AGENCY: (Express - one that occurs when a principal and an agent expressly agree to enter into an agency agreement
with each other) OR (Implied - one that occurs when a principle and an agent do not
expressly create an agency; instead, the agency is implied from the conduct of the parties)
Actual Authority
A. Express – involves
examining the principal’s
explicit instructions
B. Implied – 1) involves
examining explicit
instructions of principal,
AND
2) what else might
reasonably be included to
get job done (this is based in
part on what agent believes
the principal wishes him to
do based on agent’s
reasonable understanding of
the authority granted)
Gorton v. Doty (Id., 1937)
Rule: where one undertakes
to transact some business or
manage some affair for
another by authority and on
account of the latter, the
relationship of principal and
agent arises.
1
Business Organizations – Attack Outline – Faiq
1. Ways an Agent May Bind Principal: in a contract action, whether the principal is bound the agent’s actions?
Apparent Authority
C. Apparent to Whom?
 it is about what a 3rd
party reasonably believes
the principal has
authorized the agent to do
 look at the
manifestations between
principal and 3rd party
[R 3rd §2.03]
CREATION OF APPARENT
AUTHORITY
1) An objective
manifestation from
one party (“apparent
principal”)
2) Which somehow
reaches a 3rd party,
and,
3) Which causes the 3rd
party to reasonably
believe that another
party (“apparent
agent”) is indeed
authorized to act for
the 1st party (i.e., for
the apparent
principal)
[R 3rd § 3.03]
Ratification
D. Ratification – authority that is granted by the
principal after an agreement has been made; involves
situations where agent enters into agreements on
behalf of the principal without any authority to do so
WHAT IS A VALID RATIFICATION?
 1) whether the principal, through words or conduct,
manifests assent to affirm the agreement
 2) whether, given the facts and circumstances of
the situation, the law will give effect to that assent?
Affirmation can be express or implied
LIMITATIONS ON RATIFICATION
 Principal MUST KNOW or have reason to
know, at the time of the alleged
ratification, the MATERIAL FACTS relating
to transaction. [R 3rd § 4.05]
 Principal may not partially ratify, must be
ALL or NOTHING. [R 3rd § 4.07]
 If 3rd party manifests INTENT TO
WITHDRAW from transaction PRIOR to
ratification, principal MAY NOT RATIFY. [R
3rd § 4.05]
 Ratification may be DENIED to protect
rights of INNOCENT 3rd PARTIES.
NOTES
Once a K is ratified, retroactive authority is created. [R
3rd § 4.02]
 Exception: when principal had no capacity to
enter into the agreement at the time that it
was made. {If an agent enters an agreement on
behalf of a minor but the minor does not ratify
until she is an adult the agreement is effective
with respect to that former minor upon
ratification, not the date of the original
agreement}
Boticello v. Stefanovicz (1979)
Rule: Marital status cannot in and of itself prove an
agency relationship. Ratification of an agency
relationship by the principal requires full knowledge of
the material circumstances, regardless of the principles
receiving the proceeds of the agent’s work
Liability of an Undisclosed Principal
E. Liability of Undisclosed Principals – law will hold
them liable for unauthorized transactions when…
1) a 3rd party has made a “detrimental change in
position,”
2) the principal had notice of the agent’s conduct,
3) the conduct might induce 3rd parties to change their
positions, AND
4) the principal did not take reasonable steps to notify
the 3rd party of the facts [R 3rd §2.06]
SPECIAL RULES FOR K W/ UNDISCLOSED PRINCIPALS
1. 3rd party is sometimes entitled to:
Insist on rendering performance to the agent, or
Escape the contract entirely
2. Rendering performance to the agent: The 3rd party
may insist upon rendering performance to the agent if
the K requires the 3rd party to perform personal services
or if rendering performance to the undisclosed principal
would significantly increase or change the 3rd party’s
burden.
3. Escaping Contract Entirely: In a narrow range of
circumstances a 3rd party may escape entirely a K made
with an undisclosed principal if…
If the K between the 3rd party and agent provides that
it is inoperative if the agent is representing someone, or
The agent fraudulently represents that the agent is
not acting for the principal, the 3rd party would not have
entered into the K knowing the principal was a party,
and the agent or undisclosed principal knows or should
know that the 3rd party would not have made the K with
the principal.
4. Active misrepresentation of the principal’s role is
insufficient. The 3rd party must also show:
That had the 3rd party known of the principal’s role,
there have been no K, and
The agent or principal had reason to know of the 3rd
party’s aversion
5. Mere failure to disclose existence is always
insufficient
Mill Street Church of Christ v. Hogan (Ky., 1990)
Rule: A person possesses implied authority as an agent to
hire another worker where such implied authority is
necessary to implement the agent’s express authority
Estoppel
F. Estoppel – is an equitable doctrine that
prevents the principal from denying that an
agency relationship exists; arises when principal
has done something improper
WHEN IS ESTOPPEL INVOLVED?
 Intentional, negligent or otherwise
culpable acts or omissions by
principal that create an appearance
of authority in the purported agent,
 A 3rd party who reasonably and in
good faith relies on that appearance
of authority, AND
 The 3rd party changes her position in
reliance upon that appearance of
authority
HOW IS IT DIFFERENT FROM APPARENT
AUTHORITY?
 Estoppel requires the 3rd party change their
position in reliance on the purported authority
(i.e. detrimental reliance)
 No manifestation requirement
HOW IS IT USED?
 to prevent one party from denying the
purported agent’s authority when the 3rd party
wants to enforce K
 Exception: NOT used to create a binding
K that may be enforced on both parties

