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Business Associations Outline Fall Semester 2008 Afra Afsharipour General Overview: Economic and Legal Aspects of the

e Firm General Overview o The Firm

Old view owner and employees Excludes: suppliers, customers, creditors

New view firm as a Nexus of Contracts Owners + all involved parties connected by contract o Everything affected by the market. Firm as crossroads where all contracts intersect.

Role of the Corporate Lawyer Lawyers as value-creating transaction cost engineers How: identify and plan for transaction costs Why: the legal background matters

Making the Investment Decision Risk-return calculation o How do we quantify risk?

Probability x risk

Transaction Cost Factors & Choice of Organizational Form Bounded rationality No one can make a fully rational decision because no one has perfect information.

Opportunism Decisions made because of secret information not know by the other party

Team-specific investment The more team-specific the investment is, the more unsatisfactory a loose relationship will be.

Discrete contracting Relational

Single transaction Long-term contract Corporation

Form divides between Internal relationships between partners External relationships with everyone else

State-Provided Governance Structures (why join?) Efficiency, off-the-rack forms, rules established, dont know any better. Default vs. Immutable rules Default Rules: o o Off-the-rack rules; generally enabling. Provide parties w/ default rules that govern the relationship if the parties do not provide otherwise (subject to modification).

Immutable Rules: mandatory rules o Certain mandatory rules exist to protect firm members or negative effects of allowing firms to adopt different rules.

Tailored, Majoritarian and Penalty Default Rules

Agency Law o Background Rules Agent owes duties to Principal Fiduciary duty; duty of loyalty; duty of care A is put in a position of trust; must put Ps interest first Specific duties depend on the agency context

Agent has power to bind (create legal obligations for) the Principal Subject to limitations, eg where A has gone so far off the leash

Terminology

Agency Law: set of standard form rules that provide backdrop for Ks or market transactions among team members; govern relations b/w team members in firm & relations b/w firm and outsiders Agency Cost: cost of doing business is possible that agent may slack off, backstab, etc.

Agent: Someone who works for somebody else. BUT, if S/J are partners, they are each the agent and they are each the principal.

Principle: s/he to whom the agent answers

When does agency exist?

Def Agency exist where (1) one person (the Principle) consents that another (the Agent) shall act on Ps behalf and subject to Ps control and (2) A consents so to act

Agents Fiduciary Duty (FD) Key Concept of Agency

Duty of Loyalty: employee has to put his employer interest first. Default rule so that agents and principles know what to expect from each others.

CCS v. Reilly (1963) (while working for P, D solicits Ps clients, and then steels those clients when he quits a few months later. Court held that D was working fm himself, when he should have been working for D, and finds a breach of the duty of loyalty.

Rule A agent has a fiduciary duty to his/her principe.

Hamburger v. Hamburger (1995) (D-employee makes arrangments to start a company which will compete with his current employer; D takes out loan and rents office space. Court doesnt find breach of fiduciary duty.

Rule Employees are free to make logistically arrangements, like taking loans and leasing space, in contemplation of leaving current job. Rule Because D was intimately familiar with the pricing and clients list, he is free to use his general knowledge, experience, and memory, including remembered information" after he leaves o Cant steal proprietary information considered to be company IP, but can take general knowledge.

Employment-at-all

Def: At-will termination at any time for any lawful reason Right to discharge somewhat limited by deterrent factors/costs to ERs incl. lost reputation, subsequent service by less skilled / diligent work force.

Foley v. Interactive Date Corp. (1988) (P claims wrongfully discharged in contra to an implied K in fact. D argues at-will EE.)

Rule court will look at the entire relationship between parties and allows pleading of implied employment agreement

Rule Where no employment agreement is found, employment is generally at-will. Rule Principle doesnt owe FD to agent.

Three (3) possible exceptions to at-will doctrine (1) Discharges in violation of public policy (2) Discharges in violation of employee handbooks (unilateral contract). (3) discharges in violation of a covenant of good faith and fair dealing. (This had not been adopted.)

Manifestations of Consent/Authority in Agency Relations Generally, does Agent have authority to bind Principle

Actual Authority: when P manifests consent directly to A

o Express or Implied Implied authority is highly contextual,


often depending on prior practices or industry customs

Apparent Authority: when A is without actual authority, but P manifests consent directly to third party who is dealing with A o Express or Implied

Inherent Authority (not in restatements) o A gap-filler when the equities are in favor of holding the principle liable for the agents action even though it is near clear that the agent has neither apparent or actual authority.

Blackburn v. Witter (renegade Dean Witter investment adviser uses his position to defraud unknowing innocent clients into investing in non-existent stocks. Court holds Witter liable under theory that advisor was an agent acting with apparent authority. Facts tended to show Witter knew that he was a risk. Victims no savvy investers.)

Rule companies in better position to realize risk; most efficient mean to protect customers is to hold principle liable for acts of agent.

Sennot v. Rodman & Renshaw (P is defrauded by the son of a partner in the D-firm. Court finds no agency/liability for firm. Facts tend to show that P didnt rely on upon agency. P also didnt have clean hands in the transaction; P also a savvy investor.)

General Partnerships and Other Non-corporate Business Associations Partnerships

o Partnerships are governed by both statute and common law 4

Indiv. partners adaptability to changed circums favored over firms cont / adaptability

Formation

UPA 202 (a) the association of two or more persons to carry on as co-owners a business for profit forms partnership, whether or not the persons intend to form a partnership. (default presumption) Byker v. Mannes P &D had a number business together which they split profits and shared management.

Under 202 (a) if parties carry on as co-owners they from a partnership. 202(c)(3) presumes a person who receives share of profits is a partner, unless received for repayment of debt, service, rent, pension.

Hynanbsky v. Vietri key inquiry is whether the parties intend to be joint owners, or co-owners of business for profit. Court will look at behavior and deduce from of organization.

Ownership UPA 401 Partnership Rights and Duties (a) Each partner is deemed to have an account that is: (b) each P is entitled to an equal share of profits and is chargeable w/a share of the partnership losses proportional to the Ps share of the profits o presumption is equal share of both profits and losses

(c) partnership shall reimburse a P for payments made in the ordinary course of business. (expenses, etc..) (e) a payment or advance made by a P which gives rise to partnership obligation constitutes a loan which accurse interest **(f) each P has equal rights in the management and conduct of the partnership of the business (h) a partner is not entitled to remuneration for services performed for the partnership o default rule, can K around

**(j) difference arising in ordinary course of business may be decided by majority vote. An act outside ordinary course of business or amendment to partnership agreement needs the consent of all the partners.

UPA 807 (a)&(b) settlement of accounts (1) creditors then (2) partner accounts. Partners are liable for shortfall or losses in proportion to their share. If money left over settled to partners account.

Kovacic v. Reed court holders that parties have contracted around default rules of 807. R, who contributed only labor to partnership, not liable to K for money losses K incurred through the partnership. On equities court holds that you only loss what you put in w/r/t to other partners. Shamloo v. Ladd court holds that services given to the partnership are not capital contributions, unless the partners contract around default rules 401(h). Parties who invest cash will be settled first. Parties who invest labor, only receive share or profits after capital accounts settled. Partners free to contract around this so that labor could be consider cash deficit in their account. Cobalt v. High dispute between the parties about an aspect of their business

Rule each partner has equal right to manager partnership. 401(f). Disputes resolved by majority rule. If deadlock, dissenters can move to dissolve.

Withdrawal

UPA 601, 801 - Provides easy exit default rules

Fiduciary Duties of Partners o Basic statutes

UPA 301 Each partner is an agent to the other, and can bind other in for ordinary course of partnership business, where (1) has express authority or where he is acting with apparent authority (unless not authorize and 3rd knows or has reason to know), and (2) where not apparently carrying out ordinary business, only where authorized to bind. UPA 306 partners are joint and severely liable for obligations of partnership undertaken while they are partners UPA 103 - Fiduciary duties rules are immutable and cannot be waived rule. Cant eliminate 404(b) loyalty or 603(b)(3) loyalty during winding up. (a) Except as otherwise provided in subsection (b), relations among the Ps and b/w the Ps and the pship are governed by the pship agreement (b) The pship agreement may not: (3) eliminate the duty of loyalty (404(b)), but: o (i)[it] may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable or o (ii)the partnersmay authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty; If in the Partnership

(4) unreasonably reduce the duty of care under Section 404(c) ; (5) eliminate the obligation of good faith and fair dealingbut the pship agreement may prescribe the standards by which the performance of the obligation is to be measured UPA 103b(4) Cant Unreasonably reduce the duty of care o Duty is already so low. UPA 404 duties owned to partners duty of loyalty and care (default pretty much same as case law). (a) The only fiduciary duties a P owes to the p-ship and the other Ps are the duty of loyalty and the duty of care (b) A partners duty of loyaltyis limited to the following: o (1) to account to the p-shipforanybenefit derived by the P [from]the p-ship business orp-ship property, incla partnership opportunity (Meinhard); o (2) to refrain from dealing w/ the p-ship as a party having an interest adverse to the partnership (Storch); and o (3) to refrain from competing w/ the p-ship Violation of the duty of loyalty cannot result in divestment of the Ps original capitol investment (c) A partners duty of careis limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. (Ferguson) (d) A partner shall discharge the dutiesand exercise any rights consistently w/good faith and fair dealing Meinhard v. Salmon court finds duty of loyalty exist between partners, thought duty not explicit in their agreement. Partner show failed to disclose information, and take advantage of business deal withheld from partnership, liable for breach. Issue was the withheld deal close enough to the partnerships ordinary course of business. Yes. The punctilio of an honor most sensitive. Thought of self was to be renounced, however hard the abnegation. Only through disclosure could opportunity be equalized. [note] dissent believe parties where in JV and therefore the withheld deal outside scope of the JV.

FD Duty Loyalty

404 Definition Fiduciary may not engage in self-dealing; P is obligated to render true accounts, disclose; give accounting; not compete Vigneau v. Storch Engineers P self deals and resigns. D refuses to pay him his partnership interest b/c of breach of duty of loyalty/disclose. P uses for distribution of his share of partnership.

o Rule Capital contribution not a form liquidated


damages for breach of loyalty.

o Rule Partnership can only seek damages equal to

profits earned from the activities constituting breach of loyalty.

Starr v. Fordham Law firm partner leaves firm. Remaining partners give him a much smaller share then he deserved, They court holds they are self-dealing to increase their takes, and have breached duty of loyalty.

Note court ruled on basis of equities, fairness, and expections of the parties. But would have been the same under 404 duty of loyalty. In this case there was a K around loyalty- allowing Ps to determine payouts so each would get something different. BUT COURT finds that the payout here was too low. So while loyalty was K around, there is still an implied covenant of good faith and fair dealing.

EACH PARTNER IS TO BE TREATED FAIRLY AND WITH CANDOR AND NO ACTION IS TO BE DONE FOR SELFDEALING- Unreasonable K around Duty of Loyalty is still subject to judicial oversight. Cant unreasonably limit the duty of good faith even if limit loyalty

o Duty of care
404 Definition : breached where conduct is grossly negligent, reckless, intentional misconduct, or unlawful. Ferguson v. Williams Williams alleges Ferguson violated duty of care; evidence shows that Ferguson was a bad business person. Court uses gross recklessness standard, and finds no breach.

Rule the common law care required is minimal. Bad decisions arent enough. Would have been the same under 404.

Dissolution and Dissociation o Dissolution Formal Winding Up Process o General Dissociation: partner no longer part of partnership By own choice then dissolution Wrongful dissociation triggers byout. Dissolution: process of ending a pship; the beginning of the end Termination: the end of a pship Process Elect to Dissolve Windup business lastly Termination

Analysis & Framework of Statutes Analysis for Dissolution upon Dissociation

601 defines dissociation.

o 601(1)- Partner gives notice he wants to leave


(Partnership at will) o So we go to article 8- Winding up of partnership

603 / 801

o If at-will dissociation under 601 (1) then 801(1)


At will dissociation company dissolves

o If dissociation under 601 (2)-(10) 701


Death, kicked out, etc. transfer of interest

802 (add 802) partnership continues through winding up.

