exercise/strike price
iii. Time
6. Option positions:
i. Out of the money: there is no point in exercising the option since it
would result in a loss
ii. At the money: when the exercise price yields no gain or loss
iii. In the money: exercising the option would result in a gain
iv. Key: Dont forget to consider the price you paid for the option in
considering whether the option is in or out of the money
XII. Introduction to Finance: Expected Return and Risk
a. Expected Return
1. A measure of return that uses rudimentary concepts of probability to take
account of risk or uncertainty as to outcome

Outline

2. The weighted average of all possible outcomes

b. Risk
1. Risk is neither good nor bad in corporations; its simply a tool to measure
2. Measured in variance
3. Illustration:
i. Option 1: a 25% youll make $60, 50% chance youll make $30, and
25% chance youll make $0
A. Expected return = $30
ii. Option 2: 25% youll make $100, 50% chance youll make 30, and 25%
chance youll lose $100
iii. Option 3: 100% chance youll make $30
iv. However, Option 2 clearly has higher risk than Option 3
v. If you were to chart out these outcomes on a graph (y axis: probability
up to 100%, x axis: $outcome), you will notice that a wider curve
represents a riskier investment
A. A wider standard deviation yields a riskier investment
4. Key: Just because a variance is wider or narrower doesnt mean the
investment is good or bad, its simply a measure of the risk
5. Under financial theory, people will gravitate towards Option 3
c. Decreasing marginal utility of money

Hi

Utility

Lo
$0

$1K
Dollars
1. So considering the slope of the decreasing marginal utility of money (the

slope from $0-$5, e.g., is steeper than $1,000-$1,005), if you were to play
a game where theres a 50% chance of losing $5 and 50% chance of
winning $5, if you lose five, you lose more utility (because the slope is
steeper going down in income), than you will gain utility (because the
slope is flatter going up in income)
d. Risk premium: when the utility increase of winning is greater than the utility
decease of losing, that excess is a risk premium
e. 2 types of risk
10

Outline

f.
1. Specific risk: Events that will affect mostly the single corporation were
looking at; e.g. the probability that the talented CEO of the corporation
will die or move onto another corporation
2. Systematic risk: Relates to events that when they happen, they will affect
most of the market, or a substantial part of it (e.g. Bernanke changing the
interest rates, inflation, depression)
Investment strategies in response to risk
1. Diversification: Investments involve risk, and investors try to manage
that risk
i. Investors will hold a portfolio of various different industries and
makes sure that the specific risks of one investment isnt totally
related to the other investment, such that any loss is a wash with
another investment
ii. Therefore there is technically a scenario where you can diversify
enough such that specific risk is 0, and all you have is systematic risk
(since you can control specific risk by diversification, but clearly you
cant eliminate systematic risk, its systematic to the entire market)
2. CAPM model: Expected return to risk analysis
i. Expected return to risk relationship:

20%
Expected

Return

2%

ii.
iii.
iv.
v.
vi.
Risk
Hi

If you want to invest with 0 risk, i.e. us government bonds, you will get
compensation, probably 2%
But as you assume more and more risk, investors will demand higher
and higher expected return
Anything above the line is a good investment, and anything below the
line is a bad investment
Anything on the line is indifference curve
There is therefore an inverse relationship between the expected
return and the amount we are willing to invest
XIII. Limited Liability

a. Purposes for limited liability:
1. In the perspective of shareholders:
i. To minimize monitoring costs of management

11

Outline

b.
c.
d.
e.
ii. To protect the shareholder from creditors filing suit against them
individually (in addition to the corporation)
2. In the perspective of creditors: If you know that whatever assets you can
go after are at one place, its easier than following the one corporation
than following all the shareholders
3. In the perspective of the capital market: Allows for shares to be a
tradeable product
i. With limited liability you transform the shares into a product that can
be traded
ii. Because when the value of the share is determined not also but the
Risk and Expected Return but also by the buyer and the seller, you
wouldnt be able to trade the share
iii. Therefore you wouldnt have an equity market; you would only have a
bond market
4. In the perspective of the corporation: its easier to diversify risk amongst
many investors, since shares are freely tradeable by virtue of limited
liability
Illustration:
1. Suppose X wants to build a hotel. X goes to the bank for a loan. The bank
asks what the hotel has for collateral
2. Non-recourse loan: Loan for a specific business, and the person taking the
loan isnt going to pay for the loan beyond the asset of the building
3. With limited liability, youd like the creditor to assume the risk of the
business
4. Without limited liability, the owner assumes the risk
5. Regardless of corporations, you can regulate liability via contract
Concept: Think of limited liability as something you can contract
Limited liability and tort claimants: When we provide limited liability against
tort claimants, its as if we ask the population in large to buy their own
insurance to protect themselves from corporations that cannot pay, as
opposed to asking the corporations of buying that insurance
Limitations on the capital market: Manifestations of shareholder-manager
agency problem
1. Asset substitution
i. Assume shareholders as the bank for a loan
ii. Bank asks what the corporation is doing, and the corporation owns a
solid building in Times Square
iii. Bank says you are at risk A, and using the Risk-Expected Return
graph picks a certain % return
iv. Then, all of a sudden, the corporation decides to produce a movie,
which is a very risky business (you could make $100M, or lose
$100M)
v. Had the bank known about this purpose in the beginning, perhaps
they wouldnt have determined risk to be at point A but rather point
12

Outline

B which is higher and therefore wouldve charged a larger expected
return
vi. Essentially the corporation has forced the bank to increase risk units
without a proper adjustment in the % return
2. Increasing leverage
i. Suppose 2 corporations:
A. A: 90% equity, 10% leverage
B. B: 10% Equity, 90% leverage
ii. Clearly, when you have high lender risk, the creditors face higher risk:
e.g. if A and B lost 30% of their value, As shareholders would absorb
that lost (since they are the first to lose), but for B the creditors would
lose at least get hit by 20%
iii. The higher the leverage rate, the more risk creditors assume
iv. Therefore, lenders would charge A maybe 6%, and charge B 10%
v. However, suppose that after being lent 6%, A starts to significantly
increase leverage to 90%
vi. Then the bank is being pushed to increase its risk units without being
able to get an increased, proportional % return
3. Distributing dividends: Suppose a corporation takes out a loan and
immediately gives that to shareholders as a dividend
f. Capital market today:
1. Corporations have been looking for ways to get lenders to increase risk
units without an appropriate increase in % return, but this has gone for
hundreds of years
2. Now its so sophisticated that you cant even begin to understand
Creditor-Shareholder Agency Problem

I. Protections of Creditors
a. Piercing the corporate veil
1. Concept: Cancels the limited liability of the shareholder
2. Requirements (Sea-Land Services, Inc. v. Pepper Source)
i. Alter ego or unity of interest or domination
ii. Injustice or inequitable or inequality
3. Satisfying alter ego (Sea-Land Services, Inc. v. Pepper Source):
i. None of the corporations ever held a single corporate meeting
ii. None of the corporations ever passing articles of incorporation,
bylaws, etc.
iii. Shareholder runs all corporations out of the same, single office, same
phone line, expense accounts, etc
iv. Shareholder used the corporate funds for personal reasons, e.g. paid
alimony to his ex-wife with the corporation funds
4. Satisfying injustice: must be something you can show beyond the mere
fact that the creditor wasnt paid for
b. Enterprise theory:
13

Outline

c.
d.
e.
f.
1. Concept: Piercing the corporate veil but not getting all the way to the
shareholder of the corporations
2. Instead, we treat them (shareholder, corporation, other corporations,
etc.) all as a single unit, so were piercing up, down, across, etc.
Doctrine of agency:
1. Concept:
i. Suppose a principal creates an agency relationship with an agent, and
the agent created some contractual relationship with a third party
ii. If the actions of the agent were within the authority granted by the
principal, then agency law says that we would view the principal as if
he or she directly signed that contract with the third party
2. How we can show that the corporation was an agent and the shareholder
was a principal (Walkovsky v. Carlton)
i. Showing that the corporation is not trying to maximize its own profit
ii. Corporation is rather doing something outside its line of business
iii. Activities that are directly benefiting the owner but not through
dividends
3. If you can show the doctrine of agency, you dont need to pierce the
corporate veil
Reverse Piercing (Sea-Land Services, Inc. v. Pepper Source)
1. Concept: treating all of the shareholders corporations as 1 corporation
from which the creditor can claim priority creditor rights
2. Illustration of when this is applicable:
i. Suppose the shareholder owns 5 other companies, and the creditor
attempts to pierce the corporate veil for Co. A
ii. If the creditor successfully pierces, it might be the case that the
creditor only at best gets the shares of the shareholders other
corporations
iii. Problem: Creditor will lose creditor status with those other
companies since now creditor is a shareholder
iv. Solution: Reverse Piercing
3. Can be accomplished via piercing the corporate veil, or via the doctrine of
agency
Equitable subordination:
1. When a corporation is in bankruptcy, debt claims that a controlling
shareholder has against the corporation may be subordinated to the
claims of other persons, including the claims of preferred shareholders,
on various equitable grounds
2. Subordination is a less drastic remedy than the remedy accomplished in
piercing the corporate veil
Legal capital
1. Form of ex ante protection
2. Rules were designed to provide some amount of capital to be kept within
the corporation and serve as cushion for the creditors
14

