Corporations Overview

Three words that the rest of corporation law revolves around: 1) Personhood; 2) Agency; 3) Capital
Corporate Characteristics
1. Separate entity – corporation is a separate legal entity from the individual people involved in the
corporation
2. Perpetual existence – corporations have a perpetual existence
3. Limited liability –shareholder’s liability is limited to the amount of money they pay for the shared. The
corporation, not the shareholders, are liable for the assets and debts
4. Centralized Management – Corporations’ board of directors elected is by shareholders. Directors have
fiduciary duty to shareholders
5. Transferability of ownership interests – shareholders can transfer to others their ownership in a
corporation
Vocabulary
- Articles of incorporation is the document filed with the state plus a fee to legally create a corporation (like
the corporation’s constitution)
- Bylaws – set out governing details of the corporation

Rule: Legal hierarchy: the corporations’ articles cannot conflict with the statute under which the corporation is
organized, and the corporation’s bylaws cannot conflict with the statute or articles

Rules of Corporations
Rule #1: the corporation is managed by or under the direction of a board of directors. [DGCL § 141(a)]
Rule #2: the shareholders elect the directors
Rule #3: the directors and officers are fiduciaries owing the corporation and the shareholders duties of loyalty and
care
Modern Corporation
- Sarbanes-Oxley Act of 2002 – imposed federal standards in area previously subject to state corporate law.
Act:
o Specified the functions and membership of the audit committee of public corporation boards,
required senior corporate executive to personally certify the company’s financial statements,
banned public corporations from making loans to their directors and executives, and told the SEC
to require lawyers who represent public companies to become whistle blowers for corporate
corruption or fraud. Section 404 (controversial): required public corporations to undertake the
costly process of assessing their internal controls over financial reporting and possible corporate
wrongdoing
- Dodd-Frank Act 2010: Response to 2008 recession but regulation went way beyond banks

Internal Affairs Doctrine

The law of the state of incorporation should govern any disputes regarding that corporation’s internal affairs. An
argument in favor of the doctrine that any other choice of law rule would be difficult to administer for multi-state
businesses.

Internal affairs  The matters peculiar to the relationships among the corporations and its officers,
directors, and shareholders. Includes right of shareholders to vote, to receive distributions of corporate
property, to receive information from the management about corporate affairs, to limit the power of the
corporation to specified activities, and to bring suit on behalf of the corporation, duties that managers owe
shareholders, certain actions by the board of directors

External affairs  governed by the law where the activities occur and by federal and state regulatory
statutes. For example, state employment law governs conditions of employment of all business operations
within the state, wherever the business is incorporated.

Is there a state that is not on board on the internal affairs doctrine? Yes CA. Both CA and DE say that
their statutes are based on constitutional law. Supreme Court has never addressed the constitutional

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 question – does CA have the right to opt-out of the internal affairs doctrine if DE insists that it is a
constitutional necessity?

McDermott  Law of incorporation of the parent company applies to the actions of the subsidiary

McDermott Inc v. Lewis (DE)

Facts McDermott International was a Panamanian corporation [incorporated in Panama]. International owned a
subsidiary called McDermott Inc. which was incorporated in Delaware. McDermott also owned substantial
shares in International, its parent. During a reorganization of International, McDermott voted its International
shares of stock to become a 92 percent-owned subsidiary of International. As a result, International’s public
stockholders held approximately 90 percent of the voting power while McDermott held about 10 percent of
the voting power. The purpose of the reorganization was to avoid United States taxation and to oppose third-party
attempts to acquire control of International.
Holding Law of Panama applies, not Delaware law, to whether the subsidiary can vote its shares in the parent
company
Analysis Policy purposes of doctrine: Creates a single, constant and equal law to avoid the fragmentation of
continuing, interdependent internal relationships; facilitates planning and enhances predictability; applying local
internal affairs law to a foreign corporation is an unacceptable choice because it produces inequalities, intolerable
confusion, and uncertainty

Formalities of Board Action

Organization
 Number of board of directors can be found in the charter
 [bylaws] Board can and usually does amend the bylaws but in DE it is subject to shareholder override
 [articles] If shareholders really care about something, they want it in the articles, because their consent
will have to be sought
 Always an odd number of directors

Notice

Special Meetings  requires two days’ notice be given of the date, time and place of meeting,
unless the articles/ bylaws impose different requirements. MBCA § 8.22(b)
Regular Meetings  does not require notice for regular meetings MBCA § 8.22(a)
Waiver of Notice  Any director who does not receive proper notice may waive notice by
signing a waiver before or after the meeting MBCA § 8.23(a
Protesting Lack of Notice  Or by attending or participating in the meeting and not protesting
the absence of a notice. A director who attends a meeting solely to protest the manner in which it
was convened is not deemed to have waived notice MBCA § 8.23(b)
Meeting Mechanisms  Permits the board to conduct a meeting by any means of communication
by which all directors participating may simultaneously hear each other during the meeting
MBCA 8.2(b)

Voting
 Requires Majority Vote
Cannot vote by proxy
 Without Meeting Most states have enacted statutory provisions for allowing informal director
action under some conditions – allows board action to be taken without a meeting on the
unanimous written consent of each of the directors & Included in minutes or filed w/ corporate
records MBCA § 8.21:

Quorum
 Quorum requirements precludes action by a minority of the directors. MBCA § 8.24 –
action taken in the absence of a quorum is invalid
 But can increase/decrease but not less than 1/3 of board. MBCA § 8.24.
Emergencies

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 Courts recognize that informal board action is common and seek to protect innocent third parties from the
strict application of the traditional meeting rule on these justifications
⁃ Unanimous director approval
⁃ Emergency
⁃ Unanimous shareholder approval
⁃ Majority shareholder-director approval

Ways To Get Around Formalities

1. Amend the articles or by-laws. (See requirements)
2. Designate committees, such that the action of the committee is the action of the Board. But cannot
delegate highly visible actions (e.g. paying dividends, entering mergers)  Power resides in the
Board and those that are extraordinary are presumptively things we want/ require the Board to
pay attention to. But for every subordinate to the CEO, every K or tort is tested in terms of its
impact on the corporation to has there been some type of authority.
a. Executive Committee (MBCA § 8.25(e)): full authority of the board in all but a few
essential transactions such as declaration of a dividend or approval o a merger
b. Audit Committee – includes selection of company’s auditors, specification of the scope
of the audit, review of audit results, and oversight of internal accounting procedures
c. Committees can be permanent or temporary. Committees are desirable because they
draw incentivized directors. MBCA § 8.30(b) recognizes the expanding use of
committees and permits directors to rely on the reports or actions of a committee on
which she or he does not serve as long as the committee reasonable merits confidence

Mechanics of Shareholder Voting Rights

Annual Meetings to Elect Directors  Annual meeting requirement is for shareholders to elect directors. If annual
meeting not held within 15 months, holder of voting stock can require the corporation to convene an annual meeting.