Principal’s Liability
ANALYSIS QUESTIONS
 Did the Principal give Actual Authority to
the Agent (either express or implied)?
 Did the Principal make some
manifestations to the 3rd party creating
Apparent Authority?
 Was the Principal undisclosed, creating
liability of an undisclosed principal?
o If yes, SEE ABOVE “Liability of
an Undisclosed Principal”
 Did the Principal ratify the K?
o Do any exceptions apply (not
knowing all the facts, partial
ratification, was it unfair to the
3rd party)?
 Is Estoppel an issue?
o Did the Principal do something
wrong or fail to do something
that created an impression
with the 3rd party?
o Did the 3rd party rely and alter
their position to their own
detriment?
2
Business Organizations – Attack Outline – Faiq
2. Liabilities & Respective Duties Owed
Agent’s Liability
LIABILITY FOR K
Usually Agent’s do not incur liability as a party to the
contracts that the Agent enters on behalf of a
disclosed principal. There are two situations where an
Agent will be liable:
1) An undisclosed principal, OR
2) An unidentified principal (AKA partially
disclosed principal)
In both of the above scenarios the agent will be bound
and the principal may ALSO be bound .
 This means the 3rd party may sue either the
Principal or the Agent
 IF the Agent is sued and they were acting within the
scope of their authority, they can seek indemnification
from the Principal
ANALYSIS QUESTIONS
 DEFAULT RULE: If Principal is disclosed
and the Agent, with authority to do so,
enters into an agreement with a 3rd party,
then generally, the Principal will be bound
but the Agent will NOT
 DISCLOSED WITHOUT AUTHORITY: Agent
enters into an agreement with a 3rd party
the Principal may or may not be bound
and Agent could be liable to 3rd party via…
o Breach of Agent’s warranty of
authority, OR
o Owe damages to Principal for
damages caused by Agent as
indemnification
 UNDISCLOSED/ UNIDENTIFIED PRINCIPAL
WITH AUTHORITY: Agent enters into an
agreement with a 3rd party the Principal
and the Agent are both bound
 UNDISCLOSED/ UNIDENTIFIED PRINCIPAL
WITHOUT AUTHORITY: Agent enters into
an agreement with a 3rd party the Agent
will be bound BUT Principal will NOT,
unless…
o Ratification or other
circumstances triggering
liability for undisclosed
principal
Duty of Principal  Agent
GENERAL DUTY
 Duty to indemnify [R 3rd
§ 8.14]
 Duty of good faith and fair
dealing [R 3rd § 8.15]
ANALYSIS QUESTIONS: DUTY OF
PRINCIPAL
 If Agent incurred any
costs, expenses, damages,
does the agent have a
claim for indemnification
against Principal?
Duty of Agent  Principal
GENERAL DUTY
 Duty of care, competence and diligence [R 3rd § 8.08]
 Duty of loyalty [R 3rd § 8.01]
 Duty not to acquire material benefits arising out of the
agency [R 3rd § 8.02]
 Duty to not act as or on behalf of an adverse party [R 3rd §
8.03]
 Duty not to compete [R 3rd § 8.04]
o This duty does not extend beyond the end of
the agency relationship; once the agency
relationship terminates the ex-agent can
directly compete
 Duty to not use principal’s property [R 3rd § 8.05(1)]
o This includes the duty to not co-mingle
property of the principal with any other
property including the agent’s [R 3rd § 8.12]
 Duty not to use confidential information [R 3rd
§ 8.05(2)]
o This duty LIKELY extends beyond the scope of
the agency relationship and covers confidential
information learned during the course of the
relationship
 Duty of good conduct [R 3rd § 8.01]
 Duty to provide information [R 3rd 8.11]
o The agent must provide information to the
principal ONLY to the extent that the agent
does not violate the superior duty owed by
the agent to another person
ANALYSIS QUESTIONS: DUTY OF AGENT
 Violation of duty to Principal?
 Violation of duty to 3rd party?
 Willfully/ Negligently damaging a 3rd party?
 What damages is Agent responsible for?
Reading v. Regem (1948)
Rule: (1) An agent who takes advantage of the agency to make a profit
dishonestly is accountable to the principal for the wrongfully obtained
proceeds. (2) An agent has a duty to act solely for the master and any
profit earned while violating this duty belongs to the master.
Town & Country House & Home Service, Inc. v. Newberry (N.Y., 1958)
Rule: Former employees may not use confidential customer list
belonging to their former employer to solicit new customers
 PARTNERSHIPS: If not expressly written out, the UPA’s default rules fill in [UPA § 103(a)] – NJ, CA, DE have adopted Revised UPA 1997 but NY, PA, and MA have not and still follow UPA 1994.
 Voluntary agreement (express or implied) – This can be satisfied simply through a handshake; a written contract is not needed.
 An association of two or more persons
 To carry on as co-owners of a business
 Anticipation of profit
 Profit sharing
Characteristics
 Partnership cannot be another
entity [UPA § 201]
 Owners in a partnership
generally make some
contribution (doesn’t have to
be $) in exchange for their
share in the partnership [UPA
§ 18(a)]
 Partners generally share the
profits of the business [UPA §
18(a)]
 Partners generally share the
risk of financial loss [UPA §
18(a)]
 Partners jointly share the
management, but equal votes
or control is not needed
 Other individuals can be hired
who are not partners
ADDITIONAL BUT UNNECESSARY
CHARACTERISTICS
 Joint ownership itself doesn’t
mean a partnership exists
 Neither sharing gross returns
nor giving capital
independently is enough to
create a partnership
 Sharing profits in a business is
prima facie evidence that a
partnership exists [UPA §
202(c)]
EXECPT where profits are
received as:
o Debt service
o Wages
o Rent
o Annuity
3
Business Organizations – Attack Outline – Faiq
Does a Attributes Arising Once a Partnership is Limitations on Joint Venture, Partnership by
Partnership Established Partnerships Estoppel and Agency Theory
Exist?
THRESHOLD QUESTION Liabilities (each partner is jointly & severally liable) [UPA Agreement may NOT JOINT VENTURES
Is it the intent of the §306(a)] [UPA §103(b)] - Business endeavor undertaken by two or
parties to carry on, as Control (each partner can participate in control and management  Unreasonably restrict a more parties
co-owners, a definite of the partnership, UPA 1997 entitles each partner to one vote partner’s access to - Limited scope and limited time
business? regardless of what they contributed… alternative voting standards books and record - Just calling a joint venture does not make it
 Lack of intent to be can be agreed upon by partners)  Eliminate general duty a partnership
in a partnership is NOT Returns (Profits are shared equally, so if the partnership dissolves of loyalty (although ** Usually a fact pattern with a joint venture means
dispositive the money is divided as such… most states hold the profits are specific exceptions may partnership rules should be applied **
equally distributed regardless of the contribution of that partner) be approved)
EMPLOYEE-EMPLOYER Tax Treatment (tax responsibility for profits/ losses is passed o Delaware allows PARTNERSHIP BY ESTOPPEL
RELATIONSHIP OR A through to the partners to include on their personal tax returns) elimination of  Actual Reliance – party claiming estoppel
PARTNERSHIP? Fiduciary Duties (partners owe fiduciary duties to one another) liability for breach needs to actually rely on the manifestation.
 Court will of fiduciary duties,  Reliance Must be Reasonable – The 3rd party
examine… FIDUCIARY DUTIES [UPA § 404] including the duty may not assert that partnership by estoppel
 INTENT of A. Duty of Loyalty of loyalty, if it is due to an unreasonable assumption
parties  Account to the partnership for profits, property, specified in the  Some Manifestation by the Alleged Partner –
 LANGUAGE of benefits from the conduct (or winding up) of the agreement. The alleged partner must act or fail to act in
agreement partnership or the use of partnership property o However, actions some way that conveys the message that such
 CONDUCT of  Refrain from acting on behalf of a party with an of partners are individual or entity is a partner. Even if the
parties toward adverse interest to partnership still subject to manifestation is not made directly to the 3rd
3rd parties  Refrain from competing in the same line of business good faith and fair party, it must be traceable back to some
 Treatment of as partnership dealing. action or inaction of the alleged partner.
RETURNS of  Perform all duties in good faith and fair dealing  Unreasonably reduce
business  Avoid acting on partnership opportunities that fall within the the duty of care ESTOPPEL IS DIFFERENT FROM AGENCY THEORY
 Who bears the scope of the business of the partnership… IF acting on such  Eliminate the obligation  In AGENCY theory: a “non-partner” is treated as
RISK of the opportunity, partner MUST of good faith and fair though they had the authority of the actual partner to
financial losses 1. Disclose the business opportunity to other partners, dealing bind the partnership. This concept turns on apparent
AND  Vary the power of a authority.
Fenwick v. 2. Decide whether or not to act on behalf of the partner to dissociate The reasonable understanding must be
Unemployment partnership and take the opportunity traced back to something the partnership
Compensation  Vary the right of a court
[See Meinhard v. Salmon, “Not honesty alone, but the to expel a partner under did to create the understanding.
Commission (N.J., 1945)
punctilio of an honor the most sensitive is the specific circumstances  NO requirement of detrimental
Rule: (1) A partnership
standard of behavior”] reliance
is an association of two  Vary the requirement to
or more persons to carry B. Duty of Care (do not engage in)  Concerns ability to bind
wind up the partnership
on as co-owners a  Gross negligence  In ESTOPPEL theory: the question turns on
in certain circumstances
business for profit. (2)  Reckless conduct whether the reasonable understanding of the 3rd
 Restrict the rights of 3rd
The sharing of profits  Intentional misconduct or party can be traced back to something that non-
does not alone create a parties under the UPA
 A knowing violation of law partner did to create the understanding
partnership, despite the  All duties must be discharged in good faith and fair dealing  Concerns non-partner being held liable
parties’ intentions
as a partner
 Detrimental reliance is NEEDED
 PARTNERSHIPS: continued
Expulsion
A PARTNER MAY BE EXPELLED IF:
 Partnership agreement details it
 There is a unanimous vote of the
other partners:
o if it is unlawful to carry on
the partnership with that
partner,
o if there has been a transfer
of all (or substantially all)
of the partner’s
transferable interest [UPA
§ 601(4)(ii)]; or
o if the partner to be
expelled is another entity
ending its existence
 There is judicial determination if
certain circumstances are
satisfied involving the wrongful
conduct of the partner to be
expelled
LIMITATIONS ON EXPULSION
 EVEN PERMISSIBLE PROVISIONS
must be exercised in good faith and fair
dealing
4
Business Organizations – Attack Outline – Faiq
Nature of Partnership Interests
[UPA § 26]
A. ECONOMIC RIGHTS [UPA § 401(a)]
 Include the right to receive $
distributed from the partnership to the
holder of the economic right [UPA §
18(a)]
 Transferrable [UPA § 502]
 Do not entitle holder to any right in
any of the specific property of the
partnership [UPA § 203]
 Transferee does not have right to vote
or become partner simply by holding
economic rights [UPA § 503(a)]
B. MANAGEMENT RIGHTS [UPA § 401(f)]
 Include the right to vote and
participate in management of the
partnership [UPA §§ 9, 18(e)]
 Non-transferrable, unless all other
partners consent [UPA § 18(g)]
HOW TO OBTAIN ECONOMIC INTEREST IF YOU ARE
A TRANSFEREE?
 By voluntary transfer by the transferor
partner
 By an involuntary transfer by the transferor
partner, which may happen due to a
judgment being enforced against that
partner
 By death of transferor partner
Putnam v. Shoaf (Tn., 1981)
Rule: A conveyance of partnership property by one
another held in the name of the partnership is made
in the name of the partnership and not as a
conveyance of the individual interests of the partners
Rights of Partnerships in
Management
I. Any partner can bind partnership in
ordinary course of business [UPA §
9(1)]
a. Sometimes apparent
authority supplements and if
there is no actual authority
but the 3rd party reasonably
believed partner had actual
authority, the partnership is
bound to the 3rd party
 Other partners can bring
claim against the partner
who acted out of apparent
authority to bind the
partnership if the apparent
authority was in violation of
the partnership agreement
II. Majority approval is needed for day-to-
day operations [UPA § 18(h)]
III. Unanimous approval is needed for
matters outside the ordinary course of
business such as selling all partnership
assets
National Biscuit Company v. Stroud (N.C., 1959)
Rule: (1) The acts of a partner, if performed on
behalf of the partnership and within the scope of
its business, are binding upon all co-partners (2)
Each partner is an agent of the partnership for
purpose of its business & has ability to bind
partnership. Therefore, each partner’s acts
considered to be the usual course of business
binds the partnership, unless the acting partner
has no authority to act for partnership and
person w/ whom he’s dealing w/ knows of the
lack of authority
Partnership Dissolution & Dissociation
STEPS TO THE END OF A PARTNERSHIP [UPA § 801]
1. Dissolution [UPA §§ 29, 31, 32]
2. Winding Up – Selling of assets, paying creditors, and making distribution
to partners [UPA §§ 30, 40]
- Partners may not embark on new business
- Partners may vote to continue partnership rather than terminate (must
be unanimous)
3. Termination
WHAT IS DISSOCIATION
 Whenever a partner leaves a firm, voluntarily or involuntarily.
 It does not necessarily trigger dissolution.
 It can be wrongful.
 If a partnership is for a term of years but the partner dissociates prior
to the completion of the term, the partner may be liable to the
partnership for damages
 If a partner dissociates in violation of the agreement.
 If partnership is not for a term or for an undertaking, it is an at-will
partnership. In at-will partnerships, partners may dissociate at any point
UNLESS the agreement provides otherwise.
DISSOCIATED PARTNERS RIGHTS
Dissociated partners are entitled to receive funds that represent their share of
the partnership MINUS the damages… if any.
 Going concern value: value of partnership as an operating entity without the
dissociated partner
 Liquidation value: value one could get for selling all assets of the business
 IF At-Will: then dissociated partner is entitled to the value of their share
shortly after dissociating
GENERAL RULE OF DISSOCIATING PARTNER’S FUNDS
 Value of their partnership interest (the greater of the going concern
value OR the liquidation value); MINUS
 Partner’s share of liabilities; MINUS
 Any damages for wrongful dissociation; PLUS
 Interest paid from date of dissociation to date of payment;
 Usually, payable within 120 days if at-will, or at end of term, or end of
undertaking
Pav-Saver Corp. v. Vasso Corp. (Ill., 1986).
Rule: When a wrongful dissolution occurs, partners who have not wrongfully
caused the dissolution shall have the right to continue the business in the same
name & to receive damages for breach of the agreement
 CORPORATIONS:
Corporations are owned by shareholders, and the shareholders are entitled to residual value of the corporation after it has paid off its creditors. Shareholders do not participate in the management of the corporation.
They only elect the Board of Directors. The Board of Directors then appoints officers for the corporation.
FORMATION
Corporations are created under
state law. Articles of Incorporation
must be filed with the Secretary of
State in the state selected for its
formation.
Corporations is subject to personal
jxd.: 1) where their principal place
of business is, and 2) where their
state of incorporation is
ARTICLES OF INCORPORATION
INCLUDE:
 Name of the corp.
 Purpose of the corp. (which
may be as broad as “any
lawful purpose”)
 Number of shares
authorized for each class of
stock of corp.
 Name and address of the
agent for service of process
OPTIONAL PROVISIONS INCLUDE:
 Selection of initial directors
 Limitations on directors’ and
officers’ liability
 Restrictions on transfer of
shares
 Dividend requirements
and/or preemptive rights for
shareholders
5
Business Organizations – Attack Outline – Faiq
Characteristics
 Being treated as a separate person under
law
I. Decisions: requirement that BOD meet
and maintain minutes in order to make
decisions. Corporate formalities
demonstrate the corporation’s separate
identity from individual actors.
II. Rights & Lawsuits: can be sued in
principal place of business or state of
incorporation
III. Taxation: Corp. must file its own taxes
on the money it earns. Then
shareholders are also taxed for their
receipt of dividends. This is a double
taxation structure.
 Providing limited liability for its owners
I. Shareholders: are not personally liable
beyond the amount they invest
II. Requirements: 1) follow rules/
formalities, 2) provide notice to world
that it is a corp., 3) treat corp. as
separate from its owners, and 4) be a
real business
III. Exceptions: 1) when $ is taken out
fraudulently  but not unlimited
liability, OR 2) when shareholder loses
protection of corporate shield 
become personally liable (AKA piercing
the corporate veil)
 Creating a division between ownership and
control
 Allowing flexible capital structure
 Allowing owners to freely transfer
ownership
Shareholders
SHAREHOLDERS VOTE ON:
 Election of directors
 Amendments to articles of
incorporation
 Amendments to by-laws
 Fundamental transactions (like
mergers & acquisitions)
 Miscellaneous matters (like
approval of independent
auditors)
** Shareholder votes can only be cast
at the annual meetings **
Shareholders are entitled to residual
interest in the assets of a corporation.
 Upon liquidation shareholders are
entitled to the value of the remaining
assets after the corporation’s
obligations have been satisfied
Board of Directors
DIRECTORS OF A CORP.:
 Are elected by the
shareholders
 Serve for a set term
 Typically make the major
decisions relating to the
operation of the corporation
 Select the officers (who then
handle the day-to-day affairs)
De Facto Corporations vs.
Corporations by Estoppel
DE FACTO CORPORATIONS
If a corporation is not properly formed,
sometimes shareholders of an organization are
given protection under this equitable doctrine.
Requirements:
1) A good faith, substantial effort must have
been made to comply with the state’s
incorporation statute;
2) The business must have had a legal right
to incorporate; and
3) The parties must have had a good faith
belief that, and acted as though, they
had, in fact, formed a corporation
 If the requirements are met, then principals
have limited liability from the debts of the
corporation although this is unlikely given the
modern filing procedures.
 Because most states provide notice when
articles of incorporation are filed properly or not,
incorporators almost always have (constructive)
notice that the corporation has been formed.
CORPORATIONS BY ESTOPPEL
If a 3rd party treats an organization as though it
were a corporation, that 3rd party may be
estopped from denying the organization’s
corporate structure if the denial would result in
unjust harm to the principals.
Requirements:
1) Parties need to have consistently
treated the organization as though it
were a corporation; and
2) If one party were allowed to deny the
existence of the corporation, that party
would be unfairly benefitted
 Typically only arises in contract cases NOT in
tort cases because it requires that the party have
had prior dealings with the organization and tort
victims usually have no prior contact with the
organization.
 CORPORATIONS: Finding liability
Piercing Corporate Veil Preventing Piercing Corporate Veil of Reverse Piercing Enterprise Liability
Piercing of Subsidiary
Corporate Veil

