Business Enterprises 2009 FACTS are very important I. Week 1 a. Shock and Awe: Introduction i. Agency 1.

PAT Franchise (pg 56, definition of a franchise) a. Cannot have an agent without a principal and you dont have a case unless you have a party complaining about the agent ii. Corporations 1. Shareholders have limited rights against the board 2. Examine liability of board on behalf of the shareholders 3. Section 141(a)- Entire Course a. The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of the board of directors 4. Section 145, Section 262 iii. Setups 1. Sole Proprietorship Flexible a. Formation: no formalities, individual just decides to form. b. Management: no formalities, sole proprietor runs the business. c. Financial rights and obligations: i. Profit / Loss sharing: sole proprietor keeps all profits, all lossses. ii. Obligations for contributions: sole proprietors assets all belong to business. d. Taxation: pass-through all income from business is income of sole proprietor. e. Liability to third parties sole proprietor personally liable for all debts of the business. f. Existence: limited to lifetime of sole proprietor. 2. General Partnership - substantial common law overlay codified in 1914 with UPA (liabilities on partners are PROBLEMS) a. Formation: Consent to form a partnership, agreement by partners to participate in a common enterprise for profit. No public filing necessary, but under RUPA 303 may file a statement of partnership authority. b. Management: default rule of one-partner/one-vote (per capita voting) for ordinary business decisions, unanimous vote for extraordinary decisions such as adding new partner or selling major asset of firm. i. May be varied by contract (partnership agreement) c. Financial rights and obligations: i. Profit / Loss sharing: equal sharing of profits, pro rata sharing of losses (may be varied by contract) ii. Obligations for contributions: determined by agreement d. Taxation: pass-through. e. Liability to third parties: partners personally liable for debts of partnership. f. Existence: UPA-dissociation causes dissolution; RUPA-dissociation causes dissolution if remaining partners elect not to continue. g. Liability (Both Responsible) Jointly and Severally Liable h. Principle and Agent are both responsible 1

i. Share in the profits and the losses equally j. Every partner is an agent and a principle k. Default Rules that Cannot be Changed: 3. Limited Partnership no common law overlay, solely a creature of statute (RULPA & ULPA(2001). a. Formation: Filing of certificate, limited partnership agreement required. General partner is required (3% of equity) b. Management: General partner manages. RULPA maintains control rule prohibiting limited partners from participating in management; ULPA(2001) eliminates control rule and specifies that limited partners are limited partners. c. Financial rights and obligations: i. Profit / Loss sharing: almost always determined by agreement ii. Obligations for contributions: determined by agreement. d. Taxation: pass-through e. Liability to third parties: general partner(s) personally liable for debts of partnership, third parties may compel limited partners to satisfy their contribution obligations in limited partnership agreement. f. Existence: specified term. g. Passive Investor h. Not liable as long as you are a limited partner i. Cannot participate in management, if you do then you are not a limited partner and you are liable 4. Corporation- no common law overlay, solely a creature of state statute (Delaware Code & MBCA are the typical examples) a. Formation: Filing of certificate of incorporation & articles. b. Management: Separation of management and ownership management by board of directors and officers. Significant requirements for annual meetings, special meetings. i. Shareholders vote on (1) election of directors; (2) extraordinary transactions (mergers, acquisitions, sale of all assets, etc.); (3) amendments to articles and (in some states) bylaws; (4) nonbinding resolutions and requests for studies by shareholder proposal. ii. Very formalized. c. Financial rights and obligations: i. Profit / loss sharing: pro rata based on share ownership ii. Obligations for contributions: none. iii. Financial structure may have multiple classes of stock and debt iv. Financial structure strictly regulated by state and federal securities law. d. Taxation: double-taxation. e. Existence: perpetual. f. Board with stockholders/investors g. Protected from liability h. Invest and that is the most you can lose i. Efficient way of raising capital 5. Limited Liability Company (LLC) - move away from the greater formalities required of corporations a. Formation still requires filing of certificate or registration. 2

b. Management: any form of management is permitted. i. Member managed (more like a partnership) versus manager managed (more like a corporation) c. Financial rights and obligations i. Vary by jurisdiction. ii. Obligations for contribution: vary by agreement iii. Financial structure very flexible (may include series of shares that apply only to certain individuals, assets, operations) d. Taxation: pass-through e. Existence: approaching perpetual, but varies by jurisdiction. f. Can be an investor and your liability is limited to your investment g. But you can have a management role h. LLC is a separate legal entity and its not taxed and can participate without increasing your liability. iv. Paramount Communications v. Time Incorporated (STUDY THIS for EXAM) 1. Facts: Paramount tries to interfere with merger between Time and Warner. Time and Warner were about the merge but it required approval of Times SHs (as well as Warners). At the same time Times Board approved of Warner, they adopted several Defensive Maneuvers. After announcment and after proxies were sent out, Paramount comes in with all cash offer of $175/sh (Time was trading at 126). Not subject to financial contingencies, but subject to legal contingencies (regulatory issues). Time rejected because it presented a threat to control of its own destiny and retention of the Time Culture. So, Time restructured the deal with Warner so SH approval was not needed and Time would take on much more debt. Paramount boosted its offer to $200. Time rejected. Paramount sued to enjoin the trx. Court says No Revlon duties, but apply Unocal. 2. ROL: A board may just say no to a buyout transaction or it may refuse to take affirmative steps so as to give the SHs a chance to approve the transactions 3. Analysis: a. Times decision to acquire Warner did not trigger Revlon Duties i. Wall Street might have viewed this as in play but not legally, because it was not enough to constitute an attempted sale ii. Did not amount to a change of control of Time. Each person who owned Time would still own the same share afterwards b. Conduct of Time did not violate duties under Unocal, which governs what defensive responses are proper i. First Prong: Reasonable grounds for believing that a danger to corporate policy and effectiveness exists Time fears that SHs would tender based on mistaken belief about the strategic benefits of Paramount offer

Board may consider LT values and strategic, is not forced to only look at ST value ($200 offer) ii. Second Prong: Response was reasonable and proportional to the threat Did not foreclose all opportunities for takeover Restructuring merger with Warner was reasonable because 3

the carrying forward of a pre-existing trx in an altered form.. was reasonably related to the threat. a. Even though they would be burdened with heavy debt 4. Board has the right to make these decisions and the shareholder did not have the option to vote on the offer a. Shareholders do get to vote on some things. i. Electing Directors ii. Approve changes to the certificate iii. Vote on liquidating decisions iv. Vote on mergers and acquisitions 5. Outstanding Stock- Must specify in the certificate how much stock will be issued. This is the stock that is actually issued. 6. File a certificate with secretary of state
Cr o t n e p o r io St pa u Sa h ld r hr o e e s Saa Cr o to pr n o r i n t pa
L g l Pr o e a es n Se Tx Py On u , a, a, w

Ba oDet r o r f ir c s d o
Rs o s l f rMn g mn ep ni e o a a e e t b 1 - 1 i e p ry a 01 tms e e r

CO E CO F E p ye m es lo P s et r id n e E p ye m es lo CO O E p ye m es lo

7. Agency relationship: shareholders do not get to do very much so to them they are the principle and the boards of directors and employees are agents. b. Fiduciary Obligation of Agents i. Types of duties 1. Duty of loyalty 2. Duty of care 3. Duty of good faith ii. Worry that the agent will not do the job or will make a mistake that will create liability. iii. Reading v. Regem (the crown) 1. A British soldier in colonial Egypt escorted, while in uniform, a smugglers trucks through Cairo (thus causing police not to inspect the trucks). 2. Soldier receives 20,000 for the escort, Roughly $1M in todays $US 3. The British Government confiscated the money. Reading sues to get the money back 4. Issue: Is there a DoL violation between P & A? Interested agent transaction? No, since the principal is not a party to the transaction 4

5. 6. 7. 8. 9.

Usurping a business opportunity, Benefits Arising Out of Position? Duty of Loyalty- The crown did not lose any money, but they had an interest. Remedy: Had to return the money to the crown. There was no fiduciary relationship, but there was a dishonest use of the uniform. Rule: a. Cannot act in secrecy if you are an agent and benefit from that position. Duty of honest and good faith if this is violated then it doesnt matter that the principle was not injured. b. An agent who takes advantage of the agency to make a profit dishonestly is accountable to the principal for the wrongfully obtained proceeds.

iv. General Automotive Manufacturing Co. v. Singer 1. Plaintiff employer hired defendant employee as general manager of its business and affairs and defendant accepted employment pursuant to a written contract. But D solicited customers on his own behalf. Plaintiff brought suit against defendant for breach of contract. a. Ways to Violate Loyalty- Corporate Opportunity (part of loyalty), Secret Profits, Failure to disclose b. Candor Court makes a big deal that all he has to do is tell his employer i. Cant have secret profits ii. Fiduciary duty of good faith and loyalty. iii. Full Disclosure Ex. Fannie May, current economic situation 2. The trial court found that defendant had breached his contract of employment with plaintiff because his sideline business was in direct competition with plaintiff. Defendant appealed. 3. The court held that by failing to disclose all the facts relating to certain orders and by receiving secret profits from the orders, defendant violated his fiduciary duty to act solely for the benefit of plaintiff. Therefore, defendant was liable for the amount of profits he earned in his sideline business. 4. The court held that defendant's operations were in competition with plaintiff, and that he had received undisclosed personal profits. The court found that the amount of recovery by plaintiff was to be limited by plaintiff's stipulation. 5. Rule a. An agent who draws business away from his principal for his own enrichment is liable to the principal for his profits therefrom. 6. The rule applied by the court is a default rule that is one that applies in the absence of agreement. v. Rash v. J.V. Intermediate, Ltd. 1. Facts: Rash was hired by JV as a manager of its Tulsa division. During the terms, Rash established its own businesses, none of which were ever disclosed to JV and one of which was in competition with JV in business nature. 2. The Court held that there was a fiduciary relationship because (1) Rash was hired to build the Tulsa division from scratch and had sole management responsibilities for operations at the branch, (2) Rash contractually agreed to perform the duties of an agent, and (3) Rash does not deny that he was an agent of JV. 3. Texas law: among the agents fiduciary duties to the principle is the duty to account for profits arising out of the employment, the duty not to act as, or on account of, an adverse party without the principles consent, the duty not to compete with the principle on his own account or for another in matters relating to 5

4. 5. 6.

7.

the subject matter of the agency, and the duty to deal fairly with the principle in all transactions between them. The employee has a duty to deal openly with the employer and to fully disclose to the employer information about matters affecting the companys business. Although an employee does not owe an absolute duty of loyalty to his or her employer, at the very least, an employees independent enterprise cannot compete or contract with the employer without the employers full knowledge. Rash had a general duty of full disclosure respecting matters affecting the principals interests and a general prohibition against the fiduciarys using the relationship to benefit his personal interest, except with the full knowledge and consent of the principal. The duty of an agent is to disclose to the principal what the principle should rightly know.

c. Fiduciary Obligations of Partners i. You do not need to file a paper to establish partnership ii. One reason for using partnership is tax purpose 1. Example a. Corporation (100 earned -> IRS gets 37% -> 63% goes to corporation and shared by shareholders) b. But, partnership: pass-through (100 earned -> general partner gets 3, partner 1 gets 48.5, and partner 2 gets 48.5 -> then IRS taxes each partner) iii. Partnerships are often called aggregates rather than entities to emphasize that they have no independent existence apart from their members. iv. Meinhard v. Salmon 1. In 1902, Gerry leases a hotel to Salmon. He is probably a real estate investor. 2. Meinard is going to put up half the money and so is Salmon. 3. Salmon entered into a joint venture with Meinhard by which Meinhard would provide the investment capital, Salmon would manage the business, and the two of them would divide up the profits 40-60% for the first five years(even though capital contribution was 50:50 and capital loss was 50:50, it is up to the parties). It is a 20 year lease. 4. Twenty years later, in 1922, when the lease was about to run out and the joint venture therefore to dissolve, the property owner approached Salmon (the only one of the parties that had ever dealt with the owner) and offered him an opportunity to lease a much larger swath of property, including the current building, for a much bigger redevelopment project. Salmon agreed and entered into a new lease between himself and the property owner, without informing or involving Meinhard. 5. When Meinhard learned of this deal, he sued to be let into the deal on the grounds that the opportunity to renew the lease belonged to the joint venture. A referee agreed, and awarded Meinhard a 25% interest 6. The court further held that Salmon was an agent for the joint venture, and when Salmon agreed to the new business opportunitywhich was made available to Salmon only because he held that position with relation to the joint venture Salmon carried the joint venture into the new lease with him 7. This decision extended the duties of partnership far beyond duties under a contract. It determined that in such a relationship, loyalty must be undivided and unselfish, and that a breach of fiduciary duty can occur by something less than fraud or intentional bad faith. 6

8. Salmon need only have advised Meinhard of the opportunity when it arose and then either of them would have been free to compete for the project. 9. Rule: Managing partner in a joint venture had a fiduciary duty to inform the investing partner of an opportunity that would arise after the scheduled termination of the partnership. (Candor/Loyalty) a. Created a duty of loyalty to fully disclose to his joint adventurer 10. Dissent: Contended that any duty following from the partnership ended at the end of the twenty-year period; because the partnership was created to manage the building for the twenty-year term, the dissent felt that deals involving events to occur after the expiration of that term were of no matter to the partnership. 11. 15-404: (a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care. (b) limited to the appropriation of a partnership opportunity. (c) A partnerships duty of care to the partnership and the other partners in the conduct and winding up of the partnership business or affairs is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. d. Raising Additional Capital i. Capital is the money that a corporation can use ii. Problem 1. Understand how to get investments. 2. Refer to Game Plan 103(b) 3. If you are in a partnership and you think there is something weird going on with the numbers then you can demand an accountant to go through the books. iii. Sharing of Losses 1. Kovacik v. Reed a. Reed is a service partner; Kovacik contributes $10,000. Profits divided equally. No salaries paid. After 10 months of losses, the partnership has only $1,320 (i.e., it lost $8,680). Kovacik sues to dissolve and demands that Reed share half the loss ($4,340). b. Kovaciks capital account: $10,000 4,340 = $5,660 c. Reeds capital account: $ 0 4,340 = ($4,340) d. The general rule is that in the absence of an agreement to the contrary the law presumes partners and joint venturers intended to participate equally in profits and losses of the common enterprise, irrespective of the amounts contributed, each sharing in the loss in the same proportion as he would in the profits. e. However, that presumption applies only in cases in which each party had contributed capital or was to receive compensation to be paid to them before computation of the losses or profits. This is not such a case. f. Rule: Where one party contributes money and the other contributes services, in the event of a loss each would lose his own capitalthe one his money and the other his labor. Another view would be that in such a situation the parties have, by their agreement to share equally in profits, agreed that the value of their contributionsthe money on one hand and the labor on the otherwere likewise equal; it would follow that upon the loss of both money and labor, the parties have shared equally in the loss. g. Exceptions 7

i. Courts do not apply the Kovacik rule where The service partner (Reed) was compensated for his work The service partner (Reed) made a capital contribution, even if that contribution was nominal. iv. Notes 1. RUPA creates a different rule, 401, that says partnership losses are split in the same manner as profits. RUPA 807 says the partnership agreement can provide otherwise. Court implied that since Reed gave only services, he was not to cover losses. 2. Section 40(b): Liabilities of partnerships are paid in the following order: a. Those owing to creditors other than partners b. Those owing to partners other than for capital profits c. Those owing to partners in respect of capital d. Those owing to partners in respect of profits 3. Section 40 (d): Partners shall contribute the amount necessary to satisfy the liabilities. 4. UPA 18(a): Profits are shared equally and losses are shared proportionally v. Buyout Agreements 1. A buy-out, or buy-sell, agreement is an agreement that allows a partner to end her or his relationship with the other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for her or his interest in the firm. 2. Applies equally in the corporate and LLC context. 3. In all buyout agreements, price and valuation is critical and never simple. a. Valuation problems: i. No market. ii. Minority interest. iii. Control premium b. Solutions to valuation problems: i. Hire an appraiser. 4. Agreement should provide mechanism for selecting an appropriate appraiser because its hard to do in the middle of a knock-down, drag-out fight over control. 5. If you make an investment in a public company and buy 100 shares of X then six weeks later you sell it, then that is fine for a public company where shares are actively traded but this doesnt work in situations like Salmon and Meinhard. 6. Rule: Any lawyer who doesnt advise someone to urge a buy/sell agreement is guilty of malpractice. a. Ex. Meinhard wants out, how does he get out? i. Wise to have an exit strategy in any given agreement. II. Week 2 a. Nature and Roles of Corporations i. Promoters of the Corporate Entity 1. Why Delaware: Predictability, Flexibility, Expertise, Strong Legislature is active, Specialized Courts, and protects shareholders. If necessary they amend the state constitution. Recently they amended the Constitution to allow advisory opinions to allow agencies to ask for these. a. California is another strong state. b. Promoters and the Corporate Entity i. Promoter is a term of art referring to a person who identifies a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people. 8

ii. Section 388 of the Restatement of Agency: Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal. iii. Parent v. subsidiary iv. Brothers v. sisters v. Internal Affairs Doctrine: Refers to the law that controls the workings of a corporation. 1. Ex. Spill coffee on a person from Hawaii in the state of MI and it is a MI company then MI law applies. Internal Affairs that control the corporation is Delaware Law. vi. Corporate Law General Rule: As a promoter, owes a fiduciary obligation to the corporation. His obligation is like that of an agent to a principal. If he does not reveal his interest in the land or profit there maybe a problem. vii. Franchise Tax- Based on the Number of shares. If you do not pay it then after the second year your corporation is over. viii. Preferred Stock: Sold in 100 or 1,000 shares and you get a certain amount, usually about 5% each quarter. Much more regular kickback. In common stock you only get dividends if here is money left over. There is a contractual obligation in preferred stock. Sometimes gets a right to elect a director to the board if they do not get paid. It gets a dividend before the common. When they cannot pay and the company goes bankrupt and everything is paid off then the preferred gets a portion first. 1. Convertible Preferred- Can convert preferred to common if you want to vote or if you want a larger dividend. ix. Six Characteristics of a Corporation 1. Perpetual Existence Continuous 2. Separate Existence Single Entity 3. Limited Liability Shareholders and Officers are not liable to third parties for debts. In a partnership that is not the case. 4. Centralized Management Separation of Ownership and Control 5. Passive Ownership Stockholders have a limited voice. Separates ownership and Management. 6. Freely Transferable Transfer ownership interests. No limitations. In partnerships they have to screen the person and ok it, where in a corporation they do not. x. How do you create a corporation? 1. File a Certificate of Incorporation (the article of incorporation) 2. That is the only thing the state needs to see 3. Capital Common Stock, Preferred Stock, Debt, Bonds, High Yield Debt (Junk) xi. How does a Corporation Work 1. Works through an individual, always has to act through people 2. There are inside and outside directors a. Outside - Not an employee and is not independent b. Examine whether the board is controlled by people who are employed or looking out for the greater good. 3. Ex. Board of Directors own no stock whose interests are they looking out for? a. Fiduciary duty to the corporation and the shareholders b. Rare instances where the duty to the shareholders are not the same as the duties to the corporation. c. Ex. Can the board of a corporation decide to outsource to a jungle rather than pay for U.S. employees? i. Yes, but it is not lucrative. ii. A point where you stop worrying about the shareholders and worry 9

about the creditors. When you have left Chapter 7 and gone to Chapter 11. xii. Cases on page 200-201 1. Case 1: Ann buys land for $125,000 and sells it to Shawn for $200,000. Ann cannot make a profit by lying to the person. If Ann doesnt misrepresent or lie Shawn can pay or not pay. If he does buy then there is no problem 2. Case 2: Art bought land for $125,000 and Paula has a history with Paula because he served as her agent for acquiring land. She is seeking to acquire the land that Art owns and she does not know he owns it. She pays $200,000. If he follows Full Disclosure and tells her then things are fine. When he has a secret profit that is where the problem is. If it has been a long time since the two have seen each other the issue then becomes whether or not there is a duty that still exists. If he withholds that information he has to give back the profit under the Restatement. If there is an agent and a principal there is a duty of fiduciary duty. 3. Case 3: P Corp is owned by Paula and she is the president but Art owns the Land. Art paid $125,000 for the land and Paula wants to buy it for $200,000. Paula cannot proceed as an individual against Art since she is an owner and the corporation is a person. The Corporation paid for the land and the corporation can act through people. If it is wholly owned then she is the board, president, and owner. Paula cannot go forward as an individual since she has not role and as a president she did not put forth her own money. The owners and managers have to be separate. The corporation can bring the suit. 4. Case 4: Art buys land for $125,000. He creates the corporation. He then sells the entity to Paula. Paula pays $200,000. So the money runs through the corporation and not blackacre is a part of the corporation. Art is a promoter so there is an obligation to the corporate entity so when he sells he is benefiting from the corporation and he cannot when he is a promoter. Promoters have a fiduciary relationship. If Art sells for $200,000 and then Paula creates a corporation then if it is a promoter relationship then there is a fiduciary duty, but if not then one does not exist. xiii. Southern Gulf Marine v. Camcraft (Corporation by Estoppel) 1. Southern-Gulf filed suit for breach of contract against Camcraft for failure to deliver a ship. Camcraft responded that Southern-Gulf had no cause of action because it was not incorporated at the time the contract was executed. The trial court decided that since Southern-Gulf was not a corporation at the time the Vessel Construction Contract was signed, the contract was not enforceable because it had only one party. Boat cost more to build than what is was being sold for. 2. Promoter is fiduciary to the corporation. 3. The contract stated that Southern-Gulf a company to be formed, would purchase a vessel from Camcraft. This contract acknowledged future Vessel Construction Contract that was executed between Southern-Gulf and Camcraft. 4. Issues: a. Should Camcraft be estopped from asserting Southern-Gulf's lack of incorporation? b. Does the fact that Southern-Gulf was incorporated in the Cayman Islands instead of Texas allow for the breach? 5. Holdings: a. Camcraft should not be able to escape it's breach of contract based on the character of the organization to which it is obligated unless Camcraft's 10

substantial rights would be affected. Camcraft acknowledged the validity of Southern-Gulf when they contracted and thus should be estopped from denying otherwise. b. Camcraft had no objections originally and the contract allowed for assignments or transfers. 6. Essentially, the court found corporation by estoppel because of reliance by both parties, construction had begun, liability would have been found the other direction had Southern-Gulf defaulted. 7. Rule: a. One who contracts with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced. b. Where a party has constracted with what he acknowledges to be a corporation, he is stopped from denying the existence or the legal validity of such a corporation. 8. Camcraft made 2 arguments: a. No contract because Plaintiff corporation was not incorporated at time of execution of contract b. Corporation was incorporated in the wrong jurisdiction xiv. Piercing the corporate veil (NOT ON FINAL) 1. If the shareholder has abused the power of the corporation 2. The whole purpose of having a corporation is to have a limited liability c. The Corporate Entity and Limited Liability i. Walkovsky v. Carlton 1. Carlton, D., is a stockholder in 10 corporations 2. A taxi driver, driving a cab owned by one of these corporations, negligently hit and severely injured P. 3. Though the multiple corporations are independent, they are run as unit vis a vis financing, supplies, repairs etc. 4. And P is trying to sue all ten corporations (enterprises liability) 5. Issue: Is Carlton personally liable to P. because the multiple corporate structure constituted an attempt to defraud the members of the general public? 6. Rule: Agency principle: a. whenever anyone uses control of the corporation to further his own rather than the corporation business, he will be liable for the corporation acts. b. Upon the principle of respondeat superior, the liability extends to negligent acts as well as commercial dealings. c. However, where a corporation is a fragment of a larger corporate combine which actually conducts the business, a court will not pierce the corporate veilo to hold individual shareholders liable. 7. Corporations are responsible to Shareholders. 8. If the cab was owned not by one corporation, but by an assemblage of corporations, the larger corporate entity is liable as the principal 9. If the individual stockholder to the corporation is using the corporation as a dummy and is carrying on the business for purely personal rather than corporate ends, then he is liable as the principal. 10. P. has not alleged that Carlton, was running the taxi cab business for purely 11

personal ends. There is no justification for piercing the corporate veil. Liability is limited to corporate assets, until P can show that D was running the company in an individual capacity and not for the benefit of the corp. 11. Notes: Three types of legal doctrines that the plaintiff could have asserted: a. Enterprise Liability b. Respondeat Superior c. Disregard of the corporate entity (piercing the corporate veil) ii. Stockholder v. shareholder v. stakeholder 1. Stockholder is used in Del 2. Shareholder is used in all other states 3. Stakeholder can be employee, community, environment iii. Sea-Land Services v. Pepper Source (Piercing the Corporate Veil) 1. P shipped peppers for D. corporation Pepper Source. 2. PS failed to pay freight bill. PS had been dissolved for failing to pay annual state franchise tax. 3. P sued to pierce PSs corporate veil and render Marchese, the single shareholder, personally liable. 4. P further claimed that Marcheses other corporations were also liable as they were alter egos of each other existing for the purpose of defrauding creditors. 5. One way to terminate a corporation is to not pay your finance tax, and the corporation was then dissolved. 6. D did not formally take the money from the corporations. He just took them. He did not even have his own bank account. 7. Issue: Is Marchese personally liable (is the corporate veil pierced) because he created and manipulated these corporations for his own personal use? 8. Rule: The veil will be pierced when (Fraud and Injustice) a. There is such unity of interest and ownership that the separate personalities of the corporation and the individual cease to exist. b. Circumstances are such that adherence to the corporate form would sanction a fraud or promote injustice. (injustice). (INJUSTICE MUST BE AKIN TO FRAUD OR SCHEME OF DECEPTION). 9. Factors for disregarding separate entities a. failure to maintatin corporate records or formalities. b. commingling of funds and assets c. undercapitalization d. one corp. treating the assets of another corporation as its own. 10. Held: no, P has not shown enough to pierce Ds corporate veil. a. The first prong of the test is satisfied. i. The separation between corporation and Marchese was completely gone. ii. He held no corporate meetings; iii. no charter or bylwas; one office; iv. same expense accounts for all corporations; v. Marchese mixed his funds with PSs funds. b. However, the 2nd prong is not satisfied. P could not show fraud, which requires intent. Court notes that injustice for the purpose of the 2nd prong is not equivalent to Ps judgment not being satisfied there must be some additional wrong -- eg. undermining common sense rules of adverse possession, partners skirting rules on monetary obligations; unjust enrichment. Since P did not allege any injustice beyond the failure to 12

c. Thus, it was reversed and remanded. And when it was

satisfy its judgment, P has not shown injustice.