UPA 601 Events causing dissociation (1) Partnership having notice of partners express will to withdraw (2) agreement event in partnership agreement (3) partners expulsion pursuant to partnership agreement (4) partners expulsion by unanimous vote if o o (i) unlawful to carry on business with that partner (ii) transfer of substantially all of partnership interest, other than for security reasons, or by court charging interest (iii) 90 days after charter revoke, filed for dissolution or equivalent (iv) partnership has been dissolved / wound up.

o o

(5) by judicial determination b/c o o (i) partner engaged in wrongful conduct adversely/materially affect business (ii) partner willfully breached duty owed to partnership or partners.

UPA 701 Purchase of dissociated partners interest Sets out rules for determining and performing a purchase of a dissociated partners shares.

UPA 801 Events cause dissolutions and winding up.

(1) partner dissociates by will, under 601(1) (2) term of partnership ends (3) occurrence of event in defined in partnership agreement (4) partnership becomes unlawful (5) partners requests judicial determination (6) transfer of interest request judicial determination

McCormick v. Brevig court forces dissolution because of dissociating partner, even through remaining partners want to keep business operation. If at-will dissociation, dissolution mandatory unless parties K around.

Dissolution Payouts / Process - 807 On dissolution, assets sold and the payout in order: (1) creditors (2) partnership accounts (3) profits/losses distributed or shared by partners.

Prof notes that one can always that equities of dissolution are unfair. If dissociating partner has only been partner for a few weeks w/established business

Wrongful Dissociation A partner, who is wrongful dissociated, cannot build for control of the company. They cannot order dissolution, and if the partnership is for term, must wait until the end of term to receive their buyout price. 602 wrongful dissociations (b)(1) if in violation of the agreement (b)(2) if partnership of term, if before term completes.

o Can withhold his payment until term is completed


(c) partner who wrongful dissociates is liable for damages cause by dissociation in addition to any other obligations to the partnership or partners. o Not wrongful if another partner had left within 90 days

If wrongful no dissolution, goto 701. 701 (c) provides for damages against wrongful dissociated partner.

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701 (h) if a partnership for a term, the buyout price based on value at time of dissociation 701(b), but it is not payable until the expiration of the term. Unless, dissociated partner can show that early buyout would not cause undue hardship to the partnership. [Note] that a wrongfully dissociate partner can still use 801 (5) to can seek judicial dissolution Impracticable to carry on, economic purpose unreasonably frustrate, or contrary conduct by another partner.

Page v. Page in an unclear partnership agreement, court holds it is at-will (not for term, unless specifically Ked for). McCormick v. Brevig

Family farm

Drashner-

Alcoholic partner can be wrongfully disassociated

Fiduciary Limits on Expulsion of Unwanted Partners

601(3)- Per agreement can expel a partner. But must be reasonable Bohatch Cannot expel a partner absent an agreement. Would require judicial determination.

601(5) a partner can be dissociated on application by the partnership or another partner, the partners expulsion by judicial determination because (i) wrongful conduct that adversely/materially affected biz. (ii) willful or persistent material breach of agreement or of duty owed to partners (iii) conduct relating to biz that makes it not reasonably practicable to carry partnership

Bohatch v. Butler and Binon where partnership agreements creates a procedure for expulsion, court allows any fundamental schism that sharers mutual trust to be valid reason. P tries to aruge that Duty of loyalty extends to a duty to report partners who are overbilling. Court disagrees and finds no duty to remain partners with a whistle blower.

Contracting to Prevent Opportunistic Withdrawal General partner leaves, taking clients; partnership agreements can define acceptable protocol.

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Meehan v. Shaughnessy partner leaves taking clients, firm wants damages. Dissocation at-will OK under agreement, but breach of FD. Court finds damages (unfairly stealing clients). Acceptable Preparation: logistics, eg looking for office space, etc. Violations: handling cases so collection would come later, misrepresenting intention to leave, failure to fully disclose info to clients, etc.

Partners as Agents Allocating the Risk of Loss in Transactions w/ 3rd parties.

o General Law of Agency (w/r/t to partners) P may be liable to 3d party


on transaction conducted by A if A was actually or apparently authorized to enter into transaction

o UPA 301 - Defines extent of liability of a company for actions of its partners
(1) Each partner is an agent of the partnership for the purpose of its business. Act of a partner for apparently in the ordinary course the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person the partner was dealing knew or had received a notification that the partner lacked authority (2) Where no apparent authority partner can only bind partnership through acts explicated authorized

o PA Proporties, Inc v. B.S. Moss. party A and B in form JV. A can bind B
to agreements with 3rd parties w/o Bs knowledge or consent of actual authority. A only needs to apparent authority. This is especially true that A can bind B where B would receive up side of the deal.

Prof note professor very concerned with the equities, and asking who is in the best position to bear the burden of risk.

o Haymond v. Lundy - ??? need rule/summary o Dow v. Jones LLP partnership tries to escape liability for malpractice
resulting from a case tried by one its ex-partners after the partnership received a cert of dissolution. Court: YES, still liable, trial conducted while winding up; LLP obligated to complete work already in process at time of election to dissolve. Partnership still liable for work of its partners will winding up. (individuals may not be liable but the Business is bound by the acts of a partner)

Rule

Other Non-Corporate Business Associations o Joint Venture: Sub-category of general partnership. Pship for a particular purpose. Line between venture and a simple general partnership and JV is very thin/dull so care is needed to distinguish. Explicit agreement is best.

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Limited Partnership: Limiter partners are passive owners, w/ limited exposure to liability. Also limited power / involvement; cant actively participate in the business w/o sacrificing limited liability status. General partners actively participate in business and have full liability. Uniform Limited Pship Act (2001) 102(8)-(13), 107, 110, 301-303, 401-404, 603, 604 Defining Characteristics Separation of ownership and management functions Firms continuity / adaptability to changed circums favored > inds adaptability Limited Liability Company ULLCA 202, 203, 303, 404, 601, 701, 801 Defining Characteristics Partnership-like or centralized management Limited liability Adaptability to changed circumstances Limited Liability Partnership RUPA 306, 1001; ULPA 102(9), 404(c) Designed especially for professional partnership; lawyers, doctors, accountants, which are often, not allowed to incorporate

The Corporate Form and the Specialized Roles of Shareholders, Directors and Officers. General / Introduction / Incorporation Process o o Directors, Officers, Shareholders 109 When Articles are filed- the named individuals can amend the bylaws As soon as a shareholders buy stock they have the right to amend, repeal and make bylaws Divest named individuals

In the articles of incorporation the power to amend, repeal and make bylaws can be given to the directors but will not divest the shareholders

o 141(a)
Directors

141 - Power to manage company, unless otherwise stated in the certificate of incorporation

Default rule Decisions made by the board are made by majority vote

Nominated by sitting board; elected by plurality (see below). Get paid, but do share in the profits Can own shares, or be officers (inside directors)

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Outside directors are not shareholders

Individual directors have fiduciary duty to shareholders and corporation Usually held to a business judgment rule standard 141(d) staggered boards; can have up to 3 classes of directors, only one of which is up for election each year; can be in Articles, or bylaw passed by shareholders; may also be tied to classes of shares. 109- Power to amend and repeal bylaws

o 142

Officers DGCL 142

142 - Hired by directors to oversee day-to-day 142 - Officers titles and duties are specified in bylaws, o Except, all need a corporate secretary for keeping and verifying corporate records.

Officers are agents of the corporation, with a fiduciary duty. Statutes relativity silent on the duty of officers Sarbanes-Oxley requires CEO/CFO to certify financial reports.

Shareholders those who own an interest in the corporation They vote, sell and sue Risk bears and residual claimants No liability to corp / no FD to Shares fungible Rule All statute hold that shareholder receive voting power, but management power still with Directors unless otherwise or provided in the articles of incorporation. o Shareholders normally: assent, request, or recommend. Directors can initiate an amendment to the articles of incorporation. Since Directors wont move to curtail their own power, this rule is effectively immutable. to add control of ordinary biz decisions, that must be done through the articles of in corp.

o Rule The MBCA and Delaware default rules are that only

o Rule Shareholders can initiate changes to the bylaws, but not

Can call meetings and vote to make recommendations.

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109(a) can modify, amend, or revise bylaws

CA, Inc v. AFSCME Employee Pension Plan Court holds that a proposed bylaw requiring and specifying the conditions under which the directors must reimburse shareholders for the expense of nominating directors is invalid because it restricts the directors from exercising their fiduciary duties. Rule under 102(b) and 109(b) bylaws can only give process oriented restraints on management of the company, and cannot restrict directors full power to exercise their fiduciary duty.

Certificate of Incorporation General

102 Contents of Certificate; longs list.

Amending

241 -- Before Share sold; by majority of incorporators, or directors if elected. 242 -- After Shares issued; directors propose amendment; can call special meeting, or wait until annual meeting; give notice and explanation of shareholders; needs majority of outstanding stock, or majority of outstanding stock of each class of stock entitled to vote. 242(b) only the board can initiate amendment of process for Certificate

o Shares

Authorized Shares Number of shares the company is permitted to issue. The charter must specify the amount. The numbers affect will affect the value in relation to the shares issued. If the company is authorized for 5 million shares, and you only issue 10K shares, substantial room for signification dilution Administrative different; Delaware charges a fee per share. More shares, the more fees

Outstanding Shares The number of shares the corporation has sold and not repurchased. Authorized but unissued shares are shares that are authorized by the charter but which have been sold by the firm

Types Common Stock combine residual claimant status and voting rights

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Preferred Stock given to different investors with different incentives like dividends or liquation status; usually have limited or no voting rights.

Classes

Shares can be divided in to different class with different voting rights. For example, a certain class might have the board to elect 25% of the directors, or might have 5 votes per share dual class common. Needs to be in Article of Incorporation.

Shareholders are residual claimants. With common stock, the majority holders can liquidate and take the initial investment, or whatever is in the bank account. Using Preferred stock is the best means to adjust the value of the shares with a liquidation preference.

Voting Rights

Default Rules - DGCL 216 (1) Majority of shareholders entitled to vote = quorum o Unless AOI say otherwise/Can never be less than 1/3 of shareholders entitled to vote

(2) Decision other than election of directors need affirmative vote of a majority of shares present or in proxy, which are entitled to vote on mater (3) Directors plurality of those entitled to vote (4) Where a separate vote by class is require majority of share of that class = quorum; in all matters, except election of directors, need a majority affirmative vote by those present.

RULE 212 Straight voting default rule One share, one vote, per director Each director is separate item to vote . A has 15 shares. A can cast 15 votes for each director up for election. One person with 51% of share can then elect all of the directors. Proxies are allowed o o Proxy must be granted authority in writing

Variations on the Default Rules Cumulative Voting

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o Shareholder can vote: shares X directors can concentrate on


one or more directors. By concentrating their votes, minority shareholders have an increased likelihood of electing their director to the board. Example, A has 100 shares; 3 directors up; A can vote 300 shares in total, and vote them for one or more directs.

o Equation to determine the number of shares required to elect X


number of directors: SX / (D +1) . S= number of shares voting X= number of desired directors D = number directors up for election Example, to elect 2 directors where 100 shares are voting for 5 directors

100 x 2 / (5+1) = you need 33 shares. +1

Staggered Boards - 141(d) o o Only some directors are elected per. Protects from hostile proxy fights, but most stock holders activists, dislike as they protected from accountability.

Dual Class Common Stock o Different number of votes for different class of stock (Google)

Annual Meetings

DGCL 211

(a)(1) unless otherwise stated in the Articles or Bylaws, directors can call the time and place of meeting; (a)(2) Directors can authorize in their sole direction that shareholders may participate via remote commutation. (b) if not written consent in lieu of meeting, an annual meeting shall be held to elect the directors; written consent to elect directors must be unanimous. If less than unanimous directorships must be vacant at time of election. [gets around Hoschett v. TSI

DGCL 228 allows that unless otherwise stated in the certification of incorporation, any action required to be done in meeting, can be done without a meeting, by written consent of a majority shareholders or quorum as designated in the AOI Most public companies opt out of this provision

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Hoschett v. TSI Rule . A written consent provision does not negate the requirement of having annual meeting. A vote to elect directors by written consent does not satisfy the annual meeting requirement in DGCL. 228 allows the election of directors by consent but does negate the meeting requirement. The court orders a meeting.

Policy: meetings are an important means for shareholders to keep the directors and management accountable; a way to for shareholders to voice their concern. Many public companies opt of this. Some companies keep, so that they can cut down on the costs of meetings. Current law Section 211 (b) revises this, and allows voting and election of directors in lieu of a an annual meeting, under certain circumstances.