Piercing the corporate veil allows a creditor of a corporation to sue the RULES THAT Sometimes there are efforts to pierce Occurs when a claim against an Is sometimes referred to as “horizontal
shareholders personally for the debt that creditor is owed by the corporation. CORPORATIONS the veil of a subsidiary to get to the individual shareholder is found to piercing” but it is NOT piercing.
SHOULD RESPECT TO assets of a parent corporation be enforceable directly against the
THRESHOLD QUESTION: PREVENT PIERCING  Courts usually require a less rigorous corporation in which the Creditor claims there are several
Whether the separate existence of the corporation has been respected?  Keep the showing of fraud-like conduct or individual is a shareholder. related corporations and all or some
 If no, PIERCE CORPORATE VEIL corporation’s injustice  Does not enable a creditor to are really part of the same corporation.
 If yes, NO PERSONAL LIABILITY business  Courts will look to overlapping BoD collect on a claim that otherwise  Involves creditors effort to enforce a
separate – members between the parent and would necessarily be unpaid by claim that creditor holds against one
EFFECT OF PIERCING THE VEIL: separate bank subsidiary as an indication that the two the party reaching the piercing. corporation against other, related
The shareholders of the corporation and the corporation become jointly and accounts, are not separate  Changes the status of the claim corporations.
severally liable for the debt. separate  Subsidiaries must be separate and holder enabling the individual  Commonly seen where the
property, independent from its parent or it risks shareholder’s creditor to be commonly owned corporations are
TEST: separate records piercing treated as the creditor of the “sister corporations.”
C. First, there must be unity of interest and ownership that the separate  Keep corporate corporation.
personalities of the corporation and shareholders no longer exists; AND funds and FACTORS TEST: UNITED STATES V. RULE:
D. Second, circumstances must be such that adherence to the fiction of transactions JON-T CHEMICALS, INC. FEATURES OF REVERSE There is enterprise liability when the
separate corporate existence would sanction a fraud OR promote separate from  Parent and subsidiary have PIERCING: sister corporation transgresses the
injustice that of common directors or officers  Makes the individual corporation to corporation boundary.
shareholders’  Parent and subsidiary share shareholder’s personal
UNITY OF INTEREST ELEMENT  Hold meetings business departments creditor a creditor directly ANALYSIS QUESTIONS:
E. Failure to follow corporate formalities – not taking minutes, not of BoD and  Parent and subsidiary consolidate against the corporation,  Are two or more nominally
conducting meetings, not electing officers, not maintaining books and Shareholders at financial statements and tax which puts the creditor separate sister corporations
records least once a year returns higher in line to be paid really operating as a single
F. Failure to maintain separate accounts (AKA comingling) – keeping  Keep meeting  Parent finances subsidiary  If creditor can reverse enterprise?
personal funds and corporation’s funds together minutes  Parent caused incorporation of pierce, it can collect from  Are the corporations operated
G. Failure to “adequately capitalize” corporation – not placing sufficient  Elect BoD the subsidiary corporation on equal footing as separate entities?
funds into the corporation to enable it to operate as a viable business  Issue stock  Subsidiary is grossly with the corporation’s  Are the respective
 Adequately undercapitalized creditors corporations’ assets
SANCTIONING FRAUD/ PROMOTING INJUSTICE ELEMENT capitalize  Parent pays salaries and other  If creditor cannot reverse intermingled for use toward a
H. Unfair business practices – actions that thwart legal rights of others corporation pierce, it may only get $ that common business?
expenses of the subsidiary
I. Intentional misrepresentations  Make sure  Subsidiary gets business ONLY the corporation decides to
J. Conduct that may incur civil or criminal penalty corporation pay the shareholder Enterprise liability is similar to an
from parent
K. Creation of corporate structure solely to avoid liability 
caries minimum  Parent uses subsidiary’s property Test is same as regular agency theory of liability applied to
L. Unjust enrichment – removing assets in bad faith or leaving business amount of piercing – some states don’t corporations.
as its own
undercapitalized required  Daily operations of the two are allow reverse piercing
M. Fraud insurance  There have been cases HOW TO AVOID ENTERPRISE
kept the same
 Subsidiary does not observe the where reverse piercing was LIABILITY:
** Piercing corporate basic corporate formalities – like allowed using a shareholder  Separate books and records
PIERCING THE VEIL OF LLCS veil ONLY occurs in  Avoid sharing resources
no separate books and records that no obligation to the
- Same test as regular piercing the veil for corporations closely held creditor just as long as there  If resources are shared, make
- BUT LLC’s have fewer formalities to follow so it is more difficult to corporations** is unity of interest sure accounting practices are
show the existence of unity of interest based on failure to follow separate
formalities
** Enterprise Liability is usually used to
Walkovzsky v. Carlton (NY 1966) try and reach the pockets of
Rule: An individual can be held liable for the acts of a corporation through the transportation companies, like Taxi
Doctrine of Respondeat Superior if it can be shown that the individual used his businesses. **
control of the corporation for personal gain. However, where a corporation is a
fragment of a larger corporate combine which actually conducts the business, a
court will not “pierce the corporate veil” to hold individual shareholders liable.