Outline

i.
Entails limitations on how much money a corporation can distribute

in dividends
3. Rules on dividends:
i. Application of fraudulent conveyance laws to dividends: Dividends
are subject to fraudulent-conveyance laws
ii. Unreasonably small capital: A transfer without adequate
consideration is prohibited if it would leave the transferor with
unreasonably small capital
iii. Insolvency under the dividend statutes: Many corporate law dividend
statutes explicitly incorporate an insolvency limitation on the
payment od dividends
iv. Cash flow test
v. Balance sheet test
vi. Bankruptcy test
vii. Corporate law governs the power to declare and pay dividends
4. Not entirely effective
Shareholders-Management Agency Problem

I. Fiduciary Duties
a. Agency problem: presented normally in one of two ways
1. Is it legal for corporations to make a donation? (A.P. Smith Mfg. Co v.
Barlow)
2. More politically tense issue: Considering the nexus of stakeholders that
a corporation has (discussed in Class 1), does management have a
fiduciary duty only to the shareholders or do they have a fiduciary duty to
all stakeholders?
b. General rule: There is an understood goal for a corporation to increase the
value of shareholders (Dodge v. Ford)
1. Implication: you cant force other shareholders into a social good
2. Treat of the rule nowaday: Normally the court wont interfere with
corporate decisions as long as there is some sort of business relation
c. No fiduciary duty to creditors
1. Beyond the contractual relationship between the corporation and the
creditors, there is no other fiduciary duty
2. Exception: When a corporation is in the brink of bankruptcy, there is a
duty to creditors
3. North American v. Kiddywala: Not even in the course of bankruptcy is
there a fiduciary duty to creditors, aka rejecting the above
d. Shareholders as the owner of the corporation
1. In theory: There is nothing preventing any of the stakeholders in the
nexus of stakeholders model from owning the corporation
2. Dominant form: Shareholder ownership, i.e. the shareholders are the
owners of the corporation, and all the rest of the stakeholders have a
contractual relationship with the corporation
15

Outline

i.
Political perspective: Shareholders as the owners of the corporation is

capitalism
3. Rights of an owner
i. Ownership
ii. Residual claim
e. Complications of shareholders owning the company
1. Three brothers, F, G1, G2, need to come together to donate to one charity,
and the consideration is that they are looking to maximize their greatest
satisfaction
i. Fs ranks (highest to lowest): Yale, Columbia Princeton
ii. G1: Columbia, Princeton, Yale
iii. G2: Princeton, Yale, Columbia
2. Now rank Columbia, Yale, and Princeton based on their rankings:
i. Columbia v. Princeton: Columbia wins (i.e. F and G1 chose Columbia
over Princeton v. G2 chose Princeton over Columbia)
ii. Columbia v. Yale: Yale wins
iii. Yale v Princeton: Princeton wins
3. Notice how arbitrary and meaningless the above is
4. When the voters dont share the same goal, there is no way we can pick
an efficient decision, because look at the circus of the above
5. This is why donations and contributions are such a heated debate
because it reflects interests of voters who may or may not share the same
goal
f. Advantages of shareholders owning the company: Effectiveness and
efficiency
1. Shareholders will always want competitive pricing, competitive buying,
competitive everything, because that will maximize their residual claim
2. Therefore they are the most efficient of the stakeholders to be owners of
a corporation
II. Duty of care
a. Basic standard of care: Directors have a duty to inform themselves, prior to
making a business decision, of all material information reasonably available
to them (Aronson v. Lewis)
1. DE chose to have different levels of liability concerning directors
2. In re Emerging Communications, Inc. Shareholders Litigation: It was
incumbent on , whose expertise and explicit knowledge of the
companys intrinsic value put him in a special position to know that the
$10.25 merger price was unfair, to advocate that the board reject the
price
3. Absent cause for suspicion there is no duty upon the directors to install
and operate a corporate system of espionage to ferret out wrongdoing
which they have no reason to suspect exists (In re Caremark International
Inc. Derivative Litigation)
16

Outline

i.
Implication: Absent grounds to suspect deception, neither corporate

boards nor senior officers can be charged with wrongdoing simply for
assuming the integrity of employees and the honesty of their dealings
on the companys behalf
b. Standard of Review: Business Judgment Rule
1. Requirements:
i. Director must have made a decision
A. If management failed to do something, i.e. nonfeasance, then that
does not satisfy this factor (Francis v. United Jersey Bank)
ii. Director must have informed himself with respect to the business
judgment to the extent he reasonably believes appropriate under the
circumstances
iii. The decision must have been made in good faith
A. DE Chancerys definition of bad faith corporate fiduciary conduct
(In re the Walt Disney Company Derivative Litigation)
1) Intentional dereliction of duty
2) Conscious disregard for ones responsibilities
B. Concept:
1) If being grossly negligent is the same as bad faith, then you
have effectively cancelled out 102(b)(7) (see below)
2) Therefore Chancerys definition is the middle ground between
gross negligence and subjective bad faith
C. The directors of a corporation have a duty to make good-faith
efforts to ensure that an adequate internal corporate information
and reporting system exists (In re Caremark International Inc.
Derivative Litigation)
1) The test of establishing a lack of good faith as evidenced by
sustained or systematic failure of a director to exercise
reasonable oversight is quite high
iv. The director may not have a financial interest in the subject matter of
the decision
2. If the requirements above are met: BJR Standard of review
3. If any of the requirements fail: Gross negligence standard of review
(Kamin v. American Express Co.)
i. In some cases, courts will raise the bar to negligence, but the normal
decision is gross negligence, and with the business judgment rule, the
rule is below gross negligence
4. Standards of review:
i. Assume there are 10 steps you can take in order to make the perfect
decision, and we expect you to do what a reasonable person would do,
in this case a 6. 5 would be negligent, and 3 is grossly negligent
ii. If the standard is gross negligence, and you did 4, then you win
iii. BJR is essentially a 1, even below negligence and gross negligence
17

Outline

iv. Approving a merger without reviewing the agreement and only
considering the transaction at a two-hour meeting would fail the
business judgment rule (Smith v. Van Gorkom)
c. 102(b)(7) Defense
1. Exempt provision that applies to corporations duty of care but not duty
of loyalty, bad faith, or other claims (Malpiede v. Townson)
2. Concept: The exculpatory provision statute was adopted, in response to
Smith v. Van Gorkum, to permit stockholders to adopt a provision in the
certificate of incorporation to free directors of personal liability in
damages for due care violations, but not loyalty, bad faith, and other
claims
3. Must be included in the charter
4. The shield from liability provided by a certificate of incorporation
provision is in the nature of an affirmative defense, i.e. has the burden
(Emerald Partners v. Berlin)
5. Exception to Emerald: If the only thing plaintiff is alleging is a breach of
duty of care claim, then the plaintiff must show that breach the pleadings
(Malpiede v. Townson)
6. Consequences of an Emerald v. Malpiede regime: Discovery
i. If Malpiede reigns, all the directors have to do is show the exculpatory
provision and the case is dismissed and the parties avoid discovery
ii. If the Emerald case reigns, director would be forced to go to discovery,
and more often than not plaintiff will prevail over the directors
d. Omission
1. With omission the standard is gross negligence
2. The next question is can I use 102(b)(7)?
i. Answer: bad faith
ii. At this point were simply considering conscious disregard of good
faith, i.e. substantive bad faith
A. If yes: you cant use 102(b)(7)
B. If no: 102(b)(7) still be available
III. Duty of Loyalty
a. Distinction with the duty of care:
1. Duty of care: The Court is trying not to regulate business procedures
i. On one hand, were creating a standard of behavior
ii. On the other, were doing a lot of effort to minimize the liability of
directors for the many reasons:
A. The distinction between luck and wisdom is very hard
B. Whatever benefits come from corporate decisions go to the
shareholders, not the directors, and if you tell directors that theyll
face huge liability, then the directors will simply just only make
conservative decisions
2. Duty of loyalty: the court is heavily regulating the activities in this area
because the business activity is tainted by some conflict of interest
18

Outline

b. Arises in 3 situations
1. Direct conflict of interest: E.g. a director sells a piece of land he owns to
the corporation, or is buying a building owned by the corporation, such
that the corporation is paying too much, or the director is paying too little
2. Indirect conflict of interest: Suppose a director of the corporation also has
a relationship with another corporation, wherein the 2 corporations are
dealing with each other (that relationship most commonly being a
shareholder, etc.)
3. Mixed motives: Main focus
i. The justification for the corporations action can either be bad or
good, and its hard for us to know
ii. Its very hard to regulate because the Board mightve been acting for 2
different and distinct reasons:
A. To prevent greenmail, which is a virtuous move by the Board
B. To prevent themselves from being replaced, which is nefarious by
the Board
c. Standard of Review: Entire Fairness
1. Concept: Courts will completely review the transaction and place the
burden to show that the transaction is fair on the conflicted parties (Lewis
v. S.L. & E., Inc.)
2. Requirements: Must show 3 things when dealing with a conflicted
transaction to show that it was not disloyal
i. Fairness in dealing
ii. Fairness in price
iii. The transaction was in the interest of the corporation
d. Shifting the Standard of Review:
1. Disclosure & (Disinterested) Directors Approval (Cookies Food Products v.
Lakes Warehouse): Standard decreases to BJR
2. Disclosure & (Disinterested) Shareholder Approval: Standard decreases
to BJR on the concept of waste
i. Rationale: Shareholders dont require Business Judgment therefore
doctrine of waste should apply
ii. Rule: Shareholders can approve any transaction, but only if there is no
waste
iii. Waste: when the transaction involves either of the below (ALIS
Principles of Corporate Governance 1.42)
A. An expenditure of corporate funds or a disposition of corporate
assets for which no consideration is received in exchange and for
which there is no rational business purpose
B. If consideration is received in exchange, the consideration the
corporation receives is so inadequate in value that no person of
ordinary sound business judgment would deem it worth that
which the corporation has paid
iv. Limitations:
19