remanded to the district court, the court found in favor of Sea-Land.

iv. Roman Catholic Archbishops v. Sheffield 1. Trial court held that petitioner was an alter ego of the church, the Bishop of Rome. 2. Real party in interest purchased a dog while traveling in Switzerland from an order of Catholic monks. 3. The court held there was no evidence to support application of the "alter ego" doctrine, because there was no showing that petitioner controlled and dominated the organization with whom real party in interest contracted. There was also no showing that failure to pierce corporate veil would lead to inequity. Judgment was entered in favor of petitioner. 4. The terminology alter ego or piercing the corporate veil refers to situations where there has been an abuse of corporate privilege, because of which the equitable owner of a corporation will be held liable for the actions of the corporation. 5. Requirements for applying the alter ego a. The corporation is not only influenced and governed by that person (or other entity), but that there is such a unity of interest and ownership that the individuality, or separateness, of such person and corporation has ceased, and b. That an adherence to the fiction of the separate existence of the corporation would sanction a fraud or promote injustice 6. The alter ego theory makes a parent liable for the actions of a subsidiary which it controls, but it does not mean that where a parent controls several subsidiaries each subsidiary then becomes liable for the actions of all other subsidiaries. There is no respondent superior between the subagents. 7. Rule: No liability for brother and sister relationships. a. Where a parent corporation controls several subsidiaries, the corporate veil of one subsidiary may not be pierced to satisfy the liability of another. b. The alter ego theory may not be applied where the unsatisfied creditor-plaintiff will merely not be able to collect if the corporate veil is not pierced. v. Notes: 1. When corporation owns all the shares of common stock of another corporation the first corporation is known as the parent corporation and the second is a subsidiary 2. There are a number of reasons for this setup, but the one reason is that generally the parent, like any other shareholder, is not liable for the debts of the subsidiary, so the parent can undertake an activity without putting at risk its own assets, beyond those it decides to commit to the subsidiary. vi. In Re Silicone Gel Breast Implants Products Liability Litigation 1. Bristol-Myers is the sole shareholder of Medical Engineering Corp. (MEC) after purchase. MEC purchased 2 other companies, but all negotiations went through Bristol and paid for through a Bristol account. MEC's board of directors generally consisted of the Bristol VP, another Bristol exec, and MEC's president. The 13

Bristol VP could not be outvoted and several former MEC presidents were completely out of the loop as to board meetings, several not even knowing of the board's existence. Bristol set the employment policies and wage scales for MEC. MEC submitted reviews and 5-year plans. MEC submitted budgets for approval. Bristol's name and logo appeared in the package inserts and on promotional products of MEC. 2. Issues: a. Did Bristol have corporate control over MEC? b. Did Bristol have direct liability of MEC? 3. Holding: Yes. (social justice decision) a. The potential for abuse of the corporate form is greatest when, as here, the corporation is owned by a single shareholder. b. In a corporate control claim seeking to pierce the corporate veil to abrogate limited liability and reach the parent corporation, summary judgment could be proper if the evidence presented could lead to but one result. c. Many of the factors to be considered are present. This would be sufficient to pierce the corporate veil. d. The totality of circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation. i. The parent and the subsidiary have common directors or officers ii. The parent and the subsidiary have common business departments iii. The parent and the subsidiary file consolidated financial statements and tax returns iv. The parent finances the subsidiary v. The parent caused the incorporation of the subsidiary vi. The subsidiary operates with grossly inadequate capital vii. The parent pays the salaries and other expenses of the subsidiary viii. The subsidiary receives no business except that given to it by the parent ix. The parent uses the subsidiary's property as its own x. The daily operations of the two corporations are not kept separate xi. The subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings. xii. Specifically in this case, the court as most persuaded by the grossly inadequate capital and the parent paying the expenses of the subsidiary. e. Delaware courts do not necessarily require a showing of fraud if a subsidiary is found to be the mere instrumentality or alter ego of its sole stockholder. f. In addition, many jurisdictions that require a showing of fraud, injustice, or inequity in a K case do not in a tort situation. vii. Notes (WORTH KNOWING FOR THE FINAL) 1. Limited Partnerships came into widespread use for tax shelter investments. 2. In 1960, there developed a variation on the basic limited partnerships: a limited partnership with a corporation as a sole general partner. a. Under this form no individual was liable for the debts of the partnership viii. Frigidaire Sale Corporation v. Union Properties 14

1. Union Prop Inc is the general partner of Commercial Investors, an LLP. The other partners of this LLP served as the officers of Union Prop. 2. Frigidaire is the plaintiff and had a contract with Commercial Partners and it is a limited partnership (trying to avoid liability). The General Partner is Union Property. M and B are the limited partners in Commercial Investors and also works for Union as Officers, shareholders and directors. 3. The individual defendants were limited partners of Commercial Investors as well as officers, directors, and shareholders. 4. Ct found that just because they were also officers doesnt mean they automatically incur general liability as partners of the LLP. Since they scrupulously separated their actions on behalf of the corp. from their personal actions, Plaintiff had notice that they were not the general partners. 5. Frigidaire should have ensured some way to collect! No one was misled here, just as in Wakowski. 6. Rule a. Limited partners do not incur general liability for the limited partnerships obligations simply because they are officers, directors, or shareholders of the corporate general partner. b. When the shareholders of a corporation, who are also the corporations officers and directors, conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporations separate entity should be respected. III. Week 3 Board has a fiduciary duty to run the company for the best interests of shareholders and corporation. BJR(let the board do they decide) is good unless is really stupid. Ways to beat the BJR o To prove the breach of duty of care; real bad or terrible bad decision are not enough, it has to be really stupid so that it can be presumed that there are some other reasons behind it. o To prove the breach of loyalty (loyalty includes condor) o To prove the breach of good faith The BJR is the Central Doctrine of corp. law. o The BASIC ISSUE in corporate law is the tension between giving the directors the freedom to act in their best judgment, decision making autonomy and punishing them for their misdeeds. a. Shareholders Derivative Actions / Role and Purposes of Corporations i. Demand: Shareholder must make a demand upon the board to pursue corporation rights. Grimes. Depends on if it is derivative or direct. If you dont make a demand you dont give them a chance to fix the mistake. 1. If derivative then demand required unless plaintiff pleads particularized facts raising reasonable doubt that directors would be disinterested and independent or entitled to protections of the BJR ii. Derivative: Seeks to require the corporation to bring a cause of action on behalf of the corporation against a third party or director. (Harm to corporation that diminishes value of shares). A recovery goes to the corporation and not to the individual.) 1. Must make a demand on the board, if demand is not sought then the claim cannot be brought unless they can prove futility (disinterested board, waste) However, all of this is examined under the BJR. 15

iii. iv.

v. vi.

vii.

2. Sometimes the state requires a bond if a derivative suit is brought on his or her own. Direct v. Derivative: Direct is when something has been done to an individual such as diluting his vote. A derivative suit is about an injury to the corporation itself (contract violations, directors are competing with the corporation, ). BJR: Presumption that the Board is right. Way for the court to say we dont care if they dot it right or wrong, you have to show that they did something wrong in order to have your suit stand. Cannot go to the courts if it was merely a bad decision. It forgives mistakes. Direct: The shareholder has suffered a direct injury (Suit by a shareholder) Cohen v. Beneficial Industrial Loan Corp. 1. Facts: Shareholder brought Derivative action against Corp. BIL incorporated in DE, run from NJ. SH owned very little stock. NJ required SH who owned < 5% post a bond for $125K: DE provided no bond. Which law applies. 2. Internal Affairs Doctrine 3. ROL: (i) Not unconstitutional to base classification for SH derivative actions upon the amount of stock owned by party. (ii) Use of bonds ok in derivative actions. 4. Jackson: Management of a modern corporation has uncontrolled discretion over the handling of other peoples money. This is a problem since there is stockholder helplessness. Equity allowed a shareholder to step into the corporations shoes and to seek in its right the restitution he could not demand in his own. 5. Rule: a. Bond requirement is procedural and therefore will follow state law of NY. The Supreme Court is involved and sees the opportunity to abuse and also create a remedy for the helpless stockholders. b. A shareholders derivative suit will follow state non-procedural laws regarding the derivative suits when possible c. A statute holding an unsuccessful P liable for the reasonable expenses of a corporation in defending a derivative action and entitling the corporation to require security for such payment is constitutional. Eisenberg v. Flying Tiger Line Inc 1. Max sued Flying Tiger. He claims it was an individual action, not a derivative action. FTL claims it was a derivative actions therefore bond is needed. 2. Look to complaint to determine type of suit. If injury is to the corporation, then its a derivative action. If injury is one to the plaintiff, then its an individual and maybe take the form of a representative class action. 3. Merger was a complex plan to deprive minority shareholders of any vote or influence over the affairs of the new company. 4. Plaintiff Eisenberg argues that the right to vote on Flying Tigers affairs belongs to stockholders per se, and not to the corporation as a whole. It is a personal, direct action. 5. 251: Any two Delaware Corporations can merge. 252-254, discusses other types of corporations. 6. Holding: the essence of Ps claim is that the reorganization deprived him and fellow stockholders of their right to vote on Ds affairs. This was in no sense a right that ever be3longed to D itself. Although there has been much debate over the precise definition of a derivative suit, the current codification deems a suit derivative only if it is brought in the right of a corporation to procure a judgment in its favor. Suits are now derivative only if brought in the right of a corporation 16

to procure a judgment in its favor. 7. The shareholder just wants to get paid. Want a bond here as well. 8. It is possible for the new company to take over the old and the old take over the new or the old and new create a third company. 9. Rule: a. You need to put up a bond for a derivative claim, but you do not have to put a bond up if it is not a derivative. In this case he is arguing that he has a direct loss, he is arguing that he is losing his voting rights but he loses. b. A cause of action that is determined to be personal, rather than derivative, cannot be dismissed because the P fails to post security for the corporations costs. viii. Notes 1. Special injury test determines whether a suit is direct or derivative 2. A wrong that is separate and distinct from that suffered by other shareholders or a wrong involving a contractual right of a shareholder such as the right to vote or assert majority control, which exists independently of any right of the corporation. 3. The Delaware supreme court rejected the special injury test in favor a twopronged standard to be used in determining whether a stockholders claim is Derivative or direct under Delaware Law: a. Who suffered the alleged harm, the corporation or the suing stockholders, individually b. Who would receive the benefit of any recovery or other remedy, the corporation or the stockholders, individually 4. Attorney Fees a. Corporate managers who have harmed the corporation generally will be relieved of risk of personal losses if the corporation pays large fees to the plaintiffs attorneys in return for their willingness to accept settlement, especially one with a form of relief other than money damages. 5. Individual Recovery in a Derivative Action a. Sometimes a court awards an individual recovery in a derivative action b. State Law Disclosure/Requirement of Demand on Directors i. Grimes v. Donald 1. Facts: Demand Made and Refused. Grimes made a demand that the board abrogate an agreement to executive officer. Board refused. Grimes complaint involved allegations of violation of due care, waste, and excessive compensation; thus, derivative claim. Since derivative action, demand is required. 2. 141 managed and the affairs by the board of directors. 3. The abdication claim is a direct claim. a. But this claim is dismissed. b. If a K could have the practical effect of preventing a board from exercising its duties, it would amount to a de facto abdication of directorial authority. c. But not here (BJR applied: doctrine relieving corporate directors and/or officers from liability for decisions honestly and rationally made in the corporations best interests) 4. The due care, waste and excessive compensation claims are derivative claims a. A stockholder filing a derivative suit must allege either that i. The board rejected his pre-suit demand or ii. Allege with particularity why the stockholder was justified in not 17

having made the effort to obtain board action. b. Examples of exceptions to pre-suit demand are that i. A majority of the board has a material financial or familiar interest ii. A majority of the board is incapable of acting independently for some other reasons such as domination or control, or iii. The underlying transaction is not the product of a valid exercise of business judgment. c. Purpose of pre-suit demand i. By requiring exhaustion of intracorporate remedies, the demand requirement invokes a species of alternative dispute resolution procedure which might avoid litigation altogether ii. If litigation is beneficial, the corporation can control the proceedings iii. If demand is excused or wrongfully refused, the stockholder will normally control the proceedings. 5. ROL: If a demand is made and rejected, the board rejecting the board demand is entitled to the presumption of the business judgment rule unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption. 6. Since P made a pre-suit demand with respect to all claims arising out of the agreements, he was required to plead with particularity why the Boards refusal to act on the derivative claims was wrongful. 7. The complaint failed to include particularized allegations which would raise a reasonable doubt that the Boards decision to reject the demand was the product of a valid business judgment. 8. Demand Futility a. You believe the Board will not look at demand properly, and the Demand would be Futile b. If there is reason to doubt the board acted independently or with due care in responding to the demand, the stockholder may have the basis ex post to claim wrongful refusal. c. Factors: i. Majority of the Board has a familial or financial interest ii. Majority of the Board is incapable of acting independently iii. Underlying transaction is not a product of BJR 9. Rule: Must give the board a change to fix the problem. In this case the board went through the motions and the advice was to not go forward with the suit. Written Demand, Ninety Days: Can bypass this if futile or waste by the company. WASTE does not equal Compensation (Waste is too hard to prove). Prove reasonable doubt that the board was acting in good faith. 10. 141(c)(1): Committees of the Board a. The board can always delegate to a subset of the board the full power of the board. b. If you have a board and it says we delegate the power of the board to ____ then that is 141(c). c. Give the minority directors the ability to determine whether or not the deal should go through. Them the ability to negotiate mergers. The shareholders elect incumbents. ii. Marx v. Akers 1. Facts: Plaintiff commenced a shareholder derivative action against IBM Board of 18

2.

3.

4.

5.

6.

Directors before first demanding that the board initiate a lawsuit. It was alleged that the board wasted corporate assets by awarding excessive compensation to IBMs executives and outside executives also that the board violated duties owed to IBM by voting unreasonably high compensation. The complaint was dismissed for failure to make a demand. Demand Excused. Issue: a. Whether the allegations are sufficient and establish with particularity that demand would have been futile? i. Yes, personal benefit b. Whether Plaintiffs complaint fails to state a cause of action? i. No Three types of tests whether a failure to serve a demand is justified a. Delaware: Two Prong Test whether a failure to serve a demand is justified i. Once the director interest has been established the business judgment becomes inapplicable and the demand is excused without further inquiry ii. Whether the directors exercised procedural and substantive due care b. Universal demand: ABA has suggested requiring demand in all cases without exception. c. NY: no universal demand requirement nor the Delaware approach since nothing has been adopted by the legislature i. Reasonable Doubt Standard ii. ROL below ROL: In NY a demand would be futile if a complaint alleges with particularity any of the following a. Majority of the directors are interested in the transaction b. The directors failed to inform themselves to the degree reasonably necessary about the transaction c. The directors failed to exercise their business judgment in approving the transaction Barr Decision a. Not enough to merely name a majority of directors as parties defendant with conclusory allegations or wrongdoings. Must be specific and particular. b. Demand was excused because of the self-dealing, or self-interest of those directors in the challenged transaction. c. However, as to the disinterested outside directors, demand could be excused even in the absence of their receiving any financial benefit from the transaction if they were guilty of a breach of their duties of due care and diligence to the corporation. The purpose of demand a. To relieve courts from deciding matters of internal corporate governance by providing corporate directors with opportunities to correct alleged abuses, b. To provide corporate boards with reasonable protection from harassment by litigation on matters clearly within the discretion of directors, and c. To discourage strike suits commenced by shareholders for personal gain rather than the benefit of the corporation 19

7. Holding: a. Directors are self-interested in a transaction if they receive a direct financial benefit from the transaction that is different from the benefit to the shareholders generally. b. Demand is excused because of futility when a complaint alleges with particularity that a majority of the board of directors is interested in the challenged transaction i. Self interest in the transaction ii. Loss of independence c. Demand is excused because of futility when a complaint alleges with particularity that the board of directors did not fully inform themselves about the challenged transaction d. Demand is excused because of futility when a complaint alleges with particularity that that challenged transaction was so egregious on its face that it could not have been the product of sound business judgment of the directors. e. Directors are self-interested in a transaction where they will receive a direct financial benefit from the transaction. f. A director who votes for a raise in directors compensation is always interested because that person will receive a personal financial benefit from the transaction g. A cause of action will not stand alone on the basis of excessive salary raises unless wrongdoing, oppression, or abuse of a fiduciary position is also demonstrated. 8. When a plaintiff does not go through the demand process, the plaintiff must prove the futility of demand. To prove the futility of demand, the plaintiff must allege particularized facts, which create a reasonable doubt that, (1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. The court held that a director who voted for a raise in a directors' compensation is always interested. c. The Role of Special Committees i. Auerbach v. Bennett (Business Judgment, SLJ, Demand) 1. Allegations of kickbacks. Audit committee found bribes did occur. Hired Special Litigation Committee to figure out best course of action. SLC determined the corporation should dismiss cuz recovery chance was low and costs were high. SH sued. 2. ROL: a. Courts will not make an independent determination of whether the committee was correct in its conclusion that the probability of recovery was low and costs high. Instead, the committees substantive recommendation that the suit be dismissed and the boards approval will receive the protection of the BJR. At this point in history it was not illegal to give to political figures. i. Courts will intervene on procedural issues ii. Courts will NOT intervene on substantive issues b. A court may properly inquire as to the adequacy and appropriateness of a special litigation committees investigative procedures and methodologies, but may not consider factors under the domain of business judgment. 20

3. The business doctrine recognizes that courts are ill-equipped to evaluate what are and essentially must be business judgments. (So cannot intervene on substantive issues). Therefore, the conclusion reached by the special litigation committee is outside the scope of the courts review. 4. However, the rule shields the deliberations and conclusions of a special committee only if its members possess disinterested independence and do not stand in a dual relation that would prevent an unprejudicial exercise of judgment. 5. Important factors: a. Committee was comprised of truly independent directors b. The issue was substantive because they looked at the decision, not how they got to the decision. ii. Zapata Corp. v. Maldonado 1. Facts: Maldonado instituted a derivative action on behalf of Zapata alleging breach of FD. Maldonado did not make demand stating all directors had interests. 2. ROL: a court WILL NOT automatically grant a special litigation committees recommendation to dismiss a derivative action. A court will evaluate the Procedures a committee uses. Thus, a court must balance the interests of the parties with a 3. The business judgment rule does not confer power to corporate board or directors to terminate a derivative suit. 4. The BJR is not relevant in corporate decision making until after a decision is made. It is generally used as a defense to an attack on the decisions soundness. 5. 2 Step Zapata Test (DE Only) a. Step1: Determine if the committee acted in Good Faith and Independently i. Did the committee follow reasonable procedures during this process ii. If No in Step1; then court will automatically disregard the committees decision and allow the lawsuit to proceed b. Step2: Court can apply its own independent judgment whether the lawsuit should have been dismissed. 6. Important factors: a. ONLY apply Zapata test in Demand Excused cases b. Demand activates BJR; then court will not apply their own BJR c. If no Demand, then no activation of BJR; court will apply their own BJR iii. In Re Oracle Corp. Derivative Litigation 1. Produce a 1110 report and the guys that are the insiders and traded on inside information, but the rest of the board had to bring in new guys in order to make it look like the SLC were disinterested. 2. In analyzing whether the SLC was independent, emphasis should not be placed exclusively on domination and control. 3. Instead, the law should take into account human nature, human motivations, and the social nature of humans. 4. Thus, a court would not only consider greed or avarice, but would also take into account envy, love, friendship, collegiality, and other like motivators. 5. At bottom, the question of independence turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interest of the corporation in mind. 6. In the context of human nature, the SLC has not met its burden to show the absence of a material factual question about its independence. 21

a. Because the ties among the SLC, the trading Ds, and Stanford are so substantial that they cause reasonable doubt about the SLCs ability to impartially consider 7. Independent and Reasonableness 8. Rule: a. The question of independent turns on whether a director is, for any substantial reason, incapable of making decision with only the best interests of the corporation in mind. The court must focus on impartiality and objectivity. b. A special litigation committee does not meet its burden of demonstrating the absence of a material dispute of fact about its independence where its members are professors at a university that has ties to the corporation and to the Ds that are the subject of a derivative action that the committee is investigating. 9. MUST HAVE AN INDEPENDENT COMMITTEE, bring in outsiders that have no connection to the corporation or its board members. d. The Role and Purposes of Corporations i. AP Smith Mfg. v. Barlow 1. Facts: Value company gave charitable donations to Princeton. SH Derivative action claiming the donations were ultra vires (beyond the power). Court determined charitable contributions are ok for corporations. 2. ROL: (i) Corporations formed before the enactment of a law still must abide by that law, (ii) Charitable donations are permitted and within the charter of all corporations. The corporation is there to make money, but it can give it away. 3. Important factors: a. Not to pet charities b. Not in furtherance of personal needs v. corporate need c. Made to preeminent institutions of higher learning d. Within limits of statutory enactments e. Public policy supports charitable donations 4. Note a. Delaware 122 Every corporation created under this chapter shall have the power to make donation for the public welfare or for charitable, scientific, or educational purposes and in time of war or other national emergency in aid thereof. b. It is possible for corporations to adopt charter provisions expressly limiting and prohibiting charitable contributions ii. Dodge v. Ford Motor 1. Facts: Ford was doing very well. He was paying high dividends. Then decided to stop paying dividends to expand operations and reduce price of cars for the working man. 2. Court forced him to pay dividends of surplus, but did not stop expanding of operations. 3. Henry Ford owned 58% and did not want to pay the dividends. 4. The court is making the decisions in this case, then Henry moved out of MI and never had another problem. 5. When you read about a board that is dominated something remember Henry Ford. 6. ROL: There must be fraud or a breach of good faith which directors are bound to exercise toward the stockholders in order to justify the courts 22

entering into the internal affairs of corporations. Corporation is organized for the benefit of the shareholders, not for charitable purposes. A corporations primary purpose is to provide profits for its stockholders. The court will no longer get involved since the Business Judgment Rule. 7. Important factors a. Plenty of surplus iii. Shelnsky v. Wrigley 1. Facts: Derivative action where SH wanted Wrigley to start playing night games to increase revenue. Wrigley considered, but determined night games would decrease value of property and they owned a lot of property in the area. Since no allegations of fraud, illegality, or conflict of interest, court applied BJR. Wrigley wins 2. ROL: Allegations that directors are not acting within corporate interest, but are not fraudulent, illegal, or conflict with interests must be evaluated using the BJR. a. The directors judgment unless shown to be tainted with fraud is accepted as final - Presumption that it was formed in good faith and was designed to promote the best interests of the corporation they serve. b. The authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law. 3. Purpose is to make money and it has to be good for the legal entity/person then you are making money for the shareholder. 4. Important factors: a. No allegations of fraud, illegality, or conflict of interest IV. Week 4 a. The Duties of Officers, Directors and Other Insiders i. Inside v. Outside Directors 1. Inside the corporation is the board of directors, and below that is the CEO and the employees 2. Inside means getting a paycheck 3. Outside means not on the payroll, like the CEO and employees 4. Independent Directors Head hunters. We need special litigation committee to look at decisions of the board and decide whether or not the board is making a good decision. b. Duty of Care i. Duty of loyalty duty of fiduciary to act on behalf of beneficiary, place beneficiarys interests ahead of the fiduciary. Generally described as a duty to avoid self-dealing or appropriation of opportunities of the principal. 1. The agent is liable to disgorge any/all secret profits obtained from a transaction that breaches the duty of loyalty. 2. If the transaction is a loser, the agent is on his/her own. ii. Duty of candor duty to provide information to the beneficiary. iii. Duty of good faith and fair dealing contractual duty imposed/implied in every contract. iv. Business judgment rule Directors and officers will not be personally liable to the corporation for mere mistakes in judgment, so long as their business judgment was not tainted by breach of the duty of loyalty or gross negligence/malfeasance. 1. Practically, under Delaware law and most state codes, the business judgment rule has been codified to provide that if the directors have avoided any conflicts of interest (duty of loyalty breaches) and if they have gathered information and thought about their decision in the problem they face (exercised their business 23