6
Business Organizations – Attack Outline – Faiq
 FIDUCIARY DUTIES (& Other Checks on Corporate Action): Two major categories, duty of care and duty of loyalty.
Powers of the
Corporation
ULTRA VIRES & “WASTE”
Ultra Vires: actions taken outside
of the corporate purpose are void
or voidable
 Currently referenced as the
“Waste” of corporate assets
 Corporation’s purpose is to
maximize wealth for shareholders
ANALYSIS OF THE CHARITABLE
ACT:
Threshold Question – Whether
there is some direct or indirect
benefit to the shareholders or
corporation?
 Whether the gift was
anonymous? (if anonymous
then reduced value to firm if
the goal is marketing or
public relations)
 Whether the amount
donated was significant
when compared to the
corporation’s earnings?
 Whether the gift was made
to a “pet” charity? (More
suspect if it is a pet charity
that is not helping
corporation)
A.P. Smith Mfg. Co. v. Barlow
(N.J. 1953)
Rule: P, corporation, had a history
of donating minor sums of money
to various charities and
institutions. P voted to give $1,500
to Princeton. P instituted a
declaratory judgment action after
D stockholders questioned the
proposed gift. We find that the
donation was a lawful exercise of
the corporation’s implied and
incidental powers under common-
law principles and that it came
within the express authority of the
pertinent state legislation.
7
Business Organizations – Attack Outline – Faiq
Duty of Care & the Business Judgment Rule Procedural & Substantive Requirements for the BJR Affirmative Defenses to
Duty of Care Violation
DUTY OF CARE REQUIRES, BOD SHALL ACT: PROCEDURAL REQUIREMENTS EVEN IF VIOLATION, MAYBE NO
1) In good faith, and  BJR Protection if BoD make an informed decision LIABILITY IF:
2) In a manner the director reasonably believes to be in  NO BJR Protection if BoD makes an uninformed decision OR when BoD fails BoD can show that the transaction was
the best interests of the corporation. [MBCA § to act 1) beneficial to the
830(a)]  Standard of Proof: Plaintiff must show that 1) the BoD was corporation;
grossly negligent in failing to inform itself of material 2) fair; OR
ROLE OF BJR information reasonably available to it, AND 2) the decision 3) there were no damages
 When sued based on violation of duty of care, director is itself was grossly negligent
entitled to protection of BJR FAIRNESS:
 BJR provides protection from lawsuits that might seek to HOW TO AVOID LIABILITY FOR VIOLATING DUTY OF CARE ON - Generally, courts look to
challenge business judgment of directors PROCEDURAL GROUNDS: substantive or intrinsic
 BJR gives wide latitude to directors to successfully run the  Keep informed about and properly oversee the corporation’s activities fairness
business, protecting directors from second-guessing of and policies; - Except, in the case of a
shareholders  Be adequately informed about the corporation’s business, its interests merger then court will look to
and the relevant issues before making decisions; entire fairness
 Possess a minimum level of skill and expertise with regard to the role of
BJR APPLIES UNLESS PLAINTIFF CAN SHOW: director for the specific business; and
 Fraud;  Be aware of the financial status of the corporation.
 Illegality or “Wrongful” Conduct;
 Conflict of Interest (Duty of Loyalty Analysis Proceeds); SUBSTANTIVE REQUIREMENTS
 Bad Faith (Duty of Loyalty Analysis Proceeds in DE); Bad faith  If BoD is acting within procedural requirements, in order to avoid the BJR,
can include: Plaintiff must show that there has been a substantive violation
o Subjective bad faith  conduct motivated by an  If NO BJR Protection (because of lack of procedural or substantive
actual intent to do harm requirements) Plaintiff must show a violation of underlying duty of care
o Intentional dereliction of duty, a conscious  Threshold Question: Even though this situation does not
disregard for one’s responsibilities [In re Walt warrant the protection of BJR, did the Defendant violate the
Disney (Del. 2006)] applicable duty of care?
o Acts with a purpose other than that of advancing  IF NO, then no violation.
the best interests of the corporation [Stone v.
Ritter (Del. 2006)] WHEN DOES BJR NOT APPLY? IF…
 Egregious/ Irrational Decision (Decision with no business 1) Conflict of Interest
justification); OR
 Waste (A transaction that lacks any business rationale to 2) Bad Faith
support it or one that is so one sided that no business person
of ordinary, sound judgment could conclude “that the  If conflict of interest exists, NO BJR, unless conflict is cleaned. So not
corporation has received adequate consideration” [Glazer necessarily a violation of duty of care. If cleansed, no violation of duty of care.
v. Zapata (Del. Ch. 1993)]);  Standard of Proof: Plaintiff must show breach of fiduciary duty by
 Uninformed Decisions (Including a lack of investigation); or showing a violation of duty of loyalty.
 No Decision (for example, no action was taken by BoD but a
NOTES ON BJR:
Plaintiff alleges some action should have been taken)
Directors are allowed to be wrong or to make mistakes and still have the
protection of the BJR, as long as they: 1) act in good faith, 2) consider their
decision, and 3) have a business reason for their decision.
 FIDUCIARY DUTIES (& Other Checks on Corporate Action):
The BJR &
Protection by
Consulting an
Expert
If the Board hired or
consulted an expert
regarding certain matters,
the Board’s decisions and
action with regard to those
matters will later be
protected under the BJR as
“informed” decisions
(provided of course, that
the decision does not
violate another
requirement of the BJR).
 There is a duty of care
required in hiring an expert
(the scope of the expert’s
competence)
 Reliance upon the expert
must also be reasonable
DIRECTOR’S FAILURE TO
ACT
Remember that the BJR
protects decisions NOT the
people making them. If no
judgment is made, there is
no protection of BJR.
 No action does NOT
mean automatic liability for
directors
 Plaintiff must still show a
violation of duty of care
8
Business Organizations – Attack Outline – Faiq
The BJR & Failure to Act
or to Monitor the Firm
FAILURE TO ACT W/ VALID BJR
If the BoD decide NOT to act but
they made an affirmative informed
decision not to act, then BJR is valid
FAILURE TO ACT ACCUSATIONS:
CORPORATE WRONGDOING
Examples when a BoD is accused of
failing to act is when they fail to
- Detect
- Prevent
- Stop
actions.
CAREMARK CLAIMS
(When BJR does not apply in the
failure to act situations, a different
standard, the Caremark standard,
applies)
1) Absent suspicion of
wrongdoing, NO DUTY on BoD
to install and operate a
monitoring system
2) BoD must make good faith
attempt to ensure that an
adequate reporting system is
in place so BoD can get
information necessary to
make an informed decision
a. Once BoD is informed,
their decisions are
typically protected by
BJR
Duty of Loyalty
WHAT IS THE DUTY OF LOYALTY?
 Requires fiduciaries (like officers and directors) put the
interests of the corporation ahead of their own interests
WHEN IS THE DUTY OF LOYALTY IMPLICATED?
 When there is a conflict of interest that creates a personal
benefit for the fiduciary
CONFLICT OF INTEREST IS…
When fiduciary knows that when he is asked to take action
with regard to the potential transaction he or a person
related to him
1) Is a party to the transaction, or
2) Has a beneficial financial interest in the transaction
ANALYSIS OF DUTY OF LOYALTY
 Is there a conflict of interest? (direct or indirect)
 If NO, there is no duty of loyalty issue.
 If YES, must determine whether transaction can be
“cleansed”
 If transaction is cleansed it is protected and may
proceed. (If transaction is cleansed via a vote of
disinterested directors, the decision to cleanse will be
subject to scrutiny but likely still protected by BJR)
 If transaction is NOT cleansed, transaction is
“voidable” by the corporation and the director may be
liable for damages for breach of the duty of loyalty
TYPES OF CONFLICTS OF INTEREST:
- Self-Dealing
- Taking a Corporate Opportunity
- Stealing
- Executive Compensation
- Evaluation by BoD of Whether and How Much Info
to Give to S/H
- Entrenchment
HOW TO CLEANSE:
 Approval by vote of majority of fully informed,
disinterested directors.
 Ratification by informed S/H.
 When it is shown to have been an intrinsically fair
transaction.
Corporate Opportunity Doctrine & Its Requirement of
Defenses Offering the
Corporate Opportunity
to the Corporation
WHAT IS THE CORPORATE OPPORTUNITY DOCTRINE? IF YOU WANT TO TAKE THE
(a subset of Duty of Loyalty) CORPORATE OPPORTUNITY AS A
 Fiduciary may not take, for personal gain, an FIDUCIARY:
opportunity like a business venture or a new opportunity  MUST disclose opportunity
or discovery, in which the firm has a property right, and to the BoD
use it for his or her own advantage without first offering it  MUST disclose interest in
to the corporation. opportunity to the BoD
 BoD has right of first refusal
WHO DOES IT APPLY TO?  IF BoD does not properly
 A corporation’s officers and BoD (NOT S/H who do reject, then there still may be
breach of the duty of loyalty
not have another position in the firm); and
 Certain other individuals who have a fiduciary or UNLESS the opportunity is
fiduciary-like relationship with the corporation (like cleansed by the S/H or by
showing the transaction was
lawyers and consultants)
fair
HOW TO IDENTIFY A CORPORATE OPPORTUNITY (3
TESTS):
1) Early Test: where corporation had an interest, an
expectancy, or a necessity. (narrow test)
i. Interest: preexisting contractual right
ii. Expectancy: not necessarily a legal right but
given contractual dealings of the corporation,
where there is a reasonable expectancy that
the opportunity would be offered (like renewal
of contracts)
iii. Necessity: something a corporation needs to
stay in business (like raw materials)
2) Line of Business Test: where the corporation has
fundamental knowledge, practical experience
and the ability to pursue, which, logically and
naturally are adaptable to its business taking into
account the corporation’s financial position, needs
and aspirations. (forward-looking test)
3) Fairness Test: whether the fiduciary taking the
opportunity would violate equitable standards of
what is fair and equitable by corporate standards
COMMON DEFENSES:
- Incapacity: corporation would not have been
able to take advantage of the opportunity
anyway
- Source: the opportunity arose for the fiduciary
not because of their corporate position but
because of their personal skills and attributes
 FIDUCIARY DUTIES (& Other Checks on Corporate Action):
Corporate Opportunity Analysis
CORPORATE OPPORTUNITY ANALYSIS:
 First, whether the opportunity is a
“corporate opportunity.”
 If NO  NO breach.
 If YES, then whether the opportunity
was disclosed to the appropriate
corporate authority, such as the BoD.
 If NOT properly disclosed  Breach of
duty of loyalty.
 If YES properly disclosed, whether the
opportunity was properly rejected by
the BoD.
 If YES properly rejected  NO breach.
Decision to reject is protected by BJR.
 If NOT properly rejected  Breach of
duty of loyalty UNLESS the breach is
cleansed.
9
Business Organizations – Attack Outline – Faiq
Dominant Shareholders
GENERALLY…
 S/H acting as S/H do not have an obligation to one another;
 UNLESS, the S/H owns so much of the stock that they are seen to
have control. THEN, S/H has an obligation to the minority S/H in
specific duty of loyalty transactions;
 If there is a dominant shareholder must ask whether the
transaction involves a situation in which the dominant
shareholder has a conflict or in which the dominant shareholder
is receiving a benefit at the expense of the minority S/H OR that
the minority S/H do not receive such benefit;
 If YES, then a fully informed majority of the minority S/H will
need to be shown that the transaction was either fair to the
corporation through intrinsic fairness OR entire fairness (in the
case of a merger). Burden of proof is on the dominant
shareholder;
 If fully informed majority of the minority S/H approve the
transaction it still may be challenged by the disapproving
minority S/H BUT the burden is on the disapproving minority to
show that the transaction was not fair to the corporation.
TRANSACTIONS THAT COULD FALL WITHIN DOMINANT S/H
ANALYSIS:
 Large dividends – The dominant S/H causes distribution of
dividends to ALL S/H, so everyone is benefitting equally. In order
to challenge, the standard would be BJR.
 Failure to enforce a provision in a contract – If the dominant S/H
has an interest in the other party to the contract, the action is
subject to dominant S/H analysis; If the dominant S/H has NO
interest in the other party to the contract there is no conflict, the
standard would be BJR.
 Selling company to outside 3rd party, the standard would be BJR.
 Selling company to an entity in which the dominant S/H has an
interest, then dominant S/H analysis AND a showing of entire
fairness.
ENTIRE FAIRNESS VS. INTRINSIC FAIRNESS
- Entire Fairness: involves the substance of the transaction as
well as the process and procedure by which it was
accomplished. Both substance and procedure must be fair.
- Intrinsic Fairness: involves the substance of the transaction
(like price and terms of the transaction).
Summary of Fiduciary Duties
WHEN IS A FIDUCIARY’S DUTY IMPLICATED?
 Did BoD Act or did the situation involve a failure to act?
 Was a dominant S/H involved in the transaction, and, if so, did the transaction involve a conflict of
interest, or did the dominant S/H receive something that the other S/H did not?
 If no dominant S/H, did a fiduciary have a conflict of interest in the transaction?
 Was the transaction cleansed?
 Would the transaction be protected by the BJR?
 Even if NO BJR protection, did the transaction violate the duty of care?
 Even if the transaction violated a duty, was the transaction fair to the corporation?
DUTY OF CARE IMPLICATION:
 If there was an informed vote of the BoD and none of the BJR exceptions apply, then the BJR
typically applies and the transaction is protected.
 If the BJR does NOT apply, then there still should be an actual duty of care analysis.
 If there was a violation of the duty of care, the parties may still be protected if there was an
informed S/H vote or if the parties can show the transaction was fair to the corporation (in a duty of
care claim fairness is an affirmative defense NOT a bar to the claim).
DUTY OF LOYALTY FOR FIDUCIARIES IMPLICATION:
 If there was a transaction involving a conflict of interest, but not a dominant S/H, the conflict may
have been cleansed by the fully informed approval of a majority of the disinterest directors. Such
approval would eliminate the duty of loyalty claim.
 THEN, the disinterested majority’s approval of the transaction would be subject to the BJR and
further, if necessary, to the duty of care analysis.
 If all the directors are interested or if the transaction was not cleansed, then the transaction may
STILL be cleansed by a vote of the fully informed S/H.
 If the transaction was approved by a majority of the disinterested S/H, then no further inquiry.
 If the transaction was approved by a majority of the S/H but in order to get approval, the interested
S/H also voted, then there is a question to whether or not the transaction was cleansed. (In CA, the
transaction would not be cleansed. In DE, it is unclear.)
 If the transaction is not cleansed by the S/H or the directors, then the Defendant has the burden of
proving fairness.
DUTY OF LOYALTY FOR DOMINANT SHAREHOLDERS:
 In situations where there is a claim for duty of loyalty involving a dominant S/H it cannot be
cleansed.
 If there was a S/H vote to ratify the transaction, then, although the transaction was still not
cleansed, the burden of proof MAY shift to the Plaintiff to show that the transaction was unfair.
 If a majority of the disinterested S/H approved the transaction, the burden of proof shifts to the
Plaintiff.
 If a majority of the disinterested S/H did not vote to approve the transaction (or if there was no
vote) then the burden is on the Defendant to show fairness.
 If the transaction involved a merger (or another significant transaction that requires a vote by S/H),
then the Defendant needs to show entire fairness. If the transaction did not involve a significant
transaction, then the Defendant need only show intrinsic fairness.
 SHAREHOLDERS & THE RIGHTS & RESTRICTIONS ASSOCIATED WITH OWNERSHIP
Shareholder Ownership Rights
Shareholders vote on major transactions,
elect BoD and may also vote on various
resolutions that are typically not binding on
the BoD. Shareholders get to decide who
operates the corporation, but they may NOT
operate the corporation themselves.
 The effect of this limitation on
management is a creation of limited liability
for shareholders.
WHERE DO SHAREHOLDER RIGHTS COME
FROM?
When a corporation is formed, the Articles
of Incorporation set forth how many shares
are authorized and whether there is more
than one class of stock. Common stock
typically has the right to vote AND the right
to receive dividends. Common stock is
usually where most corporation’s economic
and voting rights reside.
SHAREHOLDER ECONOMIC RIGHTS
Regardless of how many shares (or classes)
of stock a corporation has authorized,
economic rights are determined based on
how many shares are issued and outstanding
(i.e. shares that are actually owned by S/H at
any given time).
SHAREHOLDER VOTING RIGHTS
 Election of Directors
 Fundamental Changes to the
Corporation (such as a merger, sale of
all of assets, corporate dissolution, and
amending the Articles of
Incorporation); and
 S/H Resolutions (2 types)
o i) resolutions proposed by
corporation’s management
such as a resolution to
ratify a plan or action by
BoD, OR
o ii) resolutions proposed by
S/H requesting the BoD
take some action
10
Business Organizations – Attack Outline – Faiq
How do Shareholders Vote
Shareholder voting can take place at ANY meeting of the
shareholders. A shareholder can usually vote all their shares on
a particular matter. Shareholders vote pro rata which means
the shareholders vote in proportion to their holdings in the
company.
Generally, a simple majority vote is required in order to take an
action, and the shareholders are entitled to one vote for each
share they hold. However, Articles of Incorporation or the
Bylaws may provide for different voting structures or different
numbers of affirmative votes needed to approve certain
matters.
Shareholders who hold stock on a certain date, known as the
record date, are entitled to vote in a shareholder election
immediately following that date. The BoD establish the record
date (usually a few weeks ahead of the scheduled vote). The
record date determines which shareholders are entitled to vote
at a particular meeting or on a particular proposal, even if they
sell their shares after the record date but prior to the vote.
CUMULATIVE VOTING
Cumulative voting is an alternative to traditional voting that
gives minority S/H a greater opportunity to select a director to
BoD. In a traditional vote, the majority S/H would be able to
appoint ALL BoD. In a cumulative vote, S/H are entitled to
spread out their votes for several directors or to “accumulate”
all their votes to select one or two directors, to maximize the
minority S/H’s impact and to increase the minority’s odds at
electing a director.
 Some states like CA require cumulative voting, except in
publicly held corporations.
PROXIES
What is a proxy?
 If a S/H cannot make it to a meeting but they still want to
vote they can assign their voting rights to a proxy. The proxy
agreement must be express (in writing or electronic).
 The proxy may receive specific instructions on how to vote or
may have great latitude in casting the vote.
 Proxies can be revocable or irrevocable.
 If it is specifically provided in the written (or electronic)
proxy agreement that it is irrevocable, it can validly be
irrevocable.
 Proxies are important in meeting quorum requirements for a
vote. Generally, the quorum requirement is 50% of the votes +
1 vote. (For example is a corporation has 100 shares issued and
outstanding there must be 51 shares represented at a meeting
for quorum to be met).
Proxy Rules, Fights & Costs Associated
PROXY RULES
Proxy Rules are addressed in Regulation 14A of the SEC Act of 1934, the “1934 Act.”
Solicitation Includes:
 Any request for a proxy;
 Any request to execute, not execute, or to revoke a proxy; and
 Furnishing a form of proxy or other communication, reasonably calculated to result in the procurement,
withholding, or revocation of a proxy. (Courts have found that even communications, which may constitute a
step in a chain of communications designed to accomplish such a result may also constitute solicitation.)
**Person being solicited must first receive or have received a “proxy statement.” These rules, which prohibit
materially misleading statements, are intended, among other things, to provide for adequate disclosure to
shareholders before their proxies are solicited.**
Exceptions to Solicitation Include:
 Public statements or speeches or advertisements stating how a S/H intends to vote and the reason why;
 Solicitations by someone (other than, among many exceptions, an affiliate of the corporation or a part in
interest) who does not intend to act on another’s behalf;
 Any solicitation made to 10 or fewer persons provided it is not made by the corporation; and
 Advice to any person with whom the person furnishing the advice (the “advisor”) has a business relationship
(provided that such advisor does not have certain other interests or undisclosed connections to the
corporation that would amount to a conflict of interest).
PROXY FIGHTS
A proxy fight is a battle to obtain control of a corporation through the vote of the shareholders.
- When group that wants control AKA insurgent group tries to become elected to BoD and oust existing
management AKA incumbent group by soliciting proxies from a large enough number of S/H to elect the
insurgent representatives to the BoD.
- Rules governing when an insurgent wants to contact S/H under Rule 14a-7:
o Management may mail the insurgent group’s material to S/H directly and charge the insurgent
for the cost; OR
o Management can give the insurgent group a copy of the S/H list and let the insurgent group
distribute its own materials.
RECOVERING COSTS ASSOCIATED WITH OBTAINING PROXIES IN A BATTEL FOR CONTROL
When the incumbent directors expend money to defend their positions from insurgents’ efforts to oust them, as
long as the expenses are not excessive and not illegal, incumbent group can usually reimburse themselves.
RULES FOR REIMBURSEMENT:
 Corporation may NOT reimburse either party UNLESS the dispute involves a question of corporate policy.
The dispute cannot just involve an argument that one group is better than the other. Because most people
are aware of this rule, the proxy battles are usually proposed to be “policy” disputes;
 Corporation may ONLY reimburse reasonable and proper expenses (Note: this is a broad standard that
includes disclosure statements, telephone solicitations, and in-person visits to corporate S/H)
 Corporation may reimburse incumbent NO MATTER if they win or lose;
 Corporation may ONLY reimburse insurgents if they win and (if they do not want that reimbursement to be
subject to attack) ONLY if the corporation’s S/H ratify the reimbursement after full disclosure.
 SHAREHOLDERS & THE RIGHTS & RESTRICTIONS ASSOCIATED WITH OWNERSHIP
Shareholder Proposals The Dodd-Frank Act, Director Shareholder Inspection Rights Example on Shareholder
Nominations & “Say On Pay” Voting Schemes