Special Meetings  Special meetings can be called by the board or a person authorized by articles or bylaws.
Special meeting of shareholders for a particular purpose can be called by the incumbent board or any
shareholder owning 10% or more of the company stock. If you can demonstrate that you have this power, then
you can call a meeting at any time of the year

Consent in Lieu of Meeting  Shareholder can use written consent instead of a meeting. DL  written consent
can be taken by a majority of corporation’s voting shares.

Shareholders must receive notice of meeting & purpose of meeting  Shareholders are entitled to receive
written notice of the shareholder meeting usually at least 10 days but no more than 60 days in advance
describing time and location. Special meeting notices must include purpose of the meeting. Shares entitled to
be voted are those with ownership at the record date.

Quorum Most statutes require a quorum of majority shareholders. Majority requirements for voting can be
changed in the bylaw

Proxy  Shareholders can send proxies who are default revocable to vote at the meetings. A proxy is a contract
where by you say I hereby appoint X as my proxy to cast my shares at the meeting. The proxy is designated by the
corporation to be the person who casts all the shares on behalf of the shareholders – it is always the secretary
who has this job.

Removal of directors  Shareholders can typically remove directors with or without cause – the power of removal
is mandatory and cannot be restricted.
Under the model act, directors can be removed without cause by unanimous vote and without a meeting
Directors can be removed by written consent without a meeting, as long as you have valid consent
representing more than 50% of the outstanding shares so represent absolute majority.
DE does not have such a provision but allows it to be included in the articles or bylaws of the
corporation

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Getting around the staggered board issue  What if no one is up for re-election? Call a meeting to change the
bylaws to add seats to the board. If it’s a vacancy issue, then the board and the shareholders both have the right to
vote. Generally the shareholders win this battle Campell v. Loews (shareholders have the inherent right to fill
vacancies that come up)

Impeaching directors  The other way is to remove directors or impeach them. Auer and Campell came to the
conclusion that the shareholders only have the right to remove for cause. The courts said that cause meant that proof
that the director you’re seeking to impeach did something wrong. As a matter of process, impeachment cannot occur
until charges are made against the director and giving the director the ability to defend themselves. Standard model
when corporations and their founders have chosen the typical approach (not staggered) is that impeachment
occurs with or without cause (hearing is not necessary, to press charges).

Shareholder Proposals  Shareholder Recommendations and Removal/ Replacement of Directors: SEC Rule
allows shareholders in public companies to propose resolutions for the adoption by fellow shareholders through the
corporate finances proxy mechanism provided the proposal is proper under state law.

Agency Law
Agency is the fiduciary relationship that arises when one person (a principal) manifests assent to another person (an
agent) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent
manifests assent or otherwise consents so to act. (Restatement (Third) of Agency § 1.0)

 For assent court looked to parties’ outward manifestations from the view point of a
reasonable person. Each party must have objectively manifested assent either by words or
conduct

 Control is evidenced in agency by a consensual relationship in which the principal has the
power and right to direct the agent as to the goal of the relationship

Indemnification  principal has a duty to reimburse or indemnify the agent for any promised payments, any
payments the agent makes within the scope of actual authority, and when the agent suffers a loss that fairly should
be borne by the principal in light of their relationship. § 8.15 obligation to act in good faith Restatement § 8.14

Langevoort hypothetical: Lawyer wants to start a vineyard and so bought a vineyard. The partner lacks experience,
capacity, and time to run the vineyard as a sole proprietor. Partner can create employment contract. Hire a general
manager (onsite and in charge person) – this is the creation of a principle-agent relationship. Key word for
determining whether a contract creates a principle-agent relationship is the word ‘CONTROL,’ the principle as
the right to control, call the shots, override.

Actual Authority
An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal,
the agent reasonable believed, in according with the principal’s manifestations to the agent, that the principal
wishes the agent so to act. Restatement § 2.01 Actual authority is viewed from the reasonable person in the agent’s
position. Actual authority can be express or implied – inferred from words, custom, or the relationship between the
parties.

Mill St. Church of Christ v. Hogan

- Facts Mill Street Church of Christ regularly hired Bill Hogan to paint and maintain the church
building over a period of time. The Church had routinely allowed Bill Hogan to hire his brother
Sam Hogan as an assistant on painting projects. Dr. Waggoner hired Bill Hogan again to paint the
church. No mention of hiring a helper was made during the discussion between Dr. Waggoner
and Bill Hogan. During his painting, Bill Hogan reached a point where he could not finish the job
without an assistant. The parties agreed that a helper was necessary and discussed the possibility

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 of hiring a Mr. Petty to assist, but Dr. Waggoner acknowledged that Mr. Petty was hard to
reach. The next day, Bill Hogan offered Sam Hogan the helper job. A half hour after Sam started
work, Sam Hogan fell and sustained an injury that required hospitalization. Bill Hogan reported
the accident to the Church treasurer, who paid Bill Hogan for hours spent on the project, including the
half hour Sam Hogan worked. Sam Hogan filed a claim for workers’ compensation.
- Holding Bill Hogan had actual authority – and therefore was the church’s agent – by the church to hire
Sam Hogan and therefore Sam Hogan is indemnified (b/c he is the Church’s sub-agent) by the
principal for the injuries of Sam Hogan
- Analysis Actual authority circumstantially proven which the principal actually intended the agent to
possess and includes such powers as are practically necessary to carry out the duties actually delegated.
It must be determined whether the agent reasonably believes because of present or past conduct of
the principal that the principal wishes him to act in a certain way or to have certain authority.
Nature of the task or job may be another factor considered, existence of prior or similar practices is one
of the most important factors, specific conduct by the principal in the past permitting the agent to
exercise similar powers is crucial. Applied: Bill Hogan has implied authority to hire Sam Hogan as his
helper 1) In the past the Church had allowed B to hire his brother, 2) B needed an assistant for the job
he was hired to do, 3) S had the belief that B had the authority to hire him because of past practice –
the Church treasurer even paid B for the 30 minutes of work S did