Outline

A. A shareholder vote approving a business decision that requires a
shareholder vote cant also ratify a previous decision that doesnt
require a shareholder vote (Gantler v. Stephens)
1) I.e. you cant use a required shareholder approval to also ratify
a separate act
B. Even though stock option compensation is disclosed and doesnt
require shareholder approval, acts taken in bad faith, i.e.
backdating stock options, is a breach of the duty of loyalty and not
afforded the business judgment rule (Ryan v. Gifford)
1) Standard when compensation and stock are involved:
reasonableness, i.e. negligence, against the independent
committee
2) Exception: If theres bad faith, then theres a duty of loyalty (as
in Ryan v. Gifford)
3) Exception: NYSE requires stockholder approval
3. Disclosure requirements
i. What doesnt need to be disclosed:
A. Reservation price, i.e. the price deserving of the party because of
the quality of the partys service
B. How much the party is making
C. Rationale for not requiring the above
1) When we ask for a fair transaction, were saying that wed like
to mimic an arms-length transaction, i.e. wed like the
conflicted transaction mimics arms-length
2) So, for example, if a price of $101-199 reflects arms length, any
price in that range shows a fair transaction, and since were
trying to mimic an arms length transaction, we dont have to
reveal the reservation price since it doesnt reflect the true
arms-length transaction, i.e. youre being disadvantaged
ii. Law in DE: Controlling owners, despite conflicted transactions, dont
need to reveal the reservation price, because the argument is we want
to mimic an arms length transaction
e. Another Standard of Review: Corporate Opportunity Doctrine (Broz v.
Cellular Information Systems, Inc.)
1. Factor Set 1: A corporate officer or director may not take a business
opportunity for his own considering the below factors (citing Guth v.
Loft):
i. Opportunity: The corporation is financially able to exploit the
opportunity
ii. Line of Business: The opportunity is within the corporations line of
business
iii. Interest or expectancy: The corporation has an interest or expectancy
in the opportunity
20

Outline

iv. Conflict: By taking the opportunity for his own, the corporate
fiduciary will thereby be placed in a position inimicable to his duties
to the corporation
2. Factor Set 2: a director or officer may take a corporate opportunity
considering the below factors
i. The opportunity is presented to the director of officer in his individual
and not his corporate capacity
ii. The opportunity is not essential to the corporation
iii. The corporation holds no interest or expectancy in the opportunity
iv. The director or officer has not wrongfully employed the resources of
the corporation in pursuing or exploiting the opportunity
3. Interaction amongst the factor sets: No one factor is dispositive and all
factors must be taken into account insofar as they are applicable
Shareholders-Controlling Owners Agency Problem

I. Duty of Loyalty of Controlling Owners
a. Agency problem: Theres a risk that the controlling owners decisions will
harm the minority shareholders
b. Determination of Controlling Owners: 2 ways
1. If you own 50% of the shares, its clear you have control
i. When the situation involves a parent and subsidiary, with the parent
controlling the transaction and fixing the terms, entire fairness is
triggered (Sinclair Oil Corporation v. Levien)
2. If you own less, then there is a question whether you do or do not have
control (e.g. in Kahn v. Lynch Communication Systems, Inc.)
c. Duty of Controlling Owners
1. Controlling shareholders have fiduciary duties (Zahn v. Transamerica)
2. DE Court very rigorous in requiring full disclosure by controlling
shareholders when they deal with the minority
3. Multiple classes of stock:
i. When the Board is making a decision, the Board must work to get the
best value it can for the benefit of all shareholders (In re Trados Inc.
Shareholders Litigation)
ii. 2 ways to see the role of the Board when its asked to make a decision
A. Of the classes that you have, who is truly the residual owner? Is it
possible to figure out the residual owner, and if so, we know the
duty is on that party (e.g. In re Trados, Inc. Shareholder Litigation)
B. What was the implied contract between the two groups? What was
the role of the Board in enforcing and executing that contract?
Once you figure out the implied contract you can figure out the
duty of the Board
d. Standard of Review: Entire Fairness
1. Fairness in Dealing
2. Fairness in Price
21

Outline

i.
Fairness in price is a more important factor than fairness in dealing,

i.e. fairness in dealing is proxy to fair price (Kahn v. Lynch)
3. In the interests of the corporation
e. Shifting the Standard of Review:
1. Self-dealing requirement
i. If no self-dealing is present, then the BJR applies (Sinclair Oil
Corporation v. Levien)
ii. How to determine when something is self dealing:
A. When the controlling owner is the in both sides of the transaction
B. Or when the controlling owner is receiving something that the
minority is not, to the detriment of the minority (Sinclair Oil
Corporation v. Levien)
2. Disclosure plus approval by the disinterested directors (e.g. independent
committee): Entire fairness test with the shift of burden to the plaintiff
i. Limitation: Even if an independent committee of directors approves
the conflicted transaction, if that committee did not evaluate the
transaction in the perspective of all the shareholders (e.g. failing to
consider the implications of the transaction to the corporations Class
A shareholders), then the burden does not shift to the plaintiff (Levco
Alternative Fund v. The Readers Digest Association)
3. Disclosure plus approval by the disinterested shareholders: Entire
fairness test with the shift of burden to the plaintiff
4. Exception to (2) and (3) above: Even if an independent committee or a
majority of the minority approve the transaction, if the majority
shareholder still retains the bargaining power, i.e. the independent
committee or minority shareholders didnt have any control over the
terms of the merger and the approval, then the burden does not shift to
the plaintiff (Kahn v. Lynch Communication Systems, Inc.)
f. Dividend considerations
1. Concept
i. When you issue a dividend, its a decision that affects the capital
structure of the corporation
ii. The end result: increasing the leverage of the corporation, since
youve taken some part of the equity and given it away
2. We know dividends may be partially guided by conflicts but we dont care
and dont apply Entire Fairness (assuming pro rata distribution) for 3
reasons:
i. Its hard to distinguish between the conflicted concept or the true
business concept, i.e. the risk of mistaking this is high
ii. Shareholders have the ability to reinvest the money fairly easily
iii. Assuming we have a rule that we interfered with such a decision, are
we then to supervise how the money that was put back is supposed to
be used? To what end will this supervision end?
g. Goshens Paper
22

Outline

1. When we talk about minority shareholders, we think about the rights of
the buyer and seller as property rights and liability rights
2. One rule depends on torts and another depends on the institution
3. What DE initially did, by saying that even though the default rule is the
liability rule, i.e. entire fairness, by allowing to get the approval of the
majority of the minority, we in effect allow the minority to negotiate
II. Shareholder Voting & the Board
a. Agency Problems and Conflicts
1. General business dynamic: Shareholders > Board > Management
b. 3 elements to minimize the shareholder-management agency cost
1. Board of Directors
i. Limitations of this solution:
A. Limitations of time: Board only meets a few times a year which
isnt that much time to supervise
B. Sometimes the members arent experts of the corporations
industry
C. Directors are more aligned with management than the
shareholders, even though its part of the Directors job to be the
party pooper to management
2. Takeovers
i. Popular theory in the 1980s to minimize shareholder-management
agency costs
ii. Limitation: Tender offers werent that effective, so what could
shareholders do: either exit or voice (i.e. vote concerns and policies
etc.)
3. Institutional investors
i. Popular 1990s theory that institutional investors, as shareholders,
would minimize the agency cost
ii. Limitations:
A. The institutional investors themselves have their own agency
problems as a corporation themselves
B. So there might have been mitigation of the agency problem in the
original investment, but what about that of the pension fund to the
funds investors?
4. Newest solution: hedge funds
i. Criticism: Marty Lipton argues that hedge funds are only acting for the
short prime, and want to make a quick fast profit, and they should be
prevented from doing what they do, and on the other hand hedge
funds are reducing agency problems
c. Doctrine of the independence of the board: The board has no obligation to
follow the instructions of the shareholder (Charlestown Boot & Shoe Co. v.
Dunsmore)
1. Method for shareholders to effectuate desired change: the ability to hire
and fire the board by vote
23