Rule 14a-8 allows qualifying shareholders to submit certain proposals to fellow The Dodd-Frank Act of 2010 allowed the BURDEN SHIFTING FRAMEWORK ON SHOWING PROPER PROBLEM:
shareholders for a vote by having the proposal placed on the company’s proxy SEC to adopt rules to provide PURPOSE At the annual shareholder’s
statement. shareholders with increased input about  If the shareholder wants to obtain the list of the meeting of Foster’s Supply
shareholder names, the burden of proof is on the (Supply), a publicly-held company,
 The company bears the expenses of the proposal if the proposal is on the proxy the directors elected to a BoD.
Tom, Dick, and Harry run for the
statement.  Rules were adopted to address corporation for it to show that the shareholder
does not in fact have a “proper purpose.” board of directors. There are 1000
 The proposal must be regarding an area which is a proper subject for action by the concern that shareholders of a publicly
of 1500 shares outstanding present
shareholders. Most are worded as recommendations rather than mandates and are traded company did not have the right to  If the shareholder wants to obtain corporate
(in person or by proxy) at the
non-binding in nature. nominate directors and typically could records, the burden of proof is usually on the
meeting. Tom receives 600 votes,
only vote on a “slate” proposed by BoD. shareholder to show that he or she or it does in fact with a further 200 votes marked
THRESHOLD ISSUE: Whether a shareholder proposal qualifies to be included in the  SEC’s Rule 14a-11 of the 1934 Act have a “proper purpose.” “withhold authority” (SEC proxy
proxy statement. MUST MEET PROCEDURAL & SUBSTANTIVE REQUIREMENTS BELOW. applied to companies and would have regulations do not permit “no”
allowed certain shareholders (those who INSTANCES DEMONSTRATING PROPER PURPOSE votes in the election of directors
PROCEDURAL REQUIREMENTS: had owned at least 3% of the outstanding  An effort to gain control of the corporation (unless it unless the corporation’s articles or
 S/H submitting proposal must hold either $2,000 in market value of the corporation for an uninterrupted 3-year is for a hostile or detrimental purpose to the bylaw provide for them). Dick
company’s stock OR 1% of the company’s voting stock, AND the S/H must have period) to nominate a director for corporation or its S/H, rather than to current receives 475 votes with 300
held it continuously for 12 months preceding the proposal; inclusion on the “slate” using the management); marked “withhold authority.” Harry
 S/H may not submit more than one proposal per S/H meeting; corporation’s proxy materials.  An effort to gain a S/H list for someone else trying to receives 375 votes while proxies
gain control of the corporation; representing 400 shares are
 A proposal may not exceed 500 words;  Rule 14a-11 was vacated by
 An effort to investigate alleged corporate marked “withhold authority.”
 Most proposals must be submitted to the company at least 120 days before the Roundtable & Chamber of Commerce of
company’s proxy statement is to be released; and USA v. SEC, 647 F.3d 1144 (D.C. Cir. 2011) mismanagement or malfeasance; - Under a majority scheme,
 Either the S/H or the S/H’s “qualified representative” must attend the meeting because the SEC “acted arbitrarily and  An effort to gather information to assess the values of Tom is elected but Harry
one’s shares; and and Dick are not.
at which the proposal is to be considered; capriciously here because it neglected its
statutory responsibility to determine the  An effort to communicate with other S/H in - Under a plurality voting
SUBSTANTIVE REQUIREMENTS: likely economic consequences of Rule connection with a proxy fight or S/H proposal. scheme, all are elected
 Topic of the proposal must be proper subject for action by S/H under state law 14a-11 and to connect those because the number of
where the company is organized; consequences to efficiency, competition, INSTANCES DEMONSTRATING IMPROPER PURPOSE votes (even though not a
 Proposal may not, if implemented, cause the company to violate the law; and capital formation.”  Finding potential customers for a personal business majority in Dick’s and
venture; Harry’s cases) cast in
 Proposal may not address a personal grievance or special interest that is not favor exceeds the number
applicable to other S/H;  Persuading the corporation to adopt one’s social or
cast against, given the
 If the proposal relates to the company’s operations, those operations must The Dodd-Frank Act of 2010 also allowed political concerns, irrespective of any economic
presence of a quorum at
involve at least 5% of the company’s assets, net earnings or gross sales, OR the SEC to adopt Rule 14a-21(a), which benefit to the S/H of the corporation;
the meeting.
 Instituting a strike suit (a suit without substantive
operations must otherwise be “significantly related to the company’s business.” requires publicly held companies to
basis, designed to obtain money or property from the
- Under a Pfizer scheme, all
(Proposals will be included notwithstanding their failure to reach the economic provide shareholders with an advisory are elected but Harry
threshold IF a significant relationship to the company’s business is “say-on-pay” vote (at least once every 3 corporation because the costs of litigation far exceed
must tender a letter of
demonstrated on the face of the resolution or in the supporting materials); years) on the compensation of senior the costs of settlement) against the corporation;
resignation which the
 Proposal must not violate the Proxy Rules (such as the prohibition on material executives.  Seeking proprietary information such as trade secrets board may then accept or
misleading statements);  Section 14A(a)(1) of the 1934 Act and or other intellectual property; and reject because the
 Proposal cannot be beyond the company’s power to implement (such as a vote Rule 14a-21(a) require companies to  Seeking information to aid a competitor of the number of withheld
requiring the world to adopt a universal currency); provide a separate shareholder advisory corporation. authority votes exceeds
 Proposal may not address management functions such as the company’s vote in proxy statements to approve the the number of yes votes.
ordinary business operations; compensation of their named executive State Ex Rel. Pillsbury v. Honeywell (Minn. 1971)
Rule: Denial of access to S/H was due to distinguishing a
 Proposal may not relate to specific amounts of cash or stock dividends; and officers.
proper purpose that involves any economic benefit to the S/H
 Proposal may not directly conflict with one of the company’s own proposals  Most companies conduct such votes of the company from an improper purpose that was to
that is being submitted at the same meeting. annually even though the requirement is persuade the company to adopt the S/H’s socio-political
 ADDITIONALLY, if the proposal was submitted in the last 5 years and did not 3 years. concerns.
get the required % of votes, it may be excluded. (However, if more than 10% of  These votes are advisory and NOT
the S/H voted in favor of the previously submitted proposal it will not be binding on the company.
excluded on these grounds. If fewer than 10% of the S/H voted in favor of the
previously submitted proposal, the rules become more complex).

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Business Organizations – Attack Outline – Faiq
12
Business Organizations – Attack Outline – Faiq
 ISSUES OF CONTROL
Devices for Control (usually applicable in closely-held or Limits on Control Arrangements Abuse of Control
private companies)

 Voting Trusts GENERAL RULE FREEZEOUTS

 Vote Pooling Agreements (a specific type of a S/H agreement) - Shareholders may agree on how they will act as A Freeze out occurs when the majority shareholder or block of
 S/H Agreements shareholders. shareholders earns a return at the expense of the other shareholders,
 Irrevocable Proxies - Shareholders MAY NOT agree on how directors often channeling corporate funds to the controlling shareholder block
will vote as directors or what actions they may and depriving other shareholders of the opportunity to share in funds
LIMITS ON S/H CONTROL: Shareholders may agree to exercise control to determine who take as directors. paid out by the company.
will be directors but not to determine how those directors will vote BECAUSE shareholders are
allowed to act in self-interest but directors have to act in the best interest of ALL shareholders. EXCEPTIONS TYPICAL FEATURES OF A FREEZEOUT:
When otherwise unenforceable agreements (or  The corporation does not pay dividends (or pays minimal
VOTING TRUST provisions in agreements) are enforceable: dividends) so that non (or little) of the corporation’s profits are
 Is a device whereby two or more S/H place their shares in a trust  Shareholder Unanimity Exception: Typically, S/H distributed to S/H; and
 The trust has a trustee who is responsible for voting the shares may agree how they will vote on certain matters as  The only (or vast majority of) corporate funds that are “paid out”
 The trust is usually governed by a trust agreement, which determines how long the trust directors (such as dividends or the election of are paid in the form of salary to those S/H; and
will last and how the shares will be voted officers) if ALL of the S/H have entered into that  The “frozen-out” S/H is prevented from holding a paying position;
 PROS: there is little question about enforcement because the trustee holds and votes the agreement. then,
shares; helps avoid deadlocks among S/H  There are also cases in some states that hold that,  As a result, the minority S/H or S/H’s do not receive any of these
 CONS: loss of control that accompanies relinquishing possession of shares; also there is a even if all of the S/H are not parties to the corporate funds distributed as “salary,” and therefore, are unable
limit of how long trusts can exist (usually is a 10 year limit in most states) agreement, the agreement is still enforceable IF to “profit” in any way from their investment in the corporation.
(a) the shares of the corporation are closely held;
VOTE POOLING AGREEMENT (b) none of the S/H who were not parties to the FROZEN-OUT SHAREHOLDER MUST SHOW:
 Is a device that is similar to a trust agreement object, AND (c) the terms of the  Breach of a duty;
 There is no trustee and S/H don’t relinquish control of their shares agreement are reasonable.  That the majority is diverting the funds from the corporation to
 The agreement is between two or more S/H that states that the parties’ shares will be themselves to the exclusion of the frozen-out S/H;
voted in a certain way SUMMARY  The diversion of funds deprives the frozen-out S/H of their
 Shareholders can agree about how they will vote rightful return on investment.
EXAMPLES OF VOTE POOLING AGREEMENTS as shareholders.
 May cover all S/H votes or only certain votes such as the election of directors;  Shareholders CANNOT agree about how they will
 May be for an unlimited period of time or for a defined period of time; vote as directors (with fiduciary duties) UNLESS:
 May cover a portion of a S/H’s shares or all of their shares; and o The agreement is signed by ALL the
 May delegate control to an individual who has a relatively small ownership %. S/H, OR
o When the minority S/H who have not
SHAREHOLDER AGREEMENTS agreed do not or cannot object,
 Basically, the same as a vote pooling agreement but can cover subject-matter beyond provided that the agreement is
and unrelated to the control of the corporation, such as: transferability restrictions, reasonable.
rights to repurchase stock.
 Sometimes S/H agreements try to address matters in the realm of management of the
corporation and such agreements will be deemed unenforceable.

IRREVOCABLE PROXIES
 When a proxy is given to one entity or individual who has an interest in the corporation
to enable that individual to have control
 Proxy usually involves one or more S/H handing their votes to a 3 rd party to increase that
party’s control
 To make the proxy irrevocable it must be coupled with an interest (examples are: a job
with the company, a loan made to the corporation or some other interest in the firm).
 Parties MUST intend to make the proxy irrevocable. Just because a proxy is coupled with
an interest does not automatically make it irrevocable.
 The proxy is irrevocable for as long as the interest lasts.

