Corporations Fall 2017

DBR

PART I – Agency and Partnership

I. AGENCY
A. Basics
1. An agency relationship arises when one person (the principal) manifests assent to
another person (the agent) that the agent shall act on the principal’s behalf and subject to
the principals control, and the agent manifests assent or otherwise consent so to act
(acceptance), creates mutual consent
a. 3 Elements
i. Manifestation
ii. Acceptance
Cannot force someone to accept an agency position
iii. Mutual Consent: P’s permission for A to cat on P’s behalf, A’s willingness to
act under P’s control
Must have the manifestation by P for there to be mutual consent
Manifestation does not need to come directly from P, as long as it comes on
behalf of P, A can still accept
b. An agency relationship does not require a K
c. Everything revolves around the objectively reasonable person

B. Parties
1.Agent (A): individual acting on behalf of the principal
2.Principal (P): individual who the agent is acting on
behalf of
a.Disclosed P: 3 rd parties (T) know that identity of the A’s and P’s and that A is
acting on behalf of P
i.Cannot have apparent authority [need to check this]
ii. When A is acting with actual authority and makes a K on behalf of a disclosed P:
P and T are parties to the K; AND
A is not a party to the K, unless A and T agree otherwise
b.Partially Disclosed P: T know the A is working on behalf of someone else, but
don’t know who the P is
i. P and T are parties to the K; AND
ii. A is a party to the K, unless A and T agree
otherwise c.Undisclosed P: T are unaware they are
dealing with an A
i. If A, acting with actual authority, makes a K on behalf of an undisclosed P
Unless excluded by the K, P is a party to the K
A and T are parties to the K; AND
P (if a party) and T have the same rights, liabilities, and defenses
against each other as if the P personally made the K
ii. When A makes a K with T in an undisclosed P agency  A is also bound, T
can sue A too
iii.Morris – P had the benefit of being undisclosed, so takes on the risk of liability.
An undisclosed P is liable for all acts of A, for acts usually conferred to that A,
despite any limitations because there was no way for T to know about the limits
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3.Third Party (T): people with whom A interacts on P’s behalf

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C. 3 Types of Authority: The power by which A can bind P (can go beyond A’s rights to
bind P) 1.Actual Authority (A & P):
a. When the P’s words or conduct would lead a reasonable person in A’s position to
believe that P wishes A to act in that manner.
i. Express Actual Authority: specifically stated in a K between A&P
ii. Implied Actual Authority: more general order; w/in “ordinary course of
business” – have this because not everything can be put into a K
Incidental Authority: the authority to do incidental acts that are
reasonably necessary to accomplish an actually authorized
transaction or that usually accompany a transaction of that type
iii. Must have objective manifestation of an order
iv. If there is actual authority and A acts w/in the scope of that authority  P is
bound to T
Scope of A’s authority is determined by interpretation of K as ambulatory,
focusing on the reasonability of A’s interpretation of their authority at the
time A acts
v. Undisclosed P is still bound, even if T didn’t know A had actual authority
because P set the transaction into motion and stood to gain from it
2. Apparent Authority (P & T – look for P’s actions that are observed by T):
a. Whenever the T thinks, through the actions of the P, or manifestations by A to T,
that P has authorized A to make, that the A has authority
i. If there is apparent authority and A acts w/in the scope  P is bound
ii. What matters is what T knows, not what P knows – reasonable interpretation by T
iii. This is where the power of T to bind P to A’s acts can exceed the rights of A to
bind P
iv. Power of Position
Apparent authority can be created by appointing a person to a position which
carries with it generally recognized duties. To those who know of the
appointment there is apparent authority to do the things usually entrusted
to one in that position, regardless of unknown limitations imposed on the
specific A
v. Can become salient
Ex: P hires A as a cashier, but limits what A can do. T, a customer,
assumes A has all authority that cashiers usually have
vi.Agency by Estoppel: even if A acts w/o authority, if failure to hold P
liable would result in T getting defrauded  P is liable
P who hasn’t made a manifestation that A has authority and who is not
otherwise liable as a party to a transaction done by A, is liable to T if T was
induced to make a detrimental change in position because the transaction
was believed to be on P’s account if
 P intentionally or carelessly caused such belief, OR
 P, having notice of such belief and that it might induce others to
change their position, did not take reasonable steps to notify T
of the facts
3. Inherent Authority:
a. Undisclosed P is liable for all acts of A that are usual for an A of that type
i. It is or should be foreseeable to P, that when they appoint an A, as a practical
matter A, acting in good faith for the benefit of P, is likely to deviate
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 occasionally from instructions  a loss that results from a foreseeable
deviation by the A is better placed on P than T
ii. P is liable for an act by A, even if it was forbidden if
(1) The act usually accompanies or is incidental to transactions A is
authorized to conduct, AND
(2) T reasonably believes A is authorized to do the act

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 iii. Don’t always need literal interpretation of P’s manifestations to define scope
 A can act in line with authority knowingly, if A believes that
(1) Circumstances have changed since the initial instructions,
(2) Were P to reconsider the matter, different instructions would be given; AND
(3) It is impractical to communicate with P for further clarification
before the action needs to be taken

D. Authority – other aspects

1.Termination of A’s Authority
a. Generally, P have the power to terminate A’s authority at any time, even if doing so
violates a K between the two, and even if it has been agreed that A’s authority was
irrevocable
i. Limited Exception – applies to a relationship called an agency/power coupled
with an interest, still created liability for wrongful termination
2.Ratification
a. Even if A acts w/o authority, P can be bound to T, if afterwards, P ratifies A’s
actions (explicitly agrees to honor them). Retroactive ratification creates the
effect of actual authority
b. P ratifies an act if with knowledge of the material facts either
i.Express Ratification – manifesting an intention to treat A’s conduct as
authorized; OR ii.Implied Ratification – engaging in conduct that is justifiable
only if P intends to treat
A’s conduct as authorized
c. 3 times ratification is not effective
i. (1) if in favor of a person who causes it by misrepresentation or other
conduct that would make K voidable;
ii. (2) if in favor of A against P, when P ratifies to avoid a loss; OR
iii. (3) to diminish the rights or other interests of persons, not parties to the
transaction, that were acquired in the subject matter prior to ratification
3.Acquiescence
a. Even if the A acts w/o authority, if the P fails to counteract  the P is bound by the
actions of A to T through failure to oppose

E. A’s Liability & Rights

1. Generally, if A and T enter into a K, and A’s P is liable to T under the K, then T is liable to
P
a. Liability of A to P
i. If A takes an action that they have no actual authority to perform, but P is
still bound because A had apparent authority  A is liable to P for any
resulting damages
b. Liability of P to A (duty to indemnify)
i. If A has acted w/in their actual authority, P is under a duty to
indemnify A for payments A made that were necessary in executing
P’s affairs. P must act
In accordance with the K terms
Unless otherwise agreed (either)
 When A makes a payment
 w/in the scope of A’s actual authority; OR

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  that
is beneficial to P, unless A acts officiously in
making the payment
 When A suffers a loss that fairly should have been borne by P in light
of the relationship

F. Statutes
1. §8.01 – general fiduciary principle

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 2. §8.02 – material benefit arising out of position
3. §8.03 – acting as or on behalf of an adverse party
4. §8.04 – competition
5. §8.05 – use of P’s property; use of confidential information

G. Duty of Loyalty – Fiduciary Duty/Responsibility

1. A must act in the best interest of P
a. Limits the temptation of A to act in their own personal interest, which may be in
opposition to that of P.
b. Minimizes what P & A have to do to minimize costs/risks
2. Agency costs are the sum of
a. The monitoring expenditures by P
b. The bonding expenditures by A
c. The residual loss
3. Consequences of violating duty of loyalty
a. Damages
b. Any secret profit gained by A
c. Damages to P’s business
d. Lawyer’s fees
e. Goal of punishing both, A and those complicit in the betrayal
f. Want to reassure all P’s that breaches of loyalty won’t be tolerated

H. Cases
1.Morris Oil v. Rainbow Oilfield Trucking (N.M., p.13): [Dawn = P/ Rainbow = A/ Morris
= T] Rainbow and Dawn has series of agreements, that Rainbow would manage
trucking terminal operations for Dawn and would collect all money owed to Rainbow
but keep a %. K specifically stated that Rainbow was not an A of Dawn and can’t incur
liabilities that are not in the course of ordinary management. Morris delivers oil to
Rainbow and does not know of relationship with Dawn. Rainbow can’t pay, tells Morris
to talk to Dawn.
a.Rule: P is responsible for debts incurred by its A’s in the ordinary course of business,
even
if P is undisclosed and an undisclosed agreement expressly prohibits A from incurring
debts
b. Holding: Dawn was liable
i. When P entrusts the management of its business to another, an agency is
created, and P is subject to liability for A’s actions in carrying out ordinary
business. The parties may privately agree to limit A’s authority, but the
limitation does not bind T, unless T had actual knowledge of the limitation.
Even if A exceeds its authority in incurring debts, P may still be liable if P
ratifies the debt by acknowledging it afterwards
c. Reason:
i. For M to collect from D, M must show that R was an agent
M shows R was willing to act under D’s control. All money went first to
D, who then paid R’s expenses
ii. What about what the parties said
Doesn’t matter – if it looks like an agency, its an agency
iii. Is there actual authority

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 Yes, whatever came up in the ordinary course of management
iv. Is there apparent authority
Yes, D told M that they would pay for it

2.Tarnowski v. Resop (Minn., p.24) – A’s duty of loyalty: [Tarnowski = P/ Resop = A/ Sellers =
T] Resop greed to act as A for Tarnowski to look for business investment. Resop
recommend and

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 that Tarnowski purchase X. Resop didn’t investigate X and instead presented the seller’s
fraudulent claims about the business to Tarnowski. Resop accepted a secret commission
from the sellers in exchange for making the recommendation. P successfully sues T, gets
investment back, and now wants to sue A to recover the secret commission and lawyer’s
fees. P claims breach of duty of loyalty because the A is required to act in the best
interest of the P, putting aside personal interests
a. Holding: P can recover all claims against A. Anything A makes in bad faith is owed
to the P (the secret commission). Don’t need a K, only need to show a fiduciary
duty which is loyalty, acting in the best interest of P. Here, P gets the bribe and
additional damages
b.Rule: Generally, courts are reluctant to find breach of duty of loyalty, but when they
do punishment can be harsh in an effort to create a deterrent effect. Not everyone
will find out about A’s bad behavior, so there are harsh punishments

II. PARTNERSHIP
A. Generally
1. 2+ people entering into a for profit business as co-owners
2. Can be implicit or explicit/general or implied
3. Partners can create an agreement to govern their relationships with one another
a. UPA §6/RUPA §101(6) - Provides governance if there is no K
i. Control under UPA – partnerships share equal control, if there are multiple
people, that a majority vote would be sufficient if there is a difference in
opinion regarding the operation of business
ii.Rules between P’s can be modified
If you’re going to have a partnership, you should have an agreement,
otherwise you’re under these default rules which can be somewhat
harsh
iii.Rules between partnerships and T’s are mandatory
Cannot be contracted out
4. Common issue is whether a partnership has been formed
at all 5.Partnership for Term
a. The business has a definite term or particular
undertaking 6.Partnership at Will
a. The business does not have a definite term or particular undertaking
b. continues indefinitely and can be dissolved by the express will of any
partner or automatically by the happening of a specific event under UPA
§31
i. Exception w/ regards to death: under the UPA, partners may avoid the
automatic dissolution of the business upon death by providing for its
continuation in their partnership agreement.

B. PARTNERSHIP FORMATION:
1. Depends on the factual characteristics of a relationship between 2+ people, not whether
they think of themselves as having entered into a partnership
2.Factors for determining the existence of a partnership:
a. (1) Profit Sharing
b. (2) Loss Sharing
c. (3) Management and Control Sharing

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d. (4) Parties Labels
i. General rule is, what they call themselves can be used as evidence of partnership
Exception: Hilco v. U.S. (p.73)  what partners call themselves is
immaterial with respect to T’s, when their actions make a T believe
they are partners
e. (5) Unity of Interest
f. (6) Contributions to the Business

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 g. (7) UPA §7
i. (a) joint property or (b) gross return sharing do no automatically make partners
ii. (c) profit sharing is prima facie evidence of partnership, unless it is paid as
part of wages of satisfaction of a debt/loan/sale
3.4 Element Test: if there is no express partnership agreement, a relationship will be a
considered a partnership only if there is
a. (1) Agreement to share profits
i. can occur in employer-EE, LL-tenant, or lender-borrower relationships
ii. if not stated explicitly, profits are distributed equally among partners
b. (2) Agreement to share losses
i. if not stated initially, falls equally among all partners
c. (3) Mutual right of control or management of the business, AND
d. (4) Community (unity) of interest in the
business 4.Cases
a. Martin v. Peyton (NY, 1927) – General Partnership (p.74): Securities/investment
firm involved in very speculative trading; firm is failing. One partner, Hall, is very
connected and reaches out to wealthy contact for a loan to save the firm. Wealthy
friend thinks this is a lender type situation and is not responsible if/when the firm
fails
Wealthy friends agree to $2.5M loan of liquid, easily tradable securities
with contractual stipulations. In return, they get questionable/speculative
securities. They get 40% of profits until debt is repaid (profit sharing).
They put Hall in charge of the firm. Veto power (control rights). Right to
join the firm at any time
Firm fails, lenders attempt to collect from the wealthy friends. Friends
argue that they are lenders, not partners:
 (1) Had the opportunity to join the firm, but never did. What
looks like profit sharing on its face is simply debt repayment
 (2) They did not have the power to initiate decisions, only veto power
ii. Holding: Court holds that this is simply rich friends lending money to a
struggling firm. Not a partnership. Anything pointing to control was simply an
attempt to protect their investment, they were being smart, the documents
themselves do not answer if there was a partnership
iii.Rule: for a creditor to be a partner in a firm, the creditor must be closely
enough associated with the firm to make them a co-owner carrying on the
business for profit
b. Lupien v. Malsbenden (ME, 1984) – Implied Partnership (p.78): Malsbenden is a
major cash contributor to Cragin’s K with Lupien to build a car. Malsbenden also
greatly assists Cragin toward executing the K. Malsbenden was supposed to be
reimbursed from the proceeds and car sales. Cragin disappeared, Malsbenden had
physical control of the business and interacted with Lupien a lot.
i. Holding: A partnership existed. The parties don’t need to expressly agree
toform a partnership. A partnership will be inferred by the courts when there is
evidence of an implied agreement to pool resources into a business, exercise
joint control over the business, and share in the profits. Where this evidence
exists, it is irrelevant whether or not the parties actually consider themselves
partners or not

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 ii.Rule: where 2 parties exercise joint control over a business and share in its
profits, a partnership exists, regardless of how the parties view or refer to
their relationship
c. Difference between Martin & Lupien
i. Presence/control – Malsbenden had greater day-to-day control and interaction
than the wealthy friends (Peyton) in Martin
Malsbenden was operating the daily business – had he brought in a T to deal
with the business, then maybe he could have maintained a position as a
lender not a co- owner/partner

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 Peyton didn’t need to do that because he had Hall doing it for him
Once there is a partnership  consequences are easier to figure out
because there are set rules

C. ONGOING OPERATION OF A PARTNERSHIP

1.UPA §18(e): all partners have equal rights in the management/conduct of partnership
business 2.UPA §18(g): no person can become a member of a partnership w/o the
consent of all existing
partners
3. UPA §18(h): any difference arising as to ordinary matters connected with the
partnership business may be decided by a majority of the partners
a. In a 2 person partnership, a majority is both
b. What if there is a 3 person partnership where one partner contributes 90% of capital
and the other 2 each contribute 5% each
i. Under the UPA, the 2 smaller partners can outvote the 90% partner
c.Variance from the partnership agreement must be agreed upon by ALL
partners
4. Cases
a.Summers v. Dooley (ID, 1971) (p.84): General Partnership. In a 2 person partnership,
if one person wants change and the other doesn’t, who wins?: Trash collecting
partnership, 2 man operation, whenever one was unable to work he would provide a
replacement at his own expense. Summers wants to hire a 3rd worker, Dooley
objects, Summers hires anyways.
Summers brings suit for ½ the money paid to the 3rd worker. If it’s a partnership
expense 
Dooley pays half. If its an individual expense  Summers pays all
i. Holding: when a partnership is only 2 people, one cannot unilaterally
bind the partnership by incurring expenses over the objection of the
other
Reason: UPA §18(e)(h) apply. Whether this is ordinary matter or an act in
contravention of the agreement. Here, it is an ordinary matter because the
hiring of an employee is necessary in the course of business and there needs
to have a majority vote
ii.Rule: in a 2 person partnership, the one who forbids change gets his way
b.Nabisco v. Stroud (p.87): Stroud and Freeman in partnership (grocery store). Had
always purchased bread from Nabisco. Stroud announces he doesn’t want Nabisco
bread anymore. Freeman continues to order and pay out of the partnership.
Partnership dissolves, time to settle up. Stroud wants any costs to Nabisco after his
proclamation to not count toward expenses
i. Court: No, Freeman had the authority to bind the partnership. Ordering
bread was simply carrying on in the usual way. It would take a majority to
limit his ability
c.Caveat between Summers & Stroud
i. (1) there was no agreement about hiring a 3rd person so the default UPA
§18(e,h) rule applies. However, there are times when you may not want the
default rules to be applied exactly
ii. (2) cases on the other side of this question National Biscuit Co. v. Stroud (p.87)

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 here, this is a partnership expense and relies on the same § the issue is just
whether they should stop buying the bread – and to do so you would still
need a majority vote
d. How to solve these issues
i. Set up a managing partner (His decisions rule on management decisions)
ii. Set up a managing committee
iii. Require multiple signatures on certain types of contracts (checks, etc.)
Need to be able to pitch the facts to argue for the outcome you want –
what is/is not ordinary business

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 e.Sanchez v. Saylor (p.86): π/∆ were partners, T was considering lending money to
help the partnership and restructure the company debts. T requested that π provide
his personal financial statements as a condition to granting the loan. Π refused. ∆
brought suit against π, alleging that π’s refusal to provide personal $ statements to
T violated fiduciary duties.
i. Holding: All partners have equal rights in the management and conduct of the
business of partnership. Absent an enforceable agreement covering such
circumstances of disagreement, when both partners in a 2-person partnership
disagree on prospective advantageous business transaction, it is dissolution, not
an action for breach of fiduciary duty
ii.Rule: partners do not need to provide private/personal information, its not part
of their fiduciary duty
Non-agreement = dissolution of partnership NOT breach of fiduciary duty

D. NATURE/OPERATION
1.Indemnification and Contribution
a. If a partner pays more than his share for a partnership obligation, he is
entitled to indemnification from other partners to make up the difference
i. A partner has the right to be indemnified by the partnership
ii. A partnership has the right to require contribution from one or more partners
2.UPA §9(1): every partner is an agent of the partnership for the purpose of its business,
and the act
of every partner binds the partnership (seems to conflict with UPA §18(h))

E. Liability for Partnership Obligations

1.All partners are personally liable for obligations of the partnership
a. This is personal liability to T!!
b. Under UPA, partners are jointly and severally liable for debts of the partnership
i. The RUPA doesn’t apply in NY – no joint liability
c. Individual partners, even if they were very against expense at outset, are liable for
expenses
d. Judgment can be enforced against any party
i. Partner who gets collected against can collect against the other partners
e. All rules are regarding T and involving the debt shared by the partnership
i. Once the money is granted, indemnification can occur, where the person can
then go to the partnership for an indemnification
ii. Contribution is what the other partners will have to give
f.Liability if a 2-way street, the individual creditors of the partners can use the to
satisfy
[need to get notes]
2.When do assets of a partnership become liable for debt of partners?
a. Where personal assets are insufficient, tort victims may reach a partner’s economic
interest
in a partnership
i. Victim does not become a partner (like garnishing wages)
b. Generally can’t collect money put into the partnership originally, just the money
flowing out of it (unless partnership dissolves)
3.UPA §15 – Nature of Partner’s Liability
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 a. Tort victims can sue all partners individually, or can sue only those who they
think have money (joint or several)
b. Creditors with K suits have to sue EVERY person who is a party to
the K 4.Davis v. Loftus (p.101)
a. The income partners didn’t qualify as partners under the act. They had no right to
vote on the management or conduct of the partnership business, the executive
committee decided how much the income partners were to be paid

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F. Partners Duty of Loyalty
1.Aspects of Fiduciary Duty of Loyalty
a. Prohibition on self-dealing (can’t be in business with the partnership)
b. Partners cannot compete with the partnership
c. Cannot use partnership property for personal gain
d. Cannot take business opportunity for personal
gain 2.Partners must be loyal to one another and the
partnership!
a. Many acts normally permitted in arms-length transactions will not be
permitted in the partnership context
3. Suits for an Accounting (UPA §22):
a. Partners can bring suit for an accounting
i. When a partner is wrongfully excluded from the business
ii. If the right to do so is granted under the partnership agreement
iii. When another partner appropriates an unauthorized benefit
iv. When other circumstances render it just and equitable
b. Not every fiduciary will have breached their duty even if they partake in the same
behavior
i. It is whether they are acting and in obligations, they are the partners breaching
In Meinhard, it’s possible that for someone like Meinhard disclosure
would be sufficient. But it seems like Salmons obligations may be
higher (p.116-117)
4. Cases
a.Meinhard v. Salmon – Fiduciary Duty/Deterrence (NY, 1928) (p.114): Salmon
leased a hotel for a 20-yr term, made modification costing $200K. Had agreement
with Meinhard, as a co-adventurer, where M was to give S ½ the money required to
reconstruct and operate the hotel. M to receive 40% of the net profits for 1st 5-yrs of
lease and 50% after. M and S were to share in losses equally, but S had sole power
to manage, lease, underlet, and operate the building. Lost money at first, but then
profitable. When lease was up, S entered a new 20-yr lease, unknown to M. Upon
finding out of the new lease, M demanded the lease be held in trust as an asset of the
joint venture and offered to share in the obligations. S refused.
i. Holding: as shares in a joint venture, co-adventurers owe each other a high
level of fiduciary duty. A co-adventurer who manages a joint venture’s
enterprise has the strongest fiduciary duty to other members of the joint
venture. Because S tried to pull a fast one, court demands that M be treated as a
partner and gets to split the $. A trust attaching to the shares of stock should be
granted to M, with the parties dividing the shares equally, but with S receiving
an additional share. The additional share enables S to retain control and
management of the property.
Reason: Because S’s opportunity arose, as a result of his status as
managing co- adventurer, he had a duty to tell M about it. Not telling M
about the opportunity prevented M from enjoying in it.
ii.Rule: Co-adventurer’s, like partners, have a fiduciary duty to each other,
including sharing in any benefits that result from the partners joint
venture
iii. Policy: a duty of loyalty is imposed on partners to give people an incentive to
enter into a partnership
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b.DBR on Meinhard:
i. Disclosure is another way to get away w/o having to deal with duty of loyalty
“Punctilio of an honor most sensitive” is required when parties are
dealing with each other
ii. S could have ended the relationship at the very least, giving M an opportunity
to compete. S didn’t, and was seeking to benefit alone from the previous jointly
profitable lease
iii. S seems to take an opportunity that should have been available to both partners
iv. In agency context – this would be taking a secret commission/bribe

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 v. Unlimited ways to breach – in competition, take their property/info, conflict of
interest

G. PARTNERSHIP DISSOLUTION
1.Generally
a. UPA §31: Dissolution is caused
1) Without violation of an agreement between the partners
a. termination of definite term specified in agreement
b. express will of any partner when nothing is specified in agreement
c. express will of all partners who have not assigned their interests
d. expulsion of any partner from the business
2) Wrongful – in contravention of agreement where the circumstances do not
permit dissolution under any other provision of agreement (breach of
fiduciary duty)
3) By any event which makes it unlawful for the business of the partnership to be
carried on or for the members to carry it on in partnership
4) Death of any partner
a. If there was a death of a partner, the partnership is automatically
dissolved, BUT it is not terminated until the winding-up process is
complete
5) Bankruptcy of any partner or the partnership
6) Decree of the court under
§32 b.Partnership at Will
i. Can dissolve for any reason at any time
ii. Fiduciary Duties:
At least as great as for a SH in a corp.
However, a partner may not, through adverse pressure “freeze-out” a co-
partner and appropriate the business for their own use
Partner may not dissolve a partnership to gain the benefits of the
business for themselves, unless they fully compensate the co-partner
for their share of the prospective business
Duty of loyalty continues during dissolution and
termination c.Partnership for Term
i. If a partner leaves before the term ends  it is wrongful and they will not
get the benefits of “good will”
d.UPA §38: Rights of Partners to Application of Partnership Property
i. Any partner may force liquidation in a rightful dissolution
ii. Wrongful dissolver may get less than his fair share of partnership assets
iii. Goodwill of partnership does not get paid to wrongful dissolver
iv. Partnership business may continue w/o consent of wrongfully dissolving
partner 2.Partnership Breakup Under the UPA – language is very important
1) Process of Partnership Termination
a. Dissolution: change in legal status of partners/partnership
i. An event by one/more partner(s) (they leave, etc.) or a court sets
termination in motion. Even if the business continues, the original
partnership is ended

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 ii. Does not instantly terminate the business, it continues until the
winding up of partnership affairs is complete, merely ends the carrying
on of business
iii. Partnership continues until the “winding-up” of affairs is completed
b. Winding – Up: economic event of liquidation after dissolution
i. Settling of all partnership debts, contracts, finding a buyer, etc.
ii. Duty of loyalty remains – Partners still have all the same obligations
c. Termination

20
 i. All obligations disappear. Business can still continue but run by
different people.
ii. If so, then all original partners need to come to some agreement,
either in advance or at the time of dissolution
1. Ex: food truck by A, B, and C. A leaves, B&C want to
continue. All 3 need to agree that business will continue
a. Even if only 1 partner wants out, the partnership is dissolved
i. business may continue under a new form
ii. any partner may terminate the partnership by saying they want out, so
long as the agreement doesn’t require them to stay in for a specified
period of time
b.Girard Bank v. Haley (1975) (p.125): Partner in an at-will partnership sent a
letter to the other partners stating that she was terminating the partnership
i. Rules:
1) Dissolution by express will of any partner need not be supported by any
justification. It is effective as dissolution, even if in contravention of the
agreement (K)
2) The unilateral dissolution did not violate the partnership agreement
because the agreement did not have a fixed term
ii. If the dissolution results in breach of K, the aggrieved partners may recover
damages for the breach, and if they meet certain conditions, may continue the
firms business for the duration of the agreed term or until the particular
undertaking is completed
3. Consequences
1) Dissolution by Rightful Election - Rightful Dissolution
a. When partnership dissolution is rightfully caused, each partner, unless
otherwise agreed, may have the partnership property applied to discharge its
liabilities, and the surplus added to pay in cash the net amount owing to the
respective partners
b. Under the unless clause, the partnership agreement can provide that after the
termination of a person’s status as a partner, the remaining partners can
continue the partnership business, even if the partnership has been dissolved
(continuation agreements)
a. Creel v. Lilly (MD, 1999) – Liquidation/Winding-Up – Consequences of Rightful
Dissolution (p.126): 3 partners (Creel, Lilly, Altizer) formed partnership to run
NASCAR memorabilia store. Creel dies (rightful dissolution). Agreement didn’t
specify what to do if a partner died. Partners continue business under a new name.
∆’s wanted to continue the business so they conducted an accounting as a way to
“buy-out” π. ∆’s didn’t want to sell everything. Creel’s widow (π) demanded a
liquidation. Π didn’t conduct her own accounting.
Π wants: liquidation because you put it for sale and get that price v. an
accounting is a guess on value based on what is believed the market
would pay
 Tries to use UPA §38(1): any partner may force liquidation in a
rightful dissolution (interprets it wrong)
 Can have partnership property applied to pay liabilities, then
have the surplus split between all partners

21
∆’s want: to keep going and do an accounting. Liquidation would be bad
because there are some things that are not recoverable at auction
 Concept of “Good Will”  knowledge of brand, customers
trust/loyalty, relationships with others in the business world
 Worried liquidation would decrease the value b/c it would not add in
“good will” value. An accounting would. Concerned about a “fire
sale,” undervaluing goods sold
 Π had opportunity to challenge accounting

22
 ii. Rule/Court: where surviving partners have in good faith “wound-up” the
business and the deceased partners estate is provided with an accurate
accounting allowing for payment of a proportionate share of business, then
forced sale of all assets is unwarranted
Don’t want to force a fire sale – not equitable: would give dissolving
partner too much power to harm the other partners
iii. DBR Advice:
Be wary of forced liquidation – no way to know how the court will rule
To avoid this mess always put something in the agreement for what
happens in case of dissolution
b.RUPA: the entity theory
i. Allows partnership to continue even after the departure of a member –
views the partnership as an entity
ii. Existing partnership may be continued if the remaining partners elect to buy
out the dissociating partner
c. Page v. Page (CA, 1961) (p.141): Linen supply business, each partner made capital
contributions. Main creditor is a corp. owned completely by the π. Big loss in 1st
year, then becomes much more profitable. Π moves for dissolution. ∆ claims
partnership for a term existed, because they wanted (hoped) to stay in business
until they made a return on their investment, and prematurely ending a partnership
for term is grounds for wrongful dissolution.
i. Holding: this is a partnership at will, every business has the intention of
turning a profit, not grounds for specific undertaking
However, court holds that even where a partner has the right to dissolve, he may
not do so in violation of his fiduciary duty of loyalty  dissolving the
partnership in this case would be a breach
ii. Rule: A partnership may be dissolved upon notice by any partner when
there is no definite term set for the partnership.

