Business Associations Outline

Sole Proprietorship Partnership Corporations

Definition A business that is carried
on by a single owner.
The business is the
owner.
An association of two or
more persons to carry on
as co-owners of a
business for profit.
A separate legal entity
created by authority of
lawdoesnt exit until
you go through
formalities.
Formalities None None Certificate of
Incorporation !ylaws
Issue shares of common
stoc" #hareholders $
owners directors elected
% board meetings
appoint officers regular
meetings of &arious
groups.
Control The 'ne 'wner $
(anagement
All partners are both
managers and owners)
each share in the profit
and loss.
#hareholders $ 'wners
*irectors+'fficers $
(anagement
Liability ,nlimited ,nlimited) plus -imited to the amount of
in&estment
Taxation *irect ./ time0 1rofits di&ided among
partners and reported in
each tax return
*ouble taxation
corporate tax on earners
and personal tax on
di&idend income
Lifespan Coextensi&e with 'wner)
life of the ownerdebts
from #ole 1roprietorship
li&e on.
At the will of the
partners) for the life of
the partners.
Indefinite2 not at all tied
to owners
Exit Nonesell assets 1ower to exit at any
time) but not necessarily
the right to exit at any
time
#ell shares.
Part One: Aency ! Partnership
"# "ntro$uction
""# Business Concepts
a. !usiness any endea&or with a profit moti&e
b. Accrual (ethod a method of accounting that records re&enue when earned and
expenses when incurred) rather than when they are paid in cash.
c. 3is" uncertainty) possibility that future returns will de&iate from expected
returns
/
i. -e&erage use of debt in the business
/. -e&erage creates ris"
a. potential for gain) but also the potential for loss
b. #ecurity Interest An interest in an asset which secures
payment of an obligation allow the asset to be sold upon
default to satisfy the specified obligation.
ii. Co&enants Contractual obligation or prohibition
a. in loan contract) binds the borrower and gi&es the lender an
element of control
4. Indirect control to creditors
a. ,se of funds
b. (aintenance of business
c. 3estrictions
i. -imitations on ta"ing of further loans
ii. -imitations on withdrawals
d. Control upon default
5. 3educe 3is"
"""# Sole Proprietorships an$ Aency
a. Characteristics of #ole 1roprietorships business carried on by a single owner2
i. No 6ormalities
ii. (anagement $ owners has total control
iii. ,nlimited liability
i&. *irect taxation
&. -ife of sole proprietorship is life of owner
&i. 'wner can exit by selling their assets.
b. 5 7lements of Agency 3elationship under 3estatement of Agency 8/
i. (utual Consent
/. express or implied manifestation of consent
ii. Action on behalf of another
iii. Control
/. 3estatement of Agency 8/9' &eto power is not enough there
needs to be defacto control to be considered control.
c. Agency Cases
i. Gorton v. Doty
/. *oty lent automobile to coach to ta"e football players to a game.
4. #hows application of the restatement.
ii. A. Gay Jenson Famrs Co. v. Cargrill, Inc.
/. :ery rare case where a lender will be held liable for the companies
they lend to.
"%# Authority
a. Actual Authority 3estatement 8 ;
i. Authority
/. 5 re<uirements2
a. (utual Consent
b. 'n behalf of another
c. Control
4
4. 1ower to affect legal relations of the principal
a. Agent can bind the principal in contract
b. -imited by scope of authority
5. !ased on the principals desires 3estatement 8 55
ii. Creation of Actual Authority
/. 1rincipals manifestation of consent to agent 3estatement 8 4=
iii. Incidental Authority
/. incidental usually accompany reasonably necessary
i&. Mill Street Church of Christ v. Hogan Implied Actual Authority Case
/. church painting case
b. Apparent Authority 3estatement 8 >
i. Apparent Authority
/. 1ower to affect legal relations of the principal
4. 1erson is not actual an agent
ii. Creation of Apparent Authority
/. 1rincipals manifestation of consent to third party
a. Accidents) lies) uncorrected statements
iii. Lin v. Schenley Inustries, Inc.
/. Case where -ind sues for /? commission in sales) which he ne&er
recei&ed.
a. Company could ha&e protected itself by putting the contract
in writing.
c. Agency by 7stoppel
i. 7lements 3estatement 8 >!
/. !elief in agency relation by third party
4. 3eliance by third party
a. @ad to change position
5. 6ault of the principal
ii. Hoesson v. !oos "ros.
/. 1laintiff buys furniture from salesman who turns out to be not a
salesman.
d. Inherent Agency 1ower 3estatement 8 >A
i. Inherent authority is created simply by the act or contract entered into by
the agent A e&en if expressly forbidden by the principal.
/. !est to thin" about inherent authority as a last resort.
4. Cant ha&e inherent agency power without an agency relationship
ii. #atteau v. Fen$ic%
/. !ar owner was liable for agents purchasers e&en thou be expressly
forbid them
iii. !i v. &homas A. 'ison, Inc.
/. Company liable for agent o&erstepping his authoriBation to enter
into contracts because of customary powers of similar agents.
e. 3atification 3estatement 8 >4
i. The 1rincipal acts in a manner which expresses or implies that she
authoriBes the contract after the fact) the principal will then be bound by
ratification
5
/. ,sed if no actual) apparent or inherent authority is found to exist at
the time of the agents action.
ii. "otticello v. Stefanovic(
%# Liability in Aency
a. (aster+#er&ant 3elationship
i. 7mployment
/. (aster $ employer .principal0 #er&ant $ employee .agent0
4. Cey is the control o&er the physical conduct of the agent in the
performance of the ser&ice
b. Independent Contractors 84 of the 3estatement
i. Cey is there is no control o&er the physical conduct of the agent in
performance of the ser&ice.
ii. ICs can be agents .if principal has control0 or non-agents .if the principal
does not ha&e control0
c. #er&ants &. Independent Contractors
i. 3estatement of Agency 8 44D.40 list factors to consider whether someone
is wor"ing as a ser&ant or independent contractor2
/. 7xtent of control
4. Ehether it is a distinct occupation
5. Eho supplies location and e<uipment
9. -ength of time and relationship
F. (ethod of payment
=. 1arties belief
ii. 3ele&ance of different between #er&ant G IC is the extent of &icarious
liability
/. Independent Contractors
a. 1rinciple is liable for the actions of an Independent
Contractor when the principle authoriBed the conduct .i.e.)
had a contract0
4. #er&ants
a. 1rinciple is liable for authoriBed conduct AN*
unauthoriBed conduct that is within the scope of
employment.
i. 3estatement 844> list things that are in the scope of
employment
ii. -iability is limited to scope of employment because
it is fair and foreseeable.
5. :icarious -iability
a. 7ncourages 3esponsibility
b. Cost #preading puts the burden on the company and
they will spread the cost to all the customers.
iii. Hum)le *il + ,efining Co. v. Martin #er&ant &. IC
i&. Hoover v. Sun *il Com-any #er&ant &. IC
&. Mur-hy v. Holiay Inns, Inc. #er&ant &. IC
&i. "illo-s v. Magness Construction Co. Tort -iability+Apparent Authority
&ii. Ira S. "ushey + Sons, Inc. v. .nite States #cope of 7mployment
9
&iii. Arguello v. Conoco, Inc. #tatutory Claims
%"# Fi$uciary Duties in Aency
a. 6iduciary *uty 3estatement 8/5
i. (ore than a moral relationship) legal relationship with enforceable duties
ii. 8/5 agent is a fiduciary with respect to the scope of the agency only.
b. Agent to 1rincipal
i. Contractual *uties
ii. *uty of Care
/. 7xtent of *uty of care depends on the status of the agent
a. 1aid Agent $ standard care H special s"ill
b. Iratuitous Agent $ lower standard .what the person relied
on you for.0
iii. *uty of -oyalty
/. Accounting for profits 85>>
a. Agent that ma"es profits in connection with his duties must
gi&e the profit to the principal.
b. ,eaing v. ,egem
i. #olider uses his authority to smuggle goods and gets
money
c. General Automotive Manufacturing Co. v. Singer
i. #igner was the general manager of an automoti&e
shop but sent Jobs he couldnt handle to another
place.
4. Non-competition
a. As to the subJect matter of the agency) you are not allowed
to compete.
b. &o$n + Country House + Home Serve, Inc. v. /e$)ery
i. Kou are allowed to compete with your former
employer.
ii. Kou are not allowed to use confidential information
in competing
c. "ancroft0#hitney Com-any v. Glenn
i. (anager &iolated fiduciary duty because he too"
employees with him when he left .used confidential
information.0
ii. -aw says there are fiduciary duties to both the new
and old employer
/. (ust a&oid situations where one conflicts
with the other.
5. Conflicting interests
a. @a&e to a&oid all conflicts of interest
9. Confidentiality 85LF
a. 7&en after termination
c. 1rincipal to Agent
i. Contractual *uties
ii. Indemnification 895>
F
/. All loses or expenses must be reimbursed as to the agreement or
what is appropriate
%""# "ntro$uction to Partnerships
a. Characteristics of 1artnership -aw2 ,niform 1artnership Act .,1A0
i. No 6ormalities
ii. Moint ownership and management
iii. ,nlimited liability) plus
i&. 1ass-Through .i.e.) /x0
&. -ifespan is the life of the partners
&i. 1ower to exit at any time) but not necessarily the right to exit at any time.
b. 6ormation of 1artnership
i. 7lements ,1A 8=./0
/. Consensual Association
a. Consent to elements of partnership
b. Not necessarily consent to partnership
4. Carry on as co-owners
a. (ost issues arise here
5. !usiness for profit
ii. Interpreti&e 3ules ,1A 8;
/. Not Joint interests in property
a. Must because you ha&e a Joint interest in property) doesnt
automatically ma"e you partners
4. Not sharing of re&enues alone .e.g.) sales commission0
a. #haring of profits is prima facie e&idence
i. ,nless its payment of debt) salary)
c. 1artnership 3ights ,1A 8/>
i. 7<ual share in profits and losses
/. Fen$ic% v. .nem-loyment Com-ensation Commission
4. Southe1 '1hi)ition, Inc. v. ,hoe Islan "uilers Association, Inc.
a. 1rofit #haring ins only prima facie e&idence
ii. 7<ual management
iii. Consent to adding partners
/. 7ach partner
i&. No right to salary
&. Agreement can &ary partners rights
/. Not necessarily to the outside world though) only among partners
a. Also not necessarily powers and obligations
4. Day v. Siley + Austin
a. @ad an executi&e committee that made decisions o&er
many matters.
d. Agency -aw
i. 7&ery partner is an agent of the partnership
/. Acts for apparently carrying on the business in the usual ways are
binding on the partnership
a. unlessthird party "nows partner had no authority
=
i. if they read the partnership agreement and realiBed
that he has no authority
4. Acts not for apparently carrying on the business in the usual way
are not binding
a. unlessact is authoriBed
5. Kou only worry about apparent authority if the act is not authoriBed
ii. 1artnership is charged with wrongful acts of any partner
/. Acting in ordinary course or business or
4. Acting with authority
e. 1artnership by 7stoppel ,1A 8 /=
i. 7lements
/. (anifestation .false Apart saying non-part is part0
4. 3eliance on direct manifestation
a. orpublic manifestation w+o reliance
5. N7xtension of creditN
a. seems to exclude tort situations
b. extension of credit by third party to the apparent partner
ii. -iability
/. 6or actual partnership) if authoriBed
a. consent .of manifestation0 of all partners is re<uired to
impose liability
b. partners who didnt "now arent liable) therefore
partnership isnt liable.
4. 6or apparent partner2 .creates &irtual partnership0
a. as partner) if partnership is liable
b. otherwise) with consenting apparent partners
i. 'nly those partners who "new are liable) not the
partnership as a whole.
iii. 2oung v. Jones
f. 1roperty 3ights of 1artners ,1A 849
i. 3ight in specific partnership property ,1A 8 F
/. An e<ual right to possess partnership property for part purposes.
ii. Interest in the partnership ,1A 84= .share of profit G losses0
iii. 3ight to manage the partnership
i&. Assignment of partners interest2 ,1A 84;
a. you can not sell your managerial or power in the profits
because the partnership is a &oluntary organiBation that
ta"es the agreement of all partners to change it.
4. Con&eys only interest in the partnership
5. *oes not affect partnership
&. 3utnam v. Shaof
g. 3ights of 1artners in (anagement ,1A 8/>
i. *efault rules2
/. 7<ual right to management
4. *isagreement on ordinary matters settled by maJority &ote
8/>.h0
;
5. Contra&ention of agreement re<uires unanimity
ii. Can be changed by agreement.
iii. /ational "iscuit Com-any v. Strou
/. Absent a maJority &ote to settle disagreement) re&ert to the status
<uo) which is normally that partner can act G bind the partnership
i&. Summers v. Dooley
/. different outcome from the national biscuit case
%"""# Fi$uciary Duties of Partners
a. Introduction
i. ,1A is not &ery clear on fiduciary duties
ii. 3e&ised ,1A gi&es an exhausti&e list of duties
iii. Meinhar v. Salmon
/. !est statement of *uty of -oyalty2
a. Oowe to one anotherthe duty of the finest loyaltyP
b. After *issolution
i. "ane v. Ferguson
/. No duty of care is owed to former employees of a firm
a. A partner is a fiduciary of his partners) but not of his former
partners) for the withdrawal of a partner terminates the
partnership as to him.
c. Irabbing and -ea&ing
i. Meehan v. Shaughnessy
/. *uty of loyalty stands up until the point that you are not wor"ing
at the firm.
d. 7xpulsion
i. La$lis v. !ightlinger + Gray
/. *uty of loyalty is not &iolated for being fired if you can be fired
for any purpose.
"&# Partnership Dissolution
a. 7nding a 1artnership under ,1A 85D
i. Three #tages
/. *issolution in ,1A) the change in the relation of the partners
caused by any partner ceasing to be associated with the
partnership in 3,1A) the commencement of the winding up
process.
4. Einding ,p the process of settling partnership affairs after
dissolution
5. Termination the end of a partnership
b. Causes of *issolution under ,1A 85/
i. 1ower to dissol&e
/. Always ha&e the power) but not always the right.
ii. 3ight to dissol&e
/. Kou ha&e the right to dissol&e in2
a. At will partnerships G
b. As specified in agreement
4. 3age v. 3age
>
a. 1artner may only dissol&e an at will partnership if they do
so in good faith.
iii. Automatic dissolution
/. Term expires
4. 1artnership becomes unlawful
5. *eath or ban"ruptcy of a partner
9. Court decree
c. Mudicial *issolution
i. Insanity
ii. Inability
iii. #erious misconduct
i&. ,npredictability
&. 'ther e<uitable circumstances
&i. *$en v. Cohen
/. If the court is con&inced there is serious misconduct) the court will
order dissolution.
&ii. Collins v. Le$is
/. Collins wanted a dissolution but did not ha&e the right to dissol&e.
@e wanted a dissolution form the court because -ewis did a really
bad Job running the business. The Jury reJected this.
d. 7ffect of *issolution
i. Authority is terminated
/. 7xcept as to winding up.
ii. 7xisting liabilities remain ,1A 85=
iii. 6uture liabilities only with respect to2
/. Einding up
4. Certain innocent parties
e. Einding ,p
i. *istribution of Assets2
/. Creditors other than partners
4. 1artners as creditors
5. 1artners return of in&estment
9. 1artners profits) if any
ii. Monin v. Monin
/. 1artners fiduciary duties continue until the business is completely
wound up.
f. Continuing the 1artnership
i. 1artners who ha&e not wrongfully dissol&ed ,1A85> can continue the
partnership
/. by agreement
4. 3av0Saver Cor-oration v. 4asso Cor-oration
ii. 7ffect on creditors ,1A8/; G 89/
/. Continuing partnership remains fully liable
4. Continuing partners remain fully liable
5. 6ormer partners remain liable for old obligations
a. Including winding up obligations
L
9. New partners liable for2
a. New obligations
b. 'ld obligations) but only out of partnership assets
iii. Je$el v. "o1er
/. Any profits gained during wrap-up of partnership is di&ided
between partners according to their share of the business.
g. 7nding a 1artnership under 3,1A 8=D/
i. *issociation in 3,1A) the change in a partnership caused by a
partners ceasing to be associated in the carrying on of the business.
ii. *efault 3ule2 partnership continues 3,1A 8>D/
/. 7xception includes partnerships at will
iii. In e&er dissociation) either2
/. *issociating partners interest must be purchased
4. 'r partnership is dissol&ed and wound up
i&. G + S Investments v. "elman
/. 1artnership !uyout an agreement that allows a partner or
shareholder to end her relationship with the other partners or
shareholders and recei&e a cash payment in return for her interest
in the business.
a. i.e.) capital account &alue $ boo" &alue) not fair mar"et
&alue.