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Business Organizations – Attack Outline – Faiq
 ISSUES OF CONTROL
Fiduciary Duties in Freeze Outs
IN MASSACHUSETTS:
 Apply a partnership-like analysis to closely held
corporations.
 Often the courts find some fiduciary duties among
shareholders are reminiscent of certain duties between
partners.
 The courts in this jurisdiction have taken the position that
shareholders in closely held corporations owe each other
a duty of good faith.
 In a freeze-out:
o The majority or the controlling group must
have a legitimate business purpose for its
action;
o Even if there is a legitimate business purpose,
the minority S/H still can show that the same
legitimate objective could have been
achieved through an alternative course of
action less harmful to the minority’s interest.
o Court must then balance the legitimate
business purpose against the minority’s
proposed alternative. [See Wilkes v.
Springside Nursing Home (Mass.
1976)]
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Business Organizations – Attack Outline – Faiq
Employee or Shareholder?
Many freeze out cases involve a shareholder’s
claim that he should be allowed to be an
employee and receive a salary since that was
the only way funds were distributed by the
corporation.
 These cases turn on whether the individual
is a
a) A shareholder whose right to
employment is a byproduct of his
position as a shareholder, OR
b) An employee who happened to
obtain shares as a result of
employment.
AT-WILL EMPLOYEES: do not have the
fiduciary duties protecting their rights to
employment.
HOW TO AVOID THESE
EMPLOYEE/SHAREHOLDER ISSUES?
- Have an express employment
agreement to determine the rights of
the employee/shareholder, rather
than relying on the more abstract
applications of fiduciary duties.
Minority Shareholder Protection
OPTIONS FOR A MINORITY SHAREHOLDER FACING A
FREEZE OUT:
 A S/H’s agreement, protecting the minority’s right
to be on the BoD and/or (if all other S/H agree) to
be an officer;
 An employment agreement, assuring the minority
of a certain position in the corporation and a salary;
 A buyout agreement (or a S/H’s agreement
containing buyout provisions), entitling the
minority to force the company to buy his or her
shares under certain circumstances (like a freeze
out);
 Statutory dissolution (sometimes, even minority’s
have this right in a closely held corporation to force
dissolution) which would result in payment for the
minority’s interest in the dissolution process or in a
settlement with the majority; and/or
 Mandatory dividends (provisions requiring that
certain dividends be paid might be included in the
Articles of Incorporation).
Transfer of Control
When control is purchased, the amount which the
purchaser pays in excess of the “market value” of
the stock is known as a “control premium.”
RULE:
Absent looting of corporate assets, conversion of a
corporate opportunity, fraud, or other acts of bad
faith, a controlling shareholder is free to sell, and a
purchaser is free to buy, that controlling interest at
a premium.
 One cannot generally buy a seat on the BoD
 So S/H can sell control but not offices in a
corporation
 If a purchaser acquires a majority interest in the
corporation, some courts allow the selling S/H to
facilitate the resignation of the existing BoD to be
replaced with the purchaser’s nominees
 ISSUES OF CONTROL
Shareholder Actions Derivative Lawsuit Summary

DIRECT ACTIONS (ADDRESSES HARMS DIRECTLY TO SHAREHOLDERS, THAT IS WHERE RECOVERY WOULD GO) IF DEMAND IS NOT MADE (DE STANDARDS):
Shareholder makes a claim in their own name against the corporation, or a director or officer, for a wrong that was done directly to that shareholder. Direct 1) Whether demand is made: NO.
actions are usually brought as a class action where the shareholder sues as a representative of a class of similarly situated shareholders who have suffered  Proceed to the Marx analysis (reasonable doubt)
from the same harm. 2) Whether BoD is interested
Examples of Direct Suits:  YES: Plaintiff continues suit
 Suit to compel payment of dividends;  NO: BoD appoints SLC
 Suit to enjoin an activity that is ultra-vires; 3) Whether SLC continues suit
 Suit claiming fraud;  YES: Suit continues but the SLC controls the litigation, not the
 Suit brought to protect certain S/H rights (like preemptive rights or right to vote on certain matters); Plaintiff
 Suit in which a S/H has been denied rights (like redemption rights or right to inspect books and records); and  NO: SLC terminates the suit
 Suit involving a S/H-Employee who is fired and forced to sell stock and is suing to recover their job OR stock. 4) Whether the SLC was independent
 YES: SLC is independent then MSJ is properly granted for SLC
DERIVATIVE ACTIONS (ADDRESSES HARMS TO THE CORPORATION, THAT IS WHERE RECOVERY WOULD GO)  NO: Plaintiff continues suit
When the complained of wrong has damaged the corporation and, as a result of the harm to the corporation, the shareholder is negatively impacted. 5) The Court inputs their business judgment
Examples of Derivative Suits:  If the court is PASSIVE, then the suit is dismissed if the SLC
 Claim that a director has violated their duty of care to the corporation by making a bad deal with a 3 rd party; was found to be independent
 Claim that an officer has misappropriated a corporate opportunity (or committed some other duty of loyalty violation), and the corporation failed to  If the court is NOT PASSIVE, then the suit’s dismissal by the
take action against them; SLC is subject to the court’s business judgment
 Claim that a 3rd party who has a contract with the corporation breached the contract and the BoD failed to take action against the 3 rd party;
 Claim that the senior management’s salaries are excessive; and IF DEMAND IS MADE:
 Suit seeking to prevent management practices which are calculated to prevent challenges to current management. 1) Demand is made.
2) Is refusal of the demand wrongful?
KEY DIFFERENCES PROCEDURALLY BETWEEN DIRECT AND DERIVATIVE SUITS:  NO: Dismiss suit.
 Only S/H can bring derivative suits (not creditors);  YES: Suit continues.
 Because derivative suits arise out of a wrong to the corporation, the remedy goes to the corporation NOT the S/H suing;
OVERVIEW: HOW A SHAREHOLDER SUCCEEDS IN BRINGING
 Because a direct suit arises out of a wrong to the S/H, the S/H may collect money damages;
DERIVATIVE SUIT
 In a derivative suit, the corporation is required to pay for the S/H’s attorney fees PROVIDED that the S/H is successful;
 Corporation does something (allegedly) wrong and S/H wants to
 There are many more procedural hurdles to meet in a derivative suit than in a direct suit.
sue BoD for breach of fiduciary duty to the corporation. S/H bring
suit.
BASIC REQUIREMENTS IN ORDER TO BRING A DERIVATIVE SUIT:
 First, S/H must post a bond to cover costs in event the S/H loses.
 Contemporaneous Ownership: A S/H must have been a S/H at the time of the injury claimed and at the time the suit is brought.
 Second, 1) S/H must make a demand on BoD OR 2) show that
 5% Rule: In some states a S/H holding less than 5% of the outstanding stock is liable for the costs associated with bringing an unsuccessful derivative
demand is excused (because it is futile to make a demand on the
suit.
BoD) by showing:
 Bond Purchase: In some states a S/H must purchase a bond when bringing suit to cover the potential costs of an unsuccessful suit.
i) for example that a majority of the BoD has an interest
in the transaction in question, OR
THE DEMAND REQUIREMENT IN DERIVATIVE SUITS:
ii) that a reasonable doubt exists about the exercise of
- S/H must approach BoD and demand the BoD pursue litigation before the S/H is allowed to bring suit on behalf of the corporation sound business judgment with respect to the
- If demand is made and the BoD determine they won’t bring suit then BJR protects the BoD decision transaction in question.
- Because of the BJR protection, usually Plaintiffs will seek to avoid making demand by seeking demand excusal  Third, if there is a SLC, the SLC has to 1) agree to let S/H bring suit
OR 2) if the SLC votes to dismiss the suit, then the burden of
WHEN IS DEMAND FUTILE (DE STANDARD): proof is on the S/H to show that the decision of the SLC was
 A majority of the BoD has a material financial or familial interest in the transaction; invalid because:
 A majority of the BoD is incapable of acting independently for some other reason such as domination or control (usually by an individual who is i) The process was flawed and SLC was not
“interested”); OR disinterested, OR
 The underlying transaction is not the product of a valid excuse of business judgment. (Note that since the BJR is inapplicable where the BoD did not ii) The SLC’s decision violated BJR.
exercise any business judgment, AKA the oversight cases, some argue demand is automatically excused in oversight cases BUT THAT IS NOT THE  Fourth, if the S/H doesn’t prevail in showing any of step 3, then
CASE). the S/H can hope the court institutes its own independent
business judgment.

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 SECURITIES LAW
What is a Security? Registration Private Placements (exempt from Rule 10b-5
registering)

Section 2(1) of the 1933 Act lists two broad categories of
instruments, which qualify as a security. There are some
instruments that automatically qualify as a security.
SOME SPECIFIC INSTRUMENTS INCLUDE:
 Stock;
 Notes;
 Bonds;
 Debentures;
 Options; and
 Voting Trust Certificates.
THE CATCH-ALL GENERAL CATEGORIES OF SECURITIES ARE:
 Evidence of Indebtedness; and
 Investment Contracts.
WHETHER A SCHEME, CONTRACT OR INVESTMENT QUALIFIES
AS A SECURITY: COMMON FEATURES OF SECURITIES TO
CONSIDER
 The right to receive dividends contingent upon an
apportionment of profits;
 Negotiability;
 The ability to be pledged or hypothecated;
 Voting rights that accompany an instrument and
correspond to the number of “shares” owned; and/or
 The ability to appreciate in value.
WHETHER SOMETHING IS AN INVESTMENT CONTRACT (HOWEY
TEST):
 A contract, transaction or scheme through which a person
invests money (or any other consideration);
 The investment is made into a common enterprise (either
with “horizontal commonality” in which the investment is
made with others or, in some circuits but not all, with
“vertical commonality” in which the investment is made
with a promoter who is working to make money for the
investor);
 With the expectation of profits (or some other financial
benefit); AND
 With profits to come “solely” from the” efforts of others”.
(This “efforts of others” clause is intended to include the
requirement that the investor not participate in the
operation of the investment opportunity. To expect profit
(or financial benefit) based on the efforts of others means
the investor is depending on the work, skill, expertise
and/or efforts of other people rather than himself for the
profitable result. However, most courts interpret the word
“solely” to mean “primarily”.)
In order for a security to be sold to the public, it must either be
registered with the SEC or have an exemption from registration.
Generally, publicly traded companies MUST register at least
some portions of their company’s securities if they have at least
one class of stock that is publicly traded.
SECTION 11 OF THE 1934 ACT REGULATES REGISTRATION
STATEMENTS AND CREATES RESPONSIBILITIES FOR THE
FOLLOWING GROUPS OF PEOPLE:
 Anyone who signs the registration statement;
 Officers of the issuer;
 Experts who assisted in the preparation of the
registration statement; AND
 Underwriters promoting the offering.
If you are an issuer you are strictly liable for anything
misleading (including omissions or misstatements) in the
registration statement.
Others, outside of the issuer has a defense of due diligence
(basically a negligence standard) for any misleading information
with regard to the registration statement.
THE DUE DILIGENCE DEFENSE REQUIRES:
 Reading of the registration statement; AND
 Investigating the registration statement to make sure that
the statements and assertions contained in the statement
are true. (Note, if something turned out to be false, in
order to avoid liability, the defendant in question would
need to show that he or she did not know that it was
false and should not have known that it was false.)
MAKINGS OF A REGISTRATION STATEMENT (STANDARD OF
CARE IS THE CARE THAT A REASONABLE PERSON WOULD
EXERCISE IF HIS MONEY WERE AT STAKE):
 Expertised Portion: accountants, auditors, etc. have gone
through the statement and confirmed the information
under a reasonable investigation standard and that they
believe reasonably the information is true.
 Non-Expertised Portion: non-experts must show only
that they had no reason to believe that the statements in
the expertised portion were misleading.
 Experts have NO liability with regard to the non-
expertised portion.
 Non-experts must have gone through the statement
and confirmed the information under a reasonable
investigation standard and that they believe reasonably
the information is true.
If an issuer wants to raise money without registering,
then that issuer must qualify for an exemption.
FACTORS THAT DETERMINE WHETHER IT IS EXEMPT:
 Size of the offering. How much money is being
raised? There are exemption for certain offerings
under $1 Million and $5 Million.
 Number of units offered. How many shares are
available and what percentage of the company’s
total ownership does that constitute?
 Manner of the offering. How do people hear
about the transaction? Rules restrict advertising
to, and solicitation of, the general public.
 Number of offerees. How many people are offered
the deal? The focus of this factor is NOT how many
people actually invest, but how many are offered
the opportunity to invest. (Note, often, different
offerees are treated differently. Some exemptions
doe not “count” certain sophisticated investors,
known as “accredited investors” as part of the
number of offerees. An individual accredited
investor typically has a net worth, not including
the investor’s house, over $1 Million or income
over $200,000 for the prior few years. There are
different standards for corporations seeking
accredited investor status. It is also important to
show that an offeree has access to information
from, and about, the issuer.)
Most private placements are conducted under
Regulation D or Section 4(2) of the 1933 Act. While
private placements are exempt from Section 11 of the
1933 Act, they are still subject to Section 10b-5 of the
1934 Act, as well as other provisions of the Act.
 In addition to satisfying federal standards, issuers
seeking an exemption must also satisfy state laws for
securities called “blue sky laws.”
 If the securities take place entirely in one state, they
don’t have to comply with federal regulations, as they
are exempt as intrastate, and instead have to comply
only with the “blue sky laws.”
CROWDFUNDING EXEMPTION:
- A provision in the Act of 2012 that allows
entrepreneurs and small businesses to raise up
to $1 Million from a large number of investors,
even if those investors are not accredited.
- THESE issuers are still subject to Rule 10b-5.
Rule 10b-5 creates liability for
anyone who makes a misleading
representation or omission that is
connected to the purchase or sale
of a security.
 Liability arises when someone
buys or self a security.
 Creates a private right of action
as well as SEC enforcement.
 Is also used to restrict insider
trading actions.
Section 10(b) of the 1934 Act:
It shall be unlawful…
(b) to use or employ, in connection
with the purchase or sale of any
security on a national securities
exchange or any security not so
registered, . . . any manipulative or
deceptive device or contrivance in
contravention of such rules and
regulations as the Commission may
prescribe as necessary or appropriate
in the public interest or for the
protection of investors.
To enforce Section 10(b), the SEC
created and adopted Rule 10b-5,
which states:
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce, or of the mails or of any
facility of any national securities
exchange,
a) To employ any device, scheme,
or artifice to defraud,
b) 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 the light of the
circumstances under which they
were made, not misleading, or
c) 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.