Outline

2. Hiring a new board member: You dont need cause to fire a new Board
member, but you do need a majority
d. Voting requirements
1. General
i. Whenever the Board is doing something which requires shareholder
votes, once you get that vote, the Court will treat that decision as one
that is clear from any conflict of interest
ii. If you are doing something that the Board doesnt need shareholder
vote, then if something is wrong with that decision, you can ask for
shareholder ratification
2. Levels of voting required
i. Ordinary matters: affirmative vote of a majority of shares suffices
ii. Fundamental changes: amendments to the charter, merger, sale of
almost all assets, dissolution often require majority of 2/3 majority
iii. Written consent: shareholders can act by written consent, without a
meeting, if certain conditions are satisfied (conditions vary from state
to state)
e. Empty voting: Shareholders voting in the corporation with no economic
interest
1. Concept:
i. A share has 2 rights associated with it
A. Economic rights
B. Voting rights
ii. When a shareholder with economic rights votes for a decision, that
shareholder will suffer the economic benefit or harm from that
decision
2. DE Regulation
i. Selling just the voting rights for a price is illegal, i.e. separating the
voting rights from the economic rights is illegal, unless you have
something like a compelling justification
ii. Rationale: Every shareholder doesnt think their individual vote is
pivotal, since they are 1 out of millions, but if every person thought
this then one unscrupulous party with enough money could
essentially buy everyones votes
3. Method of effectuating empty voting in light of the regulation: short
selling
i. Mechanics of the short sale: you find someone in a long position to
lend the shares to you, and you sell them in the market, and get $300.
Then you wait until it drops to $100, and you buy the shares back, and
then you give the shares back to the person who you borrowed it from
A. Why did the person let you borrow it in the first place? Because
you pay him commission for every day youre borrowing it
ii. How to effectuate a separation with short-selling:
A. I buy 10% of the shares in long position
24

Outline

B. Then, suppose I borrow an additional 10% of shares and sell them
short
C. I am therefore in a net zero situation because my long position
gains will be washed by my short position gains
D. Since you have no economic interest, I am essentially empty voting
f. Staggered Board
1. Concept:
i. If you have 9 directors of a regular board, you can essentially fire all 9
if you want/can
ii. With staggered, the Board is elected for 3 years, and every year
shareholders can only change 1/3 of the Board
2. Exception: shareholders could hire more than the 1/3 of the Board if you
have cause
3. Utility:
i. Stability
ii. Also turns out to be one of the most important elements in defensive
tactics against takeovers
g. Limitations on the Boards powers
1. The Board may not effectuate a power it is legally allowed to do for the
purposes of obstructing the rights of shareholders (Schnell v. Chris-Craft
Industries, Inc.)
2. Shares may not be issued for an improper purpose such as a take-over of
voting control from others (Condec Corp. v. Lunkenheimer)
i. This doesnt mean that stock issued to raise money to eliminate a
deficit is to be invalidated merely because directors fairly avail
themselves of an opportunity to acquire additional shares to fortify
their natural desire to remain in control
ii. But where the objective sought in the issuance is not merely the
pursual of a business purpose but also to retain control, thats bad
h. Standard of Review: Blasius Standard (aka Compelling Justification)
1. Triggered when the Board attempts to unilaterally effect a change,
regardless of the good faith intentions of the Board
i. Rationale (Blasius Industries, Inc. v. Atlas Corp.)
A. The right to fire the Board is the only way Shareholders can
protect themselves from the agency problem
B. This is such a fragile and important and sensitive right that if you
try to meddle with it, youre in fact getting more rights than you
had before because its a zero-sum game
2. Multiple interpretations of when Blasius standard is triggered:
i. If we interpret Blasius as to whenever the Board attempts to affect
voting rights, then there are many compelling justifications
ii. But if we interpret Blasius as to a Board unilaterally effectuating a
change to the detriment of the shareholders, then there might be no
compelling justifications
25

Outline

3. The Board generally cannot undertake action with the primary purpose
of interfering with shareholder voting, even if it acts in the good faith
pursuit of the corporations best interest (Blasius Industries v. Atlas Corp.)
4. Standard of review: At the very least, the rationale in Blasius did not meet
the compelling justification, i.e. the Board was trying to preclude
ownership because it didnt feel it was in the companys best interests
III. Shareholder Voting & Proxy
a. Concern of shareholder input on business decisions:
1. Management has a business plan it wants to execute, which by its normal
terms, there will be good times, bad times, we dont know
2. In between, when something goes wrong, here comes a hedge fund, which
unlike the directors, are set normally for 7 years, who only care about
short term profit, who wants to fire the directors
3. Now there will be a conflict between the short term hedge fund and the
long term management
b. Actions for Materially Misleading Proxies in Violation of Rule 14a-9
1. A shareholder could bring a private action for violation of the proxy rules,
although neither the 1934 Act nor the Proxy Rules themselves explicitly
provide for such an action (J.I. Case v. Borak)
2. Requirements
i. A material misstatement (or omission)
A. The general standard of materiality that best comports with the
policies of Rule 14a-9: an omitted fact is material if there is a
substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote (TSC Industries v.
Northway, Inc.)
B. A statement of belief by a board of directors can be a material
misstatement if the statement is false (Virginia Bankshares, Inc. v.
Sandberg)
ii. Causation: There must have been a causal relationship between the
misstatement and the proxy solicitation
A. The proxy must have been an essential link for the approval of the
transaction (Mills v. Electric Auto-Lite Co.)
1) Implication: If, e.g., 66% of the vote is required for something,
and the majority only owns 54%, then the proxy is essential
2) Consequence of this rule: Regardless of the particulars of the
case, lawyers are now incentivized to look for misstatements,
and then hope that the proxy vote was necessary
B. 3 standards exist to evaluate reliance on the misstatement,
depending on the situation (Virginia Bankshares, Inc. v. Sandberg)
1) Strict Liability: e.g. a corporation issues shares to the public;
involved is a prospectus; 10K shareholders come together and
the corporation raises $1M; eventually it turns out there was a
26

Outline

misrepresentation that had it not been misrepresented the
shareholders wouldve only paid $8 instead of $10 per share
2) Recklessness/Negligence: e.g. A corporation making a periodic
disclosure, i.e. an annual report, has a misrepresentation,
positive or negative it doesnt matter; 3 years later they find
the mistake and correct the mistake; this scenario merits
recklessness instead of strict liability because shareholders
were in different positions (i.e. some lost, some won) and
doesnt directly relate to the corporation gaining or losing
anything
3) Scienter
C. Evaluating the 3 standards above: it depends on whether
management had an interest in the transaction or not (in the IPO
its clearly directly involved, but in the annual report scenario the
corporations clearly not involved)
c. Director expenses and proxy fights: A corporation may reimburse a director
in relation to a proxy fight (e.g. defending the directors seat on the board) as
long as the following are met (Rosenfeld v. Fairchild Engine and Airplane
Corp.)
1. Reimbursement has to be about policy, not personal expenses
2. Only reasonable expenses are reimbursable
3. If the expenses related to an insurgent director:
i. Reimbursement requires approval
ii. The insurgent must have won
4. If the expenses related to an incumbent director defending his seat:
i. No approval required
ii. Doesnt matter if incumbent won or lost
IV. Transactions in Control
a. Premium for Control
1. People who are buying control are willing to pay a premium
i. Implications: Short of looting, fraud, etc., a controlling stockholder is
free to sell, and a purchaser is free to buy, that controlling interest at a
premium price (Zetlin v. Hanson Holdings, Inc.)
ii. Minority shareholders are not entitled to that premium (Zetlin v.
Hanson Holdings, Inc.)
2. Reason:
i. Control increases value to the controller
ii. Dark side: Control allows better exploitation of self dealing
b. Control in 3 perspectives:
1. Minority shareholders perspective: do they want the change in control?
2. Sellers perspective: they will be subject to higher agency costs because
they no longer have a responsibility to the company
3. Buyers perspective: why only purchase up to control instead of 100%?
i. Sharing the risk
27

Outline

ii. Positive side: its not that the buyer wants 100%, perhaps it only
wants control to increase the value of the corporation to everyone
c. Tensions of selling control
1. On one hand: when you sell control, the potential is that the buyer will be
a better manager and will create higher value, and as a society we would
like assets to move from people who value them less to those who value
them more
2. On the other hand: There is a possibility the buyer is a better thief and
will steal more
3. 2 competing rules to encourage the latter and minimize the former:
i. Private premium rule (US rule): Seller keeps premium for herself
subject only to requirement of duty of care not to sell to looter
ii. Equal premium rule: Basically says anyone who is buying a block
higher than 30% must make tender offer to everyone for the same
price
d. Limitations to the premium for control:
1. If the seller has a controlling block: Normally the seller can keep the
premium, as long as the dutys below are met
i. Directors have a duty of care to investigate when the premium for
control is very high (Gerdes v. Reynolds)
A. Relevant when the directors are also majority controllers selling
their control, and especially when a looter is involved
B. Directors have a duty of care to ensure whether the price includes
the resignation fee
1) Implication: the directors should know when the price was too
high, and the failure of the duty of care is not investigating
2) Standard of review: most likely negligence, but definitely not
BJR or strict liability
ii. Loss of corporate opportunity: Where the sale of a corporations
controlling interest commands an unusually large premium due to a
market shortage of the corporations product, a fiduciary may not
appropriate to himself the value of that premium (Perlman v.
Feldmann)
2. If the seller has a block but not a controlling block: Seller can keep the
premium depending on the below
i. If below 10%: Seller cannot keep the premium (Brecher v. Gregg)
A. Rationale: A director/manager selling under 10% of shares for a
high premium is not selling control, but rather earning a
resignation fee or effectuating empty voting, which is illegal
ii. If above 50%: Obviously the seller can keep the premium (its a
controlling block)
iii. Between 10-50%: Whether that % is controlling is fact specific
A. If it is control: Seller can keep the premium (e.g. 28% in Essex
Universal Corp. v. Yates)
28