judgment with care), courts will not permit plaintiffs to second-guess that decision if it later turns out wrong. v. Can overcome presumption by 1. Bad Faith 2. Intent to violate positive law 3. Gross Negligence vi. The rule is a rebuttable presumption that directors know better than the courts how to operate the corporation. 1. Directors are there; courts can only second guess. a. Post hoc litigation is a bad place to be making or assessing business decisions. b. Dont want an overly cautious board. 2. Presumption that directors (a) acted on informed basis; (b) in good faith; (c) in honest belief that action was taken in Corporations best interests. 3. BJR is rebutted where: a. Decision lacks a business purpose; b. Is tainted by conflict of interest or is otherwise self-interested; c. Is so egregiously bad that it amounted to a no-win decision (very rare); or d. Results from an obvious or prolonged failure to exercise oversight and supervision. vii. Two types of due care: 1. Procedural due care was the process used in reaching a decision rational; 2. Substantive due care was the actual decision substantively rational? viii. Whether the complaint states a claim of waste of assets, i.e., whether what the corporation received is so inadequate in value that no person of ordinary, sound business judgment would deem it worth what the corporation has paid. c. The Obligations of Control Duty of Care i. Kamin v, American Express Company 1. Recovery goes to the corporation. 2. Dividend in Kind: Money to the shareholders that is not necessary or expected. 3. American Express Company purchased Donaldson, Luken and Jenrette, Inc. (DLJ) at a cost of $29.9 million. DLJ's market value at the time of litigation was $4.0 million. Instead of selling DLJ's shares on the market, where American Express would sustain a large loss, which could be offset against taxable capital gains on other investments, saving the company $8 million, American Express declared a special dividend to shareholders of record pursuant to which the shares of DLJ would be distributed in kind. The rationale was that reporting the loss would have an adverse effect on American Express stock. The plaintiffs brought suit alleging a waste of corporate assets. 4. A complaint alleging that some course of action other than that taken by the board would have been more advantageous does not give rise to a cause of action for damages. (Bean Rule is that you have to have a paper trail) 5. They could have sold the shares of DJL and distributed the proceeds to the shareholders of American Express. The alternative, which they chose was to distribute the DJL shares in kind to American Express shareholders. 6. The cost was $8 million in lost tax benefits. The court even found that the decision not to sell the DJL shares might have benefited four of the defendants who were employees of American Express. ii. Smith v. Van Gorkom (Crucial Case/on past exams) Derivative Action *Split Decision* 1. Trans Union, a large publicly traded, diversified holding company, whose primary 24

revenue stream was railcar leasing, was generating significant investment tax credits (ITCs), which they could not utilize because of insufficient taxable income. In response to the ITC problem, the management team presented the Board with a report, which recommended courses of action in dealing with the ITC issue. The sale of Trans Union was not one of the recommended strategies. Nevertheless, Jerome Van Gorkom, Trans Union's CEO and Chairman, pursued selling Trans Union to a company with a large amount of taxable income. Van Gorkom proposed a share price of $55, which was above market value, but there was no evidence that the $55 figure represented the per share intrinsic value of the company. Van Gorkom negotiated a deal privately with Jay Pritzker, a wellknown corporate takeover specialist. Van Gorkom presented to the Board a merger proposal involving Pritzker. Subsequent to the board meeting and without any director reading it, Van Gorkom signed the merger agreement at the opening of the Chicago Lyric Opera. Pritzker and Van Gorkom then signed amendments to the merger agreement, which deviated from Van Gorkom's representations to the board and which made it difficult for Trans Union to negotiate a better deal. 70% of the shareholders approved the merger. The Court of Chancery found that the Board had given sufficient time and attention to the transaction to reach an informed business judgment on the cash-out merger proposal. (No shopping for a better deal and if someone notices and offers you a better deal then that is a fiduciary out. Since the obligation is to the shareholders) 2. The CEO made a deal and then presented it to the board, which approved it quickly, without adequate information and adequate deliberation and without conducting a market check. 3. The Business Judgment Rule presumes that, when making the business decisions, directors, act on an informed basis, in good faith, and in the companys best interests. (Stocking Horse person who gets the transaction going and then locking up the transaction) 4. Lockup: Lockup the deal. The purpose of the lockup is to create an incentive for oneself to purchase the company. 5. 102(b)(7): Its ok to breach the duty of care. 6. Go Shop at No Shop: Target argues for (we think $55 is good, but we have to look for anyone who will pay more). 7. 141(e): Can rely on reports of officers. You dont have to go checking. 8. Good Faith: More looking at the outcome and deciding if what the person did seems like it is in good faith. It is the opposite of blind reliance. 9. If the directors do not make an informed decisions, they must immediately cure any defects in their decision-making process as soon as they learn of the problem. 10. The board of directors failure to inform itself before recommending a merger to the stockholders constituted a breach of the fiduciary duty of care and rebutted the presumptive protection of the business judgment rule. Directors were liable for damages. 11. Duty of Care: If you have a great duty of care claim it doesnt matter. Directors can protect themselves. Delaware doesnt look at these claims, because you must allege something more than care. 102(b)(7). Loyalty direct conflict of economic interests. Good Faith act and omissions not in good faith (however we dont know what good faith is, but may be inside loyalty). 12. This was a cash out merger so that is all you get. 13. No one wants to buy the company for $55 so its a bad price. 25

14. 141(e): Poor paper trail. They should have stated that the Officer issued a report that the board relied upon. 15. What if price was negotiated or what if there was an officer report? 16. Good Faith: a. Covered in Loyalty b. No one knows what it is c. Not indemnified in 102(b)(7) 17. Notes: Cinerama v. Technicolor a. Opposed the acquisition and voted against the merger. b. The court held that Technicolor board had violated its duty of care c. The board always has an obligation to understand the deal and research it. d. Per Se Rule of awarding damages for breach of fiduciary duty of disclosure. e. Various Factors: i. The timing ii. Initiation iii. Negotiation iv. Structure of the Transaction v. The disclosure to and approval by the directors vi. The disclosure to and approval by the shareholders f. One way in which directors faced with the opportunity to sell the company can protect themselves is to hire an investment banking firm to issue an opinion as the fairness of the price that has been offered. g. Affording Directors protection from liability: 102(b)(7) iii. Brehm v. Eisner 1. In order to constitute waste, an exchange must be so one-sided that no person of reasonable mind would have entered into it. The waste-test is very stringent. 2. An exchange that is so one sided that no business person of ordinary sound judgment could conclude that the corporation has received adequate consideration. 3. The redress for failures that arise from faithful management must come from the markets, through the action of shareholders and the free flow of capital, and not from the court. 4. In comparing The Tans-union case and the this case one treats the Business Judgment rule as having a substantive content as a standard of liability only after one has first determined that the directors satisfied some standard of conduct. Raises the bar from negligence to gross negligence or recklessness. iv. In Re Walt Disney Derivative Suit (What are the Elements?) 1. Claim against Directors a. Breach of Due Care and Breach of Good Faith i. The court finds that there is no breach 2. Claims against Obitz a. Breach of Loyalty b. Negotiating a new contract c. De Facto Fiduciary (Claim doesnt hold) 3. Eisner fired Orbitz 4. Litbach: General Counsel, did not successful allege a duty of loyalty 5. Footnote 38 a. 102(b)(7) ONLY covers directors 26

6. Footnote 112: (Why?) a. Cant find someone liable just for not acting in good faith. 7. Compensation committee is comprised of outside directors, Hired Crystal a. Board is allowed to give power to committees (141e) i. Establish a committee with the full powers of the board 8. A failure to act in [may be found] . . . where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the company, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act demonstrating a conscious disregard for his duties. 9. most salient examples of a failure to act in good faith: a. where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation; b. where the fiduciary acts with the intent to violate applicable positive law; c. where the fiduciary intentionally fails to act in the fact of a known duty to act, demonstrating a conscious disregard for his duties. 10. Waste Practices: a. So one sided that no business person of ordinary sound judgment could conclude that the corporation has received adequate consideration. b. Cant be waste to honor a contract i. If you entered into a contract then the payment of a contract can never be waste. 11. Best Practices: What the board should have done, but isnt required to do. a. Bad Faith pg 16: i. Intentional dereliction of duty ii. Subjective Bad Intent iii. A conscious disregard for responsibility iv. Actual Intent to do Harm v. Intentionally violate positive law vi. Gross Negligence vii. -------------------Also, viii. Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct ix. Make material decisions without adequate information and without adequate deliberation x. Consciously ignores his or her duties to the corporation, thereby causing economic injury to its stockholders, the directors actions are either not in good faith or involve intentional misconduct. 12. Reasons why they did not act in bad faith: a. they did not adopt an "ostrich-like" approach; b. they were informed of all material information reasonably available; and c. they considered the issue for a not-insignificant period of time. v. Francis v. United Jersey Bank 1. Family business and the husband died and left the business to his wife and his sons. They became directors after he died. 2. The Creditors are bringing the claim in this case not the shareholders. 3. All the court is doing in this case is making sure that the sons do not get the money. 27

a. Wouldnt have made a difference if she would have resigned or objected 4. Duty of oversight 5. Directors have the duty to act honestly and in good faith and with the same degree of diligence, care, and skills that a reasonably prudent person would use in similar circumstances. Directors must diligently discharge their duties. Duty to keep informed, mistakes are allowed but there is still a duty to do something. You cannot just do nothing. If you do so little it may be gross negligence and may be enough to overcome the business judgment rule. vi. In Re Caremark International Inc. Derivative Litigation (Important Case) 1. Anti-Referral is the law at issue. 2. Caremark International, Inc. was indicted and pleaded guilty to violating a federal statute which made it a felony to pay kickbacks to persons for referring Medicare and Medicaid patients to it. The company was forced to pay approximately $250 million in criminal fines and civil reimbursement. The suit is a derivative action against the board, asserting negligence and a failure to monitor company activity. 3. Although directors have a duty to monitor a corporations ongoing operation, they are not liable for wrongdoings of which they had no real or constructive knowledge. 4. The directors are protected from liability if their decision was the product of a process that was either deliberately considered in good faith or was otherwise rational even if a judge or jury were to conclude that the decision was stupid or irrational. V. Week 5 a. Duty of Loyalty Directors and Managers i. Stock represents an ownership interest in the corporation. 1. Dominant Shareholder: It has to be so high that the minority shareholders cannot market their shares as easy in a publicly traded company. a. Suggested that the Duty exists, but not apparent b. When it is 51% or more of the stock c. Duty is that they have to be looking out for the minority shareholders and that they are not stuck with unmarketable shares d. Similar to the duty that the director owes to all shareholders ii. Gives shareholders a bundle of rights and powers with respect to the corporation. 1. Dividends pro rata payments by corporation to equity shareholders based on corporate earnings. a. May be cash, property (in kind), more stock (stock dividend), debt, or any other transferable rights. b. Declaration of dividends is a matter of business judgment for the board of directors. 2. Liquidation rights on dissolution pro rata distributions in cash or in kind upon dissolution of the corporation. 3. Voting rights election of directors and approval of significant corporate transactions. 4. Conversion rights right / option to convert stock into another security of the corporation. 5. Redemption rights option to force the corporation to repurchase shares, usually at a specified formula or value. 6. Preemptive rights right to acquire stock in proportion to current ownership interest whenever corporation issues stock (protect shareholders proportionate 28

share in corporation) iii. Generally two main classifications or classes of stock: 1. Common stock represents the lowest priority of ownership interests. a. Gets what is left of the corporate income (going concern) or assets (bankruptcy) after satisfaction of all other financial claims by (1) lawyers (bankruptcy); (2) secured creditors; (3) unsecured creditors; (4) employees; (5) bondholders; and (6) preferred shareholders. b. No guaranteed dividends. c. Voting rights. d. Liquidity rights it is easier to sell common stock because there is usually more of a market for it. What you see on the New York Stock Exchange is primarily common stock. 2. Preferred Stock hybrid between debt (bonds) and common stock. a. Earns fixed dividends (Guaranteed dividend of $3.60 per share.) i. Unpaid dividends often carry forward and accumulate. This provision is called cumulative. b. Fixed liquidation rights (Guaranteed payment upon liquidation of $500/share (or often par / book value)). Commonly this is the initial purchase price of the preferred. c. Participation rights right to participate with common stock in any dividends declared on the common stock. d. No voting rights can be changed by statute (right to vote on fundamental changes affecting the stock / transactions, e.g., mergers, sale of substantially all the assets of the corp.) or in the articles of incorporation. e. Conversion rights often have a right to convert preferred stock to common stock; = convertible preferred. i. Anti-dilution provisions formulae for ensuring that conversion rights of preferred stock remain a constant percentage if more common stock is issued. ii. Redemption rights option to force the company to purchase stock at specified price. iv. Bayer v. Beran 1. A director does not breach his or her fiduciary duty by approving a radio advertising program in which the wife of the corporate president, who was also member of board of directors, was one of the featured performers. 2. Rule requiring directors undivided loyalty avoids possibility of fraud and the temptation of self-interest 3. If a disinterested majority of directors had ratified a contract and if the complaining party could not prove it unfair, the courts generally held the contract valid. 4. It was not in the minutes and not approved by the board. 5. BJR is a presumption that the what the board does is ok, but there is an assumption that says that they have no internal conflicts. BJR yields to the rule of undivided loyalty. 6. No contract can be void (144) a. If the facts are disclosed or known OR b. The Board approves it. 7. This is not a duty of care case. Substance over form. 8. Directors are agents of the shareholders. v. Benihana of Tokyo v. Benihana 29

1. Benihana of Tokyo filed suit, but not clear who is on the board and who authorized it 2. The claim was a violation of Duty of Loyalty 3. Remedy: depends on what happened, similar to duty of car. a. If there is a Duty of Loyalty it will come if there is a negative effect on the shareholders stock. b. Duty of Loyalty is most of the time the same as Duty of Care i. Not properly informed 4. Written Record: a. Just helped prove that the duty has been proved b. Due Dilligence 5. Corporate Opportunity a. Duty of Loyalty 6. The court finds no violation in this case 7. If Deleware says you can do it and the board does it then your suit will not be successful. 8. Executive Committee: Do something between meetings so the executive committee are always has the power to take all the actions that the board can take. a. Every full meeting has a summary of the executive committee activities and then the board supports it. 9. BOT authorized the lawsuit against Benihana Inc. a. The shareholders of BOT (three kids + lawyer) b. The Protective Trust decided that it was bad. 10. The court below says there is no problem because of BJR 11. Staggered Board/Classified Board: If A (3 people elected year 1), B (3 people elected in year 2), and C (3 elected in year 3) and then the power is transferred to B and C even is A is reelected. Ensure that control is kept over the board. 12. In trying to show a duty of care and loyalty it is difficult for the plaintiff to show that the director did not do what he needed to do 13. Corporate waste will be very difficult to prove 14. Domination are methods to show a breach of loyalty and they have to be extremely egregious vi. Lewis v. S.L. & E. 1. A transaction in which a director has an interest other than as the corporations director is automatically suspect and subject to further review. 2. Directors must not engage in self-dealing 3. Book Value: Assets Liabilities + shareholders (Liquidation of Assets and Liabilities) 4. Market Value: What its selling for in the public sphere. (Trading Price) 5. The BJR assumes no Conflict and if there is a conflict then you have to prove that it is fair. BJR assumes that directors can make business decisions, however, not when the board is on both sides of the transaction. 6. Duty of Care: a. Tried to inform themselves, but were not grossly negligent. 7. Loyalty: a. Can have a conflict, two sides of the transaction. b. You can also have a duty to disclose. c. Corporate Opportunity d. Directors must put a corporations interests before their own b. Corporate Opportunity 30

i. Broz v. Cellular Information Systems 1. Under the doctrine of corporate opportunity, a corporate fiduciary must place the corporations interests before his or her own interests in appropriate circumstances, but a corporate fiduciary does not breach his or her fiduciary duty by not considering the interests of another corporation proposing to acquire the corporation in deciding to make a corporate purchase 2. NO paper trail in this case 3. Four Factor Test for CORPORATE OPPORTUNITY: No single factor is dispositive/Must balance all the factors a. If there is presented to a corporate officer of director a business opportunity to which the corporation is financially able to undertake and b. is from its nature, in the line of the corporations business c. Is of Practical Advantage to it and is one in which the corporation has an interest or reasonable expectancy and d. By embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of the corporation the law will not permit him to seize the opportunity for himself. ii. In Re Ebay Inc. (Duty of Loyalty, Corporate Opportunity) 1. The fiduciary duty of loyalty requires directors and officers to offer investment opportunities derived from corporate business to the corporation before acting on them individually 2. Officers and directors may not usurp a corporate investment opportunity 3. An opportunity is within the corporations line of business when it involves an activity as to which the corporation has fundamental knowledge, practical experience and ability to pursue 4. Restatement of Agency 388 a. Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal. b. Comment to Rule: i. An agent, who, without the knowledge of the principal, receives something in connection with, or because of, a transaction conducted for the principal has a duty to pay this to the principal even though otherwise he has acted with perfect fairness to the principal and violates no duty of loyalty in receiving the amount. 5. Restatement 387 a. An agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected to his agency. 6. Spinning of IPO shares is widely unethical c. The Intersection of Loyalty and Good Faith i. Stone v. Ritter (Intersection of Good Faith and Loyalty) 1. Duty of Good Faith, Loyalty, Care a. Seems to imply there is only a duty of care. If you violate Duty of Care then there is no presumption of BJR b. *Gets rid of Good Faith and questions Loyalty as being something that is under Duty of Care (After Stone, no one really knows) c. If you violate the Duty of Loyalty you must show entire fairness i. Fair Dealing and Fair Price 2. The plaintiffs in Stone brought a derivative suit against the directors of AmSouth Bancorporation. AmSouth had paid $50 million in fines and penalties for failing 31

to file suspicious activity reports. The branch employees who should have filed the reports not only did not do so but did not report the facts upward in the corporation. The directors did not know, and had no reason to know, that reports should have been filed. The plaintiffs sought relief on a Caremark theory: that the defendants utterly failed to implement a monitoring system. The Chancellor dismissed the complaint, and the Supreme Court affirmed, on the ground that no basis for a Caremark claim existed thus the directors could not be personally liable so demand on the board was not futile. There was 11,600 employees and one of them suspected. Money laundering violations. 3. OVERSIGHT: The board of directors is suppose to take care of all the offices and all the employees, but its not a breach of duty if the board did its best and tried. Sustained systematic failure to prevent oversight will be a breach of duty. 4. Specifically characterized the duty of good faith as part of the duty of loyalty. Good Faith will not subject directors to personal liability, if you have a violation of loyalty then you have bad faith. a. Good Faith disappears and is not inside the loyalty issue. 5. Two important strands of Delaware corporate law converged: a. The concept of good faith b. The duty of directors to monitor the corporation's employees for law compliance. (Loyalty) 6. "Although good faith may be described colloquially as part of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. 7. Cant just say there is a beach of good faith, must show more 8. Stone court makes clear that acts taken in bad faith breach the duty of loyalty. 9. Good faith has been subsumed by loyalty. 10. 102(b)(7): Directors cannot be indemnified if its a breach of loyalty. Can exculpate directors from monetary liability for a breach of duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty. a. If its care then you are ok. 11. Violation of positive law is a breach of loyalty. 12. No basis for the oversight claims, so with the duty of care the people in this case were informed enough and had performed their duties 13. Oversight Factors: a. Some type of procedure or system in place that the board or management is in charge of b. Consciously failing to monitor c. Must have the system and monitor the system, such as reporting 14. When merging Must be well informed d. Dominant Shareholders i. Sinclair Oil Corp. v. Levien 1. If in a transaction involving a parent company and its subsidiary the parent company controls the transaction and fixes the terms, the transaction must meet the intrinsic fairness test. 2. Majority Shareholder v. Minority Shareholder: Majority has some obligation to the shareholder. 3. Intrinsically Fair a. Shareholder can act in her best interest b. If you own 97% then it is really easy to get rid of the 3% then it doesnt 32

matter. ii. Zahn v. Transamerica Corporation 1940s (Leinhard v. Salmon Duty of Loyalty and Candor) 1. Three levels of stock: Preferred Stock, Class A and Class B. a. Transamerica owned 71.5% of Class B i. Class A can be converted and callable 2. Class A did not have the knowledge to know to convert to B, so there is a violation of the Duty of Candor. 3. If a stockholder who is also a director is voting as a director, he or she represents all stockholders in the capacity of a trustee and cannot use the directors position for his or her personal benefit to the stockholders detriment. 4. A stockholder voting as a director must vote in all shareholders best interests. 5. Callable Stock is that at anytime the corporation can bring in the shares at $60 a share. 6. There is a conflict in the case between Class A and Class B. 7. Conversion Rights ability to change the stock into another Class or type of option. 8. Preemptive Rights Preserve a persons right to stay at a certain amount in order to have control over a company. If more shares are sold that majority person has the right to buy enough shares to keep his certain percentage. e. Ratification i. Fliegler v. Lawrence 1. A majority of disinterested shareholders must ratify corporate transactions with an interested director 2. Conflict: Offered ahead of time and there was a paper trail. 3. Interested shareholders cannot ratify their own transactions with their corporations 4. Section 144 states that a property ratified contract between a corporation and one of its directors is not necessarily void or voidable because of a conflict of interest a. When there is a conflict you can satisfy b. Not voidable solely because of a conflict ii. In Re Wheelabrator Tech. Shareholders Litigation 1. Stockholders must be fully informed when they ratify an interested transaction 2. An interested transaction between a corporation and its directors is not voidable if it is approved in good faith by a majority of fully informed, disinterested stockholders. f. Disclosure and Fairness i. Definiation of a Security 1. Trading takes place on two markets: a. The primary market in which the issuer of the securities is the company b. The Secondary market in which investors trade among themselves c. Securities Act of 1933 - Concerned with the primary market d. Exchange Act of 1935 Concerned with the secondary market 2. Two Goals: a. Mandating disclosure of material information to investors b. Prevention Fraud 3. Exchange Act a. Created the Securities Exchange Commission i. Three Functions Provides interpretative guidance to private parties raising 33

questions about the application of the securities laws to a particular transaction It advises the Commission as to new rule or revisions of existing rules It investigates and prosecutes violations of the securities laws 4. Must know whether or not a particular type of instrument of investment will be deemed to be a security a. Must know i. Whether the registration requirements of the securities act apply to the transaction ii. The definition of a security is important relates to the antifraud provisions of the Acts 5. Robinson v. Glynn a. Federal securities law applies to transactions in which the investor relinquishes meaningful control over investments that are both called and carry the common characteristics of stock. b. Ordinary business transactions are not susceptible to federal securities laws 6. The Registration Process a. Securities Act prohibits the sale of securities unless the company issuing the securities has registered them with the SEC i. Three basic rules: A security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed with in the SEC Securities may not be sold until the registration statement has become effective The prospectus must be delivered to the purchaser before a sale. ii. There are exemptions from to the registering process ii. The Registration Process 1. Doran v. Petroleum Management Corp. a. In determining whether an offer to participate in a limited partnership was a private offer, the court must consider the number of offerees and their relationship to each other and to the issuer, the number of unit offered, the offerings size, and the matter of the offering. b. The status of private offerings rests on the offerees knowledge. 2. Note on Securities Act Civil Liberties a. Securities Act 11 is the principal express cause of action directed at fraud committed in connection with the sale of securities through the use of a registration statement. i. Defendant has the burden of proving that its misconduct did not cause plaintiffs damages. ii. 11 does not contain any privity requirement , the list of potential defendants is quite expansive. Everyone who signed the registration statement. b. Securities Act 12(a)(1) imposes strict liability on sellers of securities for offers or sales made in violation of 5. 34

i. Available if the seller registers but fails to deliver a statutory prospectus, violates the gun-jumping rules or commits any other violation. c. Securities Act 12(a)(2) imposes private civil liability on any person who offers or sells a security in interstate commerce, who makes a material representation or omission in connection with the offer or sale and cannot prove he did not know of the misrepresentation or omission and could not have known even with the exercise of reasonable case. d. Plaintiffs Prima Facie Case: i. Sale of Security ii. Through instrucments of interstate commerce or the mails iii. by means of a prospectus or oral communication iv. containing an untrue statement or omission of a material fact v. by a defendant who offered or sold the security vi. which defendant knew or should have known of the untrue statement vii. *PLAINTIFF NEED NOT PROVE RELIANCE e. Liability arises under 12(a)(2) only with respect to material misrepresentations or omissions made in written documents or oral communications used in connection with public offerings. f. Defendants who conduct a reasonable investigation cannot be held liable g. Due diligence is not an affirmative obligation h. Does not arise in secondary market transactions or private placements 3. 10(b) requires the plaintiff to prove that the defendant acted with scienter, for example, while 11 does not require plaintiff to prove anything about defendants state of mind. iii. Escott v. BarChris Construction Corp. 1. If false statements made in registration statement or omitted facts that should have been included are material, the registration statement is misleading 2. False statements must be material for a registration statement to be misleading 3. Due diligence defense case (look at the case brief) 4. Debenture: Unsecured Debt, its convertible into common stock and subordinated because there is other debt out there that is senior. VI. Week 6 a. The Limited Liability Company i. Designed to be simple and limit liability and have pass through taxation and simpler to manage than corporations. ii. An LLC cannot exist unless you file the papers, but you do not need a board, you only need members of the LLC to actively be involved in the management of the company. In a corporation if someone becomes too involved in management then you may be liable, but in an LLC you can be active in management yet still have limited liability. iii. Investors are called members and are taxed iv. Formation 1. Filing with the state, then it can be managed directly by the members or you can contract out the management to a particular individual or company. 2. A lot of times the court looks to corporate law to decide these cases a. Ex. Pierce the Veil b. Ex. Derivative Suit: Can have a derivative suit by the members v. Water, Waste & Land INC. Westec v. Lanham 35