4. Ad&antages of ha&ing a buyout agreement2
a. A&oid litigation
b. Allows the business to "eep going
c. A&oid unpredictability of Judicial decision
5. *isad&antages of ha&ing a buyout agreement2
a. 1rice may not be set correctly
b. ,ndermines the entire relationship
&# Limite$ Liability
a. 1roblems so far with !usiness Associations2
i. #ole 1roprietorships 1roblems
/. -imited 6unding
4. ,nlimited -iability
ii. 1artnership 1roblems
/. Too many managers
4. !etter) but still limited) funding
5. ,nlimited liability plus
b. -imited 1artnerships
i. -imited 1artnerships partnerships with two types of partners) general G
limited
/. Ieneral 1artner a partner with the right to manage the business
and with unlimited liability
i. ,niform -imited 1artnership Act 89D5
4. -imited 1artner a partner with no right to manage the business
but with limited liability
i. 89D4
/D
ii. Ad&antages of -imited 1artnerships2
/. Ireater access to funding
4. 7fficient management
iii. Hol(man v. De 'scamilla
/. A limited partner that ta"es control of the business becomes a
general partner
c. 6orming a -imited 1artnership
i. #elect Name 8/D4
/. must contain the words Olimited partnershipP
ii. 6ile Certificate of -imited 1artnership 8/D/
/. Contains minimal information
4. 1ro&ides notice of existence
5. Ienerates filing fees for the state
iii. 'ptional2 written -1 agreement
/. If you dont) default rules will apply
i&. CANN'T be formed accidentallyQ
/. 6iling creates a -1) without the filling) there is not limited
partnership.
d. -imited -iability
i. !ased on the passi&e in&estor status
/. 1assi&e in&estor status re<uired to get limited liability 85D5
ii. @istory of increasing a&ailability
/. 'riginally only a&ailable for specific purposes
a. -aw used to gi&e limited liability on a case by case basis
4. 7xpanded for industrialiBation
5. 7&entually a&ailable for all
iii. Increasing di&ersity
/. 'riginally only had -1s and corporations
4. Now there are --Cs) --1s. ---1s. 7tc.
//
Part T'o: (eneral Corporate La'
"# "ntro$uction to Corporations
a. -imited -iability
i.Is -imited -iability a good thingR
/. 7ncourages in&estment
4. 6airness to passi&e in&estors
5. -imits the cost to society of litigation
ii.Is -imited -iability a bad thingR
/. Increase sta"es for creditors
4. 7ncourages in&estors to engage in ris"y acti&ities because the ris"
is externaliBed
b. Corporations
i.Two types of Corporations
/. 1ublic Corporations
4. Closed Corporations
5. Can be in between S a public corporation that has control in a few
in&estors hands.
ii.6ormalities2 many re<uired
/. 6ilings and other documentary re<uirements
4. 3egular meetings of &arious groups
iii.Control2 separation of ownership and management
/. 'fficers are true managers
4. Ehen you ha&e separation of ownership and management you
ha&e conflicts of interest
iv.-iability2 limited to in&estment
/. Kou cant lose anything more than you ha&e put into the business
v.Taxation2 double taxation
a.maJor drop of corporation form
4. Corporate tax on corporate earnings
5. 1ersonal tax on di&idend income
vi.-ifespan2 indefinite
/. Not at all tied to owners
vii.7xit2 sell shares
/. 6ree transferability of shares
4. It is harder for corporations that are not on open mar"et exchange
.i.e.) closed corporations0
c. Contractarian Theory S a theory that &iews the corporation as a web of
contractual relationships among &arious sta"eholders rather than as a separate
legal entity owned by the shareholders
/. Must a web of contracts
ii.7mployees
/. Input2 labor
/4
4. 3ights2 fixed compensation first &ery little control
5. 3is"2 low
iii.Trade Creditors
/. Input2 property
4. 3ights2 fixed payment first &ery little control
5. 3is"2 low
iv.*ebt @olders
/. Input2 cash
4. 3ights2 fixed principal H interest some indirect control
5. 3is"2 moderate
v.7<uity @olders
/. Input2 cash) property and+or labor
4. 3ights2 residual profits control
5. 3is"2 high
d. 6orming a Corporation) i.e. incorporation
i.#elect a name
/. (ust contain OInc.P or similar title .corp.) depends on state law0
4. Cannot contain certain words) e.g.) Oban"P .depends on state law0
ii.#elect a state
a.need not be the state you do business in
4. Internal affairs doctrine Sa choice of law rule under which courts
loo" to the corporate law of the state of incorporation to determine
the internal rights and duties applicable to a corporation
5. 6or each state you loo" at the laws of that state
iii.6ile certificate of incorporation S document establishing and go&erning
the internal affairs of the corporation2 charter
/. Contains minimal information
4. 1ro&ides notice of existence
5. Ienerates filing fees for the state
iv.:arious other formalities
v.Cannot be formed accidentallyQ
e. Conflicts of Interests
i.Cey players2 (anagement and shareholders
ii.Interests of management and shareholders are usually aligned
/. e.g.) profit
iii.#ometimes interests di&erge
/. e.g.) management rights) responsibilities and benefits
a.agency costs
4. #hareholders may want to replace management
a.proxy contest
b.hostile ta"eo&er
5. (anagement wants to insulate itself
/5
a.defense tactics
b.state of incorporation
f. #tate of Incorporation
i.!enefits to state
/. 6ees
4. 3elated ser&ices industries
ii.Competition among states
a.!ig debate o&er whether this is a good thing or bad thing
4. 6lexibility + inno&ation
a.state corporate law should be able to change to the e&er
changing corporate en&ironment
5. Clarity + consistency
a.clear statutes and consistent Judicial decisions
9. 3esponsi&eness + ser&ice
a.with state legislature and officers respond to your needs
F. #ubstanti&e content
a.the actual law itself S are they good for youR
iii.3ace to the bottom S theory that competition among states leads states to
pass increasingly lenient corporate laws
a.burdens of bad laws are shared by all states) while benefits
go to the one state who gets the fees
4. 6a&ors corporations o&er others
5. 6a&ors management o&er shareholders
g. *elaware S winning of race to bottom
i.#tate of 1reference for incorporation
/. 'riginally2 more fa&orable laws
a.less regulation
4. Now2 legitimate benefits
a.flexibility + inno&ation
b.clarity + consistency
c.responsi&eness + ser&ice
5. Ehy does *elaware act moderatelyR S 3is"s federal inter&ention
a.They push as much as then can) without getting the federal
go&ernment in&ol&ed.
b.states li"e 1A do not ha&e to worry about this and blatantly
act in fa&or of management
h. (ain Issues
i.1ublic Corporations
a.many shareholders) none with a controlling interest
4. Control issues
a.indi&idual shareholders ha&e little control
/9
b.small minority interests can ha&e large influence
5. Conflicts of interests
9. #ecurities laws2 continuous disclosure
a.re<uire that public corporations continuous disclosure
&arious information about themsel&es
b.Tunder the microscope
ii.Close Corporations
a.small group of owners) who ha&e a real say in the business
4. Control issues
a.large minority interests can ha&e no influence
i. Kou can ha&e 9L? and still ha&e no say .if the other
half has F/?0
b.deadloc"
5. 6reeBe-out S action ta"en by the maJority shareholders in a close
corporation to frustrate the expectations of the minority
shareholders
""# Corporate Formalities
a. '&er&iew S starting a corporation
/. #elect name
4. #elect state of incorporation
5. 6ile certificate of incorporation
ii.@old organiBational meeting
/. Adopt bylaws
a.document) subordinate to the charter) that go&erns the
internal affairs of a corporation
4. Issues shares
a.before issuing shares) all we ha&e is the
incorporator+promoter
iii.@old shareholder meeting
/. 7lect directors
iv.@old board of directors meeting
/. Appoint officers
b. Incorporation
i.Eho can incorporateR
/. Anyone) including another corporation S *IC- 8 /D/.a0
a.parent corporation S one corporation that owns another
.subsidiary0
i. subsidiaries can own other subsidiaries
4. affiliates S anyone who controls) is controlled by) or is under
common control with) another e.g.) parent and subsidiary) or co-
subsidiaries
ii.@ow do you incorporateR
/F
/. 6irst step S Certificate of incorporation+Charter
a.*IC- 8 /D4 form on p./9D9
4. Contents
a.name
b.address
c.nature of business S dangerous) because can limit your
actions
i. anything else will be ultra &ires
/. unauthoriBed beyond the scope of power
allowed by the corporate law and+or charter
d.authoriBed stoc" S number of shares that the company can
issue and classes and series of stoc"s and their rights
.normally want to authoriBe more than you plan to
originally issue A planning for future0
i. common stoc" A security representing a basic
ownership interest in the company .general &oting
rights Uone share+one &oteV) and entitled to residual
profits G di&idends0
ii. preferred stoc" S preference on di&idends .issued
prior to common stoc" di&idends0 Alimited &oting
rights
/. for example) W/ preferred stoc" will get W/
di&idend before common stoc" gets
anything) but wont get more than the W/ per
share.
e.par &alue S a dollar &alue) specified in a corporations
charter) that establishes the minimum price for which a
share of stoc" may be issued and which is set aside for the
protection of creditors
i. par &alue is irrele&ant now A dont ha&e to ha&e it
/. lawyer ha&e put it at a penny
4. some state laws ha&e done away with par
&alue
f.names and addresses of promoter
i. lawyer and law firm
ii. initial directors .if they are selected at the time of
incorporation0
g.optional items
i. put in any rule you want to go&ern the corporation
ii. common ones2
/. preempti&e rights S the right of a
shareholder to purchase enough newly-
issued shares to maintain her percentage
ownership in the corporation
/=
a. used to be the default rule) now you
put them in the charter
i. ma"es sense in closed
corporation) but not really for
public corporations
4. special &oting rights .i.e.) may re<uire a
supermaJority of shareholders to
successfully &ote on an issue0
5. limits on directors liable for breach of
fiduciary duty
iii.Southern0Gulf Marine Co. /o. 5, Inc. v. Camcraft, Inc.
/. *e facto Corporation *octrine a legal doctrine under which
courts may treat a business that was not properly incorporated as a
corporation if the promoters made a good faith effort to incorporate
and treated the business as a corporation.
a.Ienerally in corporate law form matters
b.*oesnt ma"e much sense) as how does someone ma"e a
good faith effort to file a certificate of incorporation yet not
file itR
4. Corporation by 7stoppel a legal doctrine under which court may
pre&ent third parties from denying corporate existence if they
ac"nowledged the corporate entity and would earn a windfall by
subse<uently denying corporate existence.
c. 'rganiBational (eeting
i.*IC- 8 /D> form on p. /9/=
/. Adopt bylaws
a.(inutes2 what happened
b.3esolutions2 what was decided
4. Adopt stoc" certificate and corporate seal
a.you dont ha&e to ha&e a stoc" certificate
b.boo" entry security S a security represented by an entry in
a register a.".a.) uncertificated securities
c.corporate seal
i. unnecessary and archaic
5. 7lect directors + appoint officers
9. Issue shares
a.6ully 1aid and Non-Assessable #hare S share which has
been purchased from the issuing company and paid for in
full) and with respect to which the issuing company cannot
demand more money from the shareholder
F. AuthoriBation to do business in other states
a.@a&e to file in each state to do business there
=. #elect fiscal year
/;
;. #et annual meeting of shareholders
>. Appro&al of past acts
a.relie&e the incorporator of potential liability by official
authoriBation or appro&al of his past acts.
L. Any other business
d. !ylaws
i.6orm on p. /9D=
/. #toc"holders
i. :oting 3ules @A:7 to be in the charter) but can be
contained in the !ylaws
b.meetings
i. written consent in lieu of a meeting
c.notice .for meetings0
i. cant be too early) or too late
d.<uorum .default is maJority0
e.record date S the date on which ownership is established
for purposes of shareholder &oting
i. whoe&er owns shares /F days before the &ote
4. *irectors
i. *efault rule is that each director is elected
indi&idually
b.number
c.term
i. generally one year) but can be remo&ed for no cause
ii. could ha&e a staggered board .li"e the ,# #enate0
with a ? elected each year0
iii. !ylaws may pro&ide otherwise .can set any number
or standard0
iv. Classified !oard S a board of directors structured
so that only a fraction of its members is elected each
year for multi-year terms a.".a.) staggered board
d.meetings
e.<uorum
f.telephonic meeting+&ideo conferencing
5. !oard committees
9. 'fficers
i. *elaware is open for officers
ii. NK re<uires certain officers
b.main offices
F. #toc"
a.certificate
b.lost certificates
=. Indemnification of officers and directors
/>
a.ta"e care of indemnification that is optional
;. (iscellaneous
a.fiscal year
b.seal
c.amendment of bylaws .generally spea"ing) shareholders
can) and directors may or may not be able to .but usually
can00
"""# Piercin the Corporate %eil
a. -imited -iability the limitation of an in&estors liability to her in&estment in
business) such that business creditors cannot go after personal assets
i.Ieneral rule2 shareholders are not liable for corporate obligations
/. 7xceptions are very rare
ii.1iercing the corporate &eil holding shareholders personally liable for
the obligations of the corporation
/. Two 1art Test
a.6ailure to respect the corporate form
b.#ome inJustice
b. 6ailure to 3espect Corporate 6orm
i.6ailure to respect corporate formalities
a.If you are not respecting the corporate form) the courts
wont either
4. 6ailure to incorporate
5. 6ailure to issue shares
9. 6ailure to hold meetings
F. 6ailure to maintain records
ii.6ailure to maintain separate identity
/. ,nity of interest and ownership
4. Commingling of assets
5. *omination by shareholder
9. Oalter egoP or OdummyP
iii.#al%ovs(%y v. Carlton
/. :eil was not pierced because inade<uate capitaliBation alone will
not lead to liability absent a finding that the corporation abused the
arrangement by failing to follow corporate formalities
iv.Frigiaire Sales Cor-oration v. .nion 3ro-erties, Inc.
/. Court respect form o&er Justice. .:elasco li"es this case.0
v.Issues2
/. The <uestion is2 how much is enoughR Always a factual
determination. (issing one or two meetings probably not enough)
but ne&er holding them is almost certainly enough.
c. #ome InJustice
/. (ere fact that the inJured plaintiff goes uncompensated is not
enough) you need more.
/L
ii.6raud
iii.'ther inJustice
/. ,ndercapitaliBation failure to pro&ide ade<uate capital for the
business when incorporating
a.Mudged ex ante) not ex post
i. In other words) it had to be clearly too little from
the beginning) not Just turning out that there wasnXt
enough.
b.Co&er foreseeable and natural expenses
4. #iphoning of funds excessi&e withdrawal of corporate resources
for shareholder benefit
a.Also &iewed ex ante
5. Intentional scheme to e&ade responsibility
a.#omething more than Just the general forming of a
corporation
b.!ig elaborate scheme) that although legal) seems fishy
9. ,nJust enrichment
iv.!inney Shoe Cor-oration v. 3olan
/. If there is truly is no money) a&ailable) it is undercapitaliBation and
the corporate &eil can be pierced
4. Kou ha&e to ha&e enough assets at start up to account for slowness
in selling your product.
5. Third 1rong introduced by the court2
a.If an in&estigation would disclose that the corporation is
grossly undercapitaliBed) based upon the nature and the
magnitude of the corporate underta"ing) such party will be
deemed to ha&e assumed the ris" of the gross
undercapitaliBation and will not be permitted to pierce the
corporate &eil.
d. 3elated Theories
i.7nterprise liability a legal doctrine under which a court may hold an
entire business enterprise .i.e.) all affiliates0 liable for the obligations of a
constituent corporation
/. -ac" of separate identity
a.As between corporations .if its b+t corp G owner) its
piercing corp &eil0
4. #ome inJustice
5. Sea0Lan Services, Inc. v. 3e--er Source
a.3e&erse 1iercing going the other way with piercing the
corporate &eil
i. Another word for enterprise liability
4D
9. This is not piercing the corporate &eil the owner of the entire
corporate enterprise may still escape liability e&en if the entire
enterprise is liable.
ii.*irect liability
/. In theory) owner can be liable for the owners own action in respect
to the business.
a.@olding persons liable for what they do.
4. In re Silicone Gel "reast Im-lants 3roucts Lia)ility Litigation
a.:elasco @AT7# T@I# CA#7.
b.!y the Courts logic) enterprise liability would be the rule
and not the exception.
"%# The Purpose of Corporations
a. Ehat is the purpose of CorporationsR
/. 1rofits for shareholders
4. 1ro&ide goods or ser&ices to public
5. #elf-perpetuation
9. #ociety allows corporation 1urpose thus is to benefit society.
ii.Doge v. For Motor Co.
/. @enry 6ord could not run his corporation for social good) but
rather for profit to shareholders. (ust put interest of the
shareholders before monetary interests.
4. A court will not uphold irrational decisions about di&idends that it
determines to be an abuse of the directors discretion.
iii.Shlens%y v. #rigley
/. The court will not enter a contested situation based only on poor
business Judgment there must be fraud) illegality) or a conflict or
interest. !usiness decisions are in the hands of the !oard.
a.@ere it didnt matter that the directors didnt want to put in
lights because it was in the neighborhoods best interest)
not in the best interest of the corporation because the
property would become more &aluable if it could offer
night games.
iv.N'TIC7 T@7 *I66737NC7 !7TE77N T@7 F*,D CA#7 AN*
#,IGL'2 CA#7.
/. In Erigley the court says that corporations can ta"e into
consideration socially beneficial or inJurious factors .i.e.) dont
ha&e to Just consider profit or shareholder maximum &alue
v.A.3. Smith Mfg. Co. v. "arlo$
/. Court is more accepting of charity that it was in the Doge case.
4. (odern corporations should ha&e duties to society beyond wealth
maximiBation
5. *ifference
a.#ocially responsible beha&ior is necessary .i.e.) moral duty
to act well when forced to act at all0
4/
b.Charitable donations are not necessary they are a choice.
9. #imilarities A
a.In both cases it is a decision to di&ert resources from profit-
maximiBing uses to
F. #hould corporations be allowed to be charitableR
a.Kes A corps ha&e extensi&e resources
i. Corps better at gi&ing b+c its more con&enient to
solicit W/ million from a corp than W/ mil from
/DD)DDD indi&iduals.
ii. Corps can monitor their resources better
iii. *onations are tax deductible A if it goes to charity)
no taxes. If it goes to shareholders) its taxed.
b.No A
i. *o we really want this amount of resources directed
by those in the upper classesR
ii. Ehy should they get to spend shareholders money
iii. Tax counter-argument you can Just pay the tax
and allow the go&t to apportion it
vi.#tatutes
/. Constituencies 3ules2
a.*el IC- 8/44.L02 No mention of corporate
benefit
b.Cal CC 84D;.e02 3egardless of specific
corporate benefit
.general0
c.NK !C- 84D4.a0./402 Irrespecti&e of corporate
benefit .doesnt
matter0
4. 3ecent laws allow directors to consider any factors when ma"ing
business decisions A basically they can do as they please for the
benefit of shareholders) employees) suppliers) political lobbying
groups) etc. .4L states ha&e general laws li"e this0
b. Ehose interest should be predominantR
i.#hareholder ha&e the most incenti&e to ta"e the best route for the company
/. They loo" at all the ris" A positi&e and negati&e. Eilling to ris"
losing the corporation if they stand to ma"e tons o money.
a.#hareholders dont bear all the loss) only the initial loss of
stoc" &alue. .employees can lose Jobs) etc0. shareholders
are willing to gamble with the Jobs+li&elihoods of others.
4. 'ther groups .employees) directors) creditors0 all they want to do
is a&oid ris".
ii.Creit Lyonnais "an% v. 3athe Communications Cor-oration
44
/. Ehen corp is near insol&ency) the directors are not Just agents of
the shareholders) but owe a duty to the corporate enterprise.
a.#hareholders will be loo"ing at e<uity .Assets A -iab0
while the corp may only be loo"ing at assets.
4. Near Insol&ency2
a.Creditors bear ris" of loss) AN*
b.Interests of shareholders and *irectors+Corporation are not
aligned.
%# Business )u$ment *ule
a. !usiness Mudgment 3ule a legal doctrine that protects business decisions from
Judicial re&iew Oa presumption that) in ma"ing a business decision) the directors
of a corporation acted on an informed basis) in good faith) and in the honest belief
that the action ta"en was in the best interests of the companyP
/. An informed business decision) carefully made in good faith and
w+o conflict of interest) they will be held without fault so long as
the decision was rational. .note2 rational) not reasonable0
ii.If the courts decide that the !M3 applies) directors normally win.
iii.In most cases) the courts wont loo" at the substance of the decision2
/. waste) totally irrational) no win situation are the only ways to
challenge the substance of a business decision.
iv.Kou dont win your case) by challenging the substance of the decision
/. Kou challenge the decision ma"ing process.
a.#tandard is gross negligence
v.!amin v. American '1-ress Com-any 6/e$ 2or%7
/. 6acts2 The !oard declared a special di&idend to the shareholders
.causing a large tax liability0 instead of li<uidating a bad
in&estment. The shareholders brought a deri&ati&e suit claiming a
waste of the corporate assets.