Removal of Directors

DGCL 141 (k) -- Directors may be removed, with or without cause, by holders of a majority of the shares then entitled to vote at an election of directors, exceptions

o Staggered board (1) Unless the certificate of incorporation


otherwise provides, in the case of a corporation whose board is staggered, shareholders may remove only for cause (if not up for election); or

o Cumulative voting (2) In the case of a corporation having

cumulative voting, if less than the entire board is to be removed, no director may be removed without cause if the votes cast against such director's removal would be sufficient to elect such director if then cumulatively voted at an election of the entire board of directors, or, if there be classes of directors, at an election of the class of directors of which such director is a part.

Murray v Conseco, Inc. (Indiana): Articles of incorp dont have provisions re removal of Ds. Murray elected to Board, removed by Board. Argument: can only SHs remove him? Held: Board w/in authority in removing Murray. Alderstein v. Wertheimer (DE): P controls 75% of stock and is on board. Board calls meeting, but springs a vote on him to kick P off board and issue new shares to 3rd effective wrestling control of company of P. P has no notice of substance of meeting as controlling shareholder, he could have kicked all other board members off he know.

Court reverse vote on general farness. Board has FD to shareholders. P in dual role, had right to know substance of meeting before hand. Rule removal rules modified by fairness consideration and FD. o As controlling stockholder, the board must notify him.

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Initial Issuance of Securities o Securities Act of 1933 o Regulates offering and sale of new securities

THE SEC Created in 1934 Act Independent Agency Created to enforce securities law Creates rules and regs to make securities law more effective

Security Any note, stock, bond, debenture, investment k, or any instrument known security Look to see whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.

Registration of Securities Securities Act 1933 requires that all securities for sale must be registered with the SEC or meet an exemption Registration Description of Business Description of security to b offered to sale Info about the companys management, directors Current financial statements o Basically info to lead to sound investments

Exemptions from Registration Intrastate Exemption Sales by a local company to local investors for local use

Regulation D: provides three exemptions

Rule 504- Exemptions for some firms who sell up to $1million of their securities in a 12 month period Rule 505 o o Offer up to $5 million dollars in any 12 month period Only to accredited investors (banks etc.)

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Rule 506

o safe harbor under section 4(2) of the 1933 Act


o o Raise unlimited amount of capital To accredited investors and 35 others o 35 others must be Sophisticated investors

Must give non-accredited investors disclosure documents

Financial Statements

Governance in Publicly Held Corporations o General/Introduction [missed class / no notes] Unique Characteristics of Publicly Held Corporations National Market System and EMH o Natl Market System: virtual location where anyone can buy/sell shares IPO: initial public offer, when initial SHs can sell their shares o Efficient Market Hypothesis (EMH) Liquidity: where people are buying/selling, stock is liquid Valuation: you get what stock is worth, according to market Monitoring: people pay only what stock is worth Different Forms Semi-Strong: you cannot d1 `evelop a trading strategy that will beat the market by using publicly available info Strong Form: even if strategy is based on nonpublic info, still cant beat the market Institutional Investors Proxy Voting o Proxy Legal relationship under which 1 party is given power to vote the shares of another Person or entity given the power to vote Tangible document that evidences the relationship Federal Disclosure Rules (SEC)

[missed class / no notes]

Proxy Solicitation in Process and Shareholder Voting Proxy Either given the shareholder instruction or absolute discretion Is given the power to vote so the shareholder does not need to attend the meeting

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Can be used to pool votes especially for institutional investors

Concern about Activist Shareholders Hedge funds have been pursuing managers to make changes in how they operate the corporation o Marty Lipton: Today shareholder activism is ripping through the boardrooms of public corporations and threatening the future of American Business.

But, private equity firms have been acquiring a larger number of public corporations, and have proxies solicited in favor of them in the companys proxy statement.

Sec Proxy Rules Shareholder access to effective means of communication w/other shareholders Rule 14a-7 Solicitation Assistance to Shareholder o Requires a corporation that itself is solicit shareholders in connection with an annual meeting to provide specified proxy assistance to requesting shareholders Corporation must either 1. Provide shareholders a list of shareholders 2. Directly mail the requesting shareholders proxy material to shareholders and financial intermediaries

Rule 14a-8 Shareholder Proposals placed with Corp. Proxy Statement o o Allowing qualifying shareholders to put a proposal before their fellow shareholders And have proxies solicited in favor of them in the companys proxy statement.

Company responses to proposals Attempt to exclude on procedural or substantive grounds o Must have specific reasons to exclude that is valid under Rule 14a-8

Include with opposing statement Negotiate with proponent o o Wide range of possible comprises If the proposer is powerful (Calpers) the board will just negotiate s solution rather than put it to vote.

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Adopt proposals as submitted.

Process for Excluding a Proposals Management files a notes of intent to exclude o o Accompanied by an opinion of counsel if any of the state reasons rely on legal issues Under rule 14a-(8)f, management must notify the shareholderproponent of remediable deficiencies in the proposal and provide an opportunity for them to be cured.

Oftern Proponets send out a press release to shareholders

SEC Response Staff level action o o o Staff determines can be excluded; issues a no-action letter Staffer determines should be included; notify the issues Intermediary options notices of deficiency

Procedural Exclusions Proponent does not meet ownership/format guidelines

o 14a(8)(b) Must holds $2000, or 1% of the companies securities


continuously for 1 year..

o 14a(8)(c) One per meeting o 14a(8)(d) Can only 500 words o 14a(8)(e) if special meeting, no previous yearly meeting, or

date more 30 days from previous year, then a reasonable time before meeting. Otherwise 120 days before date of the last published proxy in the previous year. issuer must provide proponent with opportunity to cure most errors within 14 days after submission.

o ** 14a(8)(f) if fail to comply, can be exclude with notice, but

o 14a(8)(g) burden on company to show it should be exclude o 14a(8)(h) must send representative to meeting for vote.
Substantive exclusions: o Rule 14a-8(i): Grounds for mgmt to refuse to include SH proposal in the corporate proxy 1) Not a proper subject of SH action under state law; 2) Would cause corp to violate law; 3) Violates SEC proxy rules, incl 14a-9, prohibiting false or misleading stmts 4) Personal grievance; special interest 5) Relevance. Relates to <5% of assets and of earnings and is not otherwise significantly related to the companys business (Iroquois);

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6) Would be beyond mgmts power; 7) Relates to ordinary business; Function of management 8) Relates to the election of Ds 9) substantially implemented. +more see statute. Process for Excluding a Proposals Management files a notice of intent to exclude o o Accompanied by an opinion of counsel if any of the state reasons rely on legal issues Under rule 14a-(8)f, management must notify the shareholderproponent of remediable deficiencies in the proposal and provide an opportunity for them to be cured.

Often Proponents send out a press release to shareholders

SEC Response Staff level action

o Staff determines whether can be excluded; issues a no-action


letter meaning the SEC wont take object to taking the action (exlusion). o o Staffer determines should be included; notify the issuers Intermediary options notices of deficiency

Lovenheim v. Iroquoiss - P wants company to studio force feeding of geese. D defends on basis of relevance; less the 5% of companies revenue Rule 14a-8(i)(5). P argues rule allows for proposals that significantly relataed to business.

Holding otherwise significantly related includes ethical and/or social significance. The proposal only asked for a study, doesnt interfere with management.

Rule shareholders can bring up issue by using nonbinding language (no management interference under 14a-8(i)(7)) and defend relevance w/ significantly related to business under Rule 14a-8(i) (5). Goeverance Related Shareholder Proposals Governance-Related Proposals US Bancorp, Request for No Action Letter: SHs requested Board to take all steps necessary to cause annual elections for all Ds (current system w/ staggered groups). Board requested no action letter under 14a8(i)(6) no basis that such change would require amending the Article, which can only be down by a vote the shares (DE law doesnt allow board to charge Articles) o Holding -- > SEC refused to issue no action letter, proposal passed for Board to take all action, including amending Articles.

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Communications and Access to Corporate Information Missed class / no notes DGCL 220 Inspection of books and records. (b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from: o (1) The corporation's stock ledger, a list of its stockholders, and its other books and records; and o (2) A subsidiary's books and records, to the extent that: a. The corporation has actual p ossession and control of such records of such subsidiary; or the extent the corporation can control the subsidiary (might be illegal) (c) if corp refuse, shareholder can as court to force access (d) directors entitle to records that reasonable relate directors position Proper Purpose: purpose reasonably related to such persons interest as a stockholder SEC Act 14a-7 Shareholder desiring to make proxy solicitation may ask corp for 14a7 assistance corp then w/ choice b/w mailing proxy material for SH (at SH expense), or providing SH w/ list of SHs [usually choose directing mailng; more control of time.] Conservative Caucus v Chevron Corp. (DE): P-Corp wants SH list to communicate w/ other SHs re risks of involvement in Angola. Held: P entitled to list, other improper purposes irrelevant if proper purpose exists. RULE Burden on corporation to show lack of proper purpose.

Fiduciary Duty, Shareholder Litigation, and the Business Judgment Rule Role of Fudiciary Duty and The Business Judgment Rule o Duties of Corporate Fiduciaries; Business Judgment Rule Duties of Fiduciaries Directors are supposed to run the corporation for the benefit of shareholders o No actionable duty of Ds to make most money possible for SHs o BUT, there may be market consequences for Ds/Os that fail to make SHs rich FIDUCIARY DUTY Duty to the Corporation Officers are the ones that really run corps; Ds delegate their duties to Os Methods of Enforcement o Action brought by corporation at behest / under direction of directors o Derivative action brought on behalf of corp by 1+ shareholders Business Judgment Rule General: Director/officer have discretion to make business decisions relating the management of the company. o Bad decisions not enough shareholders have taken the risk the company may make mistakes, bad decision. Errors need to rise negligence to be actionable

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Gross negligence, recklessness, unlawful fraud, conflict, self-dealing, etc. o Judicial presumption that Ds have acted in accordance w/ duty of care, loyalty, and good faith o Held to an abuse of discretion standard o Shareholders have burden to show enough evidence to overcome presumption Shlensky v Wrigley: Bad business decision does not constitute negligence. Dismissed.Suit against Wrigley (as director) for negligence / mismanagement, seeking damages & order for lights on baseball field and night games. Dodge v Ford Motor Co.: SH suing D for bad decisions of upgrading facilities and lowering price of cars rather than distributing dividends to SHs. Held: Ford could pursue upgrading facility, but because of the large amount of cash on hand, and continuing revenue, court orders Ford to pay dividends. Court believes Ford abused its discretion. o Note: his would never happen today; Ds have more discretion, esp re dividends

DGCL 141-A o The business and affairs of every corporation organized under this chapter shall be managed by or under the discretion of a board directors, except as may be otherwise provided in this chapter or in its certificates of incorporation DGCL 144- Interested Directors o A transactions shall not be voided even if an interested director or officer is involved, unless the majority of the disinterested directors vote for it. o Or the Majority of the shareholders approve o Or the transaction is fair to the corporation at the time. Fiduciary Duty of Loyalty- Includes Duty of Good Faith o General Core requirement that directors favor corporations interests over their own All FD claims are concerned with the process/procedure used to evaluate, disclose, or make a decision. In many case, good procedure will thwart any evaluation of the substance (i.e., deference to BJR). o Usurping of Corporate Opportunity Factors/elements Opportunity closely related to business in which corporation is engaged Director found out about opportunity in connection w/ her duties Offeror is intending opportunity to go to corporation Opportunity is something director should reasonably think would be of interest to the corp Director / senior executive knows opportunity is business in which corp is actually engaged or plans to be engaged in (regardless of how directors finds out about opportunity) Delaware Factors( Guth/Broz) Ct analyzes equitable factors; you can ask the Board for permission, but dont have to; deference to Court; not checklist, but analysis of equities. Balancing factors Whether D breaches FD by taking a bus opp depends on May Not Take IFo Corporation is financially able to take the opportunity o Opportunity is in the corporations line of business

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Corporation has an interest or expectancy in the opportunity between directors self-interest and that of the corporation

o Embracing the opportunity would create a conflict of interest


An Officer or director may take a business opportunity if: o o o the opportunity is present to the director or officer in his individual and not his corporate capacity the opportunity is not essential to the corporation the corporation holds no interest or expectance in the opportunity

resources of the company in taking or negotiating the opportunity. Northeast Harbor Golf Club, Inc. v Harris: Golf course, surrounding land for sale, purchased / developed by director. Held: Court choose ALI approach Broz v Cellular Info Systems: Cell territories for sale, Broz/RFBC purchased. Delaware approach: ct looks at equitable factors (line of business, financial ability, interest or expectancy, fairness), and weighs them all. Held: Broz not reqd to make formal presentation b/c he had reason to believe CIS not interested in opp / couldnt take advantage even if offered. Conflict of Interest General

o the director or officer has not wrongfully employed the

Modern rule: conflict of interest of transaction voidable only if transaction / conduct of interest parties as unfair to corporation If, interested parties, then must remove themselves from decision making process, and fully disclose position. OK to be an interested party, no okay to interest, or self-deal. Concern with process good procedure (disclosure, recusal) will settle concerns about substance of deal. Example: o Enron brokers signing sales agreement, collecting bonus, then canceling

Tyco -- interest free loans to directors; waive repayment altogether.