1. Facts: Latham and Clark are members of PII, LLC. They contracted with Westec to do a job. Westec did it, PII LLC didnt pay. Westec people only did business with Lanhma and Clark but didnt know there was a LLC behind them. 2. ROL: An agent/member of an LLC who fails to disclose himself as an agent of the LLC can be found personally liable under common law. a. Additionally, an agent is liable even when the 3rd party knows that the agent is acting on behalf of an unidentified principal. Known as Partially Disclosed Principal Doctrine. 3. Important factors: a. Westec never knew, nor did Latham or Clark disclose they were working as agents for PII, LLC b. Latham and Clark failed to properly identify themselves as working for an LLC. They should have used the LLC behind the company name. c. If a third party is not aware that an agent is acting for a principal, the agent may be liable to the third party vi. The Operating Agreement 1. Exam Tip: When LLC agreement is at issue, say: a. The construction of written Ks is a matter of law. If a K is clear and unambiguous, there is no issue of act to be determined. Only where the language of the K is unclear or ambiguous or when the cirucsmtances surrounding the agreement invest the language of the K with a special meaning will extrinsic evidence be considered in an effort give effect to the parties intentions. vii. Elf Atochem North America v. Jaffari 1. Facts: Derivative action on behalf of LLC and Member manager. Formation agreement contained (i) forum selection clause, and (ii) arbitration clause. LLC never signed it but the members did. One member sued in DE, Court dismissed for lack of lack of SMJ. 2. Arbitration is private, the facts and documents will never be in the press. a. Less expensive b. More efficient 3. Claim that there was a violation fiduciary duty, more specifically duty of loyalty. 4. Manage an LLC with an operating agreement 5. Three documents: a. Certificate b. Operating Agreement c. Exclusive Distribution Agreement 6. ROL: In DE, LLC agreement is defined as any agreement, written or oral, of the member of members as to the affairs of a LLC and the conduct of its business; therefore, even though the LLC did not sign the agreement it is still bound. 7. The Act is a statute designed to permit members maximum flexibility in entering into an agreement to govern their relationship. 8. Important factors: a. DE laws based on Freedom of Contract b. Made the agreement to litigate in CA because it is much further and more difficult. 9. A limited liability companys operating agreement governs all its members acts. If you agree to do something then DE will hold you to it. You can agree to a jurisdiction clause. viii. Piercing the LLC Veil 36

1. Kaycee Land and Livestock v. Flahive a. Facts: Party wants to PCV and LLC who violated the law. LLC had only one member. b. PCV is not in the law off LLCs in this case. c. ROL: PCV is an equitable doctrine and is possible with LLC. d. Important factors: i. Rules of common law are not to be overturn except by clear and unambiguous language ii. Every other state has adopted corporate law standards and has not developed new LLC standards e. A court may pierce the corporate veil of a limited liability company. Court looked at corporate law and said it can do it there so you can do it to an LLC. ix. Fiduciary Obligation 1. McConnell (MSU Law Alum) v. Hunt Sports Enterprises a. Facts: McDonnell seeks declaratory judgment to exclude Hunt from franchise. b. ROL: Look to the Operating agreement for the members Fiduciary Obligations. Normally, members of an LLC have a FD similar to that of a partnership, but in this case the operating agreement specifically stated that members can compete with each other and the LLC. No FD here for the competition issue. i. They did have a Fiduciary Duty to follow the other provisions of the agreement, which they did not. Agreement stated they must get approval of majority before taking action, they did not. They violated their Fiduciary Duty on this issue. c. Important factors: i. Section 3.3 of Operating Agreement stated that members were allowed to compete with each other, with the LLC, with anything. ii. Operating agreement was not unclear, was not unambiguous iii. Look at plain language of the agreement iv. Must prove: No assets Use the LLC for personal Use Fraud or Injustice Do not have to prove that there is a debt unpaid d. If an operating agreement permits competition, limited liability company members may engage in a competing venture 2. New Horizons Supply Cooperative v. Haack a. Facts: Member failed to follow the proper procedures for dissolution of an LLC. She should have (i) filed articles of dissolution, then (ii) notified creditors. She did nothing. She did sell the assets then give the money to the bank. No evidence presented as to the disposition of the remaining assets. Small Claims Court said PCV cuz she failed to follow formalities. AP reversed reason, but affirmed judgment because member failed to prove disposition of assets received. b. ROL: In dissolution of an LLC, a member should follow the proper state procedures of filing articles of dissolution, then notifying creditors. i. If member sells LLC assets without following proper dissolution procedures they can be liable to the extent of the members 37

proportionate share of the claim or to the extent of the asset of the LLC distribute to the member in liquidation (whichever is less), but a members total liability for all claims under this section may not exceed the total value of assets distributed to the member in liquidation. c. A limited liability company member may be liable for the Companys debts. x. Private Action for Damages the Plaintiff must prove: 1. Defendant made a material misrepresentation or omission in connection with the purchase or sale of a security 2. Reliance 3. Scienter 4. Causation xi. Chiarella v. U.S. (Chapter 5) 1. The acquiring corporation made every reasonable effort to keep the identity of the tender offer target a secret, but Chiarella learned through his job and sold his shares for a profit. However, the supreme court held that he was not in violation because he was not an insider of the corporation. 2. Under 10b and 10b-5 a corporate insider must abstain from trading in the shares of his corporation under unless he has first disclosed all material inside information known to him. 3. No Insiders should trade, but a random person cannot get by a 10b-5. 4. 14e: Tender Offers b. The Securities Act: Inside Information and Rule 10b-5 i. Integrated Disclosure and ExchangeAct: 10(b)(5) and 10(b) Securities Law 1. The Securities Act of 1933 (33 Act) governs the offering and sale of securities to the public. It is pursuant to the 33 Act that companies file a registration statement with the Securities and Exchange Commission and make their initial public offering. The registration statement includes the prospectus which is distributed to prospective investors when a company goes public or makes a later secondary offering of its securities. We ignore it in this course except to note that the definition of security can be extraordinarily broad. 2. 1933 Act 11: Fraud in registration statement and due diligence defense 3. 1933: Regulates the offering and sale of securities 4. Three stages a. No selling activity, Registration statement filed with the SEC after this then the investment banker can offer and accept shares, b. Offers permitted but no sales c. Then the Registration statement is effective and sales are allowed. ii. The Securities Exchange Act of 1934 (the 34 Act) focuses upon public reporting and other obligations of public companies and upon secondary trading markets (typically we think of these as institutions like the NYSE and NASDAQ). iii. Purpose of Securities Law 1. Full Disclosure a. Make sure that investor have all the information they need to make informed decisions 2. Prevention of Fraud a. Agency cost problem re disclosure how to make a credible bond? iv. The 34 Act includes several disclosure and regulatory provisions: 38

Securities Fraud (10(b) & Rule 10b-5 promulgated thereunder); Ban on short swing profits by corporate insiders (16(b)); Annual disclosure of financial information (Form 10K); Quarterly disclosure of financial information (Form 10-Q) Rules for proxy solicitations (seeking votes from public shareholders) 14; Establishes rules for tender offers, repurchases of securities by issuers, exchange offers and much else which we do not deal with in this course. 7. 1934: Regulates secondary market activity : Ultimately get the SEC 8. Only required of registered companies 9. Proxy Rules 10. 10b-5: General fraud and insider trading rule v. Section 10b and Rule 10b-5. 1. Section 10b: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange - * * * * (b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities based swap agreement . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. 2. Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, to employ any device, scheme, or artifice to defraud, to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. a. to employ any device, scheme, or artifice or defraud or b. to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading c. to engage in any act, practice, or course of business which operates r would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security d. Do not trade prior to a big announcement. It must be in the public before an insider can trade upon it. e. When are you trading on inside information? i. Dirks was not an insider but he had specialized knowledge so if the insider is breaching a fiduciary duty then the tippee will be liable. Dirks in that case didnt have a fiduciary duty. f. Misappropriation: Privileged to inside information and you do not owe a fiduciary duty as an insider, but only has an attorney. g. Katie Roberts Duty: Broker or Dealer and you know hasnt been released to the public and you act on it then you are in violation. Certain people may not be an insider but still may not act on the information. 3. Section 14: Proxy Statements 4. Section 16: Executive officer any not purchase or sell within 6 months 5. Courts have created a private cause of action with respect to these provisions of the 34 Act. Thus develops federal common law. 39

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

6. Two primary issues: a. Material misstatement or omission in connection with the sale or purchase of any security. b. Insider trading trading while in possession of material non-public information. 7. Disclosure obligations under Exchange Act a. Exchange Act requires periodic disclosures of financial status and other significant events for certain "public companies" that meet given thresholds: (a) more than $10 million in assets, or (b) more than 500 shareholders. b. Exchange Act 10(b) and Rule 10b-5 Anti-fraud and Insider Trading c. 10(b) applies to any security, not just registered or publicly traded securities. vi. What does one need to establish to make a claim for fraud? 1. Economic loss 2. Scienter (wrongful state of mind; intent to deceive, manipulate or defraud) 3. Proximate cause of the loss by the misrepresentation 4. Material misrepresentation 5. in connection with a purchase or sale of a security 6. Reliance on the transaction vii. Basic Inc v. Levinson 1. Facts: Former Basic shareholders brought a class action suit against Basic Inc. ad its directors claiming the directors issued three false statements and forced the former shareholders to sell their shares at depressed prices based on their reliance on Basics statements that it was not engaged in merger discussions 2. Fraudulent on the Market Theory: Basic Theory behind FOM: Public information reaches professional investors and their trades based on that information quickly influence securities price. 3. Rule: Test for Materiality: An omitted fact is material if there is a substantial likelihood that the average reasonable shareholder would have considered it important knowledge to have before deciding how to vote. (Balancing Test: Probability and Magnitude) viii. West v. Prudential Securities Inc. 1. Facts: West brought a class action suit against Prudential Securities for securities fraud, alleging that a stockbroker had falsely told several clients that a corporations stock was certain to be acquired at a premium, artificially inflating its price. 2. The fraud on the market doctrine and its presumption of reliance on misstatements do not apply in a securities fraud class action against a securities brokerage firm alleging that a stockbroker had falsely told several clients that a particular corporation was certain to be acquired at a premium in the near future. 3. Fraud on the Market does not apply to non-public statements 4. Must have Information that hits the market to have Fraud on the Market Theory 5. Notes: a. Information, not demand in the abstract, determines stock price b. People do not pick stock because they like it, they pick it because they want to assemble a diversified portfolio of shares c. Standing: i. Blue Chip Stamps v. Manor Drug Store: Protections of Rule 10b-5 40

extend only to purchasers and sellers of a corporations securities. The plaintiff in this case had no standing because it had neither bought nor sold shares. In connection with a purchase or sale of a security d. Scienter: i. Ernst & Ernst v. Hochfelder: Liability for issuance of a false or misleading statement required proof of a state of mind referred to as scienter that is, the person making the false statement must have made it with an intent to deceive, manipulate, or defraud. Economic loss dura no loss the instant you buy Wrongful state of mind Proximate cause of the loss by the misrepresentation e. Secondary Liability and Scope of Interpretation: i. Central Bank of Denver v. First Interstate Bank: Held that there was no implied private right of action against those who aid and abet violation of Rule 10b-5. ix. Dura Pharmaceuticals v. Broudo 1. Merely alleging that the price was higher when you bought it because of a possible misrepresentation is not sufficient to establish loss 2. Do not have to prove reliance 3. But you have to PROVE CAUSATION. x. Santa Fe Industries v. Green 1. 253: If you own a lot of a subsidiary but not all of it you do not have to go ot the minority shareholders for a merger. The threshold in Delaware is 90%. Sometimes its inconvenient to have the little group there. (Squeeze Our Provision) 2. Facts: Kirby Lumber minority shareholders sued Santa Fe Industries which was Kirbys majority shareholder, seeking to set aside the merger of Kirby with Santa Fe and alleging that their stock was worth more than they were offered when the companies merged. 3. Under the short form merger statute, a parent company may merge itself with its subsidiary if the parent owns at least ninety percent of the subsidiarys stock and if the parent companys board of directors approves the action. 4. 10b-5and Fiduciary Duty: Cannot bring a breach of fiduciary duty under 10b-5. a. 10b-5 deals with fraud and deceit. b. Absent congressional intent the court was reluctant to bring fiduciary duty into 10b-5. c. It is another limit on 10b-5, and federal law is enriching on state law. i. Caremark ii. Patriot Act iii. Feds are slowly encroaching in on the Delaware Law 5. 10b-5 is there for fraud, deceit, or other bad things they can be fixed under this law. 6. 10b-5: the low valuation placed on the shared in the cash exchange offer was itself said to be a fraud under 10b-5. 7. On exam ASK: a. Need to figure out if there is s breach of fiduciary duty under state law b. Fraud or anything under 10b-5 c. Maybe you can bring both on separate actions. xi. Deutschamn v. Beneficial Corp. 41

1. Facts: Deutschamn sued Beneficial and two of its directors for breach of fiduciary duty, alleging a violation of the Securities Exchange Act of 1934 and claiming that he suffered losses when call options he purchased on Benficials stock in reliance on the market price became worthless. 2. An option trader purchases or sells a security and has standing to sue for damages under 10b and the related rules. c. Insider Information i. Godwin v. Agassiz 1. Facts: Godwin a shareholder in Cliff, filed suit against Agassiz for damages suffered during the sale of his stock. 2. A directors knowledge of the corporations condition requires that he engage in fair dealing when directly buying or selling the corporations stock. a. Stockholder in corporation filed suit, seeking relief for losses suffered by selling shares of stock in Cliff Mining Company. b. Ds purchased 700 shares of CMC that the P owned. c. D had certain knowledge material to the value of the stock, which the P did not have. d. Knowledge was that an experienced geologist thought that there could be copper under the earth where the mining operation took place. 3. P Allegations a. Ps purchasing of the stock for D without disclosing the knowledge of geologists theory constitutes a wrong for which the stockholder can recover. 4. Issue a. Whether on the facts found the Ds as directors had a right to buy stock of the P, a stockholder. Yes. 5. Rule a. Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts within his peculiar knowledge and not within the reach of the stockholder, the transaction will be closely scrutinized and relief may be granted. i. Essentially, if a director tries to buy stock from the stockholders based on inside information known only to the director, and the directors do not disclose the material information, relief may be granted to the shareholders. ii. THIS WAS THE RULE BEFORE RULE 10b-5! 6. Reasoning a. There was no fraud committed here by the Ds. b. The knowledge was merely conjectural, and nothing that the P had a duty to tell the D. c. There was no harm committed by nondisclosure. d. There was no duty to disclose to the directors. e. If the Ds disclosed and was wrong, then there probably would have been litigation too. ii. SEC v. Texas Gulf Sulphur 1. Facts: The SEC filed suit against Texas for violation of the insider trading provisions of 10b-5. a. Texas Gulf Sulphur Co. (TGS) was drilling in Canada for different minerals. 2. A person who is trading a corporations securities for his own benefit and 42

who has access to information intended to be available for business use only, may not take advantage of the information, knowing it is not available to those with whom he is dealing. a. It is unlawful to trade on material inside information until such information has been disclosed to the public and has had time to become equally available to all investors. b. A company press release is considered to have been issued in connection with the purchase or sale of a security for purposes of imposing liability under the federal securities laws, and liability will flow if a reasonable investor, in the exercise of due care, would have been misled by it.

43

c. They got signs indicating that there would be good minerals. d. TGS bought the property and kept drilling. e. A report came out that TGS struck good minerals, but then the directors filed a report that indicated that they were yet to strike good minerals, which was somewhat a lie. f. A week later, they struck millions of tons of ore. g. Between Nov. 12, 1963 and March 31, 1964, insiders bought 7,100 shares and 12,300 call options. h. They then sent reports of striking good ore, which was reported on April 16. i. Before April 16, three directors bought shares of TSG because of the strike. 3. Issue a. (1) Whether the individuals violated insider trading laws. Yes. 4. Rule a. General Rule: Anyone in possession of material inside information must either disclose it to the investing public, or abstain from trading in or recommending the securities concerned while such inside information remains undisclosed. i. Once disclosed, the inside director is on the same playing field with other investors and can buy the securities. ii. Insiders duty to disclose information or his duty to abstain from dealing in his companys securities arises only in those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security if the extraordinary situation is disclosed. iii. KNOWN AS DISCLOSE OR ABSTAIN RULE! b. Purpose of Rule 10b-5: Anyone who has access to inside information not available to the public cannot take advantage of such information for the personal benefit of anyone. c. Test of Materiality: Whether a reasonable man would attach importance in determining his choice of action in the transaction. i. Material facts include: (a) earnings and distributions of the company (b) affect probable future of the company (c) affect desire of investors to buy, sell, or hold securities. 5. Reasoning a. Individual Investors i. The initial drill of the property was material information; therefore, the information should have been disclosed. ii. When the company decided to buy the property after the results of the soil, any transaction that occurred were in violation of Rule 10b-5. i.e. the increased calls of stock violated insider trading laws. iii. The insiders were not dealing on the same footing as other possible investors on the market. b. Corporate Defendant 44

i. Court could not conclude that the press release downplaying the findings was misleading or deceptive. ii. Court remanded for the lower court to decide, using the reasonable investor test. i.e. whether a reasonable investor would have been misled by the press release of TGS. iii. Call Option a seller agrees to sell or a purchaser agrees to buy a security at a fixed price on or before a fixed date in the future. iv. Put Option gives the owner a right, but not the obligation, to sell a specified number of shares at a specified price. 1. i.e. the stock owner can back out of a put option if the price of the stock is higher than the agreed price. 2. If the price is below the stock price, then you want to execute the agreement; the other party has the obligation to pay the agreed amount. 3. REMEMBER: it gives the owner a right, but not the obligation to enforce the agreement. 4. The buyer has the obligation to pay. v. Option Premium the price paid to purchase an option. VII. Week 7 a. Inside Information i. Dirks v. SEC 1. Facts: SEC accused Dirk of violating the antifraud provisions of the federal securities laws for disclosing to investors material nonpublic information he received from insiders. Dirks is an analyst at a brokerage firm. Secrest is the insider and he quit his job. If you were an officer and quit, but if you knew there was a large transaction you are still considered an insider for the issue. 2. Secrest thinks there is corporate fraud so he contacted the SEC. Then he talks to Dirks and then Dirks recommended to his clients to get their stock out. Then Dirks told the Wall Street Journal. The price kept falling. 3. Dirks is not an insider or an issuer. Dirks did not trade. 4. They charge him with aiding and abbedding a. They argued that Dirks was a tipee and to be a tippess there needs to be a tipper b. Secrist is the Tipper c. Dirks had material information and he knew he had insider confidential information and that he had a duty not to trade on that information 5. A tipee does not inherit a duty to disclose material non-public information merely because he knowingly received the information. a. If you have a tipper and has inside material information and he violated some fiduciary duty and a tippee knows there is a violation then the tippee cannot trade. b. Insiders cannot leak information c. Spouse and Kids are forbidden from trading on what you know d. If you promise to keep something confidential and you dont then they can get you under 10b-5 6. 10b-5 general fraud rule 7. Notes: a. If Secrist had disclosed inside information to Dirks because of a bribe 45

from Dirks and then Dirks advised hid clients to sell their Equity Funding Stock the Dirks would have violated 10b-5. b. The SEC recently concluded that selective disclosure to analysts undermined public confidence in the integrity of the stock market. c. If someone acting on behalf of the public corporation discloses material nonpublic information to securities market professionals or holders of the issuers securities who may well trade on the basis of the information the issuer must disclose that information to the public d. If disclosure is intentional, the issuer must simultaneously disclose the information in a manner designed to convey it to the general public e. If a corporate officer let something slip the issuer must make public disclosure promptly after a senior officer learns of the disclosure ii. U.S. v. OHagan 1. OHagan was a partner at a law firm 2. OHagan is not involved directly, but he argues he is not an insider and has no obligation to disclose. 3. The SEC indicted OHagan, an attorney on fifty seven counts, including seventeen counts of fraudulent trading in connection with a tender offer, for his trading on nonpublic information in breach of duty of trust and confidence he owed to his law firm and clients. 4. An attorney, who based on inside information he acquired as an attorney representing an offeror, purchased stock in target corporation before the corporation was purchased in tender offer is guilty of securities fraud in violation of Rule 10b-5 under the misappropriation theory. 5. Misappropriation Theory: A person commits fraud in connection with a securities transaction and violates 10b-5 when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. a. Misappropriation satisfies 10bs requirement that chargeable conduct must involve a deceptive device or contrivance in the purchase or sale of securities b. A defendant can overcome allegations of misappropriation by evidence of full disclosure of the use of nonpublic information for trading. 6. The timing of disclosure is a matter for the business judgment of the corporate officers entrusted with the management of the corporation within the affirmative disclosure requirements promulgated by the exchanges by the SEC. 7. Liability under 10b could not have been imposed if OHagan had disclosed to the source of the information that he planned to trade on the nonpublic information iii. Notes: 1. Carpenter v. U.S. a. Winans before publication disclosed contents of his columns to several friends who then traded in the affected stocks. b. He was convicted of securities fraud and mail/wire fraud 2. U.S. v. Chestman a. News spread through the family and to a stockbroker who bought stock for his own account and the accounts of his clients b. He violated the Rule of 10b-5 c. A person violates 10b-5 when he misappropriates material nonpublic information in breach of a fiduciary duty to similar relationship of trust and confidence and uses that information in a securities 46

transaction 3. Chestman problem a. Rule 10b-5-2 provides a non-exclusive list of three situations in which a person ahs a duty of trust or confidence for purposes of the misappropriation theory. i. A duty exists whenever someone agrees to maintain information in confidence ii. A duty exists between two people who have a pattern or practice of sharing confidences such that the recipient of the information knows or reasonably should know that the speaker expects the recipient to maintain in the informations confidentiality iii. A duty exists when someone receives or obtains material nonpublic information from a spouse, parent, child, or sibling. 4. As the fiduciary duty based rationale for regulating insider trading suggests, the real concern in this area goes to the duty of loyalty rather than disclosure 5. 16b: Equal access to information. 6. Cannot trade if you are a statutory insider or a 10% shareholder within 6 months 7. SEC v. Alder a. Mere knowing possession of material nonpublic information by an insider trader was not a per se violation of 10b-5. i. Trading while in possession of such information merely raises a strong inference that the insider traded on the basis of that information ii. The insider can rebut the presumption by showing that he or she did not use such information in making trading decisions b. 10b-5-1: rejects Adler i. Prohibition of insider trading is violated whenever someone trades on the basis of material nonpublic information 8. Insider Trading: a. Trading on information that they could only have access to as an insider b. 10(b)-5: Material Misrepresentation (disclosure Probably not on the exam c. Fraud on the Market Theory: b. Short Swing Profits i. The 1934 Securities Exchange Act contains a prophylactic rule against it in 16(b): officers, directors, and 10 percent shareholders must pay to the corporation any profits they make within 6 months period, from buying and selling the firms stock ii. Reliance Electric Co. v. Emerson Electric Co. 1. Electric acquired 13.2% of Dodge. Then electric sold 3.3% so they only had 9.9% which they will sell later. Reliance (principal corporation) sues Emerson Electric (shareholder). 2. 16b: Important aspects, 10% and 6 months 3. A corporation may recover the profits realized by an owner of more than 10% of its outstanding shares from a purchase and sale of its stock within any six month period provided the owner held more than 10% at the time of both the purchase and the sale 4. Profits are not recoverable any a successor under insider trading provisions iii. Notes on 16(B) 1. Issuers: a. Section 16(b) applies only to companies that register their stock under the 1934 Act. 47

b. These include companies with stock traded on a national exchange, companies with assets of at least 10 million, and 500 or more shareholders. 2. Officers a. Trades by 10% owners, 16(b) applies to trades by directors and officers 3. Deputization a. If a firms employee serves as a director of another firm 16(b) may apply to the first firms trades in the stock of the second 4. Stock Classes and Convertible Depentures a. Share holder who owns 10% of one class of stock is subject to 16(b) b. It is based on any class of stock c. Applies only to equity securities 5. The Politics of 16(b) a. American bar includes a cadre of lawyers who make their living finding 16(b) claims, filing derivative suits and then claiming attorney fees 6. Matching Stock a. Must match a defendants purchases with her or his shares b. Courts match stock sales and purchases in whatever way maximizes the amount the company can recover c. Match the lowest priced purchases and the highest priced sales 7. Options a. Form almost always triumphs over substance in 16(b) b. The Exchange Act defines sale broadly i. Unconventional transactions are not sales c. Kern County Land v. Occidental Petroleum i. Occidental had no 16(b) liability ii. Both the merger and the grant of the option were unconventional transactions and, as such, were not deemed a sale for 16(b) purposes iii. Court use three factors to determine if transaction is conventional or unconventional: Whether the transaction is volitional Whether the transaction is one over which the beneficial owner has any influence Whether the beneficial owner had access to confidential information about the transaction or issuer. iv. Foremost McKesson Inc. v. Provident Securities Company 1. Court was trying to determine what at the time of purchase meant 2. Warehousing: parked the stock somewhere so it would get caught by 16b. 3. A corporation may capture for itself the profits realized on a purchase and sale of its securities within 6 months by a director, officer, of beneficial owner, but a beneficial owner is accountable to the issuer only if it was a beneficial owner before the purchase 4. Beneficial owners have no liability for short term profits if there status existed both before and after the sale v. UBS: Swiss Bank Accounts 1. 16b: Beneficial Honor ultimate benefit a. Doesnt mean they can find it but if they can it is a violation c. Indemnification and Insurance i. Authority or obligation of a corporation to indemnify officers and directors for any 48

ii.