4. @eld2 *eclaring the di&idend is a board decision that is protected
by the !usiness Mudgment 3ule. The court will only interfere if
there was a lac" of good faith. The fact that a decision was poor or
less ad&antageous than an alternati&e is irrele&ant.
vi.Joy v. /orth
/. :7-A#C' T@INC# T@I# CA#7 I# E3'NI
4. -imits of !usiness Mudgment 3ule
a.Cases in which the corporate decision lac"s a business
purpose
b.#ituation is tainted by a conflict of interest
c.#ituation is so egregious as to amount to a no-win decision
d.3esults from an ob&ious and prolonged failure to exercise
o&ersight or super&ision.
5. 7xtreme rare to find a case is a no-win situation .in this case it was
the loan as a no-win situation.0
45
a.The ban" had all the ris" of loss) but none of the potential
profit+gain.
9. Courts are far better at ma"ing procedural decisions than they are
at ma"ing e1 -ost facto) substanti&e business decisions.
%"# Duty of Care
a. Iross Negligence is the standardQ
i.Francis v. .nite Jersey "an% .New Mersey0
/. *irectorial management does not re<uire a detailed inspection of
day-to-day acti&ities) but rather a general monitoring of corporate
affairs and policies.
4. *irector has to obJect when they see the management engaging in
illegal acti&ity
a.!ring it to the attention of the board
b.(ust resign rather than being a part of it
5. Kou ha&e to ta"e steps to try to pre&ent illegal acti&ity2
a.:oting against it
b.Tal"ing to accountants
9. *irector of ban" in this case did nothing) thus it was clear that she
reached her duty of care.
F. *irector owes fiduciary duties to shareholders.
a.This was a special case where the director owed fiduciary
duties to creditors.
b.Ehy can clients sue in this caseR It is an insurance
company A ins cos and ban"s are different
ii.In re Caremar% International Inc. Derivative Litigation
/. #ustain and systemic failure is the standard of re&iew.
a.#tandard of re&iew is much lower than standard of conduct.
4. *irectors needs only ma"e the most important decisions) the rest
can be done by officers.
a.*ont ha&e a duty to Oenact a system of corporate
espionageP to determine if theres anything wrong.
b.Absent grounds for suspicion) board members cannot be
held liable for assuming that employees were trustworthy
c.*irector is responsible for enacting some time of
compliance+auditing+information system is in effect A a
duty to remain informed or pro&ide a process by which he
could remain informed.
i. !reach would be a sustained and systemic failure A
gross negligence
5. *irectors didnt ha&e to pay anything for their misconduct
attorneys recei&ed almost W/ million.
9. Two types of duty of care claims2
49
a.!ad decision A protected by the !M3 A courts do not loo" at
substance unless it is irrational A more concerned with
decision ma"ing process
b.6ailure to act
iii.Martha Ste$art Living
/. Corp didnt ha&e to monitor (#s personal life+affairs.
4. Ehy not) thoughR If the corp is all about herR
iv.Smith v. 4an Gor%om .*elaware0
/. *irectors ha&e an obligation to be informed.
4. 6acts2 The C7' went to a friend to initiate a merger. @e offered
this friend a low price--WFF+share. No negotiations occurred at any
point. (any of the terms of the deal were disad&antageous to the
corporation. #enior management was &ocal about their
disagreement with the deal. The deal was "ept &ery <uiet) e&en the
lawyers were uniformed. The C7' told the board about the deal
but they ne&er saw it in writing. The corporation had LD days to
accept other offer) but no solicitations to potential purchasers were
made. The board signed the merger agreement without reading it
e&en though they had almost no information as to whether it was a
good price or deal.
5. *irectors &iolated their duty of care in this transaction.
a.*idnt determine the intrinsic &alue .whats it worth0
b.*idnt get the best price .what can you get for it0
9. !ut did they reallyR They could ha&e made a decision in two
hours) considering they were experienced directors
F. (ore 7fficient (ar"et @ypothesis A
a.Is there an intrinsic &alue that is more than mar"et &alueR
Ehat does it matter if you thin" the company is worth
W=D+share but no one will pay more than WFD+shareR
b.Theoretically it might be worth W=D) and someone might
gi&e you that higher price someday) but someone is offering
you WFD now .mar"et &alue is W5F0
=. -e&eraged !uyout .-!'0
a.!orrowing money to buy a company and use the
companys profits to pay off the debt.
i. If it wor"s) you end up owning the company for
OfreeP .you dont put much capital in0
ii. If it doesnt) the business goes belly-up and youre
stuc" with the debt
b.!an"s may not want to ma"e that ris"y loan) so the person
can sell Jun" bonds
i. !onds are rated based on ris") higher ris" re<uires
more interests
4F
ii. If you ha&e too much ris") the bonds are not
considered Oin&estment gradeP and are of lower
<uality .many ban"s cant buy0 Jun" bonds
iii. @igh ris") high return. :ery speculati&e
;. 6allout2
a.This was a &ery sophisticated set of directors) selling for a
&ery high price) with an inconclusi&e mar"et test.
b.(ost people didnt e&en see this as negligence) but the
court found it to be gross negligence.
i. -ess people wanted to be directors
ii. Insurance companies didnt want to insure directors
iii. (any states passed laws allowing corporations to
eliminate the duty of care
/. In other words) corporations can put a
pro&ision into the charter a phrase that says
Odirectors cannot be liable for breach of duty
of careP
v.Cinerama v. &echnincolor, Inc.
/. There was a breach of duty of care so directors had to defend their
decision under the strict entire fairness test.
a.6air 1rice
b.6air *ealings
4. Court decided it was fair) e&en thou they breached their fiduciary
duty.
a.There is a duty of care) but the directors will not be
personally liable for a breach of the duty of care.
b.There is still the possibility of inJuncti&e relief or &oiding
the deal) Just not li<uidated damages from directors
5. :cry similar situation court upholds :anIor"um .say they dont
get the protection of the !M30 and the Oentire fairness testP applies
a.!M3 rational basis test
b.O7ntire 6airness TestP strict scrutiny
%""# Duty of Loyalty
a. Interested Transaction -aw
i.*irector Interest
/. *efault
a.7ntire fairness test burden on the defendant
4. Independent *irector Appro&al A ,nclear
a.#ome states suggest 7ntire fairness test burden on the
defendant
b.(ost often .*elaware0 business Judgment rule burden
on plaintiff
5. Independent #hareholder Appro&al
4=
a.!usiness Judgment rule burden on plaintiff
ii.Controlling #hareholder Interest
/. *efault
a.7ntire fairness test burden on defendant
4. Independent *irector Appro&al
i. If this is e&en possible
b.7ntire fairness test burden on plaintiff
5. Independent #hareholder Appro&al
a.7ntire fairness test burden on plaintiff
iii."ayer v. "eran .New Kor"0
/. #tandard of care in duty of loyalty cases most rigorous scrutiny
4. It is not improper to appoint relati&es to responsible position in a
company as long as it is done within the duty of care and does not
&iolate the business Judgment rule. A director must use the "ind of
Judgment that one would expect and gi&e in similar situation to the
conduct of his own affairs.
a.!usiness Mudgment 3ule re<uires undi&ided loyalty and the
a&oidance of the temptation of self interest.
b.Courts ha&e to limit what counts as a conflict of interest
i. If !M3 is default) than entire fairness has to be "ind
of rare
ii.
iv.8ahm v. &ransamerica .6ederal Case0
/. 6acts2 Transamerica owned nearly all of a particular class of stoc"
in the Axton-6isher Tobacco Company. It exercised its control
o&er the !oard to redeem all of its class A stoc"Ya class that had
no &oting rights. After the shares were redeemed) the corporation
li<uidated and only TransamericaYthe controlling shareholder
benefited from the li<uidation. Another class A shareholder sued
claiming that he should ha&e been allowed to benefit from the
li<uidation.
4. @eld2 Transamerica unfairly used its controlling share of the
corporation to profit at the expense of the minority shareholders
thereby &iolating its fiduciary duty as a controlling shareholder.
5. !asically
a.The company could either li<uidate or redeem A they chose
to redeem first) then li<uidate second. This caused the
minority shareholders to get less than had they Just
li<uidated first.
i. In other words) the maJority shareholder secretly
chose the option that would benefit them at the
expense of minority shareholders) b+c the minority
shareholders could ha&e traded in their stoc" for the
4;
class ! stoc" had they "nown what was going to
happen.
9. The real problem wasnXt that the minority shareholders didnt "now
the company was going to li<uidate) it was that the shareholders
didnt "now what the company was worth before the li<uidation.
F. !asically the court finds that this was a conflict of interest situation
A the company+maJority shareholder didnt disclose the &alue or
the intent to li<uidate) thus screwing the minority shareholders b+c
they didnt ha&e the opportunity to con&ert) gi&ing the company a
windfall.
a.Conflict of interest A self dealing A apply entire fairness
test.
b.!asically the class A shareholders .minority0 cant
complain about the redemption. Class ! was controlling)
therefore could ma"e decisions on their own. The duty of
loyalty problem was that the Company didnt gi&e them the
&aluation information which would ha&e allowed them to
con&ert.
v.Le$is v. S.L. + '., Inc.
/. Tolerant of conflicts of interest as long as the transaction is fair.
4. There was no interest in charging the best rent b+c they were
charging it to another company it owned.
5. The !M3 does not apply
a.(ust be a business Judgment A this wasnt) as there was no
consideration gi&en for the lease
b.*uty of loyalty issue A not all the siblings owned both
companies) yet they secured a below-mar"et &alue rent for
the renting company.
9. Ehat did shareholders winR
a.#hareholders get upward adJustment of boo" &alue
i. Add in the rent you did not get o&er time
F. #hould we allow conflicted transactionsR
a.A Tconflict of interest doesnt mean something is wrong
its Just the potential to be wrong
b.@a&ing to pro&e e&erything is fair will re<uire the courts to
loo" at the substance) which is not consistent with the
policies behind the !M3 .courts not <ualified to ma"e these
decisions0
c.There are sometimes when a conflict of interest is
una&oidable courts will need to ma"e a decision
d.
vi.#hareholder Conflict on Interest
/. Indi&idual shareholders can act in their own interests
4>
a.Kou ha&e no fiduciary duty to other shareholders
b.This is in public corporations
i. Not as much so in pri&ate corporations.
4. There are no conflicts of interest w+ shareholders.
vii.Sinclair *il Cor-. v. Levien .*elaware0
/. 6acts2 #inclair 'il owned L;? of a subsidiary. #in&en paid out
&ery large di&idends both to #inclair oil and its minority
shareholders. The di&idends were in excess of #in&ens net
earnings. A minority shareholder of #in&en sued #inclair claiming
that the di&idends were excessi&e and that #inclair breached its
duty as a controlling shareholder in paying them out since it
recei&ed the maJority of the benefit. The minority shareholder also
claimed that #inclair usurped corporate opportunity by stealing
business from #in&en through its control as the maJority
shareholder. It also claimed that #inclair forced #in&en to enter
into contracts with a wholly owned subsidiary. #uch contracts
re<uired fixed high <uantity purchases and full payment on receipt.
a.6iduciary duty apply !M3
b.Conflict of interestR apply entire fairness test
4. @eld2 This is not a breach of the duty of loyalty because the
minority recei&ed their appropriate shareYthe controlling
shareholder did not benefit at the minoritys expense. Thus) no
preference or additional benefit was gi&en to the controlling
shareholder to the exclusion of the minority shareholder.
5. 1laintiff has to pro&e his transaction was intrinsically fair.
a.#elfishness is o" as long as it doesnt rise to the le&el of
self dealing.
9. Notes
a.#inclair owes le&ien a fiduciary duty as the maJority
shareholder in #in&en .with le&ien being the minority0
i. Ehen theres control) theres a fiduciary duty.
Ehen theres a fiduciary duty) you apply the !M3.
Koud ha&e to show a conflict of interest to apply
the entire fairness test to loo" at the substance
ii. Conflict of interest2 need Tself dealing) i.e.) when
the fiduciary gets something to the exclusion of the
minority owner. .li"e being on both ends of the
transaction..selling G buying0
iii. #inclair needed money and caused #in&en to pay
out to co&er it) but theres no conflict of interest
when all the shareholders get their fair share.
b.#inclair was directing opportunities to other subsidiaries
instead of #in&en. Thats under the !M3 so long as #inclair
4L
wasnt acti&ely ta"ing away opportunities that #in&en
already had.
c.!reach2
i. Court applies entire fairness test b+c #inclair is on
both ends .contract between #inclair and #in&en)
which is controlled by #inclair0
viii.Fliegler v. La$rence
/. !urden of proof shifts to plaintiff if the transaction was appro&ed
by fully informed disinterested shareholders.
4. 3atification2 *elaware law allows conflicted transactions to be
made by non-conflicted parties. #hareholder ratification
automatically in&o"es the !M3 and the burden is on the plaintiff to
show the transaction essentially amounted to waste.
a.Note this is shareholder appro&al) not necessarily
Tdisintrested shareholder appro&al.
b.Theoretically) if the conflicted shareholders hold a maJority)
they can ratify a transaction that benefits them.
c.#tatute also allows the conflicted parties to pro&e Tfairness
w+o ratification to allow the transaction.
5. Court says that the entire fairness test applies e&en if the
transaction is ratified.
a.#o why bother with the ratificationR
i. :ote counts as e&idence of fairness) no dispositi&e)
but good e&idence
ii. !urden of proof shifts A instead of the defendant
ha&ing to pro&e that its fair) the plaintiff will ha&e
to pro&e that its unfair. 1laintiff bears burden if the
shareholders ratified the decision.
ix.In re #heela)rator &echnologies, Inc. Shareholers Litigation
/. If fully informed disinterested shareholders gi&e appro&al it &oids
the duty of care claim.
a.If you as" for a shareholder &ote) you ha&e a duty to fully
and fairly disclose all rele&ant information.
b.4an Gor%um A why didnXt shareholder appro&al extinguish
duty of care claim thereR
i. #hareholders werent fully informed
c.!urden of proof2
i. Controlling stoc"holder H fully informed
disinterested shareholder appro&al $ entire fairness
test) but shifts burden to plaintiffs to pro&e
transaction was not fair
ii. *irectors normally ha&e burden to pro&e in OdutyP
cases that the decision was OfairP
iii. Ehy are the tests differentR
5D
/. 1otential for greater influence by controlling
shareholder
iv. This was a director transaction) not controlling
shareholder A court says there was no e&idence that
44? was controlling. F/? would be presumed.
b. Zuci" #ummery of interested transaction law
i.*irector2
/. default rule is 76T w+ burden on defendant
4. If we ha&e independent) fully informed) disinterested director
appro&al2 .other directors are aware of conflict0
a.sometimes its 76T w+ burden on plaintiff
b.more often its !M3 w+ burden on plaintiff
5. Independent shareholder appro&al
a.!M3 burden is on plaintiff
ii.Controlling shareholder interest
/. *efault
a.76T burden on defendant
4. Independent director appro&al .assuming controlling shareholder
didnt appoint all directors0
a.76T) burden on plaintiff
5. Independent shareholder appro&al
a.76T burden on plaintiff
iii.76T2
/. Transaction must be fair for the corporation and its shareholders
4. @a&e to pro&e that it is entirely fair .not perfect) but fair0
5. Ehen does the transaction ha&e to be fairR
a.#ome states say at the time of the transaction .ratified later
pro&ided the transaction was fair0
b.*elaware says the transaction must be fair at the time it is
appro&ed. .no later ratification0
iv.(ain Conflict situations
/. #alaries G benefits A management gets to set its own salaries) but
its an e&eryday occurrence b+c e&ery company has to set salaries.
a. use fully informed) independent director appro&al A form a
salary committee
4. !usiness dealings w+ the director A director wants to engage in
some business dealing with the company
5. *eri&ati&e litigation A when shareholder wants to sue corporation
9. @ostile ta"eo&ers or proxy contests
%"""# Corporate Opportunities
a. As a general rule a fiduciary should not ta"e an opportunity that belongs to the
corporation for their personal benefit.
5/
i.3eal <uestion is whether it is a corporate opportunity or personal
opportunity.
/. Theres no clear test) but consider these factors2
a.The line of business A buying a direct competitor is more
Oin the line of businessP than buying a secondary
competitor.
i. (aybe shouldnt matter A conglomeration is a
corporation combined of different businesses .li"e
potato chips and microchips0
b.Interest or expectancy A li"e an extension of a lease
expected to be able to extend lease and didnt get it.
i. C7' buying land with oil under it
c.#ource of opportunity A used corporate assets and time to
de&elop or disco&er the opportunity its more li"ely to be a
corporate opportunity.
d.1arty in&ol&ed A in order of most problematic2 officers)
directors) employees) shareholders. .assuming its not a
controlling shareholder0
e.6airness A consider all the circumstances
ii.*irectors ha&e a greater duty to the business than a mere agent
/. !arber shop example2 agent .barber0 hears of other shop for sale A
can <uit and buy w+o informing.
4. *irector of barber shop is in a different boat had to inform other
directors and they had to decide as a group if the shop should buy
the other shop.
5. N'T72 director &otes A the interested directors &ote doesnt
really count .disinterested appro&al0
b. 6actors to be considered on whether something is a corporate opportunity
i.-ine of business
/. Closer it is to the line of business the more li"ely it is a corporate
opportunity
4. #ome people say it has to be in the same line of business to be a
corporate opportunity
ii.Interest or expectancy
iii.#ource of opportunity
iv.1arty in&ol&ed
/. Closer you are to an officer the more li"ely it is to be a corporate
opportunity
a.'fficer *irector 7mployee #hareholder
v.6airness
c. Test2
i."ro( v. Cellular Information Systems, Inc.
/. 13' *I37CT'3
54
4. Ehere the director belie&es that the corporation is not entitled to
an opportunity) there is no reason to present the opportunity to the
board.
5. 1resenting to the board is Just a safe harbor.
ii.'nergy ,esources Cor- v. 3orter
/. -7## 13' *I37CT'3
4. !efore a person may ta"e ad&antage of an opportunity he must
present it to the board.
5. Argued that @oward had Orefused to dealP with the company only
wanted to deal with the scientist + director
a.6ailed to satisfy other elements) though
i. *id not disclose to corporation
ii. *id not gi&e reasons @oward wouldnt deal so the
corp could possibly ma"e adJustments.
"&# Sharehol$er Actions
a. *irect &s. *eri&ati&e -itigation
i.*irect action a lawsuit initiated by an injured person on her
own behalf
/. Typical litigation2 inJured party sues
ii.*eri&ati&e action a lawsuit initiated by a shareholder on the
corporations behalf against third parties (often management)
because of managements failure to take action against the third
parties
/. Atypical2 on behalf of inJured party
4. 3easons for allowing it2
a.1erson is unable to sue
5. 1roblems with *eri&ati&e -itigation2
a.Corporation should be able to say whether or not they want
to sue) not shareholders
i. (anagement would ha&e to ma"e this call
ii. #hareholders are not supposed to run the business
b.Cant allow each and e&ery shareholder to ma"e decision
c.#hareholders may not understand all the issues
d.#hareholders may ha&e &endettas and ha&e personal
interests
iii.Cohen v. "eneficial Inustrial Loan Cor-.
/. 3eason for deri&ati&e suit management apathy
iv.'isen)erg v. Flying &iger Line, Inc.