Globe Woolen v. Utica Gas and Electric

Rule conflict of interest transaction voidable; interested parties cant sit silently, must disclose, and must oppose transactions they know are ruinous Court finds Fiduciary Duty

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o o

A beneficiary about to plunge into a ruinous course of dealing, may be betrayed by silence as well as the spoken word. The trustee is free to stand aloof, with others act, if all if equitable and fair. He cannot rid himself of the duty to warm and to denounce, if there is improvidence or oppression, either apparent on the surface, or lurking beneath the surface, but to visible to his practice eye.

Self-dealing

Def: a transaction involves self-dealing if one person, or sets of person, controls both sides of the transaction, and that party receives corporate assets (benefits) to the exclusion of other shareholders, usually at their cost. Sinclair Oil Corp. v. Levin: D-majority shareholder directs Pcompany to not enforce breach of contract against a company he owns. No benefit to P, but great benefit to D at Ps cost. o BJR DOES NOT APPLY FIRST- GO TO INTRINSIC FAIRNESS RULE FIRST THEN DETERMINE BJR benefit to the exclusive of the minority shareholders of the subsidiary and at the expense of the minority shareholders.

o Intrinsic Fairness Rule used when parent has received a

Standard If a party is on both side of the deal, Burden on D-party to show transaction is/was intrinsically fair to complaining party. [note] If this was just business judgment rule, there would be a presumption that the directors act with good faith and due care. Then burden would be on P to rebut.

o Held: self-dealing transaction; D-majority sharehold breach

fiduciary duty to other shareholders by not enforcing contract. D cant fails to prove fairness. company. But there is an exception for the controlling shareholders, who hold a majority of the shares

o Note Stockholders dont usually have a fiduciary duty to the

Statutes

144 (cleansing conflicts) Interested Directors, Quorum (a) Transaction shall not be voidable solely because officer or director is an interested parties, IF o (1) Full disclosure of interest of authorizing body or committee, and body in good faith authorizes by majority vote of disinterested directors, even thought the disinterested directors be less than a quorum, OR

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o o

(2) Disclosure to voting shareholders and the shareholders approve in good faith (3) The transaction is fair to the corporation at the time it is authorized

(b) Interested directors can be counted in determining quorum.

Shapiro v. Greenfield definition of interested director. Issue is whether a director is per se interest because of family relationship. Held: remand for determination of directors interest.

Court summarizes ALI and MBCA as: an interested director is either (1) has an personal interest in the transaction, or (2) has lost independence because a director with no interest is controlled by a self-interested director.

Rule if it would reasonable to expect that a directors exercise of independent judgment would be compromised, the director will be deemed an interested director. Conflict and Executive Compensation Unless otherwise restricted by COI or bylaws, the Board has authority to fix compensation of directors (DGCL 141h); BUT, decision lies outside BJ Rules protection Delaware Fairness Test [for ex comp] (1) Benefit Prong: is there an identified benefit to the corporation; o Options plans must provide reasonable safeguards to ensure the corporation receives the benefit of its bargain.

(2) Value Prong: Is the value of the options reasonable in relation to the benefit.

o Under 157(a), the directors can approve stock options plan.


(b) In the absence of actual fraud in the transaction, the judgment of the directors as to the consideration of received for the options is to be considered conclusive. Should be reasonable in relation to the benefit

this basically, just like consideration analysis

Byrne v. Lord: Board approves stock option plan which gives fully vested options to directors as incentive to help ailing company; one director leaves right after getting the options which are fully vested. Stockholders share for breach of FD. Court uses special test for stock options: Court applies fairness test. Held: options did not provide reasonable safeguards to ensure corp would received benefit of plan because options were fully vested. Stock backdating Scandal Is back dating illegal?

Not necessarily illegal if:

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o o o o

No documents forged Backdating is clearly communicated to the companys shareholders Backdating is properly reflected in the earnings Backdating is properly reflected in taxes

BUT, these conditions are rarely met, making backdating of grants illegal in most cases.

Fiduciary Duties of Care and Good Faith o General; Minimal duty b/c of business judgment rule To have violation, director action must be grossly negligent or reckless o Policy arguments for limiting reach of Duty of Care Shareholder voluntary assumption of the risk Courts institutional competence in assessing business decision Incentives for directors to take risk and to innovate o Duty of Care in Decision Making Smith v. Van Gorkum: shareholders sue directors after directors make an uninformed recommendation to allow buyout at a below market shareprice. Court BJR assumes directors acted on an informed basis, in good faith and in the honest belief that action was in best interest of the company. Where no informed, BLR doesnt apply. Court Duty of Care: Representation of the financial interests of others impose on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. Rule Breach of Duty of Care Party must prove gross negligence by directors who failed to inform themselves of all material information reasonable available to them. Defense to Duty of Care: D can show Entire fariness of the transaction o (1) Fair price and o (2) fair dealing Consequence of Smith was shocked incredulity. Nobody wanted to be directors because of increased liability. Process over substance; boards required to focus on decision making process to ensure that they are well informed, every disclosed and decisions have reasonable basis. Where the process is bad, FD may be violated. DETERMINE LIABILITY BJR Applies First- was there a good process to the decision making Burden is on P to show that D was grossly negligent and Directors Failed to inform themselves of material facts that were reasonably available. IF BJR is overcome by the P- substance of the Deal Then the Defendant must show that the deal was Fair- Entire Fairness Doctrine

o o

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1. That the deal got a fair price 2. And the deal was fair. If they cant prove it was fair then directors were liable for monetary damages Statutory Exculpation Provision DGCL 102(b)(7) - Statutory Exculpation Provision; In contents of the Certificate of Incorporation- Pretty Much Limits Duty of Care completely, BUT it leaves duty of loyalty Companies can include in their charter a provision eliminating or limiting the personal liability for director or shareholders for monetary damages for breach of fiduciary duty as a director, provide that the provision doesnt eliminate

o Duty of loyalty- no self dealing o Act or omissions in bad faith, intentional misconduct, or violation
of law 174, unlawful payment of dividend or unlawful stock purchase or redemption o for any transaction from which the director derived an improper personal benefit. Malpieda v. Townson: Shareholders sue the directors for violate of duty to of care for agreeing to a restrictive deal agreement and not soliciting other bids. o

Holding if all the P can show is a duty of care argument, then the statutory exculpation clause is a complete defense. [need to have statutory validity, and provision in articles]

Intersection of Duties of Care and Good Faith Landscape (1) Duty of loyalty o o Usurpation of corp opportunity Conflict of interest / self-dealing beyond gross negligence

o Bad faith/ breach of good faith (Caremark and Stone)


(2) Duty of Care o General Emphasis on all fiduciary duties is on decision-making process and procedure; bad procedure, failure to disclose/monitor, bad faith, can result in liability. Gross negligence

o Good process and bad results tolerated under BJR. 30

BJR doesnt apply where directors uniformed, or acting in bad faith.

In Re Caremark International: The shareholders sue Caremark brought in a derivative action for breach of duty of care. The shareholders claim the board was inattentive to the violations of the Anti-Referral Payment laws. Held: there is a duty to monitor but Caremark doesnt lose.

Court o Board must exercise good faith judgment that the corporations information and reporting systems in concept and design are adequate to assure that board appropriate information will come to their attention in a timely manner. Failure to do, under circumstances may render a director liable.

Rule/Test

o Duty to monitor beached when there is a sustained and

systematic failure to exercise oversight such as an utter failure to attempt to assure a reasonable information and reporting system will establish a lack of good faith, that is a necessary condition to liability.

Practical Consequence of Caremark: Created further emphasis on procedure used by boards to conduct business. Directors need to: o Be appraised of compliance, litigation and similar risk-related matters. After compliance situation has arise, board must be involved in the approved design of an effective complains and monitoring program.

Auditing Committees Major changes to strengthen. o Changes included:

(1) the independence and expertise of audit committee members; need to have a qualified financial expert. (2) the audit committees control over the financial audit process, including selection of the outside auditor; (3) communication between the audit committee and the board; and (4) internal communications between the audit committee, the CEO, the CFO, and individuals charged with carrying out the internal auditing function.

What is an Effective Compliance program

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Effective compliance programs generally consist of fie main areas. Assess ricks Establish/revise company polices to address ricks Establish procedures to ensure compliant with company policies. Training Reporting/monitoring Enforcement

Board and management oversight Implement improvements

Procedures and programs Closely tailored to a Companys particular business and associates legal risks Currently verifiable and effectively understood by all employees

Stone v. Ritter: shareholder lawsuit against directors for failing to comply with federal banking laws, resulting in big settlement to feds. Shareholders alleged failure to monitor under Caremark.

Rule Court applies Caremark standard but clarifies that the breach of good faith is a violation of the Duty of Loyalty (outside scope of exculpation provision) Caremark Standard necessary conditions predicate for director oversight liability; o o (a) the directors utterly failed to implement any reporting or information systems or controls; OR (b) having implements such a system or controls, consciously failed to monitor or over see its operations thus disabling themselves from being informed of the risks or problems requiring their attention.

Holding/Point failure to act, or bad process in decision making can be so bad to constitute breach of loyalty and avoid 102(b)(7) exculpation.

Miller v. Foodservice: Company has cause of action against CEO whole lied to board in bad faith. Liability attached. CEO has FD to board and company, and personal liability.

Special Aspects of Derivative and Direct Litigation

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General Direct and Derivative Suits

Direct Suit bring cause of action in the name of stockholder. Cause of action belongs to the shareholder as an individual. Arise from an injury directly o the shareholder. Derivative Suit Brought by a shareholder on corporations behalf. Cause of action belongs to the corporation as an entity. Arise out of an injury done to the corporation as an entity

Delawares Test Tooleys two-pronged standard to determine which type: o o Who suffered the alleged harm, the corporation, or the stockholders? Who received the benefit of recovery?

Policy Concern Directors might be interested parties, so they may not be inclined to bring a suit for the corporation against themselves, or a suit that would affect the interests of the directors Allows shareholders to hold directors accountable Plaintiff-side concerns o o o Any recover goes to the corporation (settlement or trial) Lawyer is real party in interest (they make huge contingent fees out of any recovery). Corporation also must pay plaintiffs legal fees if there is a substantial nonmonetary benefit.

Defendant-side Incentives o Strike Suits: o Settle to go away

Meritorious suits against insider defendants Indemnification: Corporation must reimburse directors expense if successful defense Settlement in which director doesnt pay anything deemed a success.

Demand on Directors General

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Shareholders are required to make a demand on directors for the desired action before bring suit against directors. o Analysis/Example,

If shareholder want corporation to sue to enforce a contract, shareholders must make demand on board. Board can then reject demand after consideration (show process) and then rely on BJR to defend their decision.

Importance Because, directors can demand rejection of demand with BJR, shareholders best shot against board it to show futility.

Futility Exception if the Shareholders can show that such a demand would be futile, the demand require will be excused. Shareholders must allege with particularity of facts why it would be futile.

Rule/Test: Demand will be excused if the plaintiff can create a reasonable doubt that

o (1) that the directors are independent and disinterested


(procedure) OR

o (2) that the challenged transaction was the not product of


informed business judgment (substance).

What kind of facts would show this: o o o o o Family ties b/w parties Financial interest of parties; parties doing business with each. Facts about his health; does he go on vacation; play golf; sickly,. Need to show more than just is age. Anything to show reasonable doubt.

Burden of demand once board consider demand, and invokes BJR, P must show the board is not disinterested. o Practice Point- Never make the demand, always argue futility as demand implies the board is not disinterested

Aronson v. Lewis Court holds that the facts alleged where not sufficient to excuse demand requirement. P had alleged that D had appointed the board, approved contracts at issue, and owned 46% of the stock. P argues that because the board approved agreement they will be liable, and as such would be suing themselves. Court holds that P needs to alleged facts with particularity that would show liability, facts that would show a problem with the process.

Director Response to Demand

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In re The Limited Inc. Shareholders Litigation Shareholder derivative claims. TO PROVE Prong one of the test

o Aronson Standard demand excused if the P can show

reasonable doubt that the board is disinterested, or lacking independence Court applies a subjective test. Court looks at directors financial ties to corp, the greater the tie, the less independent. Court finds b/c there is reasonable doubt a half of the directors, demand is excuse.

Breach of Loyalty. Because 6 of the directors were interested, there is a claim for breach of duty of loyalty.

Waste

NO. Claim requires allegations that corp received literally nothing in consideration.

[Dutch Auctions buyers gives range for price and amount that it wants, sellers offer to sell at a price of there choosing. Buyer then buys shares, at the lowest offered prices which gets the buyer the number of shares it wanted.]

a. Indemnification and Insurance i. ii. Concern is limiting Director's risk of litigation costs, settlement or criminal fees Indemnification rights come from 1. Contract 2. Corp bylaws 3. Common law and statutory rules a. At CL corporate employees were entitled to indemnification for expenses incurred on the job including certain legal liabilities but directors were not

b. Today all states have statutory provisions authorizing


indemnification to some degree. DGCL both authorizes indemnification but limits it in important ways i. 145 (c) requires indemnification of Ds if they are "successful on the merits or otherwise in defense of any suit"

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ii.

OR ALLOWS indemnification If not successful in suit but had acted in good faith 1. So no indemnification where found to NOT Have acted in good faith

DGCL 145

(a) Direct suits - In suits by SH or third parties " a corp may to indemnify the director or officer for

expenses (including atty fees) plus jments fined and amounts paid in settlements IN both civil and crim proceedings" ONLY If the person acted in good faith and reasonable belief that they were in best interests of corp and not illegally

(b) - Derivative suits- in suits brought by or on behalf of the corp may indemnify

for only expenses, including attny fees but not jments ONLY If they acted in good faith If the D was held liable to the corp he can only be indemnified with court approval

(c) corp MUST indemnify a director or officer who "has been successful on the merits or otherwise"

As for Directors and officer who are unsuccessful check whether indem is allowed under (a) or (b), If so the Corp - MAY but need not - indemnify the D or Officer 145 (c) requires indemnification of Ds if they are "successful on the merits or otherwise in defense of any suit" OR ALLOWS indemnification If not successful in suit but had acted in good faith 1. So no indemnification where found to NOT Have acted in good faith

ii.

iii.

(e) the corp may advance expenses to the officer or director provided that the latter undertakes to repay any such amount if it turns out he is not entitled to indemnification (f) corp May enter into written agreements with D's / officers that go beyond the statute; statutory rights shall not be deemed exclusive of any other rights

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See Owens CorningCan make additional K to create presumptions to grant D indemnification as long as it doesnt violate the statute.

Governance and Control in Closely Held Corporations General/Introduction o Close Corporation DGCL 342 30 or less shareholders, stock must be subject to transfer restrictions and no publicly issued stock. Articles must state that you elect to be a closed corporation

Problems that can arise in closely held companies

Controlled by majority shareholders- Member managed or Manager Managed can get kicked out, fired, or at least, just get outvoted on the board. Lock in / Frozen out Locked in as shareholders o o Close corps often restrict share transfer Even if no formal restrictions, there is no secondary market for the shares

Risk of being frozen out of decision making and compensation o o Minority shareholders may have no control over companys activities May be denied compensation if denied employment

LLCs solve problems by agreement or K

Contracting as Devise to Limit the Majorities Decision

o Contracting and Directors Decision- default manager control but can K 37

Rule Directors must exercise their independent judgment, owed FD to shareholders to do. Cant contract around with agreements that require board to keep someone on the board, violates FD> McQuade v. Stoneham (NY) o Cannot K to remove Director/Manager FD or prevent them from making independent decisions/judgments

Clark v. Dodge (NY) o P and D control 100% of company. D agrees to vote to keep P on the board, receive salary, and board would not give unreasonable salary t others. Court upholds on basis No 3rd party shareholders Court believe restrictions on D were negligible.

o Rule shareholders can abrogate directors rights, and fix their


Zion v. Kurtz (NY court, applying DE law 1980) o Court followed Clark v. Dodge and effectuated the intent of the parties who had signed a shareholders agreement even though the company had not formally become a close corporation. Dissent makes a good argument for the formal requirements of becoming a close corporation as necessary to warn future purchases of the companys share.

own rights, only when required by the corporations best interest.

Contracting and Shareholder Voting

Shareholder Voting Agreements- Mostly will enforce K

Where shareholders agree to vote together in a certain way; gives minorities shareholders a bit more control; restricts SH role only. Does not effect Ds FD

Blount v. Taft (NC Supreme Court , us1978) P argues a provision of bylaws agreed to by shareholders is actually a shareholders agreement which requires consent of all shares to be amended. D-company believe the provision is a bylaw and only needs majority vote to be amended. Basic contract analysis case. Courts holds provision is bylaw.

Ramos v. Estrada (Cal.) Court enforce shareholders agreement which created a voting pool required they vote together.

Rule Voting pool agreement valid between the parties with respect to voting shares as shareholders. The agreement doesnt constrain parties voting as directors, nor the directors generally.

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DGCL 218- Permits shareholder voting agreements as does CA law.

Solutions to Background Rules Agreement relating to limitation on the boards discretion Voting Trust o Agreement amount shareholders under which all of the share owned by the parties are transferred to a trustee, who becomes the nominal, record owner of the shares o Trustee votes the shares in accordance with the provision of the trust agreement, if any.

Advantages Efficiency Disadvantage Loss of control and flexibility.

DGCL 218: a copy of trust document must be filed with corporations registered Delaware office Some states limit to 10 years.

Vote Pooling Agreements: Enforce mechanisms Ringling Bros.

Two controlling families had agreement that they were to vote together. In the event of deadlock, the disagreement was to be determined by an arbitrator. One family later sues, arguing that having the arbitrator vote for the shareholders is against public policy.

Holding The agreement is valid, not against public policy to agree to a third-party mechanism to voting,

Fiduciary Duty and Threat of Dissolutions as a Check on Majority Action (closely help corporations).- DEALING WITH ILLIQUIDITY PROBLEM o Starting point: Analysis What kind of business association is this? o o In capacity are individuals operating? Shareholder, partner, director, etc.

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Did individual violate a contractual or default obligation or duty? o Some obligations are immutable, some are contractual.

Shareholder Fiduciary Duties At early common law, shareholders qua shareholders had no fiduciary obligations to firm of fellow shareholders Some erosion vis--vis controlling shareholders of public corporation (E.g. Sinclair Oil v. Levien) o Majority shareholder was self-dealing, court uses intrinsic and entire fariness standard

Partnership Analogy and FD Donahue v. Rodd Electrotype Co. (Mass.)

Court holds that shareholders in close corporation owe each other an utmost good faith and loyalty similar to a partnership. Holds the majority opting to buyback shares from shareholders at different/unfair prices violates duty down.

o Only good law in Mass court decides to treat as partnership,


would not happen in DE.

Nixon v. Blackwell (De) minority class-B shareholders argue that company cant give extra liquidity to class A shares. Court holds that different treatment of classes is fine. . When shareholders buy in, they rules where in the bylaws, and you would need to contract around with a shareholders agreement, amend the bylaws, etc.. Court rejects special close corporation fiduciary duty o Ex ante filing and contracting, no ex-post judging

Involuntary Dissolution Buyout o General

Method to prevent oppression via power of dissolution Minority has broad grounds to ask the court for dissolution If court orders dissolution, majority can buyout minority for reasonable price

California General Corporation law 1800 (a) Shareholders holding 33 1/3 of the shares or equity of corporation, or any shareholder of a close corporation, can fill for an involuntary dissolution on specific grounds in (b) Statute not limited to statutory close corporation.

(b) grounds for dissolution are

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abandoned business for more than one year board deadlock deadlock by shareholder factions those in control guilty of knowingly countenanced persistent pervasive fraud, mismanagement abuse, unfairness toward any shareholder or its property is misapplied or wasted in any close corporation to protect the rights of the shareholder.

2000 the corporation, or person w/50% of the shares, can avoid dissolution if the buy all of the shares from those seeking dissolution for fair value. court has a process to help figure fair value, if they cant agree.

Delaware

Only grounds for voluntary dissolution is corp w/ 2 shs (50/50, deadlock)

Oppression Cases

Re Kemp & Beatley, Inc. (NY) could order dissolution because oppression, where majority cut of P salary and dividends which he had since beginning; court looks at reasonable expectations of P Disappointment note enough; need real expectations.

Gimpel v. Bolstein (not DE) court holds the majority cannot forever freeze out P-minority shareholder. P is an embezzler and bad actor; but court things that at some point, they either need to buy him out or cut him back in to proceeds. Court defines oppression as o o (1) violation of reasonable expectations (2) burden, harsh, and wrongful conduct; lack of honesty & fair dealing.

Would not have happen in DE.

Share Repurchase Agreements o General Two types o Sell back orderly liquidation if someone dies Buy back if someone leaves

If shares subject to a repurchase agreement must be listed on stock certificate.

Interpretation/Enforce

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Subject to general contract principles

Concord Auto Auction v. Rustin (D.C. Of Mass, 1986) Shares subject to a repurchase agreement with set price and provision to reset price at boards discretion. Shareholder dies, repurchase agreement trigger at original below-market set price. Estate sues to have repriced, arguing the directors unfairly did not revalue, and violated FD> Holding this court is not willing to intervene in a shareholders agreement solely because the result may seem unfair. This court favors the contract over the equities.

Gallagher v. Lambert (NY 1989)

Company fires P 15 days before stock under a shareholders agreement would have vested. P gets nothing, and sues for violation of FD. Holding court enforces shareholder agreement. P loss. Court relies on contract, which clearly allows for termination for any reason at any time, prior to vestment.

Pedro v. Pedro (Minn. 1992)

P is fired by company for investigating other shareholders be believes are embezzling. Ps shares are subject to repurchase agreement at 75% of book value on death or consent of P. P sues on basis that he expected lifetime employment, and shareholders agreement had no termination provision Holding Court use partnership analogy and holds for P; they believe D violated its duty to P; fired him in bad faith. Award value of stock + salary through the age of 72. Court is partnership friendly. Probably wouldnt come out the same in DE.

Limited Liability Companies Limited Liability Companies o General First new legal business concept since the S corp (1950) Cross between partnership and corporation Tax advantages of partnerships o Pass-through taxation; individual income o Avoids the double taxation on corporate taxes (corporate tax + dividend/capital gains tax) Limited liability of corporations None of the restrictions (e.g. number and type of shareholder) applicable to S corporations Funding of an LLC very flexible Members contribute capital Contribution may be cash, property, services rendered, a promissory note, or other obligation to contribute cash, property, or to perform services Liability Members stand to lose capital contributions, but their personal assets are not subject to attachment

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Tax Pass-through, OR Corporate Formation Must file the articles of organization in the designated state Other formation tasks: o Choose and register name; generally need to include LLC in the name o Designate office and agent for service of process o Draft operating agreement the basic contract governing the affairs of a limited liability company and state the various and duties of the members. Members rights include: Financial interest o Profit and loss sharing Absent contrary agreement, most statutes allocate profits and losses on the basis of the value of members contributions o Withdrawal Member may withdrawal and demand payment of this/her interest upon giving the notice specific in the statute or the LLCs operating agreement Management rights o Absent contrary agreement, each member has equal rights in the management of the LLC Most matters decided by majority Significant matters require unanimous consent (default) o Manager-managed LLC option available. Can structured as a board of directors a CEO, or both Must be specified in articles of organization Important Role of Contracts Del LLC Statute (6 Del 18-1101) (b) It is the policy of this chapter to give the maximum effect to the principle of freedom of contract and the to the enforceability of limited liability company agreements. Gottsacker v. Monnier G, and Brothers Court hold even through they had authority, the statute requires that deal fairly with the other members. Being on both side of the transaction didnt prohibit them from voting under the statute. Remand to determine fairness. Rule Contract interpretation is key. There are no cases to refer to, and the statutes are unclear. Role of Fiduciary Duty VSG v. Castiel (DE) Two managers meet without giving notes to third manager, vote out third manager, turn in a corp, issue stock, and sell company effectively cutting the third member, who sues. .Rule the court holds the managers owe a duty of loyalty to both the managers and the members. You cant contract around the duty of loyalty. The fiduciary duty which comes from close held corporations, come up with LLC.

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LLC - Exit and Liquidity Similar to exit issue in other closely held enterpises: Can the majority use statutory or contractual power to force the minority out of the enterprise and acquire the minoritys ownership interest at a contractually specified sum that often is low relative to the then current value o Love v. Fleetway Issue is what does the withdrawal mean in the contract? Does it include dismissal? Court holds that the withdrawal means an intentional act. The court uses the dictionary definition case is all about contract interpretation and drafting. Can an investor force the remaining members of the enterprise to buy back the departing members interest? o Haley v. Talcott Two buyers no sellers Incomplete drafting. Situation comes up that operating agreement covers. Partner wants out. The DE statute provides a dissolution mechanism, the court imposes to allow the leaving partners exit. LLC - Liability Members are only liable to the extent of their contribution.

The Corporation as a Device to Allocate Risk Equity Cushion o General

Historical Overview was that what the stock holders paid to purchase the shares of stock was the Capital of the firm. This capital was determined to be held by the corp. to be used to pay its debts if needed. Thus the Stockholder cannot withdraw his purchase capital o The courts saw the investment as the Stockholder buying in and being entitled to any profits. BUT if the stockholder pulled out he would not take back any of his investment unless there was a residual amount after all creditors were paid out.

PAR VALUE MBCA deleted these provisions. The Delaware codes still has this. o Basically the certificate of incorporation states what the par value is- value of stock at the initial offering. o This value can be calculated by multiplying the par value times the number of outstanding shares issued. Thus others can determine what the corporation is worth at least under Par Value. Insolvency test you cant pay dividends if you liability are greater
than you assets. o Equity Cushion Initial Purpose: reduce riskiness of extending credit to corporations

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Minimum Capitalization Requirements Par value: minimum price/share that shares must be issues for in order to be fully paid Typical par value: $0.001 or $.0001 per sh o DGCL 154 - Delaware requires minimum equity (per value x no. shares) if corporations certification states a par value for stock this amount of money (shares X par value) must be set aside. But shares dont have to have par value. o Statutes Min. Initial Capital Requirements DGCL 153 consideration for stock o Share must be sold at issuance for at least par value. if no par value, can take any consideration; if certificate requires vote, then must be majority of outstanding stock w/voting rights on subject. DGCL 154 amount of capital; capital, surplus and net assets defined o Allows the specific of min capital any amount, but not less than amount equal to the aggregate par value of issued shares having a par value. (per value x no. shares) if corporations certification states a par value for stock this amount of money (shares X par value) must be set aside. But shares dont have to have par value. Quality and Valuation of Consideration DGCL 152 issuance of stock o Amount of consideration in 153 to be determined by directors. Consideration may be cash, any tangible or intangible property or any benefit to the corporation or any combo thereof. Limits on Distributions to Shareholders DGCL 154 amount of capital; capital, surplus and net assets defined o net assets = total assets liability o surplus = net assets capital DGCL 170 dividends, payments, wasting assets o Dividends payable from Surplus, or Out of net profits in the fiscal year the dividend is declared and/o the preceding fiscal year. o If cash falls below capital requirement, must fix before any dividends. o Net profits = income after expenses and taxes DGCL 244 - reduction of capital o Board of directors may by resolution reduce capital by amount equal to that represented by: retired shares (a)(1); purchased/redeem shares (a)(2); converted shares (a)(3); change in the par value of stock(a)(4). DGCL 242 o To change par value or an change to authorized stock, must be effected by amending certificate of incorporation. o Directors can change certificate by resolution & majority vote of holders of outstanding shares entitled to vote.

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reduce capital requirement, but needs shareholder approval to do anything with alter authorized stock, amount, par values, etc. Liability / Payments DGCL 174 liability of directors o If directors willfully or negligently declare dividend payments or purchase stock or redemptions they shall be liable for the full amount unlawfully paid. Valuation of Assets General Book Value: what you paid Fair Market Value: what you can sell it. Directors can increase equity by revaluing assets. Klang Rule (DE) directors can use FMV as the appropriate reference point to value assets Deference to directors method of calculating surplus, unless plaintiffs can show that directors used unacceptable date, bad faith or fraud in evaluating the value of assets.

o Note board could buy back stock, or redeem stock in order to

Piercing the Corporate Veil Piercing the Veil o General Disregarding the corporate fiction Way to make corporate insiders (shareholders) personally liable for corps activities More common in closely held corporations Shareholders are operating the company directly for their own benefit.

RESTATEMENTo Usually the separateness of the corporate entity is to be respected. However a corporations veil will be pierced whenever the corporate form is employed to evade an existing obligation, circumvent a statute, perpetuate fraud, commit a crime, or work an injustice. o Veil-piercing RULE
Court will pierce the corporate veil (and hold the shareholder liable) when the plaintiff proves: (1) Shareholder had complete domination and control, o AND (2) Shareholder use control of corporate form in unjust fraudulent, or wrongful way, o AND (3) Shareholders unjust use of control cause actual harm to plaintiff. This is a fact intensive test that everyone seems to use but in different ways. But you need all three. Consumers Co-op v. Olsen

RULEo Court looked to rules stating- That Veil piercing can be done when the Corporate Veil/Limited Liability is being used to perpetrate fraud o It could be grounds to pierce the corporate veil if the corporation maintains inadequate capitalization 46

The capital must be illusory or trifling compared to the business done Should not reward errant businessmen using corporate shells o Factors to Consider 1. Was the corporation under capitalized 2. Was the corporation following appropriate corporate formalities- if not then may lead to a finding that there was no separate existence of shareholders and the corporation o RULE- Is this just an alter ego of the shareholder or truly a separate entity? To determine if the shareholder is really using the corporation as a shell to avoid liability, must find all of the following 1. Control- That the shareholder had COMPLETE Domination of the corporation. The entity had no separate mind of its own. This can be proven by failure to follow the formalities of a corporation- ie majority owner does what he wants 2. Such control was used to perpetrate a fraud or violation of a statute or other duty or violate plaintiffs rights or violate law 3. This control caused injury to P Need all three to be proven to pierce the corporate veil COURT o The adequacy of capital is to be measured at the time of incorporation o Suffering financial setbacks does not lead to inadequate capitalization o Additionally the amount of capital as being inadequate is measured as obvious inadequacy of capital or insufficient when measured with the nature and magnitude of the undertaking:

Tort Liability and the Veil o General Comes up when the company, who is probably vicariously liable, does not have enough adequate capital or insurance. Looking at instance where the P is a third-party had ability to have born the risks. o Piercing the Veil difference in Contract vs. Tort Assumption of risk Usually an establish relationship btw P and D. P might have contract for the risk. Where a tort-plaintiff is probably a 3rd party without a prior relation to the D, so there is no assumption or bargaining for the risk. Externalizing costs Who is in a better position to prevent costs? A contracting plaintiff, is in a good position to account for risks and account for cost insurance and defensive business practices A tort-plaintiff usually doesnt have the opportunity to prevent the injury. Who do you sue? Everyone. All parties remotely connect to the injury via the company. o Western Rock v. Davis

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Shareholders held liable for injury resulting to their companies negligent blasting. Shareholders try to argue that they are protected from liability through the corporation. Held: Court pierces the veil. PIERCED VEIL Shareholders ran business Shareholders using limited liability to avoid paying damages Caused harm, intentionally did the blasting knowing people were being harmed and did it anyways- bad faith o Baatz v. Arrow Bar P injured by a drunk driver who has no insurance. P sues the bar that served the drive in violation of state law, kept serving the D after he was visibly drunk. State laws extends liability to the licensed entity who serves some visibly drunk. P also sues the owners of the bar directly. Held: doesnt pierce corporate veil to get owners. Control was not unjust, and not cause of injury. Bar has minimum level insurance require by law. Parent and Subsidiary Corporations o Craig v. Lake Asbestos Rule Just because a company is a majority shareholder, doesnt mean they are controlling the subsidiary. We must examine the internal decision making process of the subsidiary. Same test majority shareholder needs to have complete control in order to pierce the corporate veil. o US v. Bestfoods Superfund case the superfund CERCLA language which provides that any person who at the time of disposal of any hazardous substance owner or operated any facility can be held liable to repay the fund for clean up costs. COURT Corporate veil can be pierced to go after the parent corporation when the parent o Actively participated in, exercised control over the operations of the liable subsidiary o Must be directly managing this subsidiary Additionally, Agents in charge of the facility wearing the Parent Corps hat can be used to show direct participation o Under CERCLA - Individual in charge can be liable- so Agent might be liable Majority ownership not enough. Dual-board officers not enough. Investor supervision not enough. Looking for agent who was clearly acting on behalf of parent directing the operations of the subsidiary at the facility level. o NO SEPARATE MIND

Friendly Transfers of Control and Fundamental Changes Mergers and Dissenters Rights o General o Friendly/Unfriendly determined w/r/t managers or officers

Statutory Merger: Stock for Stock Company A trades stock for the assets and liabilities of Company B.

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Company B shareholders receive shares of Company A Company B ceases to exists; Company B shares canceled Company A assets and liability are combined with Company B assets and liabilities into a the Company A.

Merger v. Consolidation A + B = A (B goes away) - merger A + B = C (new entity) - consolidation

DGCL 259(a) Legal Effect of a Merger

Target goes away; surviving company gets all assets; surviving gets all duties and obligations of target, all liens, rights of creditors, obligations are not impaired and attached to the surviving company.

o Process: fundamental changes which requires both director & shareholders


Basic Procedure - DGCL 251(a) (authorizes statutory merger) (1) Boards adopts and approves merger agreement that meets statutory requirements. (2) Board gives notice & disclose terms of merger to shareholder. Notice must be 20 days before vote/meeting. (3) Majority of all shareholders of outstanding stock in both companies ratify o Voting Rights Exceptions: 251(f) - De Minimus Merger

(1) Company issuing less then 20% shares or cash in the transaction, (2) not altering cert of inc., and (3) shares before and after are the same, then the surviving company doesnt get to vote.

251(f) - No vote if no shares have been issued. 253 - Short-Form Mergers: Where A owns 90% of B, then no shareholder vote required. BJR applies.

(4) Once ratify, must file certificate of merger. (5) Agreement may by provision allow directors to terminate, or alter merger agreement w/o vote ( as long as they dont alter/change share, alter cert of inc, or adversely affect any shareholders interest.

What needs to get sent to shareholders Public Company: proxy statement

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Private company: document as require by state corporate law

DGCL 262- Appraisals Rights General o Potential Appraisal Remedy Appraisal rights give dissenting shareholders the right to demand that the corporation buy their shares at a judicially determined fair market value; perfecting appraisal rights.

Appraisal Rights Given to: Selling firm shareholders Buying firm shareholders Unless their vote was not required under DGCL 251(f)

Requirements 262(a) o Shareholder o must holds shares through date of merger not vote in favor, or consent to merger

Gets judicial process to determine FMV

262 (b) Market Out Rule

(b)(1) No Appraisal Right If Buying/Selling firm shareholders if the firm is publicity traded More than 2000 holders of record. Merger under 251(f) de Minimus

o (b)(2) Exception to (b)(1) Appraisal Rights reactivate


If Selling firm shareholder is publicly trade, BUT consideration is for these shareholder is Cash, OR Shares of stock in a non-public company

(b)(3) No Appraisal Right If Merger under 253 short form mergers Merger has nominal/trivia effect on value.

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Hewlett v. Hewlett-Packard Co. Court fails to find evidence of vote buying or fraudulent disclosure claims. Votes challenge under rule 252. P has burden of show material misrepresentation of fact; court looks at process and thinks it was done in good faith.

Getting Around Voting Rights. -- Available Techniques o Sale of Assets DGCL 271 Target company has voting rights; buying company does not. DE requires approval of a sale of substantially all of the corporations assets by the board and shareholder of the selling corporation o Shareholder approval must be by a majority of the outstanding shares entitled to vote.

DE does not require that the shareholders of the purchasing corporation approve the transaction. Only the board of the purchasing corporation needs approve the transaction. BJR.

Buying gives cash for assets, may assume some liability (or may not). The target company votes to ratify, gets cash, then dissolves distributing the assets via the statutory priority (debtor, preferred stock holders, stock holders, etc.) No appraisal rights. if majority votes to ratify, everything is done. As opposed to a merger, where the dissent would have a statutory appraisal right to of appraisel to muck things up later.

Mergers vs. Asset Sales When a merger becomes effective, the separate existence of all corporate parties, with the exception of the surviving corporation, comes to an end In an asset sale, the target company remains in existence at least for a little while after the assets sales has been completed only title of assets have changed In a Merger title to all property owned by each corporate party is automatically vested in the surviving company In an asset sale, documents of transfer must be complete for each assets. In a merger all liability transfer over automatically In asset sale, the buyer take what they want, doesnt take anything unless contract for by a written assumption

Triangular Merger (reverse or forward) Entity A creates a new subsidiary entity A1, which actually purchases the target company B.

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A owns A1. A1 wants to buy B assets. B needs to vote and ratify. B sells assets. A1 pays for deal with A shares. B dissolves. The shareholders of A do not need to vote on A1, or get appraisal rights. A1 gets all Bs liability. Only the shareholders of the constituent corporations get to vote. A shareholders do not get appraisal rights. Forward subsidiary A 1 remains, B dissolves Reverse B remains, A1 dissolve. This avoids any re-assignments of contractual obligation. B still exists, but is now owned by A. So that there is no need to write any of Bs contracts.

A shareholders dont get to vote on creation of A1 only the board votes.

De Facto Merger Doctrine General Court looks to substance over form o o Ignoring the transaction structure to grant voting and appraisal rights where end result of transaction is a merged entity. Does the combination (1) fundamentally change the corp character, interest of corp and interest of SH, (2) force share to take stock in another company with not voting/appraisal rights/

Rejected in Delaware (and in CA, basically) o Independent legal significance doctrine

Farris v. Glen Alden Corp (Pa) This is reverse merger set up an asset sale, where selling company comes to own and in effect control the target; controlling the purchasers. Court holds that in effect this was a merge that fundamentally changed the company, Grants voting rights.

Applestein v. United Board & Carton Corp (NJ 1960)

Merger setup as an asset sale, where purchasing shareholders loss control to owner of selling entity. Only the selling entity gets to vote. Court terms as a de facto merger thinks that the statutory merger is the appropriate for this transaction.

Delaware no de facto merger law here. Hairton v. Acro Electronics (DE) o Independent legal significance to each statutory section of the corporate code. If you follow the asset sale statute, it will be honored. If you follow the merger statute, it will be honored.

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Doctrine offends the equal dignity of the merger and asset sale provision of the statute.

Intersection between Appraisal Remedy and Fiduciary Duty-Based Judicial Review o General o In a cash-out merger what remedies do minority share holders haves.

Structure of cash-out mergers / Squeeze-Out Statutory Merger Two Stage Transaction -

(1) A goes to Bs shareholders to buy/trade for shares o o A buys enough share to gain control B, and becomes the majority stock holder Minority stockers remain

(2) A creates a new company-C and mergers B and C o A, as majority shareholder in B and C, vote to ratify. B cancels Bs shareholders, and Bs shareholders receive cash. B is extinguished. Dissenting minority shareholders in B have appraisal rights can sue for recession can accept the buy-out

Post-Stage 2 o o C remains, as a wholly controlled subsidiary of A. C holds all of Bs assets and obligations.

Test and Shareholder Remedies Delaware

(1) Appraisal Rights Exclusive remedy for minorities shareholders in cash-out o available because shareholders receiving cash, 262.

(2) Entire fairness Exception where misrepresentation, fraud, selfdealing, waste, or gross overreaching, there might be relief outside appraisal, such as violation of FD. Generally inquiry into process: o Court looks at Fair price

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Fair deal

Burden of proof depends on (1) if a majority of minority available AND (2) they had full disclosure/candor, THEN burden is on the Plaintiff to show it was not fair. (2) If Plaintiff can show that were not fully informed, then burden can shift back to Defendant to show fairness.

Weinberg v. UOP (DE) o Court holds merger unfair to minority stock holders, b/c company did not disclose full information about directors sitting on both boards, and didnt disclose

Non-Delware

Business Purpose Test o o Minorities shareholders can challenge a controlled shareholder merger Defendants have the burden of proving that the transaction has a business purpose other than merely serving the selfish interest of the controlling shareholder.

Coggins v. New England Patriots Football (MASS)

o Court find that cash-out merger did not have business purpose;
designed to allow D to pay off his personal debts. Business Purpose Test

o Remedy court awards damages calculated by determining

the value of the plaintiffs share had the merger not taken place. Merger was 10 years ago; recession impracticable. NOT GOOD LAW IN DE.

Hostile Acquisitions o General -- The Market for Corporate Control How do bidders gain control without the target boards consent?

Hostile mean hostile to the board. We are looking at how companies, the boards and shareholders defend themselves. DGL 251 requires that the board of each company ratify the merger agreement. Then shareholders vote.

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If board rejects the offer to merger, the purchasing company has two offers: o (1) Tender offer to buy enough shares from shareholders to gain control of the board. friendly to the bidders plan.

o (2) Proxy battle convince target shareholders to elect a board


Same proxy problems; expensive; hard to communicate to other shareholders. Staggered board; either wait it out; or remove for cause.

Overview of tender offers A public offer usually made to all shareholders of the corporation in which the bidder offers to purchase target company chares o o The offered consideration can alternatively be cash, stock, or a combination of stock & cash The offer usually has many conditions attached Ex. only buy the share if 51% are offered.

Advantages over asset sales or mergers: o Approval by the targets board of direction is a necessary perquisite to statutory transaction

Bear hug letter we want to buy, we love you, but if you dont sell we will crush you.

Tender offer permits the bidder to bypass the targets board and to purchase a controlling share block directly from the stockholder

Federal Securities Law o Shareholders Voting in Public Companies; Federal Proxy Regulations o 14(a) of the 34 act Sec Regulation 14A

Tender Offers for shares of public companies Williams Act Third party tenders offers 14(d) & (e) SEC Rules.

Williams Act Requirements o 20 Day min offering period

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o o o

Withdrawal rights Pro-rata acceptance All Holder/Best Price Rule All Holders Rule: tender offer must be open to all security holders of the class of security subject to the offer Best Price Rule: shareholders are paid MFN; everyone gets the best price.

o o

Disclosure require from both Bidder and Target Prohibitions Exclusive method of purchase

Goals Target shareholders more educate, less pressured Equal treatment

Critics Increase prices, reduces number of bids Disclosure reward free riders, second bidders Time delay enable target managers defenses Reduces tenders offer power as a check on poor management

Buyer buys a few shares in the target company so that they have standing and can threat a fiduciary duty lawsuit against the board; makes the board consider that offer.

Defenses to Hostile Take-overs o Basics o Self-tender offers Poison-pills Staggered boards White-knite sales Defensive merger, acquisitions, asset purchases Defensive debt issuance (usually for M&A)

Poison Pill or Shareholder Rights Plan

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Each share of stock obtains shareholder rights or a dividend declared by the board of directors Rights are corporate securities that give the holder of the rights the option of purchasing share

The rights become exercisable upon some triggering event, such as: Acquisition of a specified percentage of target shares o Typically 15%-20%

Announcement of a tender offer for some specified percentage of the shares.

Flip-In Provision Give shareholders (except for the raider) the right to purchase additional stock at a deep discount to market or receive a distribution of additional stock

Flip-Over Provision

Give shareholders the right to receive buyer stock in a 2nd stage freezeout merger at a deep discount stock in the buying entity.

Judicial Review of Tender Offer Defenses o BJR Usually doesnt apply because there is some chance the directors are acting to protect their jobs. Ds have burden to shot legitimate business purpose to restore presumption of good faith (1) Reasonable grounds to believe that a danger to corporate policy and effectiveness exist

o Traditional Review - Cheff v Mathes (DE): (Pre-Unocal)

o Good Faith and reasonable investigation


(2) Directors did not act for the primary purpose of preserving their own incumbency Once established back to BJR Cheff v Mathes (DE): Greenmail situation. BoD offers to buy shares from party attempting take-over; price well above market price. FOD suit for paying too much for shares. Court holds that board acting in good faith; price was reasonable because of the control premium (17% OS) Enhanced Scrutiny ****** this is the rule to use

Unocal Test Burden on BoD to show that def against hostile takeover:

(1) Reasonableness. Board has reasonable grounds for believing that a danger to corporate policy and effectiveness existed

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Burden satisfied by showing good faith & reasonable investigation

(2) Proportionality: The defense was reasonable in relation to the treat posed. o o This is were the action is; most of the legal argument Considerations for assessing threat Low price Time of offering Questions of illegality Impact of on constituencies other than shareholders. Risk of deal falling apart Quality of securities being offered

If they pass, then directors get BJR deference, which P can attempt to rebut. If they fail, directors must show entire fairness: fair deal and fair price. Was the board with the power of author of the board o o (1) Does the statute authorize this defense; and (2) If it is okay under the statute, does the firms charter impose any restrictions on the use of this defense

Unocal v. Mesa Petroleum Co. (DE) In response to back-end tender offer, DoB of Unocal Unocal makes a responsive selective self- tender backed by debt security. The idea is to make the company so heavily leveraged that the companys value is decrease below Mesas comfort zone. Mesa sues as a violation of FD. Analysis court finds the boards offers is proportional because Mesas front offer was much lower then the company was worth, and the backend offer was junk bonds. Note the selective self-tender not OK under current SEC rules.

Review of Poison Pills

Moran Standard of Review So, directors have the authority to create poison pills, but in doing so are they subject to review in creating the pill:

o Unocal standard:
Reasonableness

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Burden on directors to show they had reasonable grounds to believe that a threat to corporate policy and effectiveness existed. Good faith and reasonable investigation

Proportionality Have the directors proved that the poison pill was reasonable in relation to the treat posed.

Once you pass the Unocal standard, board is protected by BJR.

In addition, the court will review the decision to exercise or not exercise the poison pill when the hostile bid occurs. Court will review with the Unocal standard, again.

Moran . Household International, Inc. Poison pills held to be legal. Statute give board power and deference to BoD to issue stocks under DGCL 151(a), DGCL 151(g), and 157. Doesnt restrict tender offers, just makes then more expensive. Court holds reasone to think company would be target of a takeover. Pill is valid.

o Defensives Sales
Revlon Rule Once the board puts a company up for sale, the BoDs is required the BoD to seek the highest value for the shareholders.

o Role changes from defender of corporation to an auctioneer

which is triggered by going to White Knight. The company will go through a change of control; so that Shareholders will lose control and their present interest is only to get the best value in the transaction. Cannot sacrifice shareholder price for returns to other corporate constituencies.

Revlon v. MacAndrews Board brings in Whiteknight to thwart a hostile takeover, and gives the White Knight as number of asset lock, which in effect kill the bidding process. Court holds at once the BoD bring a White knight, the company is for sale, they duty of the board is to get the best value for the shareholders.

*** Reconciling Revlon and Unocal *******

o (1) Appy Unocal Rule to defensive measure (including poison pills)


Directors must show reasonableness of threat, and

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proportionality of response.

Then BRJ applies

o (2) If response involves a 3rd party buyer, or merger involve break of


company and loss of shareholder control then Paramount v. Time Rule Revlon duties are trigger when (without excluding other circumstances): (1) board actively puts the company up for sale or to effect a business reorganization involving a clear break-up of the company (2) in response to a bidders offer, the company abandons long-term strategy and seeks an alternative involving the breakup of the company.

o Court it is not enough that the transaction might be

construed as putting the company up for sale. Defensive measure are not enough by themselves to trigger Revlon duties. result in a change of control, the board will be held to the Revlon standard to maximum shareholder value. if another equally interested bidder appears, board will need to deal with them.

o QVC Rule once the board initiates a transaction that will

If Revlon Duties are trigger:

fails (didnt get best price lookup assets, etc) then;

o DoB subject to entire fairness, look at:


Critically examine the competing tender offers Act in good faith Obtain all reasonable available information on the offers and alternaives Negotiate actively with bidders.

Pass then BJR still applies.

If Revlon duties are not trigger, board is still subject to Unocal. Considerations for assessing threat Low price Time of offering Questions of illegality Impact of on constituencies other than shareholders. Risk of deal falling apart

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Note

Quality of securities being offered

Generally, an all-in all-cash offer falling in the range of value that a shareholder could reasonably expect to get is not by itself a threat. Threats are not limited back-end unequal treatment transaction, or inadequate value.

o Cases

Paramount v. Time Time and Warner are in the process of a merger, when Paramount launches a hostile take over of Time. Time doesnt want to merge with Paramount, so they recast the merger of Time; making a Tender offer takeover from Warner. This is a defensive strategy that depletes the cash in Time, and makes the target Time-Warner more expensive. And also circumvent a shareholder vote on the merger. So Paramount launches an FD law suit. Court holds the Revlon duties are not trigger because tender offer of Warner not a breakup of sale of company. Merger passes Unocal b/c response not in faith, Time can consider factors such as time culture as basis for choicing to merger with Warner. Lower Court Ruling (good to note this language). o Merger agreement would not result in a transfer of control because control of the combined entity remained in a large, fluid, changeable and changing marketing. Shareholders are getting stock for stock, they still can sell, vote, etc.

Paramount v. QVC Paramount agrees to merger with Viacom, which is almost wholly controlled by Sumner Redstone. Court holds the Revlon duties trigger because merger with Viacom is in effect a change in control and as such board has a duty to get the shareholders a the best price and control premium. Court notes that this is the last chance for shareholders to get a control premium; once deal is done, Redstone will control company.

Disclosure and Corporate Governance Two important aspects of securities law o Full disclosure o Make sure that the investors have all the information they need to make informed decisions.

Securities 1993 Act

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Transaction; register/file with Sec; prospectuses; require for any public sale

Securities 1934 Act

o Policy o

Periodic, From 10 once, 10-K annual, 10-Q quarterly, 8-K episodic; only require of registered companies.

Market price depends on access to information, because everything is forward looking Promotes competition b/w companies for investor Protect shareholders for misinformation Directors need information to do their job Enhances monitoring by accountants Facilitate enforcement actions by government

Post-Enron regulatory response Disclosure, lots of it Greater liability of CEO/CFO Additional responsibilities (burden?) on the board. Are we putting to much pressure on the boards? 2008 Trend: 42 firms lost big-name directors

Business Roundtable v. SEC o 1988: SEC adopted one share-one vote rule Rule 19C-4 prohibited any Self-Regulatory Organization (SRO) from listing any stock of a corporation that takes any action to the effect of nullifying, restricting, or disparately reducing the per share voting rights of existing common shareholders.

this would have eliminated poison pills or the creation of classes of stocks with less them 1-vote.

o Court vacates the rule on the ground that it exceeds SEC authority; states /
federalism. o Note-- > Later stock exchanges later adopted similar requirements in their listing. Cannot eliminate existing shares, or dilute voting rights.

Federal Proxy: Rule 14(a)-9 o 14(a) of the 1934 Act Allows the sec to regulated proxy solicitations as necessary and appropriate

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Rule 14(a)-9 Prohibits misleading, false with respect to material fact; or omits to state a material fact necessary in order to make the statements therein not false or misleading

Private Right of Action under 14(a)-9 General SEC can bring civil, or criminal actions; can bring injunctions to stop mergers. US attorney come in where there is fraud. No express private right of action Individuals have private right of action under JS Case v. Borak.

JS Case v. Borak (Wiscon.) P gets proxy materials on merger; sues alleging the information in proxy statement was mislead? Under state law P has 2options: (1) FD law suit or (2) appraisal rights, but Wisc requires a large bond from the P. So P attempts to bring a federal suit under 14(a)-9. Court allows the suit under 14(a)-9 because the underlying policy 14(a)-9 is to protect shareholders; so it implies individual should have access to judicial relief. Federal law supreme over state. SEC cant possibly watch over all proxy statements. Creates a industry of litigators reviewing proxy statements. Probably would come out differently today, but still good law.

Touche Ross & Co. v. Reddington No private action under Section 17 of the 1934 Act.

*** 14(a)-9 Requirements and Analysis (1) False, misleading, omitted statement (2) Must be material fact w/ substantial likelihood that a reasonable shareholder would consider it important in deciding.

o Materiality: An omitted fact is material if there is substantial


likelihood that a reasonable shareholder would consider it important in deciding how to vote.

This is the standard for materiality in many areas of corporate law. TSC v. Northway (US 1976) Asset sale (quasi-merge); proxy statement issue; suit under 14(a)-9 for omitted and false information based on members of board being on both side of the proposed merger.

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(3) Statement must have been an essential link in the outcome of the vote.

Causation Test: Was the proxy solicitation itself, rather than the particular defect in the solicitation materials, an essential link in the accomplishment of the merger? If it doesnt matter to the outcome of the vote, it is not actionable.

o Mills v. Electric Auto-Lite (US 1970) Merger proxy statement


suite by shareholder brought under 14(a)-9. Proxy materials alleged to misleading b/c they did not disclose that the all directors in target company had been nominated by the purchasing company. Court holds this is a material fact and misleading. Court requires that there me causation between the fact the and vote

10b(5) -- Disclosure related to buying or selling o Section 10(b) empowers SEC to make rues

it is unlawful to use or employ in connection with purchase or sale, public or non public security any manipulative or deceptive device of contrivance

Rule 10b(5) In it is unlawful for any person, indirectly or directly, by the use of an means of instrumentally of interstate commerce, or of the mails or of any facility of any national securities exchange to employ any device, scheme or article to defraud to make any untrue statement of material fact, or to omit statement of material fact necessary to make statements made not misleading, or to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with sale of purchase of securities.

o Analysis who can bring


SEC, DOJ (criminal) Private Parties No express private remedy under section 10 Private cause of action implied under rule 10b-5

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o Cases

Only in connection to sale or purchase, includes a cash-out merger. Needs clear deception and manipulation, not unfairness. Policy is full disclosure. Here the information was disclosed, issue is disagreement about value. Can file a FD; or appraisal. Forced cash-out merger is connection to sale or purchase for standing. Lack of business purpose (+ improper number crunching) fraud TGS-

So if insider has material nonpublic information the insider must EITHER disclose such information before trading or abstain from trading until the information has been disclosed o Based on rationale that traders all have equal information

So anyone has to Disclose if they have this information or not trade. o Disclosure means public

Chirella Corp is going to buy a target corp. Send documents to printer Printer buys shares in the target corp. o No Fiduciary duty here because he is not an agent or employed by the target company. If there is no fiduciary duty owed by the share buyer to the target corp. then there is not duty to disclose the insider knowledge. Would have been a violation if he had bought his employers shares as he would be diluting their profits and violating his duty.

Blue Chip Stamps v. Manor Drug Stores S Ct. final agrees that there is private cause of action under 10b-5; had been going on for 25 years; court finals gets a case and affirms; court is clear that there is no congressional intent, this is court made, courts have set the tone and rules; congress hasnt said anything while these have been going on.Congress

Birnbaum v. Newport Steel (2d Cir 1952) One only has standing if connection with sale of purchase. You must allege that relied on information to sale or purchase, which turned out to be fraudulent.

stays out of the political fray. Santa Fe Industries, Inc. v Green: minority SHs cashed out in short-form merger, given appraisal right. Ps were sellers, allege that majority tried to make minority think $125 offer was good deal, when Ps think shares actually worth $772 (math w/ disclosed #s).

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Held: no COA; transaction was not deceptive/manipulated, remedy = appraisal

Insider Trading- 10b5 creates a private cause of action for shareholders/16b covers a limited subset of insider trading

SEC Inside trading refers generally to buying and selling a security, in breach of a fiduciary duty or other relationship of trust or confidence, while in possessions of material or information not publically available.o Is there a violation of 10b5. Overview o o o o (1) Insider (2) Possession of material on public information (3) did not disclose (4) used in connection with sale or purchase of a security.

Insider Trading Analysis o Materiality - modern test Whether there is a substantial likelihood that a reasonable investor would consider the omitted fact important in decided whether to buy or sell securities. Factors: Nature of information Company response Market response Conduct of insiders Insider Analysis (1) Is the person a classic insider? Premised upon Fraud upon the sellers Does not arise is person is not agent, not a fiduciary or was not a person whom the sellers of the securities had place their trust and confidence. Is this a person who has a FD?- That would b an insider? o 16b Defines insiders o Fiduciary Duty ower is an insider o Chiarella v US (1980): printer who is able to deduce name of target, not insider; not everyone has a duty to disclose, not fiduciary; requires fraud. (2) Constructive Insider- Dirks Test o (1) obtain material nonpublic information from the issuer with o (2) an expectation on the part of the corporation that the outsiders will keep information confidential and o (3) the relationship at least implies such a duty. Usually comes up w/r/t to services provides, law firms, bankers, etc.. Can only be liable if you are trading shares of your client/confider

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(3) Tipper/Tippee liability Tippee inherent the duty to disclose if the tipper breached their fiduciary duty to the shareholders. Tippee Liability Test Tippee is only liable when o (1) the tipper actually breach their fiduciary duty from disclosing the information to the tippee, AND o (2) the tippee know or has reason to know of the breach of duty. To show a breach of fiduciary duty under 10b5 o Look at objective criteria and purpose of tipper, the courts must determine whether the insider personally will benefit, directly or indirectly from his disclosure Pecuniary gain; Enhanced reputation, etc. etc. You need to show this. o Both tipper ad tippee can be prosecuted. Dirks v SEC (1983) given info by broker, trades on it. No direct FD, but guilty under tipper/tippee liability. (4) Missappropriation Theory - 10b5- Breaching a duty to the principle you work for by using information you recievied by reason that you work there OHagan Misappropriation is fraud under common law, where o A fiduciarys undisclosed use of information belonging to his principle, without disclosure of such use to the principle, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates 10b-5. o Using information from your principle for personal gain Rule 10b5-1 on the basis of material nonpublic information, described. Restatement of OHagan. o Breach of duty of trust or confidence, directly or indirectly to the issue of the security, or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information. This covers. The trading parting The company whose shares you trading The company whose information you appropriated. o Only needs to show that the person was aware of the material nonpublic information when the made the trade; dont need to show they used it. Only way around is a 10b5 plan with a predetermined plan. Rule 10b5-2 situations that create trust or confidence (non exclusive) for the purpose of the misappropriation theory. o person agrees to maintain confidence (explicit expectation) o practice, history, pattern of sharing information in confidence (implied expectation) o information obtained from spouse, parent, child, sibling, unless shows that history or patter than indicates no expectations of confidentiality. (nuclear family expectation) (5) Rule 14e-3 fraudulent insider trading w/r/t to a tendering offer Prohibits anyone from insider trading during a tender offer and thus supplements Rule 10b-5

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Once substantial steps towards a tender offer taken, Rule 14e-3(a) prohibits anyone, except the bidder, who possesses material, nonpublic information about the offer from trading in the targets securities. o Rule 14e-3(d) prohibits anyone connected with the tender offer from tipping material, nonpublic information about it Rule 14e-3 is not premised on breach of a fiduciary duty. This gets around the 10b-5 limitation, which requires a breach of FD through tipper benefit. (6) SEC 16(b); Sec 1934 Act (private right action) Rule o Prohibits certain defined inside (direct, officers, owners of 10% of more) from making short swing profits Purchase and sale with 6 months of each other o Corporation can sue the insiders and make then return any profits. very strict doesnt mean youre guilty of 10b-5 just need to give the money back the SEC doesnt prosecute this. o This is based on a person status, not their information No material information requirement. Examples Example 11-5 wife tells her hairdresser that her husbands company is about to take over another company. Can the hair dresser trade? Is she an insider? Not a classic insider. The tipper is really the husband, who is the insider. The wife is the tippee and she didnt trade on it. Hairdresser is not constructive insider; not working for the company, not relationship with the company. Missappropration theory? Perhaps on 10b5-2, the wife would have an expectation of confidentiality. Probably no violation Example 11-6 law firm associate gets inform b/c she represents acquiring company? Tells the firms is quiting and trading the stock of the target. What kind of insider? No Tipper / Tippee probably not because there is no tipper Constructive Insider no she has no relationship with the target. Misappropriation theory 10b51 under OHagan, because she didnt deceive anybody. Tender offer 14e-3 if a tender offer, probably yes o

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