Outline

B. If the amount isnt deemed control, then empty voting/selling an
office position is happening and is therefore illegal
V. Mergers & Acquisitions: Structure
a. Concept of M&A: means of external growth, as opposed to internal growth
b. 3 types of M&A:
1. Horizontal: deals with corporations doing the same thing (e.g. one
distributor buying another)
2. Vertical: some part of the distribution channel from raw material to
finished product will purchase another in that channel, whether forward
or reverse
3. Holding companies who buy certain corporations that have no synergy
between the other companies held
i. Goal is not to create synergies, as with horizontal and vertical, but
rather to diversify, mitigate risk, etc.
ii. Its not vertical or horizontal but instead some mix
c. Impact of M&A on the economy
1. Positive: Taking advantage of economies of scale, efficiency, etc.
2. Negative: Creating market power, exploiting consumers, taking advantage
of regulations
d. 3 methods a corporation may take another
1. Asset acquisition
2. Stock acquisition
3. Merger
e. Asset acquisition
1. Illustration
i. Suppose Corp T and Corp A: A will make the acquisition and T is the
target
ii. First Step: A will point to a specific asset and exclaim to purchase that
asset (e.g. Ts building in Manhattan)
A. A will buy the building, title changes, and the building and cash
exchange between A and T
B. A will also negotiate with T what liabilities of T will accompany the
assets
C. If there is a transaction to buy all the assets of T, it becomes
heavily loaded with transaction costs
D. Plus, some assets you cant buy: Assume T has a franchise, e.g.
McDonalds franchise, which doesnt allow the franchisee to sell
their franchise to a third party
E. In the asset transaction, A does not inherit Ts unknown liabilities
1) Even if A took on some liabilities, A only agreed to the
liabilities A knew about, and not the unknown liabilities
2) So if there is a claim for $200M regarding the polluted river,
the claim goes at T
29

Outline

3) In some rare cases, the doctrine of piercing the corporate veil
would lead courts to allow the unknown claim to follow A, but
this isnt normal
iii. Second step is for T to dissolve and distribute all the assets it has as a
dividend to its shareholders
iv. Last step: the selling corporation, T, who sells substantially all of its
assets, according to DE law, former shareholders of T get the right to
vote and approve whether T can sell substantially all of its assets to A
A. DE law gives no appraisal rights to this transaction
B. The acquirer, A, if this is a cash transaction, then the A
shareholders need not vote on this transaction
C. If A issues new stock for the transaction, according to DE
corporate law, there still is no need for a vote
D. However, if A is listed on the NYSE, then by NYSE rules if A will be
issuing shares which represent more than 20% of As capital, A
will have to get its shareholders approval
2. Characteristics of asset acquisition
i. Unknown liabilities normally dont transfer to the acquirer
A. Rare exception: Piercing the corporate veil
ii. If asset acquisition is for substantially all of the targets assets:
A. Shareholders of the target required to vote and approve
B. Shareholders of the acquirer not required to vote and approve,
even if the acquisition is dealt in stock instead of cash
1) Exception: If A is listed on the NYSE, then by NYSE rules if A
will be issuing shares which represent more than 20% of As
capital, A will have to get its shareholders approval
C. Acquirer faces significant transaction costs
iii. DE law gives no appraisal rights
f. Stock acquisition
1. Illustration
i. First step: Corp. A will normally make a tender offer to the Corp. Ts
shareholders for a specified price
ii. Second step: Once A gets to 90% ownership, A can cash out the
remaining 10%
A. How to get to 90% varies
B. If the T shareholders agree to sell, then A gets control over T
C. If A can only tender to 40% of T, T can issue new shares to A such
that A gets to over 50%
1) Distinction with issuing new shares and tender offer: The
former is a corporate transaction with the actual corporation,
whereas the tender offer is a shareholder transaction with the
corporations shareholders
2. Characteristics of the stock acquisition
i. Distinction with asset acquisition: acquirer is not just buying the
assets, but buying the entire corporate entity

30

Outline

ii. Targets shareholder simply have to agree to sell their shares to the
acquirer; no formal approval required
A. Exception: If target is listed in the NYSE and needs to issue more
than 20% shares, formal shareholder approval for the issuance
required
iii. Acquirers shareholders are not required to approve the transaction
iv. Transaction costs significantly lower than an asset acquisition
A. Reasoning: All of the target, i.e. all the assets and all the liabilities
will be coming together to A because A purchased the whole entity
B. This means acquirer got targets franchise for McDonalds, since
its still owned by T but its just that T is owned by A now
v. Acquirer assumes all the unknown liabilities that might chase target
A. Limitation: Acquirer might lose all the targets assets because of an
unknown claim, but none of the assets that originally belonged to
the acquirer before the transaction are subject to the claim
1) Rare exception: unless you can show something very unique to
justify piercing the corporate veil
g. Merger
1. Illustration
i. Suppose Corporation A and Corporation B, who naturally have their
own assets and liabilities
ii. If A and B like to merge, theyd sign a merger agreement which, at the
end, results in A and B becoming one entity
A. Importance: at the end of the merger, there will be one
corporation as a joint ownership between A and B
iii. Articles of merger need to be filed, in the same way the charter has
been filed
iv. Once the steps are completed, by the force of law, all assets and
liabilities move to the survivor (A here), shares will move to the
shareholders of the former B, and were done
2. Characteristics of a merger transaction
i. Result: one corporation as a joint ownership between A and B
ii. There will be joint claim of all the assets and liabilities
iii. 4 approvals required:
A. Board of A
B. Shareholders of A
C. Board of B
D. Shareholders of B
iv. A & B Shareholders entitled to appraisal rights?
v. Distinction with asset acquisition: Minimal transaction costs
vi. Distinction with stock acquisition: There is no private placement,
tender offer, private offer, etc.
h. Exceptions to the merger rules
1. Small-scale mergers: When a big corporation buys a small corporation
i. Concept

31

Outline

i.
A. Instead of issuing the new shares to strangers to raise money, you

can simply issue the shares directly to the acquirees shareholders
and save all of the transaction costs involved in the formal process
B. Formal process: Since the acquiree is so small, acquirer can issue
20% new shares without any approvals, and then just tender offer
the acquiree
ii. Process
A. In the merger they will issue shares which will represent no more
than 20% of the total shares of the acquirer
B. In the merger agreement there is no change to the charter of the
acquirer, and there is no change to the other shares of the acquirer
iii. Characteristics
A. Shareholders of the acquirer not required to vote
B. Board approval of the acquirer not required
C. Shareholders of acquiree required to vote
D. Board approval of the acquiree required
E. No appraisal rights for any shareholders
2. Short form mergers: very useful, also known as cash-out mergers
i. Illustration: If Corporation A owns > 90% of Corporation S, and A
would like to merge with S, it doesnt matter if A wants to absorb S or
S wants to absorb A
ii. Characteristics
A. Board approval of the 90% holder required
B. Board approval of subsidiary not required
C. Shareholder votes not required
D. All shareholders not entitled to appraisal rights
Triangular merger
1. 2 types of triangular merger
i. Forward
ii. Reverse (more common)
2. Illustration: Assume Corporation A and Corporation B want to merge,
wherein B gets 1M stock of A
i. A creates a new corporation, M owned 100% by A
ii. A will then transfer to M whatever consideration A agreed to pay to B,
i.e. the 1M shares of A
iii. The only asset that M has is the consideration that Bs shareholders
are supposed to get, i.e. the 1M shares of A
iv. Then, B and M will sign a regular merger agreement
A. B and M will agree what the shareholders of B will get, i.e. the 1M
shares of A
B. And theyll agree that B and M will become just one entity, as is the
case with any merger
C. Plus they will decide whether the surviving entity will be M or B
1) If M survives, this is forward triangular merger
2) Is B survives, this is a reverse triangular merger
32