/. :7-A#C' T@INC# T@I# I# A !A* CA#7) #@',-* @A:7
!77N A *73I:ATI:7 ACTI'N AN* EA# 6',N* N'T T'
!7.
55
4. InJury to the corporation it is a deri&ati&e action inJury to the
indi&idual is a direct action.
b. Incenti&es
i.#hareholders ha&e &ery little incenti&e to sue
/. If they do sue) they would ha&e to incur expenses of the litigation
and then the corporation would get the benefit
a.this is a problem for people who li"e deri&ati&e action
ii.Attorneys do ha&e incenti&es
iii.7lements
/. -itigation expense
a.unpredictability
4. Contingent fee a fee charged for a lawyers ser&ices only if the
lawsuit is successful or fa&orably settled out of court) usually
representing a percentage of the award
a.Contingent fees ma"e shareholders more willing to sue
because it limits the incenti&e not to sue.
5. Award of attorneys fees
a.normally attorney will be awarded fee if he is successful
b.normally he will get the full fee regardless of reco&ery
9. Indemnification pro&isions
a.If directors dont ha&e to pay the Judgment but are going to
be indemnified by the corporation you ha&e problems.
iv.#tri"e suits a lawsuit initiated not with the intention of winning on the
merits) but with the intention of obtaining a profitable settlement
/. Eea" case) but the potential for a Jury to gi&e you a lot of money
4. 7ntrepreneurial attorney an attorney acting as a businessman
with respect to lawsuits) ma"ing in&estment decisions with her
time and ta"ing the ris" of profit and loss
5. Courts and the Corporate Eorld thin" that deri&ati&e actions are
stri"e suits
a.3easons for thin"ing this2
i. #hareholders rarely win in court .!usiness
Mudgment 3ule0
ii. #ettlements there is a &ery small dollar reco&er
/. Counter to this is structural relief is often
granted) small dollar amount is relati&e)
some changes in management
c. #tatutory #olutions
i.7xpenses
/. Awarded if successful
a.litigation costs .including attorney fees0 will be awarded if
successful
i. sometimes this is optional .OmayP language0
59
ii.#ecurity
/. #ome states re<uire that the shareholder post security for the
corporations expenses
a.it is rare that the shareholder will be liable if the
corporation wins) but it is there incase
4. NK says you need to post but not if you own F? of stoc"+WFD)DDD
iii.#tanding
/. Contemporaneous ownership rule the rule of standing pro&iding
that) in order to initiate a deri&ati&e action) a plaintiff must ha&e
been a shareholder at the time of the action complained of
a.Argument that this does not ma"e sense2
i. All shareholders can ha&e a real interest
b.#ome states .li"e NK0 re<uire that you are a shareholder at
the time of action and at the time of the lawsuit.
iv.*emand
&# The Deman$ *e+uirement
a. *emand 3e<uirement
i.!efore a shareholder can bring a deri&ati&e action he has to bring it up
before the board of directors.
/. They can decide whether it ma"es sense to sue
a.If they say no) there will be a record of their reasons and
the court can say whether they ma"e sense or not.
4. 7xceptions2
a.Irreparable @arm
i. If there will be irreparable harm from ma"ing the
demand) they dont ha&e to ma"e it
/. If time is a critical factor
b.*emand 6utility
i. If there is a conflict of interest) it would be futile to
as" the board to sue itself.
/. N'T A-- #TAT7# A--'E *7(AN* T'
!7 7[C,#7* 6'3 6,TI-ITK
a. (ostly to a&oid extra litigation costs
ii. Ehen would it be futileR
/. Conflict of interest .maJority of board is
interested in the transaction0
ii.Grimes v. Donal .*7(AN* 6,TI-ITK IN *7-AEA370
/. Kou cant Just argue that demand was futile) you ha&e to present a
case
a.not enough that they all participated in action
b.not enough that they all appro&ed the action
c.not enough that they failed to ta"e correcti&e action
5F
d.not enough to allege that they are all controlled or
dominated by a shareholder
4. 1articulariBed allegations ha&e to be made in the pleadings
!76'37 you get to disco&ery
a.Note that this is more than a notice pleading re<uirement
you must allege details before disco&ery
b.,se Otools at handP a&ailable to shareholders
i. 1ublic information
ii. Inspection rights
5. Irimes Test
a.3easonable doubt needs to be created that directors are
disinterested and independent or the challenged transaction
was a product of a &alid business Judgment
i. /
st
prong sounds li"e duty of loyalty
ii. 4
nd
prong sounds li"e duty of care
b.*oes demand futility sound li"e a loyalty issuesR
c.If demand futility cannot be shown) the court has the right
to dismiss the action.
d.3easonable doubt means that the Oboard has a reasonable
beliefP
9. 'nce you ma"e a demand) you wai&e demand futility
a.the ball is in the directors court
b.you can still argue wrongful refusal of demand
i. standard for this is the !usiness Mudgment 3ule
/. 'nce the directors ma"e a decision it is
protected by the !usiness Mudgment 3ule.
F. Class Notes
a.!asically) if demand is reJected .which will li"ely be the
case0
i. Kou can no longer plead demand futility .that
demand is excused0
ii. Kou can then ma"e a claim for wrongful refusal)
which is essentially challenging the !M3
b.1lan2
i. (a"e demand) its probably reJected
/. Kou can try to argue wrongful refusal) but
youll li"ely lose under the !M3
ii. Argue demand futility
/. @a&e to deal in particulariBed allegations)
which is &ery difficult.
4. This is the best route despite the difficulty)
b+c the other route is more than li"ely a dead
end
5=
iii.Mar1 v. A%ers .*7(AN* 6,TI-ITK IN N7E K'3C0
/. This is a deri&ati&e action so you need demand futility
4. *emand 6utility in New Kor" is established by2
i. ta"es out the reasonable doubt standard of *elaware
Test
b./
st
prong a maJority of the directors are interested in the
transaction or
c.4
nd
prong the directors failed to inform themsel&es to a
degree reasonably necessary about the transaction or
d.5
rd
prong the directors failed to exercise their business
Judgment in appro&ing the transaction
5. (aJority of board was disinterested so we respect to most of the
board demand would not ha&e been futile.
9. *ifference b+t *elaware G New Kor" tests
a.New Kor" does not re<uire Oreasonable doubtP
i. *elaware A does the plaintiff ha&e a reason to
doubtR
ii. New Kor" A the plaintiff must ha&e a reasonable
belief that the board lac"s independence
/. @arder to meet the New Kor" test
F. Ehen the board is conflicted) they ha&e to pro&e it was &alid under
the Oentire fairnessP test
a.!ut the court puts the burden on the plaintiff to allege
particular facts) where normally it would be the corp ha&ing
to show it was not conflicted
b.Ehy dont they apply that hereR
i. The court realiBes that in cases li"e this) where the
issue is director compensation) applying the 76T
would subJect nearly all similar transactions to
Judicial re&iew.
b. #pecial Committees
i.Notes2
/. These situations are generally used when demand futility is
established as a way for the corporation to a&oid litigation.
ii.Auer)ach v. "ennett .N7E K'3C #17CIA- -ITIIATI'N
C'((ITT770
/. 6ord created a special litigation committee whose decision was not
<uestioned by the court
a.The board placed the final authority to decide whether to
pursue litigation into the hands of this committee) which
was comprised only of disinterested directors appointed
after the alleged incident gi&ing rise to the litigation.
b.the process can be in<uired into) but N'T the substance
5;
i. will loo" at procedures chosen
ii. how they engaged counsel
iii. basically the court will show great deference
4. 3ule in New Kor"
a.If you ha&e a special litigation committee) properly
appointed and after a good faith in&estigation concludes
that it is in the best interest of the corporation to dismiss the
deri&ati&e suit the !usiness Mudgment 3ule will apply.
i. !asically) if there is not a conflict of interest) the
!M3 applies.
5. Class notes
a.#tructural bias2 directors will naturally be predisposed to
be biased towards one another. Court responds that if we
donXt trust the directors) we wont ha&e the !M3 and the
courts will ha&e to ma"e all the decisions.
b.Two ways to establish demand futility2 reasonable doubt as
to independence of directors) or decision not product of
&alid business Judgment.
9. New Kor" is extremely deferential toward corporations
iii.8a-ata Cor-. v. Malonao .*7-AEA37 #17CIA- -ITIIATI'N
C'((ITT770
/. *elaware that there are ris"s in the situation
a.Is the new committee really disinterestedR
i. #tructural !ias independent directors may be
biased
/. They will ha&e to ma"e decisions about
colleagues on the board) often times those
same colleagues who got them their board
position.
b.!alancing the interest of all the parties
i. Not truly to dismiss cases after years of litigation
4. Courts are applying their own business Judgment
a.Two 1art Test2
i. 7ssentially Auer)ach
ii. Courts then apply their own !M3
/. !ut that was the whole point of the !M3
4. *eleware doesnt apply the !M3 &ery often
anymore.
b.*elaware #upreme Court creates a test where courts are
applying their own !usiness Mudgment
i. 'dd de&elopment that is uni<ue in corporate law
c.Eho could Justify thisR
i. Need for some "ind of balancing
/. Counteracts structural bias
5>
5. They really dont apply their own business Judgment) but they can.
iv.*7-AEA37 court if the far extreme for not trusting directors) N7E
K'3C court is far extreme for trusting directors.
c. *eri&ati&e -itigation
i.The board is the one who decides whether or not to sue) so
ii.Ee allow shareholders to sue on companys behalf
iii.1roblems2
/. *isincenti&es for shareholders to sue
a.Costs
i. Ee allow an award of expenses) but only if they win
4. There is incenti&es for attorneys to bring deri&ati&e suits
a.-aw focuses on disincenti&es to sue to counter this
i. *emand re<uirement
/. 1articulariBed allegation
4. #pecial -itigation Committee
b.@ard for a shareholder to win in deri&ati&e action
i. Courts are not sympathetic because it is not a
shareholder right but a corporation right
&"# Executi,e Compensation
a. 7xecuti&e Compensation
i.Irowing problem
/. Top executi&es get too much money
a.disclosure of compensation pac"ages is poor
b.Courts dont "now what to do.
4. Compensation le&els is clearly !usiness Mudgment
a.Concern with structural bias A directors are conflicted in a
collegial sort of way .top officers are directors0 and in a
mutual interest way .directors are often directors for other
companies0
i. Is there really arms-length negotiation hereR If the
directors are disinterested) maybe) but e&en then)
theyre officers in other corporations.
ii. Argument for2 we ha&e to set our salaries abo&e
a&erage to get abo&e a&erage employees.
/. !ut e&eryone paying Tabo&e a&erage causes
salaries to increase exponentially.
5. Iap between 7xecuti&es and a&erage wor"ers is growing2
a.In /L;Ds a&erage gap was 9D times) by /LL/ a&erage gap
was /9D times
b.estimates in 4DD5 is FDD times
ii.6lexibility in #etting 1ay
/. 1aying executi&es based on performance
5L
a.If you set the wrong incenti&es you are in trouble
4. Compensation is based on the short term performance
iii."rehm v. 'isner
/. 7xecuti&e compensation is under the business Judgment rule.
4. *uty of Care <uestion basically) the C7' was fired and he got
W/9D million in compensation argue that anyone putting the corp
in this situation breached their duty. *eri&ati&e suit
a.Argument was that it was waste so irrational that it didnt
deser&e the protection of the !M3
i. Court said this decision had to be unconscionable
meaning it was highly unli"ely that they could win.
5. 7xtreme deference to the corporation you basically ha&e to ma"e
your case with specific e&idence in the pleadings.
&""# "n$emnification ! "nsurance- "nspection *ihts
a. Indemnification G Insurance
i.Indemnification reimbursement of a loss or expense incurred by
another.
/. 1articularly in this case) reimbursement of cost of litigation
expenses incurred by director) officer or employee .attorneys fees)
court fees) etc0
ii.#pecial 3ules of Corporate -aw that either re<uire+permit+forbid
indemnification
/. *IC- 8 /9F
a..a0 allows indemnification in direct actions .suing C7'
directly0
i. some re<uirements2
/. ha&e to be acting in the Ogood faithP of
company
4. criminal action had to ha&e belie&ed that
their actions were lawful
b..b0 allows indemnification in deri&ati&e actions .suing C7'
on behalf of corp0
i. similar re<uirements to .a0
ii. If defendant is liable to the corporation the court has
to appro&e the indemnification as fair and
reasonable
c..c0 re<uires indemnification if defendant is Osuccessful on
the merits or otherwiseP
d..d0 re<uires specific authoriBation for any indemnification
payment under .a0 or .b0
i. basically) if youre guilty) the board has to decide
whether or not to reimburse them.
e..e0 allows ad&ancement of expenses
9D
f..f0 allows additional rights
g..g0 allows liability insurance .e&en when indemnification is
not allowed
i. allows directors+officers insurance when
indemnification is not allowed.
iii.#altuch v. Conticommoity Services, Inc.
/. -aw only allows corporation to indemnify when they are acting in
good faith
4. 1ower to indemnify is limited to good faith
5. #uccess is &indication as far as the court is concerned
iv.Citael Holing Cor-oration v. ,oven
/. -imit on ad&ancement of funds is it has to be reasonable.
4. !asically the purpose is to protect you in ad&ance for things you
will be indemnified for. #o theres a presumption that youll be
indemnified.
b. Inspection 3ights
i.Ienerally) shareholders can demand to see basic corporate records
/. Charter) bylaws) minutes of board meetings) list of shareholders
ii.3easons for allowing inspection rights
/. Ehy should only one slate of candidates ha&e access to &oters
iii.#tandard for allowing shareholder access
/. 3e<uest has to be for a Oproper purposeP
a.7conomic Interest
b.:aluation Issues
c.Ta"eo&ers
d.1roxy Contest
4. 3e<uests that would not be considered proper
a.1ossibly goodwill concerns
b.1olitical Acti&ism
iv.*eri&ati&e -itigation
/. In theory is positi&ely related to the corporation and the inspection
rights would be a proper purpose
v.State e1 rel. 3ills)ury v. Honey$ell, Inc.
/. (oral arguments are not good enough for inspection rights.
9/
Part Three: Fe$eral Securities La'
"# "ntro$uction to Fe$eral Securities La's
a. @istory
i. #ecurity an instrument that e&idences the holders ownership rights in
an organiBation .e.g.) stoc"0) the holders creditor relationship with an
organiBation .e.g.) bonds0) or the holders other financial rights .e.g.)
options0
ii. #tate securities regulation
/. Common law fraud didnt pro&ide enough protection for the
sale of securities hard to pro&e fraud.
4. !lue s"y laws state security laws
a. merit regulation
i. state laws loo"ed at in&estment and decided
whether it was a good in&estment) too speculati&e
or not
iii. #toc" (ar"et Crash of /L4L
/. Ireat *epression
a. !rought federal law to the table.
i&. 6ederal securities regulation
a. helps in&estors ma"e own .good0 in&estor decision
4. (andated disclosure
a. in selling securities companies ha&e to gi&e ade<uate and
accurate information to in&estors
b. done by filing detailed reports to go&ernment which are
distributed to in&estors
5. Antifraud rules
a. company is liable if the disclosure is inaccurate or
incomplete
9. No merit regulation
a. Kou can sell any security you want to so long as in&estors
are properly informed.
b. 6ederal #ecurities -aws
i. #ecurities Act of /L55
/. 1rimary mar"ets the mar"et for securities sold by issuers to
in&estors .when the company is selling you a security) li"e an
initial public offering .I1'00
a. must register securities and deli&er prospectus before
selling securities to the public .public offerings co&ered)
pri&ate offerings are outside the scope of this law0
/. registration re<uirement ha&e to file
detailed report .registration statement0 to
#ecurities G 7xchange Commission
a. #7C re&iews registration statement
for the ade<uacy and not the
accuracy
94
b. Ehen it is complete) #7C declares
the registration statement effect
4. After this is completed) the prospectus is
deli&ered
a. 1rospectus information about the
offering ha&e to deli&er it as a sales
document.
b. Always contains the registration
statement
ii. unlessexemption is a&ailable
b. liability for false or misleading statements or omissions of
material fact .deception0
i. much tougher than common law fraud
ii. standard prohibits false statement of material fact
.no lies0
iii. also prohibits misleading statements of material fact
.no half truths0
i&. also prohibits misleading omissions of material fact
.nothing left out0
ii. #ecurities 7xchange Act of /L59
/. #econdary (ar"ets the mar"et for securities traded by in&estors
among themsel&es .e.g.) NK#7) NA#*AZ0
i. #ame structure) but implemented &ery differently
b. (ain focus is not on selling in&estor but issuing company
i. must file periodic reports on company performance
ii. must file additional reports under certain
circumstances
iii. liability for manipulation or deception
/. not only in reports but any communication
from the company .press releases)
inter&iews) etc0
i&. Indi&idual -iability A if you lie or misrepresent)
youre liable. .but you ha&e no mandated
disclosure0
4. #ecurities industry generally
a. !ro"ers) analysts) etc are regulated.
iii. #ecurities and 7xchange Commission the agency established to o&ersee
the enforcement of federal securities laws
i&. #tate law is concerned with form o&er substance) while federal law is
more concerned with substance
/. Theres no Trace to the bottom competition li"e states competing
for corporations b+c theres only one fed go& and it has preempted
the field.
c. :aluation
i. Commodities products that are abundant and fungible e.g.) produce
/. 7asier to price) because of many buyers and sellers
95
4. 1ricing is through supply and demand
ii. #pecial Ioods rare or uni<ue items
/. *ifficult to price how much is OxP painting worthR
iii. Corporation as a whole is a special good) but the share of stoc" is a
commodity
i&. #trong (ar"et
/. #trong -i<uidity ha&e to be able to buy G sell <uic"ly
4. A&ailability of information so you can analyBe before the fact
5. 7fficiency ability to buy and sell cheaply
&. There are strong mar"ets for public corporations
/. Confident traders and strong mar"et
&i. Closed corporations do not ha&e strong mar"ets
/. Not much info a&ailable) not publicly traded so not &ery li<uid)
d. 7fficient (ar"et @ypothesis the theory that) in a strong mar"et) such as ,.#.
capital mar"ets) prices <uic"ly reflect all a&ailable information
i. 1rice may not be accurate) Just that it reflects all a&ailable information
ii. EhyR
/. Combined efforts of all in&estors analyBing information creates an
e<uilibrium price
iii. Eea" 6orm of 7fficient (ar"et @ypothesis
/. Current prices reflex all past price information
4. Kou cant beat the mar"et by loo"ing at trends
a. 6alling or rising price isnt a good reason to buy or sell
the current price already reflects that.
b. Kou cant do better than youre supposed to
5. Ieneral accepted as true
i&. #emi #trong 6orm of 7fficient (ar"et @ypothesis
/. Current prices reflex all publicly a&ailable information
4. Cant beat the mar"et through analysis
a. Kou cant read financial statements) trends) industry) etc
and decide which stoc" is better A all this information is
already reflected in the stoc" price.
b. This ne&er claims that the prices are accurate) only that
they reflect all the public information
5. Eidely accepted as more or less true
a. :ery few mutual funds can consistently beat the mar"et.