Apparent Authority:
When a third party reasonably believed the actor has authority to act on behalf of the principal and that belief is
traceable to the principal’s manifestations. Restatement § 2.03

Determination is whether a principal or purposed principal has made a manifestation that led a third party to
reasonable belief that the agent or actor had authority to act on behalf of the principal or purported principal. The
words or conduct must be traceable to the principal

Ophthalmic Surgeons, Ltd v. Paychex, Inc

- Facts OSL designated Connor in their office to be the designated payroll contact for Paychex, a
payroll company service. Connor for years paid herself more than she was entitled. Paychex sent OSL
reports to Connor and OSL’s owner but the owner said he never saw any of the reports because
they were not sent directly to him. When someone took over from Connor, the overpayments were
discovered. OSL tried to recover the extra money paid to Connor by filing a breach of contract action
against Paychex. Paychex’s argument is that Paychex did not have a duty to OSL to notify them of
Connor’s behavior
- Holding By placing Connor in a position where it appeared that she had authority to order additional
checks and by acquiescing to Connor’s acts through its failure to examine the payroll reports, OSL
created apparent authority in Connor such that Paychex reasonably relief on her authority to issue
the additional paychecks
- Analysis Apparent authority can only be created through words or conduct of the principal,
communicated to a third party, such that a third party can reasonably rely on the appearance and belief
that the agent possesses authority to enter into a transaction. Applied: Paychex’s reliance was
reasonable and Connor has apparent authority because OSL put Connor in a position where it appeared
that she had the power to authorized additional paychecks. Paychex’s reliance was reasonable b/c
OSL failed to object to Connor’s transaction
-
Note: What you have to have from the principle is some affirmative act that directly or indirectly communicates
to the third party that agent has authority. Here it was inaction that would be that granting of authority because
Paychex knew that the higher-ups at OSL never paid attention to payroll issues

Undisclosed Principle Liability

- In typical actual or apparent authority case, the agent shows up to sell or buy something from another
person and under these circumstances I have authority to do it. However, if an agent does not
disclose that they are an agent, then they become liable to the contract.

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 - When a third party does not have notice that the person they are dealing with is an agent acting on
behalf of someone else – the principal is ‘undisclosed.’ If the agent was acting within the scope of
authority when dealing with the third party, the undisclosed principal can be held liable on the basis
of actual authority

Board of Directors as Agents? No – agents must be under the control of the principle. There is no higher authority
than the board of directors and therefore they cannot meet the definition of agents

Nuances in Agency Law

- Independent contractor does not implicate agency law, whether a person is employee or an independent
contractor is a very fact sensitive finding
- Keep in mind that agency relationships and employment relationships are slightly different – agency
relationships go much beyond the employer-employee setting. Agency is a larger category, employment is
the largest segment within that category.

Core Fiduciary Duties

Agent’s fiduciary duties to principal
Duty of care – level of care, competence, and diligence that an agent exercise
Duty of candor (to be honest)
Duty of loyalty (conflict of interest law)– agent must not put his or her own interests ahead of
those of the principal when the agent is acting within the agency relationship. Any time there is a
conflict of interest, there’s a loyalty problem. This is why it’s helpful to think about fiduciary
duty through the lens of honesty.
Duty of confidentiality – in force even once relationship has expired
General Automotive Mfg v. Singer
 Facts: Singer hired by GAM as general manager to help their business get out of
financial trouble but secretly takes clients for himself who he think GAM cannot handle
the business of. When he was hired, Singer executed an employment contract with
Automotive which provided for a base salary plus 3% commission of Automotive’s gross
sales. The contract prohibited Singer from engaging in other employment and/or
disclosing company information that would personally benefit Singer or harm
Automotive’s business
 Holding: By failing to disclose all the facts relating to the orders from other businesses
and by receiving secret profits for these orders, Singer violated his fiduciary duty to act
solely for the benefit of A. Therefore he is liable for the profits he earned in his side line
business. Singer’s independent activities were in competition with A and in direct
violation of his obligation of fideltity to the corporation. Langevoort: The duty of loyalty
often takes the form of acknowledging a conflict of interest, regardless of whether a
person is acting in bad faith. When you have a conflict, what you do wrong is concealing
the conflict. The rule may be to get informed consent
 Analysis: The contract Singer had with Automotive made him Automotive’s agent and
thereby owed a fiduciary duty to A. Singer was bound to exercise utmost good faith and
loyalty so that he did not act adversely to the interests of Automotive by serving or
acquiring any private interest of his own. It was within A’s discretion to refuse or
accept orders
Ratification
Allows a person to retroactively bind herself to a contract entered into purportedly on her behalf, even though the
agent or purported agent was not acting with authority at the time he entered into the contract. The effect of
ratification is to validate the contract as if the principal or purported principal had originally authorized it.
Ratification relieves the agent/ purported agent of liability for breach of her duty to her principal.
Express ratification – occurs when the person engages in conduct that justifies a reasonable assumption
that the person consents to the transaction
 Implied ratification – when a principal accepts the benefits of an authorized transaction entered into
purportedly on her behalf. If the principle stays silent/ does not immediately renounce the contract after
finding out about a contract, then the principle becomes bound by ratification

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Estoppel
The principal or purported principal is estopped from disclaiming a contractual liability. Usually raised where a
purported agent did not have actual or apparent authority, but the plaintiff asks the court to hold the defendant liable
due to some fault. The person who caused the detrimental reliance may be estopped from lacking contractual
liability/ authority