Outline

j.
3. Characteristics
i. Reverse triangular merger
A. As shareholders dont vote and get no appraisal rights (obviously
because A wasnt part of the merger between B and M)
B. Board approval of A is required
1) Concept: They are in one capacity the shareholders of M, and in
another the Board of M
C. Board approval of B is required
D. Shareholder approval of B is required
E. Shareholders of B entitled to appraisal rights
F. Unknown liabilities will only chase B, not A
G. Franchise titles owned by B will survive (since B is still alive)
H. Avoided a tender offer, private placement to get control, then
another tender offer, then cash out, etc.
I. Effected the same result as a stock acquisition but in one shot
Determining the nature of the transaction
1. Test for whether a sale is substantially all of the targets assets for
purposes of asset acquisition: Gimbel test (Hollinger, Inc. v. Hollinger
International, Inc.)
i. Substantially all depends upon the particular qualitative and
quantitative characteristics of the transaction at issue
ii. Transaction must be viewed in terms of its overall effect on the
corporation, and there is no necessary qualifying percentage
iii. The sale of assets quantitatively vital to the operation of the
corporation and is out of the ordinary and substantially affects the
existence and purpose of the corporation
iv. Qualitative prong is not met if the court merely believes that the
economic assets being sold are aesthetically superior to those being
retained
v. Qualitative prong focuses on economic quality and, at most, on
whether the transaction leaves the stockholders with an investment
that in economic terms is qualitatively different than the one that they
now possess
2. Substance v. Form
i. DE Court favors form over substance: even if the substance is the
same, even if a merger or the reorganization is effecting the same
thing, DE will respect the form nonetheless (Hariton v. Arco
Electronics, Inc.)
A. Implication: If, in form, a transaction is held as an asset
acquisition, even if in substance the transaction is really just a
standard merger, the more lenient rules for asset acquisition, not
the stricter merger rules, will apply
ii. PE Court favors substance over form (Farris v. Glen Alden Corp.)
A. Criticism of substance over form: book value considerations
33

Outline

iii. Triangular mergers: seem to favor form over substance (Terry v. Penn
Central Corp.)
VI. Mergers & Acquisitions: Appraisal Rights
a. Appraisal Rights:
1. A liability rule protection given on an individual basis, for a person who
objects to the transaction
2. Complication: We understand why wed give that right if the transaction
is conflicted, but its much harder to understand why such a right is given
when there is an arms length transaction
b. Claiming appraisal rights
1. DE Law Procedure for claiming appraisal rights
i. Before the vote on the merger/consolidation the shareholder must
make a written demand for appraisal
ii. Provides a rather short period of time, 120 days after completion of
the merger/consolidation
iii. Costs of the appraisal proceeding are assigned as the court deems
equitable in the circumstances
iv. Determining fair value: excludes from the determination any element
of value arising from the accomplishment or expectation of the
merger or consolidation
A. Invites an array of valuation methods by providing that the Court
shall take into account all relevant factors
2. Model Act procedure
i. Notice of the intent to seek appraisal must be given by the
shareholder before the vote of the shareholders is taken
ii. Appraisal proceeding doesnt begin until the shareholder has rejected
in writing the corporations estimate of the shares fair value
iii. Costs are borne by the corporation unless otherwise assigned by the
court
iv. Determining fair value: determined immediately before the
effectuation of the corporate action triggering the appraisal right as
determined using customary and current valuation concepts and
without discounting for lack of marketability or minority status
c. Determining fair value
1. DE Block Method:
i. Assigns a weight to each of the below values
A. Asset value
B. Market value
C. Earnings value
D. Dividend value (sometimes)
ii. Weight to each turns on the unique characteristics of the firm and also
the trustworthiness of the figure
2. Criticism: DE Block isnt the only thing, and DCF should also be
considered (Weinberger v. UOP, Inc.)
34

Outline

d. When appraisal rights are triggered: 262
1. Small merger of a small corporation
2. Triangular merger
3. Sale of all assets: normally no appraisal rights
4. Regular merger: appraisal rights, but an exception for the market out
i. Market out: When you have a liquid corporation, and the payment for
the merger is in liquid stock, either of the buying or some other
corporation, then there are no appraisal rights
e. Distinction of a claim for breach of fiduciary duty/entire fairness and a claim
for appraisal rights
i. Appraisal claim: youd have to bring this up on your own, and face the
risk of getting a price lower than the merger price, but the main
advantage is you have show nothing but a claim that the price is
inadequate
A. Very rarely brought up
ii. Entire Fairness claim: Youd argue there was a breach of fiduciary
duty either because there was no fair dealing, or no fair price, but
youd have the burden to show that something was wrong in the
process
A. If you lose, you stay with the merger price, and if you win you get
whatever you claim you should get
B. Therefore this is a win-win, sort of
C. Therefore the remedy here is much greater than in an appraisal
proceeding
D. Most relevant case in which this comes about: freeze-out mergers
1) Freezeout: a corporate transaction whose principal purpose is
to reconstitute the corporations ownership by involuntarily
eliminating the equity interest of minority shareholders
2) Most common freeze-out methods: tender offer then short
form merger, and standard merger
3) Complication: tender offer then short form merger has
different rules and rights than a standard merger (see M&A
structure section above)
f. Whether entire fairness or simply appraisal rights apply to a merger claim:
1. Merger offers: Challenge to a controlling owners proposed merger offer
by minority shareholders may invoke the entire fairness standard
i. Exception: If the minority was fully informed of all material facts, i.e.
the conflict, the merger, etc., and the minority approves, then the
burden of proving entire fairness shifts to the plaintiff (Weinberger v.
UOP, Inc.)
2. Tender offers: In the absence of coercion or disclosure violations, the
adequacy of the price in a voluntary tender offer cannot be an issue, i.e.
entire fairness standard doesnt apply to challenged fairness of tender
offer prices (Solomon v. Pathe)
35

Outline

i.
Implication: Since only appraisal rights is the remedy for an objection

to a tender offer, it means that no fiduciary duty exists
3. Short-form/Cash out mergers: Absent fraud or illegality, appraisal is the
exclusive remedy available to a minority stockholder who objects to a
short-form merger (Glassman v. Unocal Exploration Corp.)
i. Implication: Since only appraisal rights is the remedy for an objection
to a short-form merger, it means that no fiduciary duty exists
4. Exception to (2) and (3): In order for the controlling not to face fiduciary
duties in the tender offer to short form merger process, you must meet all
of the below (In re Pure Resources, Inc. Shareholder Litigation)
i. Make a condition that you wont go through with the tender offer
unless a majority of the minority tenders their shares (sort of like
having a vote)
ii. In order to prevent pressure, controller must commit, immediately
after, that the second stage, short form merger, will be at the same
price and happen immediately after
iii. Controller must commit not to make any threats on the shareholders,
plus give sufficient time for the board of directors to make a
presentation to the shareholders
g. Later developments to the standards above:
1. In re CNX (2010):
i. We shall equalize the tender offer & short form merger process, with a
regular merger
ii. Merger: If you have an independent director, and majority of minority,
controlling shareholder gets shift of the burden (doesnt really make
sense but whatever)
iii. In tender offer & short form: You need Majority of the minority, cash
out at same price, no threats, plus information
2. In re MFW Shareholders Litigation (2013)
i. Mergers: If you do independent director plus majority of the minority
in a merger, you dont have to deal with Entire Fairness + Burden
Shift, you now simply get BJR
ii. This equalizes the tender offer & short form merger process with the
merger process
VII. Mergers & Acquisitions: Hostile Takeovers
a. Two-tiered coercive offer
1. Illustration:
i. Situation 1: Suppose a stock is at $100; someone comes by with a
tender offer for $150/share but would like to purchase only 50.1%
A. Assuming the person isnt a looter, no one would turn this down
unless that person believed they could get much more than $150
B. Then assume the person coming in sets the future price of the
stock at $200, to compensate the risks they are taking, the costs of
taking the $150 deal, etc.
36

Outline

C. Many people wouldnt tender, because they know that under the
new guy the price of the stock could be worth $200, so theyd
rather be part of the company than sell their shares
1) Known as the pressure against tender
ii. Situation 2: In addition, suppose the person coming in with the tender
offer says he will hold a subsequent second-stage tender offer at $120
A. This time shareholders would tender because even if all
shareholders believe that another dealer out there can offer $200
if we waited just 2 or 3 weeks or a month, we still would want to
tender because we dont know what the other shareholders would
do; if the other shareholders get bought out and the guy coming in
indeed gets control, theres a chance if we hold out and wait for the
$200 offer we might get bought out at $120 in the freeze-out
2. Characteristics of a two-tiered coercive offer
i. Every time the second stage is lower than the first stage, we have this
problem, which is the essence of what we read in the Unocal case, i.e.
this is a two-tiered coercive offer
ii. Coercive because the shareholders are forced to say yes in any case,
regardless of whether they find the transaction to be efficient
3. Complications of determining whether it is coercive
i. E.g. instead of a second stage of $120, suppose the person coming in
said Ill come in for second stage a year later at $150
A. This is clearly a lower price because of inflation, etc.
b. Tender offer v. Merger negotiations
1. Advantages of tender offer over merger:
i. Acquirer goes over the head of the Board and directly to the
shareholders
ii. Agency cost of the Board behaving only in their interests to the
detriment of the shareholders
2. Disadvantages of tender offers compared to merger:
i. Allowing tender offer takeovers to take place increases the propensity
of shareholders being taken advantage of
ii. Strategic voting: Shareholders are individuals who face coordination
problems, and there are too many of them, and you can place them in
strategic voting
iii. Information problem: Shareholders arent as directly informed as
directors, i.e. the information problem
c. Solutions to the disadvantage of tender offers over mergers
1. Williams Act
i. Protective elements
A. Early warning system: if you buy > 5%, you have 10 days to
disclose it
B. Disclosure requirements: Who you are, what youre buying, etc.
and has to remain updated all the time, which is supposed to help
shareholders evaluate whether or not you are a looter