&. #trong 6orm of 7fficient (ar"et @ypothesis
/. Current prices reflect all a&ailable information) public G pri&ate
a. !asically) if I ha&e secret information) should I buyR The
strong form says no) as current prices reflect all public and
pri&ate information. #o you cant beat the mar"et with
pri&ate information
b. This theory assumes that insider trading has already
happened by the time you get the information) so the price
already reflects it.
99
4. Insider Trading the use of material) nonpublic information in
trading the shares of a company by a corporate insider or other
person who owes a fiduciary duty with respect to such information
5. Not accepted as true
a. If it was true) public announcements wouldnt ma"e a
different) but they do.
b. If this were true) it would suggest people couldnt ma"e
money on insider trading) but they do.
c. -oo"ing at the stoc" price o&er time) it doesnt Just Jump at
the moment of announcement) it starts to rise around the
time of the announcement) leading to the belief that there
were some lea"s G insider trading going on.
&i. 7<uilibrium le&el of dise<uilibrium
/. Analysts must analyBe in order for the mar"et to be efficient) but
once they do so) they are useless b+c they cant beat the mar"et.
!asically) analysts can only really hope to ma"e enough W to
analyBe.
&ii. 3amifications for #ecurity -aw
/. If strong form is true) omissions are not so important because the
price already reflects what is really happening
4. If wea" form is true) public disclosure is most important thing
because information is necessary
5. If semi strong form is true) getting information into the hands of
the public is not so important
&iii. *i&ersification the process of reducing ris" by in&esting in multiple
opportunities
/. If you di&ersify you are not gambling as much
ix. -essons from 7fficient (ar"et @ypothesis
/. *ont try to beat the mar"et
a. 7&en if someone can beat the mar"et) you cant
b. In&est in index funds
i. !asically a Obuy G holdP strategy buy stoc"s on
the NA#*AZ or #G1 FDD and hold on to them.
ii. Acti&ely managed funds .typical mutual funds0
ha&e higher trading+management fees.
""# *ule ./b01
a. 3ule /Db-F
i. #7C rule under 7xchange Act 8/D.b0
a. broad antifraud rule
b. single most fundamental pro&ision of federal security laws
4. Congressionally delegated authority
ii. 6orbids) in connection with purchase or sale of securities2
a. similar to) but broader) than security act
4. *e&ices) schemes and artifices to defraud
5. 1ractices which operate as a fraud or deceit
9F
9. 6alse or misleading statements or omissions of material fact.
iii. 7nforcement
/. #7C intended to be enforced by
4. 1ri&ate in&estors courts ha&e found an implied cause of action
a. Not clear that Congress or #7C intended this.
i&. 7lements of a cause of action under 8/Db-F
/. #cienter intent to decei&e .or rec"lessness lower courts say yes)
#C'T,# hasnt ruled0
a. fraud
4. (ateriality rele&ance+significance
a. not little details are enough
b. !asically) anything important enough to effect a decision
5. 1urchase or sale
9. Causation
a. deception must be the cause of the harm
F. 3eliance
a. plaintiff must ha&e actually been decei&ed
&. "asic Inc. v. Levinson
/. @ow should materiality be definedR
a. Anything that would affect a decision
i. 3easonable personR
ii. 3easonable in&estorR
4. Ehat court says about materiality2
a. An omitted fact is material if there is a substantial
li"elihood that a reasonable shareholder would considered
it important in deciding how to &ote.
i. OTo fulfill the materiality re<uirement Tthere must
be a substantial li"elihood that the disclosure of the
omitted fact would ha&e been &iewed by the
reasonable in&estor as ha&ing significantly altered
the Ttotal mix of information made a&ailable.P
5. 1robability (agnitude Test .4
nd
Circuit0
a. -oo" at the probability and magnitude of the e&ent to
determine if it is material2
/. Ii&es an expected &alue.
4. !asically 1 x ( $ 7xpected :alue
ii. Consider facts such as the siBe of the corporation)
effect on the &alue of the corporation) etc.
9. #ecurity -aws are about disclosure not protection) so you only
need to disclosure material facts
a. protection of corporate secrets
F. #upreme Court is not tal"ing about timing of disclosure) they are
tal"ing about the accuracy of disclosure
a. In this case) they didnt ha&e to say anything.
i. #ilence absent a duty to disclose is not misleading
under rule /Db-F. .i.e.) No Comment0
9=
ii. If you want to ha&e secrets you ha&e to ha&e a Tno
comment policy A if you deny some claims and say
Tno comment to others) the Tno comment operates
as a Tyes.so you always ha&e to say Tno
comment
b. !ut the courts say once you say something) it has to be
materially true.
=. 6raud-on-the-mar"et theory2
i. !ased on the hypothesis that) in an open and
de&eloped securities mar"et) the price of a
companys stoc" is determined by the a&ailable
material information regarding the company and its
business.
/. !asically the efficient mar"et hypothesis
its a clear adoption of the 7(@
b. (isleading statements will therefore defraud purchasers of
stoc" e&en if the purchasers do not directly rely on the
misstatements
c. The casual connection between the defendants fraud and
the plaintiffs purchase of stoc" in such a case is no less
significant than in a case of direct reliance on
misrepresentations
d. This is deri&ati&e reliance were relying on the mar"et) and
the mar"et was defrauded. !ut its a rebuttable
presumption.
i. @ow to rebutR
;. 6raud must be in connection with sale or securities
a. 1roblematic in this case b+c the misrepresentation wasnt
connected with the purchase or sale of securities. It was
made to maintain the status <uo during merger
negotiations. Court ignores this seems to be a &ery broad
interpretation that anything could lead to a purchase or sale.
&i. Santa Fe Inustries, Inc. v. Green
/. Claims2
a. low &aluation was fraudulent
b. 6reeBing out minority shareholders
i. !reach of fiduciary duty issue
4. *oes 6ederal -aw protect against unfair beha&ior) i.e.) breach of
fiduciary dutyR
a. Court of Appeals says yes) 3ule /Db-F
b. #upreme Court says2
i. There is no cause of action for breach of fiduciary
duty .or any substanti&e fairness0 under 6ederal
#ecurity -aws.
ii. !ascially) no Tunfair claims under federal securities
laws.only deception claims.
9;
"""# "nsi$er Tra$in
a. Insider Trading the use of material) nonpublic information in trading the shares
of a company by a corporate insider or other person who owes a fiduciary duty
with respect to such information
i. Goo$in v. Agassi(
9. @ow would this court decide the problemsR
a. C7' duty to the company and not random shareholder
:. Is there any harm to the corporation from Insider TradingR
a. None of the money from the stoc" mar"et goes to company
b. Indirect harm is company losses goodwill
i. @arder for the company to do another primary
offering
;. This is where the law stood before security law.
a. Included for historical purpose
b. There was no protection for insider trading
ii. Securities an '1change Commission v. &e1as Gulf Sul-hur Co.
9. Court ultimate rule on insider trading2
a. *isclose or Abstain 3ule
i. O Anyone in possession of material insider
information must either disclose it) or if he cannot
in order to protect a corporate confidence) or he
chooses not to do so) must abstain from trading in
or recommending the securities concerned while
such information remains undisclosed.P
:. 1robability (agnitude Test
a. Ehether facts are material will depend on any gi&en time
on a balancing of the probability that the e&ent will occur
and the magnitude of the impact.
;. (isleading #tatements
a. Needs to be in connected with the trading
b. 3ule doesnt re<uire trading by spea"er) Just that the fraud
needs to be connected with the purchase or sale
i. It is connected with the purchase or sale if it causes
people to purchase or sale\
ii. !asically) a false or misleading statement by the
company) and subse<uent trading by the purchaser
is enough for the plaintiff to sue.
/. !ut Tany trading is enough for #7C
<. !usiness Mudgment rule does not apply state matter &s. fed sec
laws
=. This case is not the law anymore
iii. Chiarella v. .nite States
9. (ere possession does not mean that there is deception in&ol&ed)
there must be fiduciary duty
9>
:. If a breach of fiduciary duty is decepti&e it is actionable under
federal security laws) not because it is a breach of fiduciary duty
but because it is decepti&e
a. *eception or fraud is the only thing that is co&ered by rule
/D.b0.F0 if a breach of fid duty gi&es rise to an obligation
to disclose) and no disclosure is made) it may be considered
Tdecepti&e
;. Non-fiduciaries do not &iolate 3ule /Db-F by engaging in insider
trading
i&. Dir%s v. Securities + '1change Commission
9. #7C didnt see *ir"s as a bad guy and only censored him
a. They did this to create a rule of law for the future
:. #7C theory is that once you recei&ed insider information you
become an insider
;. #upreme Court reJects #7Cs theory as trying to get rid of
Chiarella
a. Two 1art Test2
i. #ays you can inherit fiduciary duty but only when
/. the insider has breached his fiduciary duty to
the shareholder and
4. the tippee "nows or should ha&e "nown of
this breach
<. !reach of 6iduciary *uty needs to be a 1ersonal !enefit
.money or its e<ui&alent0
a. *irect to you
b. Indirect to your friends or family
c. Note that this personal benefit re<uirement is uni<ue to
federal securities law state breach of fid duty doesnt
re<uire a benefit.
=. 'nly way strangers will ha&e fiduciary duty is if they inherit the
duty
a. There must be an unbro"en change and you as" from each
person to the next go through the two part test.
&. .nite States v. *>Hagan
9. Tender 'ffer a public offer to buy a minimum number of shares
directly from shareholders at a fixed price) usually at a substantial
premium and usually part of a ta"eo&er attempt
:. Court discuss classic theory2 Chiarella
a. there is a deception only if there is a breach of fiduciary
duty
i. applies not only to personal insiders of the
company) but also to accountants) attorneys) and
others who may temporarily ha&e access to that
information.
9L
ii. Classical theory would say that '@agan had a fid
duty to the buyer .I(0) but '@ bought shares of 1
stoc") to whom '@ owed no duty.
;. #7C tries to expand scope under /Db-F
a. (isappropriation Theory
i. A person commits fraud in connection with a
securities transaction) and thereby &iolates 8 /D.b0
and 3ule /Db-F when he misappropriates
confidential information for securities trading
purposes) in breach of a duty owed to the source of
the information.
ii. !asically) you can &iolate /D.b0.F0 by breaching a
duty to the source of the information. Ehile he had
no duty to 1) he did ha&e one to I() and breaching
his duty to I( falls under this theory.
iii. *istinctions between classical theory and
misappropriation theory are slight. #ee pg FD5 for
good description
i&. -oophole2 if you tell the party you got the
information from that youre going to use it for your
own purposes) its no longer deception and youre
off the hoo". This loophole doesnt wor" with
classical theory.
<. #7C has gotten what it wants in terms of tender offers
&i. 3ule /9.e0.50
9. No trading w+any material nonpublic information regardless of
fiduciary duty
:. Court says delegation of authority under /9.e0.50 gi&es the #7C
authority to proscribe rules to pre&ent deception. Authority under
/D.b0.F0 was limited strictly to illegality and punishment of
deception this authority is a little broader.
;. 3ule /9.e0.50 is limited to tender offers
"%# Proxy Solicitations
a. #hareholder (eetings
i. *ue to shareholder apathy) shareholders ha&e no reason to go to
shareholder meetings
/. Kou can authoriBe people to &ote on your behalf thou.
4. (anagement always see"s authoriBation to &ote your shares
a. They need a <uorum to conduct business
5. If someone else as"s you) they are opposing management
ii. 1roxy
/. ./0 one who is authoriBed to act as a substitute for another) esp in
corp law) a person who is authoriBed to &ote anothers shares
4. .40 the grant of authority by which a person is so authoriBed
5. .50 the documents granting the authority i.e.) the agent) the
authoriBation or the instrument
FD
iii. 1roxy Contest competition to obtain the right to &ote shareholders
shares) often as a part of a hostile ta"eo&er
i&. 1roxy #olicitation S an attempt to obtain the right to &ote shareholders
shares) most often conducted by management
&. 1roxy #tatement a document re<uired by federal law to be deli&ered in
connection with a proxy solicitation
b. Co&erage of 1roxy 3ules
i. 7xchange Act 8 /9.a0
/. *elegation of authority to #7C
ii. 3egulation /9A
/. 7&ery solicitation of a proxy with respect to registered securities
iii. #olicitation
/. :ery broad definition
a. includes any re<uest for a proxy
4. 7xceptions2
a. 3ule /9d-4.b02 shareholder con&ersation
i. Con&ersation among fewer than /D people) it wont
count for proxy solicitation
b. 3ule /9a-/.l0.40.i&02 institutional in&estors
i. If you Just say that here is what I am going to do.
c. 1roxy (aterials
i. 1roxy #tatement
/. #er&es the 6ederal #ecurity law of (andated disclosure
4. #chedule /9A sets out all the re<uirements
ii. 1roxy Card
/. *escription of solicitor
a. because shareholders may presume it is management
4. !lan" space for date
a. It is illegal to solicit a undated or postdated proxy
i. 3eason for this is because proxies are re&ocable
5. #eparate identification of matters to be &oted on
a. discretion is an option
d. *eli&ery of 1roxy (aterials
i. *eli&ery to shareholders
/. 1rior to any solicitation
i. 6irst thing you do has to gi&e someone a proxy
statement
/. Kou cant first tal" to them and then gi&e
them a proxy statement
b. exception2 3ule /9a-/4
i. Allows a solicitation without a proxy statement.
/. Kou can ha&e discussions) before you
actually prepare a proxy statement
ii. !ut before you gi&e them a proxy card or as" you
ha&e to gi&e them a proxy statement
F/
4. (anagement solicitation for annual meeting must include annual
report
ii. #7C filings
/. 1reliminary proxy statement
a. /D days in ad&ance
4. 6inal proxy statement
5. 'ther written materials
e. 'ther (atters
i. 'pposing solicitations
/. #hareholder proposals
a. may ha&e to be included in managements proxy
4. 1roxy contest
i. @a&e to spend their own money to do that.
ii. #ometimes allow reimbursement for success proxy
contest
b. either mail materials at insurgents expense
c. or pro&ide shareholder list
5. #tate law always gi&e the right to get the shareholder list
a. This is not a conflict with the federal standard
i. 6ederal law gi&es the option) #tate law doesnt
ii. Antifraud pro&isions
/. Information must be clearly presented
4. Ci&il liability for false or misleading statements or omissions of
material fact
f. J.I Case Co. v. "ora%
i. 6irst case to recogniBe pri&ate cause of action under 3ule /9.a0.L0
ii. Argument that it doesnt ma"e sense2
/. Not necessarily the case that e&ery group always need more help
with the enforcement of the laws
g. Mills v. 'lectric Auto0Lite Co.
i. @as to pro&e three elements of proxy solicitation2
/. (ateriality
4. 3eliance
5. Causation of inJury
a. 1roxy solicitation must ha&e been an essential lin" to the
transaction
i. :otes were necessary to determine the outcome
h. 4irginia "an%shares, Inc. v. San)erg
i. If the directors actually belie&ed that the price was fair) they didnt lie.
ii. To pro&e someone didnt belie&e their opinion2
/. The statement must be obJecti&ely false or misleading) not Just that
they belie&ed it to be unfair.
iii. 6reeBeout merger A in glossary A loo" up A its forced upon minority
shareholders b+c maJorities ha&e control to do it.
i&. Ehat is re<uired to pro&e causation in proxy solicitations is -oss
Causation) not Just transaction causation.
F4
/. 7lecting directorR (ust pro&e that electing the director caused the
loss.
4. !ad mergerR (ust pro&e that the merger alone caused the loss.
&.
%# Sharehol$er Proposals 2D"D34T CO%E* T5"S SECT"O36
a. #hareholder 1roposals
i. @ow much access should shareholders ha&e to the 1roxy #ystemR
/. 3ule /9a->
4. #hareholder can get proposals in) subJect to criteria of exclusi&e.
a. #upposing that we ha&e a good standard) only the good
ones will get through
5. Eho gets to apply the standard is a real problemR
a. If it is management) often the shareholders who want to put
in ideas are the ones that ha&e problems with management
b. Court) we really dont want courts ma"ing this type of
business Judgment
9. Ehat we ha&e is a system where the company gets the first stab of
it.
a. Company has to notify #7C either that they are going to
include it or exclude it
b. If #7C disagrees they can ta"e a stab at it
c. 7ither side can appeal #7C decision to court.
i. This really doesnt happen
ii. Company doesnt want to upset #7C
iii. #hareholders dont ha&e money
ii. Criteria under 3ule /9a->2
/. #hareholder must ha&e W4)DDD or /? worth of stoc"
4. 1roposal must be FDD words or less
5. Company can exclude the proposal if they can meet one of
different standards2
a. &iolation of law
b. personal grie&ances
c. company would lac" power or authority to implement
d. company has already done the suggestion
e. idea already brought up
f. specific di&idends
i. you cant demand it or re<uest it
g. Improper under #tate -aw
i. Ehich stateR
ii. Ee are going to ha&e #7C decide what is proper
under state lawR
iii. Ehat is proper for shareholders to decide under
state lawR
/. (ost 1roposals according to 3ule /9a
4. !,T state law gi&es shareholders :73K
limited powers
F5
a. so the two are in conflict
5. #hareholders can amend the by-laws and
almost anything can be in the by-laws
h. 3ele&ance
i. If it counts for F? of company business it is
rele&ant
ii. Eho should decide whether issue OxP is rele&antR
i. 7lection
i. If proposal relates to the election of directors) it can
be excluded
/. 7lecting directors is the one thing that is
most proper for shareholders to do under
state law.
iii. Institutional In&estors
/. Care about shareholder proposals
i&. #hareholder getting greater access to proxy materials2
/. Triggering 7&ents
a. At least one director gets 5F? or more
b. #hareholder proposal to get access gets maJority appro&al
c. If the board fails to implement any shareholder proposal
that gets shareholder appro&al
F9
Part Four: Control Transactions
"# Sharehol$er Control
a. #hareholder :oting
i. *irectors manage the business) not shareholders
ii. #hareholder &oting rights are limited2
/. To elect directors
4. To amend charter or bylaws .appro&al from shareholders G *ir0
5. To appro&e certain maJor transactions
a. i.e. mergers
9. 'ther matters submitted for shareholder &ote
F. No right to manage business generally
iii. :oting standard
/. Ieneral rule2 maJority of shares present
a. present includes by proxy
4. #pecial rule2 maJority of all shares .not Just shares present0
a. i.e. for mergers
b. absent shares count as no
5. Charter can pro&ide different rules
a. election of directors plurality
i. most &otes wins cant &ote Tno on someone
9. *efault rule for <uorum is half) but can go down as low as a /+5
F. -egal re<uirement2 cant go beneath sets a minimum
a. *efault rule2 can go down.
i&. State of #isconsin Investment "oar v. 3eerless Systems Cor-.