Respondeat Superior/ Tort Liability

Scope of Employment: Two main tests
1) the motive test (most popular) [if an employer engages in behavior having to do with at least in part
with employment and motivated/ actuated at least in part to serve the need of the employer, the employer is
vicariously liable], Restatement of Agency § 7.07: an employee acts within the scope of employment when
performing work assigned by the employer or engaging in a course of conduct subject to the employer’s
control. An employee’s act is not within an independent course of conduct not intended by the employee to
serve any purpose of the employer.
2) Foreseeability test – whether the employee’s conduct should fairly have been foreseen from the nature
of the employment or whether the risk of such conduct was typical or incidental to the employer’s
enterprise
Clover v. Snowbird Ski Resort
- Facts Clover was injured when Zulliger an employee of Snowbird Ski collided with her after
jumping a crest on the side of an intermediate run. Specifically, Clover claimed Snowbird
negligently designed and maintained its ski runs.
- Holding There was sufficient evidence for a jury to conclude that Z, at the time of the accident,
was acting within the scope of his employment
- Analysis A reasonable jury could fine that at the time of the accident, Z had resumed his
employment and Z’s deviation was not substantial enough to constitute a total
abandonment of employment. Important to note that the 4 ski runs was not in direct
contravention of the employer’s instructions. Z was returning to the base to begin duties as chef.
Circumstantial evidence is that there was no set time for inspecting the restaurant and skiing was
the method used by Snowbird employees to access different locations at the resort
Termination of Principle-Agent Relationship
Either principal or agent can terminate the agency relationship at any time and for any reason by
communicating to the other that the relationship is at an end. The agent renunciates and the principal revokes. A
renunciation or revocation is valid when the other party has notice of it.

Other ways agency relationships end: 1) death of the agent, 2) Loss of capacity, 4) expiration of a specified
term for the relationship, 5) occurrence of circumstances on the basis of which the agent should reasonable
conclude that the principal no longer would assent to the agent’s taking action on the principal’s behalf.
Restatement of Agency §§ 3.06–3.10

Purpose of the Corporation

Shareholder & Stakeholder Primacy
1) Shareholder Primacy (DE)  associated with Michigan Supreme Court decision in Dodge and DE
law that the job of the board of directors is to maximize shareholder wealth (not a strong norm from
litigation perspective because the review is rational basis)
a. Friedman/ Property Model (eminent proponent of shareholder primacy) there is one and
only one social responsibility of business: to use its resources and engage in activities
designed to increase its profits so long as it stays within the rule of the game, free competition
and without deception or fraud. Property model envisions corporation as a form of privately
held property – other interests are incidental to the goal of maximizing shareholder wealth
2) Stakeholder Primacy  Shareholders are perhaps the most important but are not the only
constituency (Theodora Holding Corp.)
a. Corporation as a Social Institution: Merrick Dodd: Corporation is an economic institution
which has a social serve as well as a profit-making function. Entity Model: directors owed a
duty to the corporation as an entity, not just the shareholders. Many academics point out that
the most successful corporations focus on increasing ‘firm value,’ to all constitutents, not just

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 shareholders. Social goals is also good PR for company, can detract from unethical core
practice

Benefit Corporations (B-Corps)

Creation of the B-Corp has flipped the holding of Dodge on its head. The corporation is allowed in its charter to
renounce shareholder primacy in the form of another mechanism. For example: we aggressively seek profit but
we will never harm the environment. B Corps. must have a stated purpose of creating a “general public benefit”
in their articles of incorporation such as improving human health, advancement of the arts and sciences, or
preserving the environment.
Langevoort: Why do so many corporations prefer the shareholder primacy model over the more amorphous second
choice? Economists, we are shifting back to the old norm to stakeholder primacy and that’s too bad. We generally
do not trust directors to create profits to the extent they would if their feet weren’t to the fire under the shareholder
model
Dodge v. Ford Motor
- Facts. Over the course of its first decade, despite the fact that Ford continually lowered the price of its
cars, Ford became increasingly profitable. On top of annual dividends of $120,000, Ford paid $10
million or more in special dividends annually in 1913, 1914, and 1915. Then, in 1916, Ford’s president
and majority shareholder announced that there would be no more special dividends, and that all
future profits would be invested in lowering the price of the product and growing the company. The
board quickly ratified his decision. Ford had often made statements about how he wanted to make sure
people were employed, and generally run the company for the benefits of the overall community. The
Dodge brothers (plaintiffs), who owned their own motor company, were minority shareholders in
Ford, and sued to reinstate the special dividends and stop the building of Ford’s proposed smelting
plant
- Holding We are not satisfied that the alleged motives of the directors menace the shareholder interests.
- Analysis A business corporation is organized and carried on primarily for the profit of the
stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to
be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to
the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to
other purposes. However, because the price of the cars can be increased at any time, it is not clear what
the ultimate results of the larger business will be. Deferential to corporation as long as the corporation
can show that they are acting in the best interest of the shareholders. [BJR]

Theodora Holding Corp v. Henderson

- Facts Henderson had a controlling interest in Alexander Dawson, Inc. and dominated its
corporate affairs. The defendant's ex-wife owned a large amount of the corporations’ stock
through Theodora Holding Corp. Over the years, Henderson had caused Alexander Dawson
to make charitable contributions to the Alexander Dawson Foundation (the Foundation), a
legitimate charitable organization recognized by the Department of Internal Revenue.
Henderson asked the board to approve a gift of company stocks valued at $528,000 to the
Foundation to finance a camp for under-privileged boys. Although one director objected,
Henderson got board approval of the gift by getting rid of five directors. Theodora Holding
Corp. brought suit against Alexander Dawson, Inc. and Henderson in Delaware Court of
Chancery, challenging the gift
- Holding The relatively small loss of immediate income otherwise payable to P and the
corporate D’s other stockholders had it not been for the gift in question, is far out-weighed by
the overall benefits flowing from placing of such gift in channels where it serves to benefit those
in need of support, thus providing justification for large private holdings, and benefiting P in the
long run.
- Analysis Court uses the reasonableness test and provisions of the Internal Revenue Code on
charitable gifts by corporations as a guide. Reasonableness Test: Is the gift to a known
charity/nonprofit?; Is the gift less than 5% of corporate income?; Is the gift within the IRS
charitable gift deduction allowed?; Is the gift very costly to the shareholder? Furthermore,
contemporary courts recognize that unless corporations carry an increasing share of the
burden of supporting and charitable and educational causes that the business advantages

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 now reposes in corporations by law well prove to be unacceptable to the representatives of an
aroused public.