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 SECURITIES LAW
Claims Made Under Rule 10b-5
BASIC STANDING REQUIREMENTS OF 10B-
5: WHETHER RULE 10B-5 EVEN
APPLIES?
 Section 10(b) has an interstate
commerce jurisdictional requirement.
 Even if the facts meet the jurisdictional
requirements, the plaintiff must show
that the activity involves a “security.”
 Even if jurisdiction is satisfied, and so is
the security requirement, the activity
must involve a purchase or sale of
securities.
WHAT ABOUT SHOWING FRAUD?
 The fraud need only touch and concern
the transaction.
BEYOND STANDING, STATUTORY
REQUIREMENTS OF 10B-5: THE
DEFENDANT…
a) Employed a device, scheme, or
artifice to defraud, AND
b) Either,
i) Made an untrue statement
of a material fact, OR
ii) Omitted or failed 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
c) Engaged in “any act, practice or
course of business which would
operate or would operate as a
fraud or deceit upon any
person,” all in connection with
that purchase or sale of a
security.
ELEMENTS NECESSARY TO MEET STATUTORY
REQUIREMENTS:
 Untrue statement or omission;
 Scienter (AKA intent);
 Materiality;
 Reliance; AND
 Causation (Proximate cause OR “loss
causation”).
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Business Organizations – Attack Outline – Faiq
Analysis of 10b-5 Requirements Damages in a 10b-5 Claim &
Claims not Covered by Rule
10b-5
UNTRUE STATEMENT OR OMISSION DAMAGES
 Defendant had to make a false or misleading statement or omit information, which made a statement false or misleading. a) “Out of Pocket” Damages: which
 In situations in which liability is based on the omission of a material fact rather than a misrepresentation, then there can only be would involve a determination of the
liability if there was a duty to disclose that fact. difference between the price actually
paid or received and the price that should
SCIENTER (INTENT OR KNOWLEDGE OF WRONGDOING) have been paid without the 10b-5
 Defendant must have acted with the intent to deceive, manipulate, or defraud violation.
 Negligence alone does NOT suffice, although some courts will allow deliberate recklessness. b) Restitution/ Disgorgement: which
 This element is different from fraud because intent deals with the representation and not to the transaction itself. would involve the defendant turning over
the profit derived from the fraud
MATERIALITY perpetrated on the plaintiff.
 Defendant’s misrepresentation or omission must have been material, meaning a reasonable investor would likely consider the c) Rescission: which would involve the
misstatement or omission to be important in determining whether to buy or sell. return of the price paid or the securities
 What about the materiality of a contingent event? sold by the plaintiff, or the difference
- Basic Test: evaluate the probability that an event will happen and the importance of the event, if it does happen. There are four between the original sales price and the
possible results of the test… subsequent sale price by the defendant.
- ONE: contingent event could have both a high probability of occurring and a high magnitude of importance it does occur. IF SO, d) Benefit of the Bargain Damages: which
then MATERIAL. would only arise in a limited number of
circumstances in which there is a
- TWO: contingent event could have a low probability of occurring and a low magnitude if it does occur. IF SO, NOT MATERIAL. difference between the value received
- THREE: Even an event that has a high probability of occurring but a low magnitude if it does occur, it is STILL NOT MATERIAL, and the value promised, which may be
since it is unlikely that something of little significance would impact the stock price. established with reasonable certainty.
- FOUR: Low possibility of occurring but high magnitude of occurring, is what MOST MATERIALITY CASES ARE ABOUT. (Examples e) Punitive Damages: (not available in a
include unlikely mergers.) private 10b-5 action)
RELIANCE CLAIMS NOT COVERED BY 10B-5
 If a Plaintiff brings a private action, there must also be a showing that he or she actually AND justifiably relied on the defendant’s - Rule 10b-5 is NOT about
misrepresentation. (Can be referred to as “transaction causation” which means the misrepresentation caused the Plaintiff to engage in correcting every wrong; it is
the transaction) ONLY about full disclosure. Once
 Reliance on Omissions full and fair disclosure is made,
- Generally, no duty to disclose UNLESS officer of the company had duty to speak but did not. the fairness of the transaction is
- Given the duty to disclose, a person is entitled to rely on silence as a “statement” that there is no material information that the not an issue under federal law.
company is required to disclosed, which has not been disclosed. Thus, reliance is presumed and is a rebuttable presumption. - Rule 10b-5 claims MUST touch
 Fraud on the Market and concern the purchase or
- Creates a rebuttable presumption that, even if the Plaintiff did not hear the misstatement, there was still reliance. This theory sale of securities.
creates a presumption that the investor relied on the integrity of the market price. - The question under 10b-5 is NOT
- Invoked when: there is a public affirmative misrepresentation and the market is an efficient market (i.e. the stock market). whether a wrong had been
committed.
- CANNOT be used in private transactions.
- To Rebut: Defendants can Show
- The question under 10b-5 is
whether a wrong has been
 Misrepresentation did NOT affect the market price;
committed which meets all
 Defendants issued corrective statements, which were also priced into the market;
elements of 10b-5.
 Plaintiffs would have bought or sold ANYWAY, even with full disclosure (for example if a Plaintiff had to sell his stock
because he had other financial difficulties); OR
 Defendant did NOT rely on the integrity of the market.
CAUSATION: THAT THE MISREPRESENTATION CAUSED THE LOSS.
 INSIDER TRADING
State Law on Insider Trading
3 DIFFERENT STATE STANDARDS ON
INSIDER TRADING:
1) Majority Rule: Except in
instances involving fraud,
officers and directors of a
corporation may trade in the
corporation’s stock without
disclosing material
information. (Note, while it is
called the majority rule it is
only the law in several states).
2) Special Circumstances Rule:
Makes certain exceptions to
the majority rule, taking the
position that a corporation’s
officers and directors have a
duty to disclose information
before they trade with
shareholders of the
corporation when these
circumstances are present:
 Information is highly
material;
 Officer or director
conceals his/her
identity or engages in
some other fraud or
deceit; OR
 Officer or director is
trading with an
especially vulnerable
person with no
understanding of
financial matters (for
example, an elderly
person).
3) Minority Rule: Sometimes
known as the Kansas Rule, it
takes the position that
corporation’s officers and
directors do have a duty to
disclose material information
whenever buying from a
shareholder, at least in face-
to-face interactions.
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Business Organizations – Attack Outline – Faiq
Rule 10b-5 & Insider Trading
DEVELOPMENT OF INSIDER TRADING LAW FEDERALLY
Insider trading involves a very specific trade under 10b-5 in which someone deceives by omission.
 The omission is that the person is in possession of material, nonpublic information, which, if known, would
impact the price of the security.
 In the past, there was a blanket duty to “disclose or abstain” from trading while in possession of material
nonpublic information. [See In re Cady, 40 S.E.C. 907 (1961); SEC v. Texas Gulph Sulfur, 401
F.2d 833 (2d Cir. 1968)]
 Eventually, SCOTUS limited restrictions on the use of nonpublic information to certain situations such as those
in which the use of nonpublic information could be traced to a breach of some fiduciary duty.
 It is important to note that insiders (and constructive insiders) have a duty to disclose or abstain. However,
they are not prevented from possessing material, nonpublic information. They just may not trade on such
information.
FACTUAL DETERMINATIONS TO AN INSIDER TRADING ISSUE
 Whether the information in possession of the person involved in the trade is “material”, nonpublic
information;
 How did the person involved come to have the information;
 What did the person do with the information; AND
 Was there a breach of a duty involved in the use OR the dissemination of the information?
** NO REQUIREMENTS OF RELIANCE OR CAUSATION. JUST A REQUIREMENT OF SCIENTER (INTENT) and
MATERIALITY.**
There are two types of insider trading: 1) Traditional Insider Trading and 2) Misappropriation.
TRADITIONAL INSIDER TRADING ANALYSIS:
 Did the defendant have possession of the nonpublic information?
 If NOT, then there is no insider trading. However, if YES the defendant did have possession of nonpublic
information, was that information “material?”
 If NOT, then there is no claim. However, if YES then the next step is to determine if the person was a(n)
 Insider, meaning they were an officer, director or majority shareholder (a typical measure of a
majority shareholder is a person who holds 10% or more of the stock); OR
 Constructive Insider, meaning someone like an accountant, underwriter, lawyer, or consultant who
has a special relationship of trust and confidence with the company; whose position provides
access to confidential information and the company has a reasonable expectation that the person
will keep the information confidential, AND the person does IN FACT have an obligation to keep
that information confidential by virtue of their position.
 If the defendant is neither an insider nor a constructive insider, then they are not liable under the
traditional analysis even if they traded on the information. However, that person may be liable under the
misappropriation OR tipper/tippee analysis.
 If the above analysis does reveal that the person was an insider or constructive insider, then they are
subject to liability for the trades under 10b-5.
POSSESSION OF INFORMATION DOES NOT ALWAYS = TRADING ON INFORMATION
 Limit in Civil Cases: “while in possession” raises a strong inference that the person traded on such
information, but it is rebuttable inference which the insider can disprove.
 Limit in Criminal Cases: is even stronger in favor of the insider because courts require that the government
PROVE the defendant used the information to trade.
Tipper/ Tippee Liability (Under the
Traditional Analysis)
TIPPER LIABILITY: TIPPER IS LIABLE IF THEY…
 Disclose material, nonpublic information to others; AND
 That disclosure is made in breach of a fiduciary duty of loyalty
(or in the case of a tippee turned tipper, with the knowledge
that the information was obtained as the result of a breach of
a duty of loyalty). Either way, the question is: did the tipper
obtain a personal benefit by engaging in the “tipping?” The
existence of a breach is measured by whether the tipper
personally benefitted, directly or indirectly, from the
disclosure. It can include: monetary benefit, quid pro quo, an
enhanced reputation, or even a “gift.”; AND
 Someone traded on that information. (Note, that a tipper is
liable if anyone along the chain of information dissemination
trades on the information, not just the tipper’s direct tippee.)
NO LIABILITY if: 1) there is no personal benefit, or 2) no one traded
on the information.
TIPPEE LIABILITY: TIPPEE IS LIABLE IF THEY…
 Receives material, nonpublic information which was
disclosed in breach of a fiduciary duty by an insider (for the
personal benefit of the insider) at the company whose stock
is being (or will be) treaded; AND
 The tippee knew or should have known that the tipper was
breaching a duty by providing the information (rememv\ber
that the breach of duty is measured by whether the tipper
received a benefit); AND
 The tippee trades on that information; OR
 Provides the information to others, and receives a personal
benefit, and someone trades on the passed along
information.
NO LIABILITY if: 1) tipper breached a duty, or 2) no one traded on
the information (either themselves OR another tippee).
TIPPERS CAN PROTECT TIPPEES:
Tippers may protect tippees from liability by not telling them what
the source of the information is. However, this would only shield the
tippees. The tipper themselves would still be liable if the remaining
elements are met.
 INSIDER TRADING
Misappropriation
O’HAGAN & MISAPPROPRIATION:
Prior to O’Hagan: in order to find liability, one needed to show that the defendant
breached a duty (or in the case of tippee liability, that the information arose out of a breach
of duty) to the company in whose stock the defendant had traded.
 asked about breach of fiduciary duty to the company
O’Hagan Onwards: the misappropriation theory broadens liability to include those who
breach a duty to the source of the information.
 asks about fiduciary duties to the source of the information and about whether the
defendant breached (or knew about a breach of) a duty arising out of a relationship of
trust and confidence (“RETAC”) to the source of the information
RULE OF MISAPPROPRIATION:
A person commits fraud in a securities transaction when he or she “misappropriates”
material, nonpublic information in a breach of a duty (typically a duty of trust and
confidence) owed to the source of the information, AND does not disclose his intentions to
trade to the source of the information, AND trades on that information.
 NOTE: the fiduciary duty here is not the one to the company but rather to the source of
the information.
ASSESSMENT OF INSIDER TRADING UNDER MISAPPROPRIATION THEORY:
 Did the defendant have possession of nonpublic information?
 If NOT, then no 10b-5 insider trading claim. If YES, then was that information
“material”?
 If the defendant was in possession of material nonpublic information, the next step is
to determine how the defendant acquired the information. Did that person acquire
the information under a RETAC? (Several relationships that are RETAC are: employee/
employer, attorney/ client, doctor/ patient, principal/ agent, family members, etc.)
 Assuming there was a duty to the source of the information and/or a fiduciary
relationship or RETAC, was the information within the scope of that duty? (Be aware
that many people unintentionally skip this question.)
 If NO, then no liability under 10b-5 misappropriation analysis.
 If YES, then the final step is to determine if the defendant traded using the material,
nonpublic information without disclosing their intention to trade to the source of the
information.
 If YES, then they are subject to liability for their personal trades under Rule 10b-5.
WHEN DOES RETAC EXIST?
 Whenever a person agrees to maintain information in confidence;
 Whenever the person communicating the material, nonpublic information and the
person to whom it is communicated have a history, pattern or practice of sharing
confidences, such that the recipient should know or reasonably should know the
person communicating the information expects confidentiality to be maintained; OR
 Whenever a person receives or obtained material, nonpublic information from his or
her spouse, parent, child or sibling (however, person receiving the information may
rebut and show there is no RETAC because there is NO history, pattern or practice of
sharing confidences).
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Business Organizations – Attack Outline – Faiq
Misappropriation and Tipper/Tippee Liability
TIPPER LIABILITY UNDER MISAPPROPRIATION: A TIPPER IS
LIABLE IF…
 The tipper is in possession of material, nonpublic information;
AND
 That material, nonpublic information was acquired either:
o By the tipper through a fiduciary relationship or a similar
relationship of trust and confidence (RETAC) with the
source of the information, in which there are fiduciary (or
fiduciary-like) duties, OR
o By the tipper as a result of somone else violating a
fiduciary duty arising out of a fiduciary relationship or
RETAC with the source of the information, AND the tipper
knew or had reason to know of that violation of duty;
AND
 The tipper discloses the material, nonpublic information to
others (i.e. Does he or she “tip” anyone?) and, as a result,
receives a personal benefit (Under misappropriation, the
existence of a breach is still measured by whether the tipper
personally benefitted, directly or indirectly, from the
disclosure); AND
 The tipper did not disclose his or her intention to disclose the
information to the source of the information; AND
 Someone who receives the information provided by the tipper
trades on that information. (Note that a tipper is liable if anyone
alone the chain of information dissemination trades on the
information, not just the tipper’s direct tippee.)
TIPPEE LIABILITY UNDER MISAPPROPRIATION: TIPPEE IS
LIABLE IF…
 Receives material, nonpublic information from someone else;
AND
 That information is provided (directly or indirectly) by someone
(who could be any tipper in a chain of tippers), violating a
fiduciary (or fiduciary-like) duty arising out of a fiduciary
relationship or RETAC with the source of the information; AND
 The tippee knows or should have known that someone
(meaning any tipper in the chain) was breaching a duty to the
source of the information by providing the information; AND
 The tippee trades on that information; OR
 Provides the information to others (i.e., tips and becomes a
tipper), receives a personal benefit for the tip, and someone
trades on that information (i.e., becomes a tipper).
Rule 14e-3 & Insider Trading Relating to
Tender Offers
RULE 14E-3
Rule 14e-3 creates liability if a person trades while in
possession of material, nonpublic information relating to a
tender offer that was acquired from the person or entity
making the offer (the “offeror”) once the offeror has taken
“substantial” steps toward making the offer.
14E-3 LIABILITY IS CREATED IF:
 A person (the “recipient”) is in possession of information
relating to a tender offer being made by someone other
than the recipient; AND
 The information is material; AND
 The recipient of the information knows or has reason to
know that the information is nonpublic information
which came directly or indirectly from the offeror, the
target company (i.e., the issuer of the securities sought
by the offeror), or an officer, director, agent, employee
or constructive insider of the offeror or the target
company; AND
 The recipient of that information purchases or sells (or
causes to be purchased or sold) securities of the target
company or the offeror at any time prior to the public
announcement of the tender offer, without first
disclosing the information (along with its source) to the
person with whom the recipient is trading; if, and only
if…
 The offeror has commenced or has taken substantial
steps toward commencement of a bid for the target
company (e.g., passage of a resolution about the tender
offer by the offeror’s BoD, formulation of a tender offer
plan, arrangement of financing to pay for all or a portion
of the tender offer, preparing the tender offer
documents/ materials).
** NO BREACH OF DUTY REQUIRED FOR LIABILITY**
 INSIDER TRADING
Short Swing Profits, Section 16(b)

Section 16(b) applies to any insider at a “registered” company, who buys or sells equity securities in that company within a 6 month period. It does not matter whether the insider purchases first and then sells or sells first and then
subsequently buys. Any profit that an insider makes in such a transaction must be paid to the company.

RULES OF SECTION 16(B):

 Applies to all insiders. An insider is considered to be an officer, director, or a shareholder holding more than 10% of the corporation’s equity securities. Section 16(b) applies to someone who was an officer or a director of the
corporation either at the time of the purchase or the sale. However, it only applies to shareholders who beneficially (directly or indirectly) hold more than 10% of the corporation’s equity securities both at the time of the
purchase and the sale;
 Applies only to companies that are required to register under the 1934 Act. Companies with more than $10 Million in assets and more than 500 shareholders of record are required to register with the SEC and are subject to
certain reporting and other requirements. Section 16(b) DOES NOT apply to closely held companies;
 Only covers transactions in a company’s stock or convertible debt;
 Enables a company to recover any profit made by an insider within a 6 month period. (In evaluating the profit, the insider does not get to identify specific shares that were bought and sold. Any transaction in a company’s
securities may be matched with any other transactions in those securities that occurred within a 6 month window to determine the maximum profit (with the exception of transactions made by shareholders (who were not also
officers or directors) when they were not holders of 10% or more of the company’s equity securities). That maximum profit is what is recoverable from the insider); AND
 Allows a shareholder of the company to sue derivatively on behalf of the company to recover the profit if the company does not bring or diligently prosecute a 16(b) claim.

SECTION 16(B) DOES NOT APPLY IN SITUATIONS IN WHICH:

 The purchase or sale of equity securities is involuntary (for example required by a preexisting contractual agreement); AND
 The specific facts of the situation do not create the possibility of “speculative abuse of inside information” (for example where a 10% shareholder, because they were at odds with the company, were extremely unlikely to,
and did not, have access to any confidential information or input regarding the timing of the transaction.)

20
Business Organizations – Attack Outline – Faiq
 Table of Contents
Agency: (PAGE ONE) Agency: (PAGE TWO)
- Actual Authority - Principal’s Liability
- Apparent Authority - Agent’s Liability
- Ratification - Duty of Principal  Agent
- Liability of an Undisclosed Principal - Duty of Agent  Principal
- Estoppel

1 2
Partnerships: (PAGE THREE) Partnerships: (PAGE FOUR)
- Characteristics - Expulsion
- Does a Partnership Exist? - Nature of Partnership Interests [UPA § 26]
- Attributes Arising Once a Partnership is Established - Rights of Partnerships in Management
- Limitations on Partnerships - Partnership Dissolution & Dissociation
- Joint Venture, Partnership by Estoppel and Agency Theory

3 4
Corporations: (PAGE FIVE) Corporations – Finding Liability: (PAGE SIX)
- Formation - Piercing Corporate Veil
- Characteristics - Preventing Piercing of Corporate Veil
- Shareholders - Piercing Corporate Veil of Subsidiary
- Board of Directors - Reverse Piercing
- De Facto Corporations vs. Corporations by Estoppel - Enterprise Liability

5 6
Fiduciary Duties (& Other Checks on Corporate Action): Fiduciary Duties (& Other Checks on Corporate Action): Fiduciary Duties (& Other Checks on Corporate Action):
(PAGE SEVEN) (PAGE EIGHT) (PAGE NINE)
- Powers of the Corporation - The BJR & Protection by Consulting an Expert - Corporate Opportunity Analysis
- Duty of Care & the Business Judgment Rule - The BJR & Failure to Act or to Monitor the Firm - Dominant Shareholders
- Procedural & Substantive Requirements for the Duty of Loyalty - Summary of Fiduciary Duties
BJR - Corporate Opportunity Doctrine & Its Defenses
- Affirmative Defenses to Duty of Care Violation - Requirement of Offering the Corporate

7 Opportunity to the Corporation

Shareholders & the Rights & Restrictions Associated
with Ownership: (PAGE TEN) 10
- Shareholder Ownership Rights
- How do Shareholders Vote
- Proxy Rules, Fights & Costs Associated
9
8
Shareholders & the Rights & Restrictions Associated
Issues of Control: (PAGE TWELVE) 12
with Ownership: (PAGE ELEVEN) 11 - Devices for Control (usually applicable in
- Shareholder Proposals closely-held or private companies)
- The Dodd-Frank Act, Director Nominations & - Limits on Control Arrangements
“Say On Pay” Shareholder Inspection Rights - Abuse of Control

21
Business Organizations – Attack Outline – Faiq

Issues of Control: (PAGE THIRTEEN)13
- Fiduciary Duties in Freeze Outs
- Employee or Shareholder?
- Minority Shareholder Protection
- Transfer of Control
Securities Law: (PAGE FIFTEEN)15
- What is a Security?
- Registration
- Private Placements (exempt from registering)
- Rule 10b-5
Insider Trading: (PAGE SEVENTEEN) 17
- State Law on Insider Trading
- Rule 10b-5 & Insider Trading
- Tipper/ Tippee Liability (Under the Traditional
Analysis)
22
Business Organizations – Attack Outline – Faiq
- Example on Shareholder Voting Schemes
Table of Contents
Issues of Control: (PAGE FOURTEEN) 14
- Shareholder Actions
- Derivative Lawsuit Summary
Securities Law: (PAGE SIXTEEN)16
- Claims Made Under Rule 10b-5
- Analysis of 10b-5 Requirements
- Damages in a 10b-5 Claim & Claims not Covered by Rule 10b-5
Insider Trading: (PAGE EIGHTEEN)18 Insider Trading: (PAGE NINETEEN)19
- Misappropriation - Short Swing Profits, Section 16(b)
- Misappropriation and Tipper/Tippee Liability
- Rule 14e-3 & Insider Trading Relating to Tender
Offers