.*7-AEA370
/. 6acts2
a. !y-laws allowed for adJournment
4. !lasius Test
a. another exception to !usiness Mudgment 3ule
b. 4 1art Test2
i. /0 conditions2 plaintiff must establish that the board
acted for the primary purpose of thwarting the
exercise of a shareholder &ote .difficult test0
ii. 40 then the board has the burden to show a
compelling reason for their actions
5. (anagement tried to increase the &ote of the people that they
thought would &ote in their fa&or.
9. Ehat could a compelling Justification be for thwarting the
shareholder &oteR
a. combat other interference with &oting
b. fraud on the part of shareholders or proxies
F. Courts are &ery hesitant to in&o"e !lasius because it is such a
demanding standard
=. *uty to disclose
FF
a. no general duty to disclose under state law) but under
*elaware law a board of directors) is under a fiduciary duty
to disclose fully and fairly all material information within
the boards control when see"ing shareholder action
;.
b. Control
i. .true0 control $ FD? H / &ote
/. you always win
ii. 7ffecti&e control ] FD?
/. #hares present and &oting usually less than /DD?
a. #o you Just need maJority of present shares
4. Influence ^ control
a. 'pposing significant minority may be difficult
c. 7lecting *irectors
i. *efault 3ule
/. 7ach director is elected separately
4. 7ach share is entitled to one &ote per director
5. (aJority shareholder .FD? H/0 can elect all directors
ii. #upermaJority &oting
/. Cumulati&e &oting
4. All directors are elected together
a. #o you might ha&e /F candidates and /4 get elected
5. 7ach share is entitled to multiple &otes
a. i.e.) /D spots open) each share gets /D &otes
9. (inority shareholders get proportional representation
F. 7x.2 If you ha&e /4 shares) you ha&e /4 &otes and you can gi&e all
your &otes to one person or split them.
d. Cumulati&e :oting
i. Number of shares needed to elect directors2
ii. Number of directors that can be elected2
e. Class :oting each class of stoc" can &ote separately on some or all matters
/. Can apply to all &otes
ii. 7ach class of stoc" has different &oting rights
/. 7.g. class A stoc" gets 4 &otes per share) ! gets /
4. 7.g.) each class entitled to &ote separately on some or all matters
a. action re<uires appro&al of each class
i. e.g.) mergers re<uire appro&al of each class.
5. 7.g.) only certain classes entitled to &ote on some or all matters
a. e.g.) only common stoc" may &ote for directors
i. preferred often cant
b. e.g.) common stoc" elects half of the directors) preferred
stoc" elects half of the directors
f. 1ower Arrangements
i. Classified shares different &oting rights) different di&idend rights
/. #etting up different power arrangement
4. -oose certain tax benefits
F=
a. In order to be taxed as a partnership and a&oid the double
taxation you can only ha&e one class of stoc".
5. Could set it up where experts get class A stoc" with more control
.i.e. &otes for directors0 while the class ! stoc" goes to financiers
who get more profits per share
ii. 1roxy
/. Normally re&ocable at will
4. Irre&ocable only if coupled with an interest
a. Not necessarily clear what an interest is A but we "now that
employment contracts count. .i.e.) promise an employee a
proxy0
5. # Corporation
iii. :oting trust a plan in which shareholders transfer their shares to a
trustee for the purpose of creating a &oting bloc"
/. Actual transfer of shares)
a. usually original shareholders still get di&idends
4. Control by agreement or in one party
5. 1roblem2 limited to /D years
a. Court dont li"e) thought it was a snea"y way to get control
i. #o they imposed the /D year limitation
i&. 1ooling agreement a plan in which shareholders agree to &ote their
shares together a.".a.) shareholder agreement and &oting agreement
a. #imilar to &oting trust
4. 3etention of shares by shareholders
5. Control by agreement
9. 1roblem2 enforcement
a. Courts are more excepting
g. (anagement 7ntrenchment
i. 'wnership A tend to ha&e significant amount of shares) enough for control
/. #toc" options for execs can often lead to this situation
ii. Control o&er proxy mechanism
/. (anagement has power to solicit your proxies expensi&e for
others to oppose) management wins on plurality of &otes
4. 3ational apathy A shareholders dont really care.
iii. Class &oting
/. 7xchange offer for new shares with high &oting rights but low
di&idends
4. Ii&es general shareholders higher di&idends at the expense of their
&oting rights so management gets stoc" w+ &oting rights
i&. Capped &oting
/. @oldings beyond a certain point carry reduced &oting rights
a. e.g.) /DD shares /DD &otes /)DDD shares /FD &otes
4. This pre&ents hostile ta"eo&ers e&en if you ha&e LD? of the
company) your &otes are capped at a certain amount. .could e&en
hold LD? of stoc") but only 4DD of 4DD)DDD &otes.0
5. *ownside is management reduces its &oting power
F;
&. #hareholder Acti&ism
/. 'fficers appointed by directors) directors elected by shareholders.
In theory) shareholders ha&e the ultimate control
4. !urle-(eans thesis .glossary0 A says that officers ultimately ha&e
the final say) as they run the day-to-day business) set the agenda)
and ha&e little responsibility to directors.
a. Kou could say the officers choose the directors they set
the meeting) choose who is on the ballot) and the
shareholders essentially endorse their choices.
&i. Acti&ist companies
/. Institutional in&estors are rising they tend to ha&e more shares and
tend to pay more attention. This could thwart this theory) as these
big shareholders can exercise more control.
a. !ut corporations can choose not to deal with these
companies) so they wont be as <uic" to opposed
management.
""# Close Corporations
a. Closed Corporations
i. @arder to sell than public.
ii. 6reeBe-'ut action ta"en by the maJority shareholders in a close
corporation to frustrate the expectations of the minority shareholders
/. withhold di&idends
4. deny employment in a closed corporation
iii. Increasing trend among courts to treat closed corporations as special.
/. #ometimes they will wai&e rules .Clar" &. *odge0
4. #ometimes they will impose fiduciary duties on maJority
shareholder to minority shareholder
i&. #tate legislatures2
/. !uilding more flexibility into general corporation law.
4. #pecial Closed Corporation laws
a. #pecial laws address two problems
i. 1arties that are not aware of technical re<uirements
of corporation law.
1.-ets them run business they way they want
to contract to.
ii. 3is" of piercing the corporate &eil
b. *elaware Closed Corporation #tatute .most of the time we
are not tal"ing about a closed corporation statute0
i. To get into the statute2
1.Kou ha&e to ha&e no more than 5D
shareholders
2.Kou ha&e to ha&e no registered public
offering
3.Kou ha&e to ha&e transfer restrictions
F>
a. Transfer restrictions a charter
pro&ision or agreement that restricts
a shareholders ability to sell her
shares
4.Affirmati&e selection2
a. Kou ha&e to want to be go&erned by
the closed corporation statute
ii. (ost closed corporations dont fall under this
statute because they are not aware of this option
iii. If the statute applies2
1.!asically allows for management of
corporation by shareholder) ma"es it a lot
li"e a partnership but with the laws of
limited liability.
5. ,ingling "ros. "arnum + "ailey Com)ine Sho$s v. ,ingling
a. 6acts2 #tate statutes permitted &oting trust) but party did
not comply with the standards.
i. 1arties did their own thing
b. They did their own &oting agreement
c. *ifference between a pooling agreement and a &oting trust2
i. pooling agreement gi&e up the right to &ote) but not
the power to &ote
ii. &oting trust you lose the power to &ote
9. Mc?uae v. Stoneham
a. Corporations should me managed by management and not
by shareholders
i. If shareholders try to run the business) they are
usurping the role of directors
ii. !asically) shareholders cannot agree to force
directors to do something.
b. Are pooling agreements illegal in New Kor" under this
caseR
i. Kou cannot ha&e a pooling agreement among
directors telling them what to do.
ii. 1ower to &ote in realty telling the directors what to
do.
c. An agreement to try to control the actions of directors is
in&alid
d. #eems the problem is that some shareholders and creditors
can get hurt in the deal A see next case
F. Clar% v. Doge
a. #ame court as (cZuade) Just two years apart) similar
situation of shareholders telling directors what to do
b. Clar" distinguishes from (cZuade2
i. there is no real harm to ha&e a special agreement
controlling what the directors of the corporation do
FL
1.we are going to loo" the other way when all
the shareholders are a party to the agreement
and no one else is being harmed .i.e.)
creditors0
=. Galler v. Galler
a. OEhere no complaining minority interest appears) no fraud
or apparent inJury to the public or creditors is present) and
no clearly prohibiting statutory language is &iolated) we can
see no &alid reason for precluding the parties from reaching
any arrangements concerning the management of the
corporation which are agreeable to all.P
b. 6ollows clar" &. dodge
c. 6reeBe out A actions ta"en by the maJority shareholders to
frustrate the expectations of the minority shareholders
i. *enying employment A you thin" generally that in a
closed corp the minority shareholders would expect
employment.
ii. *enying di&idends A maJority decides when the
stoc" pays di&idends could decide instead to gi&e
himself higher salary.
d. Ehen no one else is inJured in a closed corporation) the
shareholders can tell the directors what to do.
i. #tate corporate law is becoming more flexible
allowing for more customiBed arrangements to fit
the &ariety of corporate structures) particularly with
respect to closed corporations.
e. 1ooling agreement statutes A *elaware closed corporations
A protect against
i. the ris" of disruption of the parties agreements A
agreed to arrangement they didnt "now was illegal
ii. ris" of piercing the corporate &eil for non-
compliance with rules they didnt realiBe existed.
1.6or example) what are the odds that a mom
G pop corporation ha&e an annual meeting
with =D days noticeR
&. *elaware closed corp statute A see other outline for details
&i. 6ederal -aw
/. Closed corporations can a&oid double taxation by becoming a #
Corporation a close corporation that has elected to be taxed as a
partnership rather than as a corporation
4. 3e<uirements for # Corporation #tatus
a. ,nanimous consent of shareholders
i. In order to terminate # Corporation status you only
need a maJority
b. No more than /DD shareholders
=D
c. All shareholders must be indi&iduals) estates) or certain
trusts
i. Not another corporation A cant be a subsidiary
d. No shareholders can be non-resident aliens
e. Kou can only ha&e one class of stoc"
i. Kou can only ha&e common stoc"
5. This is something that corporations often do.
a. Ehy subJect yourself to double taxation when you dont
ha&e to.
b. (ost corporations that can elect #-corp status do so
i. Theoretically the problem is that you get taxed on
e&erything the corporation ma"es) whether or not
you ta"e out anything. Any rein&estment is done
after-tax as well.
"""# Abuse of Control
a. Abuse of Control
i. #il%es v. S-ringsie /ursing Home, Inc.
/. Ieneral 3ule2
a. O#toc"holders in closed corporation owe one another
substantially the same fiduciary duty in the operation of the
enterprise that partners owe one another substantially the
same fiduciary duty in the operation of the enterprise that
partners owe to one another.P
i. 3ule sounds li"e all shareholders) and not Just
maJority shareholders) but it seems to allow ad hoc
maJority groups.
4. Court announces 4 part Test for analyBing a breach of the strict
goof faith duty owed2
a. Controlling group must be able to announce a legitimate
business purpose for their action.
b. The action must be the least restricti&e means to
accomplish the goal.
i. This ma"es it more than Just the !M3) but still less
than the entire fairness test. .:elasco now thin"s
that this may be more restricti&e than the entire
fairness test in some respects0
ii. Ingle v. Glamore Motor Sales, Inc.
/. -imiting principle that this court adopts for fiduciary duty owed by
maJority shareholders.
a. we only want to impose the fiduciary duty when they are
shareholders that are Oessentially li"e partnersP
i. In this case) Ingle was essentially li"e an employee
rather than a partner
4. (any courts .especially (A in Eil"es0 are less willing to protect
shareholders when they planned ahead and it Just didnt wor" out
they way they wanted.
=/
a. Courts are more li"ely to help you if you dont ha&e an
agreement .i.e.) failed to plan ahead0
5. Nixon &. !lac"well .pg. =FL0
a. *elaware is not li"ely to help shareholders that didnt plan
ahead.
i. OIt would be inappropriate Judicial legislation for
this Court to fashion a special Judicially created rule
for minority in&estors when there are no negotiated
special pro&isions in the certificate of incorporation)
by-laws) or stoc"holder agreements.P
iii. Smith v. Atlantic 3ro-erties, Inc.
/. Court generally dont want to interfere when shareholders ha&e
made an arrangement
a. Interfere may be appropriate when parties are truly stuc"
i. They could ha&e gotten out of the corporation) by
dissol&ing it.
i&. Joran v. Duff an 3hel-s, Inc.
"%# Corporate Dissolution
a. Corporate *issolution
i. #hareholder &ote
/. 'ften re<uires super-maJority &ote
ii. Charter amendment
a. Can limit the life of a corporate) therefore dissol&ing it.
4. 3e<uires board and shareholder appro&al
iii. Mudicial dissolution
/. Courts are hesitant to dissol&e corporations
a. profitable business
b. opportunistic beha&ior
4. Eould help minority shareholders in freeBe-out situation
a. if too easy) the minority could ta"e control of the maJority
5. (itigating factors that should gi&e comfort to courts to allow
dissolution
a. *issolution does not mean the end of the business
i. sal&age &alue+li<uidation &alue &. going concern
&alue
1.#al&age &alue the value of a business
if its assets are sold individually;
usually less than going concern value
2.Ioing Concern &alue the value of a
business if sold as a business; usually
higher than salvage value
b. #ale as a going concern
c. Alternati&e forms of relief
i&. Alas%a 3lastics, Inc. v. Co--oc%
=4
/. 6acts2 1laintiff .minority shareholder0 was being froBen out of the
corporation
4. Court doesnt thin" they are authoriBed to dissol&e in this case2
a. They feel that they are authoriBe to dissol&e when there is
Oserious misconductP
b. #he was Just a shareholder and not a partner .thus probably
shouldnt be entitled to fiduciary duties.0
&. 3ero v. 3ero
/. 6acts2 !y firing him) they are forcing him to sell at ;F? of boo"
&alue instead of intrinsic &alue AN* he will not be employed with
the company
4. Courts gi&e him his reasonable expectations of full salary till ;F
and fair mar"et &alue of his shares
a. Ehat about the duty to mitigateR
&i. Stu-arich v. Har)or Furniture Mfg., Inc.
/. #elf dealing
a. they are either on both sides of the transaction or because
they are getting something at the exclusion of others
b. in&o"es the entire fairness test
i. plaintiff has to pro&e the transaction is entirely fair
b. Mudicial *issolution
i. Eho can see" a dissolution shareholders
/. Kou dont not need a maJority to see" a dissolution
a. most states ha&e some "ind of ownership re<uirement in
terms of the amount of shares
ii. Ehen can you see" dissolutionR
/. Easte of corporate assets
4.
a. Corporation can not be run properly
5. 'ppressi&e conduct by maJority shareholders
i. Ehat oppressi&e conduct is &aries from state to
states.
b. #ome courts ha&e a high standard2
i. !urdensome) harsh or wrongful conduct
ii. :iolation of specific rights of minority
c. (iddle standard2
i. !reach of fiduciary duty of good faith and fair
dealing
ii. #ubtle forms of misconduct
d. 6rustration of reasonable expectations
i. In cases of closed corporations) the complaining
shareholder need not establish oppressi&e or
fraudulent conduct by the controlling shareholder or
shareholders.
1.3easonable expectations include
expectations that the minority shareholders
=5
will participate in the management of the
business or be employed by the company
but limited to expectations embodied in
understandings) express or implied) among
the participants.
9. *eadloc"
a. Among directors or shareholders
b. #uper-maJority &oting pro&isions
%# Transfer of Control
a. Ieneral 3ule with respect to buying and selling shares
/. _etlin &. @anson @oldings) Inc.
ii. OIt has long been settled law that) absent looting of corporate assets)
con&ersion of a corporate opportunity) fraud or other acts of bad faith) a
controlling stoc"holder is free to sell) and a purchaser is free to buy) that
controlling interest at a premium price.P
iii. Kou are allowed to sell at a premium for the most part.
/. ,nless you "now the purpose is a "nown looter or a suspected
looter.
a. 6or the rule to be meaningful you ha&e to go beyond
"nown looter because nothing is truly O"nownP
b. Eho says whether the suspected person is a looterR
i. 3easonable personR
ii. 3easonable business personR
b. #ale of *irectorship
i. #hareholders can &ote howe&er they want for a directorship
/. #elfish reasons etc.
ii. Ehoe&er you elect thouwill ha&e fiduciary duties to all the shareholders
.including minority shareholders0
/. !ut) to the extent the business Judgment rule applies) it only
protects waste and self-dealing.
iii. #hould you be able to buy a directorship by buying shareholders &otesR
/. 7galitarian concerns
4. 3ational Apathetic) people should be able to only "eep the rights
they want.
c. Transfer of Control
i. 3erlman v. Felman
/. 6acts2 !uyers had to pay for steel now) e&en thou they would not
get it till a year from now.
a. Interest free loan is gained
b. Court rules against 6eldman
4. 6eldman breach his fiduciary duty by getting a corporate
opportunity
5. N'T A I''* *7#C3I1TI'N '6 T@7 -AE) ,#7* 6'3
@I#T'3ICA- 1,31'#7#
=9
ii. Adolf !urley It has been argued that a controlling shareholder can not
sell his shares at a premium unless all can share in the premium and not
for your own personal benefit.
/. 'ne share is supposed to be one &ote) but once you ha&e someone
with F/?) the rest of the shares ha&e no realistic &ote.
iii. 'sse1 .niversal Cor-oration v. 2ates
/. If you are transferring controlling interest) you can replace the
directors right away.
4. 7ffecti&e control can be less than FD? H /.
a. @ow do we "now when we ha&e enough control to apply
the ruleR
1.Kou can only sell control if you ha&e a
controlling interest.
ii. Kou "now you ha&e control) by how you exercise it.
b. @ow many directors has he put in) do they listen to him.
c. If he can deli&er then he has effecti&e control.
5. 3eplaced directors by one by one they resigned and then they filled
the &acancies.
9. If director didnt want to resign) it probably wouldnt be
enforceable by contract because of fiduciary duty.
a. As between buyer and seller we can enforce it.
b. Cant sell control) but we will allow it if you are selling a
controlling interest.
i&. Fransen v. Jensen0Sun@uist Agency, Inc.
/. 3ight of first refusal an agreement pro&iding that) before a
shareholder can sell her shares to a third party) other shareholders
would ha&e the right to buy such shares at the price at which they
would ha&e been sold to the third party
a. 3easons for ha&ing this2
i. Kou dont want to be stuc" with someone you dont
want in a closed corporation
ii. If they are selling at a good price you might want it.
4. Ta"e along right an agreement pro&iding that) before a
shareholder can sell her shares to a third party) other shareholders
ha&e the right to sell their shares to such shareholder at the price at
which the shares would ha&e been sold to the third party
a. 3easons for ha&ing this2
i. Appro&al of who the person is selling to
ii. (inority shareholders can ta"e ad&antage of the
premium
5. Ehy ha&e both a right of first refusal and ta"e along rightR
a. New mar"et for your shares .especially in closed
corporation0
i. If it is a good price) you can buy it for yourselfIf
it is a bad price) you can sell your own shares.