Control and Management

Authority of Corporate Directors
MBCA § 8.01 Requirements for and Functions of Board of Directors: (b) All corporate powers shall be
exercised by or under authority of the board of directors of the corporation, and the business and affairs of the
corporation shall be managed by or under the direction, and subject to the oversight, of its board of directors.

Third-Party Ascertaining Whether Agent Has Authority

 Counsel representing clients will often ask for evidence of authority in the form of 1) A provision of
statutory law, 2) the article of incorporation, 3) a bylaw of the company, 4) a resolution of the board of
directors, and 5) evidence that the corporation had allowed the officer to act in similar matters and has
recognized, approve, or ratified those actions

 Third-party duty to investigate likely arises when there’s a conflict of interest; inaction/ failure to
repudiate on the basis of lack of authority after a transaction with a third party can still be binding
(Scientific Holding Co., Ltd. v. Plessey Inc.)

Best evidence of delegated authority is a copy of the minutes of the board of directors meeting at which
the board adopted a resolution formalizing its grant of authority – customary practice is to have secretary of
corporation certify the minutes

Innoviva  Vice Chairman has actual and apparent authority to bind Innoviva

Sarissa Capital Domestic Fund LP v. Innoviva Inc.

- Facts SC purchased shares in Innoviva – a DE corporation and were upset with I’s poor performance.
SC launched proxy contest against I’s board of directors. The parties negotiated a settlement with the
two main negotiators were SC’s founder and I’s Vice Chairman of I’s board. SC’s founder would
end proxy contest if I would expand board from 7 to 9 directors, appoint two of SC’s directors and
forgo a standstill. I’s VC agreed to board expansion and directors but insisted on standstill. The board
met and agreed to SC’s requests [like a truce]. Board authorized I’s VC to tell SC’s founder on the
terms, which occurred and the founder accepted them orally. While the documents were drafted,
I’s directors found that BlackRock had voted in favor of them not SC as originally expended. The
directors went on with election the next day. I’s VC called the founder to tell him the deal was off. I
argued that I’s VC lacked authority to bind I to oral contract.
- Holding I’s VC had the actual and apparent authority to bind SC to the oral contract
- Analysis I’s VC had Actual Authority: created by a principal’s manifestation to an agent that, as
reasonably understood by the agent, expresses the principal’s assent that the agent take action on the
principal’s behalf. Scope of agent’s actual authority is determined by the agent’s reasonable
understanding of the principal’s manifestations and objectives.
o Application to Actual I’s VC was ‘lead negotiator.’ I’s VC reasonably believed that
the Board had given such authority on the basis that the Board knew the clock was
ticking to reach a binding settlement agreement
o I’s VC had Apparent Authority: When a third-party reasonably believes the actor has
authority to act on behalf of the principal and that belief is traceable to the principal’s
manifestations. Manifestation can occur by placing the agent in charge of a transaction
or situation; is the exclusive means of communication; constitutes assent to be found in
according with the communications made through the channel
 Application to Apparent : 1) SC Founder believed I’s VC to speak on behalf
of I’s Board; 2) SC Founder’s belief was reasonable because I’s VC was lead
negotiator; 3) SC Founder’s belief was reasonable. that I’s VC had authority
to take such action on I’s behalf and is traceable to I’s manifestations

Corporate Criminality

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BJR and BJP does not protect any activity by the board of directors known to be illegal.

Test from Christy

1) Jury must find beyond a reasonable doubt found that the act of the individual agent constitutes the acts
of the corporation
2) Corporation may be guilty of a specific intent crime committed by its agent if: 1) The agent was
acting within the course and scope of his or her employment, having the authority to act for the corporation
with respect to the particular corporate business which was conducted criminally, 2) the agent was acting,
at least in part, in furtherance [unlike civil liability] of the corporations business interests, and 3) the
criminal acts were authorized, tolerated, or ratified by corporate management [often showed by
circumstantial evidence – all the facts and circumstances, those in positions of managerial authority acted
or failed to act in such a manner that the criminal activity reflect corporate policy]

State v. Christy Pontiac-GMC, Inc.

- Facts Christy Pontiac is a corporation engaged in the sale of GM automobiles. Christy Pontiac offered
a rebate program to its customers. Those who purchased a car during a specific period were
entitled to a rebate, paid in part by GM and in part by Christy Pontiac. Hesli submitted a rebate
application to GM with Customer’s forged signature on the form and back-dated form. The
form was signed by Gary Swandy, an officer of Christy Pontiac. Customer subsequently became
aware of the forgery when they received copies of the application from Christy Pontiac. They informed
James Christy, the owner, of the mistake. In his conversation with Customer, Christy attempted to
pay Customer half the rebate to settle the situation. Later, the Attorney General’s office contacted
Christy. Afterwards, Christy contacted GM and cancelled the rebate for Customer, which GM had
authorized. Christy Pontiac was convicted of two counts of theft by swindle and two counts of
aggravated forgery.
- Holding A corporation may be convicted of theft and forgery, which are specific intent crimes, and the
evidence sustains defendant corporation’s guilt
- Analysis:
 Specific Intent Issue: 1) Statutory definition of crime does not exclude criminal
liability – a sentence of imprisonment may be imposed, 2) Forgery and theft sections of
the code allow for imprisonment or a fine. If a corporation can be liable in civil tort for
both actual and punitive damages for libel, assault and battery, or fraud, it would seem
it may be also criminally liable for conduct requiring specific intent crimes.
 Test:
 1) Jury must find beyond a reasonable doubt found that the act of the individual
agent constitutes the acts of the corporation
 2) Corporation may be guilty of a specific intent crime committed by its agent if:
1) The agent was acting within the course and scope of his or her employment, having
the authority to act for the corporation with respect to the particular corporate business
which was conducted criminally, 2) the agent was acting, at least in part, in furtherance
[unlike civil liability] of the corporations business interests, and 3) the criminal acts
were authorized, tolerated, or ratified by corporate management [often showed by
circumstantial evidence – all the facts and circumstances, those in positions of
managerial authority acted or failed to act in such a manner that the criminal activity
reflect corporate policy] Applied: 1) Hesli had responsibility to handle new car sales
and to process and sign cash rebate applications, 2) Christy Pontiac, not Hesli, got the
GM Rebate money, 3) Hesli had a middle management position for cash rebate
applications and was referred to as a type of reputation for handling the rebate