iii.

iv.

v.

damages they might incur in connection with their corporate activities Must keep in mind 1. There are several different situations that might give rise to a liability 2. The risk of liability may be remote, but the amount of the damages can be large in relation to the individual wealth of the officers and directors and there may be forms of relief other than money damages. 3. Corporations may be able to buy insurance to cover damages and expenses of defense, but if they are allowed to do that, the question arises, why not allow them to become self insured? 4. Officers and directors need to be concerned about the possibility that the corporation will be taken over by people hostile to them Section 145 1. A corporation shall have the power (enabling) to indemnify someone who is threatened but you cannot in a derivative suit. Good Faith is in part a, b, and c. a. You get the power of indemnification in the bylaws, but you want it in the contract because that cannot be changed as easily b. (e) Fees may be paid in advance to protect against these suits 2. 145(a): Relating to suits by third parties allowing indemnification in certain circumstances for expenses, judgments, fines, and amounts paid in settlement a. Permissive b. Only for non-derivative action 3. 145(b): Covers indemnification paid in settlement or in the right of the corporation a. Derivative action 4. 145(c): Expenses must be reimbursed if the defendant was successful a. Mandatory 5. 145(e): Advancement of expenses a. Hot topic recently b. Mr. Holder was in the Justice Department with Clinton and became famous for getting corporations not to advance legal funds i. Under Bush it was modified ii. Important thing is to have a contractual right that might protect the individual from the government changing this iii. Right to advancement in the bylaws, but the bylaws get changed so since the law is enabling so you can take it away. 6. 145(f): Contemplates agreements that provide greater protection that the statute 7. 145(g): No good faith requirement Mandatory Indemnification 1. Most states require a company to indemnify an officer or directors when: a. The director/officer is completely successful in defending himself against the charges; and b. When the corporation has previously bound itself by charter, law, or contract to indemnify. Waltuch v. Conticommodity Services Inc. 1. Facts: Waltuch spent around $2M on his own defense when he and Conti were sued. Without consulting Waltuch, Conti settled the case for both Waltuch and Conti. Waltuch wanted reimbursement for what he paid on his defense. Conti argued that they paid the settlement; therefore, he did not succeed on the merits. Court says he did. 2. 145(a) says you have to have good faith; however, the guy stipulated that he did 49

not act in good faith. Who knows why he stipulated to this, maybe he wanted to be included in the settlement agreement. However, 145 was not controlling in this case because it contradicted itself. 145(g) take out insurance for directors which does not have a requirement of good faith, so the director is reimbursed despite what 145(a) says. Waltuch got reimbursed 1.2M for the civil suit, 145(c) is mandatory and 145(a) is permissive. So he only got the money for the civil suit. 3. 145(g): Can get Insurance a. Most common is AIG, however, probably not anymore. i. AIG knows they can charge a lot and include clauses that say we will pay expenses above a certain amount and only to a certain extent. 4. Difference between Advancement, Indemnification (Problems on Page pages 528) a. Advancement: Fees ahead of time b. Indemnification: Reimbursement after the fact 5. ROL: Basically the lawsuit was dismissed without Waltuch having paid a settlement and it is not for the court to ask why this result was reached. Thus, since he paid nothing and the case is over, he was successful on the merits. a. Might be different if he agreed to the settlement paid by Conti b. The issue comes down to whether the individual acted in good faith. 6. Important factors: a. Conti paid the settlement without consulting Waltuch it was basically involuntary for him. 7. A corporation must indemnify its officers, directors, and employees against legal expenses related to the defense of any legal action brought against them by reason of their position or capacity, provided the individual acts in good faith. vi. Citadel Holding Corporation v. Roven 1. Facts: Citadel and Roven entered into an Indemnity Agreement whose purpose with was to give Roven greater protection than that of the charter or bylaws. Agreement specifically states, Roven is entitled to require Citadel to advance the costs of defending certain lawsuits. Roven asked for an advance, Citadel didnt. Roven sued, wins. 2. ROL: Breach of K issue. If the agreement provides a company must provide advance payments for lawsuits, then they must. 3. Important factors: a. Agreement was specific, right of advancement did exist b. Beware, this does not guarantee indemnification only advancement 4. Distinguish between indemnification, advancement, reimbursement 5. A corporation may advance a director the costs of defending a lawsuit. VIII. Week 8 a. Problems of Control i. A short review of indemnification: 1. Indemnification is secure someone against legal responsibility for their actions. 2. Reimbursement of legal fees is after the fact. 3. Advancement is giving the legal fees prior to the case taking its course of action. 4. Most statutes permit advancement of legal fees upon the defendant director giving an undertaking to repay the expenses if she is later determined to not be eligible for indemnification. 5. Directors & Officers (D&O) Insurance 50

a. Look at DGCL 145(g) (MCL 450.1567) A Delaware corporation has the power to purchase insurance on behalf of directors and officers that will pay their expenses and liabilities even in situations where the corporation could not indemnify. 6. Directors and sometimes senior officers almost always demand such insurance as part of their compensation packages. 7. Many insurance companies either refuse to write it or place high deductibles for low insurance on the policy. 8. D&O Insurance creates a potential moral hazard situation where corporation is asking for director to be insured against breaches of their fiduciary duties. The moral hazard created here is genuine, but far less than that created for those who have health insurance. Moral hazard is a wonderful term which you can use to impress your friends at cocktail parties. 9. If a bank believes it is too big to fail (i.e., Fannie, Freddie, Citi, et al believe the federal government will bail them out and they will keep their bonuses), then they may well behave differently if they believe there are no adverse consequences from taking risks and leveraging 35:1. ii. Dynamics of shareholder voting (cribbed from Prof Barnhizer with some remarks of my own.) 1. State corporation statutes (e.g. DGCL 211, MCL 450.1402) provide that shareholders must have an annual meeting and may also have special meetings. 2. Shareholders get to vote on only a limited number of matters. They do always elect directors. This is done annually. 3. They also vote on those rare occasions when a fundamental corporate transaction, such as a merger, some other reorganization / recapitalization, or similar major change has been proposed. 4. They might also have the power to propose and vote on amendments to the Articles of Incorporation. 5. For small (close) corporations, there is normally no problem getting the small number of shareholders together for annual or special meetings. 6. For large public corporations, convening at one place and time is not practicable. In addition, few shareholders bother with the internal workings of the companies they have selected for investment. After all, they selected these companies as investments, not because they care at all about their internal politics. As Will Rogers said: Buy low; sell high. If the price dont go up, dont buy it. 7. Atypically, but increasingly in recent years, social activists have attempted to stir up annual meetings or major corporations. More on this later. 8. Large shareholders (unions, pension funds, mutual funds, private equity, hedge funds, etc.) may send representatives to vote in person at annual meetings. But even they usually have better things to do. 9. Consequently, the most the vast majority of shareholders will do, is give a proxy to an agent acting on behalf of management to cast their vote as they direct. I emphasize that this is the most they will do, because many shareholders simply trash the proxy voting materials, perhaps keeping the glossy Annual report, if it has lots of pictures. 10. DGCL 212 (MCL 450.1421) provides explicit authority for shareholders to vote in person, by proxy, or in writing. 11. Proxies are gathered in a process called proxy solicitation. 12. State law generally governs the mechanics of corporate governance and may impose substantive requirements of fairness on the matter being voted on. 51

a. BUT As a practical matter it is Federal law which governs much of what is involved in preparing and circulating proxy solicitation materials. 13. Remember that the Securities Act (the 33 Act) and the Exchange Act (the 34 Act) were passed at the beginning of the Great Depression. 14. One of the perceived causes of the Great Depression was abusive manipulation of the securities markets. [Whether this was actually a cause of the Depression can be debated; that it happened cannot!] 15. The philosophy of full disclosure established and developed by the federal securities laws over the decades regulates the amount, timing, and truthfulness of all issuer disclosures in all public company documents and other published statements. It is for this reason that in an area of law unquestionably left to the states, understanding federal law is essential. iii. The Collective Action Problem: 1. We focus throughout this course on the tension between the desire to specialize functions (i.e., let agents do what you hire them for) and the need to monitor the agents actions (to prevent them from shirking or committing acts of malfeasance or misfeasance). 2. A General Partnership has high monitoring costs associated with the unlimited personal liability one partner may incur for all partners. 3. A Limited Partnership reduces monitoring costs for limited partners because of the limited liability afforded by this form of business enterprise. 4. Corporations reduce monitoring costs still further for shareholder-owners. Owners may still want to monitor / control what others are doing on their behalf, but this need would arise out of a desire to protect and improve the investment, not out of fear of unlimited personal liability. 5. Most stockholders are investors who have precisely no interest in participating in the operations of the company. They want to receive dividends and enjoy capital gains. As we know, most such owners would rather vote with their feet (sell) than attempt to change a companys behavior while having a completely insignificant number of votes. 6. Indeed, the benefits of monitoring for most investors are vastly (or more) outweighed by the costs. a. All this creates a collective action problem. Shareholders rarely (or less often) effectively interfere with corporate governance because they the incentives for collective action are overwhelmingly outweighed by the costs of such action. iv. How the proxy process works 1. The Board selects the date of the stockholders meeting (annual meeting date may be fixed in Company bylaws, but if not, or if it is a special meeting, the date is at the Boards discretion under DGCL 211(a) & 211(d)) and the record date. The record date is the date usually 60-90 days prior to the annual meeting on which a stockholder must own stock in order to be entitled to vote at the meeting. A record date is necessary because of the time required to prepare and mail the materials by which proxies are solicited, and then to receive and count such responses as are received as the result of the solicitation. 2. The Board determines its slate of director nominees (such a slate NEVER includes more nominees than positions to be filled) and defines other appropriate issues for shareholder action. Boards thus nominate themselves. New directors who fill a vacancy created by death or resignation are normally added to a Board between annual meetings pursuant to procedures established in the Bylaws. Thus 52

a Board-nominated slate of candidates will almost always be the Board existing at the time. 3. Shareholders if they wish to, may propose their own slate of nominees in an attempt to select their own candidates for the board. 4. In either case, proxy solicitation materials are drafted and filed with the SEC for review. v. SEC Review 1. Proxy solicitations are regulated under Exchange Act 14 and Rules 14a-3, 14a-4, 14a-5 and 14a-11. (See the brief note on pp. 542-43.) 2. Proxy statements, like registration statements under the 33 Act, must fully disclose the major issues (e.g., description of directors and their qualifications, explanation of a proposed merger and accompanying merger documents, etc.) that will be raised and how the agent soliciting the stockholders proxy intends to vote on those issues. 3. The theory is the agent, often the corporate secretary of the company along with alternates, should disclose all information relevant to the (principals) stockholders decision whether to grant the proxy. 4. After its review, the SEC either states that it has no problem with the proxy solicitations or provides comments. 5. Proxy solicitations may be distributed prior to SEC approval, but would have to be corrected or retracted if SEC determines that they are improper. 6. Identification of shareholders owning shares as of the record date. b. Proxy Fights i. As a shareholder you get a proxy statement 1. A normal successful proxy meeting is "All the proxies are in, everything stayed the same /w the board and auditorsmeeting adjourned." a. Shortest proxy meetings can be 9 minutes 2. Within a corporate democracy there is little real choice as far as director 3. However, you can get a real vote on business decisions like mergers, acquisitions, bankruptcy, liquidations, etc a. Often these bysienss decisions are at Special Meetings - Proxy statements work here too ii. On the statement 1. States can vote my internet, mail, and other means and proxies are revocable should you decide to show up at the annual meeting. a. However, they typically give out paper cards as well. 2. You disclose all shareholders who own more than 5% 3. Describes holdings of insiders a. Description of the propositions up for vote and the directors iii. E-Proxy Statements 1. Could be big down the road - could make it cheap for minority shareholders to band together and cause problems for the sitting board - now proxy solicitations take millions 2. It the policy of the SEC now that businesses don't have to accept outside nominees for BOD iv. Proxy Definitions 1. Proxy substitute 2. Proxy card - mail-in card 3. Proxy statement - sex disclosure and card 4. The Proxy - colloquial - all of the above 53

5. Proxy Solicitation - process of soliciting votes 6. Proxy Solicitor - sells proxies v. Definition: A proxy contest is any competition between two competing factions (generally management v. outsiders) to obtain shareholder votes on a proposal. 1. The contest is much like a political campaign: Each side will take out newspaper ads, direct marketing (of proxy materials), makes personal phone class to important voters, and does anything else in its legal power to gain more votes than the other side. vi. Types of Proxy Contests 1. Election of Directors 2. Management Proposals 3. Shareholder Proposals vii. Why have Proxy Contests 1. Management wants to retain control, and insurgents want to gain control 2. Proxy contests are less expensive than hostile takeover bid (in theory) viii. Proxy contests have decreased over the years, while Tender offers have increased ix. Corporations hold annual meetings of Shareholders for election of directors and where necessary, for voting on other matters. 1. These meetings are not worth while x. Small firms, by contrast, the meetings are worthwhile to attend shareholder meetings because they own enough shares to affect the outcome of any vote 1. Proxy voting is also available, but less common for small corporations 2. An agent of the shareholder is called the proxyholder 3. Shareholder appoints the agent called the Proxy 4. Proxy fights result when an insurgent group tries to oust incumbent managers by solicitating proxy cards and electing its own representatives to the board 5. Proxy fights are subject both to the 1934 Securities Act and to state corporate statutes 6. Strategic Use of Proxies xi. Levin v. Metro Goldwyn-Mayer Inc. 1. Levin was director of MGM 2. Conflict between Levin and O'Brien groups on the board about how to handle the business 3. Both groups solicited proxies 4. The group that won the proxy war got paid, the other didn't 5. The O'Brien group took out the shareholders to nice dinners, used private plane, etc a. Levin said this was unfair - this money shouldn't be reimbursed to the D's b. Court said they will only step in if there are illegal/totally unfair means of communicating 6. Incumbent management may make reasonable use of corporations assets to inform shareholders pf its position in a proxy contest involving corporate policy issues c. Reimbursement of Costs i. Rosenfield v. Fairchild Engine & Airplane Corp. 1. Stockholder wants money returned from both sides of the proxy contest 2. Normally, the winner of a proxy battle gets reimbursed 3. Here, the new winning board paid back the board that lost money in the proxy battle 4. Then the new board got shareholders to ratify all this 54

5. You can't get reimbursed unless you have a policy dispute 6. "When the directors act in good faith in a contest over policy, they have the right to incur reasonable and proper expense for solicitation of proxies and defense of their corporate policies and are not obliged to idle by." 7. However, this pretty much covers anything and everything in reality 8. Absent a claim that the expenses were unwarranted, excessive, or otherwise improper, a corporation may reimburse factions for costs associated with a proxy fight involving a policy contest, but not one involving a personal power contest. 9. Under Rosenfield it may be compensated for the cost of a proxy fight if it wins. 10. It will not be compensated either for the cost of investigating firms that it discovers are properly managed or for the cost of proxy fights it loses. d. Private Actions for Proxy Rule Violations i. J.I. Case Co. v. Borak 1. Borak owned 2k shares of Case and brought suit to enjoin a merger between Case and ATC. 2. Does the D have a right of action? Yes. 3. Court looked at purpose of statute (protect shareholders) and to do this the court must have some method to protect shareholders. 4. Court said statute is so broad that derivative actions must be considered, the SEC can't really be everywhere 5. SEC can't read every proxy statement and investigate it thoroughly 6. The court really has to stretch to grant private actions 7. This case creates the personal shareholder right to sue under 14 8. This case arose before class actions. 9. It is unlawful to solicit a proxy or consent authorization using false and misleading statements, and in such event a court may enforce a private right of action for recession or damages 10. Nothing in the Securities Exchange Act or the SEC rule thereunder creates an express cause of action for shareholders suing over proxy violations ii. Mills v. Electric Auto-Lite Co. 1. Mills (P) brought action alleging violation of Section 14 saying they used false and misleading proxy statements 2. Auto Lite (AL) didn't disclose that the board of AL was the board of American Mfg Co 3. Therefore, there is domination and control of the AL board by the AMC board 4. Court permitted the action under Borak 5. Injury relies on lack of disclosure - not actual fairness 6. Lower court required misleading statement to have caused shareholders to vote differently a. This was rejected by Sup Ct 7. As long as the P can show the misleading statement was material, that is enough to show causation - no need to llook beyond this. It was material b/c because the proxy statement is false AND the proxy votes were critical to putting the proposal in place (couldn't pass w/out them) To establish a cause of action under 14 of the Securities Exchange Act, a plaintiff need show only the misstatements or omissions materiality and its ability to influence a shareholders vote. iii. TSC Indusries v. Northway 1. Supreme Court held that a fact is material if there is substantial likelihood that a 55

reasonable shareholder would consider it important in deciding how to vote iv. Seinfeld v. Bartz 1. Seinfeld was shareholder of Cisco 2. Brought derivative action be/c of the amendment to the Auto Option Grant Program for director 3. Raised initial number of options to 30k shares and raised annual options to 15k 4. P said the proxy statement was misleading b/c the value was wrong 5. P used Black-Scholes to value the options and came up w/ different numbers 6. According to P, the dollar amount was far less in the proxy statement 7. Court said that the valuation standard/calculation is not material 8. If you are going to issue options, you don't have to use Black Sholes to value it 9. You could say - is there substantially likely hood reasonable shareholder would consider it important? 10. A companys failure to disclose in its proxy statements the value of the stock options granted to its directors does not constitute a materially false and misleading statement under Rule 14a-9 of the SEC. 11. Unless the market price of the common stock appreciates over the option term, no value will be realized from the option grants made to the executive officers. v. Virginia Bank Shares case 1. In that case, the proxy was irrelevant b/c the owning company already had enough votes 2. It can't be material if the proxy vote can be taken away and there are still enough votes to meet the quorum requirement vi. Rule 14 1. Unlike 10-b5 - if you have "false and misleading" you are practically there 2. If a shareholder has a complaint (claim against company for violation of duty) shareholder can't propose that as an item for the shareholders to vote on. 3. 14(a)(a) exceptions - take a look a. You may, if a shareholder, propose shareholder referenda on investing in Sudan, etc b. Its ok, even though the company can't actually DO anything about that c. In DE, they are only allowed to vote on things the business can control mergers, etc. vii. GM Campaign: Insanity- doing the same thing over and over again and expecting a different result 1. Campaign GM worked and it pushed GM to have a more diverse board 2. Can use society to change the world by use of corporate law e. Shareholder Proposals i. Lovenheim v. Iroquois Brands 1. Lovenheim asked to have information about a resolution he proposed to make at an upcoming shareholders meeting included in the companys proxy materials, but the company refused 2. Under 14(a) of the Securities Exchange Act shareholders may include in the companys proxy statements certain materials that have limited, if any, economic impact on the company as long as they are otherwise significantly related to the issuers business 3. Notes a. The SEC reluctantly referees the shareholder proposal process b. If the SEC staff agrees that the proposal can be excluded, it will issue a socalled no-action letter, which simply states that the staff will not 56

ii.

iii.

iv.

v.

vi.

recommend that the commission bring an enforcement proceeding against the issuer if the proposal is excluded. c. Can be excluded under Rule 14a-8 d. After review by the commission the losing party can in theory seek judicial review by the U.S. Circuitt Court of Appeals for D.C. e. Rule 14a-8(i)(5): Meet the 5% economic Significance Test The New York City Employees Retirement System v. Dole Food Company 1. A shareholders proposal to form a committee to evaluate health insurance proposals before Congress does not relate to the companys ordinary business operations, but the corporation must include the proposals information in its proxy statements 2. Rule 14a-8(a)(i) allows a corporation to omit a shareholder proposal from its proxy statement because of certain enumerated circumstances 3. 14a-8(i)(7): Ordinary Business Operations: If the proposal deals with a matter relating to the conduct of the ordinary business operations of the registrant. 4. 14a-8(i)(5): Insignificant Relationship 5. 14a-8(i)(6): Beyond Power of Effectuate 6. Very good way to push a social agenda by doing it through a shareholder proposal 7. Not a way to make a case about shareholder abuse: a. If you do not like a merger or acquisition this is not the way Austin v. Consolidated Edison Company of New York Inc. 1. Shareholders may not require a corporation to include materials concerning a stockholder proposal supporting an employees right to retire with full pension benefits with thirty years service regardless of their age, because the proposal concerns ordinary business operations 2. Shareholders can raise issues, but not about the business of the company. It is an issue that isnt tied to the business directly Shareholder Inspection Rights 1. Be able to force incumbent board to include a proposal you draft in its proxy solicitation materials 2. You cannot require the corporation to include your slate in its solicitation materials so you will need to do your own proxy solicitation 3. Under 14a-7 the firm can choose either to mail your material and bill you for the costs or to give you the shareholder list instead 4. Most incumbent managements choose to mail the material themselves and keep the list confidential 5. You will want to identify the holders of large blocks of stock and to spend most of your efforts trying to convince those major shareholders to support you. 6. There is nothing in the federal proxy rules requiring the corporation to give you the shareholder list, but the federal rules do not impair any rights you may have under state law. AFSCME v. AIG, supplement 1. This case reveals the tension between the directors obligations regarding management of the business and affairs of the corporation and the right of shareholders to elect directors. 2. Parties are disputing the meaning of relates to in the context of an election. 3. Directors are responsible to the shareholders and business CA. Inc v. AFSCME Employees Pension Plan Not in Supp. (Maybe on the Final) 1. Proposed proxy that was concerned with compensation a. Cumulative Voting 57

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

i. If you have x% of the shares then you can accumulate the votes. Cast all the votes on one person. Bylaws are a way of deciding procedure not substance. If you want to attack substance you have to go to the Articles of the business. Someone running he got elected, but cannot get his expenses reimbursed The preeminence of the Delaware directors fiduciary duty to manage the business and affairs of the corporation; and Yet another example of how Federal SEC regulations impinge/intersect with state law which is meant to control the internal affairs of the legal entities it creates. Delaware permits shareholders or board to propose bylaws and the certificate of incorporation may permit Board to amend (sec. 109(a)) though shareholders also retain the right to adopt, amend and repeal. 141(a) says business and affairs under board and not shareholders. Thus shareholders do not have the same broad extent of powers as the board. 109(b) says bylaws cannot be inconsistent with Delaware law. In December 2007 the Delaware Constitution was amended to permit government agencies, such as the SEC, to certify questions of Delaware law directly to the Supreme Court of Delaware. In connection with an AFSCME proposal to CA, Inc. to amend CAs bylaws to reimburse reasonable expenses incurred by stockholders in nominating a slate of directors in a contested election, the SEC certified two questions.