37

Outline

C. The Board then gets the right to express their views about the
offer
D. There are anti-fraud provisions to make sure the disclosures are
true
E. Substantive requirements: The tender offer must be open for at
least 20 business days, open to everyone, and if you raise the price,
it was to be raised for everyone, and no private dealing; everything
must be done through the tender offer process; and if more shares
are offered, you have to buy pro rata
1) Goal of this is to assist shareholders in better evaluating the
transaction
ii. Criticism: You can still effectuate a two-tiered coercive offer
A. You can make a 20-day offer, make it pro rata, etc. and simply just
say second stage offering is at the same price but a year later
B. So Williams solved some problems, but not all
2. Allowing directors to participate in the tender offer system: 2 methods
i. Auction: the Board can participate, but only for 1 single thing, which is
to conduct an auction
A. Board can stop the tender offer, facilitate other dealers to come in,
facilitate an auction, then thats the end of it
B. I.e. the Board cant say no in any case, and can only manage the
process of the sale, but have no say in whether the company
should be sold or not
ii. Opposing view: No participation
A. We should let takeovers take place whenever, and the Board
should have 0 participation in the process
B. Argument: Auction increases the size of the premium in the
current bid, but it reduces the potential for the bid of all other
shares in the shareholders portfolio, and asset value goes down
iii. DE Law in light of these competing theories: allows Boards to say Im
not selling but if you are selling, you have to maximize the price and
sometimes that might entail an auction
A. Didnt pick auction or no-involvement rule, but rather decided to
let the Board participate in an active manner, even to a point in
which they can just say no
d. Poison Pills
1. 2 types:
i. Flip in: aimed at the first stage a hostile takeover, i.e. the purchase of
control
ii. Flip over: aimed at the second stage of a hostile takeover, i.e. the
freeze out
2. Flip in: 2 methods of a flip in poison pill
i. Call option flip in: Illustration
38

Outline

A. Assume we have a Corp with 3 shareholders A B and C who each
own 1 share, and the corporation is worth $300, and each share
costs $100
B. Corp sets a trigger where if someone buys > some % trigger
without the permission of the Board, then all other shareholders
except the person who crossed the trigger will get the right to buy
more shares for a heavily discounted price, say half the price
C. Suppose A crosses the % trigger, and B and C get the rights to buy
an additional share for $50, a share that is deeply in the money
D. Now the corporation assets is at $400 total because of the call, and
the total number of shares is 5 (instead of 3), which changes the
value of the shares to be $80 (instead of $100)
ii. Put option flip in: Illustration (used in Unocal)
A. Suppose a corporation with 2 shareholders A and B each with 1
share at $60, so total assets is $120
B. If the corporation gave B the put option for $80 and its exercised,
now theres only 1 share left, As share, which is worth $40 now,
and therefore A lost $20
3. Flip over: Same effect as flip in, but aimed at the second stage (at the first
stage you buy control, and at the second stage you freeze out the minority
and pay them with junk bonds)
i. Sets a condition that if you want to merge with that corporation, you
have to pay an expensive price for the shares
4. Redeeming the poison pill: You have to get control of the board
i. Implication: the staggered board is now extremely effective since in
order to get control of the board to redeem the poison pill, an acquirer
would need at least two elections
e. Defense against hostile takeovers and two-tiered coercive offer: Unocal
Standard of Review
1. If the 2 prongs of Unocal are met, then the company gets the business
judgment rule
i. Directors must show that they had reasonable grounds for believing
that a danger to corporate policy and effectiveness existed
A. Satisfied by demonstrating good faith and reasonable investigation
B. It seems enough that arguing that the price is too low satisfies this
prong (Air Products and Chemicals, Inc. v. Airgas, Inc.)
ii. Demonstrate that their defensive response was reasonable in relation
to the threat posed
A. Evaluation: the defensive response cannot be preclusive or
coercive (Unitrin, Inc. v. American General Corp.)
1) Preclusive: Measure precludes acquisition
2) Coercive: forces managements preferred alternative on
stockholders
39

Outline

B. A defensive response is reasonable if there are other methods
available from which the acquirer can establish a takeover (Air
Products and Chemicals, Inc. v. Airgas, Inc.)
C. It seems as if inclusion of a fiduciary out in a merger agreement is
a per se requirement (Omnicare, Inc. v. NCS Healthcare, Inc.)
1) Criticism: By always requiring a fiduciary out, the majority
opinion effectively deters bidders from engaging in merger
negotiations with corporations, which will inevitably reduce
the pool of potential bidders that would benefit stockholders in
corporate transactions
2. Shifting the standard from Unocal to BJR: stock-for-stock
i. Whenever you are engaging in a stock-for-stock merger, and that
merger doesnt involve change of control, the deal protections will be
tested by BJR (Paramount Communications, Inc. v. Time Inc.)
ii. But when youre involved in a merger that involves change of control
like in Omnicare, then the deal protection will be judged according to
the Unocal standard
f. Limitation on the Unocal Standard: Revlon Standard of Review
1. Revlon Standard: When the break-up of a corporation is inevitable, the
duty of the corporations board of directors changes from maintaining the
company as a viable corporate entity to maximizing the shareholders
benefit when the company is eventually and inevitably sold
i. Implication: Lock-up is not per se illegal, but if it ends an active
auction and forecloses further bidding to the shareholders detriment,
its illegal
ii. As for no-shop provisions: Favoritism for a white knight to the total
exclusion of a hostile bidder might be justifiable when the latters
offer adversely affects shareholder interests, but when bidders make
relatively similar offers, or dissolution of the company becomes
inevitable, the directors cannot fulfill their enhanced Unocal duties by
playing favorites with the contending factions
2. Standard of review: negligence, i.e. whether the corporations actions
were reasonable
3. When Revlon Standard is triggered
i. Generally: Revlon duties come about whenever there is a sale of
control
ii. When the transaction is stock-for-stock: Court treats 2 scenarios
differently
A. If the resulting merger is a dispersely owned corporation, meaning
that the shareholders of the target end up being dispersed
shareholders in the acquiring corp, then Revlon doesnt apply
(Paramount v. Time Warner)
B. But if the target ends up as minority shareholders, then Revlon
does apply because this is a sale of control because theres no
40

Outline

guarantee that the hidden value, future gains, etc. will be
recognized (Paramount Communications Inc. v. QVC)
4. Relationship to fiduciary duties:
i. Revlon standard is under the duty of care, unless as in Revlon the
reason for failing that duty is conflict of interest, then you have duty of
loyalty, but the normal duty is duty of care governed by 102(b)(7)
Securities Regulation
I. Efficient Markets
a. Main goal of securities regulation: to create efficient markets
b. Efficient markets: 2 concepts of efficiency
1. Informational efficiency: Everything in the market will be priced correctly
into the share price
2. Fundamental efficiency: Prices will properly reflect the true value of the
corporation (Important focus)
c. Why we want to achieve an efficient market
1. Efficient allocation of resources in the economy
i. We want good corporations to raise money easily and cheaply
ii. We dont want bad management to get as much money, or at least to
raise money on expensive terms
iii. This minimizes activities of bad corporations, and promotes activities
of good corporations
2. Reducing agency costs: Capital markets are important for this in 2 ways
i. Affects the value of the options that management has: If the
corporation does good, prices go up in value, and management earns
on their options
ii. We know that the market for control is heavily dependent on pricing:
We dont want an efficiently-run corporation to be undervalued and
trigger unnecessary takeovers
3. Many transactions in the company between private parties will use the
pricing on the stock market as a benchmark: Some private companies will
look at public corporations as a benchmark as to the value of the private
company
d. Determining the best way to allocate resources in order to achieve an
efficient market is up to the country
1. You can let government control the allocation of resources, like China
2. Or you can give that to the banks, like in Germany or Japan
3. Or you can let the stock market allocate resources
e. Categories of markets
1. Weak efficiency: If prices are reflecting only information that is embodied
in past prices
i. Empirical studies try to figure out if you can forecast future prices
using past prices: There is 0 correlation
2. Semistrong efficiency: Prices reflect immediate public information
41

Outline

i. Immediate: Within ten minutes
ii. Public: Every piece of information where there is potential to obtain it
publicly
iii. Empirical studies suggest that the market is very efficient
3. Strong efficiency: Prices immediately and accurately reflect all the
information that is available on the corporation
i. Difference between strong and semi-strong: private information
ii. 2 theories of how private information can weigh into pricing
A. Sister, brother, etc. can obtain the private information
B. Insider who knows, runs to the market and buys, and the other
participants decode the activities of the insider and guess what is
going on, and the price jumps
iii. Of course the latter method is less precise, but in any way, markets
arent efficient in the strong form
iv. The law doesnt promote strong efficiency anyway, considering
insider trading is illegal
v. The law promotes semistrong efficiency
II. Securities Exchange Act 10(b) and SEC Rule 10b-5
a. Material misstatements
1. Evaluated by the probability-magnitude test: Materiality depends on the
facts of the case, specifically the significance that a reasonable investor
would place on the withheld or misrepresented information (Basic v.
Levinson)
b. Fraud-on-the-market theory
1. Concept (Majority in Basic v. Levinson): Allows the court to assume
reliance on a corporations misstatements without requiring each
shareholder to individually prove it
i. It is common sense that people who buy or sell stocks rely on the
integrity of the market, and this integrity is based on the available
public information about companies
ii. Therefore n investors reliance on public misinformation about a
company is therefore presumed under rule 10b-5
2. Criticism (Dissent in Basic v. Levinson):
i. Fraud-on-the-market theory shouldnt apply
ii. Many buyers and sellers of stock actually engage in transactions
because they believe that the market price inaccurately reflects the
value of the company
III. Insider trading
a. 2 cases in which Insider Trading can happen (Distinction is important to
understand because the cases move between them)
1. Classic Theory: Insiders have fiduciary duty to the market, therefore they
must disclose or abstain, and if they trade without doing so, they breach
10b-5 (SEC v. Texas)
42

Outline

i.
Suppose a publicly traded corporation, and an insider within that

corporation is using information about the corporation to trade with
the securities of that same corporation
2. Misappropriation Theory: Based on a fiduciary duty to the source of the
information, and not to the market (although the minority position says it
should be based on a duty to the market)
i. Introduced in Chiarella v. United States
ii. Becomes law in United States v. OHagan
iii. Suppose a publicly traded corporation, and some outsider has a plan
to take over another publicly traded corporation, and has information
on that target, and uses that information to deal in shares of that
target
b. Arguments for prohibiting insider trading:
1. Because wed like to have a fair plane
2. Another argument: fairness doesnt address the fact that there will be
smarter people than others because it doesnt address the fact that
someone earning money is at the cost of someone losing money, so for an
efficient market it makes sense for the smarter, savvier people to earn the
money
3. To protect information traders: Information traders, at the moment they
want to capture their profits, will always lose to the insiders and lose
their earnings, and we want to promote information trading
i. Illustration: Assume 2 possibilities
A. A piece of good news that increases the corporations price from
$100 to $200
B. A piece of bad news that decreases the corporations price from
$200 to $100

Good
News
Price
Bad
News
$200
----- Insiders Effect
$150
$100
Time
ii. When insiders trade, obviously they move the price, either selling or
buying
43

Outline

iii. Now take the middle point of the buying and selling, i.e. $150, and
consider the four groups were concerned with
iv. Liquidity traders: Their strategy is buy and hold, and the trigger to
buy and sell has nothing to do with whats announced by the
corporation, but rather outside triggers, i.e. increased consumption,
increased savings, etc.
A. Now assume the liquidity trader is buying 500 shares of the
corporation, and some is at $100 pre-good news, and some is at
$200 post-good news, but those are irrelevant transactions since
the insider didnt affect the price at those levels
B. But if the liquidity trader purchases at the same time the insider
buys, they will buy those shares at $100, but the insider just
bought at $150
C. So instead of making a profit of $100 (i.e. post-good news the price
would be at $200), the insider just cost the liquidity trader $50
and the trader only makes $50
D. But, now assume that the liquidity trader held the corporations
stock at $100 pre-good news, and decides to sell at the same time
as the insider; then, instead of selling at $100, the insider has
GIVEN the liquidity trader $50 profit because the insider is buying
at $150
E. But at the end of the day, the liquidity traders loss or win from
these shares will be washed by its other investments, and
therefore the liquidity trader doesnt care about the insiders affect
on the price
v. Noise traders: sometimes they win, sometimes they lose, but they
arent too affected by insiders
vi. Information traders
A. Assuming we are in the good news scenario, information traders
are at $100 pre-good news; and based on all the information out
there, $100 seems to be the value of the corporation
B. So, when the information trader sees the insider buying at $150,
the trader will say oh, thats overvalued not knowing that the
transaction was an insider
C. So when the information trader tries to short the $150, and the
price increases to $200, the information trader just lost $50
4. Higher costs to the corporation
i. The insider with the information might try to take advantage of the
insider information before bringing the information up the chain to
the corporate heads
ii. Thus the corporation will have to spend lots of money to restrict
insider information within its own corporation, which is just another
heavy cost
c. Insider trading connection with 10(b) and Rule 10b-5
1. 10b-5 is predicated upon fraud

44

Outline

d.
e.
f.
g.
h.
i.
2. Fraud is predicated upon some thoughts of providing a misstatement or

omitting to disclose a material fact with the intention to defraud
3. Insider trading isnt about supplying misstatement, but rather trading
without disclosing the information
4. For this to be fraud, there must have been a duty for the insider to have
disclosed
5. Therefore a duty exists with the inside trader not to disclose
Rule 10b-5 Requirements for Insider Traders: Classic Theory
1. Access
2. Materiality
3. Fiduciary Duty
4. Causality (can be established by the fraud-on-the-market theory)
Rule 10b-5 Requirements for Insider Traders: Misappropriation Theory
1. Essential element: Deception
Insider information and family/spouses:
1. When theres a pattern of exchanging confidential information, theres an
understanding that you wont disclose the information
2. When you request confidentiality and the other sides agrees and
therefore gets the information, a trade on this information would also be
a breach
Insider trading connection with 14(e)
1. 14(e): Whenever there is a substantial step to a tender offer, then
anyone with nonpublic information (not necessarily confidential) may
not trade in connection with the tender offer
i. Substantial step: Hiring an investment banker, a board meeting, etc.
ii. Who cant trade: Anyone related either to the bidder or the target
cannot use that information to trade, in either shares of the bidder or
the target
Liability of the tippee of insider information
1. A breach of an insiders fiduciary duty must occur before a tippee inherits
the duty to disclose inside information (Dirks v. Securities Exchange
Commission)
i. The activity of tipping does not involve breach of duty
ii. If its not for personal gain, then its not a breach of fiduciary duty
2. Requirements
i. What was the purpose: If not for personal gain, then there is no
breach of fiduciary duty, and no liability to all those who use this
information (Dirks v. Securities Exchange Commission)
ii. If there was a breach of fiduciary duty (i.e. there was personal gain
involved): On the tippee, whether the tippee knew or should have
known that the insider got the information while breaching their
fiduciary duty
Prohibition of selective disclosure: Regulation FD
1. Old process of selective disclosure
45

Outline

i.
j.
Corporation establishes a selective conference call where only a few

analysts are invited
ii. Ahead of disclosing it to the public, corporation will tell analysts of
various things
iii. Then the abuse happens:
A. If an analyst writes a negative report, he or she is cut off the future
conference call
B. If an analyst is related to a huge proxy fight, he or she is cut off the
conference call
2. Regulation FD: anytime a disclosure is about to be made, it must be
disclosed to everyone, i.e. you cant have selective disclosure calls
anymore
i. If the selective disclosure was by mistake, it must be fixed as soon as
possible
ii. If it was intentional, disclosure must have happened simultaneously
16(b) Liability for Short-Swing Trading
1. 16(b): Any profit realized from any purchase and sale, or any sale and
purchase within any period of less than six months shall inure to and be
recoverable by the issuer (i.e. the corporation)
2. Requirements
i. Was it a voluntary transaction?
A. In some cases, this is all that matters; if it was a voluntary
transaction, 16(b) is breached
ii. Did the person have any influence on the execution of the transaction?
(Colan v. Mesa Petroleum Co.)
iii. Did the person have access to inside information? (Kern County Land
Co. v. Occidental Petroleum Corp.)
3. Calculation of profit after violation of 16(b): lowest purchase price,
highest sale price method (Gratz v. Claughton)
i. Applies even if, at the end, the insider lost money on the 6-month
transactions
ii. Rationale: even though the insider lost money in the aggregate, the
theory is that the insider knew the price was going down and all the
transactions he made was to mitigate his loss
4. Exceptions to 16(b)
i. Last sentence of 16(b) sets out an exemptive provision under which
it shall not be construed to cover any transaction where a more than
10% beneficial owner was not a more than 10% owner both at the
time of the purchase and sale (or vice versa)
46

Goshen - Corporations - F 13

Caricato da

Informazioni sul documento

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Goshen - Corporations - F 13

Caricato da

Copyright:

Formati disponibili

Corporations

Goshen, Fall 2013

Corporations Goshen, Fall 2013

Attack Sheet of the Standards of Review

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Overview of Corporate Law and Corporate Finance

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

1. Consent from the board of directors

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

2. The weighted average of all possible outcomes

1. So considering the slope of the decreasing marginal utility of money (the

Corporations Goshen, Fall 2013

XIII. Limited Liability

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Creditor-Shareholder Agency Problem

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Entails limitations on how much money a corporation can distribute

Shareholders-Management Agency Problem

Corporations Goshen, Fall 2013

Political perspective: Shareholders as the owners of the corporation is

Corporations Goshen, Fall 2013

Implication: Absent grounds to suspect deception, neither corporate

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Shareholders-Controlling Owners Agency Problem

Corporations Goshen, Fall 2013

Fairness in price is a more important factor than fairness in dealing,

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

A. Instead of issuing the new shares to strangers to raise money, you

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Implication: Since only appraisal rights is the remedy for an objection

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

Suppose a publicly traded corporation, and an insider within that

Corporations Goshen, Fall 2013

Corporations Goshen, Fall 2013

2. Fraud is predicated upon some thoughts of providing a misstatement or

Corporations Goshen, Fall 2013