Vicarious Specific Intent:

1) High Standard in Christy Pontiac shows that a corporation can harbor criminal intent vicariously.
2) Respondeat Superior Some courts use the same respondeat superior scope of employment test for
criminal liability. The easiest route for prosecutors is a pure respondeat superior test – so only prongs 1
and 2 of Christy Pontiac. This is the federal standard, any federal crime can be successful against the
corporation solely upon a showing the standard motivation test for respondeat superior

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 3) Some courts go further and apply the MPC: criminal conduct be authorized, requested, commanded,
performed or recklessly tolerated by the board of directors or by a high managerial agent acting in
behalf of the corporation within the scope of his officer or employment. Corporate criminality also
incentivizes corporations to institute safeguards against employee misbehavior.

Organizational Crime: Corporate criminality serves to induce corporate decision makers to have the
corporation internalize the costs of illegal conduct within the organization. Corporation criminality recognizes
that it may be hard to prosecute individuals when they say that ‘they were just doing their job/ what everyone
else was doing.’ Some federal courts use the corporations’ collective knowledge and action to determine
its state of mind.
Monetary Penalties: Fining a corporation can put the burden on the investors who had nothing to do with the
crime and may not be a strong deterrent.
Corporate Death Penalty: Corporate convictions can trigger a variety of sanctions whose purpose is to put the
company out of business. But a firm’s demise can impose significant hardship on innocent corporate
constituents. Also the people putting in place the monitoring mechanisms may not be those borning the crimes.
Corporate death penalty can occur in 3 ways: 1) the judge imposes fines that force the firm to divest
itself of all its assets or that render it insolvent, 2) the criminal conviction prevents the firm from continuing
business in certain regulated fields, 3) criminal conviction triggers defaults under loan covenants or
irreparably damages the firm’s reputation in stock, bond, or customer markets
Deferred Prosecution Agreements: Primary method of avoiding prosecution – cooperation and concessions.
Comes at the price of civil liberties – corporate executives are compelled to cooperate fully
Punishing Shareholders: One argument is that shareholders bear the responsibility for these bad acts. But
usually shareholders are too removed to be effectively monitoring
Corporate Executives and Directors as Criminals Law is ambivalent to whether individuals can be punished
for organizational misdeeds
Strict Liability: SL puts a lot of pressure on corporate managers to institute legal compliance programs.
Supreme Court in United States v. Park: Responsible corporate agents precludes a conviction on the basis of
an officer’s corporate position alone – criminal liability attaches if the jury can find the individual had a
responsible relation to the situation, and by virtue of his position had authority and responsibility to deal with
the situation
Wrongful Failure to Supervise: Criminal liability is readily established when a director knew of the
environmental violation either instructing subordinates to perform the illegal acts or acquiescing in their
performance. If director did not participate in illegal acts, proof of criminal knowledge is much harder
Failure to institute legal compliance programs: Sentencing Guidelines reduce monetary sanctions for
corporations maintaining internal mechanisms for deterring, detecting, and reporting criminal conduct. Also
legal compliance programs are effectively required as a matter of corporate fiduciary duty
Sentencing of White-Collar Criminals: United States v. Booker (2005) Supreme Court found mandated use of
enhancing factors not found by a jury unconstitutional, thus rendering the Sentencing Guidelines advisory only.
Collateral consequence: Provisions in federal and state law which say that if a corporation as committed a
certain crime, they will lose their license for x and y.

Shareholder Governance Rights

You’re a shareholder if you own one or more common stock of the corporation. Your votes are dependent on how
many shares you own. Standard is one vote one share but of course the weight of your vote depends on how many
shares are issued and on how many you own. The company splits up the stocks in different classes: A Shares and B
Shares. As long as one of the groups as the ability to elect the board, it is good enough for corporate law.

Schnell  1) Shareholder primacy model governs board election decisions; 2) BJR does not apply to corporate
democracy/ election matters

Stahl  Delaying a board meeting where one is not yet required to occur is not an obstruction of shareholder rights,
unlike in Schnell where the effect of the board action was to preclude effective shareholder action

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Auer  If provided in the bylaws for SH to call special meetings, the board cannot obstruct w/o valid justification
(e.g. Rule 14a-8 exceptions). A SH can use special meetings to conduct confidence votes or endorse certain
candidates, and put directors on notice of their preferences in before elections.

Campell  Under Delaware law, corporate shareholders have the power to remove a director for cause, but the
director must be given notice and a reasonable opportunity to be heard by shareholders first

Blasius  BJR does not apply to shareholder voting context even when the directors acted in good faith, strict
scrutiny will be applied

Schnell v. Chris-Craft Industries

- Facts Dissident shareholders of Chris-Craft Industries, Inc. wished to replace the existing directors
at the next annual meeting, scheduled in the bylaws for January 11, 1972. The directors employed
various tactics to make the contest more difficult for the dissidents. They refused to turn over their
list of shareholders and hired proxy solicitors to work on their behalf. At the October 18, 1971
board meeting, the directors invoked a new provision of the Delaware Corporate Law to advance
the date of the annual meeting by a month (by amending the bylaws), to December 8, 1971. This
change made it virtually impossible for the dissident shareholders to wage a successful proxy contest
to unseat the incumbent directors.
- Holding Management attempted to use the corporate machinery of Delaware Law for the purpose of
perpetuating itself in office and therefore obstruct the legitimate efforts of stockholders in the exercise
of their right to undertake a proxy contest. The January 11th date is reinstated. Court essentially says:
Rule 1) the board is given immense discretion but it serves at the will of the shareholders (shareholder
primacy) (BJR); 2) No BJR as to democracy/ election matters. If upon in fact a searching review of
the record and jury feels that this was an effort to gain an advantage by messing with the election, any
such action will be enjoined

Stahl v. Apple Bancorp Inc.