IX.

Week 9 a. Shareholder Inspection Rights i. Crane Co. v. Anaconda Co. 1. It is in New York because that is where they are registered to do business. 2. Delaware law is the same. Stockholder cannot manage, but can look at the list of shareholders for a valid reason. a. What is a valid reason or purpose? i. It is a pretty loose standard b. An improper reason c. Selling the list 3. A corporation must grant a shareholder who wants to discuss a tender offers terms directly with the corporations shareholders access to the shareholder list, unless the corporation can establish a wrongful purpose. ii. Pillsbury v. Honeywell 1. Facts: Pills lost in DC when they tried to get Original SH ledger, current SH ledger, and all corporate records dealing with weapons and munitions manufacture. On 7/3/69 Pills found out that HW was making bombs for the Vietnam War. He wanted to stop it. 7/14/69 Pills purchased 100 shares of HW for the sole purpose of giving himself a voice. He wanted all the records to insure accuracy and he wanted all other SH to know about HWs involvement. Court affirms, company does not have to hand over the list. 2. ROL: Proper Purpose contemplates a concern with investment return. a. where it is shown that such stockholding is only colorable, or solely for the purpose of maintaining proceedings of this kind, we fail to see how the petitioner can be said to be a persona interested, entitled as of right to inspect quoting 3. Company may deny access to a stockholder who purchased stock solely to access corporate books and records. 58

iii. Sadler v. NCR Corporation 1. Facts: AT&T began Tender Offer. NCR mailed the offer to all SH. NCR board rejected the offer & rejected the offer to redeem the poison pill. AT&T sought to replace the board by calling Special Meeting, so they needed a 80% of outstanding to agree. Sadler (acting on AT&Ts request) asked for CEDE & NOBO. 2. ROL: NY Law allows a party to a proxy fight to require a corporation to furnish a list of non-objecting beneficial owners (NOBO), even where the corporation is not domiciled in NY but does business there. a. Also, company must compile and produce this list b. If corporation claim improper purpose, then it is their burden to show it 3. Important factors: a. CEDE identifies the brokerage firms and other record owners who bought shares in a street name for their customers b. NOBO non-objecting beneficial owners who have given consen tto the disclosure of their identities. c. AT&T asked Sadler because NY law 1315 permits any (i) NY resident, (ii) who has owned the stock for over 6 mos Sadler qualified but AT&T did not. i. This agreement is ok d. Court says 1315 should be read liberally and in favor of SH e. Not the same as DE DE NY CEDE compiled Compile NOBO not compiled Compile b. Shareholder Voting Control i. Stroh v. Blackhawk Holding Corp. (Propriety Rights) 1. Facts: Validity of 500K shares of Blackhawk Class B stock. Provision stated that shares have voting rights, but are NOT entitled to dividends either upon voluntary/involuntary liquidation. P claims that the shares were not shares pursuant to IL law. Courts says they are shares. 2. ROL: Right to assets and rights to earnings (economic rights) may be eliminated from the other attributes of a share of stock. Only management incident of ownership may not be removed (voting) a. IL business statute (Corporation Act 163 Section 2.6) provides that shares means the units into which the proprietary interests in a corporation are divided. b. Thus, proprietary rights are rights to participate i. in the control of the corporation, ii. in its surplus or profits, OR iii. in the distribution of its assets. 3. Important factors: a. The statute specifically says OR, thus one of those rights must be given not all. b. Class B was less expensive than the Class A, this would basically give B the same rights as A but they paid less c. Current Changes: IL BCA 1983 7.40(b) now provides that corporations, in their articles, may limit or deny voting rights or may provide special voting rights as to any class or classes or series of shares. ii. Notes 59

1. Required all common shares to have equal voting rights 2. May limit or deny voting rights or may provide special voting rights as to any class or classes or series of shares 3. Providence and Worcester Co v. Baker a. Entitled to one vote for every share of the common stock b. 28% of the shares had only 3% of the votes c. Court held it was valid 4. 141(b): Board shall consist of 1 or more members and can fix the number in the bylaws, unless the certificate of incorporation states otherwise. The shareholders can vote on changing the certificate of incorporation. Directors need not be stockholders unless required by the certificate or bylaws. Director may resign at anytime upon notice given in writing. Each director shall hold office until the successor is elected and qualified. iii. State of Wisconsin Investment Board v. Peerless Systems 1. Facts: SWIB invests the assets of WS Retirement system. SWIB became a Beneficial Owner of Peerless. Peerless issued a proxy statement with 3 proposals. SWIB disagreed with #2 which provided another 1M shares could be issued. Argued dilution thus decreased value. Special Meeting held were they discussed merger with another company. Then the annual meeting held (SWIB not there), they voted on #1 and 3, but adjourned on #2. During that time, Peerless continued to solicit votes and finally when vote was held they won #2. P asserts D improperly adjourned. Summary judgment denied on both sides because more facts are needed. 2. ROL: Standing & Breach of FD by Adjourning a. Standing: SH does not need to attend a meeting to object to a proposal to preserve ability to challenge propriety of SH vote. b. Breach of FD: Application of Blasius Test. First, P must establish that the board acted for the primary purpose of thwarting the exercise of a SH vote. Second, the board has the burden to demonstrate a compelling justification for its actions. c. When to Apply Blasius Test: Only apply when the primary purpose of the boards action is to interfere with or impede exercise of the shareholder franchise, and the stockholders are not given a full and fair opportunity to vote. 3. Improper Acts are in 2 categories: a. Void Acts Those that are ultra vires, fraudulent, gifts or waste and are legal nullities incapable of cure b. Voidable Acts Performed in the interest of the company, but are beyond the authority of mgmt and are also cause for relief. If SH ratify a voidable act, then it cures the defect (provided ratification was fairly accomplished) 4. Important factors: a. Only 2/3 of the Peerlesss shareholders voted 5. Notes a. Electronic Shareholders meetings can be held at a website c. Control in Closely Held Corporations i. Important Considerations with Closely Held Corporations (CHC) 1. Employment contracts (discuss on exam) 2. Buy-sell agreements (discuss on exam) 3. Pooling agreement 60

4. Voting Trusts ii. General Rule FD of CHC Shareholder: 1. The relationship among SH in a CHC is analogous to that of partners. SH in CHC owe one another a FD. Owing a FD includes dealing openly, honestly, and fairly with other SH. Evans. iii. Ringling Bros Barnum & Bailey v. Ringling 1. Facts: There was an agreement among SH to vote together. There were 7 board spots. History they previously pooled and ousted Robert and inserted James. James went to Jail. Years later they have this board meeting. Both Dunn and Griffith show up and vote as Chairman. They had a SH agreement. The agreement provided that they would consult and confer with to the rother and to vote their shares together on any issues put to a stockholder vote. They also agree that if they cant agree o how the shares shouldb e voted, their lawyer Mr. Loos shall act as arbitrator. They disagreed and Mrs. Haley refused to vote with Mrs. Ringling and refused to comply with arbitrator. Court says agreement is valid. 2. ROL: SH are offered wide discretion when voting. They may vote any way or any reason, so long as they do not violate a previous agreement. If one party violates the agreement, they are not required to vote with the other side, instead their votes are just NOT counted. 3. Important factors: a. Today, the votes not counted remedy would probably fail. Court would probably require specific performance. b. Arbitrator did not have proxy power to vote the share. Basically, he could only arbitrate, but could not enforce the decision. 4. Remedy a. Specific performance was NOT given. Court did not make losing party vote with the other side. b. Remedy given was that Mrs. Haleys votes were not counted 5. Moral a. Make sure you setup your agreement to understand the impact of proxy power b. Specific performance was never requested in this case, it might have helped c. If you have an arbitrator, give them the power to vote the shares after the decision has been made. iv. McQuade v. Stoneham: Limiting Board Power is Illegal 1. Facts: Action for Specific Performance of an agreement between 2 parties. Agreement provided parties will use best endeavors for the purpose of continuing as directors/officers of said company.. names., then Stoneham has power to name all additional directors as he sees fit. After a few years, they ousted McGraw. McGraw sues. Court says K was illegal and void. 2. ROL: A SH Agreement is illegal and void so far as it precludes the board of directors at the risk of incurring legal liability from changing officers, salaries, or policies or retaining individuals in office, except by consent of the contracting parties. a. Directors must retain the power and have the duty to act in accordance with their own best judgment so long as they remain directors. 3. Important factors: a. This voting or shareholders agreement prevented Directors from firing McGraw and they would have run the risk of incurring legal liability 61

Effectively tied the hands of mgmt. b. Use an employment K instead 4. Thus, until the date when the D repudiated the agreement, its performance constituted a violation of the statute v. Clark v. Dodge: Limitation of Board Power Can be Ok 1. Facts: 2 guys owned 2 companies. Clark owned 25% and Dodge 75%. Clark knew the formula, Dodge had the money. They entered into a voting agreement whereby Clark would always remain employed and on the board provided he give up the formula. He gave it up, Dodge booted him. Clark wants his job back and money. Court says Clark wins. 2. ROL: Where the public was not effected, the parties in interest, might, by their original agreement of incorporation, limit their respective rights and powers. (VERY LIMITED Only in CHC where public was not effected) a. Basically a Reversal of McQuade, but ONLY when public is not effected, and ALL SHs approved 3. Important factors: a. Also a Legitimate Expectations case b. There was no attempt to sterilize the board of directors with this agreement (4 factors) i. Dodge was to vote for Clark ii. As a director Dodge should continue Clark as GM iii. Clark would always receive a salary iv. No salaries which are unreasonable should be paid 4. Differentiate McQuade and Clark McQuade Clark Publicly held shares CHC Sterilized the board Board was still free 5. Section 142(b) provides that officers shall be chosen in such manner and shall hold their offices for such terms as are prescribed by the by-laws or determined by the board of directors or other governing body vi. Synthesis of McQuade, Clark, and other NY cases 1. In order for an agreement to be valid: (i) must not harm creditors, the public, or non-consenting SHs; and (ii) must involve only an innocuous variance from the rule that a corporations business should be managed by the board. 2. Also it might be required that ALL SH consent (or at the very least that the person now attacking the agreement have previously consented to it) vii. Corporate Planning by Use of Employment Contracts 1. Duration a. Number years. Then what? b. Termination for cause i. By whom? ii. What is cause? c. Effect of illness, incapacity, etc. 2. Compensation a. Salary b. Adjustments (inflation) c. Bonuses, stock options, etc. d. Benefits e. Travel and other expenses f. Perquisties (perks) 62

3. Duties and Status a. Job description b. Other duties c. Amount of time; vacation d. Outside activities 4. Competition and Trade Secrets 5. Consequences of Termination a. Liquidated damages b. Duty to Mitigate 6. Parties 7. Mergers, etc. 8. Guarantee by majority SH viii. Shareholders Agreements, Voting Trusts, Statutory Close Corporations, and Involuntary Dissolution 1. Shareholders Agreements / Pooling Agreements a. McQuade & Clark i. Commitment to elect Board of Directors Agreements by which SH simple commit to electing themselves or others as directors are generally considered unobjectionable and are now expressly validated in many jurisdictions ii. Commitment to appoint Officers or Employees This restricts the Boards power iii. Modern view, agreements are enforceable, at least for CHC, as long as they are signed by all SHs. iv. The courts have had more difficulty with shareholder agreements requiring appointment of particular individuals as officers or employees of the corporation 2. Voting Trusts a. A device specifically authorized by the corporation laws of most states b. SH who wish to act in concert turn their shares over to a trustee. The trustee then votes all the shares, in accordance with instructions in the document establishing the trust. c. Often used to maintain control by a Family or Group d. Existence of a voting trusts generally must be made public 3. Statutory Close Corporation a. Under DE Law 342, b. Election by any corporation with fewer than 30 SHs c. Under 351 the certificate of incorporation of a close corporation may provide that the business of the corporation shall be managed by the stockholders of the corporation rather than by a board of directors 4. Advantages of CHC a. Maintain control b. Benefits of regular C-Corp c. Avoidance of any need to provide certain corporate formalities 5. Alternative to CHC To maintain effective control can be had by a. Adaptation to the articles of incorporation & bylaws b. Together with ancillary agreements such as voting agreements, employment agreements, and buy-sell agreements c. LLC is a viable alterative too 63

X.

ix. Galler v. Galler 1. Facts: 2 principal owners of the corporation, Ben and Isa, each owned 47.5%. They signed a shareholders agreement in which they agreed to pay certain dividends each year and to pay in the even to either should die a specific pension to his widow. Ben died, and Isa refused to carry out the agreement. 2. ROL: In the context of a CHC, an agreement is valid even though it limits the discretion of the Board of Directors if (i) there is no minority interest who is injured by it; (ii) there must be no injury to the public or to creditors; and (iii) the agreement must not violate a clear statutory prohibition. (Specific Performance) a. Might be applicable in a public company too 3. Important factors: a. Investors in CHC usually have more at stake than investors in a publicly held corp b. Without a SH agreement which is enforceable, the minority might be at the mercy of an oppressive or unknowledgeable majority c. Look to Public Policy too d. The court says that without a shareholder agreement, specifically enforceable by the courts, insuring him a modicum of oppressive or unknowledgeable majority. e. Under the current tax regime there are no tax considerations or benefits x. Ramos v. Estrada: Pooling Downsides 1. Facts: BG 50% ownership with 25% Ramos (pres)/5% Estrada (board). They agreed to vote as a block. If anyone violates, then forced to sell shares at 8% per year. Estrada went against the agreement. Estrada claims the agreement is void. Estrada votes with Venture to oust Ramos. At next meeting of B6, B6 excludes Ramos from Board and Ms. Schramn. Courts says agreement is ok. 2. ROL: Minority shareholders are permitted to pool their efforts to gain some control. Downside is that you lose some control within the group because you need to abide by the groups decisions. xi. Zion v. Kurtz 1. A shareholder-agreement case under Delaware law, but stated that the result would be the same under New York law. 2. No other activities could be engaged in without the minority shareholders consent. 3. Under Delaware Limited Liability Company Act 18-704(a) a. An assignee of a LLC interest may become a member i. The approval of all the members of the LLC ii. Compliance with any procedures provided for in the LLC agreement Week 10 a. Abuse of Control Always easy to find abuse i. Squeeze-Outs 1. ROL: SH in a CHC owe one another a FD of utmost good faith and loyalty. SH in a CHC may not act out of avarice, expediency or self-interest in derogation of their duty of loyalty to the other SHs and to the corporation. Donahue (MA). 2. One remedy for deadlock is dissolution. a. Partnership: If one wants out it destroys the partnership. ii. Wilkes v. Springside Nursing Home, Inc. (MA 1976) Legitimate Business Purpose 1. Facts: P and 3 other Shareholders each owned 25% of the corporation. Each holder participated in management, and received an equal salary. Relations went bad. Other 3 ousted Wilkes from CHC no salary and dropped from board. He 64

brings Breach of FD claim. Other SH violated their duty to him. Court agrees. 2. ROL: Ordinarily Shareholders have no Fiduciary Duty to each other, but in certain cases when those Shareholders are involved in a corporation, there are exceptions. One such rule is that shareholders in a CHC have substantially the same fiduciary obligations to each other as so partners in a partnership. Coadventures as Justice Scalia put it. a. 2 Step Analysis i. Majority must show they have a legitimate business purpose for their actions ii. If majority succeeds, then injured party must show there was a less harmful alternative b. Application (narrow) i. Applies only when minority holder reasonably regards his continued employment a major means of realizing a return on this stock investment. 3. Important factors: a. Grossly inadequate buyback offer is evidence of a plan to buy back shares at price below their value. b. Majority failed to show they had a legitimate business purpose c. Possible less harmful alternatives: i. Training, night school, etc. d. Still Possible to Fire someone i. if, the majority can show that they are not acting with purpose or effect of depriving the minority holder of the fruits that he reasonably anticipated from his stockholdings. ii. Need a Business reason in order to do a freeze out. iii. Solution: Lifetime Employment Contract Get Majority Shares Have a Buyout agreement, Everyone has to have an exit a. Carefully crafted as no not wreck the business early on iii. Ingle v. Glamore Motor Sales, Inc. (NY 1989) 1. At-will Before Shareholder 2. Facts: After business was running Ingle was hired. He purchased shares of the company and eventually got 40% of the shares. There is an additional offering where majority buys, and majoritys sons buys, but they never offered more to Ingle. Eventually fired Ingle. Majority bought back all his shares pursuant to SH agreement. Court says no COA. 3. ROL: A person who begins employment as an at-will employee and later becomes a shareholder does not have a COA when he is terminated and agrees to sell back his shares pursuant to Agreement. 4. Important factors: a. Started as an at-will employee b. Shareholder agreement was binding c. This is a K case, not a breach of FD d. This agreement basically allowed for a freeze-out; thus, we do not need to go through a Wilkes analysis iv. Sugarman v. Sugarman. (1st 1986) 1. Minority Need Not Sell to be Harmed 65

2. Facts: Leonard appeals DC decision that he violated FD to minority in CHC. 4 brothers started partnership selling paper products. Each owned equal share. Court says he did breach his FD. 3. ROL: in a CHC, a minority SH who merely receives an offer from a majority SH to sell stock at an inadequate price, but does not accept that offer, can still seek damages if the shareholder can prove that the offer was part of a plan to freeze the minority SH out of the corporation. Basically, Majority did not want minority to have ANY financial benefits 4. Analysis: a. First, Minority SH must establish that the majority SH employed various devices to ensure that the minority SH is frozen out of any financial benefits from the corporation through such means as the receipt of dividends or employment b. Second, Minority SH must establish that the offer to buy stock at a low price is the capstone of a majority plan to freeze-out the minority c. Must show more than just: i. Majority too excess compensation ii. Majority only offered to buy back at low price 5. Freeze-out devices employed by majority a. Leonard gave his father unequal salary and benefits b. Offered to buy back at grossly inadequate price c. Leonard received excessive compensation d. Never paid dividends e. Refused to give Marjorie desired employment 6. Remedy: a. Damages = Loss of value of shares b. No remedy for instatement 7. Buy-Sell Agreement could have helped with marketability of shares v. Brody Supplement Case 1. Plaintiff is the widow of Walter. Ignored Walter, but wouldnt buy him out. It didnt pay out dividends. 2. After a trial court ordered that majority stockholders purchase the stake of a minority stockholder whom the court found was frozen out (receiving no financial benefit or rights to participate in or manage the company), the defendant majority stockholder appealed. 3. On appeal, the Supreme Judicial Court found that the Superior Court had overstepped its authority in granting a remedy, which had heretofore not existed in Massachusetts. The Court reasoned that the plaintiff should have been placed in the same position in which she would have been, had the defendants not breached their duty of utmost good faith and loyalty, but not in a better position. 4. The Court stated that, by ordering stock to be repurchased at an appraised value, where there was no ready market for the corporate stock to start with, the trial court was creating an artificial market. Thus, the Court determined that "the remedy had the perverse effect of placing the plaintiff in a position superior to that which she would have enjoyed had there been no wrongdoing." In effect, the Court refused to enlarge remedies of minority shareholders by creating a ready market for the sale of their stock where one did not exist 5. The Court specifically suggested the remedies that were available including damages and injunctive relief to make sure that the plaintiff "is allowed to participate in company governance, and to enjoy financial or other benefits of the 66

business, to the extent that her ownership interest justifies." 6. Accordingly, the law remains the same, and with respect, at least, to the frozen out shareholder, he has no right to force a purchase to redress any harm he may have suffered. vi. Smith v. Atlantic Properties, Inc. (Mass. 1981) 1. Obligation of Minority SH 2. Facts: Veto possible for any of the 4 SHs. 1 of SHs doesnt need the money when the other 3 do. He keeps vetoing dividend distribution vote. He wants to reinvest the money, the other 3 want to distribute. Due to 80% requirement, they are deadlocked. Consequently, company is nailed by IRS with huge fine. Court says minority owes. 3. ROL: A minority SH might still be held to have FD if their shares have the ability to control the corporation and their purpose is NOT that of a legitimate business purpose. 4. Important factors: a. It is a deadlock case more so than a freezeout. Its not a freezeout but it is a functional equivelant. b. Minority purpose was personal, not business. Look to motivation 5. Remedy: a. Minority must reimburse corporation for its loss incurred as a result of his unreasonableness b. Court might also declare a dividend 6. No mechanism for controlling executive Comp. (AIG/Disney Case) 7. What if Wilson contributed to the Kennedy and sponsored a bunch of charities and is a really nice guy and these guys come in and say I want Cash. a. This may have made a real difference. vii. Nixon v. Blackwell (Delaware) 1. A stockholder who bargains for stock in a closely held corporation can make a business judgment whether to buy into such a minority position, and if so on what terms. a. Once you are in you lose your chance. 2. A stockholder intending to buy into a minority position in a Delaware corporation may enter into definitive stockholder agreements may provide for elaborate earnings tests, but-out provisions, voting trusts, or other voting agreements. 3. Minority shareholders should be able to bargain for protection viii. Jordan v. Duff and Phelps Inc. (BEANS FAVORITE) (Exam in Spring) 1. Jordan, an employee of and stockholder in Duff & Phelps, left the closely-held company and cashed in his stock according to his stockholder agreement; a pending sale of the defendant firm would have made his stock far more valuable. This company is owned by 40 people and moves with book value. 2. Duff: a. Is there a buyout agreement? i. Yes, but if you leave or die the other side must buy them. This agreement was honored. b. I told Jordan to hang on and wait a few months so he can get greater value because the buy back agreement said that the price is set by December 31. i. Jordan said ok c. On November 14, the Board found a buyer and November 16 Jordan resigned and later the Chairman got caught cheating and a resolution was passed to allow the woman to keep her stock. 67

3. Jordan: a. Corporation had knowledge about the value of the stock that disadvantaged him. b. The only told me to stay on for a short time, which I did. c. Basis for Claims: i. Failure to disclose under 10b-5 ii. Fraud iii. Breach of Fiduciary Duty d. Test: Would a normal investor think this information is material? i. Must disclose all material information Example: Someone comes and says can I use the laptop for the final exam. Ok, then anyone can use a laptop for the final. What he didnt say is that he gives As to everyone who uses a bluebook. Again, all the information is necessary. 4. It is material information and the company had to disclose in order to avoid an opportunistic conduct. 5. A former employee may recover damages for increased stock value after selling stock back to a closely held corporation. 6. ROL: Corporations buying their own stock owe a FD to those persons who are selling their stock. They must provide adequate information to the seller. 7. Dissent: A corporation owes no duty to an employee who is bound to sell his shares to the corporation by a stockholder agreements clear terms. He classified him as an at-will-employee and avoids 10b-5. b. Control, Duration, and Statutory Dissolution i. Minority shareholders of closely held corporations claim that they have been treated unfairly by the majority. ii. Remedies Available to Minority hurt in CHC 1. Courts can order Dissolution (very extreme) 2. Require Buyout at FMV (less extreme) 3. Equity Powers to fashion appropriate remedy iii. Alaska Plastics v. Coppock 1. Equitable Remedy as an Option 2. Facts: 3 owners. 1 got a divorce and had to split his share of the company with his wife. 3 owner never told the ex about meetings, votings, etc. 3 started getting salaries, Muir never received a dime. They offered her $15, but she appraised the shares at $23-40. AL purchased Valley Plastic. AL burned down, 3 did not rebuild, they just moved everything to Valley Plastics. 3 made 2 more offers, Muir sues. Both Derivative and Direct actions. 3. Must have annual shareholder meetings and you have to give notice, what if you dont give notice? 4. Directors fees are set by the board. 5. ROL: Courts can liquidate a corporation when it is shown that the acts of those in control are oppressive or fraudulent. However, courts retain equitable authority to fashion a less drastic remedy to fit the parties situation. 6. 262: Appraisal Remedy 7. 4 ways to get a Buy-out a. Provision in articles or bylaws; b. P can petition courts for Involuntary Dissolution; i. Very extreme, usually reserved when corporate assets are being 68

misapplied or wasted and court feels that liquidation of assets is best for all parties. ii. Also, illegal, oppressive or fraudulent actions iii. Creditors first, cost of liquidation second, then pro-rata to SH. iv. Different States have different standards: AL Illegal, oppressive, or fraud v. NC Reasonably necessary for protection of the shareholders c. P demand statutory right of appraisal; or i. Available upon merger or consolidation, or other fundamental change to nature of the corporate structure that there is a de facto merger which triggers the same statutory appraisal remedy d. Equitable remedy after breach of FD i. Transactions by one group of SHs that enable it to derive some special benefit not shared in common by all SHs should be subject to close judicial scrutiny. ii. Burden Shift: Heightened scrutiny requires D to show that the transaction was fair 8. BJR applies to the Derivative claims 9. Dissolution is the last resort 10. Aftermath a. Judgment for Muir for $32,000. b. Findings of oppressive or fraudulent conduct sufficient to warrant a remedy as drastic as involuntary dissolution of the corporation of a forced buy out of Muirs shares c. It allowed the superior court to liquidate a corporation when it is shown that the acts of those in control are oppressive or fraudulent. iv. Notes on Meiselamn v. Meislman 1. Michael was fired and lost his salary and fringe benefits 2. Allows a court to order dissolution where such relief is reasonably necessary for the protection of the rights and interests of the complaining shareholder. v. Notes on Limited Liability Companies 1. Upon resignation, any resigning member is entitled to receive any distribution to which he is entitled under a LLC agreement. 2. The fair value of his limited liability company interest as of the date of resignation based upon his right to share in distributions from the LLC. 3. If investors form a corporation the default rule is there will be one of no right to dissolution or buyout. 4. If they form an LLC then the default rule will grant them that right. vi. Haley v. Talcott 1. A disgruntled LLC member sought judicial dissolution of the LLC when the contractual exit mechanism failed to free him from personal liability for a business debt. 2. Reason for the guy to think that had been promised but he didnt get it. 3. A contractual dissolution mechanism must offer an adequate separation of interests. 4. LLC in this case is similar to a joint venture: a. Only has two members b. Agreement executed by the parties indicate their intent to engage in a joint venture c. The members are deadlocked 69

