Business Associations Outline Fall 2011 Davidoff Introduction I Sources of Corporate Rules: Contractual agreement/internal governance rules corporate

ate by-laws, partnership agreements State and federal statutes function as default rules usually Common law rules fiduciary duties, fair dealings, care Litigation least cost efficient means of creating and enforcing corporate law rules Agency I Intro: Agency law is about asking when one party is responsible for the actions of another and what rights and obligations do those parties have to one another. Analysis: 1) Does a principal-agent relationship exist? (i) An agent is a fiduciary with respect to matters within the scope of his agency. An agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency. 2) In what situation does the agency question arise? rd (i) Look at the principal, agency and 3 part what are the rights and responsibilities of each party to the other. Is it a tort context (who is responsible) or is it a contract context (who is bound?). II How to leave: Fiduciary duty limiting the rights of agents Community Counseling Service, Inc. v. Reilly:When agency relationship ends and duty of loyalty to prin 1) Facts reilly is an employee of CSS. Reilly lies to employer as to reasons why he wants to resign and he solicits new campaigns from customers while still employed by CSS. 2) Holding agency duties do not end when you submit resignation, only end when you actually resign. CSS entitled to accounting damages it sought of its former employee. 3) Rule have a duty of loyalty to principal until that relationship is severed. (i) Subcontractors are NOT in agency relationship. Hamburger v. Hamburger: 1) Facts David comes in and builds up business, but is not rewarded for his hard work because Ted hates him, so David decides to start his own business. (i) David only solicits customers after he leaves so his duty to the principal has already been severed. (A) The business claims that David is stealing trade secrets, but customers lists are part of public record; and cant wipe ppls mind of knowledge they learned on job. (1) This could have been prevented with a non-competition and non-solicitation agreement these agreements are scrutinized by the courts and must be limited in time and scope. Must also show a special need. 2) Holding solicitation had not commenced until after agency relationship severed. David was entitled to use his general knowledge, experience, memory and skill in establishing new business. Customer lists are not considered trade secrets if the information is readily available from published sources. III Limits on Firms Right to Discharge an Employee at Will Any at-will employee can be fired w/out cause, but if part of a federally protected class on discrimination may want to document conduct before firing to avoid litigation. Foley v. interactive Data Corp: 1) Facts Foley blows whistle on Kuhain who is under investigation for embezzlement, but everyone told Foley to shut up. Foley gets retaliatory treatment and he eventually gets fired. 2) Issues/ holding (i) Was the tortious discharge in contravention of public policy? (A) Under Restatement 381: Unless otherwise agreed, an agent is subject to a duty to use reasonable efforts to give his principal information which is relevant to affairs entrusted to him and which, as the agent has notice, the principal would desire to have and which can be communicated without violating a superior duty to a third person. (1) This is what Foley did. (2) However, courts dont want to set precedent that principal is liable for retaliatory discharge. The GENERAL RULE is only required to report when an employee discloses illegal or unsafe practices b/c want to protect the public, but dont want to extend this principal to private interests. a. Recently, the federal government is giving more protection from retaliations for whistle blowing in securities fraud context. (ii) Was there a breach of employment contract which was sufficiently established by the oral or implied contract? Did implied K override at-will K? (A) Parties actions can create implicit relationships, so employers must be careful. (B) Test to see if an implied K arose to override at will K doctrine: (1) Length of employment here 6 yrs 9 mo (2) Breach of written terminations guidelines (3) Did employee supply the co with valuable and separate consideration (such as non-compete agreement, which shows he was more than a mere at-will employee) a. On these matters Foley proved enough to take this issue to trial to see if there was an implied in fact K.

(iii) Is there punitive (tort) or K damges? (A) Public policy doesnt support the idea of punative damages in these cases. In Insurance context there is punitive

damages because there is a lack of bargaining power and cant retroactively get another insurance K if already have property damage. (1) Here there are no punitive damages b/c employee can to get another job. rd IV Agency Law and Relations with 3 parties Dealing with THIRD PARTIES: Types of agency Authority 1) Actual: Authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principals manifestations of consent to him. ( 7) (i) Actual Express Authority involves examining the principals explicit instructions (ii) Actual Implied Authority involves examining the principals explicit instruction and asking what else might be reasonably included in those instructions to accomplish the job. This includes actions necessary to accomplish the principals original instruction to the agent; and those actions that the agent reasonably believes the principal wishes him to do, based on the agents reasonable understanding of the authority granted by the principal. 2) Apparent (Ostensible authority): Apparent authority to do an act is created as to a third person by written or spoken words or any other conduct of the principal which, reasonably interpreted, causes the third person to believe that the principal consents to have the act done on his behalf by the person purporting to act for him. ( 27) (i) Steps to Analysis: rd (A) A reasonable belief by the 3 party that the alleged agent is an agent of the principal (reasonable reliance) look at manifestations btw the principal and the third party rd (B) Some action or inaction by the principal to create (or fail to dispel) that reasonable belief on the part of the 3 party; and rd (C) Some showing that the 3 partys injury could have been avoided had the alleged principal exercised control over the alleged agent. 3) Inherent: [T]he power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. (8A) (i) requires that the third party alter his or her position in reliance on the purported authority. There is no requirement of manifestation by the principal (directly or indirectly) to the third party. rd (A) Used mostly to prevent one party (usually principal) form denying a purported agents authority when the 3 party wants to enforce that K. Blackburn v. Witter: 1) Facts Long tricked Blackburn to invest in fake company. 2) Issue Who can be sued? Was it reasonable for Blackburn to rely on Long? 3) Analysis (i) Is the person an agent? Yes it appears Long is an agent (ii) What is the scope of authority? unclear rd (iii) What did the principal communicate to 3 party for apparent authority? nothing (iv) Is this an inherent authority analysis that depends on the position the agent held and the authority conveyed by that position? yes rd (v) Did the 3 party act reasonably, or did person have notice (constructive) of the absence of authority? Blackburn was NOT SOFISTICATED and therefore we must assume that by receiving rediform receipts that was reasonable for her. 4) Holding Witter co. held liable for acts of agent. Sennot v. Rodman & Renshaw: 1) Facts Jordan convinces Sennott to invest in Skyline with a fake option scheme. Sennot loses about $150K and sued Rodman and Renshaw (company) b/c they were responsible for him b/c Jordans dad worked for them. The head of Rodman summoned Sennott to discuss these Skyline options and make him sign agreements this shows company knew what its agent was doing. 2) Issue Does Jordan have any authority? 3) Analysis: (i) Is person agent? no (ii) What is scope of authority? unclear rd (iii) What did the principal communicate to the 3 party for apparent authority? A lothad meeting (iv) Is this an inherent authority analysis that depends on the position the agent held and conveyed from that position?y rd (v) Did 3 party act reasonably? No 4) Holding court says Sennot could NOT have reasonably believed Jordan had authority from Rodman and Renshaw b/c Jordan was not employed at the time and Sennot signed indemnity agreement. Sennot was someone who was involved in trades and sophisticated. So Sennot could have fended for himself. Partnership I Intro: Partnerships governed by UPA in most states, but these are default rules which can be contracted around: 1) (1914) UPA 6(1): A partnership is an association of 2 or more persons [which may consist of husband and wife] to carry on as co-owners a business for profit.

2) (1997) UPA 202(a): The association of two or more persons to carry on as co-owners a business for profit forms a

partnership, whether or not the persons intend to form a partnership. How to determine if you are in a partnership: (ELEMENTS) 1) an association of 2 or more ppl 2) carry on as co-owners of a business for profit 3) no matter if intend to form partnership or not (i) if satisfy these three elements, you have partnership, dont need formalities. Defining Characteristics of General partnership 1) Equal sharing of ownership and management functions a sole proprietor usually performs three ownership and management functions: (A) 1. she is the residential claimant and ultimate risk bearer the person who takes what is left after all employees and other creditors have been paid. (B) 2. she oversees the business and affairs of her firm, developing business policies and directing their implementation (C) 3. the sole proprietor sits at the top of the firm's day-to-day operational hierarchy, empowered to act on behalf of the firm in interactions with the firm's employees, customers, suppliers and creditors. (ii) General Partnership norms distribute these ownership and management functions equally either to each partner or to the partners as a group. (A) Each partner is a residual claimant, has a full and equal right to participate in management of the firm, and has an equal right to act as an agent of the partnership. (B) Parternship laws norms also assign to each partner an equal share of profits and an equal responsibility for losses. (C) General partnership laws norms will be most efficient if partners make similar contributions of services and capital. 2) Individual partner's adaptability to changed circumstances favored over firm's continuity and adaptability (i) Sole proprietorship agency and employment law default rules allow the proprietor to adapt to changed circumstances by hiring and firing agents at will, by changing the course or nature of the business at will, and by terminating the firm at will. (ii) General Partnership under general partnership law default rules, if the partnership wishes to terminate its association with a partner, it may do so only by dissolving the partnership and paying the expelled partner the value of her interest in cash. (A) This brings lack of stability and continuity. (B) Ordinary decisions may be made by majority vote of the partners. However, extraordinary decisions and changes in the partnership agreement require unanimity. 3) Unlimited Personal Liability (i) general partnership all partners are jointly and severally liable for all obligations of the partnership and there is no limit on this potential personal liability. 4) Fiduciary Duty (i) fiduciary duty reduces the likelihood that one or more partners will misuse their ownership power or rights. (A) Each partner owes a fiduciary duty to other partners. 5) Taxation of profits at one level Limited partnership 1) a limited partnership is a business association composed of one or more general partners and one or more limited partners and that is formed by filing a certificate of limited partnership with the secretary of state in the jurisdiction chosen by the parties in control of the limited partnership. 2) Characteristic of a limited partnership: (i) Separation of ownership and management functions ownership and management functions are divided among the firm's general and limited partners. Limited partners have essentially no management power. (ii) limited liability limited partners are not personally liable for the limited partnership's obligations. General partnership, are jointly and severally liable for the firm's obligations. (iii) firm's continuity and adaptability to changed circumstances favored over individual's adaptability under limited partnership default rules, general partners may withdraw form the partnership at will, but limited partners may not. (A) Unlike in a general partnership, such withdrawal does not automatically or necessarily trigger dissolution and liquidation of the limited partnership. (B) General partners make ordinary decisions by majority vote and extraordinary decisions unanimously. II Governance Partnership Agreement: UPA 103 1) 103 UPA 1997 governs partnership agreements, and it states the following: (i) UPA 103(a) says if no partnership agreement then UPA default: [R]elations among the partners and between the partners and the partnership are governed by the partnership agreement. To the extent the partnership agreement does not otherwise provide, this [Act] governs relations among the partners and between the partners and the partnership.

(ii) Limits on Partnership Agreement 103(b): Partnership agreement may not eliminate the duty of loyalty,

eliminate the obligation of good faith and fair dealing, vary the power to dissociate a partner (except to require notice in writing), or restrict the rights of third parties. Profits and Losses 1) UPA 18(a) The rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by all of the following rules: (i) (a) Each partner shall . . . share equally in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether of capital or otherwise, sustained by the partnership according to his or her share in the profits. Partner Liability 1) UPA 306 Except as otherwise provided in subsections (b) and (c), all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law. 2) UPA 401(b) Each partner is entitled to an equal share of the partnership profits and chargeable with a share of the partnership losses in proportion to the partners share of the profits. Compensation for Services 1) UPA 401(h) a partner is not entitled to the remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership. (i) Dont get compensation in partnership, other than profits or losses. This can be overridden through agreement to pay a salalry. Proving a Partnership 1) UPA 202(c)(3) a person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment: (i) Of a debt by installments or otherwise; (ii) For services as an independent contractor of wages of other compensation to an employee; (iii) Of rent; (iv) Of an annuity or other retirement benefit; (v) Of interest or other charge on a loan, even if the amount of payment varies with the profits of the business; (vi) For the sale of the goodwill of a business or other property by installments or otherwise. Byker v. Mannes: No formalities needed to form partnership 1) Facts Bykers and Mannes were business partners for years in several businesses until Pier 1,000 starts failing and Mannes says he doesnt want to support it anymore, but Bykers does. 2) Issue should Michigan adopt the 1997 UPA concerning intent to form a partnership? (i) What formalities do these 2 need to form a partnership? 3) Holding court remands to see if factually these two were partners of a business for profit. (i) Next time Mannes should form a partnership agreement, that allocates how profits and losses shared for business. 4) Rule partnership may be formed w/out subjective intent to form a legal partnership. No writing necessary. Hyansky v. Vietri: can look beyond 4 corners of a partnership agreement to see if parties wanted to be partners. 1) Facts parties signed partnership agreement and capital contribution agreement. Vietri doesnt think this is a partnership agreement b/c didnt read what he signed. 2) Issue is this a partnership agreement? 3) Analysis can we look at intent of parties or does Parol Evidence Rule apply here permitting us to only look in 4 corners of the document b/c there was an integration clause. (i) Just b/c these ppl called themselves a partnership, doesnt make them a partnership. Must look at facts and circumstances to see if wanted to form business for profits as partnership. 4) Holding: remanded to see if these two people wanted to carry on a business for profit (partnership test). Capital Accounts 1) How keep track of money put into partnership = capital account (CA used to start business and need financing) (i) 401(a)(1)/(2): Each partner is deemed to have an account that is: [credited]/[charged] with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, the partner contributes to the partnership and the partners share of the partnerships [profits][losses]. (ii) 401(b) partners spit and share profits and losses equally. (A) Profits are added to capital accounts (B) Losses are subtracted from capital accounts. (iii) 101(11): Property means all property, real, personal, or mixed, tangible or intangible, or any interest therein. Settlement of Accounts Among Partners on Dissolution (winding up) 1) 807(a) in winding up a partnerships business, the assets of the partnership, including the contributions of the partners required by this section must be applied to discharge its obligations to creditors. ..any surplus must be applied to pay in cash the net amount distributable to partners in accordance with their right to distributions under subsection (b) 2) 807(b): Each partner is entitled to a settlement of all partnership accounts upon winding up the partnership business. In settling accounts among partners, the profits and losses that resulted from the liquidation of the partnership assets must be credited and charged to the partners accounts. . . . A partner shall contribute to the partnership an amount equal to any excess of the charges over the credits . . . . [See also 18(a) & 40 UPA (1914)] (i) Order of priority to pay money:

(A) Outside creditors (B) Inside creditors (C) Owners

Kovacik v. Reed: In a NON-UPA state, the sweat equity partner not liable to capital contributing partner for losses on dissolution from using capital account to settle debt only applies to capital accounts deficits, not to losses to outside creditors. 1) Facts These two form business and agree to split profits on a 50/50 basis. We have 2 co-owners of business for profit so this is a partnership. UPA 401(h) says no renumeration for services and reed is only contributing labor. Kovacik dissolves the partnership. 2) Issue Whether a sweat equity partner is liable for the capital contributions of the other partners? No (not UPA) 3) Analysis since reed only contributed labor, he has $0 in capital accounts, but among partners they must share in the losses, so Reed owes money to cover losses. Reed claims this is unfair, he only contributed services, but now he owes Kovacik money. 4) Holding court agrees w/ Reed and thinks UPA is unfair for services partner to be laible for loss of Kovaciks capital contribution. So the debt is settled by using Kovaciks capital account and the balance of money that is owed to creditors is split btwn Reed and Kovacik. So basically Kovacik ends up paying capital contribution money plus half of the excess debt owed. While Reed only pays of the excess debt and gets benefit of Kovaciks capital contribution, the court rationalizes this b/c Reed gave sweat equity and time. 5) Rule Where one partner or joint adventurer contributes the money capital as against the other's skill and labor, the case hold that the sweat equity partner is not liable to the capital contributing partner for the amount of capital contributions he had to pay to settle debt on dissolution. (i) Therefore, upon loss of the capital contribution the party who contributed it is not entitled to recover any part of it from the party who contributed only services. Any amount of debt that is owed ontop of the capital account balance is split btwn both parties. (ii) *** IN UPA state, sweat equity partner shares equally in losses, so the sweat equity partner must pay of all debt and the capital contributing partner individually benefits from having that capital account and has to pay less out of pocket*** Shamloo v. Ladd: payment to outside creditors 1) Facts Ladd contributed $75K to capital account and shamloo contributes services, so $0 in capital accounts 2) Issue should a sweat equity partner be paid/rewarded for being a sweat equity partner and doing all the work? NO 3) Holding under the UPA NO. The court looked at California UPA and follows UPA and says 401(h) says no repayment for services to partnership, unless you otherwise agree. (i) Sweat equity partner only gets in trouble, where the partnership owes $ whenever the partnership dissolves. (A) Shamloo who contributes his time and services is not entitled to credit in his capital account for this service. Accordingly, he cannot share in the capital contribution of Ladd. The general holding is that "a partner contributing only services is not entitled to a share of capital on disassociation" (ii) The capital advance (A) When paying outside creditors, the rule in Kovacik v. Reed DOES NOT apply, it is strictly the UPA remember partners are jointly and severally liable so be careful w/ partner if they owe a ton of money. (B) An advance is not a capital contribution but is treated as a loan or obligation to the partnership requiring the payment of interest. A partner shall receive interest on capital contributed by him only from the date when repayment should be made. (1) Interest is therefore not due on a capital contribution unless the parties agree otherwise or until payment of the capital is due. 4) Rule: a partner contributing only services is ordinarily not entitled to share of capital on dissolution (unless have agreement); Partner who contributes an advance should be paid interest starting from date when repayment should be made. III Fiduciary Duties Duty of Loyalty 1) Common law duty of loyalty demands that partners deal with one another as fiduciaries at all times 2) Meinhard v. Salmon: Common law duty of loyalty very high standard (i) Facts Salmon gets lease of property and Meinhard finances this. This is a partnership. At first profitable, but then lease runs out and Salmon (unilaterally) signs another lease and doesnt mention it to Meinhard. (ii) Issue was there a duty of loyalty for Salmon to tell Meinhard about this new lease? (iii) Analysis the duty of loyalty in partnership is a very high standard not honesty alone, but the punctilio of honor the most sensitive, is the standard of behavior and it is a very hard accusation to overcome. (iv) Holding by holding this duty of loyalty, this opportunity naturally came to the partnership b/c Salmon only found out about this opportunity b/c he was part of the partnership. (A) Under UPA 404(b) the outcome probably would have been the same b/c cant partition opportunities that come to partnership b/c 403(c) says w/out demand any information concerning the partnership is reasonably required to be communicated to other partners. 3) UPA Duty of Loyalty (more limited than common law) (i) UPA 404(b) A partner's duty of loyalty to the partnership and the other partners is limited to the following:

(1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner

in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity; (2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. (ii) Waiving Duty of Loyalty UPA 103(b)(3) (A) The partnership agreement may not . . . . eliminate the duty of loyalty under Section 404(b) or 603(b)(3), but: (1) the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable; or (2) all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty; 4) Duty of Disclosure (i) UPA 403(c) Each partner and the partnership shall furnish to a partner . . . : (A) (1) without demand, any information concerning the partnerships business and affairs reasonably required for the proper exercise of the partners rights and duties under the partnership agreement or this [Act]; and (B) (2) on demand, any other information concerning the partnerships business and affairs [except if the demand is unreasonable or otherwise improper] (ii) TEST when opportunities arise does this naturally accrue to the partnership 5) Common law v. UPA duty of loyalty (i) Most states apply both. SO even though you can override UPA duty of loyalty through partnership agreement, there are bare minimum requirements that cant get rid of such as UPA 103(b)(3). Also, the common law overrides. Self-Dealings 1) Vigneau v. Storch Engineers: (i) Facts V is self-dealin. V should have told partnership he was doing this negotiating for both sides. There is a lawsuit b/c V is suing Storch to regain his partnership interest. V has capital account with Storch and wants repaid capital account but Storch says no b/c breached his fiduciary duties. (ii) Issue if a partner breaches his fiduciary duties through self dealing can they recover capital account, or do they forfeit it? (iii) Holding ct says dont have to forfeit, but the damages were about equal to what Vs capital account was. This shows the court disapproved of Vs conductct. penalizing V for trying to get $ back after self-dealing. Management of Partnerships Business and affairs 1) UPA: (i) 401(f): Each partner has equal rights in the management and conduct of the partnership business. (ii) 401(j): A difference arising as to a matter in the ordinary course of business of a partnership may be decided by a majority of the partners. An act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all of the partners. 2) Covalt v. High: When partners cant agree and no partnership agreement status quo (i) Fact they had at-will partnership that owned a building that is leased to the corporation of which they are partial share holders. There was a conflict of interest: covalt claims high is benefitting on both sides of this arrangement. High refuses to raise rent in building that he owns through the partnership. This is an example of self dealing and a breach of fiduciary duties to partnership. (ii) Issue what happens when partners disagree? (iii) Analysis (A) Court doesnt find breach of fiduciary duty because sites the UPA Covalt entered into arrangement willingly knowng that high had interest. Covalts claim that highs refusal to raise rent is not a breach of fid duty b/c partners can do what they want. (B) Court says if no express agreement and no agreement on issue in partnership, the prior arrangement stays in effect, so rent is not increased and they can dissolve the partnership. (iv) Rule the status quo is maintained when no agreement in partnership and no express partnership agreement to say what should happen. (A) To prevent this make partnership agreement to govern problems and conduct of partners. Contracting for Absolute Discretion 1) The relationship of fiduciary duty and private ordering is controversial. UPA 103(a)(3) and 404 are compromise positions, viewing fiduciary duty as partly mutable, but with an irreducible core. (i) Not uncommonly, a subset of partners will contract for near or absolute discretion in managing the partnerships business.Should courts review these self interested decisions when disgruntled partners assert that the partners with absolute discretion have unfairly favored themselves? 2) Starr v. Fordham: (i) Facts starr is not a good lawyer b/c entered into partnership that he didnt fully agree with concerning terms. If Starr would have kept previous job and then made the employment K, before he quit, he would have had more

bargaining power. When Starr leaves his old firm the other partners screw Starr out of profits, so he sued. He claims partners breached fiduciary duty. (A) Lower court says that the FIRM contracted around fiduciary duties in UPA 103(b)(5). (ii) Issue what is the burden of proof to show breach of fiduciary duties? (A) Burden on person accused of breach; b/c society values these fiduciary duties so want to make sure those who have burden act appropriately now and in the future. (iii) Analysis (A) The test to be applied when one partner alleges that another partner has violated his duty of strict faith is whether the allegedly violating partner can demonstrate a legitimate business purpose for his action. (1) The business judgment rule does not apply if the P can demonstrate self-dealing on the part of the allegedly wrongdoing partner. a. Having concluded that the founding partners had engaged in self-dealing when they assigned to P his share of the profits, the judge made no error. The business judgment rule did not apply to the founding partners actions. (B) An implied covenant of good faith and fair dealing exist in every contract. (1) A court has the power to determine whether a partners share of the profits is fair and equitable as a matter of law. a. The judge here determined that this decision to exclude billable hour figures was unfair to the plaintiff and indicated that the founding partners had selected performance criteria in order to justify the lowest possible payment to the P. (iv) Holding court says the firm did violate the convenant of good faith and fair dealing b/c even though there was a K, the partners created a K that benefitted themselves and didnt even consider billable hours. This is unfair and violates fiduciary duty and the duty of good faith and fair dealing implicit in every K. UPA 404(b)(3). The Duty of Care 1) In Limited partnership (i) UPA 404(c) imposes a duty of care on general partners. (A) Case law also suggests that general partners owe limited partners a fiduciary duty of loyalty and care in the exercise of management functions. (1) The imposition of a duty of care arguable is necessary to protect limited partners, who have no right to manage and control the partnership business and, thus, have little ability to monitor general partners conduct. (ii) Cincinatti Bell Case: Although there is a need to have duty of care for general partners in Limted partnership, the standard is very high and hard to achieve, so rarely find breach of duty of care in limited partnership. (A) Issue when is the duty of care important (B) Holding there is a duty of care in the limited partnership setting. (1) The standard = the limited partner has to prove that the general partners decision was recklessly uninformed or acted outside the bounds of reason. a. This is a HIGH STANDARD, so hard to breach duty of care. (C) Rule limited partner can bring suit for breach of duty of care if grossly uninformed or grossly negligent. 2) General Partnership duty of care (i) Ferguson v. Williams: No duty of care in general partnership (A) Holding none of the negligence findings involve any breach of trust or fiduciary duty of Ferguson and Welborn to Williams. Partners in a general partnership do not owe each other a duty of care. (1) Rationale in a general partnership, each partner has a say and right to manage and control partnership. No need to protect partners from one another if each should be participating in the business. IV Dissolution and Dissociation of Partnerships The basic framework 1) The rules governing partner dissociation and partnership dissolution necessarily must strike a balance btwn the individual partners ability to adapt to changed circumstances and the firms desire for stability and continuity. 2) When a partnership ends, it goes through three phases: Dissolution, winding up, and termination. 3) Definitions: (i) at will partnership a partnership formed w/out agreement that the partnership shall continue for a specified term or undertaking. (A) The general partnership is an at-will relationship that can continue only as long as every member assents. To end an at-will partnership, the relationship must first be dissolved and then the business of the partnership must be wound up. (B) In at will partnership any partner may dissociate and thereby cause a dissolution of the partnership by simply expressing his will to cease association with the partnership. (1) Once dissolution occurs, the partnership must wind up its business, pay off its debts, and settle accounts with partners. (ii) Dissolution UPA 29 (1914) the dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. (A) If have non-wrongful dissolution other partners can agree to carry on business

(1) Whenever a partner left a firm, that was deemed to be a dissolution and the remaining partners could vote

to either continue the partnership or wind up and terminate the partnership. If partners elected to buy back your partnership interest, it would be at the value of the partnership interest; minus good will (penalizes the wrongful dissolver). (B) UPA 30 (1914) on dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed. A dissolved partnership continues to exist and is owed fiduciary duties (iii) Dissociation not defined in UPA 1997, but meant to be distinguished from dissolution of partnership and is a way for partner to exist partnership while the partnership still exists. Dissociation handles partners who leave. When a partner leaves a firm either voluntarily or involuntarily (by expulsion or even death), that is known as dissociation. (1) If the partner does not have the right to leave the partnership, the n the dissociation is wrongful and the dissociated partner might be liable to the partnership for damages. a. Wrongful disassociation occurs when: (UPA 602(b)(1-2)) 1. It is in breach of an express provision of the partnership agreement; or 2. In the case of a partnership for a definite term or particular undertaking, before the expiration of the term or the completion of the undertaking. i. If the dissociation is wrongful, the partnership continues (doesnt automatically expire) and the partnership interest is bought back at the value (not subtracting good will) plus any damages for breach of the agreement. The liability is in addition to any other obligation of the partner to the partnership or to the other partners. (UPA 602(c)) b. Non-Wrongful dissociation: (express will; agreed event; expulsion pursuant to agreement; judicial order) 1. a partnership which is neither for a term of undertaking is considered an At will partnership and a partner can dissociate from an at-will partnership at any time, provided the partnership agreement does not provide otherwise i. in these cases the partnership automatically dissolves because nobody had done anything wrong, but nobody wants to carry on partnership. (B) Under UPA 1997 much more limited circumstances where partnership is dissolved and wound up when one partner disassociates three circumstances where there is a wind up (UPA 801): 1. Dissolution of an at-will partnership = wind up 2. Even provided in partnership agreement is met (end or term/goal) 3. Judicial court determines that a partners conduct is not reasonably practical to carry on the business. (C) Whether or not the dissociation was wrongful, the dissociated partner is entitled to receive funds, representing his or her share of the partnership (minus damages). (1) The dissociating partners interest may be bought out by the remaining partners (UPA 701) who will continue the business (no winding up); a. except the dissolution of an at-will partnership (non-wrongful) by a partners dissociation requires that the partnership be wound up (UPA 801) (D) 1997 UPA 701(a)-(b) Purchase of dissociated partners interest (1) If a partners dissociation does not result in winding-up the partnership under 801 [e.g. it is a wrongful dissociation], then the partnership must buy out the dissociated partners interest at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner. (iv) Settlement of Accounts (A) UPA 807 Pay: (1) Creditors, including to the extent permitted by law partners who are creditors. (2) Any surplus must be applied to pay in cash the share owed to each partner. (3) A partner shall contribute to the partnership an amount equal to any excess of the charges over the credits in the partners account. (B) UPA 401(a)(1): Each partner is deemed to have an account that is credited with an amount equal to the money plus the value of any other property . . . the partner contributes to the partnership and the partners share of the partnership profits (C) UPA 401(b): Each partner is entitled to an equal share of the partnership profits and chargeable with a share of the partnership losses in proportion to the partners share of the profits. 4) McCormick v. Brevig: (i) Facts This brother and sister have partnership. In 1995 sister sues brother for wrongful conduct and trial court said sister had to sell her share of the farm back to brother, instead of dissolving the partnership. But sister wanted to sell farm back on open market to get more money rather than get money from brother set by appraiser. She also hopes that by selling ranch on open market she can buy the ranch herself. (ii) Analysis (A) A partner may be expelled from partnership for (1) (1) engaging in wrongful conduct that materially and adversely affected the business, (2) (2) willfully committed a material breach of the partnership agreement or other duty to partners, or (3) (3) engaged in conduct making it impractical to carry on business with these partners. (B) despite the RUPA, the court forced liquidation saying it was impractical to carry on the business

(C) When a partnerships dissolution is court ordered pursuant to section 35-10-624(5) (basically UPA 807), the

partnership assets necessarily must be reduced to cash in order to satisfy the obligations of the partnership and distribute any net surplus in cash to the remaining partners in accordance with their respective interests. (iii) Holding market price is the better price so liquidate. (A) Court forced liquidation saying it was impractical to carry on business. This is fair result b/c court shouldnt decide who gets to keep business so put on market. (iv) Rule if at will partnership dissolves under the UPA liquidate the partnership unless it is unique or need appraisal to reflect accurate price. 5) Under UPA, the default rule is to liquidate the assets in dissolutionHowever there are two exceptions: (i) Nichols Case in unique and authentic business and cant get value from sale, court is willing to entertain buyout remedy (ii) Disotell Case sale not economically efficient and appraisal is a better option 6) Drashener v. Sorenson: demonstrates wrongful dissolution. (i) Facts: Drashner liked going to the bar a lot, he felt the partnership didnt pay enough distributions; they fell out, he sought a dissolution. Turns out the partnership was for a term (until the initial capital was recovered); this made his dissociation wrongful. (ii) Issue: Does the partnership have to wind-up? No (iii) Analysis: (A) RUPA 801(2): if a partner has dissociated wrongfully, a majority vote of the remaining partners can opt to continue the partnership anyway. (B) RUPA 601(5): provides for dissociation of a partner upon a judicial determination that the partner has engaged in wrongful conduct. This provision does trigger a right to damages under 602(c). (C) RUPA 801(5): provides for dissociation for partner conduct that makes it impracticable to carry on the partnership with that partner, or when it is otherwise impracticable to carry on the business. This provision does not trigger a right to damages under 601(c). The court may dissolve the partnership only when it is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement. This focuses attention on both the continuation of the business and honoring the partnership agreement wherever possible. (iv) Holding: In Drashner if the remaining partners want to continue, they have to pay the wrongfully dissociating partner his share of the value of the business as a going concern, less any damages he did and not including any goodwill value. (v) Rule: (A) Dissolution is a 3-step, ongoing process: (1) 1. The dissolution happens (2) 2. The winding-up process (3) 3. Termination of the partnership (B) RUPA 602(a): every partner has a right to withdraw (dissociate) from the partnership at any time, rightfully or wrongfully, by express will. (C) RUPA 602(c): a partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociation; furthermore if a partner wrongfully dissociates the partnership can continue without him. 7) McCormick v. Brevig: (i) Issue: did the district court err in ruling that Clark did NOT dissociate by withdrawing from the Partnership? NO (ii) Analysis: one of the pays a partner may be dissociated is expulsion by judicial decree because: (these are wrongful) a. The partner engaged in wrongful conduct b. Partner willfully committed a material breach of the partnership agreement c. The partner engaged in conduct relating to the partnership business that made it not reasonably practical to carry on business in partnership with that partner (iii) Holding: sisters amended complaint did not specifically request relief pursuant to this statuteso Brother did not dissociate from the partnership. Fiduciary Limits on Dissolution at will 1) Page v. Page: cant dissolve at will partnership in bad faith (i) Facts: Plaintiff and Defendant were brothers who ran a linen supply business. After years of losses, Plaintiff wanted to dissolve the business just as it became profitable. Defendant asserts that he and Plaintiff have run other businesses together and they always stipulated that the partnership should continue until the parties could recoup the money they invested. Defendant also believes that Plaintiff is using his superior financial position to push out Defendant so Plaintiff can acquire the whole business and receive 100% of the profits. (ii) Issue: Is the partnership for a term or at will? (iii) Holding: This is a partnership at-will, and Defendant only had hope he would recoup capital which is not enough to make this a term partnership. However, it appears plaintiff wants to dissolve the business in bad faith so must remand to figure out what to do. (iv) Rule: Unless specified, a partnership may be dissolved at will by any partner providing the partner is exercising good faith Fiduciary limits on expulsion of unwanted partners

1) Under UPA 601(3) a partner is dissociated from a partnership upon the occurrence of a partners expulsion pursuant to

the partnership agreement. (i) However, in a term partnership, if the majority ousts the deficient partner, this dissociation could be deemed wrongful exposing the ousting partners to substantial liability. (A) Therefore, partners will often negotiate in advance for terms governing expulsion. But to the extent that the partners dont agree, the right to expel will be governed by the dictates of partnership law, including fiduciary duty. 2) Bohatch v. Bultler & Binion: Fiduciary duty doesnt create exception to the at-will partnership (i) Facts: A partner is expelled from the partnership for accusing a senior partner of overbilling a major client. (ii) Issues: (A) Whether the fiduciary duty of a partnership creates an exception to the at-will nature of partnerships where a partner was expelled from a partnership for reporting suspected over billing by another partner? No (B) Whether Defendant breached the partnership agreement by reducing Plaintiffs tentative distribution for 1991 to zero without notice? YES (iii) Holding: (A) There is no fiduciary duty that creates an exception to the at-will nature of the partnership for whistle blowing. By whistle blowing she made work at the firm impossible...profound effect on personal confidences and trust essential to the partnership (B) Defendant did breach the partnership agreement when it failed to disburse the $7,500 per month draw and give notice of this reduction. (iv) Rule: Partners in at-will partnerships have the freedom to expel another partner if the offending partner damages the personal confidence and trust of the partnership. Contract to prevent opportunistic withdrawal: the fiduciary duties owed by withdrawing partners 1) in service partnerships, it is common for one or more partners to dissociate, form a new firm that carries on a similar business, and then attract a number of their former firm's clients to the new firm. (i) It is also common for partners to contract in advance concerning the rights and obligations of continuing and withdrawing partners. 2) Meehan v. Shaughnessy: (i) Facts: Plaintiffs, James Meehan and Leo Boyle, left the law firm of the Defendants, Maurice Shaughnessy et al. Plaintiffs wanted money they believed was owed to them under their partnership agreement, and Defendants countered that Plaintiffs violated their fiduciary duty and interfered with Defendants business. (ii) Issue: whether the conduct of Plaintiffs violated a fiduciary duty owed to the remaining partners of the firm? (iii) Holding: Plaintiffs conduct regarding their secret planning for their new venture after their departure from the firm was not completely unacceptable. Plaintiffs would have to engage in some initial planning for the new firm to ensure that they would have the necessary resources and know-how to start their own firm. Pre-departure planning would also be required to ensure that the needs of clients were met with their new firm. However, Plaintiffs conduct went too far concerning their retention of former clients. Plaintiffs left Defendants at a disadvantage when they denied they were leaving and when they secured clients while Defendants were initially trying to game-plan for Plaintiffs departure. (1) By engaging in pre-emptive tactics, and lying to partners about leaving, Meehan and boyle violated the duty of utmost good faith and loyalty which they owed their partners. (2) Mere preparation and game planning is OK, but getting clients before told employer they were leaving was unfair. Impermissible actions: take client files; deny plans of departure when asked; not inform clients of rights to have counsel of own choice. (B) Although Plaintiffs violated the partnership agreement by violating their fiduciary duties, Plaintiffs are still entitled to their share of capital contribution and compensation. The plaintiffs dont have to forfeit compensation. (iv) Rule: A fiduciary may plan to compete with the partnership so long as it is in the planning phase, and he doesnt otherwise violate his duties to the partnership. rd V Partners as Agents allocating the RoL in transaction with 3 parties Under general agency law, authority comes from the principals manifestations of consent to either the agent or the third part. 1) So to determine a particular agents authority under agency law must do a case by case analysis to determine what manifestations have been made and whether these manifestations are sufficient to create authority in a particular case. (i) The broadest possible grant of agency power is the general agency power granted to one who is the general manager in charge of the entire business. UPA 301 characterizes a partner as a particular type of agent, in the absence of contrary evidence, which eliminates the need for a case by case analysis of the principals manifestations of consent. 1) UPA 301 states (i) (1) Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, (A) unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.

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(ii) (2) An act of a partner which is not apparently for carrying on in the ordinary course the partnership business or

business of the kind carried on by the partnership binds the partnership only if the act was authorized by the other partners. Types of Agency Authority: 1) Actual: Authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principals manifestations of consent to him. ( 7) 2) Apparent: Apparent authority to do an act is created as to a third person by written or spoken words or any other conduct of the principal which, reasonably interpreted, causes the third person to believe that the principal consents to have the act done on his behalf by the person purporting to act for him. ( 27) 3) Inherent: [T]he power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. (8A) Agency Analysis 1) Is the person an agent? 2) What is the scope of authority (if actual, analysis ended)? 3) What did the principal communicate to 3d party for apparent authority? 4) Is this an inherent authority analysis that depends on the position the agent held and the authority conveyed by that position? 5) Did the 3rd party act reasonably, or did person have notice (may be constructive) of the absence of authority? These are essentially the same question. P.A. Properties, Inc. v. B.S. Moss Criterion Center Corp: 1) Facts UA ventures enters into agreement w/ PAP. PAP files suit against UA for compensation. UA files bankruptcy, so PAP sues B.S. Moss (b/c has deep pockets). 2) Issue whether UAs consulting agreement with PAP was an obligation of the JV, such that the remaining solvent coventurer MOSS is liable thereon? YES 3) Analysis: (i) Agency analysis: (A) Is UA an agent (B) Scope of authority inherent authority rd (C) What did principal communicate to 3 party for apparent authority? Nothing (ii) UA was acting in a way naturally w/in the scope of the partnership. So public policy rationale is we want to protect 3rd parties if reasonably rely on action of an agent for a partnership. 4) Holding: there is inherent agency authority and PAP can sue Moss. Haymond v. Lundy: 1) Facts the firm dissolved and there is an argument btwn who should pay the referral fee. 2) Issue whether Lundy has bound partnership through his oral (and later written) commitment to pay a standard referral fee, even though he exceeded his authority to bind firm under the partnership agreement? 3) Analysis (i) Agency Analysis: (A) Is this person an agent? Yes (B) What is the scope of his authority? Not actual b/c Lundy exceeded partnership agreement rd (C) What did principal communicate to 3 party for apparent authority? Nothing rd (D) Did 3 party reasonably rely on Lundys appearance of authority? Yes (ii) There is no actual authority, but there is apparent authority b/c it was reasonable to think partners have authority of general managerial agency. 4) Holding Since lundy exceeded his authority under the partnership agreement by not obtaining consent before making this agreement, only 10K of the 150K referral fee needs to be paid from partnership. Lundy must personally cover the rest. VI Limited Liability Partnerships Difference btw the Gen Partnership and Limited Partnership: 1) General Partnership (i) All partners are joint and severally liable for conduct (ii) Involved in partnership (iii) Make decisions together in business (iv) Unlimited liability 2) Limited partnership (i) Established to have limited liability in a partnership the limited partners are only liable to amount of capital that they put in the limited partnership (ii) One (usually) general partner who runs the partnership, and then limited partners who have no voice in the partnership (but can contract around this), the limited partners generally only provide capital dont work in the partnership. UPA 306 1) (A) except as otherwise provided, all partners are liable jointly and severally for all obligations of the partnership

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2) (C) an obligation of a partnership incurred while the partnership is a limited liability partnership, , is solely the

obligation of the partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, solely by reason of being or so acting as a partner. Dow v. Jones: general principles of agency and partnership law continue to govern in LLPs 1) Issue: whether the rules of agency authority are different for limited partnerships as opposed to general partnerships? NO (i) Whether JONES acting on individual capacity or in a way to bind the partnership. 2) Analysis: in LLP partners are not joint and severally liable. Dow wants to sue partnership and JONES. Partnership says no actual or apparent authority. The test is authority on subjective basis. (i) Case remanded Corporations (stopped p. 153; notes page 29; and slides 8) I The Corporate form Benefits of choosing a corporate form: 1) Eliminates personal liability creditors rely on assets and a shareholder only liable to the extent of the investment in the firm. 2) Shares are freely transferable -- Investors can easily enter/exit what makes it really different from an LLC 3) Prevents minority investors from holding up the form by threatening to dissolve it because majority or substantial majority ownership through shares controls the board 4) A juridical/legal person can sue and be sued, buy and sell property, ect (i) Third parties know who they are dealing with an authorized agent, thus easier to contract w/ parties Corporate form characteristics: 1) 1. Legal personality with indefinite life (i) Can sign contracts, close sales etc. 2) 2. Limited liability for investors 3) 3. Free transferability of share interests 4) 4. Centralized management 5) 5. Appointed by equity (capital elects the board b/c of investor ownership) Sources of Corporate Law 1) State corporation codes: provide a set of default rules for corporation organization that in some cases may be varied by shareholders or the board. (can contract around some default rules) 2) Articles of incorporation:the constitution of the entity that sets forth its basic structure and operational rules, and it may vary some of the default rules of the state corporate law. 3) By-Laws: internal governance rules for the entity. (may have to amend if want to issue more shares, ect) 4) Common Law: fiduciary duty, courts sitting in equity (Delaware Chancery Court) judge the conduct of a corporation and its directors and officers to determine whether they acted unfairly. What shapes Corporate Law/Behavior? 1) External governance forces: (i) State laws (ii) Federal Securities laws (iii) Exchange listing standards (iv) Criminal liability/federal sentencing (avoid these through complying w/ the above) 2) Internal governance forces: (i) Articles of incorporation/charter/certificate of incorp. these are like the constitution (ii) Bylaws these are like the normal laws (iii) Shareholder initiatives suggest what the board should do (iv) Debt covenants II The formation of the corporation and the governance expectations of the initial participants Where to incorporate 1) Internal affairs doctrine courts look to the laws of the incorporating state to determine the basic rights and duties applicable to a particular corporation. (i) This encourages owners of a firm to shop around and choose to incorporate in state with best rules and states have an incentive to provide attractive riles. Three distinct bundles of rights Directors, officers (management), shareholders 1) Directors The business and affairs of a corporation are managed by or under the direction of its BoD, except as otherwise provided in the Articles of Incorporation (or charter). Directors appoint officers of the corp, set dividend policy, and authorize changes the structure of the corpraotion (i) Who runs the company DGCL 141(a): The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors except as otherwise provided (ii) Size of board DEL 141(b): the number of directors is fixed by the bylaws unless the articles fix the number (iii) Classified Board DEL 141(d): Articles or by-laws (by shareholder vote) can divide the board into 2 or 3 classes of directors, with only one class being elected each year. The board shall be divided as equally as possible, and the directors serve a two or three year term (A) This prevents hostile takeovers where the board is thrown out all at once.

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(1) Remember, if put classified board in by-laws (in DEL) the shareholers (potentially hostile shareholers) can

amend tehm. But if put classified board term in Articles, need BoD approval before amending.
2) Officers under the direction of the board, they are responsible for the day-to-day management of the corporation 3) Shareholders vote, sell, sue (i) They are equity owners of the corporation through ownership of stock issued by the corp. (ii) Have power to elect directors of the corporation through proxy voting in most cases, and the right to receive the

profits of the entity.

(iii) Liability limited to amount of the investment in the corporation (iv) Wall street rule shareholders dissatisfied with their investment in the corp can sell their shares assuming there

is a market for them. But a sale has no effect on the continuation of the entity (unlike the partnership) The Articles of Incorporation, or Charter (public docs need directors and shareholders to change) 1) Name depends on jurisdiction 2) Incorporators keep it basic to allow for max flexibility (i) Name of company (ii) Address (iii) Purpose (Usually any lawful act) (iv) Capital structure (A) Classes, number of shares, rights of preferred shareholders (v) Other miscellaneous provisions 3) Can contain any provision that is not contrary to the law 4) Amending the articles (i) DEL 242(b): The board of directors must approve an amendment to the articles or certificate of incorporation, and then it must be submitted to shareholders for a vote at an annual or special meeting. The Corporate Bylaws (not publicly filed) 1) More detail than the charter about the rights and duties of various folks in the corporate structure (i) Ex. Charter establishes amount of shares, but the bylaws go into detail on how the voting structure is for those shares 2) Sometimes they can be amended by the shareholders w/o board approval (i) DEL 109(a): Shareholder may amend the by-laws unless the articles also permit the directors to amend the bylaws without shareholder approval. Shareholders Agreements 1) Formal agreements among shareholders (i) Allows lawyers to contract around default rules (ii) Important for close/controlled corps. (iii) Often address things like restrictions on selling shares, dividend payments, voting etc. (iv) If all shareholders are not signatories the enforcement will turn on whether it is fair to others who were not 2) Voting trust (i) Shareholders can publicly agree to place their shares with a trustee who then legally owns them and is to exercise voting power according to the terms of the trust (ii) Restricted by statute III Determining voting rights: using articles and bylaws to change legal norms Multiple classes of Stock: 1) DGCL 151(a): Articles may divide the shares into classes that must vote to approve an action. (i) a corporation may have several types or classes of shares with characteristics as specified in the articles of incorporation. (ii) Corporate norms specify that: (A) there must be a class of shares that carry authority to elect directors and exercise all other shareholder voting rights. (B) There must also be a class that entitles the bearer to receive the corporation's net assets upon dissolution. (1) Shares that combine both residual claimant status and voting rights are called common shares. (iii) all shares of a given class will be fungible that is, they will have identical rights, preferences, and limitations which supports an expectation that the common shares of all corporations will possess similar rights. (iv) where a corporation or its promoters find that there are different groups of investors to part with their money, the corporation may issue other classes of stock with different rights. (A) Ex: preferred shares don not have identical rights across classes or from corporation to corporation. (1) These shares may not be valued at normal market valuation. 2) DGCL 141(d): Voting Rights: default rules 1) Straight voting DEL 202: Unless otherwise provided in the articles, each share is entitled to one vote. (i) person with 51% of shares will have 100% of voting power 2) Cumulative Voting DEL 214: The Articles may provide for cumulative voting for directors. (i) Cumulative voting permits a shareholder to aggregate votes and vote them for one (or more) candidates. (A) Each shareholder gets as many votes as there are available seats, multiplied by the number of shares you own (1) If 3 seats are up, and have 20,000 shares, you get 60,000 votes.

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(B) This increases the likelihood that his candidate will be one of the top three vote-getters; and permits some

minority shareholders to have a place on the board.

(ii) EQUATION to determine how large a minority position must be to be guaranteed gaining a seat on the board, or

how many shares an investor must have to gain to get particular seat on the board. (A) S X/ (d+1) = Number of shares needed to elect the number of directors sought (1) S = shares voting (2) X = number of directors a shareholder wants to be elect (must decide) (3) D = total number of directors to be elected 3) DEL 216: Articles or by-laws can, with shareholder approval increase the number of votes required by shareholders to approve a change in the articles IV Shareholder action Shareholder Meetings: 1) DGCL 211(a)-(b): Annual meeting at the place and time as provided in the by-laws. 2) DGCL 211(d): Special meeting may be called by the board or as provided by the articles or bylaws. 3) DGCL 228: Shareholders permitted to take action by written consent w/out a meeting unless the articles do not permit such consent (no notice required). In delaware a simple majority of shareholders entitled to vote can give their written consent. (i) Hoschett v. TSI Intl: Importance of annual meeting even if mjrty written consent (A) Facts: have a minority of shareholders trying to influence the company. They are complaining there has been no annual meeting as required by DEL law. Mjrty shareholders say written consent is in articles so dont have to have an annual meeting. (B) Issue: Whether a stock holders written consent satisfies the requirements to hold an annual meeting?NO (C) Analysis: (1) 3 reasons why written consent cannot replace annual meeting: 1. Public policy If have this principal public corporations could do this 2. Check on management Annual meetings give shareholders opportunity to express themselves 3. Corporate democracy There should be a deliberative component for minority shareholders to have opportunity to change majority shareholders minds (even if it is not likely). (D) Holding: A company must hold an annual meeting as required by DGCL 211, even though DGCL 228 permits action by consent without a meeting. (E) AFTER THIS CASE DEL legislature amended DGCL 211 and added 211(b) permits the election of directors by consent unless the articles prohibit election by consent. Removal of directors 1) All jurisdictions now have statutory default rules allowing shareholders to remove directors before the expiration of their term in office, with or without cause, by simple majority vote. (i) Since this provision is now the norm, shareholders no longer need a provision w/in the corporations by laws or articles in order to be able to remove directors at some later date. (ii) However, the new norms are accompanied by statutory rules that limit or eliminate shareholders removal power when the corporation has instituted cumulative voting, staggered terms for directors, or class election of directors With cause high standard and high, basically directors must be engaging in conduct harmful to company that is not legitimate exercise to rights as directors. (i) Directors have right to defend themselves and issue a statement to shareholders defending their conduct 2) For Cause = fact dependent analysis (i) Before a directors can be removed for cause there must be the service of specific charges, adequate notice and full opportunity of meeting the accusation. Without cause most directors removed this way The two dominant approaches are found in the MBCA and the Delaware corporation code: 1) MBCA approach there are no restrictions on shareholders power to remove directors if the corporation has staggered the board into staggered terms. (i) If the corporation has cumulative voting, shareholders cannot remove a director if the votes cast against removal would have been sufficient to elect that director. (ii) If a director is elected by a particular class of shareholders, that director can be removed only by a majority vote of that class, even if the majority of the shareholders of all classes are in favor of removal. (A) Under the MBCA approach, these statutory restrictions are immutable. 2) Delaware Approach differs from the MBCA approach in three important respects: (i) First, it adds members of staggered boards to the list of directors protected from removal they can only be removed for cause. (ii) Second, these Delaware protective provisions preserve the shareholders power to remove even protected directors if done for cause, although as discussed below that is a daunting task in most settings. (iii) Third, a majority retains the ability to change the default rules and thereby permit removal in any of these situations by amending the articles (if the board is agreeable to proposing such a change) to permit a without cause removal for a staggered board or to remove cumulative voting itself. (A) DGCL 141(k) (default rule) Directors can be removed with or without cause by the holders of a majority of the shares then entitled to vote at an election of directors, EXCEPT:

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(1) Unless the certificate of incur otherwise provides, in the case of a corp whose board is classified, (141(d))

stockholders may effect such removal only for cause; or

(2) In the case of a corp having cumulative voting, if less than the entire board is to be removed, no directors

may be removed without cause if the votes case against such directors removal would be sufficient to elect such director if then cumulatively coted at an election of the entire BoD, or, if there be classes of directors, at an election of the class of directors of which such director is a part. Translation of DGCL 141(K): 1) Majority vote is all that is needed to remove a director with or without causeEXCEPT (i) If a classified board then removal only for cuase unless the articles permit removal without cause. (ii) If cumulative voting, then removal (A) without cause permitted unless enough votes to elect under formula; (B) removal for cause by majority vote and not under cumulative voting formula. (1) Delaware does not permit a corp to limit removal for cause Alderstein v. Wertheimer: How a co can be taken over under the rules set out and bylaws. 1) Facts: aldersein has business that is not doing well. He is in conflict with his board due to his business decisions. He hinders consultant from their work. He harasses workers, and he is not in business very much. (i) BoD goes and tries to find another investor to take Aldersteins place and offer this new investor a new class of stock so he can get control. Aldersteins doesnat agree. But company is running out of money (ii) BoD takes action: (A) Call meeting but dont tell alderstein that they are going to talk about Island Right investment. But when Alderstein gets there everyone else is prepared to discuss the Island Right investment and Alderstein just stays quite and refuses to speak and the board (he should have said here is my written consent and write it out I own 74% of shares and I dissent to removal of other two directors but didnt do that): 1. Issues new class of shares to Island to give him control of company over Alderstein (even though Ald, is controlling shareholder); 2. The board votes to fire Alderstein (BoD can do this); 3. The board votes to amend by-laws to permit action by written consent (prior to this bylaws prohibited written consent but in DEL the written consent must be in articles, so this is invalid) 4. Alderstein removed 2) Issue: (i) was sufficient notice given of agenda? Yes, ct says that bylaws dont require written notice of proposed agenda (ii) Did alderstien need notice of the july meeting b/c he is the director and controlling shareholder, so other directors owed alderstein a fiduciary duty? 3) Analysis: (i) Since Adlerstein is both a director and controlling shareholder special rules arise. (A) FN 28: when a director either is the controlling stockholder or represents the controlling stockholder, our law takes a different view of the matter where the decision to withhold advance notice is done for the purpose of preventing the controlling stockholder/director from exercising his or her contractual right to put a halt to the other directors schemes. (1) Outcome would have been different if Adlerstein not both director and mjrty stockholder b/c no special duties would have arisen. b/c have ability to stop all these actions if both. 4) Holding directors hold fiduciary duty to someone who is both a director and controlling stockholder to give notice of what actions will be. Fiduciary duty to give Adlerstein notice they were going to remove him b/c he was a controlling stock holder and director (need both). (i) Alderstein loses but corp put in receivership by judge and Island Wright eventually got control. rd (A) Shows how BoD and 3 party investor were able to work around rules and bylaws of a corp to unseat a mjrty shareholder and director. Protecting changes made to the statutory default rules 1) Must consider whether provisions should be placed in the corporations articles or bylaws and how to prevent the majority from amending the new rule. (i) Centaur Partners, IV v. National Intergroup, Inc: use general law of K to interpret articles and bylaws (A) Facts Centaur acquires natl stock by filing Form 13D. (1) Form 13D must be filed w/ SEC when buying more than 5% of shares from a company to put other stock holders on notice. Centaur wants to take control of the BoD to effect its strategy. Centaur cannot obtain mjrty directors b/c natl has a staggered board. So Centaur nominates directors and attempts to eliminate staggered board by changing the bylaws or charger depending on where this provision is located, but in Delaware, the board must propose amendment and shareholders approve but here board wont propose the amendment b/c want to keep their jobs. (2) So Centaur tries to amend tries to amend bylaws b/c shareholders can amend bylaws unilaterally and in this case staggered board provision is in both the articles and bylaws. (B) Issue does the 80% supermajority provision apply to amend bylaws? Yes

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(C) Holding 80% provision not ambiguous. The Court thinks these provisions are a good thing b/c it protects

minority shareholders and makes change almost impossible and this provision entrenches the board to serve for a long time. (1) Ct. says the bylaws and articles are like Ks so use general law of K. Here the K is unambiguous and if conflict btwn the bylaws and articles the articles win. (D) Rule when courts interpret charter or bylaws courts use K methods and terms construed against the corporation. Fiduciary Duties I Intro to business judgment rule Basics: 1) In corporation law, fiduciary duty has two quite different foci. (i) With respect to partners and ordinary agents the fiduciary duty of loyalty operates to constrain directors and officers in their pursuit of self-interest. (A) Therefore it is an actionable wrong for an officer or director to compete with her corporation or divert to personal use assets or opportunities belonging to her corporation. (1) This is the same application of fiduciary duty in both closely held and publicly traded corporations. (ii) Directors official conduct in directing and managing the business and affairs of the corporation. (A) Both statutory and judge made law assign to the directors the power, authority, and responsibility to manage the business and affairs of the corporation. (1) Fiduciary duty broadens to include not only a duty of loyalty, but also a duty of care. 2) An essential element of the directors authority and power is the business judgment rule (i) Business judgment rule a judicial presumption that the directors have acted in accordance with their fiduciary duties of care, loyalty and good faith. (A) The BJR traditionally operated as: (1) A shield to protect directors from liability for their decisions. (2) If directors are entitled to the protection of the BJR, then the courts should not interfere with or second guess their decisions, unless shareholders rebut presumption by showing breach fo duty of care or duty of loyalty (3) If directors are not entitled to the protection of the BJR, then the courts scrutinize the decision as to its intrinsic fairness to the corporation and the cops minority shareholders. (4) The BJR is the end of the analysis, justifying the courts decision to dismiss the complaint or deny a remedy. a. This gives managers and directors broad discretion to manage the corporations business. (ii) The business judgment rule is a rebuttable presumption that directors are better equipped than the courts to make business judgments and that the directors acted without self-dealing or personal interest and exercised reasonable diligence and acted with good faith 3) In some circumstances a directors fiduciary duty is owed directly to the shareholders (i) Directors owe shareholders a duty of disclosure when recommending that shareholders approve a merger favored by the directors. (A) A shareholder may enforce directly owed fiduciary duties via an individual action against the directors, or, if class certification is appropriate, as a class action on behalf of all similarly situations shareholders. (1) Any recovery in these direct actions goes to the plaintiff shareholders and not the corporation. 4) In most circumstances a director owes fiduciary duties to the corporation and to the shareholders collectively. (i) A corporation may enforce fiduciary duties owed to it in two ways: (A) An action brought by the corporation at the behest and under the direction of its directors, or (B) A derivative action brought on behalf of the corporation by one or more of its shareholders. (1) Courts will allow shareholders to maintain a derivative suit only when convinced that the managers are unable to impartially and in good faith control a particular lawsuit. Discretion to determine general business policies 1) Shlensky v. Wrigley: To what extent should dissatisfied shareholder be able to obtain a trial to determine the appropriateness of the directors business policies? (i) Facts Shlensky sues Wrigley b/c says Wrigley didnt act in best interest of shareholder by not installing lights in stadium. (ii) Issue whether the court should overrule decisions by wrigely absent a showing of fraud, illegality or conflict of interest? NO (iii) Analysis Wrigley owns 80% of shares and dominates the BoD. The standard to determine if this is a good Busienss decision is fraud, illegality, or conflict of interest = a high standard. (A) Shlensky pleads conflict by trying to show Wrigley is unduly benefitting from this decision. But this argument fails. (iv) Holding/rule a court will not interfere with an honest business judgment absent a showing of fraud, illegaility or conflict of interest. Discretion to consider interests of non-shareholder constituencies 1) Rule Directors may consider the interests of other constituencies if there is some rationally related benefit accruing to the stockholders, or if so doing bears some reasonable relation to general shareholder interests.

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2) Dodge v. Ford Motor Co.: case often cited but not often followed b/c example of how ct. interferes w/ busienss (i) Facts for refuses to pay a dividend, so dodge brothers sue. Ford doesnt want to pay dividend b/c he knows

dodge bros want to start their own car co to compete w/ ford and need dividends to finance their company and Ford wants to keep cost of car low to spread benefit of automobile to everyone. (ii) Issue whether shareholders can force Ford to increase the cost of the product and limit the money re-invested into expansion in order to pay out larger dividends? (iii) Holding the corporation is primarily for benefit of the shareholders, cant operate as a charitable institution under Michigan law. If this case were brought in Pennsylvania, this court may have come out differently b/c in PA can consider the community. (A) Court here does determine that it will not interfere with the price of the vehicles or the expansion since that falls under the BJR. (iv) Rule the purpose of a corp is to make a profit for the shareholder, but a court will not interfere with decisions that come under the BJR. II The Duty of Loyalty (not as broad as the partnership duty of loyalty) Intro 1) Two classic settings of the duty of loyalty: (i) Circumstances in which a director personally takes an opportunity that the corporation later asserts rightfully belonged to it; and (ii) Transaction btwn the corporation and the directors conflicting interest transactions. 2) The core of the fiduciary duty is the requirement that a director favor the corporations interests over her own whenever those interests conflict. (i) As with the duty of care, there is a duty of candor aspect to the duty of loyalty. (A) Whenever a director confronts a situation that involves a conflict btwn her personal interests and those of the corporation, courts will carefully scrutinize not only whether she has unfairly favored her personal interest in that transaction, but also whether she has been completely candid with the corporation and its shareholders. (1) Sometimes failure to be completely candid is conclusive evidence of breach of the fiduciary duty of loyalty. 3) Who makes decision if director has fairly treated the corporation she serves? (i) Traditionally courts (ii) Increasingly courts and legislatures are channeling these decisions to internal corporate decision-making bodies (A) Either disinterested directors or disinterested shareholders, with courts left to serve a lesser role. Corporate opportunity doctrine 1) The MBCA and American Law Institution Approaches to the corporate opportunity doctrine: (i) NE Harbor Golf Club v. Harris: ALI corporate opportunity doctrine (A) Facts Harris (president of golf club). The Golf Club (GC) is surrounded by property. Harris is approached to buy land and board does nothing. She plans ot develop land and 2 board members get mad. (B) Issue what is the test of a corporation opportunity? (C) Analysis (1) Line of business test (GUTH TEST) = whether the opportunity was so closely associated with the existing business activityas to bring the transaction w/in the class of cases where the acquisition of the property would throw the corporate officer purchasing it into competition with his company. 1. This is a factual inquiry decided by reasonable inference from objective facts. b. Problems with Line of business test 1. whether a particular activity is within a corporations line of business is difficult to answer. 2. The test includes as an element the financial ability of the corporation to take advantage of the opportunity. This might unduly favor insider who knows of corps financial situation. (2) Dufree test (Fairness test) = what is the unfairness in the particular circumstances of a director, whose relation to the corp is fiduciary, taking advantage of an opportunity when the interest of the corporation justly calls for protection. Must apply ethical standards of what is fair and equitable on facts. a. Problems lack of principled content (3) Miller test (combo of Guth and Dufree) = it resulted in a two step analysis: a. First determining whether a particular opportunity was within the corporations line of business, b. then scrutinizing the equitable considerations existing prior to, at the time of, and following the officers acquisition. 1. Combines all the problems form above (4) American Law Institute Test (ALI TEST) = the strict requirement of full disclosure prior to taking advantage of any corpraote opportunity. The corporation must then formally reject the opportunity. a. a good faith but defective disclosure by the corporate officer may be ratified after the fact only by an affirmative vote of the disinterested directors or shareholders. b. This test defines corporate opportunity broadly b/c it includes 1. opportunities closely related to a business in which the corporation is engaged. 2. Opportunities that accrue to the fiduciary as a result of her position within the corporation (D) Holding Apply ALI Corporate opportunityTEST: (1) Disclosure of opportunity that was offered to the corporation

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(2) Opportunity rejected (a) is fair, (b) in advance by disinterested directors or (c) in advance or ratified by

shareholders after full disclosure AND

(3) Decision to reject is protected by BJR (b), & not waste (c) a. Opportunity: Defined 1. by the source of the information about the transaction (learn about opportunity w/in scope of duty as

director) OR
2. (for an executive) if opportunity is closely related to business of the corp or in which it expects to

engage
b. Post Hoc ratification permitted if defective disclosure is cured and corporation then ratifies (5.05(d)) c. Post Hoc ratification permitted if opportunity not offered to corporation due to a good faith belief that

it was not a corporate opportunity and corporation then ratifies (must disclose at the time to take advantage of this provision) (5.05(e)) (E) Rule (1) Must disclose a corporate opportunity and get rejection in advance by disinterested directors or in advance by shareholders after full disclosure. (2) A corporate opportunity is one that is closely related to a business in which the corporation is engaged or one that accrues to the fiduciary as a result of her position within the corporation. 2) Corporate Waste (i) ALI defines waste as follows: (A) A transaction constitutes a waste of corporate assets if it involves an expenditure of corporate funds or a disposition fo corporate assets for which no consideration is received in exchange and for which there is no rational business purpose, or, if consideration is received in exchange, the consideration the corporation receives is so inadequate in value that no person of ordinary sound business judgment would deem it worth that which the corporation has paid. (ii) How to recover on a claim of waste: (in re Disney) (A) To recover on a claim of corporate waste, the plaintiffs must shoulder the burden of proving that the exchange was so one sided that no business person of ordinary, sound judgment could conclude that the corporation has received adequate consideration. A claim of waste will arise only in the rare, unconscionable case where directors irrationally squander or give away corporate assets. (iii) Disinterested directors or shareholders may decide to reject a corporate opportunity even if pursuing the opportunity might be profitable to the corporation on the grounds that corporate resources may more profitably or prudently be used in other ways. (A) Such a decision to reject a corporate opportunity would constitute a waste of corpraote assets only if the opportunity was of such obvious importance and value to the corporation that no person of ordinary sound business judgment would have rejected the opportunity. (1) AKA only if it was akin to a gift of corporate assets that no person of ordinary sound business judgment would have authorized. (iv) The Doctrine of waste serves to define the outer boundary of judicial respect for, and deference to, the directors business judgment. 3) The Delaware Approach (i) Broz v. Cellular Information System, Inc: (A) Facts CIS, whose director is Broz. Broz learns of MI2s license, but not through course of directing CIS. Broz has his own cell co and that is how he obtained info on MI2. Broz speaks to CIS CEO and asks if interested in licenseCEO says no. PriCel tries to acquire CIS. Broz against asks directors if interested in MI2, but they reject. PriCel buys MI2 license, but outbid by Broz. PricCel buys CIS and dismisses the board and sued Broz for usurpation of corporation opportunity. (B) Issue whether Broz ursurped a corporate opportunity from CIS when he outbid them for the MI2 license? (C) Analysis (1) Guth v. Loft Test: the corporate opportunity doctrine, holds that a corporate officer or director may not take a business opportunity for his own if: 1. the corp is financially able to exploit the opportunity 2. the opportunity is within the corporations line of business 3. the corporation has an interest or expectancy in the opportunity; and i. To have an interest in any specific property there must be some tie btwn the property and the nature of the corporate business 4. the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. i. No one factor is dispositive and all must be taken into account insofar as they are applicable. (2) Defending an usurpation claim: 1. Opportunity presented to director in personal capacity 2. Opportunity is not essential to the corporation 3. Corporation has no interest/expectancy in the opportunity 4. No misuse of corporate resources in obtaining or exploiting the opportunity (3) Here applying Guth ct. finds:

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a. Not financially able to exploit opportunity b. Broz was not obligated to consider the contingency or possibility of a PirCell acquisition of CIS c. At time opportunity presented, CIS was divesting its cell license holdings (4) Corporate opp doctrine is implicated whre the fiduciary seizes an opportunity and results in a conflict btwn

the fiduciarys duties to eth corp and the self-interest of the director. a. CIS fully aware of Broz potentially conflicting duties and Broz not a fiduciary to MI2. (D) Holding Broz did not usurp an opportunity that properly belonged to CIS. The ALI test is not adopted by Delaware so only have to fulfill Guth test, so dont have to present the opportunity to the BoD. But formal presentation is a good safe harbor. (A) Rule The corporate opportunity doctrine holds that an officer or director of a corporation can take a corporate opportunity if the opportunity: 1. is presented to them in their individual capacity, 2. the opportunity is nonessential to the corporation, 3.the corporation has no expectation for the opportunity, and 4. they have not wrongfully utilized corporate resources to take advantage of the opportunity. Conflicting interest transaction 1) Intro: (i) At common law conflicts of interest couldnt exist (ii) Common law abrogated by statutes and can have conflict of interest so ask what disclosure or approval permission is needed? 2) At common law: (i) Globe Woolen v. Utica Gas: Common law and NOT FOLLOWED BY COURTS (A) Facts:Globe is suing for specific performance of K. Maynard (chief stockholder and director of globe) is also a director of Utica. Maynards company Globe is suing Utica gas. Basis for the company suit is for a bad K, Maynard negotiates K w/ Utica (Greenrich), and Green gives access to Globe books to come up with K. K goes before the BoD for Utica. Questions were asked and Maynard remained silent even though he knew the K would not be profitable. Globe starts using tons of electricity and Utica cant make a profit. (B) Issue: is there a conflict such that the K is void or voidable? (C) Analysis: a. Was there dominance here by Maynard? Yes, directors rely on Maynard b/c he was a fiduciary and board member. Greenwhich was an employee so maynard was like his boss, so Greenwhich could be dominated by Maynard. b. Did maynard have a duty to speak? Have a duty similar to candor on BoD, cant sit silent, have affirmative duty so Maynards silence is not exculpatory. Nor does it matter that other directors approved of K. BoD needs full disclosure before approving something b/c need all the facts. (D) Holding: yes, Maynard had a duty to seek no harsh advantage to the detriment of his trust. Maynard could have resigned from the board before BoD got this; disclosed to the BoD it was a bad K; disclose and renegotiate K. 3) Transaction with a controlling shareholder or director (i) In circumstances constituting self-dealing transaction btwn the corp and the controlling person were subject to heightened judicial scrutiny to protect the interests of the corporation and its non-controlling shareholder. (ii) Sinclair v. Levien: if have self dealing apply intrinsic fairness doctrine (A) Facts: Sinclair USA is a big oil companied and it owned about 93% of Sinclair Venezuela. The directors of Sinclair Venezuela were all directors, officers, or employees of Sinclair USA, and they realized Sinclair USA needed money so they declared very good dividends over a number of years so that the parent corporation could replenish its bank account. Here the minority shareholders sued arguing that payment of these dividends hurt Sinclair Venezuela b/c they had business opportunities that could have been taken advantage of if not for the dividend policy. (B) Issues: what are the fiduciary duties of Sinclair USA to Sinclair Venezuela (SinVEN)? (C) Holding: Sinclair USA does have a fiduciary duty to Sinven b/c it controls the company, this duty is of intrinsic fairness (1) Intrinsic fairness test = the standard of internsic fairness invoves both a high degree of fairness and a shif tin the burden of proof. The burden is on Sinclair to prove that its transaction with Sinven was objectively fair. a. The intrinsic fairness only applies when there is evidence of self-dealing. If not self-dealing apply business judgment rule. (2) Here there was no evidence of self-dealing as to dividends paid so we apply the BJR (3) However, the contract breach was to the detriment of Sinclair Venezuela and its minority shareholders with the positive effect being exclusive to Defendant, so the K breach is self-dealing. (D) Rule: (1) If no slef dealing apply business judgment rule (2) If self-dealing apply test of intrinsic fairness. a. Under intrinsic fairness test burden on D to prove that its transaction with Sinclair Venezuela (P) were objectively fair.

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(3) self-dealing = occurs when the parent by virtue of its domination of the subsidiary, causes the subsidiary

to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary. 4) Intersection of the Common Law and Conflicting Interest Statutes and interested directors (i) DGCL 144(a) (no conflict of interest if) A K shall not be void or voidable solely because have a contract or transaction btwn a corporation and one or more of its directors or officers in which one or more of its directors or officers are also directors or officers, or have a financial interest in the transaction if the following things are done: (burden on interested director to prove did one of the following things) (1) Full disclosure of material facts and disinterested directors approve (2) Full disclosure of material facts and shareholders approve it (3) Entirely fair to corporation fair price and fair dealings a. Dont have to meet all three, only need one of these (B) how is it different from ALI Test for corporate opportunity? It is different b/c not required to get approval before hand. For a conflict of interest transaction you only have to get preapproval (generally), but if dont get preapproval go to (3) Entire fairness. (ii) More on DGCL 144: (A) The enactment of 8 Delc. Cl 144 in 1967 limited the stockholders power in two ways: (1) 1. 144 allows a committee of disinterested directors to approve a transaction and bring it w/in the scope of the business judgment rule. (2) 2. Where an independent committee is not available, the stockholders may either ratify the transaction or challenge its fairness in a judicial forum, but they lack the power automatically to nullify it. a. When a challenge to fairness is raised, the directors carry the burden of establishing the transactions entire fairness, sufficient to pass the test of careful scrutiny by the courts. 1. If a transaction is found to be unfair to the corporation, the stockholders may then demand rescission of the transaction or, if that is impractical, the payment of rescissory damages. 2. If however, the directors meet their burden of proving entire fairness, the transaction is protected from stockholder challenge. (B) Meaning of good faith (1) Here is an example of good faith as it applies to ratification of a conflicting interest transaction by independent directors. a. Under 144 a transaction btwn a corporation and its directors or officers will be deemed valid if approved by a majority of the independent directors, assuming three criteria are met: 1. The approving directors were aware of the conflict inherent in the transaction 2. The approving directors were aware of all facts material to the transaction; and 3. The approving directors acted in good faith. i. In other words, the inside transaction is valid where the independent and disinterested (loyal) directors understood that the transaction would benefit a colleague, but they considered the transaction in light of the material facts (due care) mindful of their duty to act in the interests of the corporation, unswayed by loyalty to the interests of their colleagues or cronies (good faith). (C) good faith shareholder vote in Delaware G.C.L. 144(a)(2) and similar provisions in other jurisdiction would be interpreted to preclude voting by a conflicted shareholder. (iii) Shapiro v. Greenfield: (A) Facts College park is owned by stockholder including greenfield. Shapiros are cousins of greenfield. Company operated by 1% owner to create limited liability. Actual owners do have liability b/c banks ask for personal guarnatees of 21.5 million construction loan. A meeting is called but some family doesnt attend (betty and marvin) (B) Issues: (1) Is this a conflict of interest transaction? Yes (2) Was it approved for purposes of MD statutes (same as DGCL 144(a)) for conflict of interest? (C) Analysis: (1) Are we applying conflict of interest doctrine or corporate opportunity doctrine rd a. Corproate opportunity = transaction involved w/ 3 party, not btwn co. and directors. The transaction is taken from the company. b. Conflict of interest = directors actually has stake on both sides and deals directly w/ the company. (D) Holding: The court rules this is a conflict of interest because the conflict was approved by shareholdres, but the majority of shares were voted by Greenfield so the case was remanded to find out if approving shareholders were truly disinterested. (A) Rule: when a director does not personally benefit from the transaction but, bc of that directors relationship to a party interested in the transaction, it would reasonably be expected that the directors exercise of independent judgment would be compromised, that director will be deemed an interested director w/in the meaning of the statute. 5) Director self-compensation (i) Conflicting interest problems are presented whenever the board of directors approves the compensation of its inside directors or the compensation to be paid to the directors for service as a director.

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(A) If directors set their own compensation w/out ratification by disinterested shareholders, the general rule is clear:

like any other interested transaction, directoral self-compensation decisions lie outside the business judgment rules presumptive protection, so that where properly challenged, the receipt of self-determined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation. (ii) Solutions: (A) 1. Seek shareholder ratification (B) 2. If the compensation decision does not affect the entire board, place the compensation decision in the hands of the board members who are independent and disinterested. (1) This will remove the conflicting interest taint from the directors self-compensation decision. (iii) Stock options (a K btwn a corporation and optionee, giving the optionee a righto purchase at some future date a specified amount of the corporations stock) (A) From the standpoint of managers, stock options cost the corporation nothing at the time of issue since no corporate assets are distributed to the optionees. (1) However, the value of other shareholders equity may be severely diluted by stock options that are ultimately exercised at prices far below then-prevailing market prices. (B) Common law courts have traditionally subjected stock option to heightened judicial scrutiny. (1) Delawares special test Two prong: a. 1. The plan must involve an identifiable benefit to the corporation (must contain conditions, or the circumstances must be such that the corporation can reasonably expect to obtain that benefit) Benefit prong b. 2. The value of the options must bear a reasonable relationship to the value of the benefit passing to the corporation (value prong). 6) Other tests: (i) Interested Director ALI Test (A) Party to the transaction (B) Business, financial, or familial relationship to a party that would reasonably be expected to affect the directors judgment . . . in a manner adverse to the corporation (C) Material pecuniary interest in the transaction that affects judgment (D) Subject to a controlling influence by a party to transaction or person with a pecuniary interest that affects judgment (ii) MBCA test is person conflicted III The Duty of Care Policy argument for limiting duty of care 1) In some states, including Delaware, the fiduciary duty of care is defined solely by judicial doctrine. (i) Therefore more broad than duty of loyalty 1) In other states they follow MBVA 8.30(a)(2), in 1998, the ABA amended 8.30(b) to provide that when becoming informed in connection with their decision-making function or devoting attention to their oversight function, directors shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under the circumstances. (i) purpose of the 1988 amendments was to signal to courts in states following the MBCA that directors duty of care should not be conceptualized or enforced under tort principles, but rather under principles developed specifically for corporations and their directors. (A) This limited the reach of the duty of care 2) Duty of care in general is more broad (i) Why do we want duty of care directors are entrusted with faith of shareholders. BoD are entrusted w/ company so we should impose duty of care so they do the best for the company. 2) Joy v. North: Why we limit duty of care (i) Facts: Plaintiff brought shareholders derivative action alleging that defendant officer and directors of corporation violated the national banking act. (ii) Issue: why do we have the business judgment rule? (iii) Holding: 3 reasons to uphold BJR (1) Shareholders voluntarily undertake risk of bad business judgment (2) After the fact litigation imperfect to evaluate corporate business decisions. (3) Potential profit often corresponds to the potential risk, dont want to create overly cautious corporate decisions. (B) We dont want directors to always worry that every decision they make will lead to personal liability. (C) Will hold directors liable for gross negligence Duty of Care in the Decision setting 1) In the decision setting, directors consider whether to authorize a particular course of action, activity or transaction. 2) In publicly traded corporations, outside directors play an important and difficult duty of care role. (i) First, much of the detailed information necessary to determine an appropriate course of action may be possessed by directors or other management personnel who are clearly committed to a particular course of action.

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(ii) Second, the directors are usually extremely competent business executives or are otherwise familiar with the

dynamics of the type of transaction being contemplated by the corporation. Moreover, in carrying out their general monitoring and supervisory responsibilities, they have become fully informed about the corporations business. 3) Smith v. Van Gorkom: Duty of care in takeover transactions (i) Facts: Plaintiffs, Alden Smith and John Gosselin, brought a class action suit against Defendant corporation, Trans Union, and its directors, after the Board approved a merger proposal submitted by the CEO of Trans Union, fellow Defendant Jerome Van Gorkom. (A) Pritzker agrees to pay in cashtells attorneys to draft docs in 3 days. Pritzker wants lock-up so wont be outbid by other buyers. However Van G has not told board, management, or attorney. He hires an attorney Friday and calls meeting of the board to happen Saturday and only 2 directors know about the meeting. (B) Van G meets with senior management before BoD meeting and theyre not happy with share price b/c too low and lock-up prevents other bids. (1) The directors dont get much financial information, not told how price negotiated and didnt ask, they didnt ask how merger agreement was made and approved the transaction and shareholders also approve (b/c want money) (ii) Issue: The issue is whether the business judgment by the Board to approve the merger was an informed decision. (iii) Analysis: (A) Standard for Due Care: (1) [F]ulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes 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. (2) We think the concept of gross negligence is also the proper standard for determining whether a business judgment reached by a board of directors was an informed one. (B) hold directors liable for gross negligence here the directors have an affirmative duty to inform themselves, and there is no protection for stupid judgment; was this a stupid/rushed decision? (1) Board failed to get financial adviceinfo provided to them by management was insufficient and should have known that. Uninformed as to intrinsic value of company (2) Board did not adequately inform themselves as to Van Gs role in forcing the sale of the company and in establishing the per share price (3) Board was grossly negligent in approving the sale of the company upon two hours of consideration w/out prior notice, and w/out the exigency of a crisis or emergency. a. Didnt read docs b. Acted to fast for not being an emergency (C) Boards Defenses: (1) Business Judgment Rule (2) Premium (40%+ over market price before announcement of acquisition). (3) Market test provision of agreement. (4) Experienced board with expertise in industry and knowledge of business. (5) Legal advice of Attorney Brennan. (6) Shareholder vote approving the transaction (70% favor, 7.25% against, assorted apathetic shareholders owns the rest of the shares). (iv) Holding: Board breached fiduciary duty of care, now board is personally jointly and severally liable. The BJR applies, but can be rebutted by showing breach of duty of care, but if found to be entirely fair (Fair price and fair process) then can rebut showing of bad faith. Here the court says no fair dealing so directors liable. 4) After Van G., Delaware passed DGCL 102(b)(7): to allow a company to exculpate their directors from monetary damages for breach of the duty of care. Most companies adopt this, so no personal liability for breach of the duty of care. However DGCL 102(b)(7) IS NOT A DEFAULT PROVISION, so must remember to opt in. (i) DGCL 102(b)(7): A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director in these 4 situations: (4 situations where always liable) (A) For any breach of the director's duty of loyalty to the corporation or its stockholders; (B) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (C) under 174 of this title; (D) for any transaction from which the director derived an improper personal benefit. 5) Impact after Van G have set procedures for takeovers of company: 3 steps (1) Financial valuation -- Need evaluation form outside company like an investment bank (2) Board must read agreements and consider --Must follow process to inform board, must let them know at least a week before cant spring on a board. Give opportunity to read documents (3) Board must be actively involved --Boards need to know their sale processes. a. More focus on procedure in M&A (ii) 141(e) provision that absolves directors from liability if reasonably rely upon analysis of advisers.