=F
9. !oth of these agreements only co&er sale of shares) not sale of
assets
F. This case dealt with a sale of assets.
a. Is formalism appropriate in this caseR
i. This was not really a corporate law issue) but a
contract interpretation issue.
ii. In contracts we dont go with form o&er substance)
we go with the meaning of the parties.
%"# Ac+uisition of Control
a. Ac<uiring Another Company
i. Ac<uisition a general term that refers to a business combination of any
type.e.g.) merger) stoc" purchase or asset purchase0
ii. Ta"eo&er an attempt by an ac<uiror to gain control of a target
iii. 5 Eays to ac<uire another company
/. #toc" purchase an ac<uisition in which an ac<uiror buys the
stoc" of the target from the shareholders
a. A H ! $ A H ! .two separate corps b9 G after0
i. Target becomes a subsidiary
b. #hares purchased directly from shareholders
i. Target company is not in&ol&ed
1.7ach shareholder ma"es up his or her own
mind
c. No appro&als
4. Asset purchase an ac<uisition in which the ac<uiror buys the
assets .and maybe liabilities0 of the target .Just about all assets0
a. A $ A H ! .one new co ta"es on the assets of both old0
b. Appro&al of targets directors and shareholders needed
i. Target company is in&ol&ed
ii. #hareholders get say whether their assets are sold)
but s+h of other company dont get say o&er whether
their company buys assets
5. (erger an ac<uisition in which an ac<uiror and a target
combine into one sur&i&ing company
a. A H ! $ A!
i. -i"e a marriage
ii. Can be the original company or a totally new
company
b. Appro&al of both companies directors and shareholders
i. !ecause both companies are effected.
c. 5 1ossible outcomes
i. Constituent Corporation a corporation party to a
merger
ii. #ur&i&ing Corporation the constituent
corporation that sur&i&es a merger
iii. 3esulting Corporation a new corporation formed
as a result of a merger
==
b. (erger 1rocedures
i. *el. 8 4F/
/. 1repare merger agreement
4. Appro&al of directors of each company
5. Appro&al of shareholders of each company
a. True (aJority .FD? H /0
i. Abstentions count as no
9. 6ile with #ecretary of #tate
F. *issenting shareholders ha&e appraisal rights
a. Appraisal 3ights the right to forego the contractual
consideration in a merger .or similar transaction0 and to
recei&e instead the fair &alue of the shares
i. #hares sold to company
ii. Ehat if merging corporations are incorporated in different statesR 6ollow
both) especially the one that is more strict for each part.
c. Consideration in a (erger
i. #tandard merger2
/. Consideration is shares in sur&i&ing corporation
4. Number of shares depends on &alue of constituent corporations
a. 7[2 if A is worth W/DD mil and ! worth WFD mil) the ratio
will be 4 to /. .so e&ery share from A is worth twice a !
share in new company.0 this is a &ery simplified example)
also ha&e to ta"e in to account premiums paid) amount of
shares outstanding) etc
ii. -egal possibilities2
/. -aw pro&ides that a merger agreement can ha&e any consideration
a. #ecurities) cash) property) &od"aQ
b. #hareholders from each corp dont ha&e to get the same
thing.
4. *ifferent consideration
a. Cash-out merger a merger in which one companys
shareholders recei&e cash instead of shares in the sur&i&ing
corporation
i. :ery similar to a stoc" purchase
1.*ifferences between the two2
a. Cash-out re<uires appro&al of board
b. #toc" purchase gi&es shareholders
choice
ii. #hareholders being cashed out are usually from the
target corporation.
b. (erger of 7<uals A both companies simply combine A no
real ac<uiror or target.
d. Appraisal 3ights
i. Appraisal rights
/. (ost states allow the option
4. *elaware
=;
a. Allows for mergers) but not for other type of transactions
i. Not for all mergers
b. Not for public corporations if you recei&e shares
i. Kou can sell your shares easily) where as in a closed
corporation you wouldnt be able to sell your shares
easily
1.Kou are still going to get stuc" with the bad
deal because the stoc" price will reflect the
ratio
5. 'ther states
a. (erger) asset purchase) certain charter amendments
i. 7ach #tates laws ha&e to be followed
ii. *elaware procedure 8 4=4
/. Company gi&es notice of appraisal rights
4. *emand appraisal before &ote .s+h must demand0
a. Not after the fact.
5. Cannot &ote in fa&or of merger
a. 7ither has to &ote against merger or not to &ote
9. 1etition for appraisal
F. Court determines fair &alue of shares
a. 6air &alue of shares may be less than merger consideration
b. 3easons why it may be lower2
i. 8 4=4.h0 A 6air &alue of your shares is your shares
standing alone.
1.Kou can not ta"e into account synergistic
gains
2.#ynergy the ad&antage that results when
a combination is greater than the sum of its
parts
3..i.e.) worth more than the sum of its parts0
ii. Ac<uirer often pays a premium to get the target
shares.
1.1remium used to persuade shareholders
2.1remium an amount abo&e the mar"et
price paid by an ac<uiror to target
shareholders in order to purchase the shares
iii. 7&en if the fair &alue $ merger consideration) you
then ha&e to deduct the cost of the appraisal.
c. Ehen should one see" an appraisalR
i. N'T when you are <ui&ering o&er &alue
ii. Eise person only see"s an appraisal when you are
really getting ta"en ad&antage of .li"e stoc" worth
WFD+share and the merger is going at W4F+share0
e. 6orm o&er substance
i. Cash-out merger
=>
ii. Triangular merger A merger between one company and a subsidiary of
another
/. Ac<uiror mergers its own subsidiary with a target. 'ften the
subsidiary is a shell corporation) created only to merge with the
target.
4. Ad&antages A you can a&oid a shareholder &ote of the ac<uiror.
a. The rules are target and subsidiary must appro&e. Target
shareholders must appro&e) but not ac<uiror. Need
appro&al of only subsidiary) whose &otes are made by board
of directors.
b. 'ften used when ac<uiror "nows it doesnt ha&e the
support of its shareholders b+c paying a premium) etc.
iii. #hort-form merger a procedure under some states laws where a parent
corp can merge with a subsidiary w+o a shareholder &ote.
/. 6or example) do a triangular merger and then a short form merger.
This would put the corporations in exactly the same place as if they
Just merged normally) but this was without a shareholder &ote.
f. -oopholes A ways to structure transactions to get around limitations
/. 6orm o&er law.
ii. Cash-out merger
/. Eant to merge) but you dont want each corporations shareholders
to be shareholders of the new company
iii. Triangular merger a merger between one company and a subsidiary of
the other
/. (erger between one company and the subsidiary of another
a. #ubsidiary is usually a shell corporation
4. #ubsidiary tries to merger with a target corporation
a. This a&oids the shareholder &ote of one of the companies
because the subsidiary does not ha&e its own shareholders.
i&. #hort-form merger a procedure under some states laws under which a
corporation may merge with a subsidiary without a shareholder &ote
/. As long as it is a simple merger of a parent and subsidiary) you
dont need a shareholder &ote.
&. T( followed by #6(
/. Kou can do the exact same thing that would happen in a merger)
without ha&ing to get shareholder appro&al
&i. ( $ (erger) T( $ Triangular merger) #1 $ #toc" purchase) A1 $ Asset
purchase
g. 1ractical Considerations
i. Cey2 ($merger) #1$stoc" purchase) A1$asset purchase) T($triangular
merger) #6($short form merger
ii. -iability
/. (2 Joins two companies liabilities
4. #1 G T(2 "eeps liabilities separate
5. A12 parties can .generally0 decide
a. Can buy half liabilities) can buy "nown liabilities) etc.
=L
b. Ehy would you want to buy liabilitiesR
i. (aintain business relationships) ex. 13 reasons
ii. (AIN 37A#'N you pay less for the company.
1.Net cost compared to gross cost
iii. #tructure
/. ( G A12 one sur&i&ing company
4. #1 G T(2 two sur&i&ing companies
i&. 'wnership
/. () T( G A12 ac<uirer gets /DD? ownership
4. #12 ac<uirer may get less than /DD?
a. 7&eryone may not agree
i. There will be minority shareholders
ii. 7&en if e&eryone agrees) there are always people
that dont "now+arent informed and dont sell.
b. To get around this2
i. #toc" purchase to get F/?) Create a subsidiary and
then do a triangular merger and cash-out the
minority shareholders
&. Appro&al
/. (2 both sets of directors and shareholders. @ard to get.
4. T( G A12 both sets of directors only targets shareholders
5. #12 consenting shareholders not directors. Target company is not
in&ol&ed.
&i. Appraisal 3ights2
/. *elaware2 only for (
4. #ome states2 () T( G A1
&ii. Conse<uences
/. 3enegotiation of contracts
a. Not really a problem with T( or #1.
b. Eith ( or A1 contracts will ha&e to be renegotiated) etc.
4. Nontransferable rights
a. (erger some rights transfer .as operation of law0) but
there may be non-transferable rights under 6ederal -aw.
b. Asset purchase important to ta"e into consideration.
5. Tax and accounting conse<uences
%""# De Facto 7erers an$ Free8e0Out 7erers
a. *e 6acto (ergers Cases
i. Farris v. Glen Alen Cor-oration .1A0
/. *e 6acto (erger *octrine a rule that transactions which are not
styled as mergers but which essentially are mergers may be treated
as mergers for purposes of shareholder &ote and+or appraisal rights
4. #tatutory language does not get rid of the de facto doctrine
a. Court would not let the form pre&ail o&er the substance)
stuc" with the de facto merger doctrine
b. Completely ignored the statutory mandate said that they
will not blind themsel&es to the reality of the transaction.
;D
c. -egislatures here and in other states are trying to get rid of
the statutory merger doctrine
5. 7&en thou the legislature said they got rid of the de facto merger
doctrine the court wasnt sure they wanted to go with that.
9. Appraisal rights2 when corp combines w+ another so as to lose its
essential nature G alter fundamental relationships of shareholders
among themsel&es G corp) a shareholder who doesnt wish to
continue may treat his membership as terminated and get cash for
shares.
ii. Hariton v. Arco 'lectronics, Inc. .*elaware0
/. This is the maJority rule
4. (ost states .almost all states0 ha&e mo&ed away from the *e 6acto
(erger *octrine
a. 1A+NM are outliers
5. 6'3( 137:AI-# ':73 #,!#TANC7 .e facto merger
would be substance o&er form0
b. 6reeBe-'ut (ergers
i. Cash-'ut (ergers
/. #hould they be permittedR
a. #ome shareholders do not agree and are forced to gi&e up
their shares.
i. The appraisal remedy Just gi&es them cash) e&en
thou this is what they are trying to a&oid in the first
place.
ii. This may be the only real solution .appraisal0
4. 6reeBe-out (erger a merger in which minority shareholders are
forced to recei&e cash for their shares and to lose their status as
shareholders
a. in&oluntary cash-out merger
b. 6orced buy-out is the problem not the solution.
c. Note difference from freeBe out) where minority
shareholders expectations are froBen out due to lac" of
di&idends) employment) etc. there the shareholders EANT
to sell) but cant. @ere they dont want to sell) but ha&e to.
c. 6reeBe-'ut (ergers Cases
i. #ein)erger v. .*3, Inc. .*el.0
/. 6acts2 Ee ha&e self-dealing) they ha&e to pro&e under the entire-
fairness test unless there was fully informed disinterested
shareholder appro&al.
a. There was disinterested shareholder appro&al) but they
were not fully informed
4. *irectors of ,'1 had the duty to tell the company what it new.
a. There were also directors of the other company and had a
fiduciary duty to the other company
b. They ha&e to disclose to ,'1) but they cant disclose to
#ignal
;/
c. @ow do you reconcile this problemR
i. Courts say if you create the problem) you ha&e to
deal with it. Kou ha&e to "eep fiduciary duties to
both.
5. !7#T 7[1-ANATI'N '6 7NTI37 6AI3N7## T7#T .pg. ;59-
;5F0
9. 7ntire 6airness Test
a. To see if there is entire fairness) you loo" to /0 fair dealing
and 40 fair price.
b. !asically when theres self dealing) you apply this test.
i. If there is fully informed) disinterested shareholder
ratification) the burden shifts to plaintiffs to show it
was unfair.\
ii. Court says here the appro&al wasnt fully informedQ
iii. #hareholder &ote is not necessarily the same as fully
informed) disinterested shareholder appro&al.
1.In the case where the maJority of shares are
held by the conflicted party) you would need
a maJority of the minority to &ote for
appro&al.
c. Court may ignore fair price if it was ob&iously fair dealing)
or may ignore fair dealing prong if the price is ob&iously
right.
F. Court liberaliBed the appraisal proceedings.
a. Kou can use any tools to figure out what a fair &alue is.
i. Ee will here the experts
ii. 84=4.h0 A the appraisal &alue can not include any
benefits of the merger
=. 3eJected the business purpose test.
ii. Coggins v. /e$ 'nglan 3atriots Foot)all Clu), Inc. .(ass.0
/. 6acts2 1erson wants his share) not cash) because he wants to be an
owner in the 1atriots
4. -egal Test Court 7mploys2
a. 4 1art Test
i. *efendant bears the burden of showing a business
purpose
1.!usiness 1urpose Test
ii. 7ntire 6airness test
b. Is there e&er a &alid business purpose to a freeBe-out
mergerR
i. To say there is a business purpose test is doomed to
failure.
1.Test of lawyers creati&ity
ii. This Case
;4
1.The defendant alleges the business purpose
is an eternal &ariable .N6- wants single
owners.0
a. This is the 'N-K example of where
there is an external &ariable with a
plausible reason.
2.Court doesnt buy this and has a strict
reading of what is a legitimate business
purpose.
a. If this reason is reJected) when are
we 7:73 going to allow freeBe-out
mergers
3.The rule must be that we are ne&er going to
allow 6reeBe-out mergers) because we are
ne&er going to ha&e a business purpose that
the court will accept.
5. In the end) all the person gets is money) not their shares.
a. Courts seem to be unable to recogniBe anything but the
economic interest.
iii. ,a)%in v. 3hili- A. Hunt Chemical Cor-oration
/. @a&e to pro&e entire fairness
a. 6air *ealing
i. Court says that there was not fair dealing2
1.Any sort of misconduct results in lac" of fair
dealing
2.@ere they played with the timing of the
transaction
3.6actors2
a. Negotiations
b. *isclosure
b. 6air 1rice
i. 7&eryone agrees in this case that the price was fair.
4. Things that are normally o") may not be o" for people with
fiduciary duties.
a. !asically) under the contract only it was o" to wait and pay
when the shares would be cheaper. !ut these directors also
had a fiduciary duty to the target company) and they
screwed that company by waiting until the contract expired
and they could buy the shares for less.
%"""# 5ostile Ta9eo,ers
a. Ta"eo&ers
i. @ostile Ta"eo&er ta"eo&er that does not ha&e the support of the
directors of the target
a. not exactly hostile to shareholders
b. normally done by a stoc" purchase
;5
i. tender offer
1.once you ha&e /D? .&ia open mar"et
purchase0 you ma"e a tender offer for F/?
of the company
2.6reeBe-out merger to get /DD? of the
company
ii. #hareholders li"e ta"eo&er .get premium0) management disli"e .lose
control+Job0
b. 3easons for Ta"eo&er
i. ,nder&aluation
/. (ar"et &alue of the shares) is less than the fair &alue of the shares
4. 7fficient (ar"et @ypothesis says that this is doubtful) not that it is
untrue.
ii. #ynergy the ad&antage that results when a combination is greater than
the sum of its parts
a. if true) this would result in a net gain to society
4. 7conomies of scale the reduction in unit costs generated by
buying or producing in &olume often results from the fact that
fixed costs are di&ided o&er a large number of units
5. 7conomies of scope the reduction in unit costs generated by
producing similar or related items often results from the fact that
assets or s"ills may be transferable
a. ex. computer parts co can ac<uire a computer factory.
9. 6inancial synergy the ad&antage that larger companies ha&e
o&er smaller companies in raising money
a. Internally A large company can earn a lot of money and
support itself
i. using retained earnings to support new products
b. 7xternally A cheaper to borrow or sell securities on a larger
scale than for a smaller scale.
c. 6inancial #ynergy led to the rise of Conglomeration A the
process of internal di&ersification
i. 7xpansion into unrelated lines of business
ii. Negati&e of this is that it leads to a lac" of focus
iii. *i&ersification can be a bad thing in that some
companies can be doing poorly+some well and the
poor performance can be hidden and there would be
no pressure for impro&ment
iii. Agency costs the costs associated with an agency relation i.e.) the ris"
that the agent may pursue her own interests instead of those of the
principal
a. stems from separation of owners and management
b. hard for shareholders to remo&e management
c. Ta"eo&er can help reduce agency costs.
4. Inefficient management
5. 7xcessi&e compensation
;9
9. #elf-aggrandiBement A management is tempted to impro&e siBe
o&er profits.
a. (anagement li"es bigger siBe because it gi&es them power
and prestige
b. #hareholders ob&iously would rather ha&e profits.
i&. Eealth transfers a shift in wealth from one group to another) often
without a net benefit to society
a. !A* 37A#'N for ta"eo&ers
4. Eealth ta"en from employees .ta"en by ac<uiror0
a. cut salaries) benefits or Jobs
5. Eealth ta"en from creditors .ta"en by ac<uiror A -!'0
a. After ta"eo&er business can be more ris"y
b. Ee are not worried about new creditors ."new what they
were getting into and charged appropriate interest rate.0
i. 'ld creditors lent money when it was a lot less ris"y
1.-eads to shareholders stealing from
bondholders
2.!asically old creditors get screwed A low
interest rates)
9. Io&ernment
a. #a&e on taxes
b. #hareholders wealth is at the detriment of the
go&ernment+society
F. There is some e&idence that some of the &alue that is created
comes from wealth transfers.
a. *o account for some of the &alue created for shareholders
=. There is N' e&idence that all or most of the &alue comes from
wealth transfers.
c. 3easons for *efense A .opposing ta"eo&ers0
i. problems with most of these reasons is that they are easy to claim but hard
to pro&e or dispro&e.
/. Eho gets to decide whether management gets to resist businessR
a. (anagement runs business
b. #hareholders2
i. 4 main powers2
1.&oting rights to remo&e management
2.sell shares .supposed to be unlimited power0
a. If management can resist a hostile
ta"eo&er) it is limiting your rights to
sell your shares.
ii. Coerci&e offers
/. If hostile offer is coerci&e and shareholders really dont ha&e a
choice it is appropriate for management to step in.
4. !est example is a two-tiered front loaded tender offer
;F
a. a tender offer at a premium) see"ing control but not full
ownership) with the explicit or implicit promise of a
subse<uent freeBe-out merger offering inferior
consideration to remaining shareholders
b. e&en if shareholders want to say no) they ha&e to say yes)
for fear of a worse deal
5. 'riginally coerci&e offers were pretty blatant
a. but as courts became wise) they became more subtle
i. ex. WFD in cash) or WFD in bonds on the bac"end
9. #hareholders want protection from coerci&e offers.
F. 6act is they dont much exist anymore
a. 1recisely because it is allowed to be resisted.