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5. Dissolution occurs if an LLC or Joint Venture are in a deadlock vii. Pedro v. Pedro 1. Primary Expectations 2. Facts: 3 brothers in business. 1 is terminated (wrongfully). He was fired after investigating unaccounted for money. MN court can order (i) buyout and payment in installments. They had a buyout agreement, SRA. 3. ROL: Damages: If the fair value of the shares is greater than the purchase price for the buyout as calculated from the formula in the agreement, the difference is the measure of injured partys damages resulting from having been forced to sell his shares in the company. Fair market value is more than book value. 4. Reasonable Expectations: Depends on reasonable expectations of the SHs as they exist at the inception an develop during the course of the SHs relationship with the corporation; thus reasonable expectations of such a SH can be job, salary, a significant place in mgmt, and economic security for his family. 5. Future Employment: In a CHC the nature of the employment of a SH may create a reasonable expectation by the employee-owner that his employment is not terminable at-will. 6. Important factors: a. Majority breached their FD by forcing resignation b. Can recover attorneys fees viii. Stuparich v. Harbor Furniture Mfg, inc. (CA 2000) 1. 2 Ways to get Dissolution 2. Facts: Ps were sisters, D were other family members. Father built successful business. He wants to pass the torch. He sells some of his shares at a discount to his son; thereby giving son a majority. P got frustrated because they disagreed and stop attending the meetings. Mobile Home park generates the cash and is owned by the corporation (furniture store). 3. The girls were seeking involuntary dissolution. However, the girls were making money on dividends. If they had not been making any money maybe they would have gotten a dissolution. 4. ROL: New law specifically authorizes formation of CHC and the agreements necessary to dissolution. But, this drastic remedy is aptly limited to 2 possible scenarios (might be more too) a. #1: The liquidation is reasonably necessary for the protection of the rights or interests of any substantial number of the SHs b. #2: Existence of mismanagement , abuse of authority, or persistent unfairness toward SH 5. POLICY: Court must come in to protect the interests and rights of the minority because they are unable to do so on their own. 6. Important factors: a. Father has privilege to sell to son at ANY price he wants Week 11 a. Transfer of Control i. General Rule: A controlling shareholder may sell his control block for a premium and may keep the premium himself. Clark. 1. Exceptions: a. Looting; b. Sale of a vote; and c. Diversion of collective opportunity 2. Control Block: A person has effective control if he has the power to use the 70

ii.

iii.

iv. v.

vi.

vii.

assets of a corporation (not always the majority holder) Frandsen v. Jensen-Sundquist Agency, Inc. (7th 1986) Contract Case 1. Facts: Dispute over minority rights in CHC. Walter owned 100% of JSA. He sold 52% to his family and 8% to Dennis. Additionally, Walter made them sign a Right of First Refusal agreement which provided that if the majority bloc offered to sell its shares it had to give Walter the right to buy the shares at the same offer price. If Walter declined, the majority bloc had to offer to buy his shares at the same price at which it sold its own shares. So, Merger occurring and all SHs except Walter sign. He instead wants to exercise this right to buy those shares at $62. They do not wish to sell to him. 2. In this case he had a tag along option if he didnt have the money and had the right of first refusal 3. There is an issue of the duty of loyalty. 4. ROL: (i) Asset sales generally do not trigger rights of first refusal, (ii) rights of first refusal are to be interpreted narrowly. 5. Competition is not a tort Zetlin v. Hanson Holdings, Inc. (xya) Control Premiums Are OK 1. Facts: D and their families own 44% of stock. D sell their interests in Flintkote for $15, when it was selling for $7 on open market. P contends that he and other minority SH should be given that same premium. Court says no. 2. ROL: A controlling SH is free to sell and purchaser is free to buy, the controlling interest at a premium price. Unless, there is looting, corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith. Notes on Control Premiums 1. Two paradigms: pg 698-700. Planning Problem 1. Always adopt an equal opportunity provisions 2. If the two are sisters then there should def. be a provisions 3. It may be difficult to advise all three Perlman v. Feldman (dd) (Special Facts in War Time) Taking Corporate Level Gain 1. Facts: During Korean War Feldman grew NWSC. He used the Feldman Plan to acquire interest free loans from customers. Feldmen sold his control bloc to Wilport. W then used the company as a supply company for their steel use. SH sued Feldman because they lost value. P recover individually not to corp. 2. ROL: Where the controlling SH takes a corporate-level gain and instead appropriates that gain for himself, it is a violation of FD. a. Newport could have continued to realize its extra profits by maintaining and even expanding the Feldman Plan; instead, this corporation opportunity was (apparently) transformed into abolition of the Feldman Plan and dollars into Feldmans own pocket. 3. Important factors: a. Remedy: Premium payback was to be paid solely to the minority shareholders and not back to corporation. b. Significance of Feldman seems narrow. If the corporation has an unusual business opportunity that it is not completely taking advantage (ability to raise prices, to obtain interest free loans, or otherwise to prosper in a time of great demand for its products), this opportunity may not be appropriate by the controlling SH in the form of a premium for the sale of control. c. Better to sue under Breach of Loyalty or Loss of Corporate Opportunity Essex Universal Corporation v. Yates. (2d 1962) Immediate Transfer of Control 71

1. Facts: Yates owned 28% of the shares of RPC. He agreed to sell his shares to Essex. This agreement provided that Yates will (i) deliver resignations of the majority of directors of RPC, and (ii) cause a special meeting were they resign and take the new nominees mass seriatim. He tries to back out cuz $ went up. Essex sues. Yates claims the trx was illegal, because they negotiated the sale of board positions. Court says not illegal. 2. ROL: It is legal to give and receive payment for the immediate transfer of management control to one who has achieved majority share control but would not otherwise be able to convert that share control into operating control for some time. 3. 3 Stage Analysis a. Is there a sufficient transfer of stock to justify or insulate a decision to give director positions; b. Is this enough stock to give the purchaser control; c. Burden is on person challenging the arrangement to prove that control is insufficient 4. Analysis: a. The new controlling SH had control, it would have been only a matter of time before they would have replaced all the directors because of the staggered board. THUS, this would benefit noone to make them wait for something that is evitable. viii. Notes: 1. Classified Board: Different classes of stock elect different sets of directors. 2. Delaware Law 141(k): any director or the entire board of directors may be removed with or without cause by the holders of a majority of the shares then entitled to vote at an election of directors. a. Exceptions i. The certificate of incorporation otherwise provides in the case of a corporation whose board is classified as provided in subsection d of this section, shareholders may effect such removal only for cause. ii. Permits the board to be divided into one, tow, or three classes to achieve staggered terms and for classification of shares for the purpose of electing directors 3. Amendment: Adoption by the board of a resolution incorporating the amendment and by approval by a vote of the shareholders b. Mergers, Acquisitions and Takeovers i. MERGER: Section 251(a): Any 2 or more corporations existing under the laws of this state may merge into a single corporation, which may be any 1 of the constituent corporations or may consolidate into a new corporation formed by the consolidation pursuant to an agreement of merger or consolidation 1. Two Options: a. Consolidation i. Deal is made and a Merger occurs (Board) Shares for A get exchanged for shares of B and A no longer exists. a. Can also be done after 90% is acquired ii. Cash Offer/Tender Offer (Shareholders) b. New Corporation i. A and B become C and C assumes the debt of A and B. 72

ii. Section 251(b): Board must adopt a resolution that describes the terms. 1. Merger 2. Consolidation iii. Section 251(c): Agreement is submitted to the shareholders and the shareholders vote. Must have a majority of outstanding stock. iv. Section 251(e): Certificate of incorporation of the suriving corporation is automatically amended. v. Section 251(f): No shareholder vote is needed if it doesnt amend the certificate of incorporation, if the stocks remain the same, if the plan does not exceed 20% of the common stock. vi. Section 252: Domestic and Foreign Corporations vii. Section 253: Parent and a Subsidiary Merger viii. Section 254: Corporation and Joint stock or Other association ix. ASSET SALE 271: (a): All of the assets or substantially all must be sold. x. Mergers Under SPOON 8 Forms of Mergers (1 extra) 1. Statutory Merger [Type A Reorg Trx b/w companies] a. A gives A-Stock to Bs shareholders b. By operation of law ALL B-Assets & B-Liabilities become part of A c. Approval: Both A & B shareholders d. Taxes: No tax for A & B shareholders reorganization e. Survivor: Only A-Corp survives. B-Corp dissolves, and B-Corp shares disappear. f. Type A Reorganization g. Dont forget about Appraisal Rights i. Provides that dissenting SHs to a merger are allowed a legal remedy to have the company purchase their shares at FMV, if the company is substantially different 2. Cash Out Merger [Trx b/w companies] a. A gives Cash to Bs shareholders b. By operation of law ALL B-Assets & B-Liabilities become part of A c. Approval: Both A & B shareholders vote d. Taxes: Former B shareholders pay tax since they received cash e. Survivor: Only A-Corp survives 3. Asset Sale [Trx b/w companies] a. A gives Cash to B-Corp b. B sells Assets and Liabilities to A c. Approval: Board only d. Tax: Taxable for B shareholders because they receive cash e. Survivor: A-Corp survives. f. B-Corp liquidates by distributing its only asset (cash) to Shareholders 4. Cash for Stock [Tender Offer Trx b/w shareholders] a. As Shareholder(s) send Cash to Bs Shareholders b. Bs Shareholders give their B-Corp shares to As Shareholders c. Approval: Direct transaction between A s/h and B s/h. No company approval necessary. d. Taxes: Former B shareholders pay tax since they received cash e. Survivor: Both A-Corp and B-Corp Survive f. Downside: Not all of Bs shareholders will sell their stock in this transaction. If you want 100%, then try a Statutory Merger. 5. Stock for Assets [Trx b/w companies] 73

a. A gives to B A-Corp stock b. B gives to A certain B-Corp assets and liabilities c. Approval: Selling substantial all of Bs assets; therefore, requires B shareholder approval. Not As. d. Survivor: B dissolves and distributes A-Corp shares to its Shareholders e. Tax: Tax free to A and B f. Extra: If As stock price fluctuates greatly immediately before the close of the deal, it might be renegotiated. 6. Stock for Stock [Type B Reorg Trx b/w A & Bs SHs] a. A-Corp send its stock to Bs shareholders b. Bs shareholders sends its B shares to A c. Approval: Direct transaction between A-Corp and B Shareholders d. Tax: Not taxable to B shareholders 7. Reverse Triangular Merger [Technically, Merger is between B-Corp and ASubsidiary] a. A forms new company (100% wholly owned sub) A1 b. A1 merges with B-Corp c. B shareholders get Cash or A1-Corp stock d. B-Corp becomes 100% subsidiary of A-Corp e. Approval: Requires As Shareholders approval f. Survivor: B-Corp is the surviving company g. Keeps all Bs Goodwill, License, contractual agreements, and Patents alive. h. Tax: Depends on whether cash or stock is received 8. Forward Triangular Merger [Technically, Merger is between B-Corp and ASubsidiary] a. A forms a new company (100% wholly owned sub) A1 b. A1 merges with B-Corp. c. Shields A from B-Corp liability. d. Approval: Requires Bs S/H approval, Not A since A1 is merging e. Survivor: A1 survives, B dissolves f. Tax: No tax to B if they receive stock 9. 2 Stage Acquisition Squeeze-Out Merger a. Similar to Cash for Stock Tender Offer, but 10% dont Tender b. A-Corp gets 90% of B-Corp c. A-Corp forms A1 d. A1 and B-Corp do a Statutory Merger e. Thus, remaining 10% of B-Corp hold-outs get A-Corp shares by Operation of Law xi. Steps in a Merger 1. File in the State or Jurisdiction that you are merging in to 2. Board initiation and approval a. Must adopt a document known as a Plan of Merger i. Outlines terms and conditions of the merger ii. Consideration b. Board is bound by its fiduciary duties. i. If merging with a controlling shareholder (partner) it is reviewed as a self-dealing transaction ii. Disclosure protection need disclosure of material facts 3. Shareholder approval 74

a. Plan of Merger must be submitted to shareholders of each corporation for approval b. Needs complete disclosure, complete candor c. Dissenting shareholders are bound by the will of the majority d. Targets shareholders have to approve too e. MBCA i. Requires votes by each class of stock and merger is not approved is rejected by any voting class ii. Not voting stock which is substantially effected, now gets to vote 4. Appraisal Merger a. Shareholders cannot opt out of the merger and retain their original investment b. Shareholders entitled to vote on the merger has a right to receive the appraised, fair value of their shares in cash xii. 263: Appraisal Rights 1. Only available in mergers not sale of assets a. If it is in the articles of incorporation then there are appraisal rights if the corporation allows gives that option to its shareholders 2. No rights if it is listed on the NASDQ a. If this occurs the only option is to sell, but that price may be lower than he wants b. Other than this he is stuck 3. Must hold the shares before the merger and make the demand before the meeting to vote on the merger 4. Loses his right to vote after the vote takes place and loses the right to dividends after the effective date of the merger 5. Court determines the value of the stock (All relevant factors) a. Past earnings b. Market Price c. Cash Flow d. Secret Assets 6. The Plaintiffs organize together by filing in the Court of Chancery 7. Court has the power and discretion to decide who pays what 8. The Plaintiff can change his or her mind 9. Delaware makes it very unattractive to seek appraisal rights 10. Corp pays dividend and some of the checks come back because someone has moved or dont know about the certificate then the money escheats to the state. The state of domicile of the corp. gets the money. Then if someone finds their certificate then they can go to the state in a certain amount of time 11. If someone is getting shares for shares then appraisal rights are not available if the Corporation is listed, no vote required, or more than 2,000 holders. xiii. Short Form Merger 1. Company A who owns an overwhelming majority of the shares of another Company B may merge with B with ONLY the vote of the Board of Directors of A. Skips SH approval (exception to the SH vote rule) a. DE and MBCA allow Short-form Mergers when Company A owns > 90% of Company B b. Weinberger v. UOP. c. Minority remedy: Usually limited to Appraisal Rights, unless extremely unfair 75

xiv. De Facto Merger Doctrine 1. A theory which courts create a functional merger to give minority Shareholders appraisal rights or Shareholder vote. Those are the 2 most common results. 2. KEY: Company structures merger or selects state law so that minority does not receive appraisal rights. 3. Very few courts have accepted this theory (PA & NJ ok). a. DE rejects b. Even PA seems to reject this doctrine now because the legislature has gone back and rewritten the laws. Additionally, in Terry v. Penn, the courts basically reversed. xv. Farris v. Glen Alden Corporation (PA 1958) De Facto Merger Doctrine 1. Facts: Stock for assets merger (C reorg). Companies combined following the transfer of Assets Statute in DE. Original structure was to have Glen buying List, but Glen SH were pissed because List ended up as the majority SH. SH thought List pulled a fast one. Why would List do this? Because in PA no appraisal rights are given to a purchasing companys SH, only the Target company. Thus, with this usual structure, Glen SH (minority) would have no appraisal rights. Minority wants appraisal rights. Court says, de facto merger minority gets rights. 2. ROL: De Facto Merger Doctrine applies because this merger was driven by the primary motivation to deprive the target SHs of their appraisal rights. 3. Analysis: Court basically said this was merger; therefore, de facto. The court looked to the consequences of the transaction and applicable merger laws. 4. Important Factors: a. Increase number of directors b. Name changed c. Company doubled in size d. List would control 76.5% of the shares e. Stock value decreased substantially f. All of these factors made it a merger 5. The DeFacto merger is eliminated 6. Could this be a 10b-5 case or 14(b)? a. Yes maybe Glen Alden (PA) Asset Sale Merger
xvi.

List (Del) No Appraisal Rights Appraisal Rights

Appraisal Rights Appraisal Rights

Hariton v. Arco Electronics, Inc. (DE 1963) No De Facto in DE 1. Facts: Arco agreed to sell all its asset to Loral for Loral shares (C reorg). Arcos SHs approved the dissolution of the company. Arco then liquidated and distributed to its SHs all the Loral shares it had received in return of the assets. Net economic result if Arco merged with Loral. BUT, Arco SHs did not get any appraisal rights (asset sales = no appraisal rights in DE under statute). Both Asset Sales and Mergers are covered under DE law. P wanted appraisal rights and argued Farris. Court says no appraisal rights, no de facto. 2. ROL: Where Asset Sales and Mergers are both provided for in statutes, they are both of equal weight and either one can be used by corporations. Courts will look 76

to the letter of the agreement to determine which method was selected by the corporations and will not change the form selected. 3. Important factors: a. DE had statutes for both Asset Sales and Merger b. Company selected the Asset Sale statute to perform their reorganization XII. Week 12 a. Freeze-Out Mergers i. Squeeze Out Majority tries to squeeze out the minority ii. Going Private Limiting the amount of shareholders iii. 2 Methods of Analysis (EFT or BPT) 1. DE Requires Entire Fairness Test a. First - P burden to demonstrate some basis for invoking Fairness Obligation b. Second (burden shift) - D burden to show transaction was Fair i. If corporation shows there was: Approval by majority of minority Shareholders; Adequate disclosures; AND

Arms length process (independent committee) ii. THEN, burden shifts back to P to prove the transaction was unfair. c. Result: If transaction was Fair, then BJR kicks in d. DE no longer requires Business Purpose Test. 2. Other Courts Require Business Purpose Test a. Additional requirement on top of EFT b. Even if insiders pay a fair price, they cannot put through a transaction whose sole purpose is to eliminate the minority (public) SHs. The transaction must serve a valid corporate purpose. i. 2 step acquisition Usually doesnt matter ii. Going private Makes a difference iv. Weinberger v. UOP, Inc (DE 1983) Entire Fairness Test Inadequate Disclosures 1. Facts: Signal owned 50/50 of UOP (Parent-sub). 4 key directors of Signal were also directors of UOP. 2 of these directors prepared a feasibility study which said the shares were worth $24. Signal eventually offered only $21 to SHs to to a hurriedly prepared fairness opinion by UOPs investment banks (hurriedly because Signal made it so). Signal never told UOP Shareholders about their study. Bare majority approved the deal. Court say this wasnt fair. It is a cash merger so some shareholders will get cash and lose their equity interest. If you only want to acquire 50.5%. So if you make a tender offer then you take a pro rata amount from each person till you get to 50.5%. The court thought that the review board rushed its analysis since it was only done in 4 days. 2. Factors: 77

a. Plaintiff has the burden of proof initially b. When minority shareholders approve you would have thought that was enough but it may only be c. Cannot keep secrets (Disclosure) d. Fairness of the merger, price (Paid sufficient) e. Must have business purpose 3. ROL: Transactions must pass the requirements of the 3 Prong Entire Fairness Test which looks to (i) fair dealing, (ii) fairness of price, and (iii) disclosure. a. Remedy Valuation: Use Discounted Cash Flow Method. But, DC powers are complete to form equitable and monetary relief as may be appropriate, including rescissory damages. 4. Application: Fairness in a Freeze-out Transaction (CANDOR) = EFT a. Business Purpose requirement gives little protection to minority; and therefore should be dropped in favor of EFT. b. Fair Dealing (Procedural Fairness) Failed i. Signal never negotiated with UOPs board, they just told them what price they were going to pay ii. Superior knowledge was never shared iii. Short time constrains iv. Not an arms-length trx v. Factors: timing, how initiated, structure, negotiations, disclosures, approved by Directors and SHs c. Fairness of Price Failed i. The price was unfair because the unhurried feasibility analysis said $24, but they only offered $21 Watch out: The current market price was only $14.50 at the time, but that irrelevant to fairness of price ii. Factors: Economic considerations, financial considerations, assets, mkt value, intrinsic value, inherent value d. Disclosure Failed (Loyalty and Care are the only two duties) i. Signal used confidential UOP information to prepare their feasibility study ii. Signal did not make fair disclosure of the (i) hurried UOP opinion, or (ii) unhurried $24 opinion. 5. What could Weinberger have done? Independent Committee to Negotiate a. W could have used a Special Committee of Independent Directors to negotiate the transaction b. Arms-length transactions provide additional insulation from perceived unfairness c. Had the Directors exerted its bargaining power against the other at armslength, it would have been strong evidence that that transaction meets the test of fairness 78

d. Could have raised the price at the board and released a proxy statement. 6. If you are not candor then you violate the Duty of Loyalty. There has to be fair price and fair dealing v. Coggins v. NE Patriots. (MA 1986) Legitimate Business Purpose Public company going Private 1. Facts: Sullivan fought to get back control of Patriots. He did, organized new Patriots, then executed merger which eliminated voting stock of Old Patriots. Coggins owned Old Pat stock, brought class action. Court found that Sullivan accomplished the freeze-out merger for his own personal benefit to eliminate the interests of the minority and that was a breach of his FD and so impermissible. It started out as a close corp. 2. Non-voting shareholders get appraisal rights 3. ROL: Because the danger of abuse of FD is especially great in a freeze-out merger, the court must be satisfied that the freeze-out was for the advancement of a legitimate corporate. Thus, D must show that the merger serves a valid business purpose, which is unrelated to the personal interests of the majority. a. Damage: Ordinarily rescission is possible, but this deal is 10 years old; therefore, monetary damages b. Thus Remedy based on giving the Ps what they would have if the merger were undone and the corporation were put back together 4. Important factors: (Must look to totality of circumstances) a. DC decision based on Waste used corporate assets to accomplish a persona objective b. Offered price was inadequate c. Purpose of the merger d. Accuracy and adequacy of disclosure in connection with merger e. Fairness of price 5. Commentary: a. If we know BP is required in our jurisdiction, a bright manager can structure the deal to taper to this conclusion. b. Not fair to judge in hindsight. vi. Rabkin v. Philip A. Hunt Chemical. (DE 1985) Injunction Damages 1. Facts: An agreement existed to purchase a company in steps. 63% purchase on one date, then remainder to be purchased later for $25/sh. P contend that D pushed through a merger at $20/sh to avoid paying the $25. D was the majority SH of company. D performed independent analysis, evaluations and those came to $19-25. D issued proxy in favor of $20, but also provided all other disclosures regarding other evaluations. P seeks $25 for performance of the K, not appraisal rights. Court says performance of K is correct. 2. Cumulative First Preferred Series of Preferred ($3.50), on day one when the shares were issued the promise was that every year for every 100 invested 3.50 would get back. 3. Triangular Merger 4. No claim that the price was unfair, everything was disclosed, they just wanted more money. 79

5. ROL: Inequitable conduct will not be protected merely because it is legal. Injunction is a permissible remedy if Ps prove fraud, misrepresentation, or gross and palpable overreaching conduct by D. Appraisal remedy is not the only remedy. 6. Restated Certificate of Incorporation If you have a lot of amendments compiled to a more complete recent document. 7. Important factors: a. No requirement of majority of minority SHs b. De Facto Non-Merger i. A transaction that takes the form of a merger but the P argue in substance this is a sale of assets followed by a redemption. ii. Rauch v. RCA Corporation. (2d 1988) No De Facto Non-Merger 1. Facts: GE acquired RCA. Per agreement all stock of RCA was converted into cash. P claim this is an illegal dissolution, and they were not receiving the fair value of the dissolution they were only receiving a stock price. 2. ROL: A conversion of shares to cash to accomplish a merger is legally distinct from a redemption of shares by a corporation. Thus, a corporation may resort to one section of the DE corporate law without having to answer for the consequences that would have arisen from invocation of a different section (similar to Arco Electronics) 3. Important factors: a. Merger agreement complied fully with DE law b. Redemption by the corporation was at its election not required c. No allegations that $40 price was unfair d. Majority of the Preferred Shareholders approved this transaction c. LLC Mergers i. VGS, Inc. v. Castiel. (DE 2001) 1. Facts: Court says acts taken to merge are invalid and merger is rescinded 2. Managers that fail to provide notice to all board members of their intent to hold a meeting or seek consent to a written resolution violate their fiduciary duties to each other, even if they believe that keeping an individual member from voting at the meeting is in the companys best interests. 3. 141(f): act in consent, not at a meeting. 4. The court here says Equity looks at intent rather than form. a. Here the court found that the intent was to save the company but the process they took left Castiel out of the process and stripped him of his power. The notice in this case was defective to void the transaction. A duty of loyalty also existed. 5. The could have left Castiel with the 75% economic interest (non-voting) 6. 102(b)(7) trumps the duty of care in a derivative suit. XIII. Week 13 a. Takeovers i. Defensive Tactics Against Takeovers 80

1. Before a Hostile Takeover (protection measures, preventative measures) a. Tender Offers: i. Is simply a public offer usually made to all shareholders of the target corporation in which the buyer offers to purchase target company shares. ii. Bidder makes the offer to the shareholders of the target. Then the shareholders make their decision and the shares are held in escrow. Maybe someone else makes a better bid and if so then you can take your shares out. iii. A good way for a hostile to exist. iv. Exchange of securities or cash v. Williams Act Disclosure Procedural Requirements

vi. vii. viii. ix.

x.