- Facts November 15, 1989, company’s BoD met to consider action with respect to S’ stock
accumulation. Nov. 22, 1989 S seeks amendment to company’s bylaws to add 13 individuals to the
board (him being one of them). March 19, 1990, BoD fixes April 17, 1990 as record date for annual
meeting with latest meeting date being June 16. March 28, 1990 Stahl (S) owns 30% of Bancorp
common stock and announced public tender offer for all of the remaining shares of Bancorp. April 10:
Bancorp’s BoD defers annual meeting to consider sale of company because financial advisors
explained that S’ tender offer at a 17% premium undervalued Bancorp and was unfair financially to
stockholders and exploration of alternatives would take longer than the April 17 record date. April 12:
S files proxy contest. S seeks to compel annual meeting on/ before June 16, 1990 – the theory is
that BoD deferred the meeting in response to S’ proxy contest, which is inequitable because it
only focuses on BoD’s desire to stay in place and not interest of corporation.
- Holding The action of deferring this company’s annual meeting where no meeting date has been yet
set and no proxies solicited does not impair or impede the effective exercise of the franchise to any
extent. Refusal to call a shareholder meeting where the board is not required to do so does not itself
constitute an impairment of the exercise of franchise at issue in Schnell
- Analysis Cases concerning inequitable conduct (Schnell) are distinguishable – they precluded effective
stockholder action

Auer v. Dressel
- Facts R. Hoe & Co., Inc.’s bylaws require its president to call a special meeting whenever
requested in writing to do so by a majority of its voting stockholders. The company’s certificate of
incorporation provides for eleven directors, nine of whom are elected by the class A stockholders,
and two by the common stockholders. The certificate also authorizes the board of directors to remove
their own directors. R. Hoe’s class A stockholders (plaintiffs) submitted a written request for a special
meeting to the corporation’s president, which was signed by a majority of the stockholders. The stated
purposes for the meeting were: (A) to vote on a resolution demanding the reinstatement of
Joseph Auer as president, who had been removed by the directors; (B) to vote on a proposal to

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 amend the charter and by-laws to allow vacancies on the board of directors caused by a
director’s removal to be filled only by the stockholders of the class represented by the removed
director; (C) to vote on a proposal to hear the charges against four of the directors, to vote on
their removal, and to vote for their potential successors; and (D) to vote on a proposal to amend
the by-laws so that half of the directors, or at least one-third of the total authorized number of
directors, would constitute a quorum. President refused to call the meeting on the grounds that the
foregoing purposes were not proper subjects for Class A shareholder meeting.
- Holding If provided in the bylaws for SH to call special meetings, the board cannot obstruct w/o valid
justification (e.g. Rule 14a-8 exceptions). A SH can use special meetings to conduct confidence votes
or endorse certain candidates, and put directors on notice of their preferences in before elections.
- Analysis Stockholders should have the right to elect successors of removed board members and it has
no effect on common stockholders because they only elect the remaining 2 board members. The
certification of incorporation allowing directors to remove others on charges (impeachment) is an
alternative method to shareholders, it does not replace shareholders’ inherent power to do so. But the
right to directly elect and remove board members is constrained by procedural hurdles. For instance, a
SH cannot get the current board to reinstate a part director without having a current vacancy/opening
and also must go through the nominating process.

Campell v.Lowe’s, Inc.

- Facts Joseph Vogel was president of Loew’s, Inc. Director Joseph Tomlinson and his supporters were
attempting to take control of Loew’s from Vogel and his supporters. Vogel sent notice setting a
stockholders’ meeting in September 1957 to fill director vacancies, increase the number of
directors, and remove Tomlinson and another director. Vogel sent out a letter claiming the
directors were to be removed for cause because they had been uncooperative, attempted to take
control of Loew’s, and harassed the president and corporate officers. Vogel refused to provide a
stockholders’ list to the two directors. Campbell (plaintiff) filed suit in the Court of Chancery seeking
an injunction to stop the shareholders’ meeting, bar consideration of part of the agenda, or stop
particular proxy votes. Loew’s contested the motion, but the remaining defendants did not appear.
- Holding Under Delaware law, corporate shareholders have the power to remove a director for cause,
but the director must be given notice and a reasonable opportunity to be heard by shareholders first
- Analysis Are the charges sufficient to constitute cause? Desire to take control and lack of cooperation
are not sufficient, but charges of harassment are sufficient. Directors have the right to be heard –
provide directors with a chance to present their defense to the stockholders by a statement which must
accompany or precede the initial solicitation of proxies seeking authority to remove director for cause.
Otherwise, there can be no removal for cause. The directors in this instance were not given this
opportunity. The procedure used in this case is invalid.
-
Blasius Industries, Inc. v. Atlas Corp
- Facts Blasius Industries, Inc. holds 9 percent of the stock of Atlas Corp. Blasius proposed that Atlas
sell off some of its assets, issue bonds, and distribute a large one-time dividend to shareholders.
The directors of Atlas believed this was not in the company’s best interest and rejected the idea. On
December 30, 1987, Blasius formalized their proposal and also requested the election of eight new
board members. This would increase the size of the board from 7 to 15, the maximum allowed
under the corporate charter [they would do so by amending the bylaws] [the incumbents fight back].
Fearing a takeover by Blasius, the board held an emergency meeting the next day and amended
the bylaws to add two additional board members. This move was designed to prevent Blasius from
seizing an eight to seven advantage on the board at the next election. Blasius sued Atlas, seeking to
void the board’s December 31, 1987 action as inequitable.
- Holding BJR does not apply to shareholder voting context even when the directors acted in good faith,
strict scrutiny will be applied
- Analysis BJR  Original considerations of business judgment rule are not present in the shareholder
voting context. A board decision to act to prevent shareholders from creating a majority of new board
positions does not involve the corporation’s power over its property or its rights and obligations – but
involves allocation among shareholders as a class. Board must show compelling justification for
interfering with SH votes. The board acted in good faith effort to protect its incumbency but