=. All-cash) All-shares offer an offer to buy any and all shares for
cash) with the promise to follow up promptly with a cash-out
merger at the same price in cash
a. no coercion in this offer
b. (anagement tries to claim coercion but it doesnt wor".
iii. ,nder&aluation
/. .pay less than shares are worth) but 7(@ ma"es this implausible0
4. Iood deal for ac<uire) but not for target shareholders
5. Courts protect this for a reason because management has a better
idea of what the company is worth.
i&. 'pportunity loss
/. (anagement) acting in shareholders interest) can claim this is a
good deal) but we can get a better deal
4. Eay to get around this..auction
&. Incompatibility
/. i.e.) management argues that its not a good business decision for a
potato chip company to purchase a microchip company.
&i. 'ther constituencies
/. ,nfair to employees) creditors) go&ernment) community) society)
en&ironment
&ii. 7ntrenchment efforts by management to resist ouster) as by a hostile
ta"eo&er
/. 'f course management can not gi&e this as a reason.
d. Ta"eo&er *efenses .the O@'EP0
i. 1re&iously considered2
/. 'ther constituency statues
4. #taggered boards a board of directors structured so that only a
fraction of its members is elected each year for multi-year terms
a.".a.) classified board
a. *ont actually do much because once a ta"eo&er is
accomplished) they really dont want to be on a board
where they ha&e to resist the owner of the company
5. :oting rights
;=
a. Eays that ma"e it difficult or impossible for someone to
ta"e o&er the company.
ii. Additional mechanisms2
/. Ireenmail the repurchase by a target of its own shares from an
ac<uiror at a premium .hostile buys /D? and threatens to buy all
company has to pay premium to stay them off0
a. shareholders hate thisinstead of getting the premium they
are paying the premium
b. (anagement is forced to pay greenmail to get you to go
away.
c. 1aying greenmail ma"es you &ulnerable to more greenmail
threats .they "now youll pay0
4. Crown Jewel defense a ta"eo&er defense in which the target
sells its most &aluable assets in order to become less attracti&e to
the ac<uirer
a. #imilar to shooting yourself in the foot.
5. #hare repurchase the reac<uisition by a company of its own
shares from the public
a. *o this to dri&e the price up and ma"e it more expensi&e
for the ac<uiror to ac<uire
b. 3educe the supply of willing sellers in the mar"et.
c. Increase the managements relati&e position.
9. Ehite "night defense a ta"eo&er defense in which the target
con&inces a friendly third party to ma"e a superior offer
i. Not a better deal for shareholders) if Ehite Cnight
gets ad&antages
b. Termination fee a fee to be paid to a friendly would-be
ac<uiror should the proposed transaction not be
consummated
i. 'nly if the Ehite Cnight loses so the bad ac<uiror
would ha&e to pay.
ii. Mustified because it would cost the Ehite Cnight
money to win the fight
c. -oc"-up option a pro&ision in an ac<uisition agreement
designed either to preclude a competing bidder from
ac<uiring a company or to pro&ide compensation to the
original bidder in case it loses in a bidding contest
i. 7x. of #toc" -oc"-,p
1.Ehite "night would get extra shares if the
hostile bidder wins.
d. No-shop pro&ision a pro&ision in an ac<uisition
agreement that limits the targets ability to deal with other
potential bidders
i. Ac<uiror agrees not to deal with anyone else.
F. Iolden parachute a large se&erance pay contract for top
management that is triggered by a change in control
;;
a. (anagement is gi&ing itself an exit payment by directors
i. Considered part of there compensation pac"age
=. 1oison pill .137(I73 *767N#70 - a ta"eo&er defense in
which shareholders of the target .other than the ac<uiror0 are
granted the right to ac<uire securities .or other assets0 at a
significant discount. Eith this) you CANN'T complete a hostile
ta"eo&er.
a. considered to be the ultimate defense
i. gi&es e&eryone .all other shareholders0 all of the
money+assets and lea&es hostile ac<uiror with
nothing but the name.
b. 5 ways around the poison pill
1.all of which in&ol&e elimination of poison
pill
ii. negotiate a better deal with management
1.not hostile) no poison pill
iii. get a court to order the redemption of poison pill
rights
1.'rder management to do this as part of
fiduciary duty.
i&. -aunch a proxy contest to replace board) who will
then remo&e the poison pill
e. @ostile Ta"eo&er Cases
i. Introduction
/. Cheff v. Mathes .*elaware0
a. 3edemptions can not be used by directors to pre&ent a
corporate raid if the sole purpose is to "eep the directors in
office.
i. This rule does not apply if the corporate raid is a
threat to the corporations interest as opposed to the
directors interest.
b. #tandard is satisfied by2
i. Iood faith
ii. 3easonable in&estigation
c. Class Notes2
i. *irectors ha&e to ha&e reasonable grounds to
belie&e there is a threat to company they can
argue that theyre not acting in their own self
interest
ii. *e&elopment
/. .nocal Cor-oration v. Mesa 3etroleum Co. .*elaware0
a. #tatistics of the ta"eo&er2
i. A front loaded) hostile) two tiered tender offer for
5;? of ,N'CA-
;>
ii. There was Jun" bond financing in second tier .bac"
end0Ythus the offer was &ery coerci&e to
shareholders
iii. A "nown corporate destroyer .fre<uent green
mailer0 financed the tender offer.
b. !asis of suit2 The bidder sued to enJoin the self tender
claiming it was a breach of the directors fiduciary duty.
c. *irector *efenses2
i. Consulting with lawyers and outside in&estment
ban"ers
ii. #elf tender offer by the !oard at a premium price
that was not a&ailable for the shares owned by the
bidder .(esa0
d. @eld2 There was no breach of the directors fiduciary duty.
The board acted in the shareholders best interest. 'nly a
maJority of outside independent directors acted) and they
did not stop the tender offer) they merely attempted to
remo&e the coerci&eness.
e. 3ule of law
i. All !oard defense actions are subJect to enhanced
scrutiny because of the Oomnipresent specterP that
the !oard is acting in its own best interest. This
enhanced scrutiny re<uires that directors show they
had Oreasonable grounds for belie&ing a danger to
the corporate policy and effecti&enessP existed.
ii. Note2 *irectors cant act solely to perpetuate
themsel&es in office.
iii. *efensi&e mechanisms may only be used as a
method to thwart off a ta"eo&er attempt if moti&ated
by a good faith concern for the corporations
welfare free from fraud or misconduct.
f. Courts ha&e defined the ,nocal O7nhanced #crutinyP
Intermediate Test A 1roportionality2
i. The !oard must percei&e the bidders action as a
threat to corporate policy.
ii. (ust show that the !oards action is proportional to
that threat.
g. 4 part test2
i. Cheff &. (athes
1.Iood faith
2.3easonable in&estigation
a. 3easonable grounds to belie&e there
is a threat
ii. 3esponse must be reasonable in relation to the
threat posed.
iii. In other words
;L
1.3easonableness to belie&e there was a threat
2.3esponse was proportional to threat
h. Ehat constitutes a threatR
i. Coerci&e offers .e.g.) forced to accept front end of
two tier offer b+c afraid of bac" end0
ii. Inade<uate offers
iii. 3is" of non-consummation
i&. Zuality of securities being offered
i. Now in response to this case6ederal #ecurities law
re<uires that a tender offer must be offered to all
shareholders
i. *iscriminatory offers are illegal under 6ederal law
A offers must be open to all shareholders
J. ,nocal is the basic test for defensi&e measures2
i. 3easonable grounds for threats
ii. 3easonable measure to deal with threat
1.1oison pill is considered reasonable.
". *irectors dont always win and defensi&e measure are not
always upheld) but there is a lot of discretion is still gi&en
to directors so there is not as much pressure as you would
thin" there would be.
4. ,evlon, Inc. v. MacAnre$s + For)es Holings, Inc. .*elaware0
a. 6acts2 1antry 1ride Corporation attempted a hostile
ta"eo&er of 3e&lon. 3e&lons !oard too" action to thwart
the tender offer. The defenses include bidding with
6orstmann) a white "night) and e&entually gi&ing
6orstmann a loc"-up on "ey assets a no-shop pro&ision .it
appeared that the !oard was ma"ing these defenses to
protect 3e&lons note holders0. @owe&er) despite all of
these efforts) the tender offer became ine&itable.
(acAndrews) the controlling stoc"holder of 1antry 1ride
was granted an inJunction to pre&ent 3e&lons board from
continuing the defensi&e measures. 3e&lon appealed the
inJunction.
b. @eld2 The inJunction was upheld. *irectors are allowed to
ta"e defensi&e measures when they feel a ta"eo&er bid is
not in the corporations best interest without &iolating their
fiduciary duties. Thus) the defensi&e measures ta"en were
in and of themsel&es legal. @owe&er) as soon as the
dissolution or sale of the corporation becomes ine&itable)
their duties shift and they must try to get the shareholders
the best possible price. They can no longer try to protect
the corporation or other constituencies. Thus) 3e&lon
defines the ,nocal standardYit changes when the sale
becomes ine&itable.
>D
c. 3ule2 As soon as a sale or dissolution of the corporation is
ine&itable) things change. No more defensi&e mechanisms
A The !oard becomes an auctioneer and attempts to get the
highest shareholder price.
i. Tilted 1laying 6ield A The !oard owed no duty to
the potential suitors and) therefore) does not need to
deal with them on e<ual footing as long as it is
achie&ing the best results for the shareholder.
@owe&er) the !oard can no longer fa&or other
constituents o&er shareholders.
ii. In 3e&lon) that sale was ine&itable because it
became apparent that the corporation was going to
be sold either to the bidder or the white "night.
d. *efensi&es are not per se illegal
1.It is o" to use the poison pill in response to a
threat
ii. 3eal <uestion is whether you ha&e to get rid of the
poison pill at some timeR
e. @ow do you "now when a sale is ine&itableR
i. Ehen there is definitely an auction out therewhen
there is a white "night
ii. 'therwise) #ales are relati&ely found to be
ine&itable
f. !est way to get the best price is normally an auction
i. Auctions are not re<uired thou by the court
ii. Kou can also try to get the best price by using
defensi&e measures
g. @ere defensi&es were used improperly
i. *efensi&e measures were used to end the auction
1.To insure that the white "night won.
ii. 6a&ored the white "night too much.
h. 3e&lon standard is pretty tough.
i. Companies try to a&oid the application of 3e&lon
ii. Eant to stay in the realm of ,N'CA-.
1.,nder 3e&lon you ha&e to sell for the best
price
2.,nder unocal you ha&e the ability to say no.
>/
Epiloue
I. 7thical 3esponsibilities of Corporate Attorneys
a. 7thical 3esponsibilities of Corporate Attorneys
i. A!A (odel 3ules of 1rofessional Conduct
/. 8 /./5 A most important A identify your client
a. Corporate Attorney
i. Kour client is not the C7'
ii. Kour client is not a human being) it is the
corporation
/. 1erhaps you can thin" of that as the !oard
of *irectors and not the C7'
4. !ut ultimately it is the shareholders
5. -aw says it is the corporation so you ha&e to
beha&e accordingly
iii. 3esponsibility is to report things that hurt the
corporation
/. Kou ha&e to report up the ladder
4. If the company does not care) you may ha&e
to resign
i&. Confidence is not &iolated by going up the ladder
/. #ome argue that you can go outside the
company and it still will not &iolate
confidence
ii. Is there a special role for corporate attorneysR
/. Are they ad&ocates or playersR
a. 1layers that acti&ely participate and not Just ad&ise.
i. Are you not Just representing your client and then
do you ha&e a duty to society.
ii. #7C clearly wants this to be the case.
/. #ecurity attorneys ha&e responsibilities to
society and not Just their clients.
iii. #7C enforcement
/. 6or protection of in&estors) #7C wants e&eryone in&ol&ed in
securities to beha&e responsibly
4. National #tudent (ar"et Corporation Case
a. #7C greatest success in this regard .ethical responsibility of
attorneys0
b. Attorney was found guilty of aiding and abetting a security
laws &iolation
c. @istorically #7C has not been &ery acti&e in enforcing
against attorneys
5. #tate !ars ha&e not been &ery acti&e really
i&. #ar-bans 'xoly may change all this2
/. 8 5D; A clearly authoriBes #7C to define and enforce ethical
standards for attorneys
>4
a. @ow are they going to use thisR
b. Argument that they dont ha&e the authority doesnt exist
c. Contemplates a codification of reporting up the ladder
re<uirements
i. Now you ha&e to do this.
4. 1roposed rule would ha&e re<uired a nosy withdrawal
a. If going up the ladder does not wor") you ha&e to <uit and
then tell the #7C that you are <uitting for a reason
b. #7C hasnt passed this but hasnt ta"en it off the table
5. Another possibility
a. Is that the attorney withdraws but then the company has to
tell the #7C.
&. #7C is more serious then it has e&er been.
/. 3ules ma"es securities law more ris"y
&i. Independent *irectors Article
/. #ome thin" that there is no such thing as independence because
they will always Judge the other directors as they would Judge
themsel&es.
II. -imited -iability Companies and -imited -iability 1artnerships
a. -imited -iability Companies an unincorporated legal entity created by
authority of law
/. #imple a mixture of corporate law and partnership law.
ii. Certificate of formation an official document establishing and
go&erning the internal affairs of a limited liability company a.".a.) charter
iii. 'perating agreement an agreement among the members of a limited
liability company that sets forth the structure and terms of the company
/. Can ma"e it as much li"e a corporation or as much li"e a
partnership as you want.
4. Kou "now nothing about a company when you see --C.
i&. (embers an owner of a limited liability company
&. (anagers a designated manager of a limited liability company .if any0
&i. Ehy arent all businesses --CR
/. Increasingly they are.
4. 1roblems2
a. 6ew statutory default rules
b. -ittle case law
c. 1eople unsure what they are dealing with
d. 1ublic businesses are taxed regardless) but smaller
businesses are increasingly become --C
5. -aw firms in some states cant be --C) ha&e to be some form of
partnership.
&ii. --Cs are the culmination of the flexibility in !A law.
b. -imited -iability 1artnerships a partnership with limited liability among the
partners
i. @as to be a partnership) but it is a limited liability partnership
>5
ii. 1artners are responsible for your own actions) but limited liability for what
your partner has done
/. That is limited liability) but not limited liability H
4. #ome people limited the shield to torts) but not contracts
iii. (ore and more law firms are becoming --1s
c. 6ormation
i. #ater, #aste + Lan 6#estec7 v. Lanham .Colo. /LL>0 p. 4>>
/. Third party brought suit against agents for --C) and --C for
amount due on contract for engineering ser&ices.
4. The statutory notice pro&ision applies only where a third party
see"s to impose liability on an --CXs members or managers
simply due to their status as members or managers of the --C.
Ehen a third party sues a manager or member of an --C under an
agency theory) the principles of agency law apply notwithstanding
the --C ActXs statutory notice rules.
5. ,nder the common law of agency) an agent is liable on a contract
entered on behalf of a principal if the principal is not fully
disclosed.
9. An agent who negotiates contract is not liable when he has gi&en
notice to the third party that there is a principal for whom he acts
and also notice of the name or identity of the principal. Thus) an
agent is liable on contracts negotiated on behalf of a partially
disclosed principal that is) a principal whose existence) but not
identity) is "nown to the other party.
d. The 'perating Agreement
i. 'lf Atochem /orth America v. Jaffari .*el. #up. Ct. /LLL0 p. 4L5
/. #ection />-/D/.;0 of *el.s --C Act defines the limited liability
company agreement as any agreement) written or oral) of the
member or members as to the affairs of a limited liability company
and the conduct of its business.
4. The Act is designed to permit members maximum flexibility in
entering into an agreement to go&ern their relationship. It is the
members who are the real parties in interest. The --C is simply
their Joint business &ehicle.
5. (embers can alter the default Jurisdictional pro&isions of the
statute and contract away their right to file suit in *el.
a. 1olicy of the Act is to gi&e maximum effect to the principle
of freedom of contract
e. 1iercing the O--CP :eil
i. !aycee Lan an Livestoc% v. Flahive .Ey. 4DD40 p. 5DD
/. Ehether) in the absence of fraud) the remedy of piercing the
corporate &eil was a&ailable against a company formed under the
Eyoming --C Act .Act0.
4. NIt is not to be presumed that the legislature intended to abrogate
or modify a rule of the common law by the enactment of a statute
upon the same subJect it is rather to be presumed that no change in
>9
the common law was intended unless the language employed
clearly indicates such an intention. The rules of common law are
not to be changed by doubtful implication) nor o&erturned except
by clear and unambiguous language.
f. 6iduciary 'bligation A similar to that imposed in a partnership
i. McConnell v. Hunt S-orts 'nter-rises .'hio /LLL0 p. 5DF
/. After brea"ing away from original --C) appellees obtained an
N@- franchise. Appellees sought declaratory Judgment that --C
operating agreement permitted members to compete for N@-
franchise as well as Judicial dissolution of --C. AppellantsX
counterclaim alleged interference with prospecti&e business
relationships and breach of contract and fiduciary duty.
4. NAn operating agreement of a limited liability company may) in
essence) limit or define the scope of the fiduciary duties imposed
upon its members.
5. In general terms) members of limited liability companies owe one
another the duty of utmost trust and loyalty. @owe&er) such general
duty in this case must be considered in the context of membersX
ability) pursuant to operating agreement) to compete with the
company.
9. 7xcept as otherwise pro&ided in the operating agreement) the
members of a dissol&ed limited liability company who ha&e not
wrongfully dissol&ed the company may wind up the affairs of the
company.
g. *issolution
i. /e$ Hori(ons Su--ly Coo- v. Haac% .Eis. App. /LLL0 p. 5//
/. Ehen the company dissol&ed) * failed to ta"e the appropriate
steps that were re<uired by the statute to shield herself from any
personal liability for the companyXs debts. Also) 1Xs claim did not
appear to exceed the &alue of any li<uidation distribution * might
ha&e recei&ed from dissolution of the company.
4. NEis. #tat. ch. />5 expressly permits the importation of concepts
such as `piercing the &eil` from business corporation law into
limited liability company law.
5. A dissol&ed limited liability company may dispose of "nown
claims against it by filing articles of dissolution) and then
pro&iding written notice to its "nown creditors containing
information regarding the filing of claims.
h. --C (ergers
i. 4GS, Inc. v. Castiel .*el. Ch. 4DDD0 p. ;F=
/. NThe court found that had * manager "new of the proposed
merger) he would ha&e ta"en steps to protect his maJority interest.
#ince the minority managers were aware of this) they breached
their duty of loyalty to * manager by failing to act in good faith.
4. 3eading the Act in light of the e<uitable maxim that e<uity loo"s to
the intent rather than to the form) the statute must be construed to
>F
allow action without notice only by a constant or fixed maJority. It
can not apply to an illusory) will-of-the wisp maJority which would
implode should notice be gi&en. Nothing in the statute suggests
that a court of e<uity should blind its eyes to a shallow) too cle&er
by half) manipulati&e attempt to restructure an enterprise through
an action ta"en by a `maJority` that existed only so long as it could
act in secrecy.
>=