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(A) Court in van G said that oral presentation by managers was not as good as written reports and couldnt be

reasonably relied upon. (1) However, 141(e) was amended after Van G to include oral reports and different kinds of advisors. Statutory Exculpation provision 1) Malpiede v. Townson: In delaware no pure duty of care requirement if adopted 102(b)(7) (i) Facts: Frederick negotiating a merger with Knightsbridge the terms of the merger restricted F from negotiating w/ competing bidders. However other bidders emerged and offered higher price than K. F completed merger with K and plaintiff/shareholders sued. Board in violation b/c could have implemented poison pill to prevent hostile takeover as K was buying shares on open market. (ii) Issue: whether the chancery court was correct in granting defendant motion to dismiss the Ps duty of care claim under 12(b)(7) or must you wait until summary judgment? (iii) Holding: on motion to dismiss can dismiss a pure duty of care claim on 102(b)(7), this means there is no duty of care in Delaware for monetary damages if have adopted 102(b)(7). (A) However in Delaware if have a duty of care claim intertwined with a duty of loyalty claim the courts will not dismiss and must wait until summary judgment. (iv) Rule: not duty of care in delaware if this is the only claim and have adopted 102(b)(7). The Intersection of the fiduciary duty of care and loyalty (including duty of good faith) 1) Intro (i) For a while the DEL supreme court opinion in Smith V. Van Gorkom appeared to expand the universe of potentially viable fiduciary duty claims against directors. (A) However in Malpiede v. Townson DGCL 102(b)(7) and similar exculpation statutes adopted in other states soon after the decision in VanGorkom allowed corporations and their shareholders to slam the door on damage claims based solely on claimed breaches of the duty of care. (B) In Stone v. Ritter, the Delaware court decided that GF was actually a subpart of the duty of loyalty 2) Care, good faith, and directors oversight responsibilities (i) Rule the business and affairs of the corporation shall be managed by or under the direction of, and subject to the oversight of, its board of directors. (MBCA 8.01) However, there was almost no case law explicating the directors oversight duties. (ii) In re Caremark International, Inc. Derivative Litigation: oversight duty of care (A) Facts Caremark acquired backster but there is illegal activity discovered and company pleads guilty and is fined and it sells at 200,000 loss. (B) Issue What is the liability of the board for failing to have procedures to prevent these kickbacks from happening? (oversight claim) (C) Analysis A breach of duty to exercise appropriate attention(oversight), as the court notes, is more difficult for Plaintiffs to prove than a breach of the duty of loyalty. Most decisions that would come under this duty will resemble many decisions shielded by the business judgment rule. (1) Oversight = involves the process you have in place to know whether directors have to act. Delaware doesnt look at substance of these procedures, it only looks at process of monitoring the company. a. Therefore in DEL if you have procedures then pass oversight duty of care. (D) Holding There was no evidence that the directors knew that there were ARPL violations, and there was no systemic or sustained failure to exercise oversight. However, the terms of the settlement merely required Caremark to institute policies to further assist in monitoring for violations. Therefore the settlement was approved. Board not liable. (E) Rule Directors are potentially liable for a breach of duty to exercise appropriate attention (oversight) if they knew or should have known that employees were violating the law, declined to make a good faith effort to prevent the violation, and the lack of action was the proximate cause of damages. (F) Post Caremark: (1) began to see monitoring claims a. reason: essentially, P lawyer isn't going to bring DoC claim after 102, going to bring monitoring claim/good faith- and 102b7 says you have to act in good faith b. essentially found a 3rd type of duty- duty of good faith (2) Court didn't set how high standard was a. last 5-7 years, raised standard for Caremark claim in Del.: very high standard1. have to intentionally act, 2. violate an act, or 3. intentionally fail to act b. oversight DoC claims (caremark claims) are not DoC claims- duty of good faith claims (1) Dont bring duty of care claim b/c will lose w/ 102(b)(7). But Caremark talks about GF, so a good lawyer will not bring oversight claim b/c not limited by 102(b)(7) b/c must act in GF, which means cant limit liability if GF breach. a. Remember 102(b)(7) does not limit or eliminate the liability of a director for breach of: 1. Duty of loyalty 2. Action or omissions not in GF or intentional misconduct or knowing violation 3) The role and nature of substantive review

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(i) Although the BJR prevents ct.s to second guess, there are fail-safe mechanisms by which courts could intervene if a

challenged substantive decision was really bad: (A) WASTE allows courts to find directors liable where direct proof or lack of care or loyalty is lacking, but the substantive decision seems explainable only as a product of the directors failure to carry out their fiduciary responsibilities. (1) Delaware began to clarify the role of substantive review, the definition of waste, and the nature of the duty of care in the Disney case below. (ii) Brehm v. Eisner: (A) Facts Eisner wanted to attract Ovitz to come work for Disney (1) His employment K was for 5 years term, for 39 million plus stock options and Ovitz negotiated his termination to say that if fired for cause (very hard to do) he would only be paid for what he had done to that date. If fired without cause, everything vests and get entire salary and benefits of the 5 years. a. So there was incentive for Ovitz to do just a good enough job not to be fired for cause. (2) Eventually (14 months later) Ovits fired without cause and gets 130 million dollars (B) Issue whether the directors should be held personally liable for a lack of due care in their approval of the agreement and their waste of corporate assets? (C) Analysis: (1) Plaintiffs allege that board violated procedural duty of care by approving employment contract a. Old board DoC claim:relied on expert (compensation consultants), expert then went out and said we didn't really calculate payment 1. Court: giving signal to plaintiffs- based upon facts alleged, going to dismiss because of 141 e- relied on expert; going to allow you to replead that there wasn't reasonable reliance b. P Argument: Waste to give him this money 1. Waste test: very high test- so one sided no one would make the decision 2. Court: no such thing as Sub. Due care, say there was no waste as the P's pled it c. New Board claim:P argues that board committed waste because they should have terminated O for fault 1. Court: good reasons why it did this- may have decided didnt want to go through litigation (D) Holding ct allows to amend complaint 4) Directors duty of good faith explicated (i) In Re Walt Disney: (A) Facts court finds board didnt use best practices when considering compensation package b/c they should have calculated out the payment. (1) Is this like Smith v. Van G, where general knowledge is not sufficient a high standard? a. Disney is a step back from VAN G b/c Disney board says they had general knowledge of the compensation practices, but here this is sufficient to be considered well informed. 1. Rationale: court is uncomfortable with holding directors liable for duty of care b/c it will prevent directors from making risky decisions (so a retreat from Van G). (B) Holding the court finds the board reasonably informed (1) Since this case involved a mix of the duty of care and duty of GF the case was not immediately dismissed. (2) What is the duty of GF? Court says 3 types of bad faith conduct: a. 1) subjective bad faith intentionally do something that is wrong b. 2) Action taken w/out bad intent/ Gross negligence- court says this is DoC claim, so not going to make it a Duty good faith c. 3) fiduciary intentionally fails to act in the fact of a known duty, which demonstrates a conscious disregard for his duties 1. no conscious disregard here by Board- attempted to do its duty (C) Take away duty of GF is higher standard than duty of care extremely high b/c this duty of GF is an exception to 102(b)(7). (1) In Disney there was no conscious disregard for its duty so no violation of GF in this case. (2) So in the end the duty of care is raised generally b/c we expect more from directors and have high standard of GF (reshape Van G) (ii) Summary in wake of Disney case we have 3 duties: (1) in Stone v. Ritter, what Del. said is that we have 2 duties: DoC and DoL, and duty of GF is a subset of DoL (2) doctrinal implication- Caremark claims that oversight isn't DoC claim; now viewed of DoGF, so may come under DoL (3) consequences: a. oversight claims are not under 102(b)(7), but tradeoff is determined under standard of GF which falls under the duty of loyalty. But the duty of loyalty and GF for oversight claims (Conscious disregard) is higher than DoC; therefore oversight claims very hard to sustain. 5) Officers oversight and reporting duties: MBCA 8.42 (i) Miller v. US Foodservice, Inc: officer oversight same as directors (A) Facts: Miller joins USF and finds out he misstated and misrepresented the company. Miller is sued for breach of duty of GF and Care. Millers wants his severance package (B) Issue: Does an employee have benefit of the BJR even though they are not really fiduciaries of the company?

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(C) Analysis: (1) His defense is that he is protected by the BJR so held to the same standard as directors. (2) Court asks: a. Why should we protect employees? To make decisions w/out fear b. Why should we NOT protect employees? 1. Paid more than directors 2. More inventive to get things right (D) Holding/Rule: officers duties are similar to those of directors in terms of DoC. (1) Never answer if O can get protection of the BJR IV Indemnification and Insurance Indemnification: 1) General: (i) Make sure you have director and officer insurance (D&O insurance) if a corporation lawyer. 2) Types of suits: rd (i) Direct suits direct claim by 3 party, such as criminal prosecution or securities fraud brought by shareholders (ii) Derivative claim claim owned by company, but brought by shareholders (fiduciary duty claims). Shareholder

must make demand of company to bring suit, so must demand company sue or (demand futility) allege demand futile b/c BoD is conflicted b/c probably had something to do with the breach. DGCL 145 on INDEMNIFICATION rd 1) 3 Party Actions (DEL 145(a)) (permissive not automatic) (i) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that the person's conduct was unlawful. (A) This is indemnification for direct actions. Corp can indemnify against expenses, attorneys fees, fines, judgment, and settlements, if person acted in GF. Duty of GF required, must show acted in GF to get indemnification here. 2) Derivative Actions (DEL 145(b)) (permissive not automatic) (i) A corporation shall have power to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. (A) Corp can indemnify ONLY for expenses including attorneys fees. (1) The difference from DEL 145(a) is b/c the derivative suit belongs tot eh corporation, so if corp wins and then it can indemnify the money just goes ina circle. (B) This provision also has a requirement of GFO must apply to court ot get indemnification b/c dont want boards to make decision b/c could be friends with person being sued. 3) Mandatory Payment of Expenses (145) (i) To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of this section, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. (A) If successful on mertis, can get back attorneys fees and expenses. The company must do this if successful on the mertis. 4) Indemnification Authority (DEL 145(f)) (i) The indemnification and advancement of expenses provided by, or granted pursuant to, the other subsections of this section shall not be deemed exclusive of any other rights to which those seeking indemnification or

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advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office. (A) You cant indemnify bad faith actions. 5) Advancement of Expenses (DEL 145(e)) (i) Expenses (including attorneys' fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corporation as authorized in this section. Such expenses (including attorneys' fees) incurred by former directors and officers or other employees and agents may be so paid upon such terms and conditions, if any, as the corporation deems appropriate. (A) If according to the other provisions of 145 a person is not entitled to these advancements they must return them. Owens Corning v. National Union: 1) Facts owens had been sued for securities fraud b/c misrepresented exposure to asbestos claims and have impact on future earnings. 2) Issue do directors and owners pay for settlement or does D&O insurance cover the directors and officers? 3) Analysis (i) Insurance co argues D&Os have no right to indemnification so insurance co doesnt have to pay. (ii) Court begins tour through different types of indemnification 145(a-e). (1) 145(a) + (b) require GF by looking at 145(d) of Del Code, which defines GF in default terms. a. 145(d) = test to determine GF 1. any indemnification under subsection 145(a) and (b) of this section shall be made by the corpraotion only as authorized int eh specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances becaseu the person has met the applicable standard of conduct set forth in subsection (a) and (b) of this section. . Such determination shall be made.(1) by the majority vote of directors who are not party to the action; (2)by a committee of such directors designated by majority vote of such directors, even though less than a quorum, or (3) if there are no such directors, or if such directors so direct, by independent legal counsel in a written opinion, or (4) by the stock holders. (iii) Ownes has expansive indemnification, but insurance comp says owns never made determination that directors acted in GFF. B/c they never made that determination the D&Os are not entitled to indemnification by the insurance company. (arguing 145(c)) (iv) 145 (c) Ct. sayscant get rig of GF requirement through bylaws and cant see how 10 million dollar settlement is a success under 145(c) (A) Court doesnt deem settlement a success b/c then D&Os will have incentive to settle to shift liability to insurance company. (1) success means need to succeed on mertis and 145(c) doesnt apply here (v) 145(a) or (b): (A) This is direct claim so under 145(a), this is good b/c can indemnify for more than expenses. 4) Holding: D&Os entitled to indemnification under 145(a) which is more favorable form of identification. (i) Court then says dont have to follow 145(d) to determine GF. Instead fi company extends indemnification expansively (under full extent of Del law), there is a presumption that D&O acted in good faith. (A) The presumption can be rebutted, but here insurance company never tired to rebut the presumption of GF allowed under Del law when corp gives full extent of Del law to D&Os. 5) Rule: Therefore if you have a broad provision for indemnification in incorporation documents and have a suit brought under 145(a) or (b) there is a presumption of good faith and no determination need be made under 145(d). The Closely-Held Corporation I Intro Characteristics 1) Ownership, control and management are not as clearly separated as in a publicly held corp 2) Its a corp owned by a few shareholders local business 3) Special problems arise in close corp b/c shareholders only have rights to: vote/sell/sue but if few ppl own stock that cant really be sold b/c there is no market for them have less rights. 4) Davidoff closely held corp form doesnt make sense, should elect to be a partnership or LLC. II Contracting as a device to limit the majoritys discretion Historical rules for close corp: 1) McQuade v. Stoneham close corp (A) 3 people all working on corp, 1 controlling shareholder (1) fine for 9 years, until S fires M and removes him from board of directors (B) why is this important? (C) M loses- power of the company is centered on directors, shareholders cannot by agreement avoid that (ii) Sterilizing the Board

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(A) [I]t must be equally true that the stockholders may not, by agreement among themselves, control the directors

in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries. McQuade v. Stoneham [451-452] (iii) Rule: any agreement that divests board of power is void (A) This means shareholders in a close corp who are minority cant enter agreements to protect job or interest in close corp. 2) Clark v. Dodge (i) Court back away from decision in McQuade. (ii) court rules that this is diff. than McQ: not trying to undercut board's authority here; no attempt to sterilize the board of directors (A) no one is harmed- agreement among shareholders that doesn't effect anyone else 3) Benintendi v. Kenton Hotel, INc bylaw amendment that required all BoD decisions be unanimous is void b/c unduly interfered with management of company. (not valid law anymore) Today, the immutability of majority rule by directors has no statutory support 1) Shareholder can enter agreement and bylaws requiring board unanimity is fine. (i) Furthermore, most states have close corp statutes 2) Close Corp Definition (DGCL 342(a)) (i) A close corporation is a corporation organized under this chapter whose certificate of incorporation contains the provisions required by 102 of this title and, in addition, provides that: (A) All of the corporation's issued stock of all classes, exclusive of treasury shares, shall be represented by certificates and shall be held of record by not more than a specified number of persons, not exceeding 30; and (B) All of the issued stock of all classes shall be subject to 1 or more of the restrictions on transfer permitted by 202 of this title; and (C) The corporation shall make no offering of any of its stock of any class which would constitute a "public offering" within the meaning of the United States Securities Act of 1933 [15 U.S.C. 77a et seq.] as it may be amended from time to time.

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3) Statutory Close Corporation (DGCL 141(a)): The business and affairs of every corporation organized under this

4)

5)

6)

7)

8)

chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation. (i) DGCL 341(a): This subchapter applies to all close corporations, as defined in 342 of this title. Unless a corporation elects to become a close corporation under this subchapter in the manner prescribed in this subchapter, it shall be subject in all respects to this chapter, except this subchapter. Shareholder Agreement (DGCL) (i) 350: A written agreement among the stockholders of a close corporation holding a majority of the outstanding stock entitled to vote, whether solely among themselves or with a party not a stockholder, is not invalid, as between the parties to the agreement, on the ground that it so relates to the conduct of the business and affairs of the corporation as to restrict or interfere with the discretion or powers of the board of directors. (A) Only need majority of shareholders (ii) 351: The certificate of incorporation of a close corporation may provide that the business of the corporation shall be managed by the stockholders of the corporation rather than by a board of directors. (A) Can eliminate board in certificate of incorporation so shareholders rule. MAIN ISSUE need to know close corp statute existsmost ppl dont and just form a business. (i) The close corporation is based on freedom of K so once elect to be close corp can do anything you want, dont have to be restricted by general corporation rules (BoD power infringement/ management decision/ ect) Zion v. Kurtz: This is majority opinion in most states (i) Facts: Zion is minority shareholder and partners fall out and Kurtz does stuff Zion doesnt approve of. Law of Del apply b/c of internal affairs doctrine, but have NY ct. applying delaware law. (A) This is not a statutorily created close corp b/c didnt elect to do this in articles of incorporation. (ii) Issue: how do we treat agreements that attempt to govern like close corp, but havent elected to do so under the law? (iii) Analysis: (A) P argues Del doesnt have problem w/ interfering w/ board (B) D argues never filed to be close corp (iv) Holding: (A) Treat as a close corporation b/c want to uphold freedom of K and nobody is really being harmed by this b/c had settled expectation when agreed to this to begin w/. The agreement stands. (1) NOTE most agreements have boilerplate lang., court said need to uphold corp so need to take steps and file to be a close corp to solve these problems. This overrules mcquade v. stoneham b/c the statute overrules this case through change in law. a. COURT never holds that this agreement would stand had the court not forced the parties to file as a closed corporation. (v) Dissent there are rules/procedures for a reason. We want to give notice to other people that they are dealing w/ close corp and thats what the statute does. (vi) Rule can have agreement and be treated as close corp even if didnt elect to be close corp under statute. Blount v. Taft: (i) Facts: have a close corp (but not statutorily); small # of shareholders, run by three families. B was concerned with nepotism: son of Taft hired by dad. Negotiation 250K business expansion loan, and as part of this need to amend bylaws. B takes advantage of this to deal w/ nepotism situation and proposes that there be a bylaw amendment. The bylaw is amended and 3 years later they try to get rid of amendment. (A) This agreement would probably survive under McQuade v. Stoneham b/c this agreement is in bylaws, so not a shareholder agreement and it is empowering the directors. Not taking power away from stockholders. (1) BUT this wouldnt survive Benitendi b/c requires board unanimity. (B) The close corp agreement says: (1) 7: Executive Committee comprised of 3 members (one from each family) & must agree unanimously on employment decisions. (2) 4: By-laws may be amended by majority vote of the directors. (ii) Issues: (A) Is there a valid agreement? Yes (B) Does section 4 override section 7 of the bylaws? Yes (iii) Holding: (A) Issue 1 the bylaws were agreed to by all shareholders so it is a shareholder agreement. This is shareholder agreement and is valid under N.C. law. This agreement doesnt hurt anyome. So ct. upholds agreement b/c valid and not hurting anyone. (B) Issue 2 section 4 requires only majority to amend bylaws. Section 4 was meant to apply to entire bylaws Both Blount and Zion stand for: (i) Freedom of K (ii) Dont have to elect to be a close corp, and (iii) Can put close corp agreement in bylaws or articles and not necessarily in a separate document.

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Voting Agreements as to Shareholder Decisions 1) DEL 218(c): An agreement between 2 or more stockholders, if in writing and signed by the parties thereto, may provide that in exercising any voting rights, the shares held by them shall be voted as provided by the agreement, or as the parties may agree, or as determined in accordance with a procedure agreed upon by them. (i) Is an agreement to vote your shares a certain way ok? (A) Ringling Case agreement to vote a certain way pursuant to stockholder agreements are completely valid. (B) Vote buying? (1) Cant do it under corporation law, how do you know if being paid or not? Hard to prove unless paying direct monetary payments. 2) Ramos v. Estrada: (i) Facts: 2 groups competing to get broadcast license. Decide to join forces and say broadcast corp will be dominant shareholder w/ 51% and 5 BoD. Estrada defects and votes her shares for Ventura 41 group to replace Ramos and elect someone in Ventura 41 in violation of agreement. (A) Meeting is called which triggers the buy-sell agreement (applies when employees leaves and owns shares company can buy shares at X price or employee can sell at X price) this ensures that the company and employee can part ways. (B) Here the buy sell agreement was triggered on breach of the agreement/K. (1) Ramos sues claiming Estrada violated K to trigger the buy sell agreement. The price of the buy-sell agreement is very low level, so Ramos wants to penalize Estrada with low price. (C) Estrada claims the agreement is void b/c its a proxy that has expired. (ii) Court says this isnt a proxy but a shareholder voting agreement. This is just agreement to vote shares a certain way. California code upholds these agreements. (iii) Holding: the agreement is valid, so Estrada must follow the buy-sell provision. (iv) OUTCOME IN DELAWARE same b/c Delaware enforces voting agreements. III Fiduciary duty and threat of dissolution as a check on opportunistic majority action Traditionally courts give deference to majoritys discretion: 1) It is often uneconomic for shareholders in closely held corporation to specify their rights and duties via express written agreement and they usually trust their personal relations and ability to seek equitable relief in the even the majority acts opportunistically. 2) Zidell v. Zidell: Minority shareholder has burden to prove bad faith, fraud, breach of FD, or abuse of discretion and we use corporate law norms. (i) Facts two brothers sue each other. Arnold is younger and Emory has been in the business since after WWII. Jack sells stock to Emorys son, but Emory provided money to buy the stock so now he technically owns 51% of business and is majority controller. Arnold is upset by this and Emory increases sons salary and not arnolds. Arnold demands salary increase but denied and he resigns. Arnold requests dividens. Arnold eventually sues. (ii) Procedural history no bad faith but need to pay higher dividends b/c company sitting on huge amount of money. (iii) Holding P has burden, has to prove bad faith, fraud, breach of FD or abuse of discretion and here Arnold couldnt prove any of these. (A) Arnold should have not resigned and let the company fire him which would help him build his case for bad faith. (B) This is NOT a high protection of minority shareholders and court is not making special rules. (1) So always negotiate a shareholder agreement (iv) RULE P (minority shareholder) has burden to prove: bad faith, fraud, breach of FD or abuse of discretion. The d can rebut this presumption for giving a valid reason for action. The partnership analogy as a basis for enhancing minority shareholders rights. 1) By enacting partnership norms it grants each partner an equal share in profits, a right to full information about the partnership and a right to participate in al management and policy decisions. (i) These rights can be changed only by unanimous agreement of the partners. ALSO: (A) Partners owe each other fiduciary duties that can be enforced in a direct, rather than a derivative, cause of action; (B) Also a partnership can be dissolved at will. 2) Donahue v. Rodd Electrotype: high protection of minority shareholders in a closed corp through partnership law (i) Facts: Rodd controls the company and wants to retire and arranges for company to buy his shares and BoD agree. Donahue sues saying had equal opportunity purchase these shares. (A) Court defines a close corp as: (1)a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. (1) Then the court analogizes a close corp to a partnershipquotes Meinhard v. Soloman, so know P is going to win b/c of high standard punctilial of honor most sensitive. (ii) Holding : Stockholders in Closed corp owe each other FD that partners owe to each other and decided Donahue entitled to relief and should have opportunity to get shares. (iii) Rationale: (A) Should CC be treated like partnerships?

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(1) Same attributes small corp w/ involvement in business, but if wanted to be partnership, should form as a

partnership. Shouldnt adopt new rules to accommodate dumb asses who pick to be corps.
3) Wilkes v. Springside Nursing Home:Massachusetts court when majority acts have a 3 part test (i) Facts: 4 ppl want to start a nursing home and each will be director on board. Dont enter into a shareholder

agreement and dont really get attorney advice. They eventually force Wilkes out b/c Quinn wants to buy property but Wilkes drives up price so Quinn gets everyone to turn on Wilkes to be fired. Wilkes sues for relief. (ii) Analysis: (A) Court sets up 3 prong test: (b/c the court was uncomfortable with Donahue) (1) Legit business purpose (shown by majority shareholders) (2) Minority shows there was an alternative course of action to obtain same purpose (3) Weigh 2, see which is better or least harmful (balancing prong) (iii) Holding: No legit purpose to fire Wilkes. 4) Nixon v. Blackwell: no special rules for close corp in DELAWARE (i) Facts: Company sells lumber but the case is about buyout option available to employees, but not available to family members. Family members get non-voting B class stock. B owns majority, but no voting power; can make money from shares only if given dividends. Cass B shareholders have no control. Employee stock option plan: distribute stock to trust, and would hold shares for benefit of employees, and when employee left the ESOP would buy back the shares. When leave, can keep stock or sell to ESOP; not available to family owners of class B stock. (A) Family sues for three reasons: (1) Attempting to force members to sell shares at a discount (2) Excessive compensation (3) For pursuing a liquidity policy that favored employee stockholders over non-employee stock holders. (ii) Lower court follows Donahue (iii) Higher cout disagrees with lower ct and uses Sinclar test (A) if dividend is paid equally, its business judgment; (B) however, if unequal benefit, then we are going to apply entire fairness rule. (iv) Holding here apply entire fairness b/c Ds on both side of the transaction; getting benefit that doesnt apply to all shareholder (ESOP, key management) unequal treatment of shareholders. (A) Here the corporation passes the entire fairness test (1) Pure equality does not equal entire fairness shouldnt be equality b/c msut look at ex ante expectations of shareholders. What would shareholders have negotiated if they would had known. a. The RULE IN DONAHUE is not correct, shouldnt be what shareholders WOULD have expected. (2) Entire fairness only requires: a. Fair price and b. Fair dealing (not equality) (v) court on closed corporations: didn't elect to be statutory closed corporation (A) court wont impose special rules on company that looks like closed corp, but didn't elect to be one- therefore, just use regular corp. rules (1) note: this is rule in Del. (B) if partnership, would be very different- punctilio of honor most sensitive, have to treat people equally Modern approach to Involuntary Dissolution 1) Oppression remedy for close corporation if controlling shareholders are inappropriately treating minority shareholders, then minority can sued for oppression. (i) In DEL oppression doesnt exist b/c of Nixon v. Blackwell, no special rules for close corp. (ii) In other states if you can prove oppression can have corporation dissolved or shares bought out. 2) In Re Kemp & Beatley, Inc.: Not the rule in Delaware since no special rules exist for close corp. (i) Facts: longtime employees fired, and they own 23% of company (ii) Issue: (A) Whether there is oppression (B) What is the remedy (iii) Analysis: (A) NY has a statute for oppression. And can petition to dissolve company if fraud or oppression conduct (no fraud here.) (B) Court defines oppression as conduct that substantially defeats the reasonable expectations held by minority shareholders in committing their capital to the particular enterprise we look at what shareholder expected by looking ex ante at what they expected when got shares.(look back in timewhat did you wxpect when you got your shares) (1) Reasonable expectations a. Rule: majority conduct should not be deemed oppressive simply bv the petitioners subjective hopes and desires in joining the venture are not fulfilled. Disappointment alone should not necessarily be equated with oppression. Rather, oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioners decision to join the venture. b. If oppression is established:

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1. dissolution not only remedy: once oppression proved, burden on majority to show other remedies

other than dissolution

2. any order of dissolution should be conditioned on buying back minority at the value of the enterprise

i. issues with this test: hard to value what shares are worth- no public market
(iv) Holding: There is oppression here (A) In this case there was oppression: (1) Terminated (gardstein) and resigned (dissin) due to conflict (20.33% of stock) (2) Corp ignored buy-out policy (3) Change to dividend policy to exclude non-employee shareholders. (B) When did oppression occur? (C) What if one of these did not take place? 3) Gimpel v. BOlsetin: (NY CASE) (i) Facts: family has farm and son Robert embezzeled $85K from own family. Family fires him and doesnt pay him

dividends. Rob sues for oppression. (A) This case illustrates the problem of looking at e ante expectations of a shareholder b/c Robert got shares through inheritance and didnt contract for them; shares distributed a very long time ago. (ii) Analysis: (A) Court cant use reasonable expectation test for this situation. (iii) Holding: Apply standards of fair dealing (A) Test for Fair Dealing oppression is burdensome harsh and wrongful conduct, done at the time, so doesnt look to ex ante expectations. (B) Applying the test here Robert is a thief and majority action was reasonable response so it was not oppressive. (1) But enterprise must pay reasonable dividends or buy Robert out. a. Here the court comes up with an alternative remedy instead of dissolution and not the parties. (iv) Rule where cant determine the reasonable expectations of ppl entering the enterprise we have an alternative test to look if there was burdensome, harsh, and wrongful conduct. Rule in a closed corp defined or not, if controlling shareholders are inappropriately treating the minority shareholder the minority shareholders can sue for dissolution. IV Share repurchase agreements Basics: 1) Share repurchase agreement = specifies in advance the conditions on which the corporation will repurchase the shares of a noncontinuing shareholder. 2) These agreements are usually treated as fully contingent contracts (i) Courts will generally enforce the terms of a share repurchase agreement, even if events subsequent to execution make the purchase price substantially less than the then fair value of the to-be-acquired shares, unless there is some compelling equitable reason not to enforce the agreement. 3) Lingering issues: (i) Extent to which courts will use fiduciary duty or other equitable concept to protect minority shareholders form oppressive majority conduct in connection with a share repurchase. (ii) Extent to which an agreement to have ones shares repurchased upon termination of employment converts shareholders into mere-at-will employees of the corporation. 4) Methods to control shares: rd (i) 1. Right of first refusal (3 party bid sets value) (ii) 2. Corporate consent to transfer (i.e. a veto right to corp./controlling stockholders) (iii) 3. Mandatory share repurchase (right to repurchase upon certain events, e.g. death, retirement, end employment) (iv) 4. Buy/Sell agreement (similar to a mandatory repurchase, but stockholder also has the right to require corp. to repurchase upon happening of certain events [a put feature]) 5) The Valuation Problem (i) 1. Book value [assets - liabilities]. This approach often uses historical costs for assets [GAAP], which frequently understates the true value of the firm. Many businesses use a multiple of book value or in combination with another measure. Does not include good will of business. (ii) 2. Earnings Tests. This approach computes the future value of business based on its earning power and growth. This may be very complex and subject to manipulation of the books. Many businesses use historical figures (5 year average), growth rate, and a discount rate. (iii) 3. Multiples Tests. This approach applies some multiple to earnings or another accounting performance figure (EBIT, EBITDA are the most common here). (iv) 4. Discounted Cash Flow. This approach takes the projected future cash flows of the business and discounts them back at an appropriate discount rate. (v) 5. Shareholder Agreement on value. Concord Auto Auction, Inc. v. Rustin: 1) Facts: 3 siblings and 1 died and administrator of estate refused to sell back shares of co., b/c breached fiduciary duty to revalue stock price. Market price of the stock was much higher (double). Coxs estate says inequitable and breach of fiduciary duty not to revalue stock should have cited DONAHUE to make ct think of this as a partnership. 2) Holding:

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(i) Court applies K law the K was optimally drafted to benefit Concord, but still have problem that shall have

meeting although may change price after meeting. (A) Ct. holds the K is unambiguous. Not a claim the court was going to entertain. Gallagher v. Lambert: 1) Facts: Stock repurchase agreement in 1981 to purchase 8.5% of shares of Easdil Realty. Buy back: corporation can repurchase the shares at book value until 1/31/85, thereafter based on a corporate earning formula (a much higher price). Gallagher fired on 1/10/85 b/c at-will employee. Fired right before he would have received a lot more money for his shares. 2) Issue: whether you have protection from at will employment due to your status as a stockholder? 3) Holding: fiduciary duty does not trump contract (i) No right for employment if you are a stockholder (could you imagineId go buy google stock now to be employee) (ii) Defendant abided by K, and therefore didnt breach FD (A) Furthermore Gallagher signed the stock repurchase agreement after he reviewed it with an attorney. (iii) Remember oppression based on breach of fid duty owed to Gallagher as a shareholder (not an employee) 4) Rule in NY can freely enter repurchase agreement w/out fear of being sued for oppression. Pedro v. Pedro: oppressive conduct can override agreement 1) Facts: 3 brothers in business and Alfred finds accounting fraud and told everyone else. They fire Alfred and told everyone else he had a nervous breakdown. Alfred sues for oppression and has 2 claims: (1) back employment and (2) wants shares bought out at fair value. 2) Holding: Breach of fid duty (i) Have agreement at which price of shares should be set, but oppressive conduct here overrides the agreement. 3) Analysis: (i) Is conduct of Peduro a breach of fiduciary duty under Donahue or Wilks? (A) It is conduct under Donahue b/c forcing brother out b/c he discovered fraud. Under Wilkes (business purpose) Pedro still breached fiduciary duty. (B) However this probably wouldnt pass entire fairness under Blackwell. (C) Here difference btwn Pedro and Concord (1) In Concord no bad acts just enforcing agreement (2) In Pedro have independent bad acts 4) Rule agreement cant rump bad acts (oppression) The LLC I Intro The LLC is a hybrid form of company and has its own enabling section in each state, so dont look to Delaware law. 1) The LLC came out of Wyoming and started b/c of their tax benefits w/ check the box (i) The check the box was easier b/c when form a corporate entity usually need to get IRS EIN number and if corporation you are double taxed. In partnership there is single taxation and get K-1 attributable to partner and no taxes owed form partnership. (ii) check the box allows you to choose whether to be taxed as corp or partnership The LLC lets you use the corporate form but be taxed as a partnership! 1) Freedom of K exists in LLC, very limited override rules so it is a very flexible form. (i) Limited liability!!!!!!!! 2) The downside of the LLC must draft agreement b/c of freedom of K, not good to rely on default rules. Terminology: 1) ownership interest makes one a member of the LLC, and the form of ownership is usually called a unit. A member can be an individual, corporation, or another LLC. An LLC is different from an LLP. (i) Members share ratably in the profits of the firm, but only after all other claimants and needs of the firm have been satisfied. Management: 1) Two types of management formats: Member-Managed (default) and Manager-Managed. The former is more like a partnership, the latter more like a corporation or limited partnership (which is managed exclusively by a general partner). (i) managers: run the LLC, sometimes have board of managers Default rules: 1) Unlike the corporation statutes, which provide very extensive rules, the LLC statutes do not provide many default rules, and those are mostly directed toward third-party dealings Can LLC members vote, sell & sue? yes 1) however: (i) vote depends on what agreement says (default rule= they have a vote) (ii) sell (depends on state(some treat like partnership, some allow to be freely transferable) and agreement) (iii) sue (courts in cases are looking at when you can sue and what are your grounds, may find that right to bring suit is even more limited than in corp.) Uniform Rules: 1) Duty of loyalty = does exist and it looks like partnership duty of loyalty. Varied by state.

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(i) Uniform LLC Act: Duty of Loyalty (A) A member's duty of loyalty to a member-managed company and its other members is limited to the following: (1) (1) to account to the company and to hold as trustee for it any property, profit, or benefit derived by the

member in the conduct or winding up of the company's business or derived from a use by the member of the company's property, including the appropriation of a company's opportunity; (2) (2) to refrain from dealing with the company in the conduct or winding up of the company's business as or on behalf of a party having an interest adverse to the company; and (3) (3) to refrain from competing with the company in the conduct of the company's business before the dissolution of the company. (409(b)) (ii) in Delaware, can get right of DoL (contract around it) 2) Duty of Care = very hard to establish, like a corporation and need gross negligence or reckless conduct, intentional misconduct or a knowing violation of law. (i) Uniform LLC Act: Duty of Due Care (A) (c) A member's duty of care to a member-managed company and its other members in the conduct of and winding up of the company's business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. (B) (d) A member shall discharge the duties to a member-managed company and its other members under this [Act] or under the operating agreement and exercise any rights consistently with the obligation of good faith and fair dealing. Usually the role of courts in LLC cases is K interpretation b/c they are trying to fill in the gaps of the agreements Elf Atochem NA, Inc v. Jaffari: Freedom of K in DE before the law changed 1) Facts: Jaffari and Malek enter into agreement but their relationship falls apart and Elf sues. J says that the terms of the agreement have forum selection clause, and members have agreed that any disputes between the parties will be litigated in California. Elf argues that the agreement cannot override del. Law. 2) Holding: (i) Freedom of K, policy in DE is to give agreements broad interpretation, so even though Maleck LLC wasnt a party, all the members were parties. (A) So court defers to freedom of K of parties. After ELF law in Del changed, the legislature amended section 18-109(d) to make sure of the following: 1) Ensure that people who drafted these agreement were clearer about changing forum 2) DE also did this b/c wanted cases litigated in DE b/c they get money and create new law/precedents out of litigation in the state. II Planning for the LLC The operation agreement or the limited liability company agreement is the cornerstone of the an LLC. 1) While LLC statutes provide default ownership-allocation rules, the LLC is an attractive business for sophisticated investors who both need and want to tailor their own governance structures. (i) AT A MINIMUM the operating agreement should specify: (A) The basic economic and management arrangement that will govern the firm (B) Specify the rules or process that will determine how major changes in the relationship btwn and among members and managers will take place, and (C) What rights exist to exit from the relationship and withdraw invested capital. (1) If the operating agreement is silent on key issues, then statutory default rules will govern Olson v. Halvorsen: 1) Facts: Halverson, Olson and OTT decide to form new hedge fund. Hal invests $50 million and gets special voting power. They settle where Hal gest 55%, other two each get 25%. They also get advice of counsel and he suggests they split into 3 LLCs: performance, investors (pay expenses of hedge fund); partners (general partners sharing arrangement). (i) Problem never documented profit sharing arrangement. Also the 3 founders/3 LLCs never finished filling out the longforms, went through 12 drafts of the LLC agreement which isnt uncommon. (A) One agreement is finally finalized, the agreement for the performance LLC. (1) This document says once you leave, you must sell back shares. (ii) One of the guys wants an earn out for future performance of company. He wants this b/c if he leaves will be paid % of profits even though not there. This is contrary to what the other partners wanted. (iii) Time goes on and hedge fund does really well. But they never discuss the earn out provision b/c these ppl are busy and sometimes dont deal w/ legalities b/c cant agree. (iv) Olson decides to take sabbatical, but when he tries to come back the hedge fund not doing great and other 2 partners dont want him around anymore. (v) In DE the default rule is that partners get fair value when resign not the rule anymore. 2) Holding: (i) Oral agreement is sufficient, overrides fair value statute. So Olson loses. (ii) Principals: (A) Make agreement; and (B) Will defer to agreement if in conflict w/ statute (iii) Today the DE revised statute says can resign and get fair value only when LLC agreement says so.

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III Fiduciary and contractual duties In General: 1) LLC statutes vary in the extent to which they allow contractual variations of the common law fiduciary duties of care

and loyalty. (i) Delaware permits elimination of all duties other than the contractual duty of good faith and fair dealings. (ii) Most other states do not allow for elimination of the duty of loyalty, or allow curtailment of the duty of loyalty to a lesser extent than Delaware. (iii) RULLCA does not allow elimination of the duties of care and loyalty, but does permit detailed specification of how those duties can be satisfied that allow a careful drafter to sharply curtail those duties. 2) Jurisdictional differences also exist in the treatment of member-managed and manager-managed LLCS. (i) Many jurisdictions appear to closely follow a general partnership analogy with repect to member-managed firms. (A) This is reflected in RULLCA 409(a), which provides that a member in a member-managed firm owes to the company andthe other members the fiduciary duties of loyalty and care (B) In some states, absent contrary agreement, members in member-managed LLCs do not owe fiduciary duties to each other (ii) A default rule, manager-managed LLCs are functionally closer to the corporation than to the general partnership: the management function and the ownership function are separated, giving members in a manager-managed LLC a passive governance role akin to that played by shareholders in a corporation. (A) Since the contractual nature of the LLC emphasizes freedom of contract, the uniformity of governance structures that characterizes usage of corporate form, the governance structures used by manager-managed LLCs often diverge from the simple member-manager dichotomy. (1) Therefore users of manager-managed LLCs commonly craft specialized fiduciary duty regimes, but there is no corporation-law-like uniformity in the contractual devices used to accomplish this tailoring. 3) Bay Center v. Emery Bay: (i) Facts: Bay center sues claiming Emery Bay LLC took money to pay back loan from bank. Claims: (1) breach of GF and FD w/ LLC agreement; (2) breach of fiduciary duty owed to LLC. The court is considering a motion to dismiss on breach of fiduciary duty. (ii) Issue: did they breach K or not? (iii) Analysis: (A) Court looks to LLC agreement first b/c LLCs are creatures of K. Here a lot of malfeasance was done by EPI, but Emery Bay EPI not part of the LLC agreement. But Bay Center claims Emery Bay LLC breached fiduciary duties by not regulating Emery Bay EPI. (B) Bay center says the LLC unambiguously gives Emery Bay LLC the power to manage the development company emery bay ETI. (iv) Holding: the LLC agreement seems to have 2 conflicting areas/provisions on fiduciary duties. Court reconciles by saying agreement incorporated default duties under DE law and excluded all others. (A) Court denies motion to dismiss b/c the court reconciled the conflicting provisions of the LLC agreement. (B) If you are controller of partnership then you may owe a fiduciary duty to both partnership and limited partners court puts this analysis to LLC. (v) Rule freedom of K in LLC. However there are fiduciary duties, but can be eliminated in DE by K, except implied duty of GF and fair dealing remains. Conflicting Interest Transactions 1) Under most LLC statutes, planners ability to craft fiduciary rules and exculpation provisions does not extend to the duty of loyalty and some LLC statutes specifically address the problem of self-dealing. (i) Contractual freedom only allows private ordering. (A) it cannot ensure that planners will draft unambiguous provisions that cannot be contracted away. 2) Kahn v. Portnoy: (i) Facts: Travel centers of America LLC is a publicly traded company. Hospitality properties trust (real estate investment trust) and REIT management and research, LLC is run by the Portnoy family. HPT acquires 40 truck stops, leases to TA. Portnoy is a director of TA and HPT. So there is a clear conflict of interest here. The Agreement says they have same FD that are in general corporate law. (ii) Holding: Court reads (agreement) this to apply to conflicts between the company and directors. (A) Court is trying to promote unambiguous drafting in LLC agreements. Reason for courts view: (1) Interpret language against drafter (2) Motion to dismiss going to let it through, then can argue at trial. a. If court had ruled the other way, the D would have presumption that acted properly and in accordance with duties; only way to overcome is through clear and convincing evidence, which plaintiff would have burden. 1. Here, in LLC, reshaping burden and shifting how FD apply. (iii) Rule: whenever a potential conflict of interest exists or arises btwn any shareholder or an Affiliate there of, and/or one or more directors or their respective affiliates and/or the company, any resolution or course of action by the BoD in respect of such conflict of interest shall be permitted and deemed approved by all shareholder, and shall not constitute a breach of this agreement, of any agreement contemplated herein, or of any duty stated or implied by law of equity, including any Fid Duty, if the resolution or course of action in respect of such conflict of interest is

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i. Approved by a share plurality (w interested shareholders not counted for any purpose), or ii. On terms no less favorable to the company than those generally being provided to or available from unrelated third parties or iii. Fair and reasonable to the company, taking into account the totality of the relationships btwn the parties involved (including other transactions that may be particularly favorable or advantageous to the company). Exculpatory Provisions: 1) There is no 102(b)(7) for LLCs (remember the thing that gives corporations the ability to exculpate directors, but LLCs do have freedom of K. So exculpate directors for acts except those done in bad faith. (i) Remember look to Disney case to determine what happens when there is bad faith. (A) "director doesn't act in good faith if they act w/ subjective belief that actions aren't in best interests of the corp" IV Judicial dissolution Legal Standard 1) After the IRS promulgated the check-the-box rule the tax-driven pressure to make the LLC look like a partnership disappeared, and LLC statutes moved away not only from either form of easy exist but from any exit at all. (i) Thus the only recourse for a disgruntled member may be a petition for judicial dissolution. (A) About of states follow the close corp pattern of conditioning a members right to dissolution on a finding of oppression or unfairly prejudicial conduct. (B) Most of the remaining states, including DE, use a statute asking whether it is reasonable practicable to carry on the business in conformity with the operating agreement. 2) Fisk v. Segal: Test for dissolution when have deadlock (i) Facts: after 4 years Fisk can exercise his put right. Fisk is suing and is trying to dissolve the company b/c not reasonably practical to run company anymore since not operating under LLC agreement but agreement requires 75% of members to resolve, but they are in a deadlock b/c Segal has power to stop it. (ii) Analysis: (A) DEL 18-802 allows for judicial dissolution. (B) TEST: Whether it is reasonably practicable to carry on business of a limited partnership? (iii) Holding: (A) Test: (1) Is there a deadlock? (2) Can it be navigated around? (3) Is it reasonably practicable to carry on business? a. reasonably practicable to carry on business = court quotes PC tower case: partnership purpose was to acquire land to make profits but wasnt possible to make profits, so was dissolved. 1. If business cant be carried on to further purpose, then not reasonably practicable. (B) The burden is on the company to deal w/ deadlock, and if dont show how you are going to deal with it in the LLC agreement, then you may face dissolution by court. Waiver: 1) There has been debate as to the advisability of allowing LLC participants to contract away the fiduciary duties of care and loyalty. (i) But there has been less attention to the advisability of allowing LLC members to completely waive the fail-safe exit rights provided by judicial dissolution. (ii) How far will a court go to allow a waiver? 2) R&R Capital, LLC v. Buck and Doe Run, LLC: (i) Facts: Russet brothers put up 9.7 million and Linda Merrit manages the 9 LLCs (brothers are members of 7 of them). Things fall apart and brothers petition for dissolution ro receiver. Dont sue Merrit for breach of fiduciary duties. (ii) Issue: can you go down and dissolve LLCs below a many company? NO nd (A) 2 issue for other 7 entities, can petition for dissolution go forward? (1) Problem here is conflicting LLC agreements. (iii) Holding: waiver is valid and doesnt violate public policywhy?...made deal, stuck w/it freedom of contract policy. Under policy wavier is valid. V Balancing equitable discretion and respect for private ordering in other contexts VGS v. Castiel: Court interferes w/ idea of freedom of K 1) Facts: have member-managed board which is like a board of directors. 2 members appointed by Casteil, Sahagen has one. Quinn defects and sides w/ Sahagen. Enter into 2 transactions: (i) Vote to merge LLC into a corp; (ii) Sahagen delivers promissory note to company and company issues out sufficient stock to give Sahagen 65.2% interest in corporation. (A) These 2 directors were acting secretly to foil rights of majority holder. 2) Analysis: (i) Casteil says look to agreement need unanimity court looks at agreement and it says nothing about unanimity.

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(ii) The LLC act says managers can vote w/out prior notice so LLC agreement says can act w/ written consent w/out

prior notice. Court doesnt follow agreement and court says this was not the purpose of statute and these ppl breached fiduciary duty of loyalty. 3) Holding: managers didnt waive duty of loyalty and this duty requires giving notice before abrogating power of majority. (i) If re-drafting this LLC agreement require notice. (ii) Freedom of contract didnt rule here, the court imposed fiduciary duties and merger is unwound, castile wins. (A) This case shows that freedom of K not always absolute b/c area of LLC law still hazy. The Corporate Form and Risk Allocation I Intro Statutory Rules governing the Equity cushion: 1) Basics:

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(i) Corporation- creatures of limited liability (A) want to make sure they have enough capital to function (ii) traditionally, had to have money to form corporation (iii) par value- minimum amt that company can sell shares for (A) this amt is the min. capital the company must have (B) subsequently, par value isn't that important - decided that minimum capital requirements arent nec. in US (not

true other places- ex: EU)

(C) min. capital requirements impediment (iv) In Delaware you set your taxes based on share par value.so can issue share for par or no par value. If you set a

par value can set amount.

(v) Under MBCA par value is eliminated. 2) DGCL 152: Issuance of Stock; lawful consideration; fully paid stock (i) The consideration, as determined pursuant to subsections (a) and (b) of 153 of this title, for subscriptions to, or the

3)

4)

5)

6)

7)

purchase of, the capital stock to be issued by a corporation shall be paid in such form and in such manner as the board of directors shall determine. The board of directors may authorize capital stock to be issued for consideration consisting of cash, any tangible or intangible property or any benefit to the corporation, or any combination thereof. In the absence of actual fraud in the transaction, the judgment of the directors as to the value of such consideration shall be conclusive. . . . (A) Permits the board to issue shares for cash or property DGCL 153: Consideration for Stock (i) (a) Shares of stock with par value may be issued for such consideration, having a value not less than the par value thereof, as determined from time to time by the board of directors, or by the stockholders if the certificate of incorporation so provides. (ii) (b) Shares of stock without par value may be issued for such consideration as is determined from time to time by the board of directors, or by the stockholders if the certificate of incorporation so provides (A) If issues shares under 153 min must be for par value if par value; if no par value it is up to the board to set value. DGCL 154: Determination of Amount of Capital (i) Any corporation may, by resolution of its board of directors, determine that only a part of the consideration which shall be received by the corporation for any of the shares of its capital stock which it shall issue from time to time shall be capital; but, in case any of the shares issued shall be shares having a par value, the amount of the part of such consideration so determined to be capital shall be in excess of the aggregate par value of the shares issued for such consideration having a par value, unless all the shares issued shall be shares having a par value, in which case the amount of the part of such consideration so determined to be capital need be only equal to the aggregate par value of such shares . . . . The excess, if any, at any given time, of the net assets of the corporation over the amount so determined to be capital shall be surplus. Net assets means the amount by which total assets exceed total liabilities. Capital and surplus are not liabilities for this purpose. (A) How we determine capital (1) Net assets = assets - liabiltiies DGCL 170: Dividends; payment; wasting asset corporations (i) (a) The directors of every corporation, subject to any restrictions contained in its certificate of incorporation, may declare and pay dividends upon the shares of its capital stock, or to its members if the corporation is a nonstock corporation, either (1) out of its surplus, as defined in and computed in accordance with 154 and 244 of this title, or (2) in case there shall be no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year (A) Only pay dividends out of surplus; if no surplus can pay dividends out of net profits if have profits. DGCL 244: Reduction of Capital (i) (a) A corporation, by resolution of its board of directors, may reduce its capital in any of the following ways: (A) (1) By reducing or eliminating the capital represented by shares of capital stock which have been retired; (B) (2) By applying to an otherwise authorized purchase or redemption of outstanding shares of its capital stock some or all of the capital represented by the shares being purchased or redeemed, or any capital that has not been allocated to any particular class of its capital stock; . . . . (C) (4) By transferring to surplus (i) some or all of the capital not represented by any particular class of its capital stock; (ii) some or all of the capital represented by issued shares of its par value capital stock, which capital is in excess of the aggregate par value of such shares; or (iii) some of the capital represented by issued shares of its capital stock without par value. (ii) (b) Notwithstanding the other provisions of this section, no reduction of capital shall be made or effected unless the assets of the corporation remaining after such reduction shall be sufficient to pay any debts of the corporation for which payment has not been otherwise provided. . . . . (A) Reduction of capital not below par value of stocks DGCL 160: Corporations powers respecting ownership, voting ,etc. of its owns stock (i) (a) Every corporation may purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in and with its own shares; provided, however, that no corporation shall:

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(ii) (1) Purchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation

is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation . . .. (A) Corps power respecting ownership of its own stock; corp cant cause impairment. Quality and valuation of consideration paid for shares: 1) A central concern of traditional legal capital statutes is the quality of consideration paid by shareholders. (i) In order for creditors to assume that the aggregate par value of issued shares represents an equity cushion, or perhaps a trust fund on which they may later draw, they must be convinced that the consideration paid by shareholders was worth par value. 2) The MBCA and Delaware now leave to the discretion of each corporations board of directors the determination of what type of consideration is acceptable. 3) All corp codes authorize the directors to determine an appropriate issue price, and provide that shareholders are liable to pay the amount for which their shares were issues. (i) These rules create potential liability only if the directors set an unfairly low price or set a fair price but accept consideration that has insufficient value. (A) Directors will be liable for setting an unfairly low price, or accepting consideration having insufficient value, only if their actions constitute a breach of fiduciary duty. (ii) Shareholders face no liability for purchasing stock at a bargain price, absent fraud. (A) If a shareholder pays less than all of the agreed purchase price, then they remain liable for the remainder. (B) If shareholders tender property that the directors evaluate and agree to accept in full payment of the issue price, then the shareholders will not be liable to make up any shortfall if it is later discovered that the property was not worth the agreed purchase price. Limits on Distributions to Shareholders: 1) General corporation codes have placed restrictions on corporations power to distribute money or property to shareholders with respect to their shares. (i) The most common forms of distribution subject to such restrictions are dividends and payments for share repurchases. 2) Payments to shareholders for services, rent, and so on are not distributions with respect to shares and have never been subject to statutory restrictions. 3) Currently, state codes are split into two main camps. (i) Those that restrict distributions solely by reference to insolvency tests and (ii) Those that restrict distributions by reference to legal capital rules (alone or in combination with insolvency tests) 4) The post 1980 MBCA, adopts an approach now followed by most states. (i) Such statutes restrict corporations power solely by reference to two insolvency rules commonly referred to as the equity and bankruptcy insolvency tests. (A) Under these tests, a corporation is permitted to distribute assets to shareholders so long as after such distribution the corporation: a. Will be able to pay its debts in the ordinary course of business (solvent in the equitable sense); AND b. Will still have assets equal to or in excess of its liabilities (solvent in the balance sheet or bankruptcy sense). 5) Delaware and a few other states purport ot impose greater restrictions on distributions (i) These statutes authorize distributions to shareholders only out of surplus. (A) Surplus = net assets of the corporation in excess of capital (more stringent standard) 6) Some statutes distinguish between: (i) Earned surplus a corporations net undistributed profits, sometimes called retained earnings; and (ii) Capital surplus the consideration paid for the shares that is not designated as capital. (A) states making these distinctions usually place more restrictions on distributions out of capital surplus than out of earned surplus. (B) In addition, some of these states restrict distributions for share repurchases more stringently than ordinary dividends. (C) Delaware, does not distinguish between capital surplus and earned surplus, allows dividends and share repurchases to be made out of surplus whatever its source. 7) Most state corporation codes specify the conditions under which directors will be held liable for authorizing distributions to shareholders in violation of legal capital or insolvency restrictions. (i) Statutes commonly provide that the directors, if held liable, can recover from shareholders in the amount that the shareholder received with knowledge that the distribution violated law. (ii) Corporate distributions that make a corporation insolvent may be voided under state fraudulent transfer statutes. Klang v. Smiths Food and Drug: 1) Facts:There was a leverage recapitalization of Smiths under section 152 b/c Smiths board issued stock. Shareholders sue b/c company over leveraged and board breached fiduciary duty by allowing this to happen. 2) Issue: their balance sheet shows dont have sufficient surplus and capital will be impaired 3) Analysis: (i) DGCL 160 cant repurchase shares if it impairs capital (ii) DGCL 154 = how we know impairment, cant be more than surplus

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4) Holding: the company didnt have sufficient surplus to repurchase stock so it revalued its assets and liabilities. The

court says you can do this in the absence of bad faith or fraud. Courts dont want to substitute their judgment. Court giving wide latitude to board to revalue assets under DGCL 160, b/c balance sheets not always accurate measures of a companys assets and liabilities. 5) Rule: wide discretion to revalue assets and liabilities to determine capita. Courts not really concerned on capital but want the procedural concept of laws. What to do to start a business? 1) 1) what kind of capital? 2) 2) want a salary or want shares? 3) 3) tax issue? (i) note - if going to have losses, prob want to form corp- that way can set off net operating losses by future income 4) 4) passive investor or want to be involved? what do you want your involvement to be? 5) 5) what do you want your liability to be? 6) 6) most important question: how much do you want to spend in legal fees? (i) LLC or partnership req. agreement, lots of time to create these (ii) even corp. needs agreement 7) 7) do you want shares to be fully transferrable? LLC or partnership would prob be best 8) 8) do you trust your partners? high FD w/ partnership agreement, or do you want to arrange it yourself? II Piercing the veil Intro: 1) Piercing the Corp Veil = when courts look past corporate form and hold owners and shareholders liable. (i) This can happen in closed corporations as well 2) Alter Ego/Instrumentality Test: (i) Dominance and control (ii) Injustice and deceit (iii) Proximate causation 3) Contract v. Tort (i) Court more likely to pierce the veil in a K case b/c ppl voluntarily chose who they were dealing with not the case in tort. (ii) Higher veil piercing if person hurt is a person, not corporation b/c value ppl more than corporations (iii) Pierce veil if its a group (A) Also less veil piercing in public corp as compared to close corp since ppl in close corp more directly liable since more control over company. Piercing the Corporate Veil to Reach Real People 1) Contract Cases (i) Basics: (A) Officers who sign contracts on behalf of the corporation are not personally liable if the corporation does not pay. (1) The fundamental premise is that those who deal with the corporation can adjust their price and terms according to the degree of security that the corporation provides. (B) Piercing the corporate veil in contract cases becomes a search for the factors that lead courts not to trust the bargaining relationship. (1) Fraud or conduct approaching fraud is clearly reason to pierce. (ii) Consumers Co-op v. Olsen: Under capitalization alone is not sufficient to pierce the veil (A) Facts: Typical close corp: chris, dad and mom own shares. Chirs opens personal charge account w/ consumer co-op and changes it to name of the company. Didnt require a personal guarantee. Chirs starts to use credit card and company starts to fail. ECO fails to keep current on credit card, consumers doesnt cut of credit to Chris. Consumer trying to get at Chris through corporate veil. (B) Issue: can under capitalization cause or be injustice and deceit? No (C) Analysis: (1) If going to pierce the veil, need: a. Dominance and control b. Injustice and deceit. (2) The issue in most cases is usually proving injustice and deceit (D) Holding: inadequate capitalization cannot suffice to show (as the sole factor) that there was injustice and deceit. ECO was appropriately capitalized. Courts will only look at capitalization if company changes its business in a substantial way. This is a very high test. (1) Need to test capitalization at the beginning of the corporation formation and need other factors. (2) In the end, Consumer credit is estopped and has waived their rights: extended credit to ECO after they stopped paying, and they knew who they were dealing with and had the opportunity to check things and out and didnt. (E) Rule: The instrumentality/alter ego doctrine requires proof of the following elements: (1) D had control, not mere majority or complete stock control, but complete domination, not only of finances but of policy and business practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time, no separate mind, will or existence of its own; and

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(2) Such control must have been used by the defendant to commit fraud or wrong, to perpetrate the violation of

a statutory or other positive legal duty (fiduciary duties), or dishonest and unjust act in contravention of plaintiff's legal rights; and (3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of. (iii) KC Roofing Center v. On Top Roofing, Inc: (A) Facts: Corp owned by person individually. On top run by nuggest nuggest have formed a bunch of different company but each business that accumulates too much debt is abandoned. Nuggent purchases assets of ON TOP and ruins the corporation for a few years. (B) Analysis: (1) 2 part alter ego test: a. Domination and control = evident here for Mr. Nuggent but not for Mrs. Nuggent b. Fraud and illegality? Yes R. Nuggent actually acted inequitably so pierce the corporate veil. (C) Holding: (1) If just have a bad business man = creditors cant pierce the corporate veil (this covers ppl who are incompetent or stupid) (2) If dealing with someone who enters into business intentionally and knows he will never pay back money = grounds to pierce the corporate veil. (D) Rule: a court may pierce the corporate veilwhere the separateness is sued as a subterfuge to defraud a creditor. But actual fraud is not necessarily a predicate for piercing the corporate veil; it may also be pierced to prevent injustice or inequitable consequences. (iv) NOTE: (A) concepts in bankruptcy that can claw back $ from shareholders: (1) 1) fraudulent transfers- if transfer money out, but company is insolvent, treasurer can get money back (2) 2) equitable subordination- 2 competing creditors, one inside one outside, the court if it finds it equitable can make you pay the outside creditors first 2) TORT CASES (i) Basics: (A) Tort cases are different because the corporate entity has never provided insulation for an individual committing a tortious act even if the individual purported to be acting as an officer or otherwise in the name of the corporation. (1) Therefore, the same person who signs a K on behalf of the corporation and is insulated from liability if the corporation does not perform on the K would incur personal liability if acting in the same capacity for the same corporation taking actions that were deemed tortious. (Restatement 2nd of Agency 343) (B) Piercing the corporate veil is not necessary to reach such individuals direct liability (1) They are liable as a result of agency law. (C) If the shareholder/officer/directors do not directly participate in the tort committed by someone else in the corp, when should individuals lose the insulating protection of the separate corporate entity? (1) Since the use of the corp form is a choice by the insiders, and those who are victimized by the entity with insufficient assets have no opportunity to choose the entity who would harm them, the use of corporate form in this setting offers an increased likelihood that the business enterprise will externalize part of the costs of its business. a. This approach based on direct or vicarious liability, emphasized the participation of those who act as officers or directors, although piercing is usually described as reaching shareholders. (D) In close corp, where most piercing occurs, this distinction has little practical importance since the same ppl are shareholders, directors, and officers. (ii) Western Rock Co. v. Davis: (A) Facts:Fuller and Stroud are bad guys b/c using dynamite to blow up things after insurance company said they werent going to cover the damages. Corporation sued. (B) Issue: can pierce corporate veil? (C) Analysis: (1) Alter Ego Test: a. Domination and control yes 1. Being on BoD alone not enough to pierce 2. Stroud funding and making personal decisions b. Inequitable and fraudulent conduct? Yes 1. Kept blasting, knowing had no insurance coverage 2. Caused substantial harm to ppl (D) Holding: Pierce veil. Veil pierced b/c have conduct that was known to cause damage to others and didnt have insurance to repay hurt ppl. We have proximate cause here. (1) Would classify this as a breach of duty of GF b/c careless and reckless. Shareholder could sue corp board for breach of fiduciary duty of GF. (iii) Baatz v. Arrow Bar:

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(A) Facts: Ps seriously injured by uninsured and judgment proof drunk driver. Driver had been drinking at Arrow

Bar. IN S. Dakota have DRAM SHOP LAW bar liable if serve someone drink and they drive. Bar here has insufficient assets so want to pierce corporate veil to get owners. Bar doesnt have Dram Shop Insurance. (B) Issue: Is under insurance enough to sustain a piercing the corporate veil? (C) Analysis: (1) Alter ego test: fails a. Baatz fails to demonstrate how the corporation is Edmond and LaVellas alter ego because he fails to show how the corporation was an instrumentality through which [they were] conducting [their] personal business. 1. Baatz fails to show that the corporation was undercapitalized because he offers no evidence that the corporations capital was inadequate for the operation of the business. 2. The corporation did not fail to adhere to corporate formalities simply for its failure to indicate that it was a corporation on its signs and advertising. It is sufficient that the corporate name includes the abbreviation of incorporated. (2) factors that indicate injustices and inequitable consequences: a. 1)fradulent rep. by directors b. 2) undercapitalization c. 3) failure to observe corp. formalities d. 4) absence of corp. records e. 5) payment by corp of indiividual obligations, or f. 6) use of corp. to promote fraud, injustice, or illegalities (D) Holding: a personal guarantee of a loan is a contractual agreement and cannot be used to impose tort liability. (iv) The tort cases show that there is an incentive to under insure and externalize the costs. Piercing the Corporate Veil to Reach Incorporated Shareholders 1) Basics: (i) When the shareholder behind the corporation is another corporation instead of an individual, the piercing analysis becomes more complicated. (A) The tort rule that holds individuals liable for their tortious acts taken in the name of the corporation will not often cover corporate shareholders since as intangible entities they do not physically act for the subsidiary, bur rather appoint real people to serve as officers and directors. (B) Even K claims become more difficult 2) Craig v. Lake Asbestos: reaching incorporated shareholders. (i) Facts: trying to sue parent public company through subsidiary public company. (ii) Analysis: (A) A corp is a separate entity from its shareholders and that a primary reason for incorporation is the insulation of shareholders form the liabilities of the corporate enterprise. (B) Even in the case of a parent company and its wholly-owned subsidiary, Limited Liability normally will not be abrogated. (C) The corporate veil may only be pierced where: (1) Parent so dominated the subsidiary that it has no separate existence but was merely a conduit for the parent AND (2) The parent has abused the privilege of incorporation by using the subsidiary to perpetrate a fraud or injustice, or otherwise to circumvent the law. (D) Here: (1) Dominance and control? No parent and subsidiary, however not enough control. No evidence that involvement was constant and day to day. (iii) Holding: here parents of subsidiary not liable b/c its involvement w/ subsidiary did not reach the level of dominance and constant involvement of day-to-day operations. (A) They had separate books, accounts, officers, and staff, and consulted their own financial advisor and accountants. (B) Veil piercing is a high standard and usually satisfied in large publicly traded corps b/c they follow all the corporate formalities, more likely to pierce veil of small closely held corp b/c less formalistic approach. Piercing in LLCs 1) Kaycee Land and Livestock v. Flahive: (i) Issues: (A) Can an LLC be pierced like a corporation can? YES, no reason they cant be (B) Absent fraud, can a court pierce the LLCs veil? (1) Rule: neither the members of an LLC nor the managers of an LLC are liable under a judgment, decree or other of a court, or in any other manner, for a debt, obligation, or liability of the LLC. (ii) Holding: (A) The test for veil piercing is the same for all types of veil pericingbut the test is subjective, really based on facts and circumstances, but do have some standards: unrepature/underinsurance/ evasion of tort liability are usually not sufficient to pierce veil. III Ambiguous or legally defective allocation of the RoL

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Basics 1) The existence or nonexistence of a corporation is significant in a contract setting for two reasons: (i) FIRST If the corporation does not exist, then it cannot have any agents. (A) Individuals cant act for corp before it is formed or after it is dissolved (ii) SECOND if the cop doesnt exist, then actions taken by individuals to benefit the nonexistent principal will not be protected by the general agency law rule (agency law rule so long as agent doesnt exceed her authority, an agent isnt a party to, or personally liable with respect to, contracts she makes as agent for her principal.) 2) Ks to benefit a nonexistent corporation occur in two settings (i) Before incorporation occurs, and (ii) During periods when a corporation has been dissolved by the state for failure to pay taxes, make required annual reports, maintain a registered agent or office, or other similar reasons. (A) During both of these , Ks may be entered into with creditors who have full knowledge that the corp is then nonexistent or w/ creditors who have no actual or constructive knowledge that the corp does not then exist. (1) But these creditors and those who act for a nonexistent corp may face unexpected difficulties in enforcing their K-ual epectations, because a corp that does not exist can say it never impliedly or expressly adopted the contract. a. Liability may then be on the officers, directors, or shareholders, or promoters (insiders) all of whom probably thought reasonably, that they would not be personally liable on contracts entered into for the then nonexistent corporations benefit. Ambiguous attempts to contract around personal liability 1) RKO-Stanley Warner Theatres, Inc. v. Graziano: PROMOTERS (i) Facts:RKO sues J&G, J and G say that everyong knew they were promoting for Kent inc. (ii) Issue: what is the liability of promoters and how can he get out of liability? (iii) Analysis: (A) Default rule for liability of promoters: promoters are personally liable, unless there is: (1) An agreement that is accepted by the corporation; (2) Make K that is binding but stipulate that when entity formed it is novated (need approval of other party to agree or transferred to the company like an assignment); (3) Get indemnification form corp you form (B) D claimed the second option above, that K was assigned to entity in paragraph 19 of agreement. (ii) Holding: Promoter personally liable unless agreement releases that liabilityK must be novated by corp when formed. st (A) Best way to get out of liability is to 1 form the corporation and then dont have to work about promoter liability. Allocating Losses when Insiders Make no Attempt to Contract Around Personal Liability 1) Timberline Equipment Co. v. Davenport: (i) Facts: Articles of incorp for Aeor-Fabb filed late and before filed a transaction was entered into on behalf of the then non-existent corporation. (ii) Analysis: (A) D argues: (1) Corp functioning as de facto corp acted as a crop even though legally not one. Court looks to Oregon business corporation act, so it doesnt exist. You are either a corporation or not a corporationde facto status does not exist. (2) Corporation by estoppel principal is that one who recognized corp as business entity and entered into business transaction. Equitable rule that basically waived right to assert action. Court says not going to apply estoppel here, b/c can be estopped in 2 situations: rd a. If 3 party is trying to escape liability b. Owe something, Corp has benefitted from it, and saying they dont have to pay bc/ they didnt exist 1. Harder case c. In both cases person who gets benefit is estopped. (iii) Holding: investor, but not active participant. Dr. is liable here b/c Oregon business statute says Dr. could have escaped liability if just passive investor. Here Dr. was actively involved so he is personally liable. (A) De factor corp defense is rejected by most courts in the US (iv) Rule all persons who assume to act as a corprotion without the authority of a certificate of incorporation issued by the corporation commissioner, shall be jointly and severally liable for all debts and liabilities incurred or arising as a result thereof. Allocating the ROL from Unauthorized Actions 1) Agents unauthorized actions (i) Intro (A) This area involves actual authority, apparent authority, inherent authority, and related notions of estoppel and economic efficiency. (1) Actual authority = principal manifests his consent directly to the agent. Can be express or implied from conduct of principal.

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(2) Apparent authority = agent is without actual authority, but the principal manifests his consent directly to the

third party who is dealing with the agent. Created expressly or implied. Third party must reasonably believe that the agent was authorized. (3) Inherent authority = springs form a desire to protect the reasonable expectations of outsiders who deal with an agent. Used by courts to achieve a fair and efficient allocation of the losses from an agents unauthorized action. (B) In a corporate setting loss from an unauthorized transaction will be borne either by the corporation or the creditor. (ii) General Overseas Films v. Robin Intl: apparent authority case (A) Facts: reisini and Kraft engaged in fraudulent scheme. Ro contacts GOF says has contact and needs loan, GOF gives money and R doesnt pay back. Not is issued by Rs company saying they will pay 800K, this note is guaranteed by K, only part of money is paid, rest is fraud R and K go to jail. (B) Issue: What does GOF have to who to prevail? (C) Analysis: (1) Has to show that it, through H, had a reasonable reason to believe that K was acting on Anacondas behalf. a. Apparent authority case 1. P argues lots of indices that A was providing K with authority. i. Kraft was VP and treasurer and could sign notes, drafts, bills, stationary, business card, suite. ii. But court says K had no authority b/c this was outside scope fo Anacondas normal business so K had no authority w/ active loan guarantee. (D) Holding: Anaconda not liable for Ks actions. Ct. says this was such an unusual transaction that Haggiag should have done more research asked for more of a guarantee from K that he had this authority through board of director documents or resolution; a secretary receipt; ect. To show that company knew the VP wasnt running wild.Haggiag liable. (iii) Menard v. dage-MTI, Inc: (A) Facts: Some members of the board of Dage-MTI not happy with Sterling, long-time president and director. Menard offers to purchase 10.5 acres of Dage-MTI property (30 acre parcel). Board rejects offer due to conditions of offer. Sterling lets the offer lapse and informs Menard that the Board objected to the condition. Board authorizes Sterling to offer for sale 30 acre parcel, but not authorized to sell the property w/out board approval. Sterling accepts Menards offer to purchase the entire 30 acre parcel on December 14. Board instructs Sterling to extricate Dage-MTI from the offer, and on March 29 informs Menard that it would not sell the property. (B) Issue: did Sterling have apparent authority to bind Dage-MTI? (C) Holding: There was inherent authority b/c ordinary course of CEOs duty he was allowed to be renegade (1) No actual authority, (2) no apparent authority, a. unusual transaction 1. manufactured electronic video products, nto normal course of business 2. FN 7: extraordinary transaction is only ok if principal know about this b. M had actual knowledge that S needed board approval 1. Therefore, not apparent (3) Inherent authority? a. Defer to trial court findings b. Test: 1. (1) acts that usually accompany or are incidental to transactions the agent is authorized to conduct? i. traditionally S did whatever he wanted, ii. so this was his historical incidental power 2. 2) did M reasonably believe that S was allowed to do this? 3. 3 )the other party has no notice that he is not so authorized i. notice only came 120 days later ii. should have notified earlier 2) Ultra Vires: act outside corporate charter/ that violates charter (i) Issue want to control corporations, dont want them getting into areas they know nothing about (ii) Today, can only bring UV action in 2 circumstances: (1) Sue directors for taking act and collect damages, or (2) If theyve agreed to do act and they have not yet done it, can get injunction. Federal Regulation of Securities I Shareholder investment and Governance in Publicly Held Corporations and the impact of Federal Law (p.208-250) II (1) How publicly Held Corps are different 1) A number of important differences dramatically affect the governance of publicly held corporations and influence the relative roles of law and private ordering in that setting. (i) Four of the characteristics: (1) Presence of a market for shares; (2) Impact of institutional shareholders among the census of shareholders of publicly held corporations;

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(3) The practical necessity for shareholder action in public corporations to be by proxy; and (4) Federal regulation based on company having publicly traded shares.

(a) The Market for Shares and Efficient Market Hypothesis (i) Securities markets provide three important services to publicly traded corporations and their shareholders. (A) Liquidity (B) Valuation (C) Monitoring of managers (ii) Securities markets reduce transaction costs to near zero, because almost all publicly traded shares have nearly identical legal characteristics, thereby eliminating the need for ordinary investors to incur legal costs to ascertain the rights attached to any particular corporations shares. (A) Furthermore, the competition btwn and among informed buyer and sellers means that there is a reliable market price for each share of stock, reducing research costs. (1) Efficient securities markets ensure that shareholders have ongoing, free info as to the current value of their shares; markets provide near costless liquidity. (iii) Securities markets liquidity and valuation functions have a significant impact on corporate governance: (1) First, the securities market serve as a quasi-monitor of the corporations managers. a. The possibility of corporate takeover motivates managers to operate the corporation efficiently and with view to max share value. 2) Physical and Electronic Markets for Shares (i) Two major markets for stock in the US (A) The New York Stock Exchange (NYSE) electronic trading and market for stock on the floor of the exchange. (B) NASDAQ linked set of market makers using electronic means to post price. (ii) To lessen price volatility, the traditional stock exchanges use specialists in each listed stock (A) These specialists coordinate all transactions in their assigned stocks. (1) Whenever there is a significant disparity btwn the number of persons wishing to buy or sell a stock, the specialist must step in and use its own funds to be the missing buyer or seller. 3) The efficient Market Hypothesis (i) Efficient Market Hypothesis: (A) Test 1 weakest form of the EMH posists that you cannot develop a trading strategy based on the use of past prices that will enable you to beat the market return. Basically the current market price is unbiased (B) Test 2 Semi-strong hypothesis asserts that you cannot develop a trading strategy that will beat the market by using publicly available information relevant to the value of the traded stock. (1) This is the form of market (semi-strong) that economists and policy makers have believed that our securities market is. a. This is also the belief the SEC relied on when making rules (C) Test 3 Strong form hypothesis even if your trading strategy were based on nonpublic info, you wouldnt be able to beat the market. a. This is basically the same as insider trading and is prohibited by federal securities law. (ii) Noise traders = persons who have systematic cognitive biases that prevent rational assessment of the value of available information, leading to purchase and sale decisions being made on factors background noise that are irrationally treated as valuable information by the trader. (A) Noise traders force prices away from the price that available info rationally suggests is ideal, creating profit opportunities for rational traders to step in and purchase or sell until the market again comes in line with avail. Info. (b) The Shareholder Census: The Emergence of Institutional Investors (like mutual funds, pension funds, ect) 1) Separation of ownership form control model = the controlling shareholder interest in the typical publicly traded corporation were fragmented among numerous small stakes, geographically dispersed, passive investors who simply rubber-stamped the officers wishes, electing those directors aligned with management. 2) Rational apathy = the typical shareholders lack of interest in corporate governance. (i) A rational person in the shoes of a typical small stakes shareholder would not be inclined to bear the costs required to become fully informed about corporate affairs. 3) In the last 40 years share ownership has become increasingly concentrated in the hands of large institutional investors -- mutual funds being the largest subcategory. (i) Meaning there is an ease of coordinating shareholders who seek to participate in the governance of the corporation. 4) Arbitrageurs => seek out companies whose stock is in play and seek to encourage the trends that will make them money. 5) Value investors are those who actively seek to influence corporate management so as to produce higher share value from underperforming companies. 6) Relational investors purchase large blocks in particular companies and seek a long-term relationship with management. 7) Social investors give explicit priority to social needs in guiding investment decisions 8) Hedge funds some have turned to corporate governance activism as their business plan to produce above average returns. (c) Proxy Voting

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1) Agreements appointing a proxy to act on behalf of individual shareholders, a shareholder need not be physically

present to participate in a meeting of the company. (i) Under the exchange act there are disclosure requirements for soliciting proxies which regulate what the company needs to do and what disclosure must be made when soliciting proxies. 2) Proxy = (i) The legal relationship under which one party is given the power to vote the shares of another (ii) The person or entity given the power to vote (iii) The tangible document that evidences the relationship (A) The proxy designation may create an agency relationship that requires the proxy holder to follow the shareholers instruction; OR (B) The proxy holder may be given absolute discretion to vote as he sees fit. 3) Proxy process is federally regulated (D) Federal Regulation of Publicly Held Companies 1) After great depression Congress passed 2 acts: securities act and the Exchange act (A) Securities act govners offering of securities, disclosure and periodic filing requirements (ii) Federal Law requires Disclosure in five contexts five activities that trigger federal disclosure obligations: (p.218) (1) Issuing securities (2) Proxy solicitation (3) Tender offers (4) Insider trading (5) Periodic reporting 2) (1) Regulation Via Disclosure Tied to Periodic Reporting (i) Disclosure requirements imposed simply b/c a corp has become big enough to have securities traded on a national securities exchange or if it has a class of equity securities held by 500 or more shareholders and more than $10 million in assets. (A) Corporations that meet the above requirements must register with the federal agency, the SEC, and make public reports about their business, property, management, and conflicts of interest of managers. (ii) The disclosure requirements seek to ensure that traders in those markets will have sufficient info as they buy or sell. (iii) Importance of disclosure: (1) First, there has been an increase in the amt of mandatory disclosure (2) Second, technology has made info more widely and quickly available (3) Third, growth of info tech has promoted more voluntary disclosure, through press releases (4) Fourth, there has been a dramatic expansion of the scope of liability both public (Sarbanes-Oxley Act 2002) and private. 3) (2) Disclosure and Other Regulation Triggered by the Proxy Solicitation Process and Shareholder Voting (i) 1934 Exchange Act Rules 14a-3, 14a-4, 14a-5, 14a-9 while states usually determine the substantive law governing relationship btwn a corp and its shareholders, federal law plays the dominant role in regulating voterelated communication btwn and among shareholders and the corporation. (A) Legislative history suggests that Congress was primarily concerned with preventing corporations form soliciting proxies by means of materials that did not reveal the true nature of the matter being acted upon. (B) However SEC interprets its 14(a) mandate broadly SEC plays the role of parliamentarian for this town meeting, laying down rules for who speaks, how long they speak, and on what topics they may speak. (ii) Rule 14a-3 prohibits any proxy solicitation unless the person solicited is first furnished a publicly filed preliminary or final proxy statement containing the information specified in schedule 14A of the Exchange Act rules. (iii) Rule 14a-4 regulates the form of the proxy that solicitors ask shareholders to execute. Imposes readability requirements. (iv) Rule 14a-5 regulates the form of the proxy statement and readability (v) Rule 14a-8 shareholder proposal (SEC gives shareholders more powers to make their own proposal if meet certain requirements the company must include the proposal in the proxy statement. Shareholders try to put in social action proposals to shame the company into action.) (vi) Rule 14a-9 catch-all provision Shareholder Proposals Rule 14a-8: 1) Basics: want it to be used as a check on director behavior, allows shareholder to make their own proposal. 14a-8 limits what you can bring before the board.so the issues is how can a company exclude a shareholder proposal under 14a8? (i) Economic Irrelevance Test 14a-8(i)(5) (A) Allows omission of proposals that relate to operations accounting for less than 5% of a corps total assets, gross sales, and net sales if the proposal is not otherwise significantly related to the companys business. (ii) Ordinary business exclusion 14a-8(i)(7) (A) Exclusion of proposals relating to the ordinary business of the company 2) Lovenheim v. Iroqois Brands, Ltd: economic irrelevance test (i) Facts: Shareholders want to bring proposal to not sell certain products (ii) Issue: are non-economic concerns related concerns related to the business? Yes

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(iii) Analysis: (A) Test: (1) Concern les than 5% of net assets in sales?; and (2) Not significantly related to business? (iv) Holding: SEC holds that social consideration can affect economic aspects of the business and perception of

company.
(v) Rule: social action can affect business of company but cant have numerous proposals so that it distracts from the

business. So must have proposal that relates to the business in some way. Using Shareholder Authority to Change the Bylaws: 1) Shareholder power to amend bylaws (i) State corporation law grants primary management authority to the board of directors, while reserving to the shareholders concurrent authority to make and amend bylaws. (ii) Delaware GCL 141(a) the business and affairs of a corporation shall be managed by or under the direction of the board of directors, except as may be otherwise provided in this chapter or in the certificate of incorporation. (A) Looking solely at this provision one would conclude that the Board of Directors has exclusive power to manage the business and affairs of a corporation unless there is a provision in the certificate of incorporation that limits the power and authority of the directors. (1) However, the power to act via bylaw provisions must also be considered. (iii) Delaware GCL 109(b) the bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers, or employees. (iv) Delaware GCL 109(a) the power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote. (A) Directors may be given concurrent authority to adopt, amend, or repeal bylaws by provision in the certificate of incorporation. (1) Therefore, looking only at Del GCL 109 appears that the shareholders have inherent authority to take a broad array of actions relating to the business of the corp, the conduct of its affairs, and the rights or powers of shareholders, directors, officers or employees. 1. How do we reconcile these two overlapping grants of authority? See CA, Inc. v. AFSCEM Employees Pension Plan. 2) CA, Inc. v. AFSCEM Employees Pension Plan: (i) Facts: Shareholders submitted resolution to board to include in company proxy material under 14a-8. The shareholders wanted to change the bylaws to be reimbursed for nominating directors and win. Company says it doesnt want to include in proxy b/c 14a-8 set parameters for when to exclude shareholder proposal one parameter to exclude is when proposal is illegal. So certify question do Del Sup Ct. (ii) Issue: what is illegal under 14a-8? (iii) Analysis: (A) Company claims DGCL 141 violated by the shareholder request. (1) AFSCME cites section 109(a) shareholder has power to amend bylaws and 109(b) bylaws can contain anything not illegal relating to corporation. Also cite 102(b)(1) ability to include provision in bylaws. (B) By laws regulate the procedure of the company (1) How do we rectify 109(b) and 141? a. This proposed bylaw is a mixed bylaw (substantive and procedural) so under DGCL this is a good bylaw b/c process creating functionthis bylaw is OK nd (iv) Holding: Directors win b/c of 2 part of opinion. Board could possibly discharge fid duties if this proposed bylaw is accepted. The BoD is left with no choice under proposed bylaw mandatory reimbursement. (A) So the bylaws is illegal however in the wake of this case DGCL 113 was passed it provides that bylaws can provide for reimbursement. (B) DGCL 112 allows bylaws to provide for extra conditions or nominations. Chapter 10: Federal Regulation of Security Market. III Requirements of Disclosure Basics: 1) We have regulatory regime based on disclosure 2) Structure of Federal Securities laws: (i) Securities Act of 1933 (33 Act): protects purchasers in the initial issuance of securities by an issuer. (A) Under this act cant sell shares publicly until: (1) Have registration statement S-1 form with SEC, and (2) Delivery of a prospectus along with the security upon purchase (B) Exceptions to the registration requirement for certain types of securities (section 3) and transactions (sec 4) (ii) Securities Exchange Act of 1934 (34 Act): regulates the securities markets through the SEC, covering brokerdealers, proxies, disclosure by public companies (see Reg FD), & Williams Act 5% ownership/tender offer provisions. (iii) State Blue Sky Laws: each state may enact provisions requiring registration of securities with a state regulatory body, generally incorporating the federal disclosure requirements.

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3) Criminal Securities Fraud (sec. 1348) (i) Whoever knowingly executes, or attempts to execute, a scheme or artifice (A) (1) to defraud any person in connection with any security of an issuer with a class of securities registered

under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)); or (B) (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)); (1) shall be fined under this title, or imprisoned not more than 25 years, or both. 4) Anti-Fraud Provisions (i) The anti-fraud provisions apply to any transaction in securities that meets the jurisdictional requirements of the provision (interstate commerce), and cannot be waived or altered by the parties to the transaction. (A) Section 17(a) of the 33 Act (B) Section 10(b) of the 34 Act & Rule 10b-5 (C) Section 14(e) of the 34 Act & Rule 14e-3 (D) Section 14(a) of the 34 Act & Rule 14a-9 Coverage of section 14(a): 1) 14(a) of the 1934 Act authorizes the SEC to regulate the process by which managers or others seek the proxies of shareholders. Federal purposes are achieved in several ways: (i) Required disclosure SEC rule 14a-3 and Schedule 14A have extensive disclosure requirements as to matters on which shareholders will vote. (ii) Procedural rules rule 14a-4 and other rules specify the form of the proxy that may be solicited. There are also special regulations in Rule 14a-11 and elsewhere governing contested elections (iii) Antifraud rules the required disclosure is supplemented by a general provisions in Rule 14a-9 prohibiting fraud in connection with the solicitation of a proxy. 2) the SEC can bring suits in violations of 14 and private right of action is available under 18 of the 1934 Act, but most of the judicial decisions for proxy questions arise under the implied private right of action derived from the antifraud provision, Rule 14a-9. (i) Shareholder communication Rule 14a-8 guarantees shareholders certain rights to include matters in the proxy solicitation sent out by management, a right that is attractive bc it saves the proponents the cost of solicitation and lets them avoid the regulation attendant to making their own solicitation. 3) Two issues that recur throughout the chapter: (i) the federal effort to improve the place of shareholders in corporate governance without displacing state law and (ii) the continuing desire to make corporations socially responsible in responding to issues of concern to society as a whole Rule 14a-9: No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading. 1) Under this rule if you dont correctly disclose will be penalized. 2) Express federal cause of action 21 of the 1934 Act permits the SEC to bring civil actiosn for violation of the act and 32 provides for criminal penalties. (A) the 1934 Act provides express causes of action to private parties in 9, 16, and 18. (1) 18 covers false and misleading statements in any application, report or document filed pursuant to this title or any rule or regulation thereunder. (ii) State cause of action can use this claim concurrently with federal claims. 3) Implied Private Cause of action: (i) Rule 14a-9 does nto expressly provide for a private cause of action by shareholders who believe they were misled by a proxy statement. (A) HOWEVER, the Supreme Courts holding that an implied private right of action exists for Rule 14a-9 dramatically affected the use of that rule. (1) But since the private cause of action is not expressly set out in the statute or rule, determining the elements of a private action has required judges to look beyond the statute and the rule. a. Courts have viewed Rule 14a-9 as an antifraud provision and turned to the familiar law of common law fraud or the tort of deceit. 1. The black letter elements of common law fraud or deceit require: i. A plaintiff to show misrepresentation or omission of a material fact ii. Made with scienter on which plaintiff relies iii. Suffering damages as a consequence. JI Case v. Borak: shareholders can bring private cause of action under 14a-9 1) Issue: Is there private action under 14a? Yes

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2) Analysis: (i) b/c not suing for fiduciary duty here and SEC cant look into all proxy statements, it needs help form private

plaintiffs. (A) Court says it is so important to have remedy for disclosure that private right of action should be there b/c will supplements SEC. (1) But could have problem of frivolous law suits. 3) Holding: the language of the Act does not prohibit private action, but instead implies the right. 4) Rule: the Act under section 27 grants private parties the right to bring a suit against a party for violating section 14(a) of the act. Element of a Fraud Action Common Law Tort Misstatement/omission Material fact Scienter Reliance/causation Damages 14a-9 Proxy Violation Mistatement or omission Material Fact (Can be Opinion per Virginia Bankshares) Gerstle (Negligence) Mills Essential Link Test (as modified by Virginia Bankshares & Wilson) Mills (fairness)

IV

(i) How does the federal securities action differ from a state appraisal/ Weinburger claim? (A) If fair value paid, then no state or federal claim (B) If no fair value but no misstatement, then only a state claim 1) TSC Industries, Inc. v. Northway, Inc: What does material misstatement mean? (i) Issue: Do omissions in the proxy statement meet the definition of material fact under the rules of the Act? (ii) Holding: NO, omitted facts are only material under rule 14a-9 of the act if it can be shown that there is a substantial

likelihood for a shareholder to consider the fact important when deciding how to vote. (A) In order to decide if summary judgment should apply, the court must focus on the inference that a reasonable shareholder would draw from the facts and its weight in the shareholders decision. (B) The supreme courts characterization of materiality suggests that resolving that issue by summary judgment w/out going to trail may be difficult. a. Previous standards of materiality: 1. The Seventh Circuit used the test of all facts which a reasonable shareholder might consider important i. which Marshall held was not a stringent enough test. This was a lower standard = more litigation and more disclosure 2. The Second and Fifth circuits used a more conventional tort-based test: whether a reasonable person would attach importance to the fact which was misrepresented or omitted in determining his course of action. b. Marshall's new formulation of materiality: 1. Marshall wanted the test for materiality of a misstatement or omission to serve the remedial purposes of 14a, without creating too much liability for companies by allowing any minor or trivial defect to create liability. 2. If the test was too stringent, it would cause the dismissal of otherwise meritorious lawsuits; if it were too lenient, corporate officers would be inclined to overwhelm shareholders with such a large volume of information that truly valuable facts might escape them. 3. He formulated the test as follows: an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. (medium standard) i. In other words, the court must determine whether under all the circumstances, the omitted fact would have assumed actual significance in the decision of the shareholder. Thus, materiality is a mixed question of fact and law. ii. There is a balance btwn more litigation and ex post factor disclosure or preemptive disclosure court decided middle of the road approach. (iii) Rule: Materiality Test under 14a: The standard for an omission under the Act is if there is a substantial likelihood a reasonable shareholder would have relied on the fact, and summary is not appropriate if the omission is not misleading as a matter of law. 2) Virginia Bank Shares v. Sandberg: What is a material fact (i) Facts: majority vote and no appraisal under VA law. Ps want to supplement state law remedy w/ federal remedy b/c state law remedy not sufficient. (A) Statement of belief: the BoD approved the merger bc of the high value given for the stock. (ii) Issue: when can you sue under 14a-9 under opinions as opposed to facts?

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(iii) Analysis: cant have CoA based on belief, must look at underlying facts to show they are wrong. So statements of

belief are actionable, but must look at underlying fact. (A) How to determine if underlying belief is wrong or right? (1) Cant read minds, but can derive facts from ancillary documents, such as minutes, communications, emails, ect. (iv) Holding: by not having beliefs actionable alone, cut back on litigation. (A) The court here ruled that terms like high value in a commercial context are reasonably understood to rest on a factual basisb/c of this, these terms could be found misleading by garden variety evidence. (B) In addition, the Court found that such terms can be materially misleading even if other information within the statement enables an expert to deduce that such statements are false. (1) Despite these conclusions, however, the Court ruled that because the link between the merger and the proxy statement was too speculative, there was no private right of action for the minority shareholders. Minority shareholders claim was that the vote was cosmetic, and the minority shareholders votes were not required by state law or corporate bylaw. (v) Scalia Dissent scalia notes that some statements that contain the word opinion represent facts as facts rather than as opinions, and that in this event, the normal rule of section 14(a) liability should apply. Scalia thinks that this is the case with these facts. Beliefs alone are not sufficientneed underlying facts. (vi) Rule in securities fraud case, a statement of opinion may be a false factual statement if the statement is false, disbelieved by its maker, and related to matter of fact which can be verified by objective evidence. 3) Scienter (i) Scienter is a legal term that refers to intent or knowledge of wrongdoing. This means that an offending party has knowledge of the "wrongness" of an act or event prior to committing it. (ii) The Supreme Court in the above two cases deferred the issue of what showing of culpability is required to establish liability under Section 14(a).. (A) Second Circuit Case, Gerstle v. Gamble-Skogmo, Inc., held that negligence was sufficient to establish liability under 14(a), distinguishing this section from section 10b for which the supreme court later required a higher standard of culpability. (B) But in adams v. Standard Knitting Mills, Inc., the Sixth Circuit held scienter should be an element of liability in private causes of action under 14(a). 4) Reliance, Causation, and Remedy (i) Mills v. Electric Auto-Lite Co.: reliance essential link test (A) Analysis: (1) All that is necessary for a section 14 cause of action to exist should be a finding that a misrepresentation or omission was material. This ensures that no liability will occur for trivial defects. (2) By showing shares necessary for merger show reliance by shareholders, but must show misleading statement would have changed vote by showing reliance. a. Must ask every shareholder whether relied on statement = burdensome 1. Lower court says this not feasible, just see if merger had merit and fair to shareholders, tehn reliance not shown. (B) Issue: what is the test of reliance? (C) Holding: court rejects proving reliance individually and rejects lower court fairness test b/c wants an objective test. (D) TEST: If misstatement/omission is material, then causation established if shareholder proves that the proxy solicitation itself, rather than the particular defect in the solicitation, was an essential link in the accomplishment of the transaction. (ii) VA Bankshares #2: (A) Facts: minority shareholders vote not necessary here, so requirement of proxy not essential to get vote through (B) Issue: can other situations establish an essential link? (C) Analysis: (1) Essential link argument rejected b/c vote not necessary to effect transaction (shareholders votes not needed here) (2) Second claim rejected b/c no loss of state remedy b/c there was no full disclosure in accordance w/ requirements of VA lawbut is Souter a VA lawyer? No, so how does he know that claim not lost? (D) Holding: case doesnt require ct to decide whether 14(a) provides a CoA for lost state remedies, since there is no indication of law or facts before us that the proxy solicitation resulted in any such loss. (1) How is there any loss if this transaction didnt require minority shareholders vote in the first place? So no claim even exists. (iii) Wilson v. Great American Industries, INC: remedies (A) Facts: Shareholder lose appraisal rights if vote for merger, but Great Am controls vote and price to be paid. Here the remedy is get shares appraised. Court applies the MILLS TEST. (B) Analysis: (1) Minority shareholders who lacked sufficient voting power to block merger, could still maintain action claiming proxy misrepresentations based on loss of state appraisal right (C) Holding:

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(1) Essential link normally is limited to instances in which a vote is legally necessary to effect the transaction,

although shareholders who lose a state law right arising from the underlying transaction may establish an essential link (a different sort of injury which full disclosure might have avoided) a. If a shareholder meets Wilsons requirement by demonstrating the loss of a state law right, what remedy should a federal court grant? Injunction or damages? 1. Court left question of relief to subsequent proceedings, but said that petitioners should be entitled to an interim award of litigation expenses and reasonable attorneys fees. II Disclosures related to buying and selling Rule 10b-5 1) RULE 10b-5: Employment of Manipulative and Deceptive Practices: It shall be unlawful for any person, directly or indirectly, (to use or employ in connection with the purchase or sale of any security any manipulative or deceptive device or contrivance) by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (A) (a) To employ any device, scheme, or artifice to defraud, (B) (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (C) (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, (D) in connection with the purchase or sale of any security." (ii) In the case of TSC Industries, Inc. v. Northway, Inc., the word "material" was defined by the U.S. Supreme Court "an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. 2) Rule 10b-5 catches fraud. (i) Fraud encompasses a broad variety of acts and Rule 10b-5 does not remedy all fraud, only that in connection with the purchase or sale of securities. What is Federal Securities Fraud? What Is a Common Law Fraud/Larceny? Section 17 (33 Act) (issuance) Deceit/Omission Section 15(34 Act) (broker-dealer) Section 14(a)/Rule 14a-9 (proxy) Loss by the victim Section 14(e)/Rule 14e-3 (tender offer) Gain to the defendant Section 10(b)/Rule 10b-5 (purchase/sale transactions)
3) In order to establish a claim under Rule 10b-5, plaintiffs (including the SEC) must show: (A) (i) Manipulation or Deception; (B) (ii) Materiality; (C) (iii) "In Connection With" the purchase or sale of securities; and (D) (iv) Scienter. (ii) Private plaintiffs have the additional burden of establishing (A) (v) Standing - Purchaser/Seller Requirement; (B) (vi) Reliance; (C) (vii) Loss Causation; and (D) (viii) Damages.

The reach of Rule 10b-5: Standing and in connection with a purchase or sale 1) Birnabaum v. Newport Steel Corp: (i) Facts: shareholders sue on 2 mistatements: (A) Letters w/ omission (B) Letters failed to show would make company less valuable (ii) Issue: does 10b-5 only protect purchasers or seller of stock when a misstatement is made? (iii) Analysis: (A) Here P is suing and not purchasers, just shareholders of company but want 10b-5 to give them remedy. Corporate misconduct under 10b-5. (iv) Holding: court says 10b-5 is narrow and have to be purchaser or seller, cant just be a stockholder. (A) Court not willing to construe case broadly. (1) Makes sense since everyday hold stock you are deciding not to sell. 2) Blue Chip v. Manor Drug: (i) The Ps here NEVER bought the shares and had a state cause of action. Why protect? b/c there was fraud. (ii) Problem is that the class of Ps is potentially limitless b/c anyone could claim I was going to buy that stock, but for fraud. (iii) Holding court rules there is no private CoA b/c wants to prevent undue litigation. (iv) Rule only those suffering direct loss from the purchaser or sale of stock had standing to sue under federal securities law. 3) AFTER BIRNBAUM and BLUE => must be a purchaser or seller of shares during time material misstatement or omission was made. (i) Who is excluded: (A) Potential purchaser

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(B) Shareholder but state cause of action (C) Shareholder who suffers loss in value 4) Superintendent v. Bankers Life: (i) Facts: bad guys trying to purchase M using Ms own money, and array of transactions trying to hide this. (ii) Issue: what does in connection with mean? (iii) Analysis: (A) in connection with means the alleged injury must be a result of deceptive practices touching its sale of

securities as an investor.
(B) What did bankers life do wrong? While [t]he controlling shareholder owes the corporation a fiduciary duty,

how can Bankers Life be a defendant when it did not sell the securities in the transaction at issue? (1) broad interpretation of 10b5: held liable even though they didnt have anything to do with transaction (C) the fact that creditors of the defrauded corporate buyer or seller of securities maybe the ultimate victims does not warrant disregard of the corporate entity. (iv) Rule in connection w/ = touching upon, which has broad reach so picks up Ps who are NOT necessarily buyers and sellers of shares. 5) Santa Fe Industries v. Green (i) Facts: involves squeeze out merger, majority shareholder squeeze out (push transaction through) and pay lower price for minority shares. Shareholders sue on claim appraisal of stock was fraudulent. Appraised at 125 per share but offered 150 per share, but assets of company value each share at $640 per share. (A) Shareholders were suing on state law grounds and proxy actions under 14a-9, but this cant work since no vote. (ii) Issue: Does breach of fiduciary duty equal fraud under 10b-5? No (iii) Procedural HIstory: nd (A) 2 cir says dont need material misstatement or omission as long as have breach of fiduciary dutiestrying to craft remedy for this situation business purpose. (B) This holding implies 10b-5 is more than material misstatement and omission but also includes breach of fiduciary duty. (1) Problem == this is way to expansive (iv) Holding (US SUP CT) congress didnt intend to cover fiduciary duty which is a type of fraud. Congress meant fraud in sence of manipulation of stock market. (A) There are other ways to get remedy: (1) Show material misstatement or omission; (2) Show manipulation of market; (3) State law cause of actions (v) Rule fraud under 10b-5 does not include breach of fiduciary duty. 6) Field v. Trump: (i) A breach of fiduciary duty involving garden style mismanagement will NOT trigger liability under Rule 10b-5, but where the remedy of an injunction is needed (and is available under state law) to prevent irreparable injury to the company from willful misconduct of a self-serving nature, disclosure of facts necessary to make other statements not misleading is required where disclosure the misleading statements will lull shareholders into forgoing the injuctive remedy. Elements of Common Law Fraud Applied to Rule 10b-5 1) Misrepresentation or Omission of a Material Fact (i) Basic v. Levinson: only need to disclose if have prior statement that is no longer correct then must correct info (A) Facts:Shareholder sue under 10b-5 because there was no vote so no claim under 14a-9. No Bluechip problem b/c class is ppl who bought and sold stock during the fraud. Only care about sellers b/c they had damage. (B) Issue: what standard of materiality should be applied? (C) Analysis: (1) Were these public statements material? rd a. Petitioners argue not material b/c not sure takeover would happen and wanted 3 circuit test adopted saying material only when have agreement in principal. st 1. Need to have deal 1 2. If disclose merger discussion may compromise the merger transaction and 3. Merger negotiation could mislead shareholders. i. Court rejects this test b. Lower court adopted the denial of existence of discussion: 1. Test: once you deny discussions denial creates rule that have to disclose all later discussion i. Court rejected this test too (D) Holding: nd (1) Supreme court adopts 2 circuit test: Probability/Magnitude test: a. To determine materiality under TSC/BASIC: to asses the magnitude of the transaction to the issuer of the securities allegedly manipulated, a factfinder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular even or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussion material

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(2) So basically dont have duty to disclose, there must have been a prior statement that is no longer correct such

that need to disclose to correct incorrect info. a. FN 17: say no comment so dont create a duty to disclose, that way nothing needs corrected. Another way to avoid this is to leave out material terms in agreement so can say no materiality in K yet so no need ot disclose. (ii) In Re Time Warner: (A) Unattributed corporate statements published in the media. (1) 11 statements attributed to officers (including CEO) regarding strategic alliances (e.g. serious talks) (B) Misstatement (Santa Fe)? (1) Court: not affirmative misrepresentations, just opinions a. would be untrue only if they knew there were never going to be strategic partnerships (C) duty to update opinions and projections? (1) Court: only if those statements are material and become materially misleading later on a. Here the projections were not definite, so dont need updated. Dont need to update a hope or a wish. (iii) Omissions for 10b-5 (A) Basic/Time Warner: failure to correct prior statements that are rendered misleading by subsequent events may be an omission if the information is material (probability-magnitude). (B) Materiality: [W]here the disclosure duty arises from the combination of a prior statement and a subsequent event, which, if not disclosed, renders the prior statement false or misleading, the inquiries as to duty and materiality coalesce. (C) Disclosure Duty: [A] disclosure duty limited to mutually exclusive alternatives is too narrow. A duty to disclose arises whenever secret information renders prior public statements materially misleading, not merely when that information completely negates the public statements. (iv) NOTE: safe harbor for forward looking statements (A) What are Forward-looking statements? (1) (A) a statement containing a projection of revenues, income (including income loss), earnings (including earnings loss) per share, capital expenditures, dividends, capital structure, or other financial items; (2) (B) a statement of the plans and objectives of management for future operations, including plans or objectives relating to the products or services of the issuer; (3) (C) a statement of future economic performance, including any such statement contained in a discussion and analysis of financial condition by the management or in the results of operations included pursuant to the rules and regulations of the Commission; (4) (D) any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C). (B) 21E(c) Safe Harbor (1) (A) the forward-looking statement is-a. identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement; or b. immaterial; or (2) (B) the plaintiff fails to prove that the forward-looking statement-a. (i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; or b. (ii) if made by a business entity, was-1. (I) made by or with the approval of an executive officer of that entity; and 2. (II) made or approved by such officer with actual knowledge by that officer that the statement was false or misleading. (C) Section 21E(c) incentivizes company to put out information without fear of litigation. 2) Defendants Mental State SCIENTER (i) SCIENTER DEFINED: (A) Scienter is a latin term used to refer to a Ds knowing or intentional mental state regarding a proscribed act. (1) For courts implying a private cause of action, the required mental state remained a point to be filled in. a. Strict liability standard for some ds under section 11 of the Securities Act of 1933 b. Negligence is a common standard c. Recklessness requires more than negligence, but its exact parameters are sometimes hazy; and d. Knowledge or intent only leads to individual liability when conduct has crossed a higher threshold.

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(ii) Ernst & Ernst v. Hochfelder: (A) Issue: whether private cause of action for damages under 10b and 10b-5 with scienter? Does entity making 10b-

5 misstatemetn have to know what theyre doing?

(B) Holding: NO, court said no aiding and abetting liability under 10b-5, must be direct maker of material

misstatements. rd (1) Dont want 3 parties to be so worried about vexatious litigation that dont make any disclosure. (2) Court adopts scienter requirement b/c: manipulative is term of art requiring higher level than negligence. (3) How do courts get around issue that fraud = negligence? a. SEC argued FOR negligence standard b/c this is simply duty of care and scienter (intent) is difficult standard to prove. Negligence would put burden on person who makes statement, since in a better position. 1. Court rejects thiswants limit litigation. (C) Rule: for scienter need intent, but circuits accept recklessness for scienter. (iii) Pleading Fraud in Federal Court (A) FRCP 9(b): In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity. Malice, intent, knowledge, and other condition of mind of a person may be averred generally. (B) FRCP 12(b)(6): prior to filing a responsive pleading, defendant may file a motion to dismiss for failure to state a claim upon which relief can be granted. (iv) Tellabs v. Makor: (A) Issue: in considering whether a securities fraud complaint alleges facts sufficient to establish a strong inference that the D acted with intent to deceive, as required by the PRIVATE SECURITIES LITIGATION REFORM ACT of 1995, must a court also consider competing inferences of an innocent mental state that might be drawn from the same facts? YES (B) Holding: a securities fraud complaint must allege facts establishing an inference of guilty intent that is cogent (believable) and at least as compelling as any opposing inference of nonfradulent intent. (1) The strength of an inference cannot be decided in a vacuum. The inquiry is inherently comparative a court must consider each plausible inference of intent, both fraudulent and nonfraudulent, and then decide whether a reasonable person would consider the guilty inference at least as strong as any opposing inference. (C) Rule: intent to deceive, manipulate, or defaud is required for civil liability under section 10(b) of the SEC 1934 and Rule 10b-5 promulgated thereunder and that negligence does not suffice. (v) Makor Isues & Rights v. Tellabs: (on remand) (A) On remand: (1) Posner is looking at cogentcompelling from facts standard and he analyzes 2 opposing inference: a. Poser says they actually knew what was going on in this caseso the standard is compelling b. Motion to dismiss denied and Tellabs case goes forward. 1. So despite the high standard can still get pleading through plead facts w/ compelling circumstances. (vi) Basic v. Levinson II: reliance (A) Issue: how do you prove reliance and causation, do we require Ps read disclosure and rely or trade on omission? (B) Holding: the supreme court adopts the fraud on market theory as the standard for reliance (1) Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted [1] if omitted material information had been disclosed . . . or [2] if the misrepresentation had not been made, would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market. a. Rationale when fail to disclose information I am defrauding the market b/c it doesnt have all info to be efficient. (2) This standard creates a rebuttable presumption: a. Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. 1. Market price unaffected by misrepresentation 2. Truthful information has credibly entered the market and dissipated the effects of the misstatements (truth-on-the-market defense) 3. Plaintiff did not in fact rely on the integrity of the market price. (vii) Dura Pharmaceuticals, Inc. v. Broudo: (A) Facts: False statements about FDA approval this led to lower than expected earnings and stock lose its value (B) Issue: is it sufficient to show price of stock on date of purchase was inflated b/c of misrepresentation? Do you need observable stock loss to get damages claim or can you just allege the stock price was artificially inflated? (C) Analysis: (1) The actual fraud was not the announcement of earning loss, it was the comment of no FDA approval.

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(2) Ps argue injury happened when they bought stock b/c artificially inflated and when dropped it absorbed

fraud.
(D) Holding: need actual loss, show actual economic loss, so Ps lose here b/c misrepresentation didnt necessarily

cause loss. (1) Should have alleged that corrective statement was made and show immediate price drop. Dont say artificial inflation was the cause of damage. (2) Rationale it is difficult to prove issues of how much price of stock actually inflated when dont have direct fall in stock price. (E) Rule: inflated purchase price will not by itself constitute or proximately cause the relevant economic loss needed to allege and prove loss causation. Misstatement or omissions summary: Common Law Tort Misstatement/omission Material fact Scienter Reliance/causation Damages 10b-5 Fraud Santa Fe (misstatement) & Basic (omission) TSC Hochfelder Basic (Fraud-on-the-Market) Dura (Damages) In connection with (touching) (actual) purchase or sale of any security.

Insider Trading I Foundation for Rule 10b-5 The Common law Foundation for Rule 10b-5 1) Rule 10b-5, promulgated by the SEC pursuant to 10(b) of the Securities Exchange Act of 1934, is the primary regulator of insider trading, but is not the only legal source on this topic. Rule 10b-5 as a regulator of insider trading 1) The first important step in the use of Rule 10b-5 to regulate insider trading was the SECs 1961 decision in In Re Cady, Roberts & Co., 40 SEC 907 (1961). (i) The commission brought an action against the brokerage firm of Cady, Roberts & Company and one of its partners, Gintel, for actions arising out of a directors meeting of the Curtiss-Wright Corp at which the directors voted to cut the dividend. (A) Gintel learned of the dividend decision from the director and immediately thereafter sold his customers shares and those in trust for his children and sold short for his own account. (1) The commission held that Gintel violated Rule 10b-5 and announced the principle that a corporate insider who has material nonpublic info about the enterprise is under a duty either to abstain from trading or first to disclose the nonpublic information. a. This obligation rests on two principal elements: i. The existence of a relationship giving access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone; and ii. The inherent unfairness involved where a party takes advantage of such information knowing that it is unavailable to those with whom he is dealing. 2) Terminology: (i) Options: give the owner the right to purchase (call option) or sell (put option) 100 shares of a companys stock at a stated price (strike price) by a specific date (expiration). (ii) Pricing: IBM Stock = $100 per share IBM May 110 call option = $.875 per K ($.875 x 100 = $87.50 per contract) (iii) Nonpublic Information: X Corp. will make a hostile offer for IBM at $125 per share on Friday. (iv) Insider Trading: Purchase a May 110 call option at $.875 on Thursday, and after the announcement on Friday, the stock price increases $22 to $122 and each option is worth approximately $12 per contracta profit of $1,112.50, or 1,300%, in two days. (v) Diamond v. Oreamuno:

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(A) a corporate fiduciary, who is entrusted with potentially valuable information, may not appropriate the asset

for his own use even though, in so doing, he causes no injury to the corporation.
(B) there can be no justification for permitting officers and directors, such as the defendants, to retain for

themselves profits which, it is alleged, they derived solely from exploiting information gained by virtue of their inside position as corporate officials. (C) it may well be inferred that the defendants actions might have caused some harm to the corporation. (D) This is a derivative claim for breach of the duty of loyalty brought by current shareholders. (vi) Common Law Tort of Fraud/ Deceit and Rule 10b-5 (A) Misstatement/Omission (B) Material Fact (C) Scienter (D) Reliance/causation (n/a to govt) (E) Damages (n/a to govt) (vii) Who is defrauded (the victim)? (A) Purchasers or sellers (opposite party)? (B) The corporation whose securities are traded? (recall Diamond v. Oreamuno) (C) The owner of the information (if it is other than the corporation whose securities are traded)? (D) The market? 3) Classic Insider Trading as Fraud (i) SEC v. Texas Gulf Sulphur Co.:Equal access rule and must abstain from trading if have insider info (A) Facts: Texas gulf finds huge bore of oil, but rumors circulate and texas denies it. While the rumors are circulating the insiders are buying shares and call options. So eventually in the 1960s they make $22 million trading options and $125,000 out of stock. (1) Why were they buying? b/c had inside information that the company was going to make money. Didnt tell public that the rumors were true, b/c didnt want market to get carried away w/ the rumor of this find b/c not 100% sure if the mineral find was as big as they hoped. a. The fact they were trading during this time works against their argument that they werent sure of the size of the mineral find. (2) However there are not so smart TGS insiders: a. 2 officer/directors make purchases the evening before the April 16 announcement b. 1 insider leaves the press conference and calls his son-in-law/broker to place order. 1. By these insiders doing this they are giving more money to shareholders b/c he is raising the price. i. Ex: if stock is trading at $5 per share, if someone came in and started buying a lot of shares the price is going to go up. But this is bad for potential buyers b/c it makes them pay more for shares. (B) Issue whether or not what they did was a violation of 10b-5 (C) Procedural history (1) Lower court Said this was not a violation of 10b-5 and sets high threshold for materiality b/c looking at this in hindsight. And found no insider trading. (2) Higher court says the materiality test is whether they would find information important and must balance probably with facts and circumstances. a. TEST of materiality What would reasonable man or woman attach to the facts? 1. What would be important to a reasonable man or woman. (D) Analysis (1) Rule [10b-5] is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information. (2) The core [pun intended?] of Rule 10b-5 is the implementation of the Congressional purpose that all investors should have equal access to the rewards of participating in securities transactions . . . The insiders here were not trading on an equal footing with the outside investors. (3) Why is this fraudulent? (E) Holding court says the information here is important. (1) People were buying stock so obviously a reasonable person would have found it important that insiders were buying tons of stock. So material to know the insiders are buying b/c think have huge mineral deposit. a. This is broad test of materiality 1. Step 1 Are insiders buying stock b/c of this information? If yes then it is material and important to reasonable man or woman. (F) Rule Insider Trading Rule: [A]nyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such insider information remains undisclosed. (1) What is the basis of this rule? 10b-5 is premised on equal access to information and key rule here is disclose or abstain. Tell information or dont trade. a. What is problem w/ disclosing material information stock price will go up and wont make money and also the corporation owns this information and it is not the insiders right to disclose, if disclose could be in violation of fiduciary duty to the company.

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1. So really this is an abstain rule cant disclose so dont trade (G) After this case we have possession of material non public info and trading is an omission. Absence of

equality is an abstain of disclose rule violation.

4) Extension of the Classical Theory (i) Tippee Liability and Constructive Insiders (A) Basics: (1) Fiduciary Duty owed by the tipper to company whose shares are traded. (2) Tippers Purpose for disclosing (quid pro quo): a. Pecuniary benefit b. Reputational benefit from disclosure c. Gift (Friends & Family?) (3) Tippee Scienter (knew or should know that given information in breach of fiduciary duty). (4) *****This analysis doesnt include temporary insiders described in FN 14 (B) Chiarella v. US: Tippee tipper liability (1) Facts: When sending out annual statement for shareholders, must go to printers, but ppl running the printers

get to see information so use code names for company names. Chiarella was a printer of one of these places and he figured out who were the companies the statements were talking about. a. But Chiarella was not an insider, he was getting his information from the bidders documents (in a hostile takeover) it was NOT the companys information. So here Chiarella is stealing information from hostile bidder and his breach of duty is to whom? The hostile offer, there is no duty to the target company. 1. But dont we have the language from TSC about equal access to information? Yes, but here court doesnt adopt this. (2) Holding no equal access rule, need a duty to disclose. a. So need a breach of fiduciary duty or other duty of trust and confidence (plus) trading activity and this will equal an omission. 1. Since Chiarella has no affirmative duty to disclose he is not guilty of insider trading. i. Petitioners use of that information was not a fraud under 10(b) unless he was subject to an affirmative duty to disclose it before trading b. equal access rule from case above dies we need a duty to disclose 1. Supreme court reverts to formalistic interpretation/ view of 10b-5 and it segregates who are going to be the victims and who are not. 2. [N]either the Congress nor the Commission ever has adopted a parity-of-information rule. i. Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud. When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak. (3) Dissent goes back to equal access to information rule a. What are consequences if we adopt the dissents view? A lot of ppl will be held liable for insider trading even if they stumble across information by chance. (4) Rule A purchaser of stock who has no duty to a prospective seller because he is neither an insider nor a fiduciary has been held to have no obligation to reveal material facts. a. Need breach of FD or other duty of trust and confidence plus trading = omission (5) Does Chiarella get away with this? a. No his employer, the target, the hostile bidder can sue him, so not just 10b-5 insider trading issue. (H) Dirks v. SEC: (1) Facts: Dirks finds out there is fraud going on and Dirks is a market analysis (an information processer), finds out from indiser at equity funding that there may be fraud going on, but Dirks doesnt immedieately go to the authorities. Instead he: i. Tells clients so they can sell their shares b/c of fraud ii. Tells a reporter about the incident and tells him to write about it, but reporter doesnt write on it. b. Fraud eventually disclosed and the company goes bankrupt and Dirks is charged with insider trading. c. Problems with establishing classical insider trading against Dirks he is not an insider and no relationship with company only received information from an insider. (2) Issue Is Dirks liable under 10b-5 for insider trading? (3) Holding Dirks gets off bc the tipper got no quid pro quo. Co may have suit against insider who talked about information, but not against Dirks. a. Tipper Tippee liability = when an insider deceptively or fraudulently gives info to an outsider and the outsider acts on it. b. Test Whether the insider personally will benefit, directly or indirectly, form his disclosure. Absent some personal gain, there had been no breach of duty to stockholders. (4) Analysis: a. Finduciary duty owed by the tipper to company whose shares are traded b. Tippers prupose for disclosing (quid pro quo): 1. Pecuniary benefit

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2. Reputational benefit from disclosure 3. Gift (friends and family) 4. Psychic gain feeling happy you helped someone out. c. Tippee scienter (knew or should know that given information in breach of fiduciary duty) 1. ** Tippee analysis does nto include temporary insiders described in FN 14 (p.1146-1147) who

are covered by the Chiarella/ Classic analysis***

(5) Under tipper tippee liability both tipper and tippee are liable. (I) HYPO: on plane and hear from someone that they are going to be taken over. If overhear on plane no tipper

Tippee liability, b/c the tipper has to have some kind of gain. If overhear b/c the person talking was stupid, there is no personal gain. (B) Summary: (1) Chiarella: Breach of fiduciary duty/other duty of trust and confidence and trading = omission (includes temporary insiders) classical theory (2) Dirks: Tippee can assume the fiduciary duty of the tipper when the tipe breaches the tippers fiduciary duty (quid pro quo) and triggers the abstain or disclose rule, which is violated by the tippees trading. Tippee needs to know that the trading is wrong and that they are misusing the information. (FN 14 tipper tippee liability does not exist for lawyers, accounts, ppl you hire for company they become temporary insiders and are deemed employees of the company itself so they fall under classical theory of liability) tipper tippee (C) Hypo what if tell therapist that your company is about to be taken over and the therapy goes and trades? (1) Is there classical insider trading? No, b/c the therapist is not an insider nor a temporary insider (2) Is there Tipper Tippee liability? Does the CEO (tipper) get a quid pro quo feeling better about mental health is really not a quid pro quo; but if say to therapist can I get a discount and oh by the way our company is getting taken over next week this would be tipper tippee liability. a. The best way to look at it is what is obvious (ii) Regulation FD (FD = fair disclosure) (A) What is Regulation FD: (1) Involves Regulation FD that was passed by the SEC. Before regulation FD, companies would meet with analysts and give them non public information so that the analysts could hype the company and positively analyze company and not surprise the market. Problem, analysts would tell their clients first, and this is not insider trading b/c the companies willingly given the info to analysts, but unfair b/c some ppl didnt get information right away bc didnt have these analysts. a. Regulation FD when corp decides to release info to analysts and others must disclose to everyone, cant selectively disclose non-public info to put all shareholders on the same footing. This rule doesnt apply to anyone other than the issuing company 1. Companies fiercely resisted this rule b/c the penalty. So companies started saying less b/c if give out any information have to make sure that it reaches everyone. Also some of the info the companies wanted to give out was confidential so didnt want to tell everyone. Thought would have chilling effect on disclosure of information some studies substantiate these concerns. This is bad b/c having less info is bad for trying to price the real value of stocks through market. b. SEC modified regulation SD no private cause of action, the SEC has to bring the action. There is no criminal component, just a civil fine. (B) SEC v. Siebel System, Inc: (3) Facts: SEC accuses Siebel of violated Reg FD, b/c Siebel had analyst conference, but allegation that an insider gave better info to certain analysts. Trying to figure out if this info was material. (4) Issue what is material information and how do you know when something is material or not. (5) Analysis have to give companies the benefit of doubt and must look at 7 categories set out by SEC for Reg FD. And this info fit into one of these categories. (6) Holding cant be overzealous here on what is material b/c then companies wont disclose anything. Here the executive disclosed information and the analysts and others traded immediately on the information if ppl are trading it kinda implies the info is material the court gets around this by saying its an important fact, but its not the entire story. Just b/c trading is not sufficient to say info was material, must look at other facts. Other facts suggest this just wasnt new information. a. 1 defendants' private statements to institutional investors were not nonpublic disclosures of material information in violation of the Fair Disclosure regulation; and b. 2 company did not violate disclosure control provisions of the Securities Exchange Act. (iii) Misappropriation and Rule 14e-3 (A) Theory: (1) Missapprop theory started in Carpenter v. US Winas hears about takeover and tells roommate and his roommate trades, but this is not classical or tipper tippee liability b/c info not coming from company itself. These are just roomers that Carpenter heard through reporter. a. Court adopted Missapprorpation theory supreme court affirmed 4-4. What happens when sup Ct ties, is that it has no effect and lower court decision is affirmed. (B) US v. OHagan:

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(1) Facts: OHagan is a lawyer and working at Dorsey and Whitney and their client is Grand Met. Grand met is

going to make hostile offer for Pillsbury. Ohagan not working on case, but finds out about deal from partners office and he trades for a profit of 4.3 million dollars. a. Is this classical insider trading? NO 1. Breach of fiduciary duty or other duty of trust and confidence plus tradingbut OHagan is not an insider and owes no duty b. Is this Tippee Tipper liability? NO, he steal info c. How do we find insider trading? No deception to company in which you trade so how to find 10b-5 liability? 1. But in FN 1 OHagan was convicted of theft in state court. (2) Analysis: a. Missapprorpation theory [A] fiduciarys undisclosed, self-serving use of a principals information to purchase or sell securities, in breach of a duty of loyalty and confidence, defrauds the principal of the exclusive use of that information. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the companys stock [i.e. Chiarella], the misappropriation theory premises liability on a fiduciary-turned-traders deception of those who entrusted him with access to confidential information 1. Premised on person who receives info and person who gives information. Not premised on relationship btwn company and insider. 2. The deception occurs when take information from person who we have duty of trust and confidence. b. PRObLEM with this Dissent they are stretching 10b-5, b/c the core principal of 10b-5 is taking info that doesnt belong to you and needs to be in connection w/ purchase or sale of securities. If trade in securities w/ company you directly take information from you have a direct tie. But when expand it to all types of relationships, WHAT IS THE TIE? (3) This is the issue WHAT IS THE TIE? The fraud under 10b-5 is not when I take the information but when I trade based on that information in the purchase or sale of securities. a. Ginsburg he deceives the source of the information and simultaneously harms members of the investing public. b. Does this fit the theory of fraud (deceit, gain to defendant & loss to victim c. When does the fraud occur the fiduciarys fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities (4) Holding Respondent did violate Section:10(b) and Rule 10b-5 because all of the element of the rule were met. Respondent did use deceit in connection with the purchase of securities. He did not disclose to the firm or the client that he was using the nonpublic information, and his use of it was at the expense of the client. He did not necessarily have to deceive the seller in order to violate the Rule. As a matter of public policy, it would not make sense to limit the scope of the Act to only prohibit certain kinds of activities that endanger a fair market. a. Rule 14e-3(a) did not exceed the SECs rule-making authority. Again, the purpose of the Act is to provide safeguards to ensure that the market is operating fairly and that investors can rely on the market. Rule 14e-3(a) does not require a demonstration of a breach of duty in order to find a party liable for violations of the Act. There will be instances where justice would deem this appropriate, such as in this case. b. The Court has now reversed the decision in Dirks v. Securities & Exchange Commission, or at least distinguished it, by not requiring a breach of a fiduciary duty as called for in Section:14e-3(a). The court stresses their concern to uphold the public policy behind the Act, namely to ensure the fairness of the market. c. Concurrence. The concurring opinions did not agree with the logic of the majoritys test regarding Section:10(b)s in connection with requirement, i.e. deception in connection with the purchase or sale of securities. The majority held that the deceit occurred just as Respondent intended to misappropriate the information, while the concurring opinion believed that it would not occur until Respondent actually made the securities transactions. (5) Rule An outsider who misappropriates confidential information to personally benefit violates Section:10(b) because there is deception in connection with the purchase or sale of a security. (B) OHagan also involves rule 14e-3(a). Brand Met was going to make tender offer of shares of target, and there is a special anti-fraud rule 14e-3 on tender offers. The SEC has profolactic trading rule. (1) The potential for insider trading in tender offer situation is so high that any person in possession of material info about a tender offer that is confidential which was acquired from the offering person, issuer of securities, cant trade (dont worry about intent or deception) 1. Rule 14e No requirement that person trading have a pre-existing fiduciary duty to maintain confidentiality of information (2) Rule 14e Test: a. person in POSSESSION of material information b. about a tender offer

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c. that is CONFIDENTIAL d. which was acquired from (directly or indirectly) 1. (a) the offering person [offeror] 2. (b) issuer of securities sought [target]; or 3. (c) anyone acting on behalf of the offeror or the issuer of securities to be sought [i.e. law firms,

accountants, etc.]
(3) How is 14e legalb/c based on different section of code than 10b-5. a. For final 14e is broader and per se restriction on trading for anyone of confidence involved in a

tender offer.
(C) Post ohagan we have missapprop theory if take info in breach of fid duty or breach of trust and confidence

and trade you can establish an insider trading claim. (1) Once again we have the disclose and abstain principal. Dont have to trade or could disclose. Also principal could sue you for disclosing the information so probably just an abstain rule again. II Misappropriation and Rules 10b-5-1, 1b-5-1, 1b-5-2 & 14e-3 Rules: 1) Rule 10b-5-1 on the basis SEC tries to expand the basis of knowledgehave to have some knowledge that taking and misusing knowledge. (A) A violation of Section 10(b)/Rule 10b-5 includes the purchase or sale of a security on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence . . . to the issuer [or] any other person who is the source of the material nonpublic information. (B) On the basis is defined as if the person making the purchase or sale was aware* of the material nonpublic information when the person made the purchase or sale (ii) So if hear someone on plane and hear someone say this is confidential no one should know this you are aware, but there is no breach of fid duty or duty of confidence. 2) Ruel 10b-5-2(b) defines what constitutes a duty of trust and confidence for Missapprop theory: (i) SEC took a broad view (A) When person agrees to maintain confidentiality of information. (B) A history, pattern, or practice of sharing confidences such that the recipient knows or should know s/he should maintain the confidentiality of the information. (C) Information from a spouse, parent, child, or sibling (D) DEFENSE: D can show s/he did not (1) (a) agree to maintain confidentiality OR (2) (b) know or have reason to know of an expectation to maintain confidentiality. 3) Rule 14e-3(a): (i) 14e-3(a) test (A) person in POSSESSION of material information (B) about a tender offer (C) that is CONFIDENTIAL (D) which was acquired from (directly or indirectly) (1) (a) the offering person [offeror] (2) (b) issuer of securities sought [target]; or (3) (c) anyone acting on behalf of the offeror or the issuer of securities to be sought [i.e. law firms, accountants, etc (ii) there is no requirement that person trading have pre-existing fid duty to maintain confidentiality of information. (iii) Scope of rule 14e-3 (A) [W]e agree with the United States that Rule 14e-3(a), as applied to cases of this genre, qualifies under 14(e) as a means reasonably designed to prevent fraudulent trading on material, nonpublic information in the tender offer context. A prophylactic measure, because its mission is to prevent, typically encompasses more than the core activity prohibited. [1095] (B) Under Rule 14e-3, does the government have to allege a deception? Is this an anti-fraud provision or a parity-of-information rule? 4) Criminal securities Fraud Penalty for insider trading Criminal, up to 25yrs for each count (i) Whoever knowingly executes, or attempts to execute, a scheme or artifice (A) (1) to defraud any person in connection with any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)); or (B) (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)); (ii) shall be fined under this title, or imprisoned not more than 25 years, or both. Corporation Control Transaction (Takeovers) I Intro and terms: Basics

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II Merger Terminology: Constituent Corp: A participant in the merger whose shareholders usually have voting rights. Surviving Corp: after the transaction is completed, the corporation that remains in existence (not always the acquiring

corp). Dissolved Corp: When a corporation ceases to exist, its shares are cancelled and the corporation is formally dissolved with the state. That does NOT necessarily mean that it has no continuing existence in certain contexts. Types: One (or more) constituents in the transaction may cease to exist (merger), both may cease to exist (consolidation), or one or more may continue to exist as a wholly-owned subsidiary with all shares owned by the parent III Consideration can pay whatever you want: 1) One thing that can be paid is shares of the surviving corp (most common) (i) To issue shares msut be authorized in certificate of incorporation, must have sufficient authorized shares, if it doesnt have enough authorized shares must have vote to amend articles to increase shares to issue them out. 2) Cash (most common) 3) Debts securities 4) Hybrid securities (combine debt and equity) 5) Fractional shares (receive cash if you are supposed to get a share b/c what can you do w/ a fractional share) IV Types of Mergers: Straight Merger-- not usually how it happens 1) Acquired corporation merges with and into an acquiring corporation, it dissolves and all assets and liabilities transferred to the acquiring corporation. 2) Acquiring corporation surviving corporation 3) File certificate of merger with the secretary of state and when the certificate is filed the merger occurs. (i) But whos state law governs, look at the state laws of target corporation but also state law of acquiring corp for voting rights and dissenters rights. (ii) Mergers occurs generally under laws of acquired company so look there first and it will give you guidelines on what to do. (A) Ex: if both companies are Ohio companies we look at ohio law and gives us mechanics for the merger 4) Both parties have voting rights unless 251(f) applies Reverse Triangular merger 1) An acquiring company sets up a wholly owned subsidiary and merger sub mergers with and into the acquired corporation. By virtue of the merger, all of the shares of acquired corporation are cancelled and exchanged for merger consideration (cash or stock), and all the shares of merger sub remain outstanding as shares of acquiring corp. (i) Merger sub mergers w/ and into acquired corp and in the merger all the shares of acquired corp are cancelled and ll the shares of merger sub remain outstanding of acquiring corp. 2) Why do we do this? (i) We dont want to merger acquiring corp and acquired corp (straight merger) b/c dont want the assets and liabilities of both companies to merger and become one. Forward Triangular Merger 1) An acquiring company sets up a wholly owned subsidiary and merger sub mergers into the acquired corporation. By virtue of the merger, all of the shares of acquired corporation are cancelled and exchanged for merger consideration (cash or stock), and all the shares of merger sub remain outstanding as shares of acquiring corp. (i) Merger sub mergers w/ and into acquired corp and in the merger all the shares of acquired corp are cancelled and ll the shares of merger sub remain outstanding of acquiring corp. 2) Why do we do this? (i) We dont want to merger acquiring corp and acquired corp (straight merger) b/c dont want the assets and liabilities of both companies to merger and become one. 3) Voting: (i) The nonsurviving company needs a shareholder vote (ii) Surviving company needs shareholder vote if it issues out more than 20% of its shares (iii) If merger sub pays cash no vote for merger sub (iv) The acquiring parent corporation is not part of the merger so dont analyze it under DGCL 251 Short Form Merger DGCL 253 1) If the acquiring corporation owns 90% or more of acquired corps stock, can have summary merger proceeding
(i) Dont need shareholder vote of the acquired corporation b/c the acquiring corporation already owns a substantial

number of shares.
V Ways to acquire company w/out a merger: Sale of assets 1) If dont want the liability with target, go to company and say hey Im going to buy you but only the assets I want. Pay

what I would pay in a merger and you can dissolve and distribute out capital to shareholders. Like a merger but have more control over it. 2) In Delaware there are no appraisal rights in an asset sale, so if Im afraid target shareholders are going to dissent and ask for appraisal rights then do sale of assets. Friendly Deals

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1) Both boards must approve the transaction (i) Issue whether shareholders have voting or appraisal rights 2) First id the type of transaction and who is merging w/ who? 3) Then look at the code governing the transaction to see who has voting rights. 4) Also sometimes the articles of the company require a shareholder vote and if a shareholder vote is required must look at

articles and state code to see what the vote is.

5) Finally need to ID who has appraisal rights (i) Typically contingent on having voting rights in Delaware (ii) In ohio everyone has voting rights. VI De Facto Merger 1) NEW JERSEY LAW Applestein v. United Board and Carton Corp: recognize de facto merger to protect

shareholders (i) Holding every factor present in a corporate merger is found in this plan, except the formal designation of the transaction as a merger.factors include: (A) a transfer of all the shares and all the assets of Interstate to United; (B) an assumption by United of Interstates liabilities; (C) a pooling of interests of the two corps.; (D) the absorption of Interstate by United, and the dissolution of Interstate; (E) a joinder of officers and directors from both corps. on an enlarged board of directors; (F) the present executive and operating personnel of Interstate will be retained in the employ of United; and (G) the shareholders of the absorbed corp., Interstate, as represented by the sole stockholder, Epstein, will surrender his 1,250 shares in Interstate for 160,000 newly issued shares in United, the amalgamated enterprise. (1) Accordingly, the shareholders of United were entitled to be notified and advised of their statutory rights of dissent and appraisal. a. Uniteds failure to take these steps and to obtain stockholder approval of the agreement by the statutory two-thirds vote at a properly convened mtg. of the stockholders would render the corporate action invalid. (H) Policy: Shareholders shouldnt be forced against their will into something fundamentally different from that for which they bargained when they acquired their shares. 2) DELAWARE LAW Harrington Case: want to allow corps contractual freedom do no recognition of de facto mergers (i) Holding: Even though this reorganization plan achieved the same result as a merger, its legal. The merger and saleof-assets statutes overlap some but offer corps. independent options. P even conceded that an asset sale, followed by a separate proceeding to dissolve and distribute, would be legal, even though the same result would follow. To attempt to make any such distinction between sales under 271 would be to create uncertainty in the law and invite litigation. (ii) Policy: We want the law to allow corps. contractual freedom by offering different transactional forms. There are significant tax, accounting, and liability differences bet. the traditional merger form and the alternative transactional forms. We also want there to be certainty in this area of the law. (iii) Rule: Delaware doesnt recognize de factor merger VII Exceptions to the norm that shareholders must approve a merger: The de minimis change exception This exception denies voting rights to shareholders of the surviving corp. in a merger the terms of which will not require a change in the articles of incorporation, nor significantly affect the pre-merger shareholders voting or equity rights. See 251(f) to get this exception, no more than 20% of the surviving corp.s shares may be acquired in the merger agreement. The short form merger exception The short form merger is a procedure that allows a corp. that owns most of the shares of another corp. (the subsidiary) to merge w/ that subsidiary by director action alone. See 253, which says parent has to already own at least 90% of the subsidiary. See also 251(g). 1) No vote for shareholders, but typically appraisal rights if a short form merger Asset sales, triangular mergers, and other alternative transactional forms (See below.) VIII Contracting around Appraisal and Voting Rights Some transactional alternatives to the statutory merger include the sale of a control block of stock, the asset sale, and the triangular merger. 1) Sale of assets How different from a merger: the corp. selling the assets doesnt automatically go out of existence upon consummation of the sale (although it can, by following the sale with a dissolution); the selling corp. need not transfer all of its assets; and the liabilities of the selling corp. dont necessarily have to pass to the purchasing corp. See 271. 2) Triangular mergers One point on the triangle is the corp. financing and masterminding the acquisition (the acquiring parent), which transfers the merger consideration to a wholly owned subsidiary corp. the second point on the triangle. The merger then takes place bet. the acquired corp. the third point on the triangle and the acquiring subsidiary. In a forward subsidiary merger, the acquired corp. merges into the acquiring subsidiary. In a reverse subsidiary merger, the acquiring subsidiary merges into the acquired corp.; in form the acquired corp. is the surviving corp., but the acquiring corp. ends up with all, or at least a controlling amount of, the acquired corp.s stock. 3) Tender offers A tender offer is a public invitation to shareholders of a corp. to tender their shares for purchase by the offeror at a stated price. In reality, this is tough to accomplish b/c the target corp.s board has a lot of authority to

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prevent the bidder from taking over, even when the targets shareholders want to sell. The bidder has to appease the board. IX STATUTORY PROVISIONS: VOTING RIGHTS 1) DGCL 251(c) both constituent parties to a merger have voting rights (i) The target almost always has voting right b/c the transaction usually represents a fundamental transaction for the target company and shareholders have the right to have a voice in such transactions. 2) DGCL 251(f) the acquiring company does not need a stockholder vote unless the certificate of incorporation requires one -- if (i) Dont amend certificate of incorporation (amend usually if have to increase the number of authorized shares or change the structure/size of the BoD (DGCL 242)); (ii) Shareholders rights dont change; or (iii) Corp issues less than 20% of its shares to effectuate the transaction (A) SO TO AVOID A SHRHLDR VOTE IN DE pay cash or dont issue more than 20% of shares 3) DGCL 253 Short form merger if acquiring corp already owned 90% or more of the target. (i) Dont need shareholder vote from nonsurviving and surviving company b/c already acquired such a large portion that shareholder are on notice. 4) DGCL 271 Asset Sale (i) 271(a) = shareholders must approve any sale of all or substantially all of the corporations assets. (ii) The acquiring shareholders: (A) Not get vote b/c this is not a merger so no auto vote under DGCL 251 (B) May get vote if have to amend articles of incorporation (C) If publicly traded and issuing out more than 20% of shares the NYSE rules require a vote (iii) IF THIS WERE IN NJ de facto merger doctrine APPRAISAL RIGHTS 1) Because a merger brings about a significant change in rights in company especially if non-surviving company (i) States and courts have said that in certain circumstances you can go to the court and the court will independently value you (appraise) your shares if you dont like what you are getting in the take over transaction (A) However getting appraisal rights can be difficult b/c need lawyer and go to court, ect 2) DGCL 262: (i) If you have a merger (either under 251 or 253) (A) Both sides have appraisal rights (DGCL 262(b)), UNLESS: (1) The shares are publicly traded (listed on national exchange), (2) Have more than 2,000 shareholders; OR (3) Lose voting rights under DGCL 251(f) If you are the surviving company and you issued less than 20% of your shares to acquire the constituent corporation and have no change in the articles or share ownership of the surviving company (DGLC 262(b)(1)) (B) HOWEVER, you restore your appraisal rights if you are the acquired corporation and receive as consideration for the transaction anything other than: (DGCL 262(b)(2)(a-d)) (1) Publicly traded shares or shares held of record by more than 2,000 holders; (2) Cash in lieu of fractional shares; (3) Shares of a corporation surviving the merger or consolidation; or (4) Any combination of the shares of stock and cash in lieu of fractional shares listed above. 3) DGCL 262(b)(3) any corporation may provide in its certificate of incorporation that appraisal rights under this section shall be available for the shares of any class or stock as a result of an amendment to its certificate of incorporation, merger or consolidation in which the corp is a constituent corp or the sale of all or substantially all of the assets of the corp. X Controlling Shareholders Special issues in transactions involving controlling shareholders: Controlling shareholders, who have determinative shareholder voting power and influence on the board, have judicially imposed fiduciary duties to minority shareholders. But the scope of those duties is unclear. When, beyond unlawfulness, fraud, and misrepresentation, is appraisal an exclusive remedy for minority shareholders, and when can they bring fiduciary-duty/entire fairness claims? The law is messy in this area have to make arguments. Powers of majority shareholders: 1) majority shareholder wants to sell even if minority doesnt want to he can 2) Controlling shareholder can say I wont sell shares to anyone this is bad if someone offers more money than stock worth and majority doesnt want to sell prevent change of control transactions that would reap higher value for minority shareholders. 3) When majority shareholder allows someone to strip the company assets as long as majority shareholder gets money unfair to minority. Duties of controlling shareholder 1) Majority shareholder has the right to sell, and no need for him to sell.

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2) GENERAL RULE Controlling shareholder can sell its shares and doesnt have to look after the minority and the

controlling shareholder can sell shares at a premium and leave the minority out. Controls company and can sell shares freely, so economically more welfare increasing by allowing this type of thing to happen free transfer of control: (i) Exception to this rule (Harris v. Carter) (DEL) if you have a reasonable belief that you are selling to someone who will do damage to company you have a fiduciary duty not to sell and protect minority shareholders. (A) The NY standard is higher have to have actual knowledge of a problem. (1) Neither of these standards requires investigation, just if you have a reasonable belief you cant sell. 3) Corporate opportunity: (i) (Thorp v. Serve Co) majority shareholder cannot ursurp a corporation opportunity. (A) Ex: buyer goes to controlling shareholder and says want to buy subsidiary, shareholder says buy controlling stake. (1) When instead of allowing (Guth v. Loft corp opportunity test) buyer to buy out whole company majority shareholder takes advantage and solely sells his entire controlling interest at the detriment of minority shareholders. (ii) Issue here if I go to controlling shareholder, it is easy to deal with one person, buyer just buys majority shareholder shares, but if go to board have to deal with board and may have to go through shareholder voting, appraisal rights, ect. So natural tendency to go to controlling shareholder b/c it makes life easier. (iii) URSURP Corp opp when buyer goes to majority shareholder and says want to buy entire company. Then Maj Shareholder says, no just buy my shares. There is no ursurpation when buyer goes to majority shareholder and asks him to buy share, majority shareholder can sell her b/c no duty for him to look out for minority unless he knows hes selling to a looter.

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