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 action was not justified: 1) faced with nonthreatening offer by 9% shareholder, 2) it has time to
inform shareholders of its views before the stockholder vote, 3) The board does not have the power to
determine the question of who should comprise the board – the directors are the agents of the
shareholders

Shareholder Info. Rights

DE Law  Must show proper purpose of inspection. If the shareholder seeks the books and records other than the
stock leger or list of shareholders, then the shareholder has the burden of showing proper purpose. However, if the
shareholder seeks the stock ledger or list, the corporation has the burden of showing improper purpose. Shareholder
inspection has become important pre-filing tactic by Ps bringing lawsuits – Proper Purpose

MBCE  Inspection available for articles of incorporation, bylaws, minutes of shareholder meetings, the names of
directors and officers, and similar documents. Inspection of board minutes, accounting records, and shareholder lists
requires the showing of proper purpose. Shareholders asking for ‘good stuff’ MBCE requires reasonable
particularity of purpose and the records must be directly connected with the purpose.

Remedy for denial  Judicial order and corporation must pay shareholders’ costs.

Pillsbury  a proper purpose does not exist where the motivation was solely social and political, but not economic,
concern

Pillsbury v. Honeywell
Takeaway: Shareholders must show proper cause to have access to the corporation’s books etc. Inspection rights
for whatever litigation purposes are at issue do not play a large role in gaining information from the corporation
- Facts Pillsbury found out that Honeywell, Inc. was engaged in the production of munitions used in
the Vietnam War. Pillsbury was against the war and bought 100 shares of Honeywell with the sole
purpose of gaining access to Honeywell’s business affairs so he could convince the board of
directors and fellow shareholders to stop producing the munitions. To that end, Pillsbury formally
demanded from Honeywell access to its original shareholder ledger, current shareholder ledger, and all
corporate records dealing with the manufacture of munitions. Honeywell refused to grant Pillsbury
access.
- Holding Petitioner’s sole purpose was to persuade the company to adopt his social and political
concerns irrespective of any economic benefit to himself. This purpose does not entitle petitioner to
inspect Honeywell’s books and records.
- Analysis Petitioner asks for per se rule that a stockholder who disagrees w/ management has an
absolute right to inspect corporate records for purposes of soliciting proxies. Court disagrees with
this rule – better rule is that inspection is allowed only if the shareholder has a proper purpose
for such communication – only those with a bona fide interest enjoy this power Applied:
Petitioner acquired shares in Honeywell with the sole purpose of persuading shareholders to replace
management and therefore does not have an economic interest in the company.
-
Proxy Regulation

The whole proxy regulation is built on the premise that is a federal crime for a person to solicit proxy from someone
else unless that person prepares a proxy statement and delivers it to: 1) The SEC, and 2) all the voters from who, you
are solicit proxies

SEC Rules § 14(a) of the Securities Exchange Act of 1934: Disclosure in Proxy Statements SEC rules require
any solicitation seeking shareholder proxies be accompanied by a disclosure called a “proxy statement.” Proxy
solicitations must be sent to the shareholders and filed with the SEC. Shareholders who are asked to vote must
receive a proxy card with specified format and voting options.

SEC What is solicitation? (14-a(1)) = Any request for proxy whether or not accompanied by or included in a form
of proxy; any request to execute or not to execute, or to revoke a proxy; the furnishing of a form of proxy or other

14
communication to shareholders under circumstances reasonably calculated to result in the procurement,
withholding, or revocation of a proxy
SEC Exceptions to the Rules: There are certain things that will not be treated as a solicitation. If the
person making a statement about an election is not furnishing a proxy card, and they do not have a
substantial interest other than a normal stockholder interest, they are not subject to the above rules.

Disclosure of Material Information to Shareholders

a. Proxy form must be reasonably understandable
b. Provides form and contents of the proxy statement

Rules Governing Election Contests SEC Rule 14-A-7: If you are an insurgent, you are entitled to have the issuer
either give you a list of the shareholders or mail your proxy materials for you, at your expense

Rules Regarding Shareholder Proposals SEC Rule 14-A-8: Requires that certain proposals submitted by
shareholders be in the corporation’s own proxy materials so they do not need to prepare and get approval of their
own proxy materials

Anti-Fraud Rule SEC Rule 14-A-9: Applies to corporations listed on the stock exchange or any corporation that
has total assets of over $10 Million and equity held by 2 Million+ Investors [most private companies are not covered
by this]

Public Companies have disclosure requires under the SEC regulations: annual, quarterly, and special event reports.
Insiders are required to disclose any trading in the company’s equity shares. Foreign corporations that trade on US
market are only subject to periodic disclosure requirements but not proxy voting or disclosure of insider trading

Management Proxy Solicitations Managers must produce a proxy statements (detailed disclosure document
describing board candidates and matters on which shareholders will vote). Schedule 14A of SEC is instructions for
proxy statements. Proposals requiring shareholder voting must describe pros/ cons of proposal. Non-routine
proxy statements must be filed with the SEC at least 10 days before it is sent to shareholders for review.

Proxy Card Regulates the voting ballot sent to shareholders:

- Must allow shareholders to vote for or against
- Must allow shareholder to withhold a vote on a director as a group or individual candidates. Proxy
holder can confer discretion on authority for matters the shareholder does not specify a choice
for or unforeseen matter coming up at the meeting. But otherwise the proxy holder must vote with
shareholder’s instructions.

Shareholder Nominations
Under corporate law, management controls the nomination process for board candidates in public corporations.
Unless an insurgent shareholder proposes its own directors through a proxy contest waged at its own expense, the
only candidates for shareholders to vote on are those nominated by the board and nominating committee.

Delaware Response: § 112 and § 113 on Proxy Nominations

DGCL §112 authorizes corporation to adopt a bylaw granting S/H right to include their nominees (if
less than all the directors are to be elected) in a corporation’s proxy soliciting materials
DGCL § 113 codifies the CