Short-hand Dr: director Drs: directors Bd: board shr: shareholder shrs: shareholders cp: corporation tn: transaction

tns: transactions acr: acquirer mgt = management

Table of Contents
01. 03. 04. 05. 06. 07. 08. 09. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. GEN SUM ................................................................................................................................................................................................. 2 POL QS...................................................................................................................................... ERROR! BOOKMARK NOT DEFINED. AGENCY LAW ......................................................................................................................................................................................... 7 PARTNERSHIP .................................................................................................................................................................................... 10 PARTNERSHIP .................................................................................................................................................................................... 15 PARTNERSHIP RELATIONS W/ 3PS ........................................................................................................................................... 16 CORPORATE FORM .......................................................................................................................................................................... 20 CORPORATE FORM: THE BOARD OF DIRECTORS ............................................................................................................ 20 CORPORATE FINANCE: METHODS OF FINANCING .......................................................................................................... 22 CORPORATE FINANCE: DISCOUNT RATE AND PROJECT VALUATION .................................................................... 22 CREDITOR PROTECTION .............................................................................................................................................................. 25 SHAREHOLDER VOTING: ECONOMICS & CURRENT TRENDS ..................................................................................... 27 SHAREHOLDER VOTING: RULES ............................................................................................................................................... 27 SHAREHOLDER VOTING: REMOVING DIRECTORS .......................................................................................................... 28 SHAREHOLDER VOTING: SEPARATING CONTROL FROM CASH FLOW RIGHTS ................................................ 29 SHAREHOLDER VOTING: PROXY FIGHTS ............................................................................................................................. 30 SHAREHOLDER VOTING: PROXY WAR & TOWN HALL PROPOSALS ........................................................................ 30 DEFEATED PROXY ACCESS RULE ................................................................................................................................................... 31 DUTY OF CARE.................................................................................................................................................................................... 32 DUTY OF CARE: LIABILITY SHIELDS ........................................................................................................................................ 34 DUTY OF LOYALTY ........................................................................................................................................................................... 35 DUTY OF LOYALTY: CAN DIRECTORS LOOK AFTER NON-SHAREHOLDERS INTERESTS? ............................. 38 EXECUTIVE PAY.................................................................................................................................................................................. 39 SHAREHOLDER SUITS..................................................................................................................................................................... 40 CONTROL TRANSACTIONS: INTRO AND POL...................................................................................................................... 43 CONTROL TRANSACTIONS: SALE OF CONTROL BLOCK ................................................................................................ 43 CONTROL TRANSACTIONS: FREEZEOUT & CONTROLLING SHAREHOLDER SELF-DEALING ...................... 43 TENDER OFFER: PROCEDURE & REGULATIONS ................................................................................................................ 47 02. .......................................................................................................................................................................................................................... 4

30. 31. 32. 33. 34. 35. 36. 37. 38.

M&A: MASTER RM ............................................................................................................................................................................. 50 M&A: METHODS OF TAKING CONTROL................................................................................................................................. 51 M&A: PUBLIC CONTESTS FOR CONTROL .............................................................................................................................. 53 M&A Q1: DEFENSES TO HOSTILE TAKEOVER PERMISSIBLE? ....................................................................................... 54 M&A Q2: WILL REVLON ENHANCED DOC SCRUTINY APPLY? ...................................................................................... 58 M&A Q4: SHAREHOLDER COUNTERMEASURES AVAILABLE? ...................................................................................... 61 M&A Q5: APPRAISAL RIGHTS (APPLY IF (1) THERES A FREEZEOUT, OR (2) EF) .................................................. 62 POL ON TAKEOVERS.......................................................................................................................................................................... 4 INSIDER TRADING ............................................................................................................................................................................ 63

01.

GEN SUM

A. Transactions in control
1. Benefits of control a. Control premium b. Market rule v. Equal opportunity rule c. [Digex]: Weakening of Controllers entitlement to control premium

Statutes o [* = Mandatory] o Shareholder voting DGCL 141(a) (requiring at least one director)*; 211(b) (requiring annual meetings)*; 216(3) (plurality voting is default); 216(2) (majority vote for everything else); 141(k) (removal), compare RMBCA 808(a); DGCL 242(b)(2), compare RMBCA 10.04(f) (class voting); DGCL 160(c)* (circular voting). Rules 14a-1 through 14a-12 (governing solicitations)*; Rule 14a-8* (shareholder proposals); Rule 14a-11* (new proxy access rule); Rule 14a-9* (general antifraud rule). o Contests for control Section 13(d)* and related definitions* (block disclosure); Rules 14(d)(4-7)* (governing substantive terms of tenders); Rule 14(d)(8)* (pro-ration rule); Rule 14d-10* (best price). o M&A DGCL 251* (voting rules and exceptions thereto); DGCL 271* (asset acquisitions); RMBCA 11.03 (share exchanges); DGCL 262* (appraisal rights, as modified by market-out exception); DGCL 203* (mandatory waiting period for freeze-outs). Rules 14a-1 through 14a-12* (governing solicitations); Rule 14a-8* (shareholder proposals); 2

 Rule 14a-11* (new proxy access rule); Rule 14a-9* (general antifraud rule). o Insider trading Section 16(a)* and Section 16(b)* (governing trading by directors, officers, and 10% holders); Section 10(b)* and Rule 10b-5*.

02.

POL: Duty of care

A. Are 102(b)(7) waivers good or bad from a policy standpoint?

03.

POL: Shareholder-board power allocation

A. How much deference should courts afford to disinterested board member and shareholder approval? B. ARGs CON court intervention
1. 2. 3. Parties will price it in ex ante Court intervention will increase costs of ex ante bargaining (transaction costs) Higher cost of capital Efficiency is maximized by unfettered market [Chandler in Disney]: Results manifest, capital will flow

04.

POL: Duty of loyalty

A. Does Say on Pay do a good job of avoiding duty of loyalty concerns in executive compensation cases - the classic
conflicted transaction?

B. Are different standards of fiduciary duties justified in close corporation settings?

05.

POL: Shareholder suits

A. Is there social utility in allowing shareholder lawsuits? B. Should there be a demand requirement for shareholder lawsuits? Should it be stronger or weaker than it currently is?

06.

POL: Control block sales market rule AOT equal opportunity rule)
A. Under the market rule: Less costly to buy controlling blocks Easier for looters to purchase controlling blocks
1. Looters will be willing to pay more because they can extract more value from the corporation, but that will decrease the value for the minority shareholders

B. Under equal opportunity rule would increase the cost of purchasing controlling blocks offering the same price to
each shareholder means that the new controller would have to increase the firm value overall for it to be profitable 1. Gets rid of all possible looters but also gets rid of some efficient buyers with less prominent gains

C. Rule choice you choose depends on whether you think most buyers are looters OR efficient buyers

07.

POL: Tender offers & Williams Act

A. POL PRO regulation of TOs
1. 2. 3. Removes shareholder collection action problem Without Williams, Targets shareholders lack information about Brs financies or plans for the company Cant decide if they should tender their shares now or remain invested in Target Br could unfairly pressure shareholders by tendering only for part of Targets shares and buy shares on first come, first served basis Shareholders will want to tender ASAP or else their shares will be redeemed at a low price in back-end merger [Gilson & Bebchuk]: Disclosure triggers an auction regime, which enhances efficiency of individual takeovers, without decreasing number of efficient tender offers Heavy handed rules [Easterbrook & Fischel]: Buyers can free ride from other buyers; auctioneering discourages people from searching utility-maximizing opportunities to seize control

4.

B. POL CON regulation of TOs

1. 2.

08.

POL: Takeovers
A. POL RAT for requiring shareholder approval

1.

2. 3.

RAT1: M&A decisions are too big/important to be left to management a. But, it probably isnt just about the size of the corporation because the BJR applies to decisions that involve the same transactional value RAT2: Mergers dont require expertise to evaluate a. Probably not true because knowing which firm to buy draws a lot on managers expertise RAT3 [Real reason]: M&A decisions pose unique agency problems a. Last decision the manager will make, so its not likely that they are particularly interested in making a decision that will get shareholder votes b. Because shareholders interests are not necessarily aligned with managements interests, even though management has better expertise and more information (which usually justifies BJR) there is not the same amount of deference here Remove inefficient managers Discipline all managers via deterrence [Icahn, Easterbrook & Fischel]: Board should be passive in the face of hostile tender offer. If shareholders like the deal, they should do sothis represents market forces at work. Just say no defense entrenches bad directors a. [Time]: Board can just say no so long as they have some basis for arguing that their long-terms strategy will secure more value for shareholders Economic question: Is the acquisitions may K-H efficient? a. Value increases b. Economies of scale c. Economies of scope d. Vertical integration e. Management efficiencies f. Often convince managers to agree to mergers by paying them off g. Smoothing (project diversification) i. Not very persuasive; shareholders can diversify on their own Takeover artists arent making robust value propositions to shareholders: Theyre coercing, greenmailing, etc. Doesnt discipline the absolute shittiest managers (whose firms are too fucked up to be worth buying) Necessitates golden parachutes for managers (who otherwise wont serve as managers b/c too pussied out by fear of M&A doods). Forces managers to focus on short-term value AOT long-term projects Managers will rush to burn through retained cash b/c its attractive to Brs Increased corporate debt (b/c targets restructure to pay dividends and stave off hostile bids, and b/c successful Brs often heavily mortgage company). Value transfers a. Tax transfers away from public fisc i. Can carry net operating losses (NOLs) of one company to reduce future tax liability of acquiring company b. Transfers from creditors i. Switch equity to debt c. Transfers from consumers i. Anticompetitive merger leads to pricing power d. Transfers from minority shareholders i. Freeze out of minority Value destruction a. Overestimation of benefits b. Empire building c. Poor incentives for managers Regulation at the control block acquisition stage a. Control share statutes: (e.g., Ohio, Indiana) prevent a bidder from voting its shares beyond a specific threshold (20-50%) unless a majority of disinterested shareholders vote to approve the purchase of the stake. b. Constituency statutes (e.g. Pennsylvania, Indiana): allow the board to consider non-shareholder constituencies.

B. POL PRO takeovers

1. 2. 3. 4.

5.

C. POL CON takeovers

1. 2. 3. 4. 5. 6. 7.

8.

D. REGULATIONS on hostile takeovers

1.

2.

3. 4.

Disgorgement Statutes (Pennsylvania & Ohio): require bidders to disgorge short-term profits from failed bid attempts. Regulation of second-step freezeout a. Business combination (freeze-out) statutes: (e.g., DGCL 203 (SS 197) prevent a bidder from merging with the target for either three or five years after gaining a controlling stake unless approved by the targets board. b. Fair price statutes: (e.g. Maryland) set procedural criteria to determine a fair price in freeze-outs. Illinois Rule: Found unconstitutional as preempted by the Williams Act (Edgar v. Mite) but what really bothered the court was that the state legislature could sit in judgment of deals State statutes that are permitted a. Control Share statutes b. Regulation of Tender offers c. Constituency Statutes d. Disgorgement statutes e. Combination*/Freeze out statutes f. Fair price statutes

c.

09.

POL on defensive measures

A. POL PRO strong defensive measures
1. 2. PP provides directors with ability to bargain on shareholders behalf Overcomes CAP White knights serve as stalking horses and enable shareholders to get most value out of the hostile bidder (Forstmann in Revlon) Liptons study showing that shareholder value benefits from PP has been discredited In any case, we can't measure the economic effect b/c every DE corporation effectively has the pill PP has led to significant decline in of hostile TOs Poison pill may be adopted without a shareholder vote (as in Delaware), but must be necessary and reasonable in relation to the threat posed. However, pills may only be used to maximize shareholder valuethey may not be justified by reference to other corporate constituencies. And in order to be reasonable in relation to the threat posed, a pill must provide a mechanism for shareholders to eliminate it, for example by board election or by a sunset provision

B. POL CON strong defensive measures

1. 2. 3. 1. 2. 3.

C. Japanese middle ground on PP

D. POL Qs on Shareholder voting

1. 2. 3. 4. 5. 6. What are the pros and cons of staggered boards? What are the costs/benefits of providing shareholders with more rights? Is the Froessel rule the right rule for reimbursement of challengers and incumbents? Is SEC regulation of Proxies efficient? Should we have less stringent rules regarding shareholder proposals? Should the DC Circuit have struck down the new proxy access rule? Was that a good rule?

10.

Agency Law

Agency o Consent Usually by contract, but not always o Agent (A) has power to bind principal (P) to a third party (T) Economic value of agency is this power o Formation/termination o Ps liability for As authorized and unauthorized contracts, and for (some) torts committed by A o As duties to P Types o Scope Special agent Limited to single transaction General agent o Disclosure Disclosed Undisclosed Do not know that A is an agent (e.g., Disney World and M.T. Lot Corp.) Partially disclosed T does not know identity of P o Control Employee/servant Detailed control Independent contractor Less extensive control Termination o Cannot enter into agreement not to revoke agency Always can be terminated, by either party, at any time Uncomfortable with agents ability to continue to bind unwilling principals Jenson Farms Co. v. Cargill, Inc., Minn. 1981 o Warren buys grain from farmers; Cargill financing Warren and buys 90% of grain o Over time, Cargill develops extensive control over Warren Managerial advice o [Warren has collapsed and is now judgment-proof] o Even without explicit agency agreement, Warren held to be agent for Cargill Implied consent through course of dealing of P and A Exercising more control than a bank Conduct is more important than parties conceptions Protecting third parties o However, many of Cargills suggestions were never implemented 7

 Does this undermine courts holding? Economic value of agency relationship comes from ability of A to bind P to T Authority o Actual Reasonable person in the agents position would infer authority Derived from Ps instructions/actions o Apparent Reasonable third party would infer authority Derived from Ts observations o Inherent Usually accompanies or is incidental to transaction authorized As long as T is not aware that Based on third partys beliefs about agent Exists to protect people harmed by dealing with agents White v. Thomas, Ark. 1991 o White (P) had authorized Simpson (A) to buy specific parcel of land at auction, up to $250k Gave A blank check Buys lands for > agreed-on price o A agrees with Thomas (T) to sell section of land to make up difference A represents that she has power of attorney and signs contract She did not, in fact, have POA o Court concludes no actual authority (from As perspective) o Court concludes no apparent authority (from Ts perspective) T did not exercise due diligence after asking about POA o OK that P accepts one agreement, but not other Creates agency problem for third parties Jackson: This will lead to increased prices, because it will include premium for uncertainty Gallant Ins. Co. v. Isaac, Ind. 2000 o Thompson-Harris (A) transfers Isaacs (T) insurance to her new car, on behalf of Gallant (P) A represents that Ts insurance is bound Upgrade happens over weekend, so T is to come in and sign/pay deposit on Monday o Accident before Monday o No actual authority Agency agreement requires Ps approval of changes o No apparent authority Even though A regularly binds insurance before receiving approval from P o Inherent authority A says insurance was binding Therefore reasonable for T to believe A could be bound [Third Restatement changes a bit; requires notice to P to protect them] How do we reconcile White and Gallant? o What is proper sharing of information costs between P and T? Who is lowest cost-bearer of information? Who should have burden of due diligence? In White, T In Gallant, P Also agency by estoppel or ratification 8

Tort Liability Respondeat superior liability: o Rsmt. 3d of Agency, 2.04 (Supp. p. 23) o Employee (rather than independent contractor) Test focuses on level of control exercised by P Rsmt. 3d of Agency, 7.06 (Supp. p. 35) o Control test for acting within scope of employment Problem with this test is that P knows about this test when deciding level of monitoring to exercise o acting within scope of employment Franchise advantages o Lower monitoring costs o Lower capital costs o Incentivize franchise owner o Brand protection Humble Oil & Refining Co. v. Martin, Tex. 1949 (p. 30) o Car rolls away from filling station and over pedestrians o Negligence by employee hired by Schneider (station manager) o Based on contract between Humble and Schneider, find that he is an employee, rather than independent contractor Great deal of control, Humble products sold on consignment Humble could direct Schneider o Therefore, Humble liable Hoover v. Sun Oil Co., Del. 1965 (p. 32) o Negligence by employee hired by Barone (station manager) o Based on contract between Sun and Barone, find that he is an independent contractor, not an employee Freedom to set hours, sell non-Sun products, took title to goods, ownership stake Though Sun made suggestions, not same level of control o Sun not liable If only about monitoring incentives, would want to hold station managers liable o However, most station managers probably judgment-proof Therefore unlikely to internalize monitoring costs Distinguish two cases: business model o Barone, not Sun, held risk of profit and loss, whereas Humble Oil paid most of Schneiders operating costs Conclusion that Sun has less control over Barone Duties in Agency: Fiduciary duty o Duty of obedience To be obedient to documents/to agreement o Duty of loyalty pervasive obligation always to exercise legal power in a manner that . . . is best to advance the interest of purposes of the principal or beneficiary and not to exercise such power for a personal benefit Not to acquire financial benefit for self when following duty of principal Agent cannot generally act on behalf of adverse party 9

But, can if o P consent o A acts in good faith and discloses o There is fair dealing Justifications: o Dont want to prohibit efficient transaction, when it is best transaction, just because A is conflicted Mere appearance of unfairness will get you to a jury on duty of loyalty o Duty of care Tarnowski v. Resop, Minn. 1952 (p. 36) o Juke box route o Resop (A) lies to Tarnowski (P) o Deal voided o Also gets remedy against A $2000 secret commission + fees o Importance of duty of loyalty o P overcompensated Justified by Holmess bad man theory of the law Deterrence for A In re Gleeson, Ill. 1954 (p. 38) o Land in trust; trustee is lessor After Ps death, leases land for an additional year o Seem to actually benefit beneficiaries (raises payment) o But courts take duty of loyalty so seriously o Policy: P is dead, so cannot monitor A; may be more protective of trusts than other agency relationships Cf. collective action problem of shareholders = like a dead woman

11.

CN: Partnership

Two principals owe duties of loyalty to each other Characteristics of partnership o All partners are liable as principals o All general agents of partnership o Jointly and severally liable for debts of partnership, just like single principals o All partners share equally in control (unless they agree otherwise) Why have a partnership? o Lower cost of capital (debt) o Human capital, with aligned incentives Meinhard v. Salmon, N.Y. 1928 (p. 47) o [Justice Cardozo] o M & S are joint venturers in Bristol Hotel M is passive investor; S holds lease and manages S gets 60% for first 5 years; split 50/50 thereafter o S enters new venture to redevelop and lease whole block for 80 years 10

Without consulting M o Information about opportunity was property of the business S misappropriated information o Strong language about duty of loyalty Punctilio paragraph o M gets 50% - 1 share o Other possible solutions Same terms option (close to Cardozos remedy) Disclose and compete/renegotiate Cardozo suggests this is what Ss fiduciary duty required Salmons option Probably most K-H efficient; as manager and full owner, S would work harder o Problems: disincentivizes managers from seeking out new opportunities, because they do not get full benefit Cf. Dreamworks exception to this rule in their charter Legal truths: o If a court cites Meinhards language, the loses If a court uses the word punctilio, the loses big All a business is is a successive series of opportunities Partnership formation o Without more, joint ownership of property ( 7(2)) or sharing of gross returns (7(3)) do not establish a partnership o Sharing of net profits is prima facie evidence of partnership ( 7(4)) As long as not debt, wages, or as interest on a loan o Profits as proxy for control Vohland v. Sweet, Ind. 1982 (p. 52) o Nursery o Sweet gets 20% of profits, though no explicit agreement Called commission, but actually profits o Inventory built up over the years built up with Ss money o Holding that S & V are partners Ex ante incentive to build up inventory K-H efficient o Capital contribution not required for partnership Debts o General partners are unlimitedly personally liable for debts of partnership o Jointly and severally liable for partnership torts and contracts Exhaustion Rule: must exhaust business assets before pursuing personal assets Who can creditors pursue? When can an ex-partner escape partnership debts? Brudney problems (p. 55--56) o Ars, Gratia, & Artis (art for the sake of art) o Mayer contributes money to Artis and is promised half of promised Ars & Gratia did not know he existed Not partner, because requires consent Subpartnership, perhaps o [FROM MALAIKA:] o Whom can creditors pursue: Who is a partner? 11

o Brudney UPA Problems (AKS 55-56): Three parties: (1) Ars contribute labor and is entitled to $5,000 or 1/3 of profits each year (whichever is greater); (2) Gratia contributes land worth $40K and handles sales; (3) Artis contributes $30K cash and handles purchasing Half the cash comes from Mayer (which others know), half the profits go to Mayer (which others dont know) 1 (a) If consumer is injured by defective equipment Artis knew was defective, is Ars liable? Is Mayer? Ars: Yes, he is a partner. Just by contributing sweat equity Ars can be held accountable. (See Vohland) Mayer: Mayer on the other hand (UPA 18(g)) is not likely to be held a partner, because the other partners dont even know about him. (Compare this to Agency where parties knowledge doesnt matter). You could, however argue that Mayer and Artis are in a sub-partnership. This is very weird sub theory, however, and is unlikely to be successful. Gratia: clearly a partner 1 (b) If G failed to respond to a customer causing them to lose considerable sales? Tort of omission Artis: Under UPA 13, it would seem that he was. Artis would likely argue that he was not a partner. Artis and Ars, however, would likely be held liable. Mayer: Will also be on the hook. Under UPA 18(b) (SS 48): If ordinary or properly youd be required to respond to a customer, he can be held accountable. (2) Low exhibits various elements of control: has veto power of expenses exceeding $10,000, can get his money back whenever he wants (thus, if he took it back when the business was in trouble, he could effectively end the business). Low is probably a partner. Low, however, would argue that he is just a bank (like in the Cargill case). Under UPA 17, if hes held accountable, he would only be liable for future partnership debts and not for those existing prior (these can only be taken from partnership property) Exiting Partners UPA 36(2): Partner is discharged from liability on the partnership assets when there is an agreement to that effect. o Courts work hard to find an agreement to that effect o Rationale: it seems unfair to hold partners liable when they no longer have any control over the partnership Whats the policy rationale for making it easy for exiting partners to avoid liability? o Dont want to hold partner liable when they have no control. Ex ante this might discourage them from joining partnerships. What are reasons for making it difficult? o Dont want it easy for partner to load up lots of liability and then leave Third-Party Claims Against Partnership Property Key is distinguishing partnership property and individuals property o tenancy in partnership Partnership Governance and Authority UPA 18(h) Majority = head count, not majority of ownership Nabisco v. Stroud 12

o Stroud couldnt restrict the ability of Freedman on an ordinary business matter connected with the partnership because he wasnt a majority of the partners. o On an ordinary business matter, less than a majority of the partners cant stop a partner from taking action. Here, two partners, so one can never be a majority Gap in UPA! Cuts towards action! o What could Stroud have done ex ante to protect himself from this? This was a default rule so they could have agreed ahead of time N.B. UPA is merely the default rule. You can opt-out, for example, by creating a partnership agreement. Termination: Dissolution and Disassociation: Under the UPA, a partner exiting can lead to a dissolution. Under the RUPA, a partner exiting is not enough. The UPA is still the law in most jurisdictions. In most states, unless a partnership agreement says otherwise, a partner can usually windup a partnership at any time.

Accounting o Assets - liabilities = equities and earning o *** PUT IN SLIDES Dissolution o UPA/common law A single partners exit leads to a wind-up Still the law in most states Default rule; can be opted out of o RUPA Exit alone is not enough Adams v. Jarvis, Wis. 1964 (p. 65) o Doctors office o Can contract out of default rules of dissolution Dreifuerst v. Dreifuerst, Wis. 1979 (p. 69) o Partners cannot agree on how to wind up farm o Holding: unless partnership agrees (ex ante or ex post) to distribution in kind, must wind up by selling all partnership assets Violates UPA 38(1) (withdrawing partner entitled to cash) Under UPA, disincentive for leaving partnership, because incoming partner gets more money than person leaving o Does not get full buy-out price o Under RUPA, exiting partner does get full buy-out price Page v. Page, Cal. 1961 (p. 73) o [Justice Traynor] o Oral partnership agreement to run a laundry o One partner tries to dissolve Other partner accuses him of trying to take advantage of new opportunity of new AFB o Trial court implies term to partnership, until debt is repaid Concerned with being taken advantage of o Partnerships are presumptively at will 13

Not for a term o IF, however, proved to be in bad faith, wrongful dissolution, and liable for damages o Duty of loyalty is sufficient protection Limited liability o Creditors of partnership cannot attack assets of individual partners Liability shield Goal of making investor comfortable that they will not o Types Limited Partnership (LP) Give up control to one general partner, in exchange for limited liability Complete liability shield Leads to agency costs o Monitoring, however, is tricky, because cannot monitor too much without breaking down shield o Solved by paying general partner a percentage of earnings Limited Liability Partnership (LLP) Structure just like general partnerships o Give all partners control Because of control, however, liability shield is qualified o Usually limited only to torts, malpractice Limited Liability Company (LLC) Members Control Meaningful limit on liability Pass-through tax treatment o Income of entity is passed through to individuals, who pay income tax Rather than two-tiered event, as in corporate form

14

12.

Partnership
A. Definitional issues & General rules
1. 2. 3. 4. 5. 6. 1. 2. 3. 1. 2. Partners are essentially co-principals and co-agents. Partners both have a right to share in business profits (but need not share profits to be partners) All owners are liable as principals All partners are general agents All general partners are jointly and severally liable for the debts of the partnership (much as single principals are) All partners share equally in control, unless they agree otherwise (as in Meinhard) Cost of debt of an individual principal may become prohibitively high, such that giving up an ownership stake is less costly Partner contributes human capital Ability to create a separate legal entity It can be hard to DST good faith conflict b/w owners from the cheating by the controlling owner seeking to exploit the non-controlling owner [Meinhard]: M and S are joint venturers in leasing a hotel for 20 years. M supplies half the capital for the lease. S gets 60% of profits for first five years, then they split 50-50 for remaining 15 years. As lease is about to run out, S renews lease for 80 years without consulting M. M wants a share. a. H: S violated duty to M to inform M of the duty to inform him about the opportunity to secure the lease. M is awarded about half of the interest that S obtained by renewing the lease. i. KF: M learned about this opportunity by virtue of his agencyif not for his work in the JV, he would not have learned of this opportunity b. Economic arguments in favor of and against M and S i. Core Q: The court here must supply a gap-filling rule that supplies the agreement the parties would have arrived at ex ante. What contract would the parties have agreed to ex ante? A. OPT1 [Best for M]: Same terms option, in which M has the option to participate in any new opportunity on the same terms as in the 20-year joint venture. (Close to courts remedy: M gets 50% of the new deal, just like the old one B. OPT2: Disclose and compete option, in which S is bound to inform M of new opportunities, and must compete for, or renegotiate over, any new opportunity 1. Court suggests this is why Ss fiduciary duty required 2. BUT this option is best for the seller (not the partners), b/c it would create an auction that drives up prices C. OPT3: Salmons option, in which S can keep the new opportunity OR offer a piece to M at his pleasure (this is what S actually did) 1. Ex ante, M would then have demanded a larger share of the initial profits 2. This rule gives S the best incentive to seek out Kaldor-Hicks efficiency maximizing transactions D. PROF: We can use Ss active role in the partnership to arrive at a totally different conclusion 1. For PROF: Ss active role SHOULD lead us to conclude that S should NOT be burdened with an onerous duty, since we want to incentivize him to seek out efficient transactions. A. From a Kaldor-Hicks efficiency perspective, the rule arguably does not matter 2. For Cardozo: Ss active role leads court to conclude that S owes a duty to M Uniform Partnership Act 6(1): A partnership is an association of two or more persons to carry on as co-owners a business for profit UPA 7 provides rules of inference for judging whether a partnership exists (even if the purported partners deny it). a. UPA 7(1): Without more, joint ownership of property does NOT establish a pship b. UPA 7(3): Without more, sharing of gross returns does NOT establish a pship c. UPA 7(4): Sharing of net profits is prima facie evidence of a partnership, BUT NOT IF by way of: i. Repaying a debt

B. Why have a partnership?

C. Conflicts among owners

D. Partnership formation
1. 2.

15

3.

4.

ii. As wages iii. As interest on a loan KFs in whether or not court is likely to infer a partnership a. Control over the enterprise b. Profit sharing i. RAT: UPA assumes, as in Humble Oil, that sharing of profits insinuates a sharing of control. If control is shared, then we have a partnership. c. Intent of the parties [Vohland v. Sweet]: S apprentices to V the Elder. V the Younger takes over the enterprise and rename it to Vs nursery. Beginning in 1963, S was paid 20% of net profits of Vs Nursery. No explicit agreement. Ss 20% share is erroneous called commission. In 1979, S sues to dissolve the partnership (i.e., S wants to wind up the business, sell its assets, and distribute proceeds). S is basically running the place a. Q: Is S a partner? b. H: S is a partner. i. KF: Sharing of profits. ii. IR that S did not place any capital into the business (since S contributed human capital) iii. IR that S did not engage with the business in the same way that the other Partner did c. PROF: This is another case about incentives. i. S was investing his own money by buying inventory. If S wasnt getting a partners share, it wouldnt make sense for S to put his money into keeping the inventory stocked and invest his time into running the business. ii. The H in this case gives Sweet incentive to maintain stock and effectively operate the store

13.

Partnership relations w/ 3Ps

A. RSM provisions on the rights of pship creditors
1. 2. CR1 [UPA 15]: Partners are jointly and severally liable for partnership torts; jointly liable on partnership contracts CR2 [RUPA 306]: Partners are jointly and severally liable on partnership torts AND contracts, BUT a. Creditors must exhaust business assets before pursuing personal assets Q1: Whom can creditors pursue (i.e., who are partners) Q2: When can an ex-partner escape pship debts? Brudney UPA problems [CB at 55] a. Q1: Ars, Gratia, Artis form a pship to create Argrar i. Ars contributes sweat equity, and et $5k, or 1/3 of profits eachyear ii. Gratia contributes land worth $40K and handles sales iii. Artis contributes $30K cash and handles purchasing A. Unknown to Ars and Gratia, half the $30K cash comes from Mayer, to whom Artis is promised half of profits iv. Q1(a): Consumer is injured by equipment that ARtis knew was liable A. Ars liability: Ars should also be liable, as he is a partner 1. KF: Artis day-to-day operational control places him in a position to take care 2. KF: Artis gets a share of profits 3. IR that Artis B. Mayers liability: No, Mayer can NOT be liable as a partner because of the lack of Ars and Gratias knowledge of his profit-sharing with Artis 1. KF: Mayer has no control 2. KF: Parties consent/conception of who is in the partnership has controlling importance 3. Arguably, Mayer may be a partner of Artis (but not of Ars or Gratia), and may be liable as partner for Artis liabilities on that theory v. Q1(b): Consumer is injured due to loss of resales b/c of Gratias conduct A. Artis is liable as partner B. Mayers liability 1. UPA 18(b) may work to force Mayer to indemnify partners for loss

B. Core Qs:
1. 2. 1.

C. Q1: Who is a partner?

16

b. Q2: Low loans the business $50k for ten years, in return for interest in an amount equal to 25 percent of profits and a veto on large expenditures. Loan is repayable on demand. Low would advice on financing of transactions i. ANS: Low likely qualifies as a partner ii. As in [Cargill], this is a lender whose control over the enterprise is substantial enough to qualify him as a partner A. NOTE: Oridnary commercial loans made by banks ordinarily do NOT confer this level of control iii. Q: Can Low be liable for NEW debts incurred by the pship? A. ANS: Likely yes B. UPA 17: Incoming partners cannot be liable for EXISTING debts, but CAN be held personally liable for newly incurred debts after joining the pship

D. Q2: Liability of exiting partners

1. 2. 3. UPA 36(2): Exiting partner is discharged from any existing liability upon end of pship by an agreement to that effect between himself, the creditor, and the person/partnership continuing the business UPA 36(3): Exiting partner is released from liability, IF creditors received notice of departing partners exit POL Considerations of imposing exit liability on exiting partners a. Ex ante incentives to join a partnership b. Ex ante incentives to lend money/enter into contractual agreements with partnerships 3P claims against partnership property a. Statutory structure i. UPA 25(1) creates a special vehicle, the tenancy in partnership, in which all pship property is held A. This gives those who deal with the pship an assurance that, because the pship property is NOT held personally by partners, the pship property cannot be looted by partners for individual gain ii. UPA 25(2): Partners cannot assign their interest in pship propert iii. UPA 26: What partners DO own is their share of the profitsTHAT share corporation be transferred b. Implications i. Creditors of the pship have priority of access to pship assets. Creditors of individual partners can go after pship assets, but have lesser priority than pship creditors. c. RAT i. Otherwise, pship creditors would have high monitoring costs b/c they would have to be concerned about the credit health of partners in their individual capacity, for fear that they might default on their debts and thus expose pship assets to claims by individual partners ii. Otherwise, partners would have incentives to engage in highly risky behavior, as they have their pship assets to pay off debts UPA 18(h): Any difference arising as to ordinary matters connected with the pship business may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners a. These are merely default rules: pships uslaly opt out of these rules b. A partner who is the minority on major decisions (e.g., to contract with a 3P) is still bound by the decision (and thus, the minority partner is liable despite his objection to the contract). c. NOTE that 18(h) counts bodies, NOT capital contribution i. IR that the minority partner contributed the majority of capital [Nabisco v. Stroud]: S and F are partners. S refuses to be personally lbe to 3P (Nabisco) for any bread deliveries. F requests continue deliveries from Nabisco. Pship dissolves. a. H: Court finds S lbe b/c S, by himself, was not, and could not be a majority of the partners, and consequently could not restrict Fs authority to bind the pship on an ordinary matter connected with the pship business i. NOTE that the court seems to side with finding pship authority (and thus binding all the partners) to conduct ordinary pship business (e.g., continuing to receive bread shipments) ii. PROF: Presumption that ordinary-course-of-business conduct serves Kaldor-Hicks efficiency. b. Policy RAT: A contrary outcome would enable individual partners to exercise effective veto power over the operations of the pship c. NOTE that S could have avoided liability by EITHER i. RT1: Ex ante, contracting out of the default UPA rule

4.

E. Partnership governance and authority

1.

2.

17

3.

ii. RT2: Terminating the pship after the disagreement arises Brudney UPA [CB 62]: The 3 partners of Argrar disagree over how extensive alterations to a business should be. Gratia signs a contract with a 3P to build an alteration that costs $50K. a. Q1: The pship and the partners are likely NOT bound by the agreement to pay $50K. i. UPA 9(2): AN act of a partner which is NOT apparently for the carrying on of the business of the pship in the usual way does NOT bind the pship, unless authorized by other partners b. Q2: [missed] i. QQ c. Q3: If Artis intervenes and tries to stop the agreement, but both Ars and Gratia agree to bind the firm i. ANS: Agreement is not binding. Per UPA 9(2), if the activity is NOT in the ordinary course of business Minority partners have a veto right Balance sheet: Defines, at a moment in time, the firms assets and liabilities Income statement: Calculates net income based on revenue, less COGS, less operating earnings, less taxes and interest a. Over time, net income flows through to the value of the firm and lands on the balance sheet Definitions a. Dissolution i. UPA 29: Dissolutionany change of pship status/relations (e.g., exit of a partner) ii. RUPA 801: Onset of liquidating pship assets and winding up of its affairs b. Dissociation i. RUPA 601: Partner leaves the pship c. TErmiantion i. UPA 30: Pship ceases entirely at the end of winding up d. Winding up i. UPA 37: Orderly liquidation and settlement of pship affairs CRs on who and when pships may be wound up a. CR1: Under UPA, at-will partnerships may be wound up by any partner, at any time b. CR2: Not so under RUPA Issues on dissolution or exit rights a. Q1: Opting out of UPA i. [Adams v. Jarvis]: A withdraws from a 3-doctor clinic and contends that his withdrawal constitutes a dissolution that gives him right to require a wind up. A. Drafter of the partnership agreement confused the terms dissolution and windup, and it ends up ambiguous B. Court ends up ignoring the terms of the agreement and decides to honor it spirit C. TKY: Where there is a conflict, the pship agreement always trumps UPA [Dreifuerst v. Dreifuerst]: P and D form partnership to operate feed mill. P serves D with notice of dissolution & windup. Parties could not agree to windup. D requested that pship be sold, and partners would bid on entire property. (This would enable Ps to continue to pship, and Ds pship equity to be satisfied in cash) a. LC: Denies Ds request for sale, and divides pship assets in-kind according to Ps valuation of assets b. D ARG: He is entitled to in-cash settlement after judicial sale c. H: i. GEN RULE: In-kind distribution is permissible only in limited circs d. UPA 38(1): When dissolution is caused in any way, except in contravention of the pship agreement, each parther may have the pship sold off and receive in-cash payment, unless otherwise agreed i. RAT for UPA 38 favoring in-cash settlement A. In-kind distributions may affect creditors right to collect on debt owed 1. Pship assets may be worth (if sold as a single bundle for cash) more than the assets once divided up Brudney PROB (CB 72): Artis wants to resign from the Argrar pship. The pship is worth $700K as a going concern; if liquidated and sold off, it is worth $400K; if sold intact to a related business, it would bring $500K. a. Q: How much would Artis secure? b. CR1 [UPA]: Artis would receive 1/3 of liquidation value ($400K) i. NOTE that the remaining partners (and any new entering partner) would receive 1/3 of $700K, so we are effectively giving a windfall to them and punishing the exiting partner c. CR2 [RUPA]: Artis would receive the GREATER of 1/3 of liquidation value or going-concern value

F. Partnership termination
1. 2.

3.

4.

5.

G. Statutory default rules for dissolution and limits thereon

1.

2.

H. Recourse in equity to keep things fair when a partner exits

18

1.

[Page v. Page]: Partners enter into pship laundry business. Pship has indefinite term. Business lost money, but then begins to turn profitable. Exiting partner wants to dissolve pship to enter into business of his own. a. LC: Although pship agreement specified no term, but court implies a term anyway to prevent a Meinhard-type situation in which partners try to take advantage of each other i. It seems clear that the going-concern value is almost certainly greater than the liquidation value, so the court really doesnt want to allow this kind of b. H: Refuses to imply a term. The i. Court simply gives the parties what they bargained for A. RAT: A rule that allowed courts to imply terms might deter have deterred the parties from entering into the pship in the first place Loss of an efficient transaction c. BUT the court acknowledges the possibility that exiting partner may be liable for damages if he breached fiduciary duty of loyalty (e.g., by attempting to appropriate for his own use his the new prosperity of the pship without adequate compensation to his co-partner).

I.

Limited liability modifications of pships 1. Limited liability: Creditors of the pship cannot proceed against assets of indiviudla partners 2. OPT1: Limited partnership a. Limited partners are passive investorsthey contribute capital and get profits, BUT have limited control and have limited liability b. General partners are like the partners of an ordinary partnership c. PROB: Theoretically, this can create agency problems b/c the general partners may not try hard enough to further the interests of the limited partners i. SOL: PE firms like KKR give general partners a 20% cut of profits and a flat 2% fee This aligns interests of the general partners with those of the limited partners by ensuring that the general partners will try hard to maximize profits d. Q [CB 78]: Why might some firms opt to remain GPs (AOT LLPs)? i. Remaining a GP sends a message to clients that each individual partner is willing to put their personal wealth on the line ii. Remaining a GP indicates that partners are better able to monitor each other A. Conversely, very large firms with partners that are not able to cross-monitor are more likely to opt for LLP form 3. OPT2: Limited liability company a. Advantages that LLC form gives to each member i. Active participation in the entity socntorl ii. Limited liability iii. Pass-through tax treatment b. Q: Does an LLC qualify as pass-through, one-time tax treatment (AOT taxed twice, like a corporation)? i. [OLD] IRS applied a 4-factor test A. TS1: Limited liability for owners of business? B. TS2: Centralized management? C. TS3: Freely transferable ownership infteret? D. TS4: Continutiy of life E. IF an entity fails 2 of these factors Entity is taxed twice, as a corporation ii. [Post-1997 rule]: IRS allows entities to simply check a box and opt for taxation as partnership or corp c. For most people looking to form a business, this is the ideal form i. Thus, LLCs have grown dramatically ii. BUT most wealth continues to be held in corporations iii. Also, many LLCs are prevented from engaging in certain businesses (medical practice, law, etc.)

19

14.

Corporate form
A. Key move is to separate out liability from control B. Benefits of limited liability
1. 2. 3. 4. 5. Reduces need to monitor agents (managers) Reduces need to monitor other shareholders Makes shares fungible (which also facilitates takeovers) Facilitates diversification (without LL, minimize exposure by holding only one company) Enlists creditors in monitoring managers (because they bear risk in LL form) Incentivizes shareholders to encourage management to spend too little on preventing accidents Encourages investment in hazardous industries In contracts, this is negotiated around a. Sometimes shareholders waive LL Permits takeovers==>disciplines management (deterrence) Allows shareholders to exit without disrupting business And because of LL, shares are fungible, facilitates market-driven steering of behavior and incentives towards returns/efficiency DGCL 141(a):shall be managed by a board of directors Fiduciary duties in exchange for delegated authority a. Board is economic agent of shareholders How can law encourage managerial diligence, given rational apathy by shareholders? a. [rationally apathetic = logical not to spend time on oversight] b. Contra Europe, with larger % shareholders, where should not be rational apathy How can law solve shareholders collective action problem? How can law encourage decisions that are best for shareholders as a whole (and therefore society)? Potential solutions a. Shareholder voting b. Disclosure Shareholder with 55% wants to sell firm; must be approved by board a. corporate bylaws require 75% for extraordinary measures, such as replacing board/selling b. supermajority provision Bylaws are contract a. Board of directors stands between majority and minority in a way that is socially useful b. Information advantage over individual shareholders

C. Torts
1. 2. 3.

D. Benefits of transferable shares

1. 2. 3.

E. Corporate Governance
1. 2.

F. Questions:
1.

2. 3. 4.

G. Automatic Self-Cleansing Filter Syndicate Co. v. Cunninghame, Engl. 1906 (p. 103)
1.

2.

15.

Corporate form: The board of directors

A. Board Structure
1. Broad powers: a. Declare/pay dividends b. Amend the corps bylaws c. Create committees i. Required to create some, such as audit and compensation comms. d. Agenda-setting authority e. Sole power to initiate major corp decisions, such as mergers Generally one-year terms, but sometimes staggered a. Up to 3 classes (DGCL 141(d)) i. Board classification requires shareholder approval Rules of formality a. E.g., quorum required by DGCL 141(b)

2.

B. Power of shareholders is held in board, rather than individual directors

1.

20

b. Write resolutions

C. Independent directors vs. Manager-directors

1. 2. Over time, increasing number of independent directors PRO independent directors a. Reduce agency costs b. Know less about the corporation More pliable to large institutional investors or controlling shareholders CON independent directors a. Lots of dispersed, individual shareholders Prefer knowledgeable manager-directors b. However, they have less expertise about area and managers Informal action (3 of 4 directors met before official meeting) The mere fact that directors are gathered does not a meeting make. Sale-and-leaseback Egmore (VP and director), acting for Board of Directors, did not have apparent authority a. Jennings not entitled to rely solely on agents representations b. Must be Board who makes these decisions KF: Extraordinary transaction, outside the scope of ordinary business

3.

D. Fogel v. U.S. Energy Systems, Del. Ch. 2007 (p. 107)

1. 2. 1. 2.

E. Jennings v. Pittsburgh Mercantile Co., Pa. 1964 (p. 110)

3.

21

16.

Corporate finance: Methods of financing

A. Debt v. Equity
1. Debt right a. Maturity date requires repayment at a specified time. Interest must be paid at specified times at specified rates. b. Acceleration clauses give creditors rights, including control rights, if a payment is missed (i.e. debtor is in "default"). c. Tax law preference permits corporations to deduct interest payments as an expense. d. Debt is less expensive capital than equity i. Buyers get a lot of rights so are willing to give capital more easily. ii. You may require higher price for stocks b/c stocks give you fewer rights. Right to dividends, but these are set in boards discretion Right to residual claims on the value of the corporation, but these may be zero, timing of payout is in the boards discretion. Right to vote for directors and on other matters Investors require MORE in exchange for equity capital b/c stocks have fewer rights attached to them. Preferred stockholders at least get a liquidation preference-- amount that will be paid to preferred stock b/f common stock. Preferred stock has lots of contractual flexibility (See DGCL S 151 page 182) a. See example of US Treasury investment in AIG. Government was able to convert its preferred shares to common shares to start selling off the company back to the public. Redeemability--ability of either the holder of the preferred stock or the corporation to cash it in. Gives both sides flexibility. Conversion: Corporation or holder of security has ability to take what I hold and turn it into a different class of stock. a. Ex: when AIG ready to pay back Treas, they turned preferred stock into common stock. When you have lots of contractual terms in the preferred stock, that makes it less fungible.

B. Equity rights
1. 2. 3. 4. 1. 2.

C. Preferred stock v. common stock

3. 4.

17.

Corporate finance: Discount rate and project valuation

A. Discount rate
1. 2. 3. Opportunity cost of money As discount rate rises, the present value lowers Formulas n a. FV = PV (1+r) n b. PV = FV / (1+r) 1/n c. r = (FV/PV) 1

B. IF NPV is positive Firm should pursue the project/transaction C. Expected Value

1. 1. 2. 3. Sum of (probabilities * outcomes) Premium charged because outcome is variable Try to reduce by diversifying risk via linking together multiple risks so they cancel out Individual investment is risk averse: Do not like investments (or games) with widely varying outcomes a. Sources of risk aversion i. Declining marginal utility of wealth ii. Endowment effect: Regret losing what we have more than regret not gaining what we dont have

D. Risk premium

22

23

24

18.

Creditor protection
A. RM: Forms of secure creditor protection
1. 2. 3. 4. 1. 2. Ineffective regulations (disclosure, distribution, minimum capitalization, capital maintenance) Suit on UFTA: Intent to defraud; OR constructive fraud Action for equitable subordination: Subordinate shareholders debt holdings (that he converted from equity) Action to pierce veil: (1) No separate identity; AND (2) Injustice to creditor if we dont pierce veil Disclosure requirements: Meant to protect shareholders, not creditors Distribution constraints a. NY: can only be paid from surplus, UNLESS there is shareholder permission b. DGCL 154: defines surplus i. 170: nimble dividend test: May pay out of surplus or net profits c. Calif.: modified retained earnings test (AKS p. 138) d. RMBCA: assets > liabilities + preferential claims i. Loophole: if fair valuation (e.g., from investment bank) can pay out more Minimal capitalization requirement: Provides little ongoing protection for creditors Capital maintenance: Require mandatory action in the event that capitalization falls below a particular level a. Investors/creditors can contract for this type of rule. Convertibility Security interest Protective covenants [Credit Lyonnaise]: As the corp approaches insolvency, shareholders will try for riskier ventures, even if its NPV negative, because they know bondholders will be paid first and thus shareholders benefit from the venture that pays off an amount well in excess of the bondholder payout PROP: When corporations approach insolvency, directors should be able to go under a new rule a. CTR: Unadministrablehow do you know youre in the insolvency line? If you do know, parties will game that line b. CTR: Creditors can contract for that ex ante i. CTR: There may be a lack of information/excessive transactin costs to ex ante price the protections into loan agreements (i.e., how does a creditor quantify the value it derives from forcing a corp to maintain a certain level of capital?) SUM: Corporations cannot take money out of the till that should be going to creditors T1: Intent to defraud T2: Constructive fraud a. Applies where the capital looks unreasonably small i. Debtor was engaged in a transaction for which the debtors assets were unreasonably small b. PROB: Judge will exercise hindsight bias, and arent good at figuring out what level of capital is sensible i. Leveraged buyouts (LBOs) can be attacked as fraudulent conveyance ii. ii. Also, the uncertainty of whether courts will interdict these contracts will increase cost of equity Usually applies to the loan made by maj shareholder who converts his shares into a loan to corporation [Costello]: Partners replace their equity to loans. Creditors claim that the partners loans should be subordinated. a. H: Court subordinates partners loan b. KF: Gross under-capitalization i. History of the partner suggested more capital was needed to run the corporation properly c. KF: Real unfairness to creditors WRT what they relied upon when they signed the loan i. CF1: If this had been a brand new firm, with no history of interaction bw creditors and partners Less substance on which creditors would be relying Harder for creditors to claim unfairness ii. CF2: If this had been a long-ailing firm and creditors knew it Again, creditors had no reason to rely on beliefs in the validity of their notes

B. RT1: Ineffective methods

3. 4.

C. RT2: Contractual methods

1. 2. 3. 1.

D. PROB: As a corporation approaches insolvency, shareholders will prefer non-KH-efficient conduct

2.

E. RT2: UFTA Sections 4 & 5

1. 2. 3.

F. RT3: Equitable subordination

1. 2.

25

G. RT4: Piercing the corporate veil

1. 2. Brings shareholders personal assets onto the table GEN RULE: No piercing IF ANY a. Public corporation b. Passive shareholders c. Minority shareholders d. If all formalities are observed and there is nothing funny with the accounts TS1: Shareholder and corporation do not have separate identities a. KF: No corporate records/formalities b. TS [Tinkerbell]: Shareholder must believe in the separation c. [Lowendahl]: Shareholder completely dominates corporate policy TS2: Is there injustice to the creditors? a. [Van Dorn]: Would adherence to fiction of separateness would sanction a fraud or promote injustice? b. RT1: Shareholders engaged in unequitable conduct c. RT2: Actual fraud d. RT3: Shell game: manipulation of corporate assets to defeat creditors expectations i. [Sealand]: Creditors seek reverse veil-piercing (pierce through to person, and then through again to that persons other corporations) A. POL PROB with reverse-piecing: It may upset the ex ante bargains of the creditors of Private Owners other companies 1. Thus, the prospect of reverse-piercing resurrects the specter of monitoring costs, which the corporate form is designed to resolve 2. This kind of revival of agency costs arises whenever corporate liability is abandoned 3. Also, creates uncertainty in lending TS3: Did creditor assume the risk? a. [Kinney Shoe]: Created two liability shields. Once owned the asset, the other subleased it. i. H: Creditors can generally rely on corp assets, subject to normal wear and tear, as of the date of creditors agreement with the corp a. Future corp transactions must generally preserve this value, again subject to normal wear and tear b. So long as the first two element are satisfied, the owners personal assets will be shielded from creditors claims RAT: This seems like a sound rule that small businesses would want a. Supported by the Bob Thompson study, which indicates that courts are much more willing to pierce where owners engaged in misrepresentation b. Also, courts are more willing to pierce to help out a contract creditor, AOT a tort creditor Applying this test a. Sea-Land would come out the either way (i.e., in favor of veil piercing) because Marchese was moving assets around b. Kinney would also come out the other way (because there was no moving around)

3.

4.

5.

H. PROF: Proposal for an efficient piercing rule

1.

2.

3.

I.

The case for limited liability in tort 1. We expect that LL in tort leads to: a. Too little investment in safety, and b. Too much product at too little cost 2. We expect this to happen much less in contract, since contract creditors can bargain ex ante (and thus, achieve a Kaldor-Hicks efficient result) 3. Potential solutions a. Regulation of precautions i. PROB: Requires state regulators to know the optimal precaution b. Mandatory insurance REQs i. PROB: Requires state regulators to know how to price risk ii. PROB: May cause a race to the bottom c. Give tort creditors first priority in bankruptcy i. This gives contract creditors to seek precautions ii. This seems best, since it will create a flexible market mechanism by which contract creditors will bargain with the firm to furnish credit at a lower costs iii. PROB: May not necessarily result in pricing-in of additional costs to contract creditors

26

19.

Shareholder Voting: Economics & Current Trends

A. Economics
1. 1. 2. Rational apathy: Vote makes little difference; Gets very small percent of any changed effected [Easterbrook & Fishel]: IF cost to me of gathering information < (benefit to corp. * percentage of shares I own I will not bother gathering information [Black]: Financial institutional investors COULD be active monitors, but their hands are tied by legal rules a. Legal rules keep financial institutions smaller than they would otherwise be, prevent them from acquiring large percentage stakes, intervene in companies in trouble, enter the boardroom, suppress cross-holdings and antitrust entanglements b. CTR [Pozen]:Still expensive for institutional investors to gather information [Kahan]:Hedge fund are effective monitors a. Private pool of capital being invested privately b. Take positions designed to hedge risk to general market trends c. Compensation tied directly to performance of firms, unlike mutual funds Shareholder rights movement a. Institutional investors form major blocks of these shares b. Often advised by ISS Majority vote requirements: Corporate law now facilitates, and many companies have now adopted, a requirement that directors are elected by a majority (not plurality) of the votes cast. eProxy makes it cheaper to run an insurgent slate: Reduces costs of distributing proxy materials, and likely gives more power to institutional investors. Delaware Court invites 14a-8 resolutions that require reimbursement of shareholder proxy expenses: AFSCME decision rejects the specific resolution at CA but leaves the door open through better drafting. Delaware legislature makes clear that proxy access procedures and expense reimbursement are a proper matter for bylaws: Newly passed DGCL 112-113 Shareholder proxy access (even via private ordering) makes contested director elections more likely: Using Rule 14a-8, shareholders will be able to enact bylaws that will allow them put their own nominees on the company ballot.

B. Collective action problems

3.

C. Recent shareholder-empowering changes

1.

2. 3. 4. 5. 6.

20.

Shareholder voting: Rules

A. Mandatory rules
1. 2. 3. 1. 2. 3. 1. 2. Mandatory board Annual shareholders meeting, with notice and quorum requirements Proxy system Election/removal of directors Fundamental corp. changes (mergers, sales of all assets, dissolutions, charter amends.) Shareholder resolution Mandatory annual meeting Special meetings (the only way for shareholders to initiate action) a. [RMBCA]: Special meeting can be called by board OR 10% of shareholders b. [DGCL]: Special meeting can be called by board OR shareholders, ONLY IF charter provides for it c. POL PRO: Easier special meetings More monitoring Less agency costs Lower cost of capital d. POL CON: Easier special meetings Drain on D/Os time & resources; Disrupt corporate effectiveness Written Consent a. [DGCL 228]: In lieu of meeting, shareholders can act on any issue they could act on in meetings via written consent b. [RMBCA 7.04] Shareholders may act without meeting, IF there is unanimous written consent Straight voting: One vote for each seat on board Cumulative voting

B. Shareholders are entitled to vote on:

C. When can shareholders meet to vote?

3.

D. Methods of voting
1. 2.

27

3.

A given shareholders number of votes = number of shares owned * number of seats to be filled; Board is filled in order of candidates with most aggregate votes. Thus, min shareholder can get a few directors on the board by concentrating their votes on a handful of candidates. b. Ensures min shareholders will have representation on board roughly equal to their percentage Plurality vs. majority voting a. [DGCL 216] is default for plurality b. Votes withheld are irrelevant; votes against impossible if uncontested c. Majority is very high hurdle d. Other option = majority of all shares voting POL a.

a.

E. Class voting requirement

1. Efficiency of class voting terms depends on whether differences between class voting regimes are priced in by shareholders b. Different classes of stock may have divergent interests DGCL 242(b)(2) a. Class voting only protects legal rights i. E.g., does not apply to subordination of shares b. Does NOT apply in mergers RMBCA 10.04(a): Classes have right to vote as class when charter amendments affect economic interests or legal rights a. (f)---Requires class voting on mergers NYBCL 804(a)(3) a. Class voting on charter amendment, IF class's rights would be subordinated by authorizing senior shares

2.

3.

4.

21.

Shareholder voting: Removing directors

A. Removing directors
1. RULE [DEL]: Can be removed with/without cause . . . a. UNLESS staggered board OR cumulative voting Requires cause to remove director b. BUT Board has the right to replace removed directors - 223(a) (default rule, can be amended) RULE [RMBCA]: OPT1: Amend charter a. NO, can only do if Board proposes [DGCL 242(b)(1)] OPT2: Amend bylaws a. YES, not even charter provision can divest shareholders of right to amend bylaws [DGCL 109(a)] OPT3: Can expand board size OPT4: Can get rid of staggered board a. NOT an option if staggered board is in charter i. Can only do it if Acquirer removes ENTIRE board, because theres still cumulative voting OPT5: Remove directors a. NO, with staggered board, can only remove for cause [DGCL 141(k)(1)] OPT6: Break up company a. NO, requires proposal by board [DGCL 275] Implementing a staggered board a. Only the board may recommend a change of the corporate charter (mandatory) - 242 (b) i. Shareholders always retain the right to amend bylaws (mandatory rule) - 109(a) b. Need shareholder vote to implement c. Maximum of 3 classes; Directors are divided into classes and each year only one class is up for election Makes it more difficult for an acquirer to take control a. Delay problem b. Two-election problem c. Firm offer problem Effective staggered board a. Cannot be dismantled by bylaw amendment

2. 1. 2. 3. 4.

B. STRAT: Removing an Unfireable CEO

5. 6.

C. Staggered Board
1.

2.

3.

28

b. E.g., if staggered board is in charter

22.

Shareholder voting: Separating control from cash flow rights

A. [DGCL 160(c)]: No circular voting structures
1. RULE: Shares cant vote OR count toward quorum if they are EITHER a. Treasury stock (owned by corporation) b. Shares held by subsidiary in which corp. has majority of voting stock STD [Speiser]: Judge will fill gaps in corporate law by ferreting out functional equivalents of circular voting a. Corp1 bought Convertible preferred stock in Corp2, which then bought stock in Corp1 i. Scheme to evade 160(c) b. Functionally equivalent to prohibited circular voting i. Therefore, votes not permitted POL PRO [Easterbrook & Fischel]: There is good reason to limit free market operation here a. Legal rules tying votes to shares increase corporate efficiency b. New agency costs would be created by allowing separation of voting rights from equity interest would create i. If controller of 75% of votes owns only 25% of cash flow Wont invest as much in monitoring c. Shareholders will sell their votes for LESS than expected dilution of equity interest (b/c they dont think their votes will affect outcomes and so under-value their votes) [Schreiber] a. Loan; court characterizes as vote buying i. Therefore, voidable b. Does not void transaction i. Nature of transaction is such not to void A. Other shareholders were not hurt, because they voted in favor of it 1. Cured vote buying violation Stock pyramids a. 50%, 50%, 50% will lead to 12.5% ownership, but voting control b. Disfavored by tax law Cross ownership a. Phalanx of corps. own each other i. Contra pyramid, not clear who is at top b. Never seen in US; disfavored by tax law Dual class structures a. Different voting power in different classes of stock b. Generally, dual-class recaps not permitted, but can have multiple classes at IPO i. Though SEC rule struck down, NYSE has rule banning dual-class recaps

2.

B. RULE: No vote buying

1.

2.

C. EXs: Controlling minority structures

1.

2.

3.

29

23.

Shareholder voting: Proxy fights

A. Q: Who gets reimbursed for proxies?
1. 2. PROF: Analyze Amount, conditionality, bias MAJ [Froessel] a. Insurgents get full reimbursement ONLY IF they win b. Management gets full reimbursement for proxy expenses i. STD: Technically, management only gets reimbursed for matters of corporate policy A. In practice, though, no distinction between corporate policy and personal interest ii. REQ: Proxy expenses spent in belief that theyre in best interests of shareholders iii. REQ: Proxy expenses must NOT be spent for personal power MIN [Super-Froessel Rule]: Reimburse both sides, no matter who wins a. Incentivizes proxy fights

3.

24.

Shareholder voting: Proxy war & Town hall proposals

A. RM: Options open to insurgents
1. 2. 3. 4. 1. Insurgent can send out own proxy solicitations (but Froessel problem) Include proposal on directors proxy (town hall proposal) Propose a bylaw amendment allowing proxy access [Under rejected 14a-11]: For larger shareholders, put candidate directly on directors proxy RT1 [14a-1(l)]: Solicitation is Any communication reasonably calculated to result in the procurement of a proxy a. Must file Schedule under 14a-3 (memo + schedule 14A) (lose element of surprise) b. EXC1: Not seeking power to act as proxy, directly or indirectly c. EXC2: Soliciting 10 or fewer RT2: BUT Owns more than $5M in stock Even if exempt, must file notice Addressed by 14a-4(d)(4), which allows to solicit proxies for management nominees Q1 [14a-8]: Town hall rule a. REQ: Must own certain amount of stock for a year, and propose 120 days in advance, at most 500 words Q2: Can management exclude a proposal from proxy? a. RT: Substantially implemented i. Carpenters Pension Fund case study (p. 214) A. Proposal to move to majority vote; Board tries to implement similar plan in response B. H: Not excludable as substantially implemented b. RT: Ordinary business i. TS1: Is it a task fundamental to managements ability to run the business ii. TS2: Or does it focus more on significant social policy issues? iii. TS3: Seek to micromanage the corporation on complex matters? iv. NiSource case study (Supp. #2) A. Proposal to eliminate PAC can be excluded as ordinary business v. CSR proposals c. Improper under state law usually cant bind the corporation to do things, suggestions only d. Violates the proxy rules i.e. materially false information e. Personal grievances f. Not Relevant: Accounts for only a very small amount of the companies business g. Company would lack the power to implement the proposal h. Conflicts with one of the companys own proposals i. Already substantially implemented j. Requests a specific amount of dividend k. Relates to the election of board members or a procedure for such nomination or election** Q3: Will SEC permit exclusion of proposal? a. Management will seek no-action letter to ensure SEC will not punish corp. for disallowing a particular shareholder proposal

B. Q1: Must a notice be filed b/c it is a proxy solicitation?

2. 1. 1. 2.

C. Short slate problem D. Q2: Will the proposal appear on directors proxy?

3.

30

b. RULE: SEC will apply a case-by-case approach to determine if CSR proposal could be excluded i. [Medical Committee for Human Rights v. SEC] A. H: Shareholder proposal improperly excluded. Proposal to stop producing napalm NOT related to ordinary business ii. [Cracker Barrel letter] A. Sexual orientation discrimination related to ordinary business B. Reversed in 1997; now, a case-by-case approach

E. Antifraud Rule [Rule 14a-9]

1. 2. RULE: Prohibits fraudulent obtaining of a proxy RULE: Includes private right of action, with following elements: a. REQ: Materialitysubstantial likelihood that a reasonable shareholder would consider the misrepresentation/omission important in deciding how to vote b. REQ: Culpability[CRs] Negligence // intentional // gross recklessness c. REQ: Causation/reliancepresumed if the proxy solicitation was an essential link in accomplishment of the transaction and the misrepresentation was material i. QQ [Virginia Bank Shares]

25.

Defeated proxy access rule

A. RULE [14a-11]: Allows shareholders who owned 3% of corp. shares for 3 years to place nominees on directors proxy
for up to of all board seats 1. BUT must not be seeking control 2. If staggered: calculated by whole board, not just those up for reelection 3. TKY: Under 14a-11, insurgents could skip proxy war (sending proxies to shareholders and persuading them to give over proxy voting right) and directly put your candidate on the incumbent directors proxy card a. Gave insurgents the ability to get around the [Frossel] problem of non-reimbursement

B. Does NOT allow a control slate C. Now, if you want to avoid a proxy contest, the only possible way to do it is to use 14a-8 to propose an amendment to
the bylaws allowing proxy access 1. Not clear how the SEC will rule on these yet 2. If theyre not-excludable, then, you can propose your candidate via a shareholder proposal on the directors proxy

D. [Business Roundtable]
1. 2. 1. 1. 2. 1. 2. 3. 4. Stayed by SEC Does not apply for this years proxy season Passed in response to SEC Shifts lots of power into hands of institutional investors, ISS, who may not have firms best interests at hear Labor unions may place their directors on board Other countries give shareholders much more control No shareholder directors could be elected w/o a majority shareholder vote Only if conditions were really dire will a shareholder-nominee would be willing to overcome arduous triggering conditions, year-long wait, and subsequent shareholder votes Proxy access is much more important in post-PP world, where getting control of board is prerequisite to buying a majority of shares (because you need to redeem the pill in order to buy the shares)

E. [DGCL 112] Allows for a bylaw providing for proxy access F. POL CON proxy access rule:

G. POL PRO proxy access rule:

31

26.

Duty of Care
A. RM
1. 2. 3. Was there knowing criminal action? 102(b)(7) waiver applies? (DO acted in GF and was not gross negligence) Board was passive, which caused losses? a. Failure to exert minimal effort b. No monitoring system c. Failed to implement monitoring system d. Ignored red flags Boards bad action caused losses? a. Grossly negligent process Board has burden to show EF b. No self-dealing, reasonable investigation, rational belief that they were helping shareholders BJR Good faith a. Honest b. No conflict of interest c. Not approve/condone wrongful/illegal activity No waste a. Rationally further corporations interests Reasonable care a. Informed in making decisions b. Monitor and supervise corporate activities D/Os BJ violated a criminal statute a. KF: Were the shareholders among the class to be protected the criminal statute? b. [Miller]: Shareholders were among the class to be protected by ban on corporate spending on political campaigns i. H: No BJR for illegal conduct by DOs D/O pursued broad social/political goals unrelated to corporations welfare REQ: Did DO act in good faith? a. 102(b)(7) prohibits waiver for non-GF conduct REQ: DOs conduct was knowing violation of law? a. 102(b)(7) prohibits waiver for knowing crime REQ: DOs conduct must NOT be intentional, conscious dereliction of duty a. [Disney]: Gross negligence is NOT bad faith REQ: DOs conduct was gross negligence? a. [Cede]: If yes, proceed to EF review, and THEN decide of 102(b)(7) eliminates personal liability b. RAT: Concern there may be DoL violations mixed in IF WAIVER APPLIES, and there are ONLY DoC claims Dismiss (per Emerald Partners) IF NO waiver (or there are non-DoC claims) Was there inaction, or malfeasance? RT1: Failure to exert even minimal amount of care a. [Francis]: Total failure to position oneself to detect red flags is breach of DoC i. Duty at least involved looking at books ii. Duty required more than mere objection/resignation RT2: Director omissions despite red flags of crime/fraud No BJR protection a. BJR does not apply to director omissions b. Law & econ analysis does not apply: Purpose of BJR is to discourage risk averse decisions, but these are not decisions, so no incentive to protect i. Doctrinally, deference to active business decisions, but no reason to defer to inaction c. Q: Was there a red flag? i. RULE [Allis-Chalmers]: Directors are entitled to rely on compliance of their employees until a red flag (suspicious circs) emerges A. Q: Was Board on notice that would make reasonable person suspect wrongdoing, but still didnt act?

4.

B. Facets of Duty of Care

1.

2. 3.

C. Q1: Reason to immediately knock out BJR?

1.

2. 1. 2. 3. 4.

D. Q2: Is there a 102(b)(7) waiver that covers DO?

5. 6. 1.

E. Q3: Is the boards passivity in detecting fraud/crime a breach of DoC?

2.

32

3.

4.

5. 1. 2.

B. RAT: It would be inefficient to require directors to just ALWAYS monitor, since monitoring is costly and it makes more economic sense to require directors to expend monitoring on costs only when, and only on those areas of their corporation that are showing red flags ii. RULE [Citigroup]: Generalized market/business conditions are NOT a red flag RT3 [Caremark]: Board utterly failed to implement any reporting/information system to detect wrongdoing a. ART(D) [Citigroup]: Frame the loss-causing risk as a business risk (for which there is no monitoring duty) RT4 [Stone]: Board consciously failed to monitor/oversee control systems to detect fraud/crime a. Board must know that its shirking its fiduciary duty of care b. Grossly negligent failure to detect wrongdoing is NOT enough RT5: Failure to accurately disclose information to shareholders to help them decide how to vote STD: BJR presumes directors do not breach DoC REQ1 [Cede II]: Gross negligence with respect to process Directors have burden to show EF a. BUT [Cede III]: Gross negligence doesnt necessarily mean that the substance was unfair---you can have gross negligence and still the transaction can be EF REQ2: No self-dealing a. Does D have a financial stake? b. QQ What if there is self-dealing? REQ3: Adequately informed decision a. D acquired all material information reasonably available to them i. STD: Courts usually require grossly negligent failure to obtain material information. A. [Van Gorkom]: D-CEO failed to commission formal study OR solicit other bids prior to selling company. 1. KF: The CEO, not the buyer, proposed sale price 2. KF: Board made no attempts to learn intrinsic value of the company 3. KF: D-Board approved sale based solely on CEOs oral presentation 4. KF: Board made decision in 2-hour period, with no real crisis 5. KF: Court suspected that board acceded to the autocratic CEO 6. IR: The merits of the case (whether the sale price was fair, which it probably was) were trumped by the boards grossly negligent process b. Consider surrounding circumstances (time pressure on decision?) REQ4: Rational, actual belief that the BJ was in corporations best interest a. STD [Disney]: Court will not use 20/20 hindsight to judge BJs b. REQ: DOs conduct was unreasonable i. RT2: No-upside transaction A. [Litwin]: Decision to purchase bonds with an option for seller to buy bonds back was so improvident, risky, unusual, unnecessary D liable for decline in value ii. RT3: Disguised self-dealing c. REQ: Standard is objective, but does consider DOs special skills d. REQ: Consider nature/size of business e. REQ: Reasonable reliance on officers, employees, lawyers, accountants, other retained experts, committee of the board i. Boards decision to rely on expert is protected under BJR if the boards procedures are reasonable POL RAT for BJR a. Avoid discouraging risk-taking and innovation by D/Os b. Courts are poor judges of business reality c. Shareholders should bear risk of business misjudgment QQ Insert EF analysis Q [Emerald Partner]: Did damages result entirely from the breach DEL [Cede]: If DO violated DoC IR if P cannot prove causation ART(D): If multiple DOs violated DoC Each can argue that the rest of the board would have voted that way anyway, so my conduct did not cause the bad outcome

F. Q4: Is this wrong action covered by Business Judgment Rule?

3.

4.

5.

6.

G. Q5: If BJR is overcome, can Board prove entire fairness?

1. 1. 2. 3.

H. Q: Were Ps damages caused by the breach?

33

27.

Duty of Care: Liability shields

A. Only 3 cases where directors have had to pay out of pocket:
1. Van Gorkum, Enron, and Worldcom

B. BJR: Presumes DoC was met C. Waiver: No liability for DoC violations, UNLESS there is a GF violation D. Indemnification
1. RULE [DGCL 145(a)]: MAY indemnify for any claim, except for act taken in bad faith or had reasonable cause to believe was unlawful a. Permissive; Corp is not required to indemnify RULE [DGCL 145(c)]: Mandatory indemnification for legal expenses actually and reasonably incurred, if you win a. Point is to minimize D/Os risk aversion b. N.B. Also deductible as corporate expense DGCL 145(f) a. Suggests you could indemnify more broadly b. But cannot do anything that conflicts with 145(a) RULE [DGCL 145(g)]: Can purchase insurance for DO whether or not they could indemnify that person RULE [DGCL 145(c)]: Even if not in good faith, success in a legal action (e.g., settlement with no payment) Mandatory indemnification

2.

3.

E. D&O Insurance
1. 1.

F. Reimbursement of legal expenses

34

28.

Duty of Loyalty
A. RM
1. Does shareholder owe a duty to other shareholders? a. SH owns a fiduciary duty ONLY IF it owns a majority interest in, or exercises control over the business affairs of the corporation i. RT1: Shareholder owns > 50% of shares automatic status as controlling shareholder ii. RT2: Shareholder owns < 50% of shares no automatic status; the plaintiff must allege domination by a minority SH through actual control of corporate conduct Was there self-dealing? Was the self-dealing by a majority shareholder, or by board? a. [Apply master DoL RM] Theft of corporate opportunity? Breach of duty of GF? Close corporation Is BJR review passed? Is EF review passed? (fair dealing; fair price; what happened to the corp after the transaction)? Remedies: Rescission OR restitution Core Q [Gleason]: Can the principal monitor the agents actions? Or is the trustee dead/disabled General REQs for self-dealing transaction a. Disclosure? i. IF YES: Did a majority of disinterested directors approve? A. YES No breach ii. IF NO: Disclosure after the transaction (either before suit or a reasonable time after suit filed)? b. All material facts disclosed? c. Entire fairness? d. Approval by non-conflicted independent directors, voting in good faith? SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF: a. REQ: Transaction was entirely fair when approved, AND EITHER OF b. Full disclosure to board AND majority of disinterested board members approve; OR c. Full disclosure to shareholders AND majority of shareholders voted to approve in GF d. PROF: Not really a safe harbor RULE [SEC Regulation S-K]: D/Os must disclose what interest they have QQ: Is it a DoL breach if director fails to disclose material facts about his interest? Director has interests in corporations counterparty in the transaction Looting or giving self a discount QQ Refusals to deal, if directors/ controlling shareholders planned to seize that deal for themselves later IF YES (i.e., majority shareholder is dealing with corp, or with min shareholders) a. SP1: Even with full disclosure, board approval, and/or shareholder ratification, the transaction will likely be subject to EF review i. Sinclair: Parent makes sub pay large dividends to itself ii. McMullin iii. Cookies: Main shareholder of business has Corp deal on favorable terms w/ his other businesses Disclosed, BUT iv. Wheelabrator: b. SP2: Apply Weinberger roadmap c. [Cookies]: Court suspects that board, even though technically disinterested, is under sway of charismatic CEO d. SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF: i. REQ: Transaction was entirely fair when approved, AND EITHER OF ii. Full disclosure to board AND majority of disinterested board members approve; OR iii. Full disclosure to shareholders AND majority of shareholders voted to approve in GF iv. PROF: Not really a safe harbor

2. 3. 4. 5. 6. 7. 8. 9. 1. 2.

B. DEF [Self-dealing]: Corporation conducted business with DO or family member?

3.

4. 5. 1. 2. 3. 4. 1.

C. Types of conflict transactions

D. MASTER DOL RM: SELF-DEALING by a MAJORITY SHAREHOLDER?

35

2.

IF NOT maj shareholder self-dealing (i.e., general corporate transaction b/w board and corporation) Did disinterested board members have full disclosure and approve transaction? a. IF disinterested board approved, pre-transaction i. CR1 [Cooke]: Court will apply BJR review, if disinterested directors conduced business appropriately (only irrational or egregious conduct will fail) ii. CR2: Court will apply EF review iii. CR3: Court will defer to Board, unless P shows fraud b. IF YES, but board approved post-transaction Apply EF review c. IF NO disinterested board approval i. Did a majority of shareholders ratify the transaction? A. IF the transaction was NOT ratified Apply EF review B. IF transaction WAS ratified Is the claim for waste? 1. IF claim is for waste Apply EF review [Vogelstein] 2. IF claim is NOT for waste Apply BJR d. SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF: i. REQ: Transaction was entirely fair when approved, AND EITHER OF ii. Full disclosure to board AND majority of disinterested board members approve; OR iii. Full disclosure to shareholders AND majority of shareholders voted to approve in GF iv. PROF: Not really a safe harbor Q1: Does charter contain a DGCL 122(17) waiver? a. [Dreamworks]: Charter eliminated execs duties to (1) refrain from engaging in business directly competing w/ Dreamworks; and (2) communicate the opportunity to Dreamworks i. HIST: Post-IPO performance was abyssmal Q2: Was the opportunity a corporate opportunity? a. CR1 [Expectancy of interest test]: opportunity grows out of an existing legal interest of the corporation b. CR2 [Line of business test]: Any opportunity falling within the corporations line of business i. KF: How the opportunity came to the attention of director ii. KF: Remote from the core economic activities of the corporation? iii. KF: Corporate assets used to find or exploit the opportunity? c. CR3 [Fairness Test]: Holistic analysis Q3: Was there incapacity or disability for corporation to seize the opportunity? a. IF YES Director can take opportunity, no breach of DoL b. IF NO disability Did Board decide to pass up the opportunity, in good faith, and with approval of disinterested directors? i. [Broz]: Director need not present opportunity to board ii. IF disinterested board passed up No breach of DoL iii. IF no disinterested approval Was there a 122(17) waiver? A. [Dreamworks] B. IF NO waiver EF review [Stone]: Failure to act in GF does not result, ipso facto, in fiduciary liability. BUT failure to act in GF may indirectly trigger liability. Q1: Where on the malevolent intent--gross negligence spectrum does this lie? a. [Disney]: Intent to do harm ---- Intentional dereliction; conscious disregard of duties ---- Mere gross negligence b. There may be a level of negligence so profound as to trigger lack of BF No 102(b)(7) Q2: Does the subjective state of mind of the director INTEND to not serve shareholders? a. IF NO No breach (Disney) b. IF YES Possible breach STD: Balance partnership-based notions of fiduciary duty w/ courts belief about what parties would have bargained for ex-ante a. ARG(D) [L&E approach]: Minority shareholders could have contracted for Close corporation characteristics: a. Small # of shareholders Greater likelihood of controlling shareholder b. No public market in stock Min shareholders cannot liquidate their investment c. Less liquidity in shares

E. RT4: Theft of CORPORATE OPPORTUNITY

1.

2.

3.

F. RT5: DUTY OF GOOD FAITH breached?

1. 2.

3.

G. RT5: In CLOSE CORPORATIONS, heightened duty owed by shareholders to each other

1.

2.

36

3.

4.

5.

d. Majority shareholder participates in daily management of firm Space for opportunistic behavior TS1: LEGITIMATE BUSINESS REASON test a. Q1: Did minority shareholder challenge transaction? i. IF YES Can majority shareholder show legitimate business reason? A. No Minority shareholder wins B. Yes Can Minority shareholder show that majority shareholder could have accomplished same objectives in a manner that harmed minority shareholders less? 1. Yes Minority shareholder wins 2. No Majority shareholder wins. TS2 [Donahue]: EQUAL OPPORTUNITY rule a. [Donahue]: Claim of violation of fiduciary duty because minority shareholder was not given same chance to sell shares back to corporation i. Invokes partnership jurisprudence, and applies partnership-level duty b/w/ shareholders in a close corporation ii. Equal opportunity to have shares bought out iii. Concurrence: Approves of decision in terms of selling shares, but not for other decisions in running a close corp. [Smith v. Atlantic]: 4 shareholders, 25% each. Charter required 80% vote to approve corp. affairs a. Close corp. never pays dividends/ IRS assesses penalty, then other three shareholders sue b. H: Court applies reasonableness overlay to determine that Wolfson breached fiduciary duty i. Court imposes reasonableness overlay ii. Went beyond the limits of reason, despite explicit clause in charter that seemed to permit his conduct c. PROF: Majority shareholders could have dissolved corp. with only 40% of the votes, so this holding is a stretch RMBCA 8.61/DGCL 144 Entire fairness (): But see Siliconix (BJR only, if Controller TOs directly to min shareholders) Business judgment rule (): Cooke v. Oolie, RMBCA 8.61(b)(1) & Comment 2 Business judgment rule (): RMBCA 8.62(a) & Comment 1 Waste () ALI Principles of Corporate Governance 5.02 Entire fairness ()

H. SUM
(Burden of Proof) Neither board nor shareholders approve. Disinterested directors authorize

Reasonable belief in fairness (): ALI 5.02(a)(2)(B) Entire fairness (): ALI 5.02(c), 5.02(a)(2)(A), 5.02(b). Waste ()

Disinterested directors ratify Shareholders ratify

37

I.

29.

Duty of Loyalty: Can directors look after non-shareholders interests?

A. CR1 [31 states]:
1. EX: PA constituency statute a. D/Os may consider the effects of their actions on any or all groups affected by such action, including employees, suppliers, customers Under this kind of statute, Fords decision would have been approved a. These statutes seem radical and overturned a lot of prior corporate law, but they have only been invoked twice, both in the context of the a. CTR: Friedman i. The role of corporations is to make money ii. CTR: Friedman presents a false choiceits possible to do good and generate profits

2.

B. CR2 [Delaware]: There is NO constituency statute

C. GEN RULE: Virtually every corporate action can be justified on a shareholder value-maximizing theory
1. REQ: When DoL is implicated, benefits rendered to non-shareholder constituencies may violate DoL a. EX: Ross Johnsons donations were NOT deferred to i. Arranged for endowment of academic chairs in the directors names at universities of their choice ii. Arranged for fat donation to a college where a directors wife was a trustee iii. ANS: These donations raise the specter of self-dealing (i.e., personal gain for the directors) rather than corporate value [Swartz v. Friedman] a. ARG: Swartz (CEO of Timberland) b. F: Clothing company is well-known for shutting down a week per year so that employees can go work for charities c. Do good things for society, and profit will follow [Barlow] a. Q: Should corps be able to make charitable contributions? b. F: Corp donates ot Princeton. Shareholder challenges, claiming that corporation has no power to make the contribution. i. 1930 NJ statute allows corps to create and maintain charities. ii. Thus, D/Os can basically always make this argument c. H: Court defers to directors judgment that purchasing this affiliation with Princeton was good for shareholder value Q1 [AKS 301]: Can corps contribute to controversial political causes? a. Barlow probably allows this, as indicated by Target case THM: Recall self-dealing concerns from Tarnowski v. Riesop a. Courts get concerned where there is a possibility of self-dealing

2.

3.

4. 5.

38

30.

Executive pay
A. RULE
1. 2. 3. 1. Apply DoC analysis Traditionally, if compensation is approved in advance by disinterested directors/shareholders Immunizes it from shareholder attack BUT there must be some benefit to corporation, or else its waste. PRO a.

B. PROP: We should allow markets to constrain pay

[Disney]: Corporate decisions are made, risks are taken, results manifest, capital flows, shareholder value is increased i. Ps claim gross negligence to negate GF and 102(b)(7), but court refuses to set executive pay by judicial fiat Shareholders say-on-pay will lead directors to make compensation decisions based on uninformed shareholder preferences

b. 2. CON a.

[Bebchuk]: Directors do not bargain over CEO pay at arms length i. [Bebchuk]: Directors have incentives to be reelected. CEOs have power to benefit directors. Directors want to be loyal to CEO b/c he appointed them. Directors prefer that boardroom is colleegial. Directors internalize few costs of favoring CEO (since they own only fraction of stake), but they reap large benefits b. [Posner]: c. [Jones v. Harris]: >> FILL IN from lecture d. Shareholders say-on-pay is good i. Mitigates rational apathy problems ii. Opt-in or opt-out?

C. STRATs: Shareholder measures to tie CEO pay to performance

1. 2. OPT1: Tie CEO pay to revenues, costs, profits OPT2: Tie CEO pay to stock price a. BUT this may exacerbate CEO risk-aversion b/c it means his investment financial/personal capital if less diversified b. BUT stock options may INCREASE risk-preference b/c further declines in stock value do not hit CEO hard, where as further gains are worth as much to CEOs as to shareholders IRC 162(m): Stock options are performance-based compensation that can be deducted even over the $1M cap for top-5 executive compensation. SEC-required disclosures in annual proxy statements: a. Regulation S-K: Compensation of CEO, CFO, and 3 top-paid executives b. Item 402: Detailed discussion of compensation policies, link bw pay and performance, and descriptin of how compensation decisions were made c. Item 402: Summary compensation table Sarbanes-Oxley a. 304: CEO & CFO must pay back any bonus, incentives, or stock-based gains paid within 12 months of any financial statement that is later restated due to misconduct i. [CSK Auto]: Exec forced to return bonuses even though he was NOT accused of wrongdoing Limits on compensation for TARP firms a. [ARRA s. 111]: i. Required clawback of compensation to top 5 execs and next 20 highest-paid employees ii. Prohibited bonus payments to certain employees, EXCEPT bonuses conditioned on first repaying TARP funds, had value <1/3 of that employees total pay, and was paid in restricted stock (i.e., not an option) b. Treasury-appointed Special Master for TARP executive compensation empowered to i. Approve all compensation paid to top-5 and next 20 highest-paid ii. Approve compensation structures for all executive officers and next 100-highest paid iii. Interpret s. 111 as to all TARP recipients iv. Easterbrooks worst nightmare: An unaccountable bureaucrat overriding market forces c. HIST: Feinberg cut compensation by an average of 50% for 175 employees at 7 firms d. HIST: Blue-chip companies NOT subject to TARP voluntarily cut pay

D. Federal intervention
1. 2.

3.

4.

39

5.

6.

7.

[Dodd-Frank 953(b)] a. Disclosures as to (i) executive pay in comparison with financial performance of the issuer and (ii) the ratio of the CEOs pay to median pay of all other employees b. PROF: Disclosure reduces agency costs for shareholders to monitor i. PROB: Disclosure publicizes compensation May actually drive compensation UP during good years [Dodd-Frank 951]: a. At least every 3 years, proxy will give shareholders a chance to pass a nonbinding resolution to approve executive pay b. At least every 6 years, shareholders will give shareholders a chance to decide if say-on-pay vote should happen every 1, 2, or 3 years c. Shareholders also vote to give themselves annual vote DESIGN CHOICES UNDERLYING DFA 951 a. POL Q: When considering default rules that are designed to facilitate shareholder monitoring, is optout or opt-in better? i. PROB: Shareholder opt-in will cause the rule to NOT extend to some corporations for which its efficient; Opt-out will cause the rule to extend to some corporations for which its NOT efficient ii. PROF: For a rule that gives shareholder more power, its better to have an opt-out rule A. We can rely on Board to opt-out of rules that are not efficient for their corporation B. By contrast, shareholder will probably fail to opt-in to rules that are efficient (b/c of apathy) C. Opt-in rule is good if we think that shareholders will iii. DFA 951 is an opt-out rule iv. Favorable, because solve collection action problem v. Shareholders May STILL have rational apathy at point of voting, but at least it gets past procedural stage and onto ballot vi. Contra Rule 14a-8, which is an opt-IN rule b. Advantages i. Solves collection action problem ii. Shareholders can make views known iii. Feel like they have a say, which helps to solve collective action problem iv. Unbundles preferences about pay from preferences about directors c. Institutional investors want to vote every year on this type of thing d. Nonbinding, because if binding, might cause Board to act contrary to fiduciary duty i. Must have fiduciary out ii. If Congress had made it binding, would have overruled Del. law e. Implications of DFA 951 i. Unclear how this will matter to jodges ii. In 2009, shareholders approved executive pay at every TARP firm anyway

31.

Shareholder suits
A. RM of shareholder suits
1. Narrative analysis: Does P make demand? a. IF demand is made Does board refuse? i. IF board refuses BJR applies ii. IF board does not refuse Corporation brings suit against directors b. IF no demand is made Is demand excused under Aronson/Levine TS [(RT1): Not disinterested/independent; OR (RT2): Challenged decision not protected by BJR] i. IF demand is required Suit dismissed ii. IF demand is excused Does firm form SLC? A. IF no SLC formed Suit continues B. IF SLC is formed SLC recommends dismissal or settles? 1. IF SLC recommends dismissal A. TS [Zapata] : (REQ1) Corporation proves GF, independence, reasonable investigation; OR (REQ2) Courts exercise of BJ validates dismissal 2. IF SLC recommends settlement

40

A. Are the attorneys fees appropriate? B. Is settlement approved?

B. Background
1. 2. Same conduct that supports a derivative suit can usually support a direct action (usually class action). a. P can bring BOTH actions. Derivative suit technically represents 2 suits in one: One by shareholder charging directors with failure to sue on the corporation claim (usually b/c their alleged wrongdoing is the source of the corporation claim), one by the corporation actually suing directors on that corporation claim Recovery from derivative suit goes directly to corporation Q [Tooley]: Who suffered the alleged harm (corporation or shareholders?) Q [Tooley]: Who would receive benefit of recovery/remedy? Q [Grimes]: Direct suits vindicate individual shareholders structural, financial, voting, transferability rights a. Compel payment of declared dividends, compel inspection of lists b. Challenge fraud on shareholders c. Challenge sale of corporation in a merger where directors failed to be informed/structure fair transaction d. Challenge restrictions on share transferability, e. Challenge denial/dilution of voting rights, compel holding of shareholders meetings, REQ: Shareholder-P must have owned shares at time of injury REQ: Shareholder-P must own shares for duration of the suit RT1: Shareholder-P brought potential suit to the board, OR RT2: Demand requirement waived under 23.1 b/c it would be futile a. TS [Levine gloss on Aronson]: Demand is excused as futile IF EITHER: i. STD [Levin]: Very favorable to directors. Levine had lots of bad KFs that seemed to favor P. ii. RT1: Directors are NOT disinterested & independent iii. RT2 [Levine]: Show particularized facts that create reasonable doubt of the soundness of the challenged transaction? POL on Demand Requirement a. DE rule effectively creates rule of universal non-demand. If shareholder-P does not claim demand futility, he concedes that Directors are disinterested & independent b. ALT PROP [ALI]: Shareholder-P must ALWAYS make demand, and can sue only if not satisfied by boards response to demand c. ALT demand rules i. RMBCA: Must make demand and wait 90 days, unless irreparable injury If demand is refused, shareholder may continue by alleging that Board is interested, or did not act in GF ii. ALI: Must make demand and unless irreparable injury If demand is refused, court will review board motion to dismiss derivative suit using one of 3 standards: A. No dismissal if alleged undisclosed self-dealing B. BJR for alleged DoC vibrations C. Reasonable belief in fairness for DoL violations Background & Purpose a. [DGCL 141] Generally authorizes board-created committees (but no clear statutory authorization for SLCs) b. When SLC is used: If demand is excused, and some directors are interested Board may convene SLC to move separately for dismissal on merits i. SLC is usually composed of independent directors chosen for disinterestedness. ii. If SLC determines suit is not in corps interests SLC files MTD on behalf of corporation c. SLC is NOT mandatory d. CR1 [DE/Zapata]: If SLC is independent & informed Court applies its OWN BJ e. CR2 [NY]: If SLC is independent & informed BJR deference applies TS [Zapata]: Should court accept SLCs recommendations and MTD? a. Q1: Corporation bears burden to prove independence, good faith, and reasonable investigation i. Failure to bear burden MTD is dismissed and shareholders suit proceeds

3. 1. 2. 3.

C. Q1: Direct or derivative?

D. Q2: Shareholder has standing?

1. 2. 1. 2.

E. Q3 [DE]: Demand requirement satisfied, by EITHER

3.

F. Q4 [DE]: Special litigation committee

1.

2.

41

ii. [Oracle]: Oracle board appointed two Stanford profs (also board members) to SLC. SLC recommends refusing to sue Oracle. A. STD: SLC is likely to be bound by norms of human conduct. Causing a corp to sue a generous patron to SLCs university is just not done B. H: SLC is NOT independent, DESPITE 1. CTR-KF: SLC produces 1,110-page report concluding Oracle should NOT pursue Ps claims against D-Directors 2. CTR-KF: Extensive scope of SLCs investigation 3. CTR-KF: SLC members did extensive due diligence before even joining SLC 4. KF: Director-Ds were big direct donators to Stanford and created research foundations 5. KF: Ellisons stature in Silicon Valley is so large that the impartiality of ANYONE in that community WRT a suit against Ellison is suspect b. Q2: Court applies its own BJ to determine if MTD should be granted i. POL CTR: I have no business judgment. If I did, I wouldnt be a judge.

G. Q5: IF there is a settlement, did it meet REQs?

1. 2. STD [Carlton]: Court will exercise own BJ, but approve a settlement so long as its not badly off the mark PROB: We should suspect settlements b/c of CAPs and incentive misalignments a. Attorneys want to settle, b/c costs of suit increase while attorneys fees and risk of zero recovery do NOT get more favorable over time b. Directors want to settle, b/c D&O coverage will pay costs of settlement i. But a finding of fraud/self-dealing at trial Personal liability TS [Fletcher]: Substantial benefit? a. KF: If the derivative suit produced a common fund, fees may be paid from that fund b. RT: Suit maintained health of the corporation c. RT: Suit prevented abuse that would harm corporations/shareholders interests d. RT: Raised standards of corporate governance policies i. ART (Dell settlement): Corporation adopts governance policies (rule that 60% of board be independent, new accounting code, improved ethics/reporting functions) e. ART (Attorneys): Avoidance of litigation costs is a substantial benefit to the corporation f. Codified in RMBCA 7.46

H. Q6: Are attorneys fees appropriate?

1.

I.

POL on social utility of shareholders suits & attorneys fees 1. PRO a. Solves collective action problem, which would stop individual shareholders from bringing derivative suit b. Increases corporate value: Deterrence, recovery, governance changes c. Substantial benefit rule is good (over and on top of common fund rule). We want to reward value enhancing arrangements, whether or not they are qualitative or quantitative. i. Attorneys incentives aren't the same as shareholders, so maybe we want to be especially sure there's a benefit to the corporation (which we'll show by money). 2. CON a. Lost value through D&O premiums and litigation costs b. Recovered funds are merely cycled back out of the corp through D&P premiums. c. Attorneys fees supply motive for Ps counsel to bring suit (and are awarded in 90% of settled cases) i. Are fees calibrated with desirable levels of monitoring/deterrence? d. Problem of scope if we treat avoidance of litigation costs as a "substantial benefit"-- every settlement could prevent future legal fees Too much litigation if we treated that as substantial benefit.

42

32.

Control transactions: Intro and POL

A. Why pay a control premium?
1. POL on market rule a. PRO market rule [Easterbrook & Fischel] i. Sale of control blocs promotes dynamism, whose benefits include new plans, new management, reduced agency costs ii. Unequal distribution of gains reduce costs to buyers of control and increase incentive for inefficient controllers to relinquish position iii. Control premium already prices in most value-increasing opportunities (e.g., Feldman plan) b. PRO forced sharing of control premium (or equal opportunity rule) [Berle] i. Control is a corporate asset

B. Controlled mergers are highly problematic b/c they present maximum agency costs: Its a fundamental transaction,
AND there is a controlling shareholder

C. Ways to acquire control

1. 2. 3. STRAT1: Purchase control block from Old Controller STRAT2: Purchase shares of numerous small shareholders STRAT3: Once you are Controller, freeze out small shareholders

33.

Control transactions: Sale of Control Block

A. GEN RULE [Zetlin]: Market rule applies, subject to 3 CONSTRAINTS ON SELLER OF CONTROL BLOCK
1. EXC0 [Exchange Act regulations] a. RULE [14d-10]: Tenders offers in public corporations must be open to ALL shareholders b. RULE [14d-10]: Each shareholder must best price offered to any shareholder EXC1: Seller-of-control-block cannot take for himself an opportunity that belongs to all shareholders a. RT1 [Perlman]: Opportunity to extract premium for corporate asset/opportunity (i.e., having access to steel when other manufacturers dont) i. [Perlman]: Premium extracted for goodwill / unique market position A. H: Minority shareholders were entitled to share of premium paid to Old Controller B. NON-KF: Acquirer did not loot or harm the corporation in any way C. KF: Wartime, fixed prices on steel. Acquirer decided to buy the steel supplier so they can sell steel to themselves. b. RT2 [Digex]: Opportunity to extract compensation for waiver of DGCL 203 i. Board did not extract compensation from Acquirer for waiver of 203 violate boards burden to show entire fairness A. [203]: Prevents party who purchases control of Target to cash-out within 3 years, UNLESS Targets board approves ex ante ii. Board has duty to benefit all shareholders, including minority iii. Weakens market rule EXC2: No sale of corporate offices (AOT capture of control premium) a. ART(D): The premium didnt reflect the agreement to sell my office! b. STD: Smaller the control block & higher premiums More suspicion c. [Muscat]: Control block is 10%; slightly above-market premium, new Directors reelected by shareholders Upheld d. [Brecher]: Control block is 4%, 35% premium; CEO fired by board Disgorgement of control premium EXC3: Seller-of-control-block must screen out looters a. RULE [Harris]: Duty to make inquiry that reasonably cautious person would make i. Cursory investigation by Board would have revealed Acquirers suspicious financial statements to be worthless b. POL CTR [Fischel]: Its too hard to detect looters ex ante. i. Most refusals to sell on this basis would be false positives. ii. Better to ex post punish/imprison looters (accounting for undetected looting)

2.

3.

4.

34.

Control transactions: Freezeout & Controlling shareholder self-dealing

A. RM

43

1. 2.

3. 4.

TS1: Does the shareholder owe a duty to other shareholders? TS2: Was Weinberger roadmap followed? a. Independent negotiating committee that exerts bargaining power and deliberate carefully b. Transaction is subject to majority-of-minority condition TS3: Apply judicial scrutiny a. If roadmap not followed Controller bears burden of showing EF TS4: Remedy is appraisal, UNLESS Controller committed fraud a. Appraisal is pro rate claim on going-concern value of shares [DGCL 251]: Enables controlling shareholders to freeze out minority shareholders, e.g., by arranging a merger b/w/ Corp and a Dummy Corp owned by controlling shareholders, in which Dummy Corp buys minority shareholders shares with cash. Draws intense scrutiny b/c agency problems for minority shareholders 1970s: Stock prices fell and freeze-outs surged, suggesting opportunistic freeze-out activity Freeze Outs a. SP1: Controlling shareholder forms a new corporation and funds it with cash b. SP2: Controlling shareholder forces merger between new corporation and the corporation of which it is the controlling shareholder c. SP3: In shareholder vote, controlling shareholder dominates and votes yes. d. SP4: New merged corporation pays dissenting minority shareholders cash and cancels their shares. Controller might offer a smaller percentage (20% or so) in IPO, see how the corporation is going and once it is going well, freeze out the minority shareholders and take the investment value for itself Especially problematic because they couple both fundamental transactions with controlling shareholder maximum agency costs

B. Background
1.

2. 3. 1.

C. How a controlled merger + freezeout works

2. 3.

D. REQ [SEC 13e-3]: Required SEC DISCLOSURES/FILINGS for going-private transactions E. TS2 [Weinberger]: Parent/Controller-sub FREEZEOUT ROADMAP
1. 2. TRAD [Singer, overruled by Weinberger]: Freezeout w/o a colorable business purpose is per se a breach of DoL as a matter of EF RULE [DGCL 203] prevents a bidder from merging with the target for either three or five years after gaining a controlling stake, UNLESS EITHER: a. Takeover is approved by target board before the bid occurs; OR b. Acquirer gains more than 85% of shares in a single offer (i.e., moves from below 15% to above 85%), excluding inside directors shares; OR c. Acquirer gets board approval and 2/3 vote of approval from disinterested shareholders (i.e., minority who remain after the takeover). i. NOTE that this provision makes Acquirer want FEWER shareholders to tender into first-stage offer SUM: Freezeout roadmap a. RT1: Majority shareholder attempts freezeout via merger EF review, maybe w/ deference to board i. Board will receive deference IF b. RT2: Majority shareholder TOs directly to min shareholders BJR review, IF ALL i. Not coercive; independent directors have a role; i-banker analyses are disclosed RT1: IF the majority shareholder is attempting a FREEZEOUT VIA MERGER EF fairness in dealing AND fairness in price a. REQ: Fairness in price i. Q1: Controller bears burden to show EF, but can shift burden IF EITHER A. RT1: Special committee is used (by Sub), and has true negotiating power and is truly independent; OR B. RT2: A majority-of the-minority condition is used ii. Q2: How should price be assessed? A. CR1 [262 & post-Weinberger cases]: Value of the merger does NOT get built into appraisal B. CR2 [Weinberger]: Valuation includes ALL economic and financial considerations such as assets, market value, earnings, future prospects, etc. (note the expansion beyond appraisal statute valuation) b. REQ: Target creates independent negotiating committee of non-overlapping directors

3.

4.

44

5.

[Kahn]: Possibility that a not-quite-independent committee will NOT shift burden (but read this narrowly) c. REQ: Transaction is subject to majority-of-minority condition d. REQ: Did Acquirer and Target exert bargaining power at arms length? e. REQ: Evidence of genuine deliberation/negotiation b/w Subs directors and Controller i. KF: Was there an IB analysis? ii. KF: Was the transaction concluded very speedily? f. REQ: Shareholders must get full disclosure i. [Pure] g. [Weinberger]: Signal owns 51% of Target and 6/13 of Targets board seats. Overlapping directors develop report that $24 is a good price, but do not share report with Target. i. Signals offer: 55% premium; conditioned on majority-minority approval A. KF: Target approves minimal negotiation and w/ only a hastily-drafted IB proposal B. KF: Overlapping directors were involved in negotiations and persuaded nonoverlapping directors (but abstained from final vote) RT2 [Siliconix]: If Controller TENDERS DIRECTLY TO MINORITY SHAREHOLDERS No EF review; just BJR, IF ALL OF: a. GEN RULE [Siliconix]: Controlling shareholder has NO DUTY to offer a fair price UNLESS actual coercion/disclosure failures are shown i. RAT: As long as TO is pursued properly, free choice of min shareholders to reject TO is sufficient protection b. REQ1: Disclosure of I-bankers analyses/valuation opinions to shareholders c. REQ2: Offer is not coercive, as fulfilled by ALL OF: i. Majority-of-minority condition (and the minority excludes all insiders), AND ii. Controlling shareholder promises to consummate a 253 (short-form) merger at the same price at where the first-stage offer was made, if it obtains 90% of shares, AND iii. Controlling shareholder has made no retributive threats d. REQ3: Target boards independent directors must be permitted a role, by: i. Having free rein & adequate time to react to TO; ii. Hiring own advisors; iii. Providing minority shareholders with recommendation as to Controllers offer STD: If BOTH a. KF: Feisty special committee, bargaining hard, court will likely accord deference b. KF: Evidence in the deal that the minority got something (standstill, MoM provision) [Lynch]: a. KF: Disinterested IC approved the freezeout, but on threat of a hostile bid b. H: IC appropriately simulated 3P transaction, where negotiations are conducted at arms length and there is no compulsion to reach agreement i. TKY: The Acr dominated the Lynch board (were a 43% owner, you need to do what we tell you) ii. On remand, burden remains with c. TKY: BUT dont read Lynch too broadly a. [In re Western National]: Use of a truly independent committee, together with a standstill agreement Board decision gets BJR [In re Siliconix]: Majority shareholder has NO duty to secure best price if he TOs directly to minority shareholder a. Strategic implications i. If Controller dealing with a board cant get a deal they like, they can just TO directly to the min shareholders ii. In a settlemtn, the settlemtn will be less since everyone knows that it will be scrutinized under BJR as opposed to EF review. iii. TO is a risky move, since is shareholders reject it, itll be hard to go back to the board b/c there is now proof that the price is not adequate b. Conditions upon going down the Siliconix route i. [Pure]: TO to min shareholders with a MoM. Pure forms an independent committee and recommends accepting the offer.

i.

F. SUM of judicial scrutiny of TO and SC freezeouts

1.

2.

3.

4.

45

5.

6.

A. H: MoM provision is inadequate b/c the minority includes management B. H: Controlling shareholders did not disclose I-banker analysis about the value of the firm to ii. Three general rules for a rule to succeed under Pure/Siliconix A. REQ1: Offer can NOT be coercive 1. REQ1Real MoM condition (AOT a fake one in which the managers own a lot of stock) 2. REQ2: Promies to conduct 253 merger at same price 3. REQ3: Controller can not make retributive threats B. REQ2: Target boards independent directors MUST be involved somehow---you cant totally go around them 1. Hire advisors, present to shareholders, be able ot disclose information C. REQ3: Details developed by i-bankers must be presented to iii. SUM: Two approaches to freezeouts: A. RT1: Merger, subject to EF review B. RT2: TO, subject to Pure/Siliconix REQs iv. POL: Shareholders seem to receive less value when they go the Pure/SIliconix route. But dose this matter? A. ARG that it does NOT matter: Shareholders can price it in ex ante B. CTR: Shareholders dont understand thatthey might be frozen uot in this way, so maybe they cant price it in ex ante [Technicolor]: Br completed first-step TO of Target. Br proceeds to second-step freezeout a. H: Br satisfied his DoL to minority shareholders, as there was arms length bargaining and no new information that went unshared with minority shareholders. Synthesis a. Shareholders may want to bring FD claim, since appraisal is onerous/costly; DoL claims can be brought as class actions; class actions allow Ps counsel to aggregate claims and, thus, fees Appraisal is exclusive remedy, UNLESS there is either a. RT1 [Weinberger]: Fraud b. RT2 [Rabkin]: Potentially, other factors may also trigger non-appraisal remedies i. KFs: Misrepresentation, self-dealing, deliberate waste, gross & palpable overreaching ii. [Rabkin]: Controller promised to not cash out within 12 months except at the price that it purchased control block at. Cashed out at 12 months and a bit A. H: Shareholders may sue for breach of DoL Appraisal does NOT include value of post-merger entity TO is a risk strategy for an Acr, since if shareholders dont accept it, that is compelling evidence in the hands of the special committee to turn down the offer that the offer is not enough

G. Minority SHAREHOLDERS REMEDY

1. 2.

3. 1.

H. POL/STRAT considerations on Siliconix

46

35.

Tender Offer: Procedure & Regulations

A. Background: How a Tender works
1. 2. Select target (usually, undervalued company whose real value is not reflected in stock) Secretly purchase small percentage (no more than 5%) a. RAT: This saves money on purchasing once price goes up, and recoups costs if Target mounts a a white knight/share repurchase defense Arrange financing a. Usually, finance via bank loans and junk bonds b. Optionally, form a ShellCorp that will buy all the tendered shares using junk bonds/loans statutorymerge itself into Target Target corp now takes on obligations of ShellCorp Junk bonds/loans are now secured by Targets assets Publicly announce TO, stating number of shares sought after, offered price, stated minimum of shares a. Exert pressure to tender i. RT1: Implicit threat of back-end merger Targets management mounts defenses a. Seek white knight, self-restructure, pay one-time dividend, institute poison pill, share repurchase, crown jewels, etc. Outcome: a. OPT1: Bidder cant get enough shareholders to tender b. OPT2: Other bidder wins c. OPT3: Initial bidder wins Q1: Did group/person acquire +5% BENEFICIAL OWNERSHIP of a public company? a. 13(d)(1): Any person who directly/indirectly acquires more than 5% of any class of stock in a public corp must file a Schedule 13D with the SEC b. REQ1: Beneficial owner of a +5% stake must file. Beneficial owner is anyone who i. RT1: Has the power to vote of shares, OR ii. RT2: Has power to acquire shares within 60 days iii. RT3: Has power to sell of shares iv. RT4 [13d3]: Attempt to evade A. Elements 1. Use of contract/ arrangement 2. Purpose/effect is to prevent vesting of beneficial ownership 3. Part of scheme to evade reporting requirements B. [CSX]: Acquirer buys 14% of Targets stock in the form of TRSs, which are sold by ibanks. Acquirer could demand shares be delivered immediately. 1. H: Imputes beneficial ownership, as this is a scheme that violates 13(d)-3b 2. KF: TCI owned just under 5% of the stock (4.5%) 3. KF: TCI emails discussed the need to ensure that counterparties controlled less than 5% 4. KF: Testimony that the purpose of the plan was to not pay a higher price for the stock c. REQ2: Duty arises for individuals OR to persons acting in concert who acquire +5% stake i. Written agreement is NOT necessary d. Effects of triggering disclosure obligation i. RULE: Filing with SEC is due within 10 days of acquisition ii. RULE: Disclosure must contain: A. Exact number of shares purchased by person/group making the filing B. Source + amount of funds used to make purchase C. Purpose of buying shares (plans to seek control? Cause merger? Sell assets?) D. Plans to take company private Q2: Does HART-SCOTT-RODINO apply and require a waiting period? a. REQ: One party has assets of +100M; other party has assets of +10M b. REQ: Bidder would end up with +15% of targets stock c. IF YES HSR Act applies to the acquisition: i. RULE: Bidder must notify FTC and DOJ Antitrust about proposed acquisition ii. RULE: Bidder must wait 15 days before buying any more shares for cash, and 30 more days before buying any more shares for securities

3.

4.

5.

6.

B. Williams & Hart-Scott Rodino Act

1.

2.

47

3.

4.

A. Agency may obtain extension of 10/20 days Q3: Apply SECS 8-FACTOR TEST to determine whether there was a tender offer a. STD: Court is looking for factors to indicate that CAP may be especially active (and compel shareholders to tender) b. Active & widespread solicitation of targets public shareholders c. Solicitation is for substantial percentage of Targets stock d. Offer to purchase is at substantial premium over market price e. Non-negotiable terms of offer f. Offer is contingent on tender of a fixed number of shares g. Offer has limited time h. Offerees pressured to sell i. Br publicly announces acquisition j. STD: Coordinated offers are VERY LIKELY to be deemed tender offers i. Only contrary case [Brascsan]: Private calls made to 50 large investors out of 50K total; less than 0.5% premium for most blocks purchased; no stated time window; offer was negotiable (and was more like a statement of interest in buying); solicitees were sophisticated professional investors A. Only the substantial percentage prong is met B. H: Not a tender offer k. Things that do NOT qualify as TOs i. Mere purchase of large quantity of stock, without more ii. Privately-negotiated purchase iii. Open-market purchase, IF purchaser keeps secret his intent to acquire significant stake in target (obv, this isnt possible 10 days after Br crosses 5% threshold) Q4: IF its a tender offer, apply REGULATIONS APPLICABLE TO TOS a. CF1: IF it was NOT a tender offer Br need only make the 13(d) disclosure after acquiring +5% of shares b. CF2: IF there was a tender offer Regulations of Tender Offers i. RULE [14(d)(1)]: If TO would result in Bidder owning +5% of shares A. REQ: Bidder must disclose identity, financing, plans for company in a Schedule 14D-1 B. REQ: Bidder must make reasonable attempt to notify all of Targets shareholders ii. RULE: Communications by ANY party advocating shareholders to accept/reject TO are must make Schedule 14D-9 disclosures iii. RULE: Traffic rules A. Shareholders may withdraw stock from TO at any time that TO remains open B. Bidder must buy from each tendering shareholder pro rata (if TO is over-subscribed) C. Each tendering shareholder must receive best price given to ANY shareholder D. TO must be kept open for 20 days iv. RULE: Limitations on the form of TOs c. Antifraud rules [14(e)]: Unlawful to make untrue statements/omissions/deceptive or manipulative practices in connection with TO or solicitation i. Does NOT bar substantive unfairness ii. 14(e) creates implied private right of action giving rise to damages/injunction, if P SHOWS: A. REQ: Misrepresnetaion/nondisclosure was material B. REQ: D had intent to defraud/mislead C. REQ: P relied on misrepresentation/omission D. REQ: P must have standing (bidder, non-tendering shareholder, shareholder who bought/sold shares in reliance on information/omissions) iii. Remedies A. OPT1: Injunction (e.g., against bidder from consummating TO, against one party from misleading shareholders as to the opposing side, from proceeding without disclosure) B. OPT2: Recover damages (available to tendering & non-tendering shareholders, but NOT bidders)

48

49

36.

M&A: Master RM
A. Master RM
1. 2. 3. Method of acquisition Is it a tender offer? If so, apply Williams Act DoC issues a. Board didnt scrutinize offer closely and allowed a suspected-self-dealing transaction? (Van Gorkom) b. Board didnt pursue highest price (Revlon) Waivable as to monetary relief, but NOT waivable if P is seeking to enjoin a measure/transaction 4. Theft of corporate opportunity issues? a. Perelman 5. DoL issues b/c board may be self-dealing? a. Van Gorkom 6. Duty of faith? 7. Boards defensive measures permissible (in the case of hostile takeover)? 8. Can Acquirer wage a successful proxy fight (to seize the board and redeem pill)? 9. Shareholder suit 10. Shareholder can sue for appraisal after freezeout 11. Freezeouts a. RT1: Merger proposed by Controlled shareholder is subject to EF review b. RT2: Pure/Siliconix directly to min shareholders

50

37.

M&A: Methods of taking control

A. TRAD: Either proxy contest (running insurgent directors and convincing other shareholders to vote for them), or tender
offer (acquire majority shares and vote your own directors in) 1. MOD: Proxy contest and TO merged into single hybrid form of hostile takeover

B. STRAT1: STATUTORY MERGER

1. 2. 3. Boards of each corporation meet and negotiate terms of the merger a. Independent board committees should be used as early as possible to avoid Eisenberg problems) The two boards draft and agreement that usually provides for a transfer of the targets stock for stock of the acquirer TS: Proxy materials are sent to the shareholders if needed a. RULE: The vote is NOT a class vote, unless specified in the merger b. SP1: Targets shareholders vote c. SP2: Do Acquirers shareholders get a vote? i. TS1: [251(f)]: IF Acquirers stock will be increased by more than 20% the acquirers shareholders are entitled to a vote 251(f) A. 50% of ALL outstanding shareholders must vote yes to get a majority B. RAT: ii. TS2: [NYSE] Whenever there is an increase of stock of more than 20%, there needs to be a shareholder vote and 50% of stockholders who are actually voting need to approve iii. TS3: EXC: No vote is required for Acquirer if: A. The agreement doesnt require an amendment of the charter B. Each share of stock of will be identical to the stock in the surviving corporation C. There will be less than 20% of the acquirers stock added because of the merger If majority of shares approve, the targets assets merge with the acquirer and the targets shareholders receive acquirers stock Certificate of merger is filed with the secretary of state Dissenting shareholders may bring appraisal rights How it works a. Boards of the two firms negotiate a deal b. Boards present the negotiated agreement to the shareholders of the target corporation only c. Only the target shareholders get to vote ( 271(a)) i. [RMBCA]: Shareholders are only entitled to a vote if the sale leaves nothing behind (12.02) d. If shareholders approve, title for each of the actual physical assets is transferred to the acquirer i. Transaction costs are higher e. After the sale of substantially all of its assets, the target corporation distributes the consideration received to its shareholders Q1: Why use this method instead of a merger? Q2: What constitutes a sale of substantially all assets requiring a vote? a. KF: Size of the sale b. KF [Thorpe]: Not just size of the sale, but also what the qualitative effect on corporations character & purpose will be c. KF [Thorpe]: Is the transaction far out of the ordinary course of the corporations business? How it works a. Boards negotiate b. Target company presents offer to the shareholders who vote c. If majority vote is achieved, the targets shares are exchanged for the acquirers shares d. Shareholders of target and acquirer both own shares in the acquirer and the target becomes a wholly owned subsidiary of the acquirer Q1: Why use this approach? a. Benefit of wholly owned subsidiary is that there is a liability shield liabilities of the target dont transfer directly to the acquirer How it works a. Acquirer forms a subsidiary

4. 5. 6. 1.

C. STRAT2: ACQUISITION OF ASSETS

2. 3.

D. STRAT3: COMPULSORY SHARE EXCHANGE (ONLY in RMBCA jurisdiction)

1.

2.

E. STRAT4: TRIANGULAR MERGER

1.

51

2.

b. Acquirer transfers all the consideration that it will give to the target for the merger in exchange for all of the stock in the subsidiary c. Target merges with subsidiary (Subsidiary survives) (statutory merger) d. Merger consideration is distributed to shareholders of the target and the targets shares are cancelled e. Acquirer then owns a subsidiary filled with the assets of the target and the target shareholders own shares of the acquirer Voting procedure a. Target always gets a vote b. Acquirer only gets a vote IF more than 20% of new stock is issued under NYSE rules i. No vote under DE law because the acquirer is not a constituent of the merger Same as regular triangular except when the target merges with the subsidiary, the target survives Voting procedure a. Target shareholders always gets a vote b. Acquirers shareholders only gets a vote if more than 20% of new stock is issued under NYSE rules i. No vote under DE law because the acquirer is not a constituent of the merger c. Merger consideration is distributed to shareholders of the target and the targets shares are cancelled d. Target gets a vote because the shareholders will trade in their own stock in the target for stock in the acquirer so it will not be the same shares 251(f)(2) requirement is not met, so no exception from voting under DE law Create a subsidiary of Acquirers corporation Subsidiary makes tender offer to Target If Acquirer gets more than threshold percentage of shares Reverse triangular merger a. Target survives as a wholly owned subsidiary of Acquirer b. Remaining shareholders get the same payout as given in tender offer. Targets shares (that were purchased by acquirer) are cancelled. New target shares are converted STRAT Q: Why do a tender coupled with a triangular merger instead of just doing a merger?

F. STRAT5: Reverse triangular merger

1. 2.

G. STRAT6: Tender offer + Triangular merger

1. 2. 3.

4. 5.

52

38.

M&A: Public contests for control

53

39.

M&A Q1: Defenses to hostile takeover Intro & Types

A. RM
1. Q: Will takeover defense receive BJR protection (DE law)? a. IF YES BJR protection b. IF NO Defense must satisfy EF and show fair dealing/price (per normal self-dealing transaction rules) Review of defensive measures a. Unocal: Legitimate threat; Reasonable fear; Not coercive; Not preclusive; Proportional to threat; Within reasonable range b. Blasius: Any franchise-tinkering? Will enhanced scrutiny apply? IF YES No more defensive measures Do deal protection measures pass Unocal review? Shareholder countermeasures? Freezeout by a controlling shareholder a. IF freezeout via merger Weinberger analysis b. IF freezeout via TO Siliconix Pre-offer structural defenses a. REQ: Shark repellant usually require charter amendments (and thus, shareholder approval ) b. OPT1: Supermajority of shareholders required to approve merger/major sale c. OPT2: Majority of minority approval requirement d. OPT3: Staggered board e. OPT4: Anti-greenmail amendment f. OPT5: New class of stock g. OPT6: Poison pill i. Valid under DGCL 157, BUT thats only a default rule and it can be opted out A. BUT no corporation has ever opted out of the freedom to adopt a PP ii. Call iii. Flip in iv. Put Post-offer tactical defenses (SEE EM p. 482) a. Defensive lawsuit b. White knight i. Give white knight a lock-up (e.g., option to buy crown jewels) ii. Give an option to buy stock at favorable price c. Defensive acquisition (e.g., to create antitrust problems, to jack up debt) d. Corporate restructuring (e.g., take out big debt/sell assets to pay one-time dividend) e. One-time dividend f. Greenmail (buy back Brs partial stake at above-market price) g. Sale to friendly party who can be trusted not to sell to hostile bidder (white squire) h. Public share repurchase i. Exclusionary share repurchase i. NOT valid under 14d-10 (TO must be open to all holders) ii. Validated in Unocal

2.

3. 4. 5. 6.

B. Types of Anti-takeover defenses

1.

2.

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M&A Q1: Does TAKEOVER DEFENSE qualify for MODIFIED BJR?

A. Outliers & potentially overruled by DE courts [Pillsbury/Interco]: If board puts forth its own offer It must
redeem the PP and let shareholders decide b/w offers

B. STD: DE courts apply modified BJR, because of higher-than-usual probability that DOs will be acting out of selfinterest when they enact defensive measures 1. Under modified BJR, DOs must make special showings to be qualify for BJR protection 2. Unitrin gets us very sloe

C. REQ0: The measure represents an ACTUAL BUSINESS JUDGMENT

1. POL PROB: Do hidden poison pills qualify for BJR? a. DEF: A PP that is wrapped up in business judgments (e.g., pill with a built-in provision that says, if the pill is redeemed, it triggers a massive payout to some 3 rd party?) i. [Oracle v. Peoplesoft]: Oracle (Br) bids on Peoplesoft (Cp). Cp responds by launching Customer Assurance Program that triggers a massive payout to customers if Oracle acquires. A. Peoplesoft claims this is a business measure 1. Program is designed to assure that were providing proper care to our customers, and those customers specifically want Peoplesoft service and will be unhappy if they dont get that (or get compensated appropriately) B. Oracle claims this is a takeover defense 1. The program only triggers IF Oracle is acquired! ii. NOTE that DE courts have NOT yet decided on hidden poison pills

D. REQ1: Is the THREAT LEGITIMATE?

1. 2. 3. 4. 5. 6. 7. 8. IF NO reasonable legimtate threat Enjoin defensive measures STD: To find a reasonable fear is quite lenient to Board REQ: DOs acted to protect shareholder value, NOT just their own jobs RT: Threat need not be real, but merely, reasonably perceived (Cheff) RT: Threat to corporate culture (Cheff; Paramount) RT: Threat to long-term strategy unless there is clearly no basis (Time) RT: Br would change business practices in a way that would destroy value RT: Tender offer will leave corp with unreasonably high levels of debt (e.g., b/c Br will finance the acquisition with junk bonds) 9. RT: Hostile offer would cause shareholders to suffer opportunity loss (to hear Boards better offer) 10. RT: Structural coercion of shareholders a. STD: Cases forcing PP redemption usually involve all-cash, all-shares TOs (Interco; Pillsbury) 11. RT: Substantive coercion of shareholders (fear that shareholders will tender into offer b/c of ignorance about true value of the company) a. Insufficient bid alone is sufficient to constitute substantive coercion (Unitrin) b. Shareholder confusion c. ART (D): Our shareholders are rationally apathetic. Its inevitable that theyll be underinformed about the deal and confused. 12. EXs of legitimate threats a. [Moran]: Threat that someday a hostile takeover attempt might emerge Legitimate threat validating a PP. BUT use of a PP/plan will be evaluated when the issue arises.

E. REQ2: Is the FEAR REASONABLE?

1. 2. 3. 4. 5. 1. IF no reasonable fear enjoin the defensive measure KF: Good faith & conducted a reasonable investigation coming to the threat conclusion. KF: Time spent discussing measure KF: Extent of analysis KF: Outside experts valuations REQ: Not preclusive (makes it totally impossible for hostile takeover to succeed) a. IF preclusive Court will enjoin defense b. EX: A PP call plan that gives each shareholder the right to buy a share of Brs stock at 1/10 th market value c. EX: PP put plan that gives each shareholder right to sell back stock at 10x market value d. EX [Omnicare]: Absolute lockup that makes it inevitable a favored bidder will acquire company

F. REQ3: Defense is NOT PRECLUSIVE/COERCIVE

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STD [Toys R Us]: Some mathematical probability that other bidders may still find the deal viable Defensive measure is reasonable. REQ: Not coercive (does not cram down on shareholders DOs plan) a. [Selectica]: Defense that would merely continue status quo ante business strategy is NOT coercive b. EX [Unocal]: Discriminatory self-tender offer is banned under Williams Act c. EX: D/Os waste corps assets in the course of mounting defense (e.g., extravagant price paid to buy back shares in greenmail; selling off crown jewel at below-market price) IF NOT reasonable in relation to threat EF review REQ: The measure must somehow benefit stockholders a. [Revlon]: If the measure clearly deprives shareholders of the highest price for their shares no BJR KFs that Board should consider to mount a reasonable defense a. Inadequacy of price offered b. Nature and timing of offer c. Questions of illegality d. Impact on constituencies e. Risk of nonconsummation f. Quality of securities being offered IF NOT proportional EF review Courts are unclear as to what work this prong does [Mentor]: Board puts in place a 6-month slow hand pill that prevents future board from redeeming the pill. a. H: Slow hand pill is disproportionate under Unocal/Citrin i. Board did not give a good enough reason for needing the defense (besides we need 6 months to respond to a hostile offer). b. H: Delaware SC asserts that current board cannot bind future boards. This seems to prove so muchcurrent boards can and do bind future boards.

e.

G. REQ4: Defense is REASONABLE IN RELATION to the threat posed

1. 2. 3.

H. REQ5: Defense is PROPORTIONAL in relation to threat

1. 2. 3.

I.

REQ6: IF Boards defensive measure TINKERS WITH SHAREHOLDER FRANCHISE 1. RAT: As Delaware courts have moved closer to just say no Greater reliance on preserving proxy contests as means of shareholder exercise of choice & avenue to Acquirer taking control 2. Franchise tinkering = no BJR UNLESS a. RT0 [Hilton]: If there is a mixed bag of defenses, including some franchise-tinkering Review Unocal+, but Blasius-lite i. Courts face an issue of severability ii. Courts will try to get into the minds of directors to assess whether if they had known certain things would be invalidated, they would still have undertaken other measures b. RT1: Rebut Blasius by showing shareholders voted for the transaction (Gantler) c. RT2: Make a showing of ALL OF i. REQ5.a: Threat to corporate policy (Unocal) ii. REQ5.b: Compelling justification for the measure (Blasius) iii. REQ5.c: Measure was proportional to the perceived threat (Unocal) per Liquid Auto. A. [Carmody]: Dead hand provision for poison pill 1. Serious disenfranchising effect because shareholders are powerless to elect board that can redeem 2. Measure is preclusive, and thus disproportionate and unreasonable 3. EXS of shareholder franchise tinkering a. CF1: Board takes action on specific votes, timing of specific votes i. Change the date of the SH meeting (Schnell) ii. Adding more Board members in response to proxy contest (Blasius & Liquid Auto) b. CF2: By contrast, structural measures are more likely to be reviewed under Unocal STD i. Issue more shares to allied shareholders ii. Buy back stock at market price selectively from a large shareholder who would likely vote for insurgents iii. Issue additional stock at market price to allied shareholders (does not run afoul of Liquid auto) REQ6: DUTY OF GOOD FAITH breached? 1. RT1: If board acts to entrench itself, or

J.

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2. 3. 4. 5.

6.

RT2: Acts in bad faith, or RT3: Is intentionally derelict in its duties to collect information [Stone]: Failure to act in GF does not result, ipso facto, in fiduciary liability. BUT failure to act in GF may indirectly trigger liability. Q1: Where on the spectrum from malevolent intent--gross negligence does this lie? a. [Disney]: Intent to do harm ---- Intentional dereliction; conscious disregard of duties ---- Mere gross negligence b. There may be a level of negligence so profound as to trigger lack of BF No 102(b)(7) Q2: Does the subjective state of mind of the director INTEND to not serve shareholders? a. IF NO No breach (Disney) b. IF YES Possible breach STD [Revlon]: Strict view of who qualifies as independent. a. [Revlon]: Directors who were also significant shareholders, or had business ties to corporation, were NOT independent

K. Quasi-REQ5: Majority of board is independent directors

1.

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M&A Q2: Revlon enhanced DoC scrutiny applies?

A. CLR: Revlon claim is a DoC claim, but non-waivable b/c it Revlon claims seek injunctive relief B. Revlon applies where EITHER
1. 2. 1. 2. Entire company is up for cash sale; OR Control of company would pass to a single individual/group RT1: Targets challenged transaction a merger another public company thats NOT controlled by single individual/small entity RT2: Board is just saying no to lift a PP in response to a tender offer (even if all-cash and high-premium) a. If Brs tender offer is conditional on some act by the board (e.g., redemption of PP), Board may refuse to do so b. BUT the decision to say no (e.g., to keep a PP in place) must satisfy Unocal (reasonable fear, proportional) and Revlon (if level playing field was triggered) RT0: Other KFs about a challenged merger that push toward Revlon mode a. All-cash, or all-nonvoting-stock (AOT all-stock): Because court is equipped to judge cash consideration, whereas board should have deference to judge value of stock; and because nonvoting stock will not enable Targets shareholders to exercise control over company b. Acquirer is a whale, Target is a minnow: Because merger of equals implies a business strategy of synergy c. Acquirer is a controlling shareholder of Target: Because this looks like a sale of control, and court wants to ensure shareholders of Target capture control premium RT1: Target initiated an active bidding process for itself, OR RT2: Seek a transaction involving a breakup of the company (usually in response to hostile bid)? RT3 [Viacom; QVC]: Control will pass to a single individual/small group? a. IF YES Revlon scrutiny kicks in b. EX [QVC]: Boards preferred transaction would shift control from fluid aggregation of unaffiliated shareholders to cohesive new controlling shareholder i. Paramount and Viacom are in merger talks. QVC jumps in with hostile TO to Paramount. Paramount puts up defenses. ii. Br and Target embed special provisions into merger agreement to ensure that Target wouldnt simply be put in play for another Br to snap up (no-shop, cancellation fee, lockup stock option) Merger agreement fails enhanced scrutiny A. KF: Target board gave insufficient attention to features of the deal that impeded maximizing shareholder value B. KF: Target board had a competing offer on the table for a much higher price, but it was uninformed and didnt take that offer seriously C. H: On Revlon review, strikes down no-shop, termination fee, and stock options b/c they were designed to limit a competitive offer c. NON-EX [Time]: Boards preferred transaction is a stock-for-stock exchange that keeps control of Target in public shareholders hands i. Time and Warner were already in merger talks. Paramount hostile TOs to Time. Time puts up defenses. Time shareholders make Unocal and Revlon claims. A. H: No Revlon duties, because the merger would NOT result in breakup and ownership of Time would remain with public shareholders d. RAT: Control premium is costly, and compensates the minority shareholders for their lost voting power. But once current shareholders of Target sell of their shares and give up control premium, theyll never be able to recapture it. So the current sale of control must make most of opportunity to realize for shareholders the best value reasonably available. POL on Revlon duties a. Revlon imposes a tax on Acquirers b. PROF: It doesnt make sense to STD: If management is one of the bidders and/or has seats on board, court will scrutinize corporations negotiations very closely a. Target should form a special committee to handle negotiations RULE: Once management offers company for sale NO MORE defensive measures

C. Q1: ENHANCED SCRUTINY WILL NOT APPLY where:

D. Q2: Ways to TRIGGER REVLON duties

1.

2. 3. 4.

5.

E. Q3: IF YES LEVEL PLAYING FIELD rules kick in, else Boards approval of transaction is QQ (void?)
1.

2.

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3. 4.

5.

RULE: DOs have duty to obtain highest price for shareholders a. NO auction-ending lockups unless further bidding is unlikely RULE: DOs must perform market check for higher bidders a. EXC: No market check needed if directors have reliable evidence with which to evaluate the fairness of transaction RULE: DOs must treat equally all would-be bidders (no favorable treatment for white knights) a. ART(D): The defensive measures were merely meant to maximize bidding! (by leveling out the playing field by boosting the underdog and stoking a bidding war (to shareholders benefit) b. CTR-ART(P): The purpose of the measure is shut down the auction and give win to white knigth c. [Revlon]: Board gave white knight crown jewels option, no-shop option , private financial information, and promised $25M cancellation fee. Prime reason was b/c white knights offer would better protect corps creditors, who might sue Board i. CF1: Boards initial defensive measures (PP, share repurchase plan) were OK b/c of boards reasonable fear that buyer would impair corporations effectiveness by using junk bonds and selling assets to pay debt ii. CF2: BUT as soon as board authorized management to negotiate a merger/buyout DOs duty is to maximize shareholder value (auctioneer), NOT to defend the bastion of corporate value OR defend intersts of any other constituency iii. KF: Boards favoring of white knight was primarily motivated by fear of personal liability from creditors STD: Unocal is the appropriate standard in evaluating the reasonableness of deal protections where SH franchise is not implicated (Omnicare). TS: Board bears burden of passing Unocal & including fiduciary out, to receive BJR (else, injunction & damages) a. REQ0: Deal protection contract must contain a fiduciary out, in the case of lockups issued while in Revlon-mode b. REQ: Reasonable grounds for believing that a corporate policy existed and was affected by the persons stock ownership (Cheff) i. Threat to corporate policy: threat of non-consummation of the deal is typically a viable threat (OmniCare TRU) c. REQ: That the defensive mechanisms were reasonable in light of threat posed i. Per se categories A. No fiduciary out in the deal protection provisions (Omnicare) B. Precludes any additional bids because so coercive and severe ii. Where a measure is not coercive/preclusive, it is likely that the court will determine that the measure was reasonable. A. Toys R Us -- some mathematical probability that other bidders may still find the deal viable, the protection measure will be ground to be reasonable. If Unocal duties are met BJR. a. If not, the transaction may be enjoined and the BOD liable for FD damages. Does there have to be a fiduciary out in DE law? a. Omnicare Decision: DE S.Ct. held 3-2 that a fiduciary out was required in these instances b. RJ: This decision is likely to be reversed and we are not responsible for this case, but note this outcome and its ambiguities c. Under Unocal, this a grey area outcome with arguments on both sides i. For transactions subject to Revlon, the court requires a fiduciary out (implicitly; so that directors can gain the best value) ii. Why might directors pay a termination fee even when the court didnt require them? A. Directors want to be Odysseus (tied to the mast) to encourage purchasers to emerge B. In some ways DE courts are grappling with exactly the issue that Odysseus struggled with about being tied or following the sirens POL on deal protection a. PRO Deal Protections: Without them, ex ante buyers may not emerge knowing that their deal could be jumped by a later buyer i. Deal protections are the way that directors latch themselves to the initial offer b. CON Deal protections: There is a cost that accompanies this since they wont enlist in later offers so we must weight the costs of this against its benefits:

F. Q4: Are the DEAL PROTECTIONS subject to BJR, or will they cause transaction to be enjoined?
1. 2.

3. 4.

5.

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Practically, Fiduciary Out provisions amount to handing Odysseus a pocket knife where they can explore other deals if appropriate under fiduciary obligation A. This may be destructive to the value that hostile offers bring to the table Our policy choice depends on our analysis of the benefits or cons and the degree to which fiduciary outs prevent offers from arising

i.

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M&A Q4: Shareholder countermeasures available?

A. Competing visions of the corporation
1. 2. 109(b): Bylaws [which shareholders may pass] may contain ANY provision relating to business of the corporation, conduct of its affairs, rights/powers of directors, shareholders, etc. 141(a): Corporations business and affairs are managed by board of directors a. GEN STD: 141(a) trumps, so a shareholder bylaw to mandate redemption of the PP would likely FAIL PROP: Bebchuk proposes to CA to amend its bylaws to say that pill can be adopted only by a unanimous board vote, and pill expires automatically after one year unless ratified by shareholders a. SEC refuses to grant no-action letter allowing CA to omit it from its proxy NOTE that, if adopted, this proposal would enable Br to take over a firm w/ a staggered board in just one election (since the Br can establish a foothold in the board Poison pill will expire in at most a year and won't be ratified)

B. STRAT: Shareholders can AMEND BYLAWS to limit use of pill

1.

2.

C. RULE: BOARD CAN TIE ITS HANDS in a way that shifts more power TO shareholders, but it can NOT tie its hands in a
way that deprives shareholders of power (b/c of fiduciary duty) 1. [Unisuper]: News Corp (Cp) agrees with large shareholders to a board policy that any PP put in place would expire after 1 year, unless extended by shareholders. Br bids. Cps board extends pill in contravention of the earlier policy. a. Note that board is basically tying the hands of future boards b. H: The agreement to not extend PP is binding upon the board and future boards 2. Courts analysis seems to suggest that Board is merely an agent of shareholders, and must act as shareholders wish a. PROF: But as DGCL 141(a) suggests, directors CAN deviate from shareholders express wishes i. The entire reason that PPs are upheld is that the board is free to NOT follow shareholder instruction

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M&A Q5: Appraisal rights (Apply if (1) theres a freezeout, or (2) EF)
A. Process of obtaining appraisal (DGCL 262)
1. Shareholder gets notice of appraisal right at least 20 days before meeting Submits written demand for appraisal BEFORE vote Votes against/abstains merger Within 120 days after merger is effective, file petition in Chancer Court Court holds valuation proceeding to determine shares fair value, exclusive of any value arising from accomplishment/expectation of merger Statutory merger [DGCL 251]: Yes, if T shareholders vote, UNLESS stock market EXC (262) a. EXC [262(b)(1)]: Market-out Exception DENIES appraisal rights IF ANY i. RT: Shares are market-traded, OR ii. RT: Corporation has +2K shareholders iii. RT: Shareholders are not required to vote on the merger b. CTR-EXC [262(b)(2)]: Appraisal right is restored IF ANY i. Merger consideration is NOT in the form of EITHER A. Shares in surviving corporation B. Shares in a third corporation that is exchange-traded, or has +2K shareholders C. Cash, BUT ONLY IF its provided in place of fractional shares Asset acquisition [DGCL 271]: No, UNLESS provided in charter Share exchange a. [DEL 262]: No b. [RMBCA 13.02(a)]: Yes, UNLESS stock market EXC SUM CHART: Voting rights and appraisal rights a. Merger: Shareholders of BOTH constituent parties have BOTH rights (MBCA & DE) b. Triangular merger: Targets shareholders have voting rights AND appraisal rights (subject to marketout exception) c. Sale of assets: Targets shareholders have voting rights ONLY; no appraisal rights Value as minority share: Apply a minority discount to the share block Value as pro rata claim on going-concern value: Not discounted Value as pro rate concern including benefits of deal: Count additional value from the transaction MOD: DCF a. CR1 [Weinberger]: Valuation may include post-merger earning potentials, so long as it has proof and is not speculative i. BUT Weinberger court probably did this only because he was trying to make the appraisal remedy look more like EF remedy, and in doing so stretched 262(h)] ii. EX [Cede]: New business strategy implemented after a merger b. CR2 [DGCL 262(h)]: Shareholders in an appraisal action are NTO entitled to gains from that transaction TRAD measures: a. Market value of shares b. Earnings value based on previous 3 years of earnings c. Value of liquidated assets, less liabilities d. DEs old block method, which combines the above 3 measures

2.

B. Q: D Does shareholder have APPRAISAL RIGHT?

1.

2. 3.

4.

C. Q: WHAT VALUE is received under appraisal right?

1. 2. 3. 1.

D. Q: HOW TO VALUE?

2.

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Insider trading
A. Efficient Capital Markets Hypothesis
1. 2. 3. Weak form: Semi-strong form: Strong form: We get closer to true prices b/c investors are always on the lookout for mispriced assets. For many assets, there are straightforward methods of ascertaining their value. All that is needed is info and math. Information is plentiful, and investors have good reason to invest in its production. Market prices should reflect well-informed estimates, based on all available information, of the discounted value of the expected future payouts of corporate stocks and bonds. Unless ECMH is approximately correct, there would be big arbitrage opportunities (we could all jump into the market and make big profits). Ockham's razor: Holding all else equal, the simplest solution is probably the right one. SEC and DE courts tend to use this hypothesis. EX: Oracle acquisition of Peoplesoft. Testimony in court of CEO led immediately to market shifts.

B. SUM
1. 2. 3. 4.

C. PRO Why believe ECMH?

1. 2. 3.

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