Two Components a. 13(d): Get to 5% have to declare your ownership b. 14(d) and 14(e): What you have to do in a tender offer 13(d) any person who acquires more than 5% has 10 days to report its ownership 13(d)(e) defines person: Could be a group that acts to acquire ownership The agreement doesnt have to be formal or in writing 13(d)(3)(a): Beneficial Ownership as having or sharing, directly or indirectly, the right to cote or dispose of or direct the voting or disposition of the stock. Must disclose who you are and your plans and intention within 10 days after acquiring more than 5%. After every 1% addition you must resubmit your report and discuss if there is a change in your intention

If you screw this up then you can be stopped from voting for the current shares that you hold. xi. Commence a tender offer for more than 5% of a class of a targets equity securities. Notice has to go out to everyone Public Announcement Publication

NOBO v. CDEC statements xii. If an offer is for 51% and 100% tender then pro rata applies xiii. Creeping Tender Offers: xiv. Street Sweep: We think we might be interested and then the price runs up and then they say no we arent and then it collapses. 81

(Fraudulent? Manipulative?) b. Staggered Board i. Only a portion of the board is elected each term. ii. Another portion of the board is elected next term iii. How this helps It takes a minimum of 2 terms to elect a new controlling board Work around for hostile company a. Call a special meeting of the shareholders

Work around for defending company a. Make the % necessary for calling a special meeting very high (in Articles) b. Amend Articles to only allow Directors to be removed for good cause c. Board usually fight because they are looking out for their own interests. c. Golden Parachutes i. Lucrative contracts for senior management teams which provide for very high payments if there is a change in control ii. Basically a legal form of Greenmail 2. During a Hostile Takeover a. Anti-Trust i. Get the DOJ involved and get them to interject Usually only works if acquiring company has been buying up other similar businesses ii. Could buy other companies Could cause anti-trust problems for acquirer Could create regulatory problems for the bidder (bank)

As well as, increasing the size of the fish b. Buy your own Stock i. This works on a supply/demand basis; thus, the more you buy, the less stock remains and the remaining stock will be worth more per share. ii. Results: Cash is reduced significantly; thus, acquiring company cannot use your cash to finance the buyout

Cost per share increases c. White Knight i. Basically, go out and find another friendlier buyer for the company ii. Company is still taken over, but management and board might be 82

able to stay iii. Incentives for the White Knight Lock Up Provisions a. If their buyout attempt fails, they can buy assets at a bargain price (Crown Jewel Provision)

Termination Fee if they attempt to buy, but it fails, then they still get something a payment iv. Mechanics Usually requires a buyout amount very close to the hostile companys offer. d. Leveraged Buyout (LBO) i. Basically, creating another company who tries to acquire the existing company. ii. Effect is that it privatizes the company within the management or directors. Makes their own White Knight Management LBO e. Pac-man Defense i. Burrows Corp tried this and now they are no longer around, very risky ii. The Target company begins a Tender Offer for the Bidding company Turns the tables. f. Poison Pill i. A companys stock has a provision which gives the holder the right to buy additional shares if a hostile corporation comes in and purchases a certain percentage of the common stock. It basically increases the cost of the tender offer and makes it harder for the hostile take over company to gain control Can be used before or during a hostile takeover

Purpose is to stop or deter the hostile takeover, or strengthen the negotiating power to give the existing Board and management more power ii. Provisions Flip-In Rights (usually activated pre merge) a. In lieu of purchasing additional preferred stock, existing shareholders are given the option to buy common stock at an extreme discount (usually 50%) Flip-Over Rights (usually activated post merge) a. After a certain trigger (possibly 20% acquisition) 3 things normally happen: 1) The rights become separately tradeable; 2) The rights are no longer 83

redeemable by the targets management; and 3) The existing shareholders gets the right to acquire shares of the bidder at price. Rights to Redeem always exist a. Board can redeem these rights following a buyout attempt or unsuccessful attempt. ii. Cheff v. Mathes. (DE 1964) Greenmailing - Anti-Takeover Device 1. ROL: If the board shows that a particular hostile takeover will damage the corporations existence or business policies, and buying back the raiders shares at a premium in return for a standstill agreement will prevent the takeover attempt, then DE courts will generally approve the transaction even though it enriches the bidder at the expense of the corporations treasury. 2. Important factors: a. Buyer was a known Greenmailer and Raider b. Board was justified in fearing the worst if the Raider took over 3. Note: Greenmail a. If court determines that the decision to pay the Greenmail was motivated mostly by the Boards desire to retain their positions, then the Greenmail payment will be struck down. iii. Unocal v. Mesa Petroleum. (DE 1985) Enhanced Scrutiny Analysis 1. Facts: Mesa made a 2-tier offer for Unocal (they already owned 13%). Board said the 1st tier was coercive, because 2nd was so unattractive. They looked toward various defensive measures and went for a competing tender offer or selftender offer for notes, but purposely excluded Mesa. In DE, a statute provides that a Board has the authority to buy/sell their own securities to whomever they want. 2. ROL: Any response to a potential takeover bid must be proportional to a reasonable threat. To determine whether a defense was proper, a boards power to act derives from its fundamental duty and obligation to protect the corporate enterprise (including SHs) from harm reasonably perceived, regardless of its source. 3. Unocal Analysis or Enhanced Scrutiny 2 Step Analysis is born: Always include fiduciary duties (Breach of Duty of Loyalty-Self Interest (Duty of Care-Look to see if they have all the information needed) a. #1: Did the board reasonably believe there was threat to the corporation? i. Can look beyond the premium paid in current time ii. Is it a real threat and it is proportional? iii. Was there a threat to LT values and strategies iv. Burden is on Directors to prove they acted reasonably (more than normal BJR) Must show Good Faith Reasonable Investigation b. #2 Were the Boards measures reasonable under the circumstances? 84

i. Enhanced by independent board decision ii. Great if majority of board are outside directors iii. Again, Burden is on Directors c. Important factors: i. Burden is on Directors because there is inherent Self-dealing with all defensive maneuvers. ii. Today Securities Law are a bit different: Now SEC requires the same price to be offered to all SHs. Rule 14(d)-10 OVERVIEW OF HOSTILE TAKE OVER DUTY: If the Board perceives threat to the corporation or the shareholders then the threat has to be real and the response has to be proportional. If the Board is taking defense mechanisms then their response must be proportional to the threat. The threat must be reasonably perceived. If they start talking to a white-knight then examine under Revlon. If there is going to be a change in control then focus on Revlon. Examine fiduciary duties (Care and Loyalty). Look at Overall Picture Is there a hostile takeover right now? YES, use Enhanced Scrutiny NO, look at Traditional Business Judgment Rule 4. SEC Reactions and Poison Pills a. Pills are used in a variety of forms i. Security known as a right Warrant which grants the holder the option to purchase new shares of stock ii. Adds three additional elements not found in traditional rights Flip in element Flip Over element

Redemption provision iii. Adopted by the board of directors 5. Junk Bonds as the Back-End Consideration a. Debt obligations of a corporation that are usually subordinate to other debt. b. Concerned about the riskiness of such obligations for two reasons: i. Junk bonds are riskier than investment grade bonds, they are less serious that the common stock that the shareholders already own ii. A person who is reluctant to hold junk bonds receive in an exchange can sell them iv. Revlon, Inc. v. MacAndrews. (DE 1985) Revlon Duty 1. Facts: Revlon was target and Pantry was hostile acquirer. Revlon said no and 85

adopted Poison Pill and Share Repurchase. Then began looking for White Knight They found Forstmann Little. Bidding war started, Revlon eventually accepted Forstmanns $57.25 v. Pantrys 56.25 (not yet final) a. Additionally, Revlon gave Forstmann (i) crown jewel option to buy 2 subs at well below mkt price; (ii) agreed to no-shop provision; and (iii) agreed to a $25M cancellation fee. b. Revlon provided additional confidential information/materials to F that they didnt provide to Pantry. 2. ROL: Revlon Duty: In a situation were the company is going to be sold (no question), the duty of the Board MUST be to maximize the amount they can get for each share. a. Basically courts will give Enhanced Scrutiny to both the process that the Directors followed and to the substantive fairness of the result. b. The company went out in search for another bidder so it seemed like the company was up for sale. In Time the Revlon duties are not invoked since there was no rival bidders. Always examine fairness of the offer, such as self-dealing (breach of loyalty) then go into entire fairness (fair dealing plus fair price) c. If there is a sale for sure then the Board must get best deal for shareholders. When they talked to the white-night instead of the hostile takeover they should have began negotiating to get the best rpice. 3. Analysis: The court determined that the first 2 provisions of PP and SR were reasonable. But the next 3 provisions (althought not per se illegal) are not enforceable because: a. There was NO question the company was going to be sold i. Then the duties of the Board change. It becomes the SOLE duty of the Board to get the highest price the company (they basically become Auctioneers) ii. These are now called Revlon Duties b. Enhanced Scrutiny Test: Was this done to maximize profits? Cuz you cannot play favorites at the same time. Must have an impartial auction after crossing the lie and putting the company in play. i. Question of defensive maneuvers becomes moot 4. Important factors: Revlon permits management to justify poison pills and other defensive tactic because they may lead to an auction and thereby produce a better price for shareholders than would a sale to the first serious bidder. a. They started favoring one deal over the other b. Gave financial data to Forstmann and not Pantry c. Waived covenants for one but not the other d. Basically played favorites 5. 2 Situations Trigger Revlon Duties a. Corporation initiates active bidding process b. During bidding a target abandons LT plan and seeks an attractive 86

transaction v. Paramount v. QVC Networks, Inc. (DE 1994) Change in Control Apply Enhanced Scrutiny 1. Facts: Paramount is target Viacom is acquirer. Viacom made cash tender offer for 51%. Additionally, they included provisions to rpevent this transaction from being put in play. Provisions were unbalanced (i) no-shop, (ii) termination fee provision, (iii) lock-up stock option. After they agreed, QVC also made Cash Tender Offer for 51%. Paramounts mgmt portrayed the QVC offer in a bias manner, there appears to have been some favoritism toward Viacom. They made their Viacom prosition a bit better, but not by much. 2. ROL: Enhanced Scrutiny now occurs whenever the Board proposes a transaction that would result in a shift of control from the public to a particular individual or small entity. a. Similar to Revlon, courts will give Enhanced Scrutiny to both the process that the Directors followed an to the substantive fairness of the result (when the Board sells control) 3. Analysis: Paramount argued that Revlon duties do not apply to them because Paramount was not up for complete sale Court did not care. Basically 51% or 100% either way it is clearly a change in control 4. Situations requiring Enhanced Scrutiny Test a. The threatened diminution of the current stockholders voting power b. The fact that an asset belonging to public stockholders (a control premium) is being sold and may never be available again c. The traditional concern of DE courts for actions that impair or impeded SH voting rights 5. Key Features of the Enhanced Scrutiny Test a. A judicial determination regarding the adequacy of the decision making process employed by the directors, including the information on which the directors based their decisions b. A judicial examination of the reasonableness of the directors action in light of the circumstances then existing c. The directors have the burden of proving that they were adequately informed and acted reasonably d. The court will not substitute their business judgment for that of the directors, but will determine if the directors decision was, on balance, within a range of reasonableness 6. Application of Enhanced Scrutiny a. Break-up does not have to be present or inevitable b. Just needs to be a fundamental change of control is contemplated or occurs c. Accordingly, when a corporation undertakes a transaction that will cause: i. A change in corporate control, or ii. A break-up of the corporate entity iii. THEN the directors have an obligation to seek the best value reasonably available to the stockholders 87

7. 2 Circumstances where Enhanced Scrutiny Applies a. The approval of transaction resulting in a Sale of Control i. Directors must act in accordance with their fundamental duties of care and loyalty to the corporation and the SHs ii. Board need to adequately inform themselves in negotiating the sale of control iii. Outside independent directors are particular important, need their active participation iv. Need to seek the best value reasonably available to SHs b. The adoption of defensive measures in response to a threat to corporate control 8. Specific Obligation of the Board: a. Be diligent and vigilant in examining critically the transactions and offers b. Act in Good Faith c. To obtain and act with due care on all material information reasonably available, including information necessary to compare the offers to determine which of the trx or look for alternative action would provide the best value reasonably available to the SHs d. To negotiate actively and in GF with both or all parties 9. Lock-Up Options a. If bringing in Lock-Up options, then make sure those option will enhance and foster the bidding process. 10. Analysis for the Exam a. State the important facts i. No Shop Provision: Cant go out and peddle yourself, but it will be in the news so the deal may be considered by other people When someone comes in you cant talk to them unless they can prove they can finance the transaction No Shop agreement on page 804

This agreement cannot trump its fiduciary duties ii. Termination Fee Provision b. Applied Enhanced Scrutiny, because there is a conflict since it looks like they are trying to keep their jobs i. Directors have an obligation to get the best value for the stock holders once the company is in play (Revlon) ii. Paramount argued that Revlon duties do not apply since they are not up for complete sale. iii. Change in Control: In this case the stockholders were becoming a minority and Viacom could do whatever they wanted. Where in Times it was a change in stock but the board was going to stay the same and it was merely a change of stock. In this case they may just be backing away from Times. 88

c. d. e. f.

iv. The court is mad that they had a lot of leverage and didnt use it. Shareholders vote was limited: Cant screw around with shareholders power (Peerless) Control Premium: You can pay them Offers were coercive: Tender Offers with back end All facts are the same except when they get to $90, Viacom walks away and Berry negotiates a nasty deal i. IBM and Sun: Board doesnt have a change to negotiate since they lost IBM and Sun disappears at 9.40. ii. 102(b)(7)

XIV. Week 14 a. Extension of the Unocal/Revlon Framework to Negotiated Acquisitions i. Omnicare Inc v. NCS 1. ROL: Defensive devices in a merger must be reasonably related to a perceived threat. 2. Ad Hoc committee: Committee of note holders. 3. No Shop v. Exclusivity a. No shop: Cant seek it but can talk b. Exclusivity = No Talk, can only work with the one person 4. Just because there is an agreement, doesnt mean it doesnt violate a fiduciary duty. 5. The Market knew about the deal. 6. Aftermath: b. Extension of the Unocal/Revlon Framework to Shareholder Disenfranchisement i. Hilton Hotels Corp v. ITT Corp. (NV 1997) Deprive SH Vote 1. Facts: Hilton wanted to buy ITT and announced plans for proxy contest. ITT decided not to have their annual meeting. Hilton filed suit, but court says ITT bylaws do not require this annual meeting. ITT comes up with a Comprehensive Plan and decides to split their company into 3 parts and tries to create a classified board. Court says ITT purpose for implementing the Comprehensive Plan is impermissible and deprives the SHs of the opportunity to vote to re-elect or to oust incumbent ITT directors. Remedy: comprehensive plan is out, and ITT must have their annual meeting. 2. ROL: Implementation of a comprehensive plan to sidestep a takeover attempt is impermissible where it basically deprives the SHs of the opportunity to vote on the deal or if it involves depriving SHs the right to re-elect or oust incumbent directors. a. This might have been possible, if the bylaws were different 3. Important factors: a. No Revlon duties, because no threat of takeover b. Comprehensive plan was preclusive c. ITT offered no credible justification for not seeking SH approval of the 89

Comprehensive Plan c. State and Federal Legislation i. CTS Corp. v. Dynamics Corp. of America. (S.Ct 1987) 1. Facts: IN Control Share Acquisitions Statute restricts hostile takeovers by preventing the acquirer from voting the shares that he just purchased. He can call a special meeting of the SHs, but if he fails to get approval, then the target may redeem the control shares from the bidder by paying him the FMV a. Basically bidder must pay for this special meeting (very expensive) and if he loses the vote, he may be stuck with shares that have no voting rights 2. ROL: State Takeover statute are lawful as long as they only apply to those corporation chartered by the state (rather than principle place of business) 3. Analysis: IN statute is Ok. (i) No conflict with Williams Act because both acts were devoted tot eh same purpose (protect the minority by requiring full disclosure), (ii) does not unreasonably burden interstate commerce because the very commodity being traded is one that is created and maintained under state law (incorporated business) 4. They had hope that they could get it thrown out because of the Mite Case. In Mite, the state statute upset the purpose of the Williams act. Section 203: If you get over 15% then you have to wait 3 years to do a merger. d. State Anti-Takeover Legislation i. Generally 1. 1980s witnessed the fight between raiders and targets move from federal to state courts 2. Now most issues are handled in State courts 3. Federal Acts tender to favor neither party, but State Statutes tend to heavily favor the target company who is within their borders. ii. Federal Tender Offer Act 1. Designed to present a set of rules 2. Attempted to ride the fence and not favor either party iii. Went to the State Takeover Statutes 1. 1st Generation: State Takeover Statutes a. Basically mimicked the federal laws b. But, the Court held they were unconstitutional because they violated (i) the commerce clause, and nd 2. 2 Generation: State Takeover Statutes a. Control Share Acquisition Acts i. General provisions Acquisition company becomes subject to the statute when their total holding exceeds control threshold (usually 20, 33, or 50%) Acquiring Company can acquire control shares only if other shareholders approve. 90

a. A majority of disinterested shareholders have to approve. Meant to protect against coercive tender offers by authorizing collective shareholder action. ii. Business Combination Model Acquirer obtains a specific number of shares cannot for a period of X or more years enter into a second stage merger unless: a. A certain price is met; b. The Board and a majority or supermajority of the other shareholders approves c. The Acquirer obtained control in a tender offer for a significant majority of the stock (>85%) d. The original Board had approve the acquirers purchase b. Still exist in 26 states c. Michigan Control Share Acquisition Act Handout #7 i. Basically when someone buys enough stock to go over the threshold, they will not be able to vote those shares until a majority of disinterested shareholders agree ii. No mandatory filing, like there were in the 1st gen iii. They must: Call a shareholders meeting Get a majority to say they can vote

Get a majority of disinterested to grant voting rights iv. If they didnt get approval for voting rights, then the target company has the ability to redeem their shares v. If they do get the approval, then all the other shareholders can treat this as an acquisition, and ALL other shareholders get dissenters rights. vi. This was challenged in the CTX case (IN). The Court held is not like the 1st Gen statutes. It is OK It is merely a state statute d. Michigan Business Combination i. Company has to expressly state they are participating in the statute within their Articles ii. If a shareholder acquires more than 10% or more Before approval of a merger requires approval of a supermajority 90% of all shares and 2/3 of all shares outside of the 10% You have to meet both 91

iii. Then minimum price has to be met and have to wait 5 years, unless iv. The Board opted out with respect to this shareholder before he becomes 10% shareholders e. The Share price of companies i. Companies have the option to opt-out of the statutes protections f. Delaware Statute i. A person who acquires 15% or more of a DE corporations stock is disabled for the next three years from effecting any merger or business combination unless certain conditions are met e. Bear Sterns Question: i. Bear Sterns: 1. Public statements were made that nothing was going to happen: 10b-5 Material Misstatements a. Economic Loss Yes b. Scienter c. Proximate Cause d. Material Misrepresentation Yes, prudent investor would believe it was important. e. Purchase or Sale f. Reliance on Transaction 2. Duty of Care Smoking Pot and playing bridge a. 102(b)(7): Can free directors from liability in a derivative suit in a duty of care. If it is in your Charter or Bylaws. After VanGorkom they were scared no one would want to be on the board so this is how you avoid being liable under the duty of care. b. Is this truly a duty of care issue? i. Must be knowledgeable and educated especially in a take over situation ii. Must be responding to the takeover iii. BJR: Is it violated? Presumption that the directors are acting in the best interest of the company. a. Not informed, ignoring the crisis or keeping himself up to date. b. Stone v. Ritter says good faith has three parts: 1) Violation of positive law 2) Intentional Duty to act 3) Oversight 3. Maximize Shareholder Wealth: Revlon Issue 4. Maybe issues with Unical 5. Loyalty Issues/Insider Information when sold for $80. 92

6. Always discuss whether it is a direct or derivative suit a. What is the action and what are the cause of actions, such as due care, insider trading. b. Direct: Claim to compel Dividends if you have equity and the contract says you are going to get dividends. So its a contract claim. f. Notes: i. ii. iii. iv. Can the Plaintiff get an injunction? The proxy fully disclosed all facts: Start with that! Statutes may be attached, merely refer to it Advancement and Indemnity 1. Advancement: (Prior) Sign something that says you will take it back. g. Review: i. Agency: 1. Always start with that and there are arrangements of each type. (Ownership and Management separate then there is an agency issue) 2. Board has so much authority because you cant have all the shareholders manage it. 3. If they dont like it a. Vote out the board b. Derivative or Direct Action c. Sell their Shares ii. Fiduciary Duties 1. Corporate Opportunity 2. Abuse of Position iii. Partnership 1. General: Shouldnt exist, it is malpractice 2. Limited 3. Always have an exit strategy iv. Piercing of the Corporate Veil v. Derivative and Direct Suits 1. Way to enforce shareholder rights vi. BJR: The board runs the company 1. Directors act in good faith, informed, and in the best interests of the company, but really it is about the burden of proof. 2. If it is on the Pl. it is tough to establish a claim. If the Pl. can get it to switch then its hard for the board a. Self dealing = entire fairness b. Derivative action assert a duty of care: Even if established 102(b)(7) is in the charter and says it protects directors of liability and will be reimbursed by the corporation. 3. Dodge v. Ford is a good case for the BJR. 93

xvi.

vii. Small Operations 1. Close Corps 2. LLC viii. Shareholder Votes 1. When a board in trying to offend a takeover limits the shareholders votes. Very high burden when limiting the shareholders votes. ix. Good Faith and Loyalty 1. Intersect 2. Courts are saying good faith are a part of loyalty along with candor and corporate opportunity 3. Good Faith a. Violation of Positive Law b. Conscious Disregard c. Actual Intent to do Hard d. Under Stone you need to do more. x. SLC (Special Litigation Committee) 1. Board member has financial interest 2. 141(c): Entire power of the board xi. Corporate Waste 1. Executive Compensation: Very hard to prove xii. Securities: 1. 10(b): Fraud 2. 10(b)-5 3. 14(a) 4. 14(a)(8): Shareholders get resolutions without paying for printing and mailing 5. Full Disclosure 6. 14(a) v. 10(b)-5: If it is not with the purchase or sale of securities then it is not a 10b-5 action. a. If the corp. is issuing it then it is a security. xiii. Federal v. State 1. Sate Fe Case: Fundamental Decision not to make all fraud federalized. xiv. Proxy fights a. Under 14 xv. Access a. Books and Records b. Shareholder List Premium a. If you have a large block then you can sell for more b. Greenmailer=bad guy 94

xvii.

Freezeout v. Squeezeout a. Freezeout taking advantage of the short term merger, 90% xviii. Merger v. Takeover a. Merger subsidiarys, taking advantage of 251 or others. b. Takeover i. Proxy Contest ii. Sale or purchase of shares xix. Takeovers

95