2) Wrongful Dissolution
a. If a partner wrongfully causes dissolution, although the partnership is
dissolved, the remaining partners can continue the partnership business
(UPA§38(2)(b))
b. Can be cashed out now or in the future with interest
c. UPA §31(2): In contravention of the agreement between the partners, where
the circumstances do not permit a dissolution under any provision of this
section, by the express will of any partner at any time
-Drashner v. Sorenson (SD, 1954) (p.152): Real estate business, partnership for a term,
until
the loan was paid back (not at will). Π was a wrongful dissolver, didn’t go to work,
drank too much, and tried to take more money than he was entitled to
 Court: π was in contravention of the agreement. In SD, a partner who dissolves
in contravention of the partnership agreement is not entitled to a valuation
that includes any good-will of the business
oΠ was past being a lazy employee because his conduct was so bad it
was impractical and ineffective to run a business with him in it.
And here the business had a lot of good will
- UPA§38 - Partner has the right to leave, but will face consequences

23
  Wrongful dissolver may get less than his fair share of partnership assets
 Good will of partnership does not get paid to wrongful dissolver
 Partnership business may continue w/o consent of wrongfully dissolving partner
3)DBR on Dissolution
a. Statute is not enough, need to add layer of K to set up procedures for
i. Expulsion
ii. Business continuation

24
 iii. Buy-outs
b. Default application is at-
will 4.Expulsion (Remedy)
a. A way to avoid risk of dissolving. A partner per the terms of a partnership
agreement is deemed a rightful dissolution
b. If clause in agreement  Rightful expulsion
i. Can be done with good cause or w/in the framework of the agreement
ii. Will not face wrongful dissolver status
c. If clause NOT in agreement
i. Can still expulse if you can show good cause
d. Expulsion clauses can be a powerful tool
i. Get rid of an incompetent partner
ii. Protect against fiduciary duty
claims e. UPA §31(1)(d)
H. UPA STATUTES
1.§6 (Partnership Defined): “an association of two or more persons to carry on as co-
owners in a business for profit.”
2.§7 (Rules for Determining Existence of a Partnership): persons who are not partners to
each other are not partners as to 3rd persons. Factors going to determining a partnership
include joint tenancy, common property, receipt of share of profits (except as debt,
wages, annuity, interest on a loan, or consideration).
3.§9 (Partner Agent of Partnership as to Partnership Business): every partner = agent of
the partnership for the purpose of its business, and acts of each partner occurring in the
apparent usual course of business binds the partnership, unless that partner lacks
authority to so act and the 3rd party knows it. No one partner may assign partnership
property in trust for creditors, dispose of good-will of business, do acts making it hard to
carry on ordinary business of partnership, confess a judgment, submit a partnership claim
or liability to arbitration or reference. Partners acts in contravention of restrictions on
authority won’t bind the partnership if 3rd persons know of the restriction.
4.§15 (Nature of Partner’s Liability): all partners are liable jointly and severally for
everything chargeable to the partnership under §§13 (Tort) and 14 (Breach of Trust). All
partners are jointly liable for all other debts and obligations of the partnership, but any
partner may enter into a separate obligation to perform a partnership contract.
5.§18 (Rules Determining Rights and Duties of Partners):
a. Each partner shall be repaid his contributions to the partnership and share equally
in profits and surplus remaining after all liabilities are satisfied, and must
contribute to losses sustained by partnership according to his shares.
b. Partnership must indemnify every partner regarding payments made and personal
liabilities incurred.
c. Partners who aid the partnership by making payments or advances beyond the
capital s/he agreed to contribute will be paid interest from the date of that
payment/advance.
d. Partners shall receive interest on capital contributed by him only from date when
repayment should be made.
e. All partners have equal rights in management/conduct of the partnership.
f. No partner can be remunerated for acting in partnership business, except that
surviving partners can be reasonably compensated for his services in winding up
partnership affairs.
25
 g. Differences are to be decided by a majority of the partners, but no act
contravening any agreement between the partners can be done without the
consent of all the parties.
6.§21 (Partner Accountable as a Fiduciary): every partner must account to the partnership for
any benefit, and hold as trustee for it any profits derived by him without the consent of
the other partners from any transaction connected with the formation, conduct or
liquidation of the

26
 partnership or from any use by him of its property. This also applies to reps. of a
deceased partner liquidating the affairs of the partnership as the personal rep. of the last
surviving partner.
7.§29 (Dissolution Defined): the change in the relation of the partners caused by any partner
ceasing to be associated in the carrying on as distinguished from the winding up of the
business.
8.§30 (Partnership Not Terminated by Dissolution): on dissolution the p’ship is not
terminated, but continues until the winding up of p’ship affairs is completed.
9.§31(Causes of Dissolution): Dissolution is caused:
a.(1) without violation of agreement between the partners
i.(a) by the termination of the definite term or particular undertaking
specified in the agreement.
ii.(b) by the express will of any partner when no definite term or particular
undertaking is specified.
iii.(c) by the express will of all the partners who haven’t assigned their
interests or suffered them to be charged for their separate debts, either
before or after the termination of any specified term or particular
undertaking,
iv.(d) by the expulsion of any partner from the business bona fide in accordance
with such a power conferred by the agreement between the partners;
b.(2) In contravention of the agreement between the partners, where the
circumstances do not permit a dissolution under any other provision of this
section, by the express will of any partner at any time;
c.(3) by any event which makes it unlawful for the business of the p’ship to be
carried on or for the members to carry it on in partnership;
d.(4) by the death of any partner
e.(5) by the bankruptcy of any partner or the
p’ship f.(6) by decree of court.
10.§32(Dissolution by Decree of Court)
a.(1) on application by or for a partner the court shall decree a dissolution whenever
i.(a) a partner has been declared a lunatic in any judicial proceeding or is shown
to be of unsound mind.
ii.(b) a partner becomes in another way incapable of performing his part of the
p’ship K. iii.(c) a partner has been guilty of such conduct as tends to prejudicially
affect the carrying
on of the business.
iv.(d) a partner willfully or persistently commits a breach of the p’ship
agreement, or otherwise so conducts himself in matters relating to the p’ship
business that it is not reasonably practicable to carry on the business in
p’ship with him.
v.(e) the business of the p’ship can only be carried on at
a loss vi.(f) other circumstances render a dissolution
equitable
b.(2) on the application of the purchaser of a partner’s interest under §28
or §29 i.(a) after the termination of the specified term or particular
undertaking,
ii.(b) at any time if the p’ship was a p’ship at will when the interest was assigned
or when the charging order was issued.
27
11.§38(Rights of Partners to Application of Partnership Property):
a.(1) when dissolution is caused in any way, except in contravention of the p’ship
agreement, each partner, as against his co-partners and all persons claiming through
them in respect of their interests in the p’ship, unless otherwise agreed, may have the
p’ship property applied to discharge its liabilities, and the surplus applied to pay in
cash the net amount owing to the respective partners. But if dissolution is caused by
expulsion of a partner, bona fide under the p’ship agreement and if the expelled
partner is discharged from all p’ship liabilities, either by payment or agreement, he
shall receive in cash only the net amount due him from the p’ship.

28
 b.(2) When dissolution is caused in contravention of the p’ship agreement, the
rights of the partners shall be as follows:
i.(a) each partner who hasn’t caused the dissolution wrongfully shall have:
I. All rights specified in para. (1) and
II. The right, as against each partner who has caused the dissolution
wrongfully, to damages for breach of the agreement.
ii.(b) The partners who have not caused the dissolution wrongfully, if they all wish
to continue the business in the same name, either by themselves or jointly with
others may do so during the agreed term for the p’ship and for that purpose may
possess the p’ship property, provided they secure the payment by bond
approved by the court, or pay to any partner who has caused the dissolution
wrongfully, the value of his interest in the p’ship at the dissolution, less any
damages recoverable under clause 2aII of this §, and in like manner indemnify
him against all present or future p’ship liabilities.
iii.(c) A partner who has caused the dissolution wrongfully shall have:
I. If the business is not continued under the provisions of paragraph 2b
all the rights of a partner under para. 1 subject to clause 2aII of this
section,
II. If the business is continued under paragraph 2(b) of this section the right
as against his co-partners and all claiming through them in respect of
their interests in the p’ship to have the value of his interest in the p’ship,
less any damages caused to his co-partners by the dissolution, ascertained
and paid to him in cash, or the payments secured by bond approved by
the court, and to be released from all existing liabilities of the
partnership; but in ascertaining the value of the partner’s interest the
value of the good-will of the business shall not be considered.
12.§40(Rules of Distribution)

PART II – THE CORPORATE FORM

A corp. is a legal person or entity with an existence separate from its
owners/shareholders.
I. THE CORP. FORM
A. Basic Characteristics of a Corp. (5 main, 1 extra)
1. Limited Liability
a. Typically, SH’s/managers are not personally liable for corp.
obligations/debts. Managers, if acting w/in the scope of their authority,
are treated like A’s not P’s for liability purposes. SH’s more willing to
take equity shares with no management rights
b. Could lose entire investment – but you cannot lose more than that
c. An entrepreneur can borrow money that they must pay back (debt
strategy) or they can bring on co-owners to bring in capital (equity
strategy)
i. Debt Strategy
1. To get the loan, the bank needs to check whether you have
collateral, good credit, etc. Equity cushion is needed by the
bank to ensure that they will get their money back
ii. Equity Strategy

29
 1. Is much more viable because there is only limited liability
2. Fee Transferability of Ownership Interests
a. Shares can be sold openly
b. Easy to sell shares in a corp., because they can be freely transferable
and you don’t need consent from the owners (unlike partnerships)

30
 c. Allows for more easily moveable assets and ability for an investor to
change their mind
3. Continuity of Existence
a. Life of a corp. is perpetual, cannot be dissolved just because one owner
wants out, unless a shorter time is specified in the certificate of
agreement. If corp. goes out of business, then it’s over. Very stable
i. Must be approved by very high % of SH’s
ii. Can have a bankrupt corp.
b. Unlike at-will partnerships, uncertain, can dissolve at any time. can write
around default rule
4. Centralized Management
a. Power to manage is vested in the board of directors by SH vote. SH’s
don’t have a right to take part in management decisions. Con – director
may be voted out, not much say
b. Unlike partnership because control in a partnership is disbursed throughout it
i. Many businesses prefer to use partnership components in this
sense to safeguard their rights in management
5. Entity Status (don’t need to worry about this)
a. Corp. is recognized as a legal person or entity, can therefore exercise
powers and rights in its own name. Can sue or be sued. Can own real or
personal property
6. Taxation
a. In a corp. – double taxation, the corp. itself is taxed and so is the individual
b. In partnerships – pass through treatment, pass value through to owners.
Partners are taxed on the income, but the partnership itself is not taxed

Default Rules Corp. Partnership

Liability Limited
Transferability Freely transferable
Continuity Perpetual
Management Centralized, board of directors.
SH’s don’t have a right to
manage directly, only act
indirectly, control by owners
Regulation/Gov Must file w/ govt. – more
t. Regulation heavily regulated because need
to file with sec. of state, its
easier for regulators to find the
corp.
Unlimited, partners personally liable
Limited/Hard, need consent of co-
p’ers, who can refuse to accept new
p’er
Uncertain
Dispersed, p’ers have an equal
say in management (UPA§18)
Under the radar, can come about w/o
even the partners knowing about it,
much harder for the govt. to know

B. State of Incorporation
1. General rule: is that laws of the state of incorporation will govern the corp.’s
internal affairs. Stated in the Charter granted by the state.
2. Selecting a State of Incorporation
a. Small Businesses
- Generally, incorp. in a state where they pay taxes
31
  Lawyers more familiar with local JX
b. Large Businesses: Most incorp. in DE
- Historical advantage, earliest to allow corps. to inc. for “any lawful business”
- DE stays current on corp. law
- DE judiciary, the Ct. of Chancery

32
  Dedicated to corp. cases, NOT combined with equity
oJudges are corp. experts, up to date on markets and corp. operations
oMove very fast/responsive (faster than state cts.)
- Most pro-management laws/regulations
 Critics: Race to the Bottom, best for managers
 Response: Race to the Top, best law for all involved

C. Organizing a Corp.
1. FILE Document
a.Certificate/Charter/Articles of Inc. – filed with secretary of state
- Sets out classes of stock, number of shares authorized for issue, provides
for start- up of organization by naming board of directors
- Explains purpose of corp., usually “any lawful purpose”
- Can be amended, but difficult because all SH’s must agree on the changes
2. Hold a MEETING
a. Directors/SH’s adopt bylaws (typically very long), which give more
complex explanation of how the corp. will run
- Easier to amend than certificate, can be amended by board of directors
or SH’s acting alone
- Bylaws of large publically traded corps. are often available to the public
3. OBTAIN FINANCING (2 main ways) NEED TO GET NOTES FROM ESTHER
a. D
ebt
b.Equit
y
-Common Stock
-Preferred Stock

II. CORP. FINANCING

A. (1) Debt: (borrowing) Creditors do not participate in profit of corp. Holders of debt
have a right to receive a set stream of income and repayment over time
B. (2) Equity: (provides for co-owners) Equity owners can share in profits. Dividend
availability differs between common stock and preferred stock, but only equity
owners (not debt holders) get dividends. If corp. is dissolved, once all other creditors
are paid off, any remaining value in the corp. is parceled out to equity owners
1.Common Stock:
a. Ownership or equity interest
b. Normally, carries the right to vote in election of directors and certain other matters
-Residual interest – claim to what is left after all senior claimants (debt,
preferred stock) have been satisfied
2.Preferred Stock:
a. Permanent investment for the life of the company
b. First claim in the event that the directors are able and willing to pay
dividends c.Straight Preferred Stock
- Most frequent type of preferred stock
- Fixed % of the par value of the stock or fixed number of dollars per
share in the case of stock w/o a nominal or par value
d. Priority position is only with reference to common stock, creditors still have priority

33
 - Right to vote in election of directors if, and only if, preferred
dividends are in default for a designated number of periods
C.P ayment Order Upon Liquidation
1. Debt holders  preferred SH’s  common SH’s
D.C ontrol

34
 1. Common SH’s can vote on major events (directors, sale of major assets, dissolution)
2. Preferred SH’s usually lack the right to vote unless they have dividends owned
3. Debt holders never have a right to vote

Types of Security Risk of Loss: may not be Control Potential Gains:

big deal if they have enough investor who cares
potential gains to help most about gains out
mitigate loss. of investment
Debt A: what you want to invest F: debt holders C
in if you want s/t stable and have no
secure management
rights
Equity – F: you could lose A: power with A: if the business is
Common everything. Very dangerous voting rights successful, this is
as a single investment, and more the residual taker.
might be different if it is access to Default they are
part of a portfolio of control entitled to whatever
investments is left after everyone
is paid off
Equity - C: after debt in terms of C: no voting B: (depends on how
Preferred liquidation but somewhere rights unless the preferred is
in the middle in terms of explicitly given at structured) generally,
loss some point created greater
dividends but are still
not residual owners
who can take the
most

Difference Between:
Type of right Owners of Equity Owners of Debt
Voting/Control Have some voting rights, impact on Do not have the right to vote
decision making or manage affairs of the corp.
No permeant ownership
relationship
Return/Paymen Some kind of share of the profits Some kind of agreed upon rate
t Ex: dividends – when the of return
business is Ex: a straight interest rate, a
making profits and the board votes to bond that pays 5% interest for
return some to SH’s 10yrs
Repaymen Don’t get investment back until the Priority for repayment
t Priority corp. dissolves and then get paid from after liquidation
any money left after creditors are paid Get repayment prior to the
off equity holders.
Ex: residual ownership interest – if lots
of money left, good opportunity to
make a lot

35
E. Difference between PREFERRED & COMMON STOCK
1. WHAT THE ACTUAL FUCK!!??!!??
2. Preferred (intro to hybridization of default rules)
a. This SH has a preference over common
b. Preference in terms of dividends, common tool in the venture capital space
c. Preference in liquidation, get paid after the debt (creditors still get paid first) but
they are in line first ahead of the equity owners
d. Don’t have the right to vote, unless they have the right if dividends are in rears
e. Hybrid

36
 - They look like debt in terms of voting and entitlements to debt
- They look like equity
where f.Common
F.H ow to choose between Debt and Equity structures
1. Cannot finance with 100% equity, need to have some combination of investors who
are willing to have a risk of loss (equity cushion)
G.H ow do bonds work
1. Issued to a large number of individuals, this can make it hard to distinguish them
from shares. “Bond” is used as the generic term for all long-term debt securities
2. Concept of indentures

III. TYPES OF DEBT & DEBT COVENANT

A. Generally, Debt is a fixed claim against the corp. for principal & interest 
guaranteed some type of return

B. 4 Types of Debt
1. Trade Debt
a. Consists principally of amounts that a corp. owes for goods and services at any
point in time (payment due in 30, 60, 90 days…)
- Appears on corps. balance sheet as “Accounts Payable”
2. Bank Debt
a. Any commercial or bank loans, appear on a corps. balance sheet as “Loans Payable”
3. Bonds (generic term for all long-term debt securities) & Debentures
a. Promises, embodied in an instrument, to repay amounts that the firm has
borrowed on a long-term basis, typically by selling the bonds on the
general/special market
- Bonds appear on balance sheet under “bonds payable” or captions
describing the specific bond name, “7.5% Senior Debenture”
b. Represent money borrowed from the public, or at least from a significant
group of lenders or investors
c. Promissory notes issued pursuant to and governed by longer K’s know as
“indentures”
- Bonds set out a promise to pay that runs to the holders of the bonds
- The indenture is a bundle of additional promises, including a backup
promise to pay, that run to a trustee
- Bondholders are 3rd party beneficiaries of the promise in the indenture
- Tax advantage, can deduct dividend payment (some corps. prefer debt
because of this)
4. Notes
a. Unsecured, long-term obligations
b. Tend to be intermediate term securities, coming due in 10yrs or less
- Whereas debentures tend to mature in 10yrs or more

C. Classical Ultra Vires Doctrine (not used, states have statutes to abolish this)
1. Early corp. charters tended to narrowly circumscribe the sphere of activities in
which a corp. could engage
a. Transactions outside that sphere were characterized as “ultra vires” (beyond
the corps. powers) and
37
 - Unenforceable against the corp. because they were beyond the scope of
powers
- Unenforceable by the corp. on the grounds of lack of mutuality
b. Originally intended to protect the public or the state from unsanctioned corp.
activity 2.Powers & Purpose: classically applied to 2 situations

38
 a. Whether a corp. has acted beyond its purpose and engaged in a type of business
activity not permitted under its certificate
b. Whether the corp. had exercised power not specified in its certificate
3. Problem/concern  the power of the corp. to be a general partner
a. Present day statutes make this moot by explicitly empowering corps. to become
partners
- DE statute §122: specific powers DE gives to corps. even if not listed
in their bylaws, limits the ultra vires doctrine

IV. CORPORATE OBJECTIVES

A. Basic Corp. Objective: Maximizing SH Wealth/Value
1. No longer what a company is permitted to do, now that states follow the “any lawful
purpose” criteria, but what should a company do
a. Rests on the assumption that whatever is good for the SH is good for the corp.
2. Need to look at reasonableness and practicality. Hard to tell managers what to do
because the corp. objective differs whether SH is in it for the
a. Shor
t-term
b.Long-
term

B. Interests other than Maximization of SH Wealth

1.Dodge v. Ford Motor Co. (p.253): π sues because if ∆’s desire to reinvest in his own
company and lower car prices as opposed to paying out special dividends. ∆ had been
paying out $10mill in dividends previously. ∆ alleges he wants to lower car prices and
raise employee salary because he is a philanthropist. ∆ does not say he is doing this
because more money for the employer will create more money for ford and then for the
SH’s
a.Rule/Court: cannot run a corp. like a philanthropy especially when you have
objecting SH’s, all decisions need to be for betterment of the corp. objective of a
for-profit organization, especially with minority SH’s, is to maximize SH value
and not keep all the cash w/in the corp.
- By taking an action with no business concerns motivating it, ∆ and the
directors who supported the decision were acting arbitrarily, to the
detriment of the SH’s in whose interest they were supposed to be acting
2.eBay v. Craigslist: Craigslist (1) had a staggered board, where not every board seat
was up for election each year, (2) had right of first refusal, gave right of Craigstlist
company first to buy shares before selling it to others and (3) had a “Poison Pill,”
makes it harder to purchase enough shares of a target company to take it over from
the outside
a. Procedure: eBay sues, saying all 3 things are wrong because they don’t
maximize the company in the SH’s pov
- eBay says: you can’t do that, you have to serve the SH’s. You can’t refuse
a profit or run it as a charity, if they are a for-profit company that has
minority SH’s
- Craigslist says: goal of the company is to serve the community.
Argues their service was practically free and a benefit to the
community that would be undermined by a takeover
39
 b. Court: Craigslist should have said, they were building a customer base, changing
things to better the corp. you cannot set up a corp., take $ from eBay, then use $
in ways eBay objects to. Company culture argument was insufficient
3.DBR
a. Not many cases where corps. are so reckless about how they justify actions
regarding maximizing majority SH value that when the minority holders bring
complaint they are unable to justify behavior as being a proper corp. objective
- When advising corp. on including social mission – make sure to get like
minded investors who also have social minded outlook

40
 - Properly prepare people for testimony
b. To avoid an eBay type problem Directors can
-Other Constituency Statutes (in some/not all states)
 State statute that gives SH’s notice that the corps. board will focus not only
on maximizing SH value but also the employees and objectives of
the corp. itself
oCould have social policy objective
 DE does not have
-Benefit Corps.
 Available in about ½ the states
 Directors must consider the benefit to the public in making any
company decisions

C. Corp. Charitable Contributions

1.A.P. Smith Mfg. Co. v. Barlow: AP made a charitable contribution to Princeton
University, claiming it had a duty to support the public good and that it was a corp.
benefit because it fostered educated people to hire from. Barlow alleges the
contribution came from profits that AP could/should have given to the SH’s
a. Rule: A corp. action may include authorizing charitable contributions as long as
its in line with state law. Terms of a corps. articles of incorporation from the
state can be changed at any time. And, corps. have a lot of $ in todays world,
and contributions help the community.
b. Court: c/l + statutes = not a bar on charitable contributions.
- SCOTUS: “public interest” statutes, such as the one here, are
constitutional, even though those statutes might lead to a loss of value for
the shareholders
2. How to work through whether a corp. can/cannot do something
a. When deciding whether a corp. can/cannot do something
- (1) reasonableness
- (2) nexus - between the donation and the corp. that is beneficial
 Political contributions don’t count
 Cannot have a personal reason
- (3) charitable contributions (“pet charity”) - Limitations on
Charitable Contributions
 Cannot donate to a director’s charity as additional means of compensation.
SH’s do not have a say in what is not charitable
b. Are the actions beyond the corp. objective? Boards are given broad discretion

D. Other Constituency Statutes

1.NY-BCL §202(a)(12)
a. Each corporation, subject to any limitations provided in this chapter or any other
statutes of this state or its certificate of incorporation, shall have power in
furtherance of its corporate purposes:
-(12) to make donations, irrespective of corporate benefit, for the public
welfare or the community fund, hospital, charitable, educational,
scientific, civic or similar purposes, and in time or war or other national
emergency in aid thereof.
2.NY-BCL §717(b)

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a.(b) In taking action, including, without limitation, action which may involve or
relate to a change or potential change in the control of the corporation, a director
shall be entitled to consider, without limitation, (1) both the long-term and the
short-term interests of the corporation and its shareholders and (2) the effects that
the corporation's actions may have in the short-term or in the long-term upon any
of the following:

42
 -(i) the prospects for potential growth, development, productivity and
profitability of the corporation;
-(ii) the corporation's current employees;
-(iii) the corporation's retired employees and other beneficiaries receiving or
entitled to receive retirement, welfare or similar benefits from or pursuant
to any plan sponsored, or agreement entered into, by the corporation;
-(iv) the corporation's customers and creditors; and
-(v) the ability of the corporation to provide, as a going concern, goods,
services, employment opportunities and employment benefits and
otherwise to contribute to the communities in which it does business.
b. Nothing in this paragraph shall create any duties owed by any director to any
person or entity to consider or afford any particular weight to any of the
foregoing or abrogate any duty of the directors, either statutory or recognized by
common law or court decisions.
c. For purposes of this paragraph, "control" shall mean the possession, directly or
indirectly, of the power to direct or cause the direction of the management and
policies of the corporation, whether through the ownership of voting stock, by
contract, or otherwise.

V. LIMITED LIABILITY & PIERCING THE CORP. VEIL

A. Limited Liability (default) - “no liability rule”
1. Default rule of corps.
2. SH liability/risk is limited to their investment
a. Not liable for corp. obligations by statute. The most they stand to lose, even if
the corp. fails, is the amount paid for their shares
b. Unlimited liability for all SH’s would lead to liquidity issues in the market for
shares
- Richer SH’s would be more at risk than poorer SH’s
 Potentially solved by instituting pro-rata liability rules
oIssue is not all states will do it and corps. will just
incorporate elsewhere, making it too unattractive for
any state to adopt
3. Corp. managers not liable for corp. obligations on straightforward agency laws
a. BUT corp. managers may be liable to 3rd party if, they personally commit or
directs the commission of a tortious act

B. Exception – when SH’s will be held personally liable for corp.

1. When cases involve “disregard of the corp. entity” or “piercing the corp. veil” they
really involve only a conclusion that under certain circumstances there are good
reasons why the normal statutory rule of limited liability should not be applied
a. Ex: when there is a tort claim, where damages are more than the value of the
corp., if a corp. is incorporated then you are out of luck v. in a partnership the
SH’s would become personally liable

C. Piercing the Corp. Veil

1. Generally
a. Applies when you have a SH being held liable for corp. actions
b. Only occurs after π wants judgment

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 c. Safety value for when limited liability imposes serious costs society is not willing to
pay

D. Cases
1.Fletcher v. Atex – Extraordinary Circumstances Exception (p.398): Kodak (parent
company), wholly owned Atex (subsidiary). Π Sued Atex and Kodak arguing their
keyboards caused repetitive stress injuries. The subsidiary harmed the π. Judgment for
π. They cannot get
$. Π goes to Kodak as being essentially the same.

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 a. Issue: can π pierce the veil to get to Kodak? Can a SH be held liable for corp.
debt if the SH and corp. didn’t operate as a single entity, or if their actions didn’t
create injustice of its own? Π Argues: Here, π failed to show substantial overlap
between the two to create a single economic entity and that π did not show
enough to prove resultant injustice
2.Fletcher – 2 ways to pierce the corp. veil
a.(1) Actual Fraud: doesn’t exist here
b.(2) “Alter Ego Theory”: π must show BOTH of the following
-(a) Single Economic Entity: the SH (subsidiary) and the corp. (parent)
functioned in a manner that it would be inequitable to uphold a legal
Elements to consider distinction between the two. Factors to consider include
for “single economic  participated in cash management system – all profits
entity” include: from Atex would be withdrawn and deposited into Kodak accounts.
1) economic If Atex needed money, Kodak would send it to them
entangleme odid this take advantage of differential
nt finance position of the parent and the subsidiary? Yes
(integrity)  why does π point to finances to disregard corp.
2) formalities personality
3) overall ointermingling: between parent/subsidiary
injustice a. cash management – are assets being pushed
(fraud) between the two as if there is no distinction
4) undercapitaliza oundercapitalization: what if this is being
ti on – done to bleed the subsidiary of assets so they become judgment-
subsidiary set proof
ocorp. formalities (Overlapping Directors)
up with no
a. court says this does not necessarily show
sufficient evidence for piercing  was it treated as separate
corps. or all a mish-mash, if so then why shouldn’t π be
allowed to treat the parent as the same
-(b) Presence of an “overall element of injustice of unfairness”
(fraud) in limited liability not just concerned about subsidiary being
harmed but the π
 don’t need to show fraud, but need some injustice sufficient to say
we are uncomfortable letting the π continue to suffer
3.Walkovszky v. Carlton (NY, 1966) (p.403): Small Closely Identifiable SH’s. π
injured by taxi owned by ∆. ∆ independently incorporated each taxi in effort to limit
liability faced by any single cab, but complied with state law by maintaining
minimum requirement of $10K insurance. Cab subsidiary had no assets to pay with.
a.Rule: Piercing is only allowed if ∆ was operating corp. where there was no
distinction between the corp. and ∆, need to show they functioned as one
b. Holding: ∆ taxi company is not liable, no piercing the veil here just because ∆
owns lots of subsidiaries
c. Reason: if each individual corp. fulfilled its requirements, ∆ should not be
penalized. If laws do not foster responsible practices, it is the job of the
legislature to amend statutes
- Court tells π to amend complaint and attempt to pierce the veil by showing
lack of economic integrity, failure to comply with business formalities, etc.
d. Dissent: These corps. were intentionally undercapitalized and this is an abuse
of corp. privilege that comes at too great a price
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E. Enterprise Liability – not generally used (p.408)
1. If sister corps. all answered for the debts of one another, if held by one single owner
who has shares in each sister corp.
2.Minton v. Cavaney (NY, 1996) – Undercapitalization [rare] (p.414): S operated a
swimming pool at a leased facility. They had no other assets than the lease, which
they lost for

46
 nonpayment of rent. ∆ was director, secretary, and treasurer of S. π brought suit
after his daughter drowned. Π awarded $10K for wrongful death against the corp.
running the pool. Payment was never made due to undercapitalization. Π brings
suit against ∆ personally.
a. Holding: ∆ was personally liable for $10K. Court leaning hard on ∆ acting as a
corp. fiduciary  once you accept the role you cannot get out of all
roles/responsibilities of officers/directors
- Reason: ∆ knew what he was doing. Here, the undercapitalization was
sufficient given ∆’s involvement, the lack of assets & insurance, and it was
a pool set up for kids
b.Rule: Owners of a corp. may be held liable for corp. debts if the business is
inadequately capitalized and the owners actively participated in the business.
Typically, undercapitalization alone is not sufficient

F. Torts π v. Contract π
1. Generally should be easier for tort π because they are more sympathetic re: injustice

G.P iercing Corp. Elements

1. [need] Formalities OR Economic Integrity; AND
2. [need] Injustice OR Fraud
3. [helpful] Undercapitalization
4. [helpful] Tort v. Contract

VI. FORMAL CORPORATE ACTION

A. Background
1. In large corps., SH’s, officers, and directors are all vying for power
a. Formalities take on bigger roles and tend to be more salient
2. No express formalities for small closely held corps.
a. Formalities are not required to see what the corp. is doing because its small and
easy to see
b. Some JX will give a break to small corps. that fail on formalities
- If a corp. is undercapitalized and tort π is owed but corp. cannot pay 
courts will look at failure of corp. formalities
- If corp. is trying to get out of something … NEED TO GET FROM ESTHER

B. Board of Director Governance & Requirements for Board Action

1. The board is empowered as an entity of the group, they are empowered with the
authority to manage affairs of a corp. A single director cannot act on behalf of
everyone. Even if a corp. only has 1 SH, articles of incorporation generally still require
at least 3 board members to make decisions. Director action needs “group action/group
think”
a. The only way boards can act outside of an in person/media meeting is on issues
so NOT controversial they would get unanimous consent, then they can be
passed.
b. As boards get larger they may delegate some tasks to committees
- Varies depending on state statutes and some actions are so serious that they
cannot be delegated
c.Pros:
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 - Group decision-making will lessen individual impulsiveness, corruption, etc.
- Group entity allows for broader representation of SH’s
- Group created segregation of duties and a system of checks and balances
 Fosters a responsible business judgment process
d. Cons:

48
 - There are psychological studies showing that group dynamics sometimes
lead to riskier decisions (group think)
 Can limit the negatives of “group think” by focusing on who gets put
on the board
- Group decision-making can be
inefficient 2.Process – requirements for valid
board action
a. Meetings:
- All participating directors must be able to hear one another and interact
(phone, skype, etc.) – concern that people over media will not effectively
understand the others p.o.v.
- Board can act by unanimous written consent w/o a meeting
b. Notice:
- Regularly scheduled meetings  formal notice/purpose is not required
- Special meetings  every director must be given notice including time,
date, place, purpose
- Must be given in a stated period of time – can be changed by bylaws or
certificate of incorporation
- Can be waived – in writing before or after a meeting
- Attendance at a meeting is a waiver, unless the director attends just to
protest the meeting
c. Quorum:
- State statutes set the default, usually a majority of directors authorized by
articles of incorporation. The number authorized is usually larger than the
number of directors.
- Minority of JX – (DE) allow bylaws to lower the number needed for quorum
to as low as 1/3.
d. Voting:
- As a default, the majority of directors present (not just those voting) must
vote for a resolution for it to be authorized. Some statutes will require a
supermajority vote for specific types of substantial action.
- Can delegate some of its decision making to committees, but certain tasks
are non delegable.

C. Cases
1.Fogel v. US Energy Systems, Inc. (DE, 2007) – NOTICE (p.226): 3 directors looking
to remove CEO(π). Termination occurred at meeting that was not technically a
directors meeting and occurred w/o notice to π of a special directors meeting. Π
claims he was never validly terminated, and was entitled to call a special SH’s
meeting
a.Rule: Before a corp. may hold a special meeting of its board of directors, each
director must receive notice of the meeting and its general purpose
b. Holding: the “meeting” to remove π was not a meeting but an ambush
-Π was entitled to notice & reason for meeting. Notice of meeting topic would
have enabled π to immediately call a special SH’s meeting, eliminating any
questions of validity. Directors cannot control SH’s, but can hold a special
meeting to try and state his (π) p.o.v.
2.Classin (follow up to Fogel)
49
 a. CEO under fire agrees to orderly firing, works through with corp. for months to
organize everything for a new CEO. Then he goes to court wanting the Fogel Rule.
Court says no. With the months of involvement he clearly had notice and purpose

D. Notice & Context Claims Don’t Last Forever

1.Fogel – bad notice will not act as a legit argument against firing for forever. Just
showing up to the meeting negates any argument about notice

50
 2.Exception – as to the context of the notice – given a little more time, getting to the
meeting to see what it is about, is needed to be able to protest

E. SH Governance & Requirements for SH Action

1. Fundamental, Exclusive, Must Exercise Rights: For limited fundamental decisions, SH’s
must
vote and the board cannot intervene
a. Election of directors
b. Fundamental changes
- Charter amendments (corp. constitution, also called articles of incorporation,
etc.)
- Mergers
- Sales of all or substantial portion of corp. assets
- Dissolution
2. Other Rights which SH’s May Exercise Rights: These rights can be exercised with or
without directors, both parties have authority
a. Informational rights
b. Amendment to bylaws
c. Litigation
rights 3.Process
a. Meeting: usually in a banquet hall in a hotel with representatives from the
board, a few directors, and maybe a few SH’s, must be held atleast annually.
b. Notice: SH action normally taken at annual or special meetings. Notice of
time, place, and date is required for both. Purpose must be described for
special meetings.
- Del. Gen. Corp. §213 & Model Act §7.07 – board can set 2 record dates
 One determines which SH’s are entitled to notice of meeting
 One determines which SH’s can vote at the meeting
c. Voting: often done by proxy (right to cast vote for another). Proxies are sent in
by the SH’s to a representative attending the meeting serving the investor
interest. No over the phone proxy voting.
- Quorum: is the minimum number of shares needed to participate in a vote. No
less than 1/3, but default: majority of shares outstanding.
 Usually requires plurality, majority of a quorum. Can be more or
less if stated in certificate, usually cannot be lower than 1/3
 Some states require a straight majority of all outstanding shares for
certain actions
oDel. Gen. Corp. Law §251 – requires majority vote for mergers
 Some states and/or corps. require super majority for certain actions
 Percentage of shares requirements:
 Straight voting:

F. Election of Board of Directors:

1. Staggered Boards: (very rare in large publically traded corps.)
a. A board that is divided into 2+ classes, each which is elected separately for
staggered terms
- Seen as a defense against takeover

51
 - Proposed bidders may be deterred from making a takeover bid because
the dissident majority would have their investment in the corp. tied up
w/o acquiring control of the corp.
2. Cumulative voting:
a. A SH can distribute among her nominees, in any way she wants, a number of
votes equal to (the number of her shares) x (the number of directors to be elected)
- If you have 100 shares and there are 5 candidates, you can cast a total of
500 votes and stack them in any way you choose – all for one director or
split between them
3. Straight Voting:
a. Can cast 1 vote/share

52
 b. Director voting is typically uncontested. The corp. will put up a slate of
candidates equal to the number of seats available. SH’s can then either vote all
candidates in or not for some
4. Proxy Contest: is contested voting
5. Majority voting:
a. Unless director on the slate gets a majority of the votes cast, they will not get elected
- Can end up with an empty seat to be filled later on – unsure if this
actually empowers the small SH
6. Plurality voting:
a. Nominees who receive the most voted were elected even if none of them had a
majority
- As long as person in seat got 1 vote  got into office
7. Proposed Slate: often appointed by…
8. Short Slates:
a. Will foster proxy contest, by proposing slate smaller than the total number of seats
- Meant to get some new voices/ideas in w/o altering everything
9. Removal:
a. Removal of directors is relatively rare, unless a corp. has put in a provision
allowing for removal of directors w/o cause
- SH’s generally want this type of provision in the takeover context
because of the danger of controlled boards
G. Statutes
1. DE §141(a) (Directors & Officers): The business and affairs of every corporation
organized under this chapter shall be managed by or under the direction of a board of
directors, except as may be otherwise provide in this chapter or in its cert. of incorp. If
any such provision is made in the certificate of incorporation, the powers and duties
conferred or imposed upon the b.o.d. by this chapter shall be exercised or performed to
such extent and by such person or persons as shall be provided in the certificate of
incorp.

VII. ALLOCATING POWER AMONG CORP. ACTORS

A. Legal Structure of Publically Held Corps.
1. 3 Major Organs of a Corp.
a. the board
b. the SH’s
c. the executives (especially the CEO)

B. Legal Distribution of Power Between the Board & SH’s

1.Charlestown Boot & Shoe Co. v. Dunsmore (NH, 1880) (p.271): Dunsmore was a
director of Charlestown Boot. The SH’s voted to form a committee to help directors
close up the corps. affairs and nominated Osgood to work with the directors. SH’s
were not confident in the directors and wanted Osgood to step in. Directors
ultimately refused to listen to Osgood, and failed to close up or insure the corps.
assets which were later lost in a fire, prompting π’s suit.
a.Rule/Holding: Directors were not liable, it was w/in their discretion to ignore
Osgood’s advice. Once elected, the directors of a corp. manage the corps. affairs,
and the SH’s cannot compel them to act in a particular manner. Power of SH’s in

53
managing the corp. limited. They can take indirect action because they hired the
directors and can check what the directors are doing in fundamental decisions.
- Shows bright-line distinction, that directors manage and SH’s vote. SH’s
can have more authority if put in the articles of inc., if not, state law
generally assigns management authority to directors.

54
 b. DBR: π’s could have had a better chance at winning had they brought a
breach of fiduciary duty claim, where the directors would be held for gross
negligence. Today failure to insure is almost always breach of fiduciary duty

C. Equitable Limits on the Boards Legal Powers

1.Schnell v. Chris-Craft Industries (DE, 1971) – Corp. Dealmaking/Take-Overs (p.
273): SH’s weren’t happy with the current directors, wanted to oust them with a
proxy contest by getting their own slate of directors. Need enough proxy votes to
have majority at the annual meeting. Proxy contest = public. Chris-Craft board finds
out and adopts amendment to bylaws (this is allowed) and change the date of the
annual meeting. Π argues that while this is
technically within the ∆’s powers, it is unlawful because they cannot do so with the
intention of disrupting the balance of power.
a.Rule/Holding: Corp. directors may not act with the sole purpose of obstructing
SH action, even if the methods are legally permissible
b. Reason: DE court is very concerned about motivation here. Directors have a lot of
power over SH’s money, and all SH’s have is voting/exit rights. Directors in this
case are trying to subvert power structure of director/SH relationship just to keep
themselves from being voted out, which is exactly the purpose of SH voting power.
- Decision based on equity since everything done as technically legal
 Directors won’t be allowed to use a loophole to get around basic
power balance
 At some point actions of directors go too far in interfering
with corp. democracy, and those actions will be restrained
2.Blasius Industries, Inc. v. Atlas Corp. (DE, 1988) (p.275): Blasius is the largest SH
of Atlas. Blasius (P) met with the management of Atlas (D) and proposed that Atlas
(D) engage in a leveraged restructuring and distribute cash to shareholders. This
would involve the corporation raising cash by selling assets, taking out loans, and
making large cash and non-cash dividends. The management of Atlas (D) believed
the proposal was not feasible. Blasius (P) then sent to Atlas (D) a written consent
recommending that the board adopt the restructuring proposal, amend the bylaws to
expand the size of the board from seven to fifteen members (the maximum allowed
under Atlas’ charter), and elect eight named persons to fill the new positions. This
would allow Blasius (P) to gain a majority on the board and implement its plans. The
management of Atlas (D) viewed the consent as an attempt to take over the company
and called an emergency meeting on December 31, 1987. At this meeting, the board
voted to increase the board from seven to nine members and appointed two new
individuals to these positions. This would prevent Blasius (P) from placing a majority
of new directors on the board. To facilitate the deal, Blasius wants to send a consent
form to minority SH’s.
a. Holding: Although the board acted in good-faith to prevent a majority SH from
taking control and injuring the company, the directors violate the director/SH
relationship and the board’s action is thus void
b. Reason: Even in good-faith, a board may not act for the principle purpose of
preventing SH’s from electing a majority of new directors
c.Rule: When an act is taken that shifts the allocation of power between SH’s and
directors and violates the duty of loyalty to SH’s the board of directors must
show a compelling justification
55
3. 2 Different Standards Considered by the
Court: a.Business Judgment Rule
(BJR):
- When directors make a business decision with good information and absent
conflict of interest, courts won’t look at the substance of the decision.
 This is a very deferential standard of review favored by boards.
oHere, Atlas could argue that they were informed and were doing
what was best for the corp., no conflict of interest because they
truly felt the offer was a bad idea
oBUT the directors do have an interest here in keeping
their jobs b.Compelling Justification Standard (CJS):
- When a board takes action that interferes with SH voting, they must have
compelling justification for their actions
 Court does not say the board’s actions were taken in bad faith.

56
  Court looks at the context:
oBJR is okay for ordinary business decisions, but usually not for
obstructing SH votes
a. Atlas tries to meet the standard by arguing that this was a bad
plan, but there is a democracy in corps. and directors can’t say
that SH’s don’t know how to vote for directors
-Application: The CJS only applies when directors act with a primary
purpose of interfering with SH voting
 It is increasingly difficult for SH’s to show that CJS should apply
 Courts have also held that is SH’s have a chance to reject a boards
decision that impacted SH voting ability, and they ultimately ratified
it instead, they are not entitled to CJS
-Defenses:
 Show that the primary purpose was not disenfranchisement
 It will be okay if there is ratification by the SH majority

D. Standards of Review
1. Business Judgment Rule – directors win every time
2. Enhanced Judgment
3. Fairness
4. Compelling Justification – must be an incredibly strong reason to get past this
a. Directors avoid this by showing their action has a purpose other than interfering
with SH voting
b. SH’s need to show that directors purpose was to interfere with their voting rights

VIII. SHAREHOLDER VOTING/INFORMATION RIGHTS – PROXIES & PROXY

CONTESTS
A. Legal Powers of SH’s
1. Right to elect directors
2. Can amend corps. bylaws w/o boards concurrence if the content of the amendment is
proper
3. Things that need to be approved by the board & SH’s = fundamental changes
a. Amendments of the corps. certificate of inc.
b. Sales of substantially all the corps. assets
c. Dissolution of the corp.
d. Economically significant mergers

B. SH - Individual Investor:
1. Buys stock in publically held corps., BUT tend not to pay attention to voting (the only
way they could have any control)
2. Problem: Ownership becomes separate from control
a. Often don’t think they know enough to vote effectively. This is a rational
thought/decision, but when collectively many SH’s sit out, it impacts how
SH’s can discipline directors

C. SH - Institutional Investor:

57
1. Modern change in landscape where institutional investors are holding more and more
shares in American corps. (over 50%) which leads to more concentrated
shareholdings.
a. These investors begin pushing state legislators for more control with their
ownership stakes.
b. They are not rationally apathetic because (1) they have a bigger stake and (2)
they can work together with other institutional investors more easily and the
disbursement effect is less cumbersome.

58
 Further, they have greater expertise so they derive less benefit from directors. They
are in the business of investing so they have better information and expertise than
individual investors
2.Examples of Institutional Investors
a. Hedge Fund: People invest in the fund, then the fund invests in companies. Pool
of investments managed by a professional investment manager. Investor has
very limited withdrawal rights, conditions on withdrawals not being harmful to
other fund investors.
No voting power
b. Private Pension Fund: Established by private employers to assure income for
employees upon retirement, can be done with or w/o SH involvement/guidance
c. Public Pension Fund: Established by government employers (states, cities)
to assure retirement income for public employees
d. Banks: Bank trust departments often manage funds of pension plans and are thus
trustees for individuals and estates
e. Investment Companies: Manage money for individuals and/or entities
f. Insurance Companies: Accumulate liquid funds based on premiums paid by their
insured.
These are invested in portfolios that include equities
g. Unions
h. Private Equity: Consisting of equity securities that are not publically traded.
Investors are usually large investors committing large sums of money for long
periods of time
3.Problems and Solutions:
a. Institutional investors have helped ameliorate the problems of coordination and
concentration, but social/legal forces still present problems. E.g. conflict of
interest, institutional investors with ties to management won’t vote against
management interests
b. As a result, there is an increased sense that Shareholder Activism can lead to
increased portfolio value; however, holding limits reduce investor’s cost-benefit
ratio for active involvement in order to maintain management authority with
directors
c.Shareholder Activism: is on the rise, where their investments are their business
models (public pension funds & private equity/hedge funds)
- There is generally a consensus that you don’t vote against management,
with public pension funds being the exception. Thus, these groups have
potential for more voice, but are not completely realizing it
-Pro: way to police directors/control corps. if w/o being there would not be a
way to control
-Con: Bad for corp./economy because big investors are looked at as the
villain because they look for short term gain not long, risky capital
decisions, bad for employees
4.Institutional SH – Meaningful Roles
a. Assess corps. governmental structure (takeover defenses, conduct of
elections, management self-interest)
b. Assess proposed structural changes (e.g. mergers), and use market reactions to
justify a given proposal’s merit
c. Assess overall management efficacy by comparing with other corporations
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 d. Play a role in corp. business policy and in dismissal of CEO’s
5.Forms of Institutional Involvement
a. Taking an active posture in voting on management/SH proposals
b. Don’t just vote, but make SH proposals concerning structure/rules of corp.
governance
c. Elect individuals as directors to represent institutional investors
d. Consult with management (threats of votes imminent)

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D. Proxy Contests/Materials
1.Materials
a. Documents regulated by the SEC in which a public company outlines its
methods and procedures. These documents are used to inform SH’s and solicit
votes for corp. decisions, such as the election of directors and other corp.
actions
2.Agent/Principal Relationship
a. Context:
- In large, publically held corps.
 Ownership and Control are separated
oSH  Owners; Board/Officers  Control
 The notion that control has become divorced from ownership has
resulted from
o(1) the great number of SH’s and
o(2) the wide dispersal of holdings.
 This compromised the agent/principal relationship because (1) SH’s
holding only a small amount of stock will be “rationally apathetic” to
the corp. (they won’t spend much time keeping up with corp. affairs
AND (2) voting is done by proxy, rather than in person, when SH’s
are widespread.
oSH’s who want to vote against s/t must find a way to
coordinate and pay the cost of a proxy contest.
oDisgruntled SH’s will sooner sell their shares as opposed to
voting against management  incumbent management, not
SH’s, usually have functional control over the corp.
b. Impact:
- There is always a possibility that an agent won’t act in the best interest
of the principal. When you have large, disbursed SH’s, having
directors monitored becomes difficult. SH’s run into a collective
action problem where SH’s have essentially relinquished all control to
directors
c. The “Wall Street Rule”:
- Recognizes that the choices are to stay in a corp. and vote for change and/or
sue, or sell the shares. However, when you are in a situation where you are
one of many SH’s, and there are some directors making decisions that affect
you, you cannot exercise your voice through voting directors out, proposing
changes to how the corp. is run, telling the media, writing letters to editors,
etc. BUT this takes time and resources, making exit safer/easier.
d. Considerations: Why should SH’s give up control?
- Tradeoff to acquire expertise of directors
- SH’s can vote by walking away (Wall Street Rule)
- SH’s can defer to directors and concentrate their efforts elsewhere
- Until the rise of institutional investors, this seemed like a reasonable tradeoff
3.Contests
a. Can happen when there is a contested director election
b. Can happen when there is a contested SH election (happens in an odd way)
- SH’s receive more than one set of potential directors and separate proxy
card from the group contesting the election

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  Willneed to choose whether to pick “team management” or “team
insurgent”
 Problem when individuals vote for both – if so it’s who is the last card
turned in
c. Very expensive on outsiders
- Need to send own set of directors on proxy card to all SH’s w/ any/all
necessary information

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 - First need to file with SEC – identity/background of participants,
interests, understanding about control (Blasius)
4.Rosenfeld v. Fairchild Engine & Airplane Corp. (p.321): In a policy related
stockholders derivative action seeking a return to the corp. of $261K paid out in
reimbursements to both sides for a proxy contest.
a. Issue: Who will pay? The changes hoped for, must be profitable enough to
invest in a proxy contest. Having to bear ones own cost will “chill” proxy
contests
b. Holding: The proxy disbursements can be upheld. If directors of a crop. Cannot
in good faith incur expenses for soliciting proxies, wealthy stockholders will be
able to take control by funding their proxy materials.
c. Dissent: Providing funding to dissenting stockholders who win could raise
policy implications whereby stockholders launch aggressive attacks to seize
control and reimburse themselves. “To the victor goes the spoils” philosophy is
not compatible with successful corp. governance
d.Rule: In a proxy contest over policy, corp. directors have the right to make
reasonable and proper expenditures from the corp. treasury for the purpose of
persuading the stockholders of the correctness of their position and soliciting
their support for policies which the directors believe are in the best interests of
the corp.
e.Test:
-When incumbent costs will be covered by the corp.:
 Good faith
 Only reasonable and proper expenses
 Policy v. personnel – must be for policy only
- When dealing with insurgent proxy & Corp. reimbursement
 once you have vote of SH’s to ratify, you can be reimbursed, so you need:
oSH ratification
oThe proxy must
win oGood faith
oOnly reasonable and proper expenses
oPolicy v. personnel
 Some argue that winning should not be a prerequisite as some
stockholders will be discouraged from challenging policies for
fear they may not be reimbursed
-Sometimes in unsuccessful cases
 SH may bring a claim, and the corp. will pay settlement to avoid any
further litigation (another way for costs to be paid)
oClaims: breach of fiduciary duty prompting proxy contest,
technical failure for not complying with SEC, problem with
how proxy contest was run..

E. SEC Rule 14(a): Makes it unlawful for any person to solicit a proxy with respect to
securities if that solicitation is done in any way that is against what the SEC will say
1.§14(a)(8): SH proposals, written so even the most unsophisticated investor can
understand them, list of requirements SH must meet to be included in the corps. proxy
so they do not need to send out their own proxy to all the SH’s. Much less expensive.

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Wants to encourage SH’s to be involved in their investments and this makes is much
easier
a.What is allowed
- If the proposal would disqualify a nominee who is standing for election
- If the proposal would remove a director from office before their term expired
- Questions of competence, business judgment, or character of one or more
nominees or directors

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 - Seeks to include a specific individual in the company’s proxy materials for
election to the board of directors
- Otherwise could affect the outcome of the upcoming election of
directors b.Some things not allowed
- Cannot send in proposal by phrasing it as a SH proposal  director
candidates are not the proper thing to be put on a proxy
- Cannot nominate a particular director §14(a)(8)(i)
-Other things include….

F. Cases
1.CA, Inc. v. AFSCME Employees Pension Plan (DE, 2008) (p.292): AFSCME is a
stockholder of CA, Inc. and submits a proposal for a vote to change bylaws allowing
expense reimbursement for expenses incurred by shareholders in nominating candidates
for a board. The boards excludes the proposal saying that it was an improper violation
of management’s right to “business affairs” provided in DE law
a.Rules: (1) a bylaw is permissible if it defines the process and procedure by which a
board of directors makes business decisions (2) a corps. board may not enter a K
that requires it to act in a manner that would violate its fiduciary duties
b. Holding: SEC upholds the board’s decision to exclude the proposal. The proposal
is OK under DE law because it established a process for decision making rather
than mandate decisions of management. However, in certain circumstances,
directors would be compelled to reimburse election expenses that a proper
application of fiduciary principles would preclude; thus is adopted, it would cause
CA to violate DE law. SH’s cannot command management to do certain things,
they can only make recommendations (Charlestown)
- (1) this is ok under §14(a)(8)(i) because SH’s are allowed to effect process
of how a corp. is run BUT cannot effect the substance of the corp. (bylaws
are only about procedure)
- (2) this is NOT ok under §14(a)(8)(ii) – the court is concerned this bylaw
would violate fiduciary duty
 this could be fixed by adding a “fiduciary-out clause”

G. Response to CA v. AFSCME – all done through bylaw amendments because people

want to have a better chance at getting past §14(a)(8)(i) and get onto a proxy
1.§112 – Access to Proxy Solicitation Materials
a.SH’s can put something into bylaws that says in addition to rights under federal
securities law, an individual corp. can allow SH’s to put nominees for the board
into the proxy.
This is totally different from other programs which keep the process separate.
This is making proxies set up like a ballot.
2.§113 – Proxy Expense Reimbursement
a. Enables corps. to allow for expense reimbursement of expenses by stockholders
when they add bylaws to the proxy. Proxy expense reimbursement must be
viewed as part of the question: How much power should SH’s have? This is
because soliciting proxy materials can be very expensive and eliminating
reimbursement could quell shareholder activism. Conversely, enabling SH’s
encourages contested elections
- Allows for short stack, one-bite rule, relative success, limitations on amount

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- Allows comps. to channel changes for reimbursement in particular
ways. Can provide for categories not like in Rosenfeld
- Limitations can be imposed

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 H. Alternatives to CA v. AFSCME
1. Amend certificate of incorporation
2. Seek recourse from the DE General Assembly

I. Times when Proxy Access Might Not be a Good Idea

1. SH elections when contested are very distracting for directors
a. If directors are doing really bad  distraction might be worth it. BUT if
not then distraction could overwhelm any possible benefit
b. In this case maybe a “staggered board” could help

IX. SH VOTING & INFORMATION RIGHTS & SH PROPOSALS

A. Background
1. Investors (public) need information to make investment decisions and so they can
monitor management performance. It would be unfair if people made investments
and had no way of monitoring management. Also, the right to vote is largely
dependent upon the right to information; knowledgeable votes cannot be made
without reliable information. Lastly, SH’s will want access to information in order to
make decisions to sell or sue; w/o sufficient information, π cannot meet pleading
standards in order to bring a case.

B. Generally
1.SH rights include:
a. Voting in BOD elections
b. Right to suggest bylaw amendments
c. Right to exit by selling (Wall Street Rule)
- Especially for individual investors
- Institutional investors – not easy to exist, often best to invest in taking
voting actions to be empowered through investment
d. Right to certain information (§220)
e. Right to
sue 2.Information
a. Is important to enhance the rights of SH’s by virtue of the agent/principal
relationship
- There is a concern that the agents (BOD) wont manage the company in
the best interest of the SH, but rather in their own interest (like engaging
in conflict of interest transactions where they benefit personally)
b. Without access to information it’s hard for a SH, could be individual or
institutional, to form decisions about suing, choosing BOD candidates, whether
they should sell
3. Disclosure
a. Is the fundamental theory of securities regulations
- Need to get enough information into the public market, so the public
can make informed decisions
b. When registered with the SEC
- Any company that is registered with the SEC must make periodic
disclosures that become public, like the 10-K forms, and after big
issues/special events

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 - IPO (initial public offering) –a huge amount of disclosure must be
provided to the public in a templated form so that investors can be
knowledgeable about the company
c. Problem
- Unsure if all disclosure is really a good thing. Depends on the type of SH
 Individual SH  will tend to throw away disclosure, perspectives,
and they do not Google or do any research on the matter

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 Investors  they are more likely to read,
 Institutional
understand and analyze the information
oRemember mutual funds are bought into by individuals who
think the fund will buy, sell, vote at the right time and in the
proper way
oPeople buy into passive funds that replicate the S&P 500 v.
Active management. People choose active when they want
to rely on a manager to know and have the information for
what to pick

C. Requirements for Information Access

1.Credible Basis Requirement:
a. As a general proposition, investigating for wrongdoing or mismanagement are
proper purposes for SH access. Courts nonetheless condition access on the
requesting SH showing by a preponderance of the evidence a “credible basis”
from which the court can infer there is possible mismanagement or wrongdoing
such that further investigation is warranted
2.“Proper Purpose”:
a. Courts have recognized the following as proper purpose for exercising SH
inspection rights
- Determination of corps. financial condition
- Ascertainment of value of petitioner’s shares
- Facts which, in general, would reasonably raise suspicion
3.“Mixed Purposes”:
a. Where a SH has several purposes, at least one of which is proper, improper
purposes become irrelevant. Thus, even if SH’s have ulterior motives, they are
not barred from relief unless the ulterior purpose is the primary purpose
4. Common Law v. Statutes
a. Common Law: A SH “acting in good faith for the purpose of advancing the
interests of the corp. and protecting his own interest has a right to examine the
books and records at a reasonable time.”
b. Statutes: Sometimes apply a more limited coverage such as only certain kinds of
SH’s with certain amounts of ownership for certain duration can only investigate
certain types of documents

D. Cases
1.Saito v. McKesson HBOC, Inc. (DE, 2002) (p.336): [How broad is the right to
information under DE §220] McKesson bought all HBOC stock, becoming its
owner, with HBOC becoming a wholly owned subsidiary. After the merger, it
became known that there were financial irregularities in HBOC’s statements.
McKesson SH’s were frustrated because they bought HBOC stock whose actual
value was $300 million less than they said. SH’s first suit was dismissed and court
told them to make a request for “books & records” under §220, arguing that the BOD
breached their fiduciary duty by buying this messed up company, while the BOD of
the corp. argued that they don’t have to give information over.
a.Rule: When a SH has a proper purpose to inspect corp. Books and records, his
right to do so is not limited because a secondary improper purpose exists, or
because relevant documents were produced by a 3rd party

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-Limitations on Scope Even w/ Proper Purpose:
 Proper Purpose: once a proper purpose has been established the SH is
entitled to all records reasonably related to the stated purpose, even
if some of the records even serve an improper purpose
oNeed to read note on p.340 for when it is/is not a proper
purpose

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  Timing: Under §220, scope is not limited to only the time when the
person was a SH, BUT the information is limited to what is
reasonably related.
 Third Party: SH’s are entitled to documents prepared by 3 rd parties
and provided to the SH’s corp. which may be necessary for the SH to
fulfill their proper purpose
b. Holding/Reason: here investigating suspected wrongdoings on the part of corp.
directors was a proper purpose, even though preparing for unrelated litigation
was not
c.§220 Takeaway:
- It is often a precursor to another kind of claim, it’s a way to get the info
you may need to effectively draft a complaint
- Can be used in an effort by the SH’s to get information to inform their voting
- Can be used to get list of SH’s to influence the way they will vote.
 Simple curiosity is not sufficient, requesting SH must have a bona fide
desire to communicate with other SH’s about the corp., meetings,
or voting
2. If you want internal documents about a financial decision, then need to show more (like in
McKesson)

E. Stockholder Lists
1. Courts will more readily grant access to stockholder lists than to confidential financial
and business information (ex: internal data and K’s). Production of SH lists is
necessary for SH’s to participate in corp. governance, imposes minimal burden on
corps., and usually wont injure corp. business (unlike more confidential documents).
Some statutes make distinctions between different types of books and records
- Note: SEC proposed federal rule for creating access to shareholder lists
rather than state law, but SEC backed down. It may happen now that SH’s
are lobbying for greater rights
b. Registered/Record Owners: Have a direct relationship with the issuer because
their ownership shares, names and addresses, are listed on records maintained by
the issuer or its transfer agent. Registered owners have rights to vote and to
appoint a proxy to act on their behalf at SH meetings. It’s easy to distribute
proxy materials to registered owners.
c. Beneficial Owners: The vast majority of investors in shares issued by US
companies today are beneficial owners, which means that they hold their
securities in book-entry form through a securities intermediary, such as a
broker-dealer bank
d. Non-Objecting Beneficial Owners List: Is the list of people who are beneficiaries
of the stock certificates that have the right to vote, not non-human entities that
merely hold the stock certificates
- Always need to ask for the list of non-objecting beneficiaries not the record
owners because if not, you will get people who are “holders” and not true
owners
2.Pillsbury v. Honeywell, Inc. (Minn, 1971) [request for corp. info/SH lists – bona fide
purpose]: Pillsbury, a Honeywell SH, opposed the Vietnam War and wanted
Honeywell to produce all records dealing with weapons purchased and manufactured.
Pillsbury contended that its desire to communicate with other SH’s to try to get
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Honeywell to stop making weapons was a proper purpose. Honeywell responded that a
proper purpose contemplates only a concern regarding investment returns.
a. Holding/Reason: The court found that Pillsbury did not have a bona fide purpose.
The decision was rendered by Minn. court applying DE law. However, DE
following Pillsbury has suggested they would not have gone as far. DE says that
desire to communicate with SH’s, even if combined with an improper purpose,
will be sufficient to get a SH list.

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 b.Rule/DE Courts: The bona fide purpose underlying the request for information
has to relate to an investment concern, cannot just seek the list to get fellow
SH’s to push the company to stop creating bombs for Vietnam because it’s bad
for the world.
-DE courts: If you want to get info about a corp. you need to
articulate a SH interest in the request for info.

09/20/18 Class notes

F. SH Proposals & Proxy Rules (Federal)

1.SEC 14a-8: When SH’s can put one of their proposals on the corp. proxy
a. Reduces the cost of getting the list of SH’s, figuring out who they are, and
communicating to them on your own about the issues you want raised. Instead,
you piggy back on the company’s proxy that they have to send every year
regardless, to which you can add your SH proposal, as long as you meet the
requirements
- Requirements to get proposal on the company’s proxy
 (1) The entity requesting the information to be added to the company’s
proxy must be a beneficial owner
 (2) SH must have at least 1% or $2K of the company’s shares
 (3) SH must have had stock for at least 1 year
 (4) SH can submit 1 proposal/year – courts want to limit “attention
costs” b.Company can choose to exclude the proposal
- If they determine it is not a “proper subject” for action, the company can
send the submitted proposal along with a statement of reasons why it deems
the omission of the proposal to be improper to the SEC seeking a “no action
letter” to say that the SEC won’t act if the proposal is excluded or warn the
corp. that if it excludes the proposal, SEC will take action
c.Proxy Advisors: provide advice on how to vote on proxy (Institutional SH Services).
Very likely to recommend corp. governance proposals v. recommending voting
in favor of social policy reasons
d.2 Types of Proposals:
-Social Policy Proposals: almost never win, hard to get on company proxy,
often lead to directors deciding own way to address the issue. Even
though SH’s don’t want to vote on social policy proposals the SEC still
encourages them
 Makes them feel included
 Could spur a director to want to change or propose it himself
 A natural right of a SH
 Appropriation is a democracy and this is how we push the idea
-Corp Governance Proposals: win about 50% of the time
 CA case – structuring and reimbursement, issue to access documents
– more likely to be passed
e. Trinity Wall Street v. Wal-Mart Stores, Inc.: To make such a determination,
courts consider the subject matter of the proposal and whether that subject
matter relates to the company’s ordinary business operations. If the answer to
the second question is yes, the corporation must still convince the court that
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 the proposal does not raise a significant policy issue that transcends the
nuts and bolts of the company’s business.

f. Under 14a-8(i)(7): the board is allowed to reject proposals related to

decisions about the ordinary course of business. SH’s can only make
suggestions for significant decisions outside the scope of ordinary course of
business. This limitation serves to maintain power of directors to manage the
corp.
-Standard Pacific Corp. [no action letter – social policy proposal] (p.363):
Institutional investor is proposing that the corp. become more
environmentally friendly. The company says that they don’t have to
include the proposal in their proxy because, they say, the proposal deals
with the company’s ordinary business operations and “risk assessment”
which is not for the SH to decide.
 Holding/Rule: The proposal may not be omitted/excluded under the
statute. Something that effects the environment is something that
might influence how a SH might vote. SEC: if the proposal is based
on larger social policy,

74
 then it must be included. If it deals only with day-to-day operations
of the management function of the board then its excludable
-Excludable Proposals Ex:
 How many homes to build
 Where to build them
 How much to sell them for
 What kind of homes to build
-Includable Proposals Ex:
 Removing staggered boards
 Other governance related proposals
2.SEC 14a – 9: Materially Misleading Proxies/False or Misleading Statements
a.(a) Says that corps. can’t lie about material facts actively or by omission, or by
failing to correct, when you are sending out a proxy solicitation subject to the
federal proxy rules.
Or when the corp. fails to correct anything being solicited
b.(b) The SEC will not check all the facts in all the proxy materials, because
they don’t have the manpower to fact check all proxy solicitations.
- Notes:
 Most times false/misleading facts are not found out about
 If they do find out, it’s usually because something happened after
the fact (McKesson)
 A SH or the SEC can bring this action before the court
- Examples of what, depending on particular facts and circumstances,
may be misleading w/in meaning of this section
 Predictions as to specific future market value
 Material which directly or indirectly impugns character, integrity or
personal reputation, or directly or indirectly makes chares concerning
improper, illegal or immoral conduct or associations, without factual
foundation
 Failure to so identify a proxy statement, form of proxy and other
soliciting material as to clearly distinguish it from the soliciting
material of any other person or persons soliciting for the same
meeting or subject matter
 Claims made prior to a meeting regarding the results of a solicitation
-JI Case Co. v. Borak: SCOTUS held that a SH could bring a private action for
violation of proxy rules even though it’s not provided in the statute because
private enforcement supplements the SEC
 SEC can enforce 14a-9 but the Supreme Court in Borack
ruled that individual SH’s can also since it was not explicit
in the SEC
c. Mills v. Electric Auto-Lite, Co. (SCOTUS, 1970) [Materiality - Misleading
Proxy Info]: π’s were SH’s of ∆ company when it merged with Mergenthaler.
Π’s brought suit day before meeting to approve merger asking for an injunction
claiming mispleading proxies. Π alleges that failure to inform SH’s that the
companies were closely related rendered the board’s approval for the transaction
misleading to the SH’s.

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-∆ argued, how do they know anyone would have voted “no” if they did
know (this is the aspect of reliance – torts, person would have acted
differently if not for the omission)
 This is hard to prove because would need to prove enough SH’s were
fooled to have changed the vote. Too many people and no class
certification.
- Holding: Failure to disclose interrelationship was misleading. Remanded
to lower court to determine remedies such as reverse merger and/or
monetary relief if damages are shown
-Rule: Where an omission in a proxy statement is determined to be material,
the SH has established sufficient causation between the violation of 14a
and their injury

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  SCOTUS: Removes the requirement of reliance. NOW only need to
show whether the omission or misstatement was a material fact and if
the vote in question was an essential link in the transaction.
Materiality shows causation and reliance. If an
omission/misstatement is determined to be material, it is inherently
something that a reasonable SH would want to know about before
casting a vote. Even though the terms of the merger in question may
have been fair, the merger was not appropriately approved by the π
SH’s.
d. Addressing “Materiality” for Misleading Proxy Info: TSC Industries, Inc. v.
Northway
- Objective standard, involving the significance of an omitted or
misrepresented fact to a reasonable investor. Generally, and omitted fact is
material if there is a substantial likelihood that a reasonable SH would
consider it important in deciding how to vote. The disclosure must be
viewed as having significantly altered the total mix of available
information in the eyes of a reasonable SH. (i.e. in Mills, the defect must
have a significant propensity to affect voting process).
There

PART III – THE DUTIES OF CORPORATE DECISION MAKING

I. GENERALLY
A. Fiduciary Duty
1. Directors are considered fiduciaries to a corp. and thus owe the corp. the
related duties including: (1) Duty of Care and (2) Duty of Loyalty
2. Dodge and EBay – part of the concern was that decisions were being forced by
controlling SH’s onto minority SH’s
3. Fiduciary duties can change and adapt depending on the situation
a. Blasius – courts were responding to concerns about takeovers which raised
thorny issues because directors responding might be acting in the best
interests of the SH, or they might be acting to preserve their jobs.

B. Liability of Directors for Breach of Fiduciary Duty

1. Directors are sued in their individual capacity, and the liability that would attach is
personal liability in tort. Breach of fiduciary duty is a tort against the corp., and the
directors’ personal assets are at risk. Corps. can sometimes insure and indemnify
directors, and some states have enacted statutory limits on liability and contain
indemnification provisions

C. Standard of Conduct – What you are supposed to do

1. “A director or officer has a duty to the corp. to perform their functions (1) in good
faith, (2) in a manner that they reasonably believe to be in the best interests of the
corp., and (3) with the care than an ordinarily prudent person would reasonably be
expected to exercise in a like position and under similar circumstances”
a. Directors Application

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 i. Duty to monitor, inquiry, to make prudent reasonable decisions on
matters that the board is obligated or chooses to act upon, Duty to
employ a reasonable process to make decisions
ii. Don’t need to be expert in everything but need to be attentive, rely on
experts when reasonable, etc.
iii. Directors can take risks as long as it would be reasonable
under the circumstances
b. Officers Application

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 i. Comparable to directors, but for most decision making is likely to
be more important than monitoring
2. Standard of conduct for corp. directors is reasonable care – more strict than under the
BJR
a. But there are many cases where liability wont attach where BOD failed to
act with reasonable care, so standard of review is not the same as standard
of care.

D. Standard of Review – Used to evaluate whether liability will attach

1. Often determinative, once you know what standard to apply you know who is going
to win. It is also important to know who holds the burned to show that the standard
has been met.
2. Factors that impact the burden of proof and standard of review determination:
a. Process:
i. whether there was sufficient disclosure, deliberation, whether corp. actors
voted. (Francis, Kamin, Van Gorkom)
b. Type of Transaction:
i. Ordinary decision v. major fundamental change to the corp., how
important is the transaction
c. What Type of Corp. and/or Actor is Involved:
i. Publically traded, closely held (Francis), non-profit
ii. Was the action by a controlling SH? Does the BOD also hold positions
w/in the corp. or are they completely external? (inside/outside or
independent)
3. Less strict standard than under standard of conduct. Will be times when liability
will not attach and directors get leeway from the BJR
4. Different Standards of Review
a. Rationality: easiest to meet, was there any possible rational basis for the
decision b.Reasonableness: intermediate level, would a reasonable person in
the shoes of the
director act that way
c. Fairness: highest standard, whether the decision actually was the best for the corp.
i. BoP on directors to show (1) they engages in a reasonable process AND
(2) the decisions was substantively reasonable
5. Requires the determination of whether the BUSINESS JUDGMENT RULE
will apply or not.
a. If it does  a less strict standard of review will be applied  Standard of
rationality
will be applied, as long as the decision was not grossly negligent

E. BUSINESS JUDGMENT RULE

1. The BJR creates a presumption respecting the autonomy of directors to make
managerial decisions and places the burden of proof on the π to prove that an
element of the BJR does not apply. Still want directors to act reasonably not just
rationally.
a. BOD always wants the BJR because, that means that they will almost always
get off the claims, if they can point to at least some remotely rational basis for
the decision they made (Blasius). Under the BJR, courts want to relieve the
79
 BOD from being afraid that is they are slightly wrong in their decision, they
will be held liable.
b. On the other hand, this lower standard may motivate directors to act with less
scrutiny in making their decisions = the reason for 4 preconditions
2.4 Preconditions for BJR to Apply
a. The BOD Must Make a Decision
i. Total failure to act, as opposed to deliberate decision not to act, will
not be protected under the BJR
1. Director cannot be sitting on the beach when the decision was
made, they actually have to participate in the deliberations that
lead to the decision
b. Directors Must Have Made an Informed Decision

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 i. This is about the process by which the decision was made, they are not
concerned about the substance of the decision. Did the BOD get sufficient
info to make a well informed decision?
c. Directors Must Act in Good Faith
i. Did the directors make a decision that they knew was wrong, and go
through the process as a cover-up or sham?
d. There Can be No Conflict of Interest
i. Director cannot be personally interested in/have a financial interest
in/benefit from the transaction the BOD wants reviewed under the
BJR
3. Application, Standard & BoP:
a.If all are met BJR
i. Rationality Standard
ii. BoP falls on the π’s (often the SH’s) – π’s must show the BOD
actions were irrational (gross negligence), basically impossible to
prove
b. If π proves that the corp. fails to meet any one of the 4
i. If you fail #4  becomes a duty of loyalty case
1. Fairness standard
2. High BoP on ∆
ii. If you fail #1 and/or #2  still duty of care
1. Standard goes back to reasonableness
iii. If you fail #3  potential application of fairness standard
1. Was this the best decision for the corp., not just whether a reasonable
person would think so, but if it actually was
2. BoP on ∆ directors
iv. If any of the 4 are not met  BoP is on the ∆
directors 4.Policy Questions:
a. Why force directors to act like they are making good decisions (insulate the
substance of their decision) as opposed to actually making good decisions?
i. Encourage risk-taking among directors
ii. Institutional competency – judiciary claims not to know how to value
substantial business decisions
iii. Create incentives for board service (increased personal liability  don’t
want to serve)
iv. Full employment for lawyers and investment bankers (cynical view)

II. DUTY OF CARE

A. Generally
1. The duty of care requires directors to perform their duties with the diligence of a
reasonable person in similar circumstances; varies based on context. Most decisions
involving duty of care, are protected under BJR. The focus of any judicial inquiry
will usually be on the decision-making process, not the substance of the decision.
Absent a showing of gross negligence by the π, the courts will only ask whether the
board’s action was rationally related to a legitimate business objective
a. In DE cases: the presumption is that the BJR will apply in a duty of care case,
and it is up to the π to counter that presumption. If they prove their point, then

81
 directors don’t get BJR deference and will have a more difficult time proving
that their actions were ok and they shouldn’t be liable
B. Cases
1. Francis v. United Jersey Bank (NJ, 1981) – failure of BOD to make a decision
(p.603): π was trustee to the bankruptcy estate of P&B, a reinsurance broker and
closely held corp. ∆,

82
 the widow of old director and mom of the sons, was technically a director of the corp.
but maintained virtually no involvement. Sons commingled funds of reinsurers with
their own funds and drew from this account calling them “loans,” but in reality were
disbursements they took for themselves. Mom/director never did anything about it,
never protests, resigned, threatened litigation (the only way she could have fulfilled
her obligation)
a. Holding/Reason: Breach of fiduciary duty is a tort = duty (yes), breach (yes),
causation (???), damages
i. Causation is not the focus of future cases. If you have directors who fail
to uphold their fiduciary duty courts will not stop the damages award
based on an inquiry into causation. This is a “non-feasance” case – not
that the ∆ did something bad, but that she didn’t do anything at all.
Hardest to prove on causation
b. Rule: A director has a duty to know generally the business affairs of a corp.,
and to act as a reasonably prudent person would.
i. Duty to know general business affairs of corp.:
1. Basic understanding of what corp. does
2. Informed on how company is performing
3. Monitoring corp. affairs/policies
4. Attending board meetings
5. Inquiring into questionable matters
ii.∆ didn’t make a decision (#1)  doesn’t get BJR  burden is on ∆ 
will be very hard for her to prove actions were okay
2. Kamin v. American Express (NY, 1976) – BJR applies BOD wins (p.618): AmEx
bought stock in DLJ, and the stock went does. What is being challenged is what the
directors did once the stock drops. Here, rather than pay the dividends in cash they
pay the SH’s in a section of DLJ stock, which was worth nothing. SH’s are suing
because the only good thing about a losing investment is that you can use the loss to
shelter your gains on your investment in taxes.
a. Rule: Courts will not interfere with a business decision made by directors of a
business unless there is a claim of bad faith, fraud, or self-dealing. An error by
directors, as long as the business decision was made in good faith, is not
sufficient to maintain a claim against them.
b. Holding/Reason: BJR applies, so π BoP is to show that the ∆’s decision was
irrational, which they couldn’t do
i. Decision  ∆’s did decide to send out tax dividends
ii. Informed  ∆’s decided that by issuing stock v. declaring the loss it
would be a way to help protect the share price of their own stock. ∆’s
considered alternatives SH’s wanted, but decided it was not the right
option. Despite the decision possibly being poor, they acted fully
informed
iii. Good faith  yes
iv. COI  (not enough evidence) There was a concern about 4/20
directors who were part of a compensation plan because their personal
compensation was linked to share price.
3. Smith v. Van Gorkom (DE, 1985) – Decision was not informed (p.627): SH’s of Trans
Union brought suit, seeking a rescission of a cash-out merger, against Trans Union
BOD. Van Gorkom was CEO/chairman/director/ officer of Trans Union, comes up
83
with $55/share price through his own research. With no recommendation from the
BOD, Van Gorkom sought a buyout from his friend Pritzker.
a. Rule: Under the BJR, a business determination made by the corps. BOD is
presumed to be fully informed and made in good faith and in the best interest of
the corp. However, this presumption is rebuttable if the π’s can show that the
directors were grossly

84
 negligent in that they did not inform themselves of “all material information
reasonably available to them.”
b. Holding/Reason: Here the BOD was not fully informed. The BOD did not
adequately inquire into Van Gorkom’s role/motives behind bringing about the
transaction, including where the price of $55/share came from. The directors
were uninformed of the intrinsic value of Trans Union. And lacking this
knowledge, the directors only considered the merger at a 2-hour meeting, w/o
taking the time to fully consider the reasons, alternatives, and consequences.
Court doesn’t care that the directors were smart/educated, they must be
informed
i. No physical documentation, 2-hr meeting
ii. Not a true market test for determining the price
iii. Problem with amendments – actually shortened time to decide

C. Post Van Gorkom: Courts are worried about directors not taking enough care in their
decisions. If we make directors afraid of having personal liability, then you wont have
educated people wanting to sit on corp. boards if it is just too risky. So if the goal is to
get attentive qualified people on corp. boards, then why have such a strict duty of care.
1.DE §102(b)(7)
a.Purpose
i. Allows a corp. to amend their certificate of incorporation by opting in a
provision that will limit or remove personal liability from directors, for
damages based on breach of duty of care only. Amending the certificate is
a fundamental change and requires SH approval through a vote. SH’s will
often vote for §102(b)(7) because they want to enable trusted directors to
make decisions.102(b)(7) only eliminates personal liability fir monetary
damages. π can still get injunction
b.4 times when §102(b)(7) will not limit/remove personal liability of directors
i. Acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of the law  will have the same
liability as in a corp. w/o a 102(b)(7) provision (Miller)
ii. Acts that breach director’s duty of loyalty, any action where
directors put personal benefits ahead of the corp. (ex: land sale
transaction)
iii. Acts where directors unlawfully use the dividend structure to benefit
themselves
iv. Any transaction where the director gets an improper personal
benefit c.If adopted
i. If a π SH alleges only a breach of duty of care against a corp. that has a
§107(b)(7) provision, the ∆’s can just get it dismissed immediately
ii. Once §102(b)(7) is on the books, the only way you can get to the court is
to allege something beyond breach of duty of care  why we have good
faith and duty of loyalty
1. Caremark (π’s try to dodge a 102(b)(7) dismissal), Miller, Disney, and
Ritter

III. DIRECTOR OVERSIGHT

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A. Generally
1. Van Gorkom = SH’s can make all the claims they want  §102(b)(7) comes in
and gives exceptions  Caremark and good faith come in.
a. These ideas get linked, a lack of good faith might not just be intentionally
trying to harm the corp., but might also include something like a
Massey/Caremark violation.
i. In other words, maybe a claim for lack of good faith is also the claim
about the failure to monitor?

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B. Cases – Duty to Monitor
1. Caremark (DE, 1996) (p.643): Caremark is a healthcare company that was entering
agreements with healthcare providers to offer training, consulting, research grants,
etc. Although Caremark took affirmative steps to avoid quid pro quo referrals in
violation of the Federal Anti-Referral Payment Law, many of these healthcare
providers referred Medicare/Medicaid patients to Caremark. DOJ began investigating
and finds that many of the “research grants,” weren’t being used for research.
Caremark pays $250 million in settlement that also required implementation of
internal control structure so that the company is more likely to comply with ARPL.
Federal govt. was worried that paying for referrals would make faulty referrals just
for the money, and then the govt. must pay the Medicare/Medicaid payments. Even if
doctors are not paid for referrals, there may still be non-monetary incentives (like
professional relationships) that aren’t clear whether it is noncompliance with the
federal laws. Background: This was a derivative action, when SH’s sue the BOD on
behalf of the corp., not because the BOD harmed the SH’s personally, but because
they allegedly harmed the corp. If π SH’s are successful, remedy goes to the corp. not
the SH’s individually.
a. Issue: Whether the BOD had to stop the lower level staff, agents of the
corp., from setting up relationships that violate compliance with no-
payment-for-referral laws.
i. The court is not assessing whether there was liability. The court is only
determining whether the settlement/remedy was appropriate, taking into
account that settlement would be less expensive for all parties and would
keep corp. out of media
b. Holding: the BOD did not engage in systematic and sustained failure to
exercise oversight
c. Rule: Directors have an obligation which includes a duty to attempt, in good
faith, to assure that a corp. information and reporting system exists that
enables decision making to be reasonably informed.
i. The requirements of the internal control structure shall be based off the
complexity of the corp. Standard for design of information system is a
question of business judgment. A sustained and systematic failure to
implement a corp. information and reporting system results in
personal liability of directors.
ii. Absent grounds to suspect deception, neither BOD or senior officers can
be charged with wrongdoing simply for assuming the integrity of
employees and the honesty of their dealings on corps. behalf
1. Sentencing Guidelines (tells courts to go easier on a corp. with a
legitimate reporting system in place, reviewing, outside auditors,
teaching compliance) are important  defense if you are a corp. with
a bad employee you didn’t find out about until it was too late
d. Note: Good faith standard in failure to monitor cases is a little more rigorous
than BJR 2.In re Massey Energy Company (DE, 2011) – SUSTAINED AND
SYSTEMATIC
FAILURE IN OVERSIGHT (p.655): Mining company where the board knew that
the CEO thought that he knew better than federal safety regulators and would just
pay the fines because they “knew better.” BOD said that was fine, and to keep
operating as is. There was a mining accident where 29 miners were killed, the BOD
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 had personal liability because they actually consciously knowingly failed to act. They
flagrantly, consciously disregarded their duty
a.Rule: The duty of care owed by corp. directors may be breached by either
(10 active decisions or (2) negligent failure to act
3.CityBank: BOD didn’t realize that subprime mortgage crisis was coming, and the SH suit
that said the BOD should have seen it coming and done something about it, is not a
sustained and systematic failure to exercise oversight

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IV. DUTY TO ACT IN GOOD FAITH
A. In re Walt Disney – trying to challenge behavior that is not director personal enrichment
BUT is the director is just not doing a good job. Good Faith is viewed as a way for π’s
to penalize directors and get away from BJR and 102(b)(7): Ovitz was hired as president
for a 5-year term but terminated within a year because he did a terrible job. He was
given $140 in severance. BOD and compensation committee met shortly to discuss
hiring Ovitz and didn’t read the documents but approved the K to hire and the payout if
fired w/o cause. Π’s allege (1) plain vanilla duty of care – approving the K and decision
to hire Ovitz AND (2) even if K was valid for breaching fiduciary duties by actually
making the huge severance payout
1. Rule: The concept of intentional dereliction of duty and a conscious disregard for
one’s responsibilities is an appropriate standard for determining whether directors
have acted in good faith
2. Holding: Although the process of approving the K and hiring Ovitz were not
“corp. best practices,” directors did not breach any fiduciary duty to the corp. (1)
Directors did not breach duty of care in approving K or hiring because they were
sufficiently informed of all available information, including payout AND (2) no
breach of fiduciary in paying out because, under the BJR, the BOD is allowed to
rely on advice from the CEO.
B.B ad Faith
1. Easiest care to bring for bad faith is when the director does absolutely
nothing (Mrs. Pritchard)
2. Types:
a.Subjective Bad Faith
i. Director actually intends to harm the corp.
b. Acting with Purpose Other Than Best Interest of the Corp.
c. Acts with intention to purposefully violate the law
i.Miller
d. Grossly negligent act OR failure to act
i. If there is gross negligence, cannot get past 102(b)(7) and it is also a lack
of good faith
ii. Gross negligence can only be bad faith is it was done in HUGE conscious
disregard. Only becomes bad faith is the result of the gross negligence
creates an extremely bad outcome for the corp.
e. Intentional Dereliction of Duty = Conscious Disregard
i. If you intentionally fail to act, that is bad faith and will get past
102(b)(7) and BJR
C.S tone v. Ritter (DE, 2006) (p.676): Where directors fail to act in face of a known duty to
act, thereby demonstrating a conscious disregard or an intentional dereliction for their
responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary
obligation in good faith. An intentionally sustained systemic failure to exercise
oversight is indicative of a breach of duty of loyalty. Add: “and this failure to act is a
breach of good faith in the duty of loyalty.”
1. Rule: Directors will be liable for failure to engage in proper corp. oversight where
they (1) fail to implement any reporting or information system OR (2) having
implemented such a system, consciously fail to monitor or over see it

V. DUTY TO ACT LAWFULLY

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A. In cases where π’s allege, a breach of fiduciary duties for breaking the law, π’s do not
need to prove breach of fiduciary duty to state a claim, they just need to prove the
elements of the law they allege was breached. Part of acting in good faith is not
breaking the law

90
 B.M illerv. American Telephone & Telegraph Co. (p.679): SH π’s allege that ∆ failed to
collect a
$1.5 million debt owed by the DNC for services provided in the 1968 democratic
convention. SH’s claim this was illegal under federal law because it was illegal for a
corp. to make a political contribution
1. Rule: A business decision that results in illegal activity is not protected by the
BJR  a knowing violation of the law by directors = breach of good faith
a. Note: down the line, a knowing violation of the law is not by itself a breach
of good faith. Also, this case was not in DE, but if it was 102(b)(7) has an
exception for violation of law

VI. WAYS TO PROTECT DIRECTORS FOR MAKING A NOT SO GREAT DECISION

A. Business Judgment Rule

B. §102(b)(7) – default in DE

C. Indemnification
1. Corps. are often required to provide indemnification for some things, like legal
expenses for a director who successfully defended against a breach of fiduciary duty
claim. Possible to add indemnification provisions if the corp. wants
a. But, there cannot be indemnification for bad faith, breach of duty of care &
loyalty, acts in bad faith, or violation of the law

D. Insurance
1. Provides corps. with DNO insurance, access to funds to pay indemnification is
the need arises. Limited by duty of loyalty and bad faith. Insurance companies
will want to be involved in litigation and settlement decisions

VII. DUTY OF LOYALTY (DOL)

A. Generally:
1. Deals with directors who act in their own self-interest as opposed to the best
interest of the corp. Can cause a lot of harm to the corp., but easier for SH π to win
because the BJR and
§102(b)(7) do NOT apply. Note: There is no flat prohibition on self-dealing in corp.
law, because some interested transactions might be in the corps. best interest. Since
corp. decisions are made by a board that can intervene, courts look to the process of
the transaction first, then to the substance
a. Examples: only limited by ones creativity
i. Self-dealing
ii. Conflict of interest (COI)
iii. Appropriation of info or opportunities that should belong to
the corp. b.Fairness Standard
i. Requires directors to only approve transactions that are (“Fair 4”)
1. Fair in price
2. Fair in terms
3. Fair in overall content
4. Fair dealing – process of approving transaction, requires FULL
disclosure c.Burden of Proof
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i. Once π’s can show there was a conflict/violation and point to a
specific transaction, DOL applies  ∆’s burden to prove transaction
met the “Fair 4”

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B. Decision – Tree to Use on Final
1. Is there a conflict of interest?
a. BOP on SH π
2. Did disinterested directors or SH’s approve?
a. Disinterested Directors: (1) in good faith and (2) after full disclosure
b. SH: after full disclosure
3. If disinterested directors approved appropriately
a. BoP = on SH π
b. BJR applies
c. Standard = gross negligence
i. Unless ∆ is a controlling SH  standard =
fairness 4. If SH’s approved appropriately
a. BoP = SH π
i. Standard = waste
ii. Have to show the transaction was a gift, where the corp. is not getting
anything in return
b. Usually applies in compensation cases
i. Once π alleges a conflict, if ∆ can show (1) full disclosure and (2)
disinterested director approval  BoP shifts back to the π to show
waste = harder than fairness
1. Because, if owners approve after full disclosure, courts want to
support owner decisions
5. If no appropriate approval
a. BoP = ∆ directors
b.∆ Directors must show transaction was fair
i. fair price
ii. fair terms
iii. fair to enter into the transaction at all

C. DOL can be Regulated in 2 Main Ways

1. Common Law:
a. Focuses on (1) failure to disclose, and (2) substantively bad transactions
i.Π must 1 st show that directors and officers took part in self-interested
transaction ii.∆ directors/officers then have the BoP to show that the
transaction was fair and
reasonable
1. fairness looked at in terms of (a) procedure – i.e. disclosure and (b)
substance
– i.e. price
b. A conflicted transaction is voidable at the discretion of the corp. unless
one of the following happens
i. SH ratification  if SH ratified then there is less review by the courts
ii. Disinterested director approval  if there is such approval, there will
be less rigorous review of the transaction
c. Talbot v. James (SC, 1972) – C/L BASELINE (p.707): π/∆ formed a corp.
together, the purpose was to build and operate apartment complexes. ∆ was
president, π was VP

93
– both were on the BOD. The BOD allows ∆ to enter into any agreement he
needs to, including a construction K, for the corp. ∆ then executes a K on behalf
of the corp. with James Construction, ∆’s personal construction company. ∆
never disclosed that he was doing the construction and being paid $25K+.
i. Issue: (1) was there a conflicted transaction, and if so (2) does the ∆ hold
the BoP ii.Rule: As part of their fiduciary obligation to SH’s, directors
generally may not
benefit financially form their personal dealings with the corp. Such self-
dealing is

94
 only permissible if the other directors consent after being fully informed.
Any gain from an improper self-interested transaction must be returned to
the corp. 1.Application: Officers/Directors must always fully disclose all
relevant facts when entering into a K with the corp. in order to prevent
them from using
their fiduciary position to their own advantage. If not: they must
prove fairness because an uninterested K is voidable to the extent that
it is unfair to the corp.
(1) look to whether the transaction was fair through procedural lens
AND
(2) Substantive lens
d. DBR: DOL is a determent – can get caught in trouble for providing a service,
even if it was a positive, if you do not disclose. Talbot, ∆ was getting paid
under market value
2. Statutes (only applies to directors):
a. How does a statute potentially change the C/L baseline? Virtually all states
have a statute that says an interested/conflicted transaction is not inherently
void simply due to the fact of the director’s conflict.
i. The effect of the statutes is broader. Statutes generally appear with an
either or with the 3 requirements (1) transaction is fair, (2) disinterested
director approval, or (3) SH approved.
1. If there is SH or disinterested director approval  the transaction
is not void/voidable. Whether there is liability depends on JX
b. NY BCL §713
i.First, π must show that directors took part in a self-interested
transaction ii.Second, the court will ask if there was disinterested director
or SH approval of
the transaction (was legit process involved)
1. If Yes  BoP is on the party challenging the transaction to prove
it was either unfair, grossly negligent, or a waste of corp. assets
Unclear what standard π must meet. Π will always want only to
have to prove transaction was merely unfair
2. If No  BoP is on the interested party to prove it was fair in price,
terms, execution
c. Del. Gen. Corp. Law. §144
i.First, BoP = on the π to show a conflict of interest (director on both
sides, both sides of K, taking of corp. opportunity, etc.)
ii.Second, determine whether the SD’s or disinterested directors
approved/ratified after full disclosure of material facts. If ∆ directors
are able to prove yes:
1. If Yes, Disinterested Director Approval  BoP goes back to π to prove
gross negligence (transaction was irrational)
2. If Yes, SH Approval  BoP goes back to π to show the transaction
was waste, which is a standard higher than irrationality that must be
reflected in the disinterested director approval
If Yes, SH approval, but fiduciary at issue is a controlling SH 
BoP on π to show unfairness
3. On the Final: pay attention to location of the courts in the hypo

95
a. One question will be about large publically held DE
corp. i.Tyson
b. One question will be a small closely held corp. or partnership in a fictional JX
i. Will need to figure it out - Cookies, SC non-publically traded
corp. c.IO v. DE

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 i. IO says nothing about liability. DE says the statute deals with both
liability and violability. This makes more sense because undoing a
transaction is complicated. Paying damages is not.
4. Case
s

a. Lewis v. SL & E, Inc. (NY, 1980) (p.698) – Who has the BoP: S owns land,
L owns tire shop on the land. L leases land owned by S. Both are related
because they have
some common SH’s. The problem is if the lease is not on fair terms, then the L
siblings are getting a benefit the S siblings are not. S claims L wasted the assets
of S by paying under market value. Only revenue S gets is the lease revenue, so
when time to sell comes around the S stock will not be worth as much as it
should be because L has been paying under market value for the lease. S
directors are the SH’s of L  basically signing own lease on both sides of the
transaction
i. Holding: the district court improperly allocated the Burden of proving
waste on π ii.Rule: The BoP is on the ∆ to show that self-interested
transaction are fair and
reasonable under NY-BCL §713 – Absent any processes, a self-
interested transaction is still voidable if the interested ∆ directors cannot
show fair process and price
b. Cookies v. Lakes Warehouse (IO, 1988) (p.715): Cookies, BBQ sauce,
entered into a distribution K with Lakes. Herrig was the president of Lakes
and a majority SH of Cookies. Herrig increased his role in Cookies (director,
controlling SH, officer – distribution, taco royalties, warehouse, consultant)
and profits increase. With the increase in involvement, Herrig also increases
his compensation.
i. Problem: SH’s are upset that they are not being paid dividends and bring
suit against corp. asking for a sale of the corp. as the only way to get a
return on their investment since it is not publically traded.
1. DBR: (on Final) common problem in small privately held corps.,
especially where a majority SH is involved. Many states have a
minority SH doctrine, oppression, to help with this
ii. Holding: Herrig did not breach fiduciary duty of loyalty, he did so much
for the corp. and got paid relatively little, so it is a fair deal for the corp.
(Talbot dissent)
iii.Rule: The only thing the statute affects is whether the action is void/voidable.
IO
§144 statute says nothing about liability. To answer questions of liability
you are stuck with the C/L standard - ∆ director has the BoP to show in
good faith it was fair

D. Special DOL Issues

1. Compensation: In determining compensation for senior executives/officers where
compensation is set by directors, courts may not want to use the same duty of loyalty
analysis framework because compensation decisions are annual transactions that are
inherently conflicted. It is impossible to get disinterested directors in this context and

97
the courts should be hesitant to open up in a flood of litigation for standard duty of
loyalty claims
a. Structure of Executive Compensation: total annual compensation
i. Short-Term Components of Compensation: include salary, bonus,
and other annual compensation
ii. Long-Term Components of Compensation: ways to align executive’s
interest with the interest of the SH’s, include
1. Grants of restricted stock
restricted, typically a 5-yr vesting period  incentive to stay with
the corp., prohibits the executive from selling the stock during
the vesting period
2. Stock options

98
 gives the manager the right, but not the obligation, to purchase a
share of the firm’s stock for a pre-specified price (the exercise
price) on or before a pre-specified date. Incentivizes exec who
gets the option to work hard to make those securities rise so
when they use the option it will be worth more
3. Long-term incentive plan payouts
payouts similar to bonuses but awarded for performance over
several years. Only occur when a long-term target is met
4. Incentive Compensation
Treated more favorably for corp. tax burden than $ simply
paid to employees
 Tax code limits how much paid to executives can qualify
for tax cut
One way to pay is through “options” – purchasing at a later date at
particular price (the price of shares on public market on date it is
issued
– Tyson)
 Should incentivize executives to act in the best interest of the
corp. so share prices go up down the line but they can buy
at a lower price on the current market.
2. Ratification: [need to clarify] Usually SH approval is required when option
or equity payments are made to directors/officers as compensation. If SH’s
have voted on compensation, there is a check in place, and they have
arguably been protected
3. Waste [need to clarify] – idea of exchanging corp. assets for no compensation:
Courts use C/L waste standard to review substantive transactions. Courts believe
that they are not in position to challenge SH-approved compensation unless it is an
egregious waste of corp. assets. Courts thus count on SH’s to protect themselves.
The waste standard has been criticized as inefficient due to its intense factual
scrutiny, and that directors should prefer a gross negligence or fairness standard
because courts seem better able to resolve cases under these standards. Some argue
that the waste standard actually takes up directorial and judicial resources. Applies
to corps. Listed on the NY stock exchange.
a. Freeman v. Adams (DE, 2013) (p.733) – Waste is VERY hard to prove: π
alleged that XTO’s BOD committed waste by failing to adopt a plan that
could have made its bonus payments tax deductible – compensation awarded
to officers over $1mill/year was tax deductible only if paid pursuant to
§162(m) of the IRS code. After suit was filed, XTO’s BOD approved a
§162(m) plan, but never made use of it because they merged with and into a
subsidiary of Exxon. Π dismisses claims as moot, but files subsequent action
seeking $1mill in attorney’s fees and arguing that the initial complaint
benefited XTO by causing them to adopt §162(m)
i. Holding/Reason: The complaint failed to state a claim of waste. BoP falls
on the π in claims of waste (Disney). Compensation that is a corp.
expense is treated more favorably tax wise than just giving people money
because the corp. is financially successful (like when corps. pay SH’s
dividends). This creates an incentive to pay executives the kind of
compensation that qualifies for this type of deductible. Corp. here wanted
99
 to have flexibility of how to use their money rather than a tax benefit. If
spending $40 mill in unnecessary taxes is not waste, then what is? (2)
“The decision to sacrifice some tax advantage in order to retain flexibility
in compensation decisions is a classic exercise of the BJR”
ii.Rule: Waste is only when $ is being spent on something unconscionable,
where directors irrationally squander or give away corp. assets

10
0
 b. TysonI & II (DE) – Successful waste CoA: π SH bring suit against company
for granting stock option plan pursuant to declaration of compensation
committee. SH’s ratified the plan.
1.Π’s alleged: compensation committee acted outside its discretion by
“Spring-Loaded Options”: issued at current market price, but
people issuing the options have information and know the market
price is about to change. Directors know the current market is
undervaluing the shares. [ex. Issuing at $10 but already know the
true price is $12]
 Problem  there is no incentive for the executives to work
hard to make the options rise in price/do anything positive
for the corp.
“Back-Dating”: when you know the price today is $12 but
dating it for before when the price was $10
2.∆ POV: yes, it is conflicted but falls under §144 protection because they
have committee that approved it, so the burden shifts to π. And SH
approved so π cannot win unless they show it was a waste
3.Rule/Court: ∆ behavior doesn’t get §144 protection because
(1) BOD lost on disinterested committee approval because
the BOD/committee didn’t authorize this transaction in
good faith
(2) BOD lost on SH approval because SH’s gave permission to
assign compensation, sure, you didn’t violate the letter of what
was approved, but you violated the spirit of the power to issue
compensation. In order for SH approval process it has to be real
and transparent
(3) BOD must prove fairness
c. Need to know difference between DE and IO interested transaction laws

E. Corporate Opportunity Doctrine

1. It is a breach of the duty of loyalty for a director to take an opportunity that would
belong to the corp. for themselves. Once something is deemed a corp. opportunity, a
director has no more right to take it for themselves than they do to embezzle funds.
However, in an effort to promote talented people becoming directors, the doctrine
attempts to draw a clear line between what is a corp. opportunity and what is not,
and also to provide directors with process by which they can pursue corp.
opportunities.
2. Process:
a. Determine if the opportunity is one that should rightfully belong to the
corp. This requires an analysis of
i. (a) how the executive learned about the opportunity, and
ii. (b) the relationship of the opportunity to the corps. business [4 tests in
Northeast Harbor]
b. Senior executives may not take advantage of such opportunities unless they
first disclose all material facts to the corp. and the transaction has been
formally approved by a vote of the directors and/or SH’s
3. DBR:

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 a. Once you know you have a corp. opportunity, regardless of the JX, a director
who took that opportunity is in violation and a fairness review with full
disclosure will be applied. DE v. ALI shows how broad a category this is (DE
is much more narrow)
4. North East Harbor v. Harris (ME, 1995) (p.762): Harris is president/director if the
NE golf club. A broker selling adjacent land, assuming the golf club would want to
buy it to prevent further development, approached Harris. Harris buys the land herself
(personally) and does not disclose the opportunity to purchase the land to the club
until after she bought it. She later

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 decided to develop the land. Trial court rules in favor of Harris, saying that the
golf course was not in the real estate business. Π appeals.
a. Holding: This was a corp. opportunity because (1) π could have developed
land for themselves or (2) prevented other types of development, or (3)
flipped it for more money. Court looks at different tests before settling on
ALI standard.
i.“Line of Business Test” (DE):
1. Asks whether
(1) the opportunity was so closely associated with existing
business activities as to make the transaction the type that
would put the corporate officer into competition with the
corp. AND
(2) whether the corp. is financially able to take the opportunity
 Problem: It’s hard to say what a corps. “line of business” is.
And unduly favors directors by allowing financial ability to
be a factor
2.“Fairness Test” (MN): Calls for a broad-ranging, highly fact-sensitive
inquiry into the fairness of the director’s actions. Applies ethical
standard of what is fair and equitable.
Problem: how do you market test an opportunity, not
predictable enough
3. ALI Standard – Corp. Opportunity Rule (focus on process): Any
opportunities that are closely related to the corps. business activities
will be corp. opportunities, but the rule doesn’t include a financial
capacity element.
More narrow category of things the court will look at
 (1) Is the opportunity related to the corp. business activities?
 (2) Did the fiduciary get the opportunity because of their
position in the corp.?
If a corp. opportunity comes into the fiduciary’s view, they should
offer the opportunity to the corp. (BOD/SH), and only if the
corp. rejects it, can the fiduciary take the opportunity for
themselves.

F. Remedies for Breach of Duty of Loyalty

1. Traditionally: Restitutionary in nature  less severe than for breach of duty of care

VIII. DUTY OF CONTROLLING SH’S

A. Generally
1. Can be either (1) an individual SH or (2) another corp. It is a factual question
whether the SH owns enough to be controlling. Do not need to dominate all seats on
the board. To be controlling SH, just need to be in a position where they dominate
the actions of the board
2. Once you have a SH with control  fiduciary duty will attach to that controlling SH
in at least some actions they take because they have the power to dominate the board
and corp. law must adapt to hold them accountable for fiduciary duties. At the same
time, courts want to promote value to paying a premium for majority control, which
would be diminished if it created too much liability. Minority SH’s can sue the
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controlling SH or the BOD/execs – depends on who has deeper pockets. Big question
is whether a particular action is one a fiduciary duty should apply to, and if so what
should the standard be?
a. Ex: How it appears in today’s cases
i.Zahn – decision to redeem shares and liquidate corp.
ii.Lynch – controlling SH seeming to merge his corp. and the corp. that he
controls iii.Sinclair – dividends and self-dealing by controlling SH

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B. Process
1. Controlling SH’s are able to vote in their own interests; however, when they take
over the decision of the board (act as directors), then majority SH’s are charged with
a duty of loyalty to minority SH’s
a. First: Whether a controlling SH can be deemed a fiduciary
i. Depends on voting preference & domination of board
b. Second: what standard of review applies & who has the BoP
i.If π’s claim, the controlling SH’s have influenced the board 
controlling SH has burden of proving fairness
1. Standard = Fairness
2. BoP = on ∆ to show fair price, terms, dealings

C. Parent-Subsidiary Transactions (Special Rule)

1. ONLY apply Sinclair rule when there is a parent of a non-wholly owned corp.
a.First: π mustshow self-dealing where parent has obtained a benefit to the
exclusion and detriment of the minority SH’s
i.If Yes  ∆ parent has BoP for fairness
ii.If No  BJR applies with BoP on minority SH’s to show gross negligence
and/or no rational basis (π will lose)
1. Under the BJR, a court will not interfere with judgment of BOD,
unless there is a showing of gross and palpable overreaching
2. Policy Consideration:
a. Point of having a parent corp. is to have conflicted transactions  they are
meant to work together. The subsidiary is necessary for when operations are
in different geographical locations.
b. Parents and subsidiaries frequently interact and are thus often exposed to
duty of loyalty claims so the requirement of a benefit to the exclusion and
detriment of minority SH’s serves as an obstacle to limit susceptibility

D. Cases
1. Zahn (Axton) v. TransAmerica Corp. (p.827): π SH’s brought derivative action
alleging harm to the corp. 3 main types of stock: (1) Preferred (2) Common A – π,
had liquidation preference (should get 2x value on B shares if A was still around
during liquidation and convertible at the option of A SH’s to go to B. (3) Common
B - ∆ is controlling SH. Class B has better voting, so they have more control and
can elect directors. At the time Axton’s prime income was its physical tobacco
store. Value of tobacco was $20mill, ∆ knew this but
Class A SH’s did not. ∆ caused Axton to “call” Class A = force A to sell their shares
back to the company (“redemption”) and A SH’s would be paid a fixed price, this
was part of A’s K. Once, A shares were redeemed, ∆ liquidates the company, taking
all of the ~$20mill residual value for themselves.
a. Holding: A board acting fair would have issued full disclosure. (1) calling
would have been okay if ∆ had fully disclosed and (2) if ∆ had fully disclosed
 liquidation would have been okay because then π’s would have had the
option to convert to B shares. Disclosure obligation is very strong. Must
disclose everything. It matters that ∆ was is held as a fiduciary because
otherwise there would be no duty to disclose.

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 b. Rule: Majority has the right to control, but when it does, it has fiduciary duty
in relation to the minority to prove good faith and inherent fairness
standard for the corp. And those interested. Also, the controlling SH has a
fiduciary duty only when taking on a role of director, not when voting their
own interests as a SH.
2. Sinclair Oil v. Levin (p.782) – Controlling SH is the Parent Corp.: Sinclair is an
oil company that owns 97% of Sinven’s stock, π minority SH’s (Levin) own 2.5%
of Sinven.

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 Sinclair nominates all members of Sinven’s BOD, and all directors were
employees of Sinclair  owns Sinven fiduciary duty. Levin claims Sinclair (1)
forced Sinven to pay excessive dividends (2) stole corp. opportunities not allowing
it to expand to other parts of the world and (3) compelled Sinven not to enforce a
K against another Sinclair company.
Sinclair wants BJR, Levin wants fairness standard
a. Holding: Court develops special threshold test, in the parent/subsidiary with
a non- wholly owned corp., it is okay to place a burden on the minority SH’s
because they knowingly bought into this type of corp.
i. Excessive Dividends: BJR (almost always applies). Minority/majority
both received correct % payout. Π got a check too, just wished the corp.
could have used the money for something else, but SH’s cannot decide
that, they don’t run the corp.
ii. Corp. Opportunities: Possible for a parent to siphon off opportunities
from the subsidiary to themselves, for 100% personal gain. In DE, π
would need to show
(1) in the line of business and (2) financial capacity. Here, there was not
enough evid.
iii. Breach of K: Fairness standard should be applied. Decision not to litigate
breach of K claim resulting only in a benefit to Sinclair.
b. Rule: In the parent/subsidiary context, with a parent on both sides of the
transaction, we will only look with greater scrutiny at those transactions
where the parent gets a benefit to the exclusion of and detriment to the
subsidiary
i. If yes  controlling SH parent has BoP to show the transaction met
fairness standard
ii. If no  BJR applies
3. Kahn v. Lynch Communication (DE, 1994) (p.788) – Independent Committees: π
sought
to enjoin the acquisition of Lynch by Alcatel pursuant to a tender offer and cash-out
merger. Π alleged that Alcatel was a controlling SH of ∆ (43.3% shares) and breached
its fiduciary duty to its minority SH’s. Lynch attempted acquisition of Telco, Alcatel
disapproved, and instead pushed for a merger with Celwave (a subsidiary of Alcatel’s
parent company). Lynch created an independent committee, which unanimously
opposed the merger. Alcatel withdrew Celwave proposal and made a new offer to
acquire all equity interest in Lynch at $14/share. Lynch’s independent committee
determined $14 was inadequate, recommended $17/share as final offer. Alcatel made
it clear that they would proceed with an unfriendly tender offer at a lower price if
Lynch didn’t agree at $15.50/share. Lynch took offer, minority SH Kahn sued.
a. Issue: Whether a controlling SH can access some of the pre-approval and
full disclosure types of intra-corp. decision making (§144), as directors
can when in a conflicted situation, to help protect themselves by
mitigating potential litigation.
b. Rule: In self-interested transactions by a controlling SH (on both sides), the
controlling SH has the BoP under the fairness standard. The independent
committee must have the ability to negotiate at arms-length, here that was
compromised by Alcatel’s threat of a hostile tender offer
i.BoP Shifts: With application of an Independent Committee

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 1. If there is an Independent Committee  BoP shifts to the minority
SH π, and the standard stays with fairness
Unlike when the self-interested action is by a director  the
director has the BoP under fairness standard. BUT, if there is an
independent committee that voted on the conflicted action, the
BoP shifts to the π’s under a BJR standard
4. Jones v. HF Ahmanson Company (CA, 1969) (p.799) – Extreme case of
controlling SH, acting with their shares rather than making a decision: π
brings independent suit so the recovery goes directly to her rather than to the corp.
∆’s hold 85% of USLA shares. At the

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 time, each share was worth $1,400, very expensive. Minority SH’s are facing a
liquidity problem. They hear how valuable their shares are and want to sell on in the
market, but they are not publically traded. In order to profit, ∆’s created a new
company, UF, with their 85% of USLA. This was a transaction outside of the board
room. UF now holds majority of stock in USLA. UF is publically traded so ∆’s able
to make a big profit. Π is stuck with their hard to trade expensive USLA shares.
a. Holding: Obliterating the marketability of USLA shares to anyone but UF is
the controlling SH obtaining a benefit for themselves at the expense/detriment
of minority SH’s, in violation of their fiduciary duty to minority SH’s and the
corp.
i.∆ could have met fairness if they had done a stock split or brought
everyone over to UF. Majority secured debts of UF using assets of
USLA, may be viewed as a corp. opportunity by some courts.
b. Rule: Any use of power must benefit all SH’s proportionately and must not
conflict with the proper conduct of the corps. business.
i.Standard  inherent fairness (duty of
loyalty) ii.BoP  on ∆ controlling SH
(fiduciary)

E. Sale of Control
1. Generally:
a. When controlling or dominating SH’s sell controlling block at a premium over
market price for individual shares, several issues arise:
i.Issues Re: Premiums
1. Should a controlling SH be permitted to sell for a premium, and if so,
should that SH be permitted to keep the premium or should they be
required to share it with the corp.? Generally, courts reject sharing of
control premiums
ii.Issues Re: Sale of Office
1. New controlling SH’s want control over the board BUT corp. offices
cannot be sold per se, as this is against public policy. Naked sale of
office is prohibited, but transfer of offices is NOT naked if it brings
along a controlling interest of shares. The issue that arises is what
constitutes a controlling interest, straight majority of shares or
effective control?
2. Duty to Investigate Buyer: Controlling SH’s may be held liable to the corp. to
disgorge profits for a sale to a damaging buyer, if:
a. The circumstances where such that despite ignorance of unlawful future
plans, such plans were a reasonably foreseeable risk, OR
b. If the price paid was actually for resignation of directors
i. Factors to consider include:
1. Nature of assets going to purchasers by reason of the transaction
2. Method by which transaction is to be consummated
3. Relation of price paid to the value of the
stock 3.Equal Opportunity Doctrine (policy
consideration):
a. Supporters – argue control should not be allowed to be sold at a premium w/o
allowing minority to share in the premium. This may help distinguish good
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 buyers from bad, if buyers honestly think they can run the corp. better, there is
no reason to allow them to buy control on back of minority who will be subject
to control with no payoff. Looks at corp. control as an asset that should be
shared among all SH’s
b. Most Courts – reject the doctrine on grounds that it only raises costs on buyers,
and that a market for corp. control is good for the economy, promotes risk-
taking, and there is no reason to block a transaction by imposing higher costs on
buyers.
i. Most cases hold there is no per se rule against taking a premium, it
will not violate fiduciary duty to do so unless fraudulent circumstances
are implicated

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 c. Market for Control – is another way to discipline managers. If BJR is not so
effective in punishing managers, investors can see bad management, buy
control, and kick out managers on their own and replace with someone better.
This is why lots of stockholders like takeovers. Promote policies fostering
exchange of control

F. Cases re: Premiums

1. Zetlin v. Hanson Holdings, Inc. (NY, 1979) (p.836) – Default Rule Sharing
Premiums: Zetlin had 2%, majority had 44.4% (despite being less than 50%, it’s
still sale of control because this was the largest block of jointly owned shares).
Majority sold 44.4% to another corp. at way over market value, almost 2x as much,
and so got a hefty control premium.
Minority wanted in on that premium because they were not able to sell their shares
at such a high price.
a. Holding: Rejecting the Equal Opportunity Rule, minority SH’s are not always
entitled to share in premiums paid for control, because the controlling interest
was not theirs to sell.
b. Rule: There is no per se rule that a controlling SH may not accept and keep all
of a premium. Controlling SH’s invest in that control and probably paid more
when they either purchased the stock or they put extra work into the corp.
This was not done by the minority  they don’t deserve some of the
premium.
i. Absent sale to looting of corp. assets, conversion of corp. opportunity,
fraud, or bad faith a controlling SH is free to sell and purchaser is free to
legitimately buy control at a premium
2. Gerdes v. Reynolds (NY, 1941) (p.840) – Exception when sold to looters/Duty to
Investigate Buyer: Controlling SH sold shares for a lot more than they were worth.
Sold to an outside buyer who paid on installments over time. Buyer took control of
the corp. which managed publically traded securities (like bags of cash: publically
traded and easily liquidated), sold them and took the money.
a. Holding: Investigation into the buyers would have shown that they clearly did
not have the means to run the corp. and thus it was no surprise when they
misappropriated all of the liquid assets. It’s not that the controlling SH’s knew,
but they should have known based on the circumstances of the deal  ∆’s
breached duty of loyalty to minority SH’s for personal benefit of higher
premium.
i. This was also Sale of Office – because buyers paid premium for assets
they wanted to loot. Got access through the directorships. Directors
cannot resign if the immediate consequence is to leave the corp.
vulnerable to this
b. Rule: Sellers may be held liable if (see above for factors)
i. The circumstances where such that despite ignorance of unlawful future
plans, such plans were a reasonably foreseeable risk, OR
ii. If the price paid was actually for resignation of directors
3.DBR: What you should do if someone wants to pay way over
purchase price
a. Seller needs to be assured that price is justified for sale of control (Zetlin), as
opposed to a sale to looters, which is not okay (Gertes)
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 i. If controlling SH’s do their due diligence  might be protected from
one of the exceptions
1. Valuing company, understanding buyers position to pay
premium, understand buyers reason for purchasing
4. Perlman v. Feldman (1995) (p.845) – Whether/how minority SH should have
access to premium in an exception case: Feldman was director, president, majority
SH of Newport Steel, fiduciary from all angles at all times. Buyers are a syndicate of
steel end-users who wanted to control steel supply in a tight market. Feldman knew
this, more knowledge than an ordinary SH would have. He could have gotten the
end-user to pre-pay for access to steel and

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 use that profit to improve the corp., but doesn’t do that, rather he sells shares at a
premium. In a way, Feldman took a corp. opportunity away from the corp. by
stripping the corp. of the power to allocate their steel to whom they chose at a time
where there was a war and steel was hard to come by.
a. Holding: Here, premium was not being paid for control but for a corp.
opportunity that should have been shared by all SH’s.
b.Rule: When a majority SH is also a director/officer, and there is a sacrifice of
corp. opportunity in exchange for an unusually high purchase price paid to the
fiduciary  fiduciary must account for his control premium gain and pay
damages to the minority.
The premium represents the assets of the corp. rather than the
control i.Standard: Fairness
ii.BoP: on ∆
c.DBR: This is a derivative suit, fiduciary breached duty to the corp. not the
individuals, so damages should be paid to the corp. BUT the court makes an
exception here: any damages go to the minority SH’s because if they go back to
the corp., the buyer will be
the one benefitting. And the transaction cannot be undone because the benefit
would go back to Feldman.
i. Good case to cite because all things lead to liability – duty of loyalty,
sale of control/exception for corp. opportunity

G. Case re: Sale of Office

1. You can quit your job, but if you do so in circumstances where you now, or should
know, that the corp. will be looted, that will create liability (Gerdes)
2. Times when it has been okay, to sell office for a premium
a. When buyer will get controlling stake and transferring office is not a breach
(Perlman)
b. When directors own a very small stake in the corp. and sell their share to
someone else, and then resigns to be replaced by that buyer = sale of office
dressed up as sale of shares (Gerdes)
c. When purchaser buys a block that doesn’t clearly transfer control, but it might
(Yates) 3.Essex Universal Corp. v. Yates (NY, 1962): Yates had 28.3% of shares.
Decent size, but not
majority. As part of the K of sale, Yates agrees to deliver the buyer the
resignation of the board, so it can be filled by nominees of the buyer. On the
closing date, Yates bails and doesn’t want to do it, and says the K is not legal on
its face.
a. Rule: Naked sale is not okay, but numeric/working control with sale of office is
okay
b. Holding: Judges all agree that if the sale of shares was a true majority, the K
can require that the board resign. They disagree on what the π has to show in
order to get the K enforced
i. Judge Lombard: Since the clause would have been legal if it was for a
majority, it is also true if the transfer is of practical/working control (Zetlin
– 44.4%) because most SH’s don’t vote, having a significant portion of the
votes gives the holder working control.

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 1. BoP: on whether the % is working control goes to the person attacking the
K
ii. Judge Friendly: Would remand and let them work it out at the state
level. Only way to determine what constitutes working control is with
an election

IX. ENFORCING DUTIES – SH SUITS

A. Direct Suits
1. Suit pursues a remedy for a wrong done to an individual or class of individual SH’s
directly, with damages going by default to individual SH’s, not the corp. It is brought
on the SH’s own behalf against either the corp. fiduciaries or the corp. itself.
Successful π must demonstrate an injury in a way that is not dependent on an injury
to the corp.

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B. Derivative Suits
1. Suit brought by SH’s on behalf of the corp., pursuant to a wrong done by the corp.
Derivative suits are brought on the corps. behalf against either corp. fiduciaries or 3rd
parties. Any damages, by default, are paid to the corp.
2. Procedural Rules
a. Demand (next section): Before a SH can bring a derivative suit, they must go
to the BOD and demand that they bring the suit on behalf of the corp., unless
that would be futile. If a SH did not do this before bringing a case, that case
will not be heard
b. Special Pleadings: Derivative claims must be plead with particularity,
rather than allowing conclusory statements on information and belief.
Heightened standard is meant to avoid strike suits.
i.McKessen  π originally brought derivative action claiming that the merger
negotiations breached fiduciary duty. Claim was dismissed because π
wasn’t able to plead with particularity of facts
1. Can’t just say, “on information and belief…” Need to state exactly
what the facts are that support the alleged claim.
c. Security for Expenses Statutes: Most states have these statutes, where π;s in
derivative suits have to post bond to cover a portion of the ∆’s attorney’s fee
should their claim be meritless, unless the π has a substantial portion of the
stock (because if they forces the corp. to waste time and money on a meritless
suit, they would be hurting themselves). Some courts will soften the blow by
issuing a stay, allowing π to bring in others to help with the costs.
i.On Final: Will never have enough info to apply on the test. Say the attorney
will need to check the state statute and then apply what is applicable. DE
has this, but it is rarely, if ever, enforced
d. Adequate Representation: SH π in derivative suit must be an adequate
representation of the corp. because they are bringing suit on behalf of the
corp.
i. This is really asking, whether the π’s attorney is right to represent this corp.
Another way to discipline unscrupulous behavior by π’s attorneys
e.Contemporaneous Ownership: Only a π who was a SH at the time that the
alleged
act/omission occurred is an appropriate π, and must remain a SH during the suit
to get recovery. Basic rationale is that courts don’t want people buying and
selling lawsuits. Also applies in mergers (Massey)
i.2 Exceptions:
1. Devolution by Operation of Law – non-contemporaneous SH
allowed to bring derivative action if their shares devolved upon
them when someone died (McKessen)
2. Continuing Wrong Theory – π can bring action to challenge a
wrong beginning before their acquisition of shares but
continuing thereafter
f. Personal Defenses (will prohibit SH from being proper π): remember, a
derivative action is an equitable remedy, and if your behavior is not proper,
you cannot get equitable relief

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 i. Unclean hands – π participated in the
wrong ii.Π consented to the wrong or
explicitly ratified it
iii.Π is guilty of laches (letting too much time go by, too late in articulating
rights) iv.Π acquiesced in the wrong by failing to object
g. Settlement Review: To settle a derivative action, the court must approve the
settlement and all of its components. FRCP, NY and DE law all require judicial
approval. This is important because courts need to make a decision that
settlement is getting a good value from ∆ and an important part of that is
reviewing attorney’s fees. FRCP and some

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 states require SH’s to be notified of settlement of derivative actions.
Refusing to approve settlement is very rare.
i.Caremark – the chancellor was balancing the settlement with the underlying
strength of the claims. They approved the settlement because the claim
was weak and so was the settlement offer, but would only approve
attorney’s fees if they were lowered.
3.2 Exceptions: When courts will permit a π to file a direct suit rather than derivative
a. When a π seeks injunctive relief, courts will allow π’s to proceed directly,
whereas they otherwise would be derivative. Exception is discretionary,
not mandatory
i. Courts do not impose procedural hurdles in this context because individual
SH’s are not getting any $ out of the deal, so bringing the suit directly does
not signal that SH’s are trying to launch a strike suit or sue for an improper
purpose.
ii. Also, when seeking injunctive relief, time is generally of essence and so
procedural requirements might render injunctive relief fruitless. There is
concern in the derivative suit arena that because derivative actions give
rise to attorney’s fees, in nonmonetary damage cases, π’s attorneys could
easily collude with the board which will pretend to make changes and just
pay their attorney’s fees
b. Cases brought by SH’s of closely held corps. (Barth): many courts allow suits
that should otherwise be brought derivatively to be brought direct when brought
against ∆’s in closely held corps. DE has not adopted this! The reasons for this
exception include the facts that
i. SH’s in closely held corps. stand in a fiduciary relationship to each
other and must deal fairly, honestly and openly with each other, AND
ii. SH litigation in the closely held corp. context will not implicate policy
considerations of large corp. derivative suits where corps. would be
inundated by a flood of litigation
1. Rule: Complaints that would need to be brought derivatively in the
context of large corps. might be permitted as direct action in
closely held corps. where such allowance will not
Unfairly expose corp. or ∆’s to multiplicity of actions
Materially prejudice interests of creditors of corps.
Interfere with a fair distribution of the recovery among all
interested persons
4. Policy Concerns
a. Strike suits (meritless law suits)
b. Agency costs – most serious in derivative/class actions suits. If too expensive
 π have no way of disciplining agents/wrongdoers
c. Need collective mechanism to bring suit.
d. Problems with attorney’s. Basically, puts attorney in charge of suit, has
incentive to bring suit because will only get paid from the collective recovery,
not from individual SH’s. Attorneys can either be paid by
i. Percentage, 15-20% - Doesn’t account for how challenging the case was
and how hard they worked. Some claims won’t be prosecuted because
attorney will only choose cases that won’t be a lot of work, but will be
decent payout. At the impact settlement stage, maybe attorney won’t keep
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 going because they won’t get a higher % (current choice of courts,
recovery = fewer perverse incentives)
ii. Lodestar, [hours] x [fee, set by judge] - Attorney works extra hours,
frivolous motions to get more $. Each individual SH will not be good at
checking whether the attorney is doing the right thing

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C. Direct v. Derivative
1. Generally, courts don’t want too many direct suits because derivative actions are
more efficient in that they discourage duplicative actions by individual SH’s.
Conversely, SH’s generally prefer direct actions because they do not have as many
procedural hurdles and provide damages/direct relief to the π. Although courts
prefer derivative suits, in an effort to avoid strike suits by π SH’s, derivative actions
have far greater procedural hurdles than direct.
2. Examples/HYPOS
a. Direct – Being denied opportunity to inspect books/records, harms SH π,
remedy is an injunction going to the individual SH’s. DE §220 request
(McKessen)
b. Direct – Voting rights, personal to the SH, doesn’t harm the corp. (Blesias)
c.Derivative – Breach of duty of care/fiduciary duty, alleging gross negligence,
classic
harm to the corp., π SH only impacted to the level they are interested (Van
Gorkom) d.Derivative – Breach of duty of loyalty/fiduciary duty, harms the
corp. (Northeast
Harbor - Golf club case)

D. Cases
1. Tooley v. DLJ, Inc. (DE, 2004) (p.1024): π’s claim ∆ harmed they by delaying a
merger. Π merely got their money 22 days later, but claimed if they had gotten it
earlier it would have increased in value because they would have had time to invest
it. They are not arguing it’s a bad merger, or that the price was unfair. They are
arguing that there was a contractual right that the BOD interfered with.
a. Holding: this was a direct claim, but π’s failed to state a claim on the merits.
If ites a contractual claim, you need to look at the K, and the K says that you
can push the merger date back. Dismissed w/o prejudice to bring again.
b. Rule: BoP is on the π SH to demonstrate that they have been injured in a
way that is not dependent on an injury to the corp.
i. Test to make it easier to determine direct or derivative
1. Who experienced the alleged harm – individual SH’s or the corp.?
2. Who should receive the recovery in order to remedy the wrong –
individual SH’s or the corp.?
c. DBR: injury may appear small when looking at the individual SH, but when you
look
at all the SH’s together, the numbers get very large. One reason for derivative
and class action suits, way to discipline directors when individual SH’s would
not be able to bring suit alone
2. Barth v. Barth (IN, 1995) (p.1031) – Closely Held Corp. Exception: ∆ is
president/majority SH of a closely held corp., and minority SH sues on grounds that
∆ paid excessive salaries to self/family, used corp. employees to service his/sons
homes w/o compensating them, and appropriated corp. funds for personal
investments.
a. Holding: Derivative action rules don’t apply to closely held corps. because of
fiduciary duties of close corp. SH’s and policy concerns of direct actions (e.g.
strike suits) are not implicated in closely held context

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b. Rule: Testto determine whether a claim that should be derivative can be
brought as direct in context of a closely held corp.
i. Multiplicity of Actions – if there are a lot of SH’s, don’t want a lot of
separate direct suits. If there is multiplicity of actions  direct not
allowed
ii. Prejudicing Interest of Creditors – (most common reason not to allow
direct) If corp. has lots of debt, there is harm to the corp., not a lot of
assets  if it goes direct, $ would be paid to the SH’s before going to
the creditors. Reason why if there is a lot of debt suit will be derivative

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 iii. Fair Distribution of Recovery – in a closely held corp., if the fiduciary
who is being challenged is also a large SH, then giving money to the
corp. will actually benefit that SH. Direct is favored here so money goes
to individual harmed.

X. SH SUITS – THE DEMAND REQIREMENT

A. Generally
1. SH π’s must bring demand to the corp. for them to bring a derivative suit. Π’s must
demand the corp. bring litigation b/c the corp. is harming the corp. Gives the BOD a
chance to correct any error, as opposed to spending time/money on litigation. This
will discourage strike suits, because the BOD would not bring one. On the other
hand, it’s not supposed to be so onerous that SH’s will not be able to ever correct
issues and bring suits. Demand requirement says, “before we let SH’s sue, we want
to make sure corp. won’t bring this claim on their own.” Theory aligns with
Charlestown by placing the ultimate decision on whether to bring suit on behalf of a
corp. with directors because it is a management issue.
a. Particularity Requirement: the π’s complaint must particularly state the
merits and what efforts the π’s have made to address the wrongdoings of
the corp.
2. Demand is only excused if it would be futile, meaning it would be absurd to think
the board would honor or investigate this demand

B. Process
1. First Ask: DID THE SH MAKE A DEMAND ON THE
BOD? a.IF YES, ASK: DID THE CORP. ACCEPT THE
DEMAND?
i. If yes  corp. handles suit and SH’s don’t have to. Recovery goes to
the corp. and filters down to the SH’s. SH’s lose control
ii. If no (BOD rejects demand)  SH’s can challenge refusal by suing on
claim of rejection was improper/breach, a duty of care claim.
1. If the BOD used all BJR, π can claim the rejection was irrational
DE says if a SH concedes, i.e. goes to board to seek demand, this
indicated that π thinks demand could have worked and thus
demand will not be excused as futile for interested board = π will
lose on duty of care breach
2. Note: π would prefer to go right to excused because they don’t want
to be subject to BJR and once you request demand you lose the
opportunity to say demand is excused as futile.
2. IF NO, THE SH’S DID NOT MAKE A DEMAND ON BOD
a.Ask: is demand excused for being futile?

C. Methods of assessing Futility

1. DE Standard: (Aronson v. Lewis)
a. Must show 1/2
i. Was the majority of the BOD not disinterested or not independent (BJR
type of claim, duty of care)

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 1. Director is interested: when there is some financial
interest 2.Independent: positional context, personal
relationships
ii. Was the decision not the product of sound BJR (Sounds like duty of loyalty)
1. Procedural integrity (informed decision)
2. Substantive integrity (terms of transaction)
b. Standard = Reasonable doubt (BoP = on SH π)
i. SH’s don’t need to prove the case, just raise reasonable doubt for either
prong
1. Unusual standard. DE wanted it because there are so many things
going against SH’s, they wanted to balance between all things
given to the corp.

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 (like BRJ) and the demands made on the SH’s to hold the corp.
accountable.
Lets more cases through based on the merits
c. If answer to both is NO  demand is NOT excused and the case is dismissed
d. If answer to either is YES  demand IS excused and SH may
proceed 2.Universal Requirement Approach
a. Can only be adopted by the legislature. Abandons specific determinations and
requires demand in every derivative suit, unless demand is excused where π
shows irreparable harm to the corp. would result. In many JX, SH’s must wait
90 days after serving demand to file suit, unless demand is rejected before then
or the irreparable harm.
3. NY Approach: (Marx v. Akers)
a. Like DE approach but w/o the reasonable doubt standard. Demand will be
futile is the complaint alleges with particularity that either:
i. A majority of the directors are interested in the transaction, OR
ii. The directors failed to inform themselves to a degree reasonably
necessary about the transaction, OR
iii. Transaction is so egregious on its face that it is clear that the directors
failed to exercise BRJ in approving transaction

D. Independent Litigation Committee: only if Demand Excused as being futile

1. Created to consider whether an ongoing derivative action is harmful enough to the
corp. that it should be dismissed. Should only consist of outsiders.
2. DBR: Concerned ILD are not really independent because they are new to the board
and experience tremendous pressure to please the old board. ILC cannot really be
objective, this is why in some JX courts will not allow for this. NY does allow it.

E. Policy Issue
1. All of these are basically duty of care/loyalty standards, but in demand on the
board cases they are being addressed at the pleadings stage. Is there a problem with
dealing with merits like this so early in the case?
a. Makes is very hard for SH’s to bring derivative actions. BUT, because
reasonable doubt is all that is needed in DE, π’s are more likely to be able to
bring suits

F. Cases
1. Marx v. Akers (NY, p.1051): π brought derivative suit against IBM without
demanding that the BOD bring the action. Π complained that IBM board wasted
corp. assets by excessively compensating executives and directors. Court must
decide if demand on the board will be futile
a. Holding: With respect to the executives, only 3 of the directors were
executives, thus the majority was not interested in the suit against them, so
demand is not excused. However, with respect to directors, all of them were
obviously interested and thus demand is excused for that suit
2. Auerbach v. Bennett (NY, p.1062) – Independent Committees in NY: General
Telephone began an internal investigation to see if the corp. had engaged in
questionable payments to foreign govts. The US had passed a federal Act making
any bribes by officials to other countries illegal. Discovered that $11 mill in bribes
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had been made and some directors were personally involved. SH π, sued
derivatively but never made a demand, and corp. didn’t challenge claim based on
this. Time passes ∆ doesn’t want case to go forward, forms an independent
litigation committee, of people who were not involved in the transactions and were
not on the BOD at the time the transactions were made. ILC found litigation could
damage corps. reputation and harm the corp., litigation should be dismissed.

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 a. Holding: Decision of ILC was upheld. Courts are ill equipped to second guess
business judgment and should not absent bad faith or fraud. If the ILC
investigated the matter thoroughly and the BOD sought its advice. The decision
would have to be so negligent and irrational that it could not have been the
product of proper business judgment
b. Rule: How to test whether to follow the recommendation of
the ILC i.(1) Whether the ILC is really independent and
disinterested.
ii.(2) Whether the procedure the ILC followed was sufficiently
thorough 1.BoP: on the corp. to show disinterest, good faith,
and reasonable
investigation/process
3. Zapata Corp. v. Maldonado (DE, p.1067) – Independent Committee in DE: Zapata
adopted a stock option plan in 1971 which the BOD was authorized to amend freely.
Purpose and effect of the plan was to allow senior officers to benefit at Zapata’s
expense. SH Maldonado brought a derivative suit alleging breach of fiduciary duty
by directors and asserted demand would be futile because all directors were ∆’s and
allegedly participated in the acts. ILC determined that it would be counter-productive
to pursue litigation. Should ILC be authorized to dismiss a derivative SH suit?
a. Holding/Rule: Not okay with simply dismissing suit after years of litigation
at the recommendation of an ILC. Basically, once demand is excused, don’t
want to give control back to the BOD so easily just because they made an
ILC
i. Will still use:
1. Is board disinterested or independent
2. Was decision product of sound business judgment
ii. And gives court of chancery judges special discretion to apply their own
business judgment to determine (in their mind) whether
1. It would be better for the corp. for litigation to continue, OR
2. If continuing litigation would be more harmful to the corp.

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12
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XI. CLOSELY HELD CORPS. (CHC)
A. Characteristics of a Closely Held Corp.
1. Relatively small number of individual SH’s
2. Lack of liquidity
3. Overlap between management and ownership – see veil piercing due to
increased involvement by SH’s in management
4. Not a passive investment, role in the corp. is an important part of their career and
livelihood
5. Can’t take the type of risk and volatility because they can’t diversify portfolios and
offset risk
6. SH rights to make fundamental changes (merger, sale of all or substantially
all assets, amendment of articles) are threatened by lack of enforcement
options

B. Partnerships & Closely Held Corps. Compare/Contrast

1. Need to go over to make sure this is all correct – I don’t think it is
CHARACTERISTI PARTNERSHIP CHC
C
Basic Norms Heavily contractual
Governance Very contractual, UPA/RUPA Many corp. statutes were
set up default rules. Absent mandatory regarding
contrary K, P’s have equal rights internal governance
in management and manners
relating to ordinary p’ship
business.
Requires majority of P’s
approval and unanimous
approval for those outside
p’ship business
Authority Any partner may bind p’ship SH’s have no right to
on matter in ordinary course participate in management of
of business, even if P lacks corps. business and lack
actual authority to bind apparent authority to bind corp.
Distributive Shares P’ship profits shared per capital, Corp. distributions shared in
no P is entitled to a salary proportion to stock ownership,
not per capita
Transferability No one can become a member Shares of stock and SH’s
of p’ship w/o consent of all status they carry are freely
partners. No interest, except transferable
stream of income is freely
transferable
Term Usually created for limited Term is perpetual, and
term. If term is unspecified, P dissolution is difficult
can cause dissolution at any
time. if term is specified,
dissolution occurs at end of
term or under certain specified
other circumstances
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Fiduciary Duties P’s are fiduciaries to each other
Liability P’s are individually liable for
p’ship obligations
Traditional view: SH’s not in
direct fiduciary relationship.
This has changed
SH’s not individually liable for
corp. obligations, unless corp.
veil is pierced. In practice no
limited liability because they
often have to make a personal
guarantee to get credit

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C. Restraints in CHC’s
1. Often shareholders take on personal liability in order to obtain credit for closely held
corporations and/or because shareholders in these contexts are more likely to be
subject to the piercing corporation veil doctrine. Also, shares in closely held
corporations are not easily transferable, there is no market for closely held
corporations, so shareholders are unable to vote with their feet and are particularly
sensitive to management decisions. Generally, there are a lot of dynamics in closely
held corporations that default corporate common and statutory laws do not fix.
Modern courts have come to understand that closely held corporations need special
treatment when there is “oppression of fellow shareholders"
2. When shareholders engage in mechanisms to give themselves more control in order
to feel more comfortable with their investment, traditional corporate law would void
these actions under the Charlestown precedent establishing a clear distinction
between ownership and control. However, closely held corporation case law indicates
a modern trend that courts will uphold shareholder agreements even when they
restrict board discretion by interpreting agreements to
a. be about voting with director provisions being merely incidental, or
b. openly restricting board discretion in a reasonable manner where other parties
such as creditors and minority share-holders are not injured.
3. When shareholders have not contracted around certain rights to increase their
control, fiduciary duties shared among shareholders in closely held corporations
act as a post facto protection for investment

D. Responses/Resolutions
1. Limited Liability Company – s/t between a CHC and P’ships
a. Allows owners to solve problem of CHC’s. Company in contractual form, few
mandates like in corp. law, combines potential for limited liability and other
p’ship like features on things like transferability and termination. Because it’s
governed by contract law, you set the rules for yourself as opposed to abiding
by corp. law
2. Some JX deal with these attempts by SH’s to K around the defaults of corp. law so
they can get a system of governance and operations that is more effective for their
needs while still being called a CHC
3. Some JX actually change their law

E. SH Mechanisms to Gain Control in Closely Held Corps. NEED TO REVIEW!!!

1. Vote Pooling Agreements (Ringling)
a. K’s where SH’s in a CHC agree to pool their votes to achieve a particular
outcome. Typically doing it to protect themselves and their interests. SH’s will
either agree in advance (1) vote together or (2) to vote for a specific person
[Ringling]. It’s easier to enforce K to agree in advance to vote for a specific
person, but it is also risky because it may be found to be a Charlestown
violation. Alternative is to put in an arbitrator where you agree just to vote
together as opposed to for a particular slate (harder because you need to get
arbitrator involved, but easier because it is less likely to be found
unenforceable)
i. Generally, majority of courts hold with type of vote pooling K valid as
long as no side-payment (can’t sell vote just like you can’t sell BOD seat).
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ii.Modern cases have started to grant specific performance more often
because damages will be inadequate. Where π want certain people as
directors, but damages for breach of K are more easily awarded
1. You can have agreements on how to pool votes, and you on what the BOD
is going to do once they are elected. It’s not only agreeing on how to
vote for directors but how they will conduct corp. affairs

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 2. Including an irrevocable proxy will make the agreement more
enforceable when coupled with an interest. The proxy must link to
the interest you are voting for
2. Voting Trusts (Statutory creature – often time limited by 10years)
a. Two or more persons with stock in a CHC create a trust and put shares into it.
Trustee now has legal title to shares and will be record owner of shares, thus
does not need proxy. But if you use voting trust, you separate legally
beneficial rights retained by SH’s from legal title to shares invested in the
trustee, who has been instructed on how to vote shares. With a voting trust, it
does not matter if you trust fellow SH’s because the trustee is the one voting
3. Classified Stock & Weighted Voting
a. Varying default weight for voting  certain classes of shares may be weighed
against each other to make oppression more difficult. Also, can play around
with quorum and voting requirements
4. Other Options to Prevent Conflict – Enhance representation of small/minority SH’s
a. Impose Sumer Majority Quorum or Majority Requirements.
i. Unanimous consent – would make it impossible in large publically
traded corp., but in CHC’s this may be possible. It also makes sense in
CHC’s because SH’s not only risk their investment, they are also
investing time in management, occupation, etc. and they me even expose
themselves to personal liability.
b. Cumulative Voting
i. Where you vote the number of shares by the number of positions,
you can cumulate them for one candidate
c. Change bylaw provisions – re: director voting

F. Cases
1. Ringling Bros. Barnum & Bailey v. Ringling (DE, p.442) – Vote Pooling
Agreement: Circus has 1,000 outstanding shares owned by Edith (π, 315), Haley
(315), and John (370). There had been a voting trust set up to have a trustee vote the
shares, but it expired so Edith and Haley came up with a voting agreement. The K
said they would unite their votes in all actions that came up for SH approval, and
where they could not agree, the dispute would be submitted to an arbitrator. They
could not agree on a candidate for an open director seat so it
went to the arbitrator. Edith followed the arbitrator’s instructions, Haley did not.
Edith brings suit for breach of K and Haley’s defense was that the K was invalid.
a. Holding: Uphold the K, ruling in favor of Edith. But the court is not going to
specifically enforce the vote pooling agreement. Instead they invalidated the
voted of the breaching parties and told them to vote at the next meeting.
Arbitrator here doesn’t have a right to vote shares because the proxy for him
was not included in the K (drafting issue)
i. Issue: Revocability, cannot solve enforcement issue if it can be
revoked b.Rule: Shows the problems of making vote pooling effective w/o
making specific
performance a remedy. Now courts will look at the specific set of facts for each
case to decide.
2. McQuade v. Stoneham (NY, p.456) – Strict Approach (older rule): McGraw, McQuade

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and Stoneham were owners/officers of NY Giants with Stoneham owning majority.
The SH’s entered into K to vote for each other as directors and officers (vote pooling
K). They want to be directors/officers because they want the salaries. Like in
Ringling, this was fine until the friends stop being friends. And so, the majority SH,
Stoneham, did not vote for McQuade to be director and treasurer. McQuade sues to
get specific performance order to make him director and treasurer, as agreed between
the parties

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 a. Holding: No damages and no specific performance. K is void because it robs
the board of its authority to make its own decisions. The K decides all of the
officer positions ahead of time taking the power away from the board. There are
also minority SH’s who are not mentioned, and they too are entitled the benefit
from director decision making.
b. Rule: Traditional/rigid approach of SH’s being able to contract for how they can
vote their shares, but they cannot K to abridge how they will exercise their
rules as fiduciaries when they step in to being directors/officers when there are
minority SH’s who are not parties to the agreement. Do not allow SH’s to
contract as to how they will conduct themselves as fiduciaries, at least when
there are minority SH’s not in the picture.
3. Galler v. Galler (IL, p.460) – More recent trend, protection of minority SH’s by
enforcing K that ties the hands of directors will be enforced if it is reasonable:
Benjamin and Isadore were 50/50 owners in an incorporated drugstore. The bothers
entered into a K, where id one brother died their respective family would have equal
control of the corp.
Emma, as heir to Benjamin, sought enforcement of the K requiring payment of
certain dividends, continuation of salary, and buyback options. Isadore refused to
honor K, claiming it was void because SH’s cannot K to usurp powers of directors
(Charlsetown/McQuade type violations)
a. Holding/Reason: K is valid. There is a big problem in CHC’s that shares
cannot be easily liquidated and SH’s cannot protect themselves like someone
w/ a diversified portfolio can, so courts will uphold a K that violated corp.
statutes on the ground of practical considerations. Modern trend: allowing
SH’s to engage in the type of pre- decision in directorial/officer matters
through K’s, even when there might be minority SH’s.
b. Rule: Agreements like this are allowed as a way for SH’s to protect themselves
as long as they are reasonable, not harming other SH’s and/or creditors
i. Compensation – what is the compensation like in other places for
similar positions
ii. Dividends – what is a reasonable dividend for such a business
iii. Length of time - Courts limit voting trusts to 10 years, so this cannot be
indefinite

XII. CHC’S FIDUCIARY OBLIGATIONS OF SH’S

A. Generally
1. Ex post way to protect minority SH’s in CHS’s
2. Standard of duty: SH’s as directors/controlling SHs must have acted with utmost
good faith to other SH’s (p.480)
a. Act with degree of diligence, care, and skill ordinarily prudent person in that
situation would under like circumstances
b. Discharge their duties in good faith with view on furthering the interest of the
corp./one another
c. Disclose and not withhold relevant info from one another that affects the
status/affairs of the corp.
d. Not use position to gain any special privilege/advantage over
others 3.Examples:
a. Equal opportunity to buyback shares
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 b. Actions must be taken under best business judgment
4. Where minority alleges that majority has breached the strict good faith standard,
courts will ask if there was a legitimate business purpose for the majority’s action.
a. Difference will be given to the majority, but minority can rightfully inquire
whether a less harmful method (opposed to freeze/squeeze outs of minority)
was possible to achieve a legit business end.

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 5. ON FINAL: Make sure to use MA rule (Donahue) for fiduciary duty of SH in CHC’s.
Cannot K out of fiduciary duty in CHC. But can K out in limited liability corps.

B. Problems
1. Freeze-Outs: Where the corp. form creates an opportunity for the majority to
disadvantage/oppress the minority by not allowing the minority to regain the capital
of their investment because there is no liquidity in them as there is no market for
CHC’s shares, so they are trapped at the mercy of majority SH’s who typically
control the BOD and SH voting.
a. Is done when the majority (1) may refuse to declare dividends, (2) may drain
off corps. earnings for salaries/bonuses or (3) may deprive minority SH’s of
corp. offices and of employment by the corp.

C. Cases
1. Donahue v. Rodd Electrotype Co. (MA, p.471) – Oppressed minority SH’s where
majority has breached fiduciary duty: Rodd and Donahue split shares 80/20.
Rodd gives
most of his shares to his sons but has the company buyout 45 of his shares at
$800/share so he gets a substantial cash payout. When Donahue dies, his wife wants
to cash out at the same price, but Rodd’s sons decline. Donahue’s wife sues for breach
of fiduciary duty where she wants out of the corp. and the only realistic buyer, the
corp., will not buy her out
a. Holding: Buyout of Rodd w/o giving the same opportunity to Donahue was a
breach of fiduciary duty. Controlling HS’s must offer each SH an equal
opportunity to sell shares (buyback). They cannot use control of the corp. to
obtain special advantages and disproportionate benefits from its share
ownership Exception only applies in CHC’s because they are more subject to
freeze-out issues
i. Reason: CHC’s are more like partnerships, so it doesn’t make sense
to apply corp. formalities.
b. Rule: SH’s owe the utmost loyalty to one another. To apply ask:
i. Is this a CHC? (small # of SH’s, no ready market for stock,
overlapping management/ownership)
1. If yes  Relationship among SH’s must be of trust, confidence and
absolute loyalty
c. Remedy:
i. Reverse transaction of majority SH’s
ii. Have majority SH’s/corp. pay the same price to the minority SH’s
d. If the parties in CHC’s contracted to their buyout exit rights, when creating
the corp., they wouldn’t have to deal with this
1. Wilkes v. Springside Nursing Home (MA, p. 481) – Exception when utmost good
faith is not required: Wilkes (π), Riche, Quinn, and Connor were the 4 directors of
Springside, each owning equal shares and having equal power in the corp.
Relationship went bad between Wilkes and the others. When Springside became
profitable, ∆;’s wanted to payout salaries to themselves and not include π. At the
annual meeting, π was not reelected as director and was informed that he was no
longer wanted in the management of the group. During all of this, π carried on his
duties to the corp. π lost his job, salary, and investment in the corp.
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a. Holding: When a SH is acting in a proper manner, other SH’s have no legit
purpose to fire or squeeze-out. Majority SH’s breached fiduciary duty to π.
b.Rule: Majority SH’s in a CHC, owe minority SH’s strict duty of utmost
good faith/loyalty, unless a legitimate business purpose can be
demonstrated to justify a breach of that duty
i. Test:
1.Π must show
It is a CHC

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 They were
harmed 2.∆ must show
legitimate business purpose for breaching their fiduciary duty
MUST be for the corps. benefit
acted in the least harmful
manner 3.π must show
there was another less harmful approach to achieve the same
outcome c.Remedy: Damages work in this type of action because there is a
hidden problem of
liquidity. When π was fired – no salary – no way to get cash for his investment
(shows courts resistance to specific performance)
2. Smith v. Atlantic Properties Inc. (MA, p.486) – a minority SH can owe a fiduciary
duty to the majority where the K allows the minority to exercise control: 4
people invest in corp. to buy land. It becomes profitable, they retain earnings rather
than give dividends. They had an ex ante provision, for any corp. action to be
approved, 80% (super majority) must agree, basically is a unanimity provision.
Therefore, each of the 4 SH’s hold veto power. One SH had a falling out from the
others because he wanted to use the profits to repair property and the others wanted
dividends, especially since the IRS was imposing fines for failure to pay dividends.
Others sue him for breaching fiduciary duty for refusing dividends, claiming
majority oppression.
a. Holding/Rule: Minority SH’s are bound to the same fiduciary duty as majority
SH’s.
Court orders dividends, but wont order a stated price for the. Even in CHC’s,
there are some issues where courts will refer to director’s judgment
i. Reason: Any situation where corp. machinery is used to benefit one SH
over another will be subject to Donahue. There is obligation not to use
corp. machinery to abuse other SH’s. SH’s cannot cat in their own self-
interest, they have to act in the best interest of fellow SH’s
3. Merola v. Exergen Corp. (MA, p.491) – EXCEPTION/LIMITATION to SH
fiduciary duty in CHC: Merola began working for ∆, under an at-will employment
K, and was told that overtime he would become a majority SH. Π gets fired. Later
on, ∆ gets bought out and makes lots of money. Π wants in because he said he
missed out on a corp. opportunity.
Claims he is like π in Wilkes
a. Holding: ∆ did not violate fiduciary obligations. Even though π termination
lacked a legitimate business purpose it was not done for the ∆’s financial
gain or in contravention of public policy.
i. Reason: Merola was treated fairly, not like Wilkes, because here, he sold
his shares at a fair price, he did not experience a freeze-out situation,
and his salary was never contingent on stock prices
b.Rule: There is a difference between salary and an investment in stock
i. Where the vast majority of corps. earnings, are paid out to SH’s as
salaries, a termination of a SH w/o cause is suspect
ii. Where SH’s salaries are independent from their equity investment,
termination may be ok

XIII. VALUATION
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A. Generally
1. There are many ways to value a corp., if you did each one right you would get the
same number. But each method relies on assumptions so courts rely on different
methods that are more accurate depending on the context. Becomes an issue in
CHC’s where the SH’s concern is getting paid for their shares.

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 B. DE Approach: will use 3 different methods to determine value, have the judge look at
all 3, then weigh/average them
1. Market Value:
a. What do the shares trade for on the market?
b. Issues
i. Based on perception, not necessarily on the actual value of the corp.
ii. Market may be systematically off (inflated in periods of optimism,
deflated in periods of pessimism)
iii. Price/share is generally the price for a minority share; would
generally pay a premium for control over the corp.
iv. Not helpful for CHC’s, by definition there is no ready market for shares,
and does not account for the large chunks of shares that also give SH’s
power/control
2. Stream of Earnings:
a. Try to anticipate the future stream of earnings a corp. will payout over
time, then calculate the present value of that stream
i. How much would I pay today for an investment that would get me access
to that stream (account for inflation, risk, loss of access to other
opportunities, etc.)
b. Issues
i. Unpredictability of the future
ii. Guessing every step of the way re: future price, earnings, risk…
iii. Potential for costly
miscalculations 3.Asset Valuation:
a. Value all things owned by the corp.
b. Issues
i. Determining value of intangible assets (relationships, goodwill, brand, etc.)
ii. Depreciation
iii. What valuation do you use (book value, market value, etc.)
iv. Disregards future cash flow

PART IV – STRUCTURAL CHANGES AND INSIDER TRADING

I. MERGERS & OTHER CORP. COMBINATION

A. Generally
1. Types: (1) sale of assets, (2) mergers, (3) tender offers
2. SH rights/protections: (1) voting, (2) appraisal

B.K ey DE Corp. Combination Statutes

1. Sale of Assets: §271 – only selling corp. gets voting rights, no appraisal rights
a. All or substantially all assets – a vote is likely for a sale of majority of assets.
At that level, need to carefully consider whether the transaction transforms
the quality of the investment that the SH’s made
i. *might want to use the sale of assets instead of a merger to avoid liability
transfer because here, the buying corp. can pick and choose what they
want/don’t want to buy
2. Merger: §251 – voting rights

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 a. Small-scale: §251(f)
b. Short-form: §253 – Parent/subsidiary
3. Appraisal Rights: §262(b) – gives appraisal rights to parties in certain transaction
including
§251 merger

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 a. Exceptions: §262(b)(1) – market out – publically traded and/or greater than
2000 SH and no appraisal rights for surviving corp. in small-scale merger
i. §262(b)(2) – exception to exception – even where (b)(1) eliminates appraisal
rights, you are being paid in cash, appraisal rights re-attach

C.S H Rights/Protections:
1. Generally:
a. Varies depending on context. The goal of SH protective rights is to strike a
balance that will protect SH’s from threatening takeovers, but not “straight
jacket” corps. and prevent them from making efficient, profitable combinations.
2. Voting: Allowed in certain combination context, determined by statute. Typically,
requires a 2/3 majority vote
a. Merger = Voting
b. Sale of Assets (§271) = NO
voting c.Exceptions
i. Small-scale merger = NO vote
ii. Short form merger = NO vote
3. Appraisal [DE §262]: Right to be cashed out of shares at a court determined fair price,
reflecting the value of their shares. Π’s only need to show that they didn’t want the
transaction. Very costly to the corp. (why SH’s want this protection). Mainly impact
minority SH’s because, if a majority SH didn’t agree with a transaction they would
have voting power. Statutory schemes allocate appraisal rights based on principals of
expectations and fairness a.Key questions
i. What kind of transaction is this
ii. What side of the transaction is the SH on
iii. Are they entitles to appraisal on that side
iv. Does short-form change that
v. Does small-scale change that
vi. Does market out apply
vii. Are they getting cash as consideration
viii. What is the fair value that SH’s should receive for their shares?
Most courts accept that it’s not just market value of a particular
share on a given day. The court must decide the total value of the
corp. (including
control premiums) and divide by number of total shares to determine
the value of each
b. DE §262: Whether appraisal rights attach depends on the substance of the transaction
i. Mergers & Consolidations = Given to SH’s of both corps.
ii. Small-Scale Merger = NOT given to surviving SH’s
iii. Short-Form Merger = NOT given to majority SH’s
c.“Market Out” Exception [§262(b)(1)]: No appraisal rights will be given when
the stock of the corp. is listed on a national security exchange list or is held by
2K+ SH’s. This is intended as an exception for when SH’s can get their
money’s worth via the stock market w/o need for judicially determined value
4. Breach of Fiduciary Duty Claims: If combination is used in a way that violated
fiduciary duty, SH’s may be able to bring this against the relevant directors

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D.S ale& Purchase of Assets [DE §271]: Corp. A, wants to acquire Corp. B by purchasing
B’s assets. B gives assets and A gives consideration in the form of cash/debt. Only seller
SH’s have to approve the sale/transaction under DE. A fundamental change in the type of
investment is made. Under DE law, there are no appraisal rights (§271 is excluded from
eligible transactions under
§262) (Hollinger – defines “substantially all”)

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 1. Cash/Debt for Assets: At the end of the transaction there are still 2 corps., A & B.
But, A has the assets of both, B is left with cash/debt securities. B is basically a
bank account with the money received from A. Usually after such transaction, B
dissolves and its money is distributed to B SH’s.
a. SH Protections: Statutes protect the selling corps. SH’s, giving them voting
rights, because they are the ones experiencing the fundamental change (they
were once invested in a particular business and now only invested in bank
accounts)
2. Stock for Assets – “De Facto Merger Doctrine”: Corp. A wants to buy assets of
Corp. B, but instead of issuing cash/debt securities, they issue shares of their own
stock to Corp. B as
the consideration for B’s assets. B transfers substantially all of its assets to A in
exchange for shares of A stock.
a. Creates 2 options thereafter:
i. B remains alive as a holding company. A owns the assets of both corps.,
B holds shares of A
ii. B is liquidated and the shares of A it holds are distributed to the B
SH’s in liquidation
b.π’s argue: what their corp. did is not a stock for assets transaction, but just a
merger, so the π’s should get voting/appraisal on both sides
c. SH Protections:
i. DE (Hariton) rejects de facto merger doctrine, finding validity in both
sections of the DE code and does not look at realities of situation. No
appraisal rights to dissenting SH’s
ii. PA (Farris) looks at the substance of the transaction and accepts de facto
merger doctrine, granting voting and appraisal rights to dissenting SH’s
of target corp.

E.M erger/Consolidation:
1. Statutory Merger: (stock of B is converted into stock of A) A combination of 2
distinct corps., only 1 survives. The corps. formally agree to merge and under that
agreement, the stock of the “transferor” corp. will be converted into the stock of the
surviving corp. These are “friendly” transactions (opposed to hostile
takeovers/tender offers), negotiated between the BOD’s of both corps. BOD’s come
up with K detailing the terms of the merger/consolidation and present to the other
corps. SH’s for approval via proxy solicitation.
a. SH
Protections:
i.DE §251:
Voting  Both buyers and sellers get to vote on the merger because
both parties are affected substantially. Buyer SH’s take on assets and
liabilities as well as taking on a whole new group of SH’s that may
dilute ownership and disrupt voting trends. Sellers now own a
completely different corp.
Appraisal  SH’s voting “no” on both sides have this protection
b.Statutory Consolidation: Identical to a statutory merger, except that here, stock
of A & B are being converted into stock of a new Corp. C. Same SH
protections
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2. TwoExceptions to §251 General Rule: SH’s won’t need voting/appraisal
protections a.Small-Scale Merger [DE §251(f)]: Merger where the corp.
being absorbed is very
small compared to the surviving corp., therefore it shouldn’t matter that
much to the acquiring corp. because it is basically a purchase of assets. Look
for 3 elements
i. (1) The surviving corps. certificate of incorporation is not amended; no
major fundamental change
ii. (2) Surviving corps. SH’s do not exchange their shares – do not lose
number of shares owned
iii. (3) No transfer of shares to the transferor SH’s OR it’s such a small transfer
that the total increase in the survivor shares is no more than 20%

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 SH Protections:
 Surviving corps. SH’s (A) do NOT get to vote to approve the
merger and do NOT get appraisal rights.
 Dissolved corps. SH’s (B) still get voting and appraisal protections
b.Short-Form Merger [DE §253]: Only applies when a parent corp. owns at least
90% of
the subsidiaries shares. Statute allows the subsidiary to merge into the parent w/o
a vote on either side (Sinclaire). Minority SH’s don’t get a vote because if parent
already owns that much the vote will be moot and costly. Majority SH’s don’t
vote because acquiring less than 10% will not have a huge impact on them
i. SH Protections = Appraisal Rights:
Given only to subsidiary SH’s under §262(b)(3)

F. Cases
1. Hollinger Inc. v. Hollinger International (DE, p.1139) – §271 Sale of
Assets/“Substantially all”: Hollinger International (∆) was a newspaper
conglomerate with lots of subsidiaries, including Telegraph, Chicago and Jerusalem.
∆ wants to sell off
Telegraph, arguably more valuable than Chicago. Π only holds 18% of the value of
shares in
∆, but controls 68% of the vote on sale, so they become a controlling SH who can
block the sale. Π objects to the sale, files suit seeking an injunction (courts will often
grant). Π believes that the sale of Telegraph amount to all or substantially all of ∆’s
assets. Issue is whether the sale of one subsidiary is going to be a sale of all or
substantially all assets to trigger a SH vote required under §271.
a. Holding: SH request for an injunction to require a SH vote is denied
b.Rule/Test: When not all of the assets are being sold, DE law will look at 2
aspects of the transaction to determine whether §271 is implicated:
i. Quantitative vital to the operation of the corp.: the number of assets being
sold
Are the assets that are being transferred somehow numerically really
important to the corp.? (doesn’t need to be a majority). Court looks at
what is being retained once the subsidiary is sold, not what is being
sold
 Here, selling Telegraph, keeping Chicago and Jerusalem =
neither are majority
ii. Qualitatively affects the existence/purpose of the corp.: quality of
assets being sold (hard to determine)
Court finds that the parent will still have profitable subsidiaries left
after the sale. SH invested in a newspaper company, and after the
sale they will still have an investment in a newspaper company
 Π tries to argue about the type of asset. Telegraph = respected v.
Chicago
= tabloid. Court – this is not about aesthetics
2. Hariton v. Arco Electronics, Inc. (DE, p.1170) – DE stock for assets v. merger
combination [stock for Assets de facto merger in DE, DOES NOT entitle π SH to
appraisal rights]: Arco and Loral Electric wanted to join forces in electronics
business and Arco entered into a Reorganization plan whereby Arco agreed to sell

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all assets to Loral in consideration for shares of Loral stock. The plan was approved
by 80% of SH’s, but non- voting SH π sought to enjoin plan on the grounds that it
was unfair and illegal, and that the plan is a scheme to rob them of appraisal rights
a. Holding: π was not entitled to injunction and/or appraisal rights
b.Rule: DE court found that the reorganization plan accomplished here through
§271 (sale of assets) was legal, even though the practical effect is that of a
merger under §251.
Both statutes are independent and of equal validity; corps. may use either. DE courts

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 will not look to the substance of the transaction to decide what is really is,
corps. chose which statute they want to use and that is what DE courts will look
at.
i. Result: Very hard on π’s, not in accord with protecting SH’s from
having an investment in something different than what they initially
invested in.
3. Farris v. Glen Alden Group (PA, p.1174) – PA stock for assets v. merger
combination [PA adopts de facto merger doctrine and π is entitled to
voting/appraisal rights]: Officers of
Glen Alden and List Industries executed a reorganization agreement approved by
Glen Alden SH’s, whereby Glen would acquire all of List’s assets in return for
Glen’s stock. A reverse buyout, is orchestrated to eliminate voting/appraisal rights.
Smaller company is buying larger one by swapping stock that were kept artificially
low. Lots of facts about how much the SH needs the protection offered in mergers –
shares are diluted, prices of shares dropped, corp. will not engage in many different
businesses than it originally did, comp. will take on a large debt. Π’s bring suit on
grounds that they should have appraisal rights, they did not want to be SH’s of a
diversified holding corp.
a. Holding: PA applied a de facto merger doctrine and says that this transaction
cannot go forward until merger level protections are put into place. *Even in
states that advance SH protections, still need to take into account the particular
states “soft laws” that might change outcome.
b.Reason: The question for PA courts is substantive, whether the combination will
so fundamentally change the character of the corp., such that to refuse π’s the
right to remedies of a dissenting SH, would force them to give up stock in one
corp. and accept shares in another against their will. The reality of this
transaction in terms of effect on SH investment bothered this court.

II. FREEZEOUTS
A. Context
1. Freeze-out: A corp. transaction principally intended to change the corps. ownership
by involuntarily eliminating minority SH’s. Also called squeeze-out in CHC’s.
Encompasses any set of transactions that force minority SH to sell out to majority.
a. Common Issue: Whether such transaction is permissible if it is effected w/ no
business purpose other than to increase the controlling SH’s portion of the pie
2. This deals with how fiduciary duties apply to provide rights to minority holders in
order to supplement protections provided by the statutes in last section. Minority
SH’s are also protected by duty of loyalty from majority SH’s. If cash is being
provided for mergers, appraisal would still be available even if market-out would
have prevented it

B. Process
1. Generally (Weinberger)
a.Π challenging cash-out mergers must allege specific acts of fraud,
misrepresentation, or other misconduct to show unfairness of merger for the
minority
b. The ultimate BoP is on the majority (∆) to show, by preponderance of the
evidence, that the transaction was fair (fair price & dealing)
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 c. BUT, where, the ∆ can prove effectiveness of either based on an
evaluation of all material info, that the transaction was
i. Approved by an informed vote of the majority of the minority SH, OR
ii. Independent committee evaluated the merger
BoP shifts 100% to SH π to show the transaction was unfair to
minority SH’s 2.Short-Form Merger
a. Only duty on majority SH’s is to fully disclose so that minority can determine
if they want to accept merger or seek appraisal

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C. Modern Type of Freeze-Out
1. Cash-Out Merger (most likely to survive):
a. Most states allow the survivor of any type of merger to issue cash as well as, or
instead of, stock or other securities. Similar to debt or redeemable stock, except
that the survivor issues cash rather than stock or other securities. This extends to
cases where the parent does not own the % of stock required for short-term
mergers.
b. Process: Controlling SH causes the controlled corp. to merge into either the
controlling SH’s corp. or some shell entity they own, this brings assets under
majority’s control. Then, rather than completing merger by issuing shares of
the corp. to former minority SH’s minority gets cash. This gets minority SH’s
out of the corp. structure
i. Allowed in DE, however, payment of cash often triggers other rights such as
§262(b)(2)
§262(b)(2): Appraisal rights become available even in the case of large
publically traded corps. This is because market price at time of merger
will only give you what was agreed upon in the merger agreement, not
necessarily fair market value

D. Other Types of Freeze-Outs

1. Dissolution Freeze-out:
a. M (individual, group, or corp.) owns 70% of Corp. A, and wants to eliminate
Corp. A’s minority SH’s. M will cause Corp. A to dissolve under a plan whch
provides that the corps. assets will be distributed to M (or an entity M controls),
while cash/notes will be distributed to minority SH’s, freezing them out of
future investment opportunities. Typically, illegal and violation of public policy
that all SH’s be treated equally upon dissolution
2. Sale of Assets Freeze-Out:
a. M organizes a new corp. (B), all of whose stock M owns. M then causes A to
sell its assets to B for cash/notes  result is M owns A’s business though B,
while the equity interest of A’s business is involuntarily terminated. Often
found improper. If M sets price, they need to prove it’s fair; if price is so low to
be coercive  illegal transaction
3. Debt or Redeemable-Preferred Mergers:
a. Begins like sale of assets freeze-out, with creation of new corp. (B) by M. But
then B will issue either (1) short-term debentures or (2) redeemable preferred
stock. The interest of A’s minority SH’s in B either terminated automatically
after a number of years (in case of debentures) or is terminable at A’s election
(redeemable preferred)

E. Other Terms
1. Going Private:
a. Changing the corp. from being a publically held corp. to one that is privately
held. Can be accomplished through a freeze-out, but not the only way. The
corp. will no longer have to register with the SEC and gain the benefits of
lesser regulatory burdens
2. Going Dark:

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 a. No longer publically traded. Minority doesn’t need to be eliminated, but reduced
enough not to need to follow SEC regulations
3. Management Buy-Out:
a. Transaction where group of management acquire all/dominant shares, can happen
while also eliminating the minority, might involve going private or going dark.
Consideration does not need to be in cash
4. Leverage Buy-Out:
a. Transaction where SH’s are bought out with borrowed funds. Question is
how is the buyout being financed, because cash is necessary to complete
transaction

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F. SH Protections in Mergers
1. Minority SH
a.Informational rights
b.Voting and appraisal rights, and
c.Stand-by fiduciary duty  potential litigation right where SH’s can seek
review of the merger on a claim that fiduciaries negotiated a transaction that
breached their duty of care/loyalty
i. Van Gorkom – merger case
Question is whether directors were being careful enough in their review
of the merger. This is an example of pursuing fiduciary violations
under duty of care in merger transactions
ii. Lynch – standard duty of loyalty case of controlling SH who is
dominating the BOD and making the board merge into the controlling
SH’s corp.
2. Controlling SH, if they want to merger with another corp.
a. They can do different levels of intra-firm actions (Lynch), independent
committees, condition deal on approval of majority of minority SH’s after full
disclosure to convince future court to apply a less rigorous standard of review.
[*cases today show roadmap for how it’s done]

G. Cases
1. Weinberger v. UOP, Inc. (DE, p.1190) – Cashout Merger undone because of unfair
price and circumstance: π’s are UOP SH’s who are concerned they are not getting
enough money in the buyout/freezeout of their shares. In a previous friendly tender
offer, Signal made an offer for 50.5% of UOP shares, it was accepted and Signal
became a UOP controlling SH. Now Signal wants the remaining 49% of UOP. Rather
than another tender offer, Signal wants to do a cash-out merger, which can easily be
accomplished because they control the majority of the vote. Appraisal, not vote,
would still be available with cash out to protect SH’s. A feasibility study values UOP
at $24/share, but Signal decides to offer $21. There are lots of overlapping board
members resulting in biased opinions on price (need both boards to approve
transaction). Signal SH’s know about the $24 valuation but are happy to buy at $21,
while UOP SH’s never knew about $24 valuation. Π’s allege, breach of fiduciary
duty
a. Holding: ∆’s did not follow fairness standard (dealings/price). Π’s awarded
damages (appraisal+) which needs to account for the fact that the merger
won’t be undone
i. Reason: Failure to disclose into to UOP minority SH’s raises duty of
loyalty issues by majority SH’s and directors
b. Rule: Proper business purpose is no longer DE standard in regard to freeze-
outs. Now focus on fairness standard (fair price and dealings)

H. Post Weinberger: What if a controlling corp. has 90+% of shares of the target corp., do
you have to spend the time/money on vetting the transaction? Are they going to have to
defend the fairness standard? [in all following cases, appraisal remains, but question is
over whether Weinberger applies]
1. Freeze-Outs can be Good: When Corp. A owns majority of Corp. B shares, A is
already very involved in B. So, A decides it’s better to just own B and have B as
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 a division of A, rather than something separate. DE courts protect these types of
transactions from being stopped by minority SH’s if there has been:
a. (1) independent committee (2) majority of minority vote (3) fair
dealing/price 2.Glassman v. Unocal Exploration Group (DE, p.1209) – No
fairness standard in short-
form merger: Considers fiduciary duties owed by a parent corp. to the subsidiary’s
minority SH’s in context of a short-form merger. DE short-form merger statute does
not include the requirement of fair dealing. DE says, enough already, you are in
investor in a company of

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 which 90+% is owned by another company – what did the minority SH’s think was
going to happen?
a.Rule: Absent fraud/illegality (which comes back to issues of disclosure, but need
to be really bad extremes), there is no remedy except appraisal available to
minority SH’s in short-form mergers, there is no claim to them being unfair,
and they will be dismissed i.If you have less than 90%  Weinberger
standard
3. Solomon v. Pathe (DE, p.1211) – voluntary tender offer by controlling SH’s: Can
use a tender offer to get over the 90% and then follow Glassman. But a tender offer
by a controlling SH is different, because it shares a lot of the risky qualities of a
Weinberger transaction, especially if the plan is to follow it with a short-form
merger. A controlling SH can use their tender offer to eliminate minority SH’s, but
there will always be some remaining shares. What is the standard/who has the
BoP?
a. Rule: No requirement for tender offer to be a fair price. As long as it is
voluntary, courts will only police for false and/or misleading disclosure, under
the Glassman standard
4. Pure Resources (DE, p.1212) – defines “non-coercive”: A controlling SH tender
offer states that it will be followed immediately by a short-form merger, that’s the
plan all along
and is communicated to the SH’s. Condition of this tender offer is that the short-form
merger price will be the same as the tender price, so this isn’t take it now or lose it
because that is coercive, and that the majority of the minority agrees to being bought
out
a. Rule: Non-coercive tender offer when the following are met, and absent
fraud/illegality, there is no risk for the tendering entity
i. Tender offer subject to non-waivable, majority of minority SH’s must
accept tender offer for the offer to stand
ii. Controlling SH promises a prompt short-form merger at the same price,
if they obtain 90% ownership AND
iii. Controlling SH has not made any retributive threats against those SH’s
that don’t want to tender their shares

III. TENDER OFFERS – GENERALLY

A. Tender Offer
1. A publically made offer directly to a corps. SH’s to buy a specified number of shares,
on a set date and at a set price that is usually above market value, with the purpose of
gaining control of that corp.
a. BOD approval is unnecessary – they may think the transaction will be bad
for the SH’s/corp. as a whole, or just concerned about their own positions
b. Offers are often cash, sometimes they can be debt securities
c. High cost/risk – Big regulatory fees and defensive costs to the corp.
subject to the takeover.

B. Federal Law – Williams Act 1934:

1. The act is neutral as to whether tender offers are good or bad, but does offer
market guidelines to regulate the fairness of the offer and protect SH’s. Applies
regardless of the state of incorp.
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 a. Pro tender offers as way to combat agency costs (acquirer chooses an under-
performing corp., an accepted TO would take control away from the current
BOD, and would try to make it more successful).
b. Cons: can be value destroying, can acquire for personal benefits that won’t
create value for the SH’s, constituents and the acquired corp., bidders just pay
too little because the SH’s don’t know enough, fire people, move out of the
community
2.§§13(d), (e) and 14(d), (e), (f) make tender offers expensive. The focus is on
disclosure and fairness, and the idea is that the market for corp. control is good as
long as minority SH’s

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 can be protected, treated equally, and be fully informed (geared towards getting
info to investors)
3.2 Main Requirements Under the Williams Act
a.Disclosure by Both Acquirer & Target
i. Puts people on notice (Blasius) that corps. do this type of transaction.
Anyone who acquires at least 5% (cumulatively) needs to give a
statement stating (a) who they are and (b) what their intentions are in
acquiring the corp.
 Puts SH’s on guard for when people are amassing control so they can
understand the fluctuation of the price that happens during an
acquisition
Once the TO is made, the target corp. must respond by telling
SH’s their opinion of the TO and they need to file with the SEC
b.Fair Play/Equality Components
i. Tendered shares are withdrawable during the period of time the TO is
open, so if there is a defense by the target corp., the SH’s can pull back their
tendered shares ii.Pro Rata Purchase, all SH’s must be treated equally.
When there is a TO for some
% of the corps. shares, each tendered SH will have apportionment of their
shares bought out if it is oversubscribed. Avoids first come/first served or
lottery decision.
All Holders Rule: TO must be made to all holders of that class of
securities (reaction to Unical)
Best Price Rule: Must be paid the highest price, even if you tendered
earlier and the higher price wasn’t paid until after your tender
iii.§14(e) Anti-Fraud Provision: §14(e)(3) addresses insider trading related to
TO’s

C. Corp. Defensive Measures

1. Directors can try to block TO’s by implementing a variety of defensive measures
making the TO more difficult to complete and/or more expensive. Ex:
a. Making target corp. less attractive, by identifying why the bidder wants to buy
the corp., and selling away or creating the option to buy aspects of the corp. the
acquirer is interested in
b. Making it more difficult for the offeror to obtain financing, because TO’s are
usually paid in cash which amounts to a ton of money that the acquirers might
not readily have forcing them to borrow
i. Acquirers will obtain financing by borrowing against the assets they plan to
acquire in the TO, by telling lenders to come get the assets they’re planning
to acquire if they default. BUT you need 100% of the corp. to do so. (poison
pill)
c. Make transaction more expensive or less valuable
2. Typical Defenses
a. Self-Tender: When the target corp. offers its own TO to its own SH’s for a
price. Can also decide that the acquirer is not included in the offer.
b. Poison Pill: Grant by the BOD to existing SH’s, other than the acquirer, the right
to purchase additional shares of common stock at a discount. This would dilute

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the value of the target stock the bidder wants to acquire. Often include a
triggering event, usually a TO. (Moran)
i. Flip-In Poison Pill: Grants existing SH’s, not the acquirer, the right to
purchase additional shares of the corp. at a discount (usually 50% of the
current market price). Rights are triggered by a certain event, like
publication of TO or acquisition of % of the corp. (usually 15-20%).
Purchase rights like these are void in hands of acquirer

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 Good deal so people take it, results in more shares, diluting % control
acquirer has, and makes it more expensive for acquirer to gain control
because there are more shares they will need to buy
ii. Flip-Over Poison Pill: Gives SH’s of target the right to buy additional shares of
the acquirer at a deep discount. This dilutes existing SH’s of the acquirer,
they will not be happy, and forces acquirer to sell off capital at deep
discounts. This is because after the merger, all liabilities of the target corp.
transfer to the bidder, including the poison pill
c. Staggered Boards
d. Dry-Up Defense: Go to banks that the corp. has a relationship with and agree
that they won’t finance a competing offer
3. Ask, (1) is the transaction cost increased, (2) does the defensive measure decrease
value of what acquirer is getting?

D. Damages
1. In cases seeking damages, opposed to an injunction, because the idea is to stop a
TO, you might have to choose whether the case falls under duty of loyalty or duty
of care a.§102(b)(7)  when a corp. has adopted a charter provision opting into
102(b)(7) then
damages are unavailable for straight duty of care claims, only available for
breach of loyalty
i. duty of care claim, the standard arguments about making a poor decision
ii. this is what happened in Lyondell v. Ryan (DE, p.1273)

IV. TENDER OFFERS – UNOCAL STANDARD (needs more than BJR)

A.U nocal v. Messa (DE, p.1227): Messa was already a 13% owner of Unocal. Messa made a
2- tiered front end loaded offer, Unocal was concerned this was not good for its SH’s. 1st
step: the front end was a cash TO for 37% of Unocal shares at $54/each, which would
make Messa a controlling SH at 50%. 2nd step: the back end, the SH’s who did not tender
would get less money in the form of junk bonds that are also very risky and may not be
paid off in full. (The back end is a separate merger, not protected under Williams Act).
The merger would need BOD approval, which Messa would have at this point.
1. Concern: this is coercive, because SH’s will have to sell their shares by force in the
TO, so they don’t get stuck with junk bonds. There is also the threat of greenmail – a
payment made to potential acquirer to buy out shares they acquired in a TO to stop
them from taking over the corp.
2. Unocal Defensive Measures:
a.(1 st) Self-Tender, If Messa met their goal of buying 37%, Unocal would
protect the back-end merger by offering $72/share to any Unocal SH,
excluding Messa SH’s, for 49% of the shares. This would stop the transaction
in its tracks because no one would tender to the front end for $54/junk bonds,
but want the $72. Low risk to Unocal
i. This was too preclusive for TO to even occur, not allowed
nd
b.(2 ) Revised Self-Tender, Unocal agrees to buy shares even if Messa wont
acquire 50%. More risky to Unocal because need to have money ready, which
requires them to take on more debt. Messa still excluded, claiming this is a
violation of fiduciary duty.

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3. Analysis: BOD has power to use self-tender, but, just because the power is delegated
to them in DE statute, under Schnell, using that power may not comply with the
required fiduciary duty. What standard should apply?
4. Holding: There was a reasonably perceived threat, junk bonds deserve the name and
there would be a panic to tender. Defense was proportional because had they let
Messa participate, it would undermine Unocal’s attempt to protect its SH’s
5. Rule/Test/Standard: Intermediate Scrutiny, only applies when BOD’s act defensively

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 a.2 Prongs
i.(1) Was the defense in response to a reasonably perceived threat? AND
This goes to process. (e.g. inadequacy of deal shown after long
meetings, dealing with known greenmailer, impact on other
constituents, adequacy of price, questions of illegality, etc. Say, “we
don’t like offer because ”)
ii.(2) Assuming (1) was met, the defensive measure must be
proportional to the threat (BoP on ∆)
Response will be per se unreasonable if it is coercive/preclusive.
Moran = proportional defense. Unitrin = preclusive and coercive
b. If directors can meet this initial burden, they get the BJR; if not, they are
stuck with fairness review.
c. Successful π would have to show that the boards decision was primarily based
on perpetuating themselves in office, fraud, lack of good faith, or being grossly
uninformed
d. Reason: If TO is a corrective measure, courts want to let them through and
place extra pressure on the defensive measure. If TO is bad, courts want to
stop them

B. Post Unocal: SEC add the “all-holders rule”  corps. can no longer make a selective
self-tender offer
1. Unitrin – Gloss on Unocal Standard: Gives more info on proportionality requirement.
There are 2 defenses that will be per se unreasonable
a. Defenses that are coercive – force SH’s hand giving them no choice
b. Defenses that are preclusive – make takeovers impossible (why poison pills
with no redemption feature are prohibited), but some TO are done for good
reasons
2. Moran: Applies Unocal to the adoption of a poison pill by a corp. that was not
subject to a TO, but were scared that they would be taken over. SH’s sued because
some liked TO’s because they often get lots of money for it, they want to have
opportunity to get TO’s, and enforcing a poison pill makes it less likely that a
corp. will make a TO.
a. Holding: Poison pill was adopted in response to a reasonably perceived threat,
a lot of corps. being acquired. It was proportional because it could have been
taken out at any time from the corps. rules
b.Rule: Having a poison pill in your bylaws is fine as a low grade defensive
measure. It can be lying in wait. But once you are actually using it, Unocal
standard applies.
Redeeming a poison pill means stopping the issuing of shares at a heavy
discount. It must be redeemable.
3. Air Products v. Air Gas (DE, p.1244) – Poison Pill w/ Staggered Board: AP
attempting a hostile takeover of AG using a TO. The TO fails and AP decides to
attempt a proxy fight. AP places 3 of their own people on AG’s board, claiming they
would be independent and would consider any offers by AP w/o any biases. The 3
people decide that AP’s offer was in fact too low and the poison pill should not be
redeemed. AP argues the combination of a staggered board and the poison pill violate
Unocal.

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 a. Holding: AG’s actions are in response to a (1) reasonably perceived threat
(even the bidder’s people thought the price was too low), (2) it’s not coercive
because there is no management alternative (they’re just saying don’t do this
deal), (3) it’s not preclusive because requiring a little more time to get the pill
redeemed doesn’t mean it’s completely impossible

V. TENDER OFFERS – REVLON DUTIES

A. Generally
1. When the breakup of a corp. is inevitable, the duty of the BOD is no longer to
maintain the corp. as a viable entity, but to maximize SH profit/benefit

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 a. Directors need to be like auctioneers and get the pest price for their SH’s. If
not, then they have breached their fiduciary duty and defensive measures will
be engaged. When Revlon is triggered, it is more likely the SH’s will succeed
B.R evlon v. McAndrews (DE, p. 1250): Revlon set up initial defensive measures to avoid
threat of a takeover from Pantry Pride because the owners did not get along. Despite
these measures, PP made an offer and Revlon responded by entering into a number of
agreements with Frostman (white-knight). Revlon knew that they were going to be
bought so they hoped Frostmann would make a better offer. The arrangement included,
(1) a no-shop provision, (2) an asset lock-up provision, and (3) a $25 million
cancelation fee. All of these agreements prevented an effective auction process. PP
even agreed to bid whatever it took, but Revlon’s BOD closed its deal with Frostman
because it protected note-holders and directors worried about personal liability to
creditors if PP deal went through, eliminating covenants for note-holders. PP brigs suit
to enjoin Revlon merger with Fortmann
1. Holding: The arrangements were not per se illegal under DE law, but their use under
the circumstances were impermissible. Before bidding wars, Unocal standard
applies and directors get BJR. Once bidding war starts, Unocal is not appropriate
because directors take on role as auctioneer. Here, directors are negotiating an
acquisition, not protecting the corp. from one. Revlon assigns directors with duty to
get the highest price for SH’s, not just make reasonable and proportionate efforts to
avoid a hostile takeover once the corp. is up for auction. Here, directors did not meet
duty to get best price and injunction affirmed because lock-up, no-shop and
cancelation provisions have no place in this auction context
2. Rule: When a corp. is up for auction, directors can only take actions that are
rationally related to maximizing return for SH’s.
a.Test/Standard:
i. Because there are defensive measures Unocal applies
Are the defensive measures responding to a reasonably perceived threat?
Are the defensive measures proportionate?
ii. BUT once bidding war begins, need to look at director duty differently
because an acquisition is inevitable and a defensive measure will no longer
do anything positive for the SH’s
Now the only concern the BOD should have is, getting the best price
for the SH’s
 Once breakup is inevitable, you can’t even consider the interests of
other constituents except to the extent to which they will factor
into the price SH’s will now get
b. Application: 2 situations that will trigger Revlon
i. When a corp. initiates an active bidding process to sell itself or effect a
business reorganization involving dissolution of the corp.
ii. In response to a bidder’s offer, a target abandons long-term strategy also (1)
involving dissolution or (2) change in control
C.P aramount v. Time (DE, p.1260) – Defensive measures proper under both
Unocal/Revlon where enacted to protect long-term strategic merger: Time wanted to
expand and wanted to join Warner (good fit), not Paramount (bad fit). Years of
negotiations, Time enters a friendly negotiated merger agreement with Warner. This was
a no cash deal, but a stock for stock merger, which required a vote from SH’s on both
sides. Members of Times BOD are worried about the “Time culture,” so while Warner
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gets majority control of stock, Time gets special control of editorial committee to
maintain the culture. To secure the deal, Time/Warner put strategies into place to protect
it including, lock-up and no-shop provisions. Paramount then issues a cash TO with
several conditions and Time is worried that the Warner merger will not go through
because SH’s will be enticed by the cash deal and not see the long-term value. Time
changes to deal to a

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 cash TO by Time to Warner’s SH’s, which strips the vote from Time’s SH’s who are
tempted by the Paramount offer but don’t understand the long-term value plan. To get
Warner SH’s to tender, Time insists that the prior agreements over the governing
structure will be done in a way that wont forget Warner’s entertainment objectives.
Warner SH’s tender, but now Time is in billions of debt to finance the TO. Times BOD
says this needed to be done to keep corp. and corp. culture. Time SH’s claim this was a
breach under Revlon, while Paramount claims this falls under Unocal
1. Holding:
a. Revlon  Does not apply because there was no substantial evidence that Time’s
BOD made the decision to dissolve the corp. and break it up. In fact, the
evidence shows that Time was developing a long-term strategy for the corp.,
including growth to keep it going
b. Unocal  Yes. This is a problem because of the lock-up, dry-up, and no-shop
provision in the first deal. An injunction should be granted
i. Reasonably Perceived Threat: Under the Paramount deal, Time culture
would not be maintained
Ex: Ebay v. Craigslist – Craigslist wanted to preserve their culture of
being a free ad, but court denied the claim because they were a for-
profit corp. with SH’s. (Hollinger too)
ii. Proportionality: The defenses here are okay because they kept the deal with
Warner going, which is exactly the kind of preferential treatment that was
rejected in Revlon’s Frostmann case. This is because in Revlon, their only
goal was to get the best deal. Plus, there was no auctioning off here, it was
Time that wanted to acquire another corp.
D.P aramount v. QVC (p.1273) – Fiduciary Out [fiduciary duties violated when Paramount
directors refused to renegotiate defensive measures where corp. control was sold -
expands Revlon]: Viacom and Paramount want to justify several deal protections
designed to assure the merger of the two firms and to stop the efforts of QVC which was
offering a substantially higher price, but was not the favored suitor according to a “Time
Culture” type argument. In the favored transaction, Viacom acquires Paramount and
Paramount gets a significant amount of stock, but it is non-voting stock so control is
significantly limited. Defensive measures included:
a. (1) no-shop provision, P cannot solicit other offers and has a no-talk provision
that directors cannot discuss any business combination with a 3rd party unless
the 3rd party can show there are no contingencies on its financial part, unless
directors can show that their fiduciary duty requires them to talk to the 3rd party
(Fiduciary-Out)
b. (2) $100 mill termination fee, P will have to pay to V if the deal doesn’t go
through
c. (3) an option that V had to buy 24 mill shares of P if the deal didn’t happen.
P drags it’s feet and doesn’t respond to the QVC offer, QVC gets impatient and filed
this action and a TO conditioned on invalidating the defensive measures with V.
2. Holding: P is required to accept the highest offer. Unocal doesn’t apply. P’s conduct
was not reasonable because they did not seriously (procedurally) consider the QVC
bid which exceeded V’s by $1bill, and they failed to use the QVC bid as leverage
against V.
3. Rule: Revlon applies when SH investment is (1) fundamentally changed, or (2) there is
no future to protect the SH’s from, then the only thing that matters is how much they
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can get for their investment. Value of control is an asset of the corp. because many
SH’s presently control it; transaction leading to a single majority SH takes away that
control. When the happens, the selling directors should seek out a premium for the
control. This is an end game scenario because the SH’s will never be able to have the
same kind of control again a.Revlon Applies:
i. Change/shift in control

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 ii. The corp. is so fundamentally changed, there is no hope/future in the corp.
for the SH’s
E.O mnicare v. NCS Healthcare (DE, p.1281) – Shows when Unocal can actually stop
something: NCS was in a financial crisis, but Omnicare said they would wait until NCS
was bankrupt, because then they will be less expensive to acquire. NCS looks for a
staking-horse, someone to get the bidding going but doesn’t have to be serious about the
purchase. They find Genesis, who wants to actually buy NCS, so they make an offer
with an exclusivity provision. NCS agrees to work with Genesis on the exclusivity
agreement, they greed because they was the one and only way to save the company.
Omnicare makes their own offer which NCS doesn’t respond to because of the Genesis
exclusivity agreement, but they tell Genesis who improves their offer. NCS wants the
deal with Genesis to go through so there are several defensive provisions NCS has to
agree to,
a. SH voting, have to agree to submit merger to SH’s even if they don’t continue
to recommend it. DE statute specifically states that a merger agreement can
contain this
b. No-talk, Cant talk to anyone about acquisition unless they receive an
unsolicited proposal in writing that the BOD believes will result in a
superior deal
c. No broad fiduciary out, like in Paramount, Genesis wont agree to
d. Termination fee, much smaller than in QVC, in part because the corp. is worth
less and it cost less to put the deal together
e. Voting agreement, 2 SH’s agree to vote all their shares in favor of merger
agreement, which would guarantee that the merger happens because together
they control the vote.
This vote is specifically enforceable by Genesis via proxy
i. In Ringling the court didn’t enforce the voting agreement like this,
lots of JX enforce voting agreements when it seems reasonable to do
so, like in Galler
ii. This voting agreement ultimately guarantees that the merger will happen
because nothing can stop it.
2. Holding: Will apply Unocal. The defensive measures used by NCS are per se invalid,
thus are unenforceable, and NCS can pursue bids from Omnicare. Neither of the
below actions would be coercive or preclusive if the board has only negotiated a
fiduciary out clause
3. Rule: Defensive measures may be draconian (preclusive or coercive). The court
must conclude that the defensive measures were not draconian before shifting
focus to range of reasonableness.
a. Reason: The voting agreement combined with the requirement to send a vote
to SH’s w/o any consideration for future occurrences, works coercively
because it makes the SH’s experience this transaction regardless of their
preferences, guaranteeing that the merger will happen no matter what.
i. Its not that they are coerced by fear, but its that how they vote does not
matter because regardless of their vote, merger will happen. Different than
how coercive was described in cases where SH’s were forced to act out in
fear of what would happen if they didn’t approve the transaction
This is preclusive because no other bidder can be successful.
F. Post Omnicare
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1. Concern is what is going to be preclusive, coercive, and reasonable
a. Coleman – tried to do something similar but the controlling SH’s and acquirer
agreed to allow the minority to approve the transaction. Court found Unocal
was not violated
b. DBR – DE courts will continue to struggle with Omnicare

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VI. HARMONIZING: TO, FREEZE-OUTS, BLASIUS
1. Unocal – applies anytime defensive measures are put into play, was measure
reaction to a reasonably perceived threat and was it proportional
2. Revlon – applies when there has been a shift in control or a fundamental change to
the corp., look at getting the best value for SH’s
3. Blasius – if the BOD is acting with the primary purpose of controlling SH voting, the
action is impermissible, unless the BOD can prove a compelling justification
(insurgent wanted to take over the board, the board acted defensively to stop the
insurgent by amending bylaws. Standard = compelling justification = good for π,
will basically win every time)

B.M M Companies v. Liquid Auto (DE, print out) – Application of Unocal with Blasius
folded in: MM is 7% SH of Liquid. MM tries to get control of Liquid but the Liquid
board initially refuses. MM then tries to solicit proxies to SH’s, for a 4-seat increase to
the board, and Liquid drags its feet. Liquid then increases the board on its own by
adding 2 seats and MM complains that voting on 2/7 rather than 2/5 would not be
worth is and thus SH’s would not even bother to vote, limiting MM’s chances of
getting control. MM brings suit on the ground that Liquid’s
actions were to infringe upon SH voting rights, requiring a compelling justification under
Blasius. Liquid argued that they were just trying to add talent to the board.
1. Holding: Liquid’s defensive measure was invalid. Here, the BOD failed to prove a
compelling justification for its action to perpetuate itself in office and maintain corp.
strategy. Not trusting SH’s is not a compelling justification.
a. Reason: the court found the real reason Liquid took its course of action was to
prevent MM from taking control of the board as it was suspected that incumbent
directors would leave due to acrimonious relationships with MM directors, and
thus inhibiting corp. pursuits favored by incumbent directors. Therefore, where
the board acts with the primary purpose of impeding SH vote, the board must
show a compelling justification for its actions, even if acting in good faith
2. Rule: Blasius will not apply every time there is an interference with SH voting,
because there may be times when this type of defensive measure is taken and needed.
Blasius is for extreme cases. To keep board action out of Blasius review, just advise
the board to keep a record of why they took the action that is not primarily centered
on impeding SH voting a.Application:
i. Under Unocal
∆/director’s duty to show that the defensive measure was taken in
response to a reasonably perceived threat
 procedurally intensive analysis: look at board’s inquiry into the
threat, was it in good faith. Was there a substantive threat
identified
∆/director’s must show that their response was not draconian,
coercive, or preclusive
ii.π/SH’s have burden to prove that the BOD’s primary purpose was to
impede SH voting (rebuttable by ∆)
iii. If π is successful, the board must prove a compelling justification for its
actions.

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 The idea is that any action inhibiting SH democracy is only reasonable
in light of a compelling justification. If the board can show this, they
almost always get their actions approved
b.To challenge a defensive measure that influences SH voting, under MM, follow:
i. Reasonably perceived threat
ii. Draconian – coercive/preclusive
iii. Blasius analysis
iv. Proportionality

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VII. OVERVIEW OF DE STANDARD IN CORP. COMBINATION CONTEXT
A. Did the BOD meet statutory and general fiduciary duty standards?
1. Statutes – (1) Give voting and appraisal rights (2) other constituency statutes
2. Duty of Care –Engage in a process that was not grossly negligent (Van Gorkom)
3. Duty of Loyalty – Full disclosure
B. Did the BOD employ defensive measures?
1. Examples
a. Defense against existing takeover – Unocal
b. Defense to takeover environment – Moran
c. Defensive deal protection devices – Time, Omnicare, etc.
2. If YES, Unocal standard applies to test compliance
a. Step 1: BOD has BoP to show
i. Reasonably perceived threat
ii. Proportional response
iii. Not draconian = not preclusive or coercive
iv. Within the range of reasonable responses
b. Step 2:
i. If BOD meets Step 1, only BJR scrutiny applies
ii. If not, action will likely be enjoined
C. Did the BOD’s action create an end-game situation for SH’s?
1. Examples
a. Inevitable breakup – Revlon
b. Fundamental change – QVC
2. If YES, Revlon standard applies to test fiduciary compliance
a. BOD must show they acted to get the best short-term value for SH’s
i. Reasonable process – information, no favoritism
ii. Reasonable result – price
D. Did the BOD act with the primary purpose of interfering with SH voting?
1. If YES, apply Unocal/Unitrin with Blasius folded in to test fiduciary compliance
a. In addition to showing the defense was to a reasonably perceived threat and was
not draconian, for the defense to be deemed proportional, the BOD must show a
compelling justification for it. Saying the BOD knows better than the SH’s is not
compelling

VIII. SECURITIES FRAUD & INSIDER TRADING

A. Background
1. Policy, Goals and Perils of Insider Trading
a. Insider trading occurs when a person buys or sells securities based on material
nonpublic information. Prohibitions on insider trading encourage disclosure and
discourage the use of private information by taking away the benefits and
imposing fines
b. Opposing View: Why would court allow insider trading?
i. Some believe it should be that the ability to trade on inside info is a
component of compensation and it is a good way of getting qualified
members on the board w/o causing harm. Further, insider trading
encourages information seeking and gets market value closer to the real
value. This argument could seem especially appealing in light of the

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prevalence of insider trading and the ineffectiveness of most regulatory
efforts to stop it.
Counter argument:
 (1) Allowing directors to trade on insider info will raise cost of
capital in the market due to a lack of confidence in the market for
stocks. Directors will be incentivized to keep some info private for
their own benefit and

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 the general public will feel they are unfairly disadvantaged in their
ability to invest. Therefore, such a policy could prove catastrophic
to the ability of the public exchanges to raise capital
 (2) There are other less disruptive means to compensate corp.
directors that do not raise fairness considerations

B. Legal Framework
1.SEC §10(b)
a. Provides SEC with broad discretion to develop and enforce rules against insider
trading
b. The delegation of power is not limited to securities traded on an exchange
i. SEC does regulate with RULE 10b-5 which is also very
broad 2.RULE 10b-5 – can only be brought in federal court
a. Anything that is fraud/deceit is unlawful as long as it is in connection with the
purchase or sale of securities
i. Nowhere in the statute does it say, “insider trading,” but the concept is
rooted in deceptive devices, fraud, or deceit [10b-5(a) or (c)]
b. RULE 10b-5: Employment of Manipulative and Deceptive Devices
i. It shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality or interstate commerce, or of the mails or of nay
national securities exchange,
To employ any device, scheme, or artifice to defraud
To make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in
light of the circumstances under which they were made, not
misleading, or
To engage in any act, practice, or course of business which operated or
would operate as a fraud or deceit upon any person, in connection with
the purchase or sale of any security

C. 10b-5 – Elements
1. Traditional Elements
a.Deception/fraud
i. Misleading statement, omission, failure to connect
b. In connection with purchase or sale (if you have a private π, they need to have
bought or sold)
c. There must be interstate commerce
2. Additional Wharf Elements
a. The presence or absence of scienter
i. Equivalent of mens rea” What was your mindset - Knowing or
recklessness is required (p.890)
b. Materiality of the misrepresentations/omissions
c. Damages sustained through reliance - causation (if you have a private π)

D. Potential Plaintiff’s
1. SEC: Can bring enforcement action seeking civil remedies and/or an action for
criminal penalties when collaborating with the DOJ
2. Private Action/Individual SH’s: SH’s have to show they were harmed, whereas the SEC

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just has to show the markets were harmed. BoP differ depending on who is bringing
the claim (SEC/Private). Private SH’s who want to bring a claim are also limited to
purchasers or sellers of stock. Thus, individuals hurt by long periods of
nondisclosure are not proper π’s unless they are buyers/sellers of shares at the time in
question

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E. Possible Defendants
1. Original Approach – Cady, Roberts
a. Rule 10b-5 applies to secured transactions by any person. There is an affirmative
disclosure duty on corp. insiders (directors, officers, controlling SH’s). The anti-
fraud provisions are phrased in terms of “any person” and the aforementioned
insiders don’t exhaust the categories of persons on whom there are disclosure
obligations. Insiders thus must include both (1) traditional insiders and (2)
anyone who has access to information only intended to be available for corp.
purposes. Anyone with access to insider info must either “disclose or abstain”
from trading
2. Modern Trend
a. Tends to pull back on how broad of a view of insiders and attempts to remove
liability for the hypothetical ∆ who overheard insider info on the bus but has no
formal insider relationship to the corp. Policing everyone would require too
much govt. intervention and there are private methods, such as an analyst who
provides disclosure and might be impeded by govt. regulations. Regulators want
efficiency and fair play, but other justices have view that there will always be
people with more info and it is a fool’s errand to try and achieve complete
symmetry of info. Further, such efforts may undermine the ability of investors
and professionals to investigate and trade on info, as they are scared of possible
prosecution. The implication of defining a ∆ is that improper ∆’s are absolved
for the “disclose or abstain” duty
3. SEC Rules Defining the Class of Proper ∆’s
a.SEC Rule 14e-3
i. Applied only in context of TO’s. Broader language than 10b-5. Imposes
classic disclose or abstain choice on ANYONE who gets material
nonpublic info about a tender offer and knew or should have known that
the info came from the acquirer, target, or those acting for them. In
response to Chiarella
b.Regulation Full Disclosure
i. In circumstances where the issuer selectively discloses nonpublic info to
someone where it is reasonably foreseeable that trades will occur –
requires simultaneous public disclosure. This regulation affects people
like Secris in Dirks, traditional insiders cannot selectively disclose info,
even if for benevolent purpose such as whistleblowing
c. RULE 10b-5(2)
i. Expands Misappropriation relationships beyond employer/employee or
clients as suggested in O’Hagan
There is a presumptive duty of trust and confidence in circumstances
where a person agrees to maintain confidentiality, regardless of
whether there is a duty
There is also a presumptive duty giving raise to misappropriation
liability when there is a history between the parties of sharing
confidences
Certain family members (parents, children, spouses,
siblings) have presumptive relationships of trust and
confidence
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  Note: 10b-5 misappropriation standard applies to all 3 of these, but
this presumption can be rebutted and someone can always argue
that this rule is beyond SEC authority
d.RULE 10b-5(1)
i. Creates a Safe Harbor so people can plan in advance so that trading will
not be on basis of nonpublic info. It is useful for people that expect to come
into contact with nonpublic info regularly. To be protected they must plan
their trading in advance and have it in writing

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 F. What is Inside Info? What Duties Arise?
1. Insiders are allowed to trade shares of their own corp., but they cannot rely on
material nonpublic info. Insiders will always have some nonpublic info, but they
cannot trade on what is material.
a. Materiality: Reasonable person standard, evaluated on probability of future
events and their magnitude given the totality of the circumstances.
i. The Test, is whether a reasonable person would attach importance to the
info in making an investment decision. The importance is that all that is
needed, not whether the info would have been determinative
b. Duty: Any individual with access to insider info must disclose or abstain from
trading, there is no middle ground. Further, once disclosure is made, insiders
must give info time to disseminate which is dependent on the mode of
distribution

G. Damages
1. Causation (only for private actions)
a. Transaction Causation: The violation of 10b (misrepresentation/omission)
caused the private SH to buy/sell. Often presumed in 10b-5 claims
b. Loss Causation: Not only did the material misstatement, omission, or fraud
cause π to buy/sell, but also caused their loss/damage and wasn’t caused by
some other market force.
i. While supreme court said you need both loss and transaction causation, it
is up to the ∆ to argue this
c. Examples:
i. Affiliated Ute – Unsophisticated buyers dealing in market created by sellers.
Courts will assume that a π relied on a material omission
ii. Basic – Where ∆ denied material information relating to possible merger,
courts will assume reliance in class action due to fraud-on-the-market
theory. In class actions, it is impossible to show reliance for each
individual SH, thus courts will accept fraud-on-market theory. Further,
affirmative misrepresentations into the market, where information
creates price, is enough to show reliance because we can assume that
SH’s relied on price as value of what they are buying
2. Reliance
a.Materiality can substitute for reliance, if it is established
circumstantially 3.Actions brought by SEC
a. Can bring suit for injunction or other appropriate relief based on a
misrepresentation that violates RULE 10b-5, even if investors had not relied on
the statement

IX. Securities
Fraud
A.Wharf
1. As long as an option is a security, and as long as the oral agreements are
covered by the statute, there is little doubt that what Wharf did was deception
2. Additional elements for securities fraud claim under 10b-5:

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 a. The presence or absence of scienter. Equivalent of mens rea” What was your
mindset - Knowing or recklessness is required (p.890)
b. Misrepresentations/omissions must be material
c. Damages sustained through reliance - causation (if you have a private π)
i. Transaction Causation
ii. Loss Causation
B.A ffiliated Ute (SCOTUS, p.893) – Omission Case: Securities issue because there was a
shift from communal ownership to more typical private ownership of members of the
tribe becoming

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 incorporated and have access to shares which were tradable. Gives tribe members
option of liquidity. Many want to sell to get cash. ∆ (G&H) working for bank handling
tribal shares, and selling to non-members, therefore “making a market.” The omission
was not telling the tribe members that they were selling at too low a price.
1. Holding: ∆ had a duty to disclose this info to the tribe members since they were the
ones who created the market
2. Rule: When there is an omission case, we can presume reliance as long as the
omitted fact was material
C.B asic v. Levinson (SCOTUS, p.896) – Misrepresentation/Misstatement Case: Basic
was a publically held corp., considering a merger for years. They made 3 public
statements denying any merger discussions. Later, they made a statement that they had
accepted an offer and asked the NYSE to hold trading on shares. This fucks up the price
of shares because not all info was publically available. Π’s are people that sold their
stock too early, before the merger was announced and the price shot up. Π’s claim that
false/misleading statements induced them to sell their shares.
1. Issue: is to materiality, when does a corp. have to disclose to the
public? 2.Rule/Holdings:
a. Materiality – the omitted fact is material if there is a substantial
likelihood that a reasonable SH would consider it important in deciding
whether to buy/sell
i. Think about and balance probability & magnitude
b. Causation/Reliance – problems when trying to certify a class, because each
individual would need to prove this
i. Can allow a presumption of reliance under Fraud-On-Market Theory
The price reflects the fraud, shows materiality. Only applies to
publically traded corps. Everyone who buys relies on the price,
so there is the presumption of reliance.
∆’s can rebut the presumption by bringing evidence at the time
of class certification that the price was not affected by the
misinformation

X. INSIDER TRADING
A. Generally
1. Involves someone with inside info that is going to be relevant to the share
price, who purchases or sells securities
2. Cady, Roberts (p.928) – defines insiders
a. Fiduciaries – directors, officers, controlling SH’s (traditional view)
b. Any person with a relationship giving them access to info intended to be used for
a corp. purpose and who uses that info against the corp., or in a transaction with
someone they know doesn’t possess the same info

B. 2 Avenues for insider trading 10b duty breaches

1. When trading is done by the person who initially has the info
a. Active misrepresentation or deception
b. Duty breaches
i. Classic insider or temporary insider who has a duty to the corp.

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 Misappropriation theory – you don’t have the standard insider position and
ii.
its duty to the corp. and their SH’s, but you still breached through use of
info because you had a duty to your employer
2. When trading is done by a person receiving tips (Dirks)

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C. Cases
1. SEC v. Texas Gulf Sulphur (TGS) (SCOTUS, p.929) – Classic insider trading: TGS
began drilling on a cite and found a high mineral content. To keep the purchase price
of the site low, TGS kept the results of the drilling quiet. When word of the high
mineral content started to get out (like Blasius merger discussions), TGS released a
statement saying the reports were exaggerated and the site content was inconclusive.
Before the info was fully available, ∆’s bought stock and options with locked-in
prices, also tipped off their relatives to do the same. The people issuing the options,
didn’t know about the secret info.
a. Holding: ∆’s were liable for insider trading. They were required to return the
profits obtained from the date of purchase until the date the mineral findings
went public to an interest-bearing escrow account to be turned over to TGS.
Here, a reasonable person would have found the results to be significant and
influential to an investment decision
i. There might also be a claim for breach of fiduciary duty for issuing
fraudulent press releases
b. Rule: For there to be insider trading, must have (1) insider who is using (2)
material nonpublic info for a personal benefit, when then (3) know that those
they are dealing with don’t have this same info. Therefore, ∆’s needed to either
(1) abstain from trading or (2) disclose the info to the public

D. SCOTUS – need stricter view on who will be a proper ∆ in an insider trading case
1. Chiarella v. US (SCOTUS, p.949) – No fraud absent a Duty to Speak: Chiarella
(∆) was an employee for a printer company that handled documents concerning
corp. takeovers. He
found out about a corp. takeover deal that was about to go to press, so he bought
stock in the crop. Beforehand. He made $30k in 14 months. The SEC investigated
him, he signed a consent decree to give back the money and was also fired. Chiarella
didn’t go to private people, he operated on a public market. Π simply stayed silent on
the material nonpublic info. Was this insider trading?
a. Holding: No. Court was likely influenced by the fact that Chiarella was a
regular, not big-shot, working person who ended up being criminally
prosecuted. The fact that he traded impersonally and did not divulge the
nonpublic info is not enough for criminal liability under 10b if there is no fraud
i. Reason: Chiarella was an employee of the printer, serving the potential
acquirer, he had no duty to disclose to the target corp., thus he is not liable
for insider trading
b. Rule: The only time that failing to disclose material nonpublic info is when
there was a duty to disclose. Not every instance of financial unfairness or
fraud based upon nondisclosure of info constitutes fraudulent activity under
10b. Must have a fiduciary relationship or be in a relationship of trust and
confidence
i. Misappropriation - Alternative Theory: There is a duty of confidentiality to
ones
employer, you knew or should have known of the duty, and you breached that duty.
Criminal liability under §10(b) can be predicated on the
“misappropriation theory”, which holds that a person commits fraud
“in connection with” a securities transaction, and thereby violates
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§10(b) and Rule 10b-5 when he misappropriates confidential
information for securities trading purposes in breach of a duty owed to
the source of the information (either his employer or employer’s client)
and uses that information to trade. Such use defrauds the principal of
the exclusive use of that information
 Chiarella knew he was not supposed to use the info for his personal
benefit but did anyways. Despite Chiarella meeting the elements
for misappropriation, the court rejected it because it wasn’t
properly raised

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 2. Post Chiarella:
a. It is no longer the case that anyone who comes into contact with material
nonpublic info is subject to 10b. 10b only prohibits fraud or deception, it does
not prohibit all insider trading

E. Specific Regulatory Process when TO’s are Involved

1. RULE 14e (specific for TO’s)
a. In the context of TO’s, 14e-3 says you don’t have to prove a breach of duty.
Rather, anyone who comes in contact with material nonpublic info that has to
do with TO’s must either (1) disclose the info to the public or (2) abstain from
trading
2. United States v. O’Hagan (SCOTUS, p.957) – Misappropriation & §14a-3(TO):
∆ was a partner in the law firm that represented GM in its TO of Pillsbury
common stock. The possibility of the TO was confidential and not public until the
offer was formally made by GM. When the potential TO was still
confidential/nonpublic, ∆ used the inside info he got through the firm to (1)
purchase call options in Pillsbury, giving him the right to buy 100 shares by a
certain date, he owned 2,500 unexpired options, and (2) bought 5000 general
stock in Pillsbury at $39/share. After the info of the TO went public, Pillsbury
stock skyrocketed to $60/share and ∆ sold his shares, making $4+ million profit.
a. Holding: O’Hagan was liable for insider
trading b.Rule:
i. Under 10b – Traditional Theory: Traditional insider liability is the duty
breach by not disclosing to your trading partners, to whom you have
some kind of
fiduciary obligation, that you know something they don’t know. Slightly
expands who is an insider to include lawyers because they have a
fiduciary to their clients.
But here, it’s the wrong corp., O’Hagan’s firm didn’t represent the
target, whose stock he bought, but the bidder corp.  O’Hagan is
not liable under classic 10b because he had no duty to the target
corp.
ii. Under 10b – Misappropriation Theory: Misappropriating material
nonpublic info from one’s employer is a breach to the source of the info,
∆’s firm, to whom he owed a duty of confidentiality, and the duty is
breached in connection with the purchase/sale of the security when he
used the info to trade in the stock
O’Hagan wouldn’t be liable under misappropriation if his firm told him
it was ok to trade
3. Different than Chiarella
a. Here, made lots of money, an attorney is a good person to make an example
out of, issues of market integrity and fair price

F. Liability for Tippees

1. What if the person who obtains the info doesn’t trade on it, but instead tips the info to
another person and that person trades? What if there is a long train of tips?
a. Rule: The test is whether the insider personally benefits, directly or indirectly
from their disclosure. Absent some personal gain, there has not been a breach
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 of duty to the SH’s. and absent a breach by the insider, there is no derivative
breach by the tippee.
2. Dirks v. SEC (SCOTUS, p.979) – Tippees: Dirks was an officer of a brokerage firm
that specialized in investment analysis of insurance companies. One of Dirk’s
insurance contacts, Secrist, told him about massive fraud going on at an insurance
company, and asked Dirks to investigate and disclose. While investigating, Dirks let
some of his clients know about the fraud, they then sell $15 million worth of stock in
the company before the fraud was made public and the stock plummeted.

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 a. Holding: Dirks didn’t have a duty of confidentiality to Secrist because Secrist
told him to disclose the info, rather it was Secrist who had a duty to the
insurance company’s SH’s. Dirks also did not have a duty to the fraudulent
insurance company’s SH’s.
b. Rule: A breach of an insider’s fiduciary duty must occur before a tippee inherits the
duty to disclose inside info. The tip will only be a breach if the tipping was done
to gain some kind of personal advantage (money/reputation) for the person
giving the tip i.Test:
Tipper/insider’s liability – did they breach their fiduciary duty by
tipping for a personal advantage?
Tippee’s liability – (if the tippers duty has been breached) the tippee
knew or should have known that the tip was a breach by the insider
trying to gain a personal advantage
3. Note on 14a in Dirks & “Constructive (temporary) Insiders”:
a. Under some circumstances, where corp. info is revealed to underwriters,
accountants, lawyers, consultants, etc. These outsiders become fiduciaries of
the SH’s, subject to the same Cady, Roberts duty as traditional insiders.
i. A lawyer getting this info is not treated as a tippee, but as an insider himself

G. Summary of Insider Trading Under Common Law and SEC

1. Classic Insider Trading: Texas Gulf Sulphur: In situation where inside director has
material information and then buys stock in corporation, the insider is required to
disclose or abstain from trading, and after disclosure they are required to give
enough time for the information to get out to the market.
a. Chiarella says absent a fiduciary relationship to trading partner,
trading on undisclosed, material information is not per se prohibited
under §10(b) regime.
i. SEC responded to Chiarella by enacting Rule 14e-3 to apply in tender offer
context. Rule 14e-3 assigns disclose or abstain duty to anyone who gets
material, nonpublic information about a tender offer and knew or should
have known that the information came from the acquirer, the target, or those
acting for them.
2. O’Hagan: Misappropriation Theory: Another category of people who will be liable
are misappropriators. They will be liable when they breach a duty owed to the
source of the information they steal. This becomes securities fraud when that
information is used to trade. Thus, employees are liable for stealing information
from their employers and/or clients and other people in relationships of trust and
confidence are similarly liable.
a. Rule 10b-5(2): Expands misappropriation relationships beyond
employer/employee or your clients as suggested in O’Hagan. 1) There is a
presumptive duty of trust and confidence in circumstances where a person
agrees to maintain confidentiality, regardless of whether there is a duty, and the
person uses that information to trade. 2) There is also a presumptive duty giving
rise to misappropriation liability when there is a history between the parties
sharing confidences. 3) Certain family members (parents, children, spouses, and
siblings) have a presumptive relationship of trust and confidence. i.Note: Rule
10b-5 misappropriation standard applies to all 3 of these, but this

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 presumption can be rebutted and someone can always argue that this rule is
beyond SEC authority.
3. Dirks v. SEC: In order for tippee to be liable, there must be a tip made for
personal advantage of the tipper, and the tippee must know or should have
known of tipper’s breach (this can be run out to many people, but further away
you get, the more remote the possibility of knowledge of breach)
a. Regulation FD (Full Disclosure): In circumstances where issuer selectively
discloses nonpublic information to someone where it is reasonably foreseeable
that trades will occur, simultaneous public disclosure is required. [This
regulation affects people like

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 Secris in Dirks, traditional insiders cannot selectively disclose information,
even if for benevolent purposes such as whistleblowing]
4. Rule 10b-5(1): Standing orders with brokers create safe harbor for traditional insiders.
Regular pre-planned transactions with evidence in writing are OK. Anything less than
that, even pattern over time, will not serve to disprove insider trading.

H. Who can be liable under federal securities law for trading (see also Rule 10b5-1) or
tipping on material, nonpublic information?
1. Chiarella/Dirks: Traditional Insiders and Temporary Insiders
a. With breach of duty to trading partner
i. Tippees of Above
With tip that breaches duty of tipper (personal advantage) and
Tippee know or should have know of tipper breach
2.O’Hagan/Misappropriation: Misappropriators of material, nonpublic
information
a. With breach of duty to someone
i. Tippees of Above
With tip that breaches duty to keep information confidential or tip for
personal advantage and tippee knew or should have known of tipper
breach
3.O’Hagan/Rule 14e-3: Anyone who knew or should have known information regarding a
tender offer came directly or indirectly from an acquirer, target, or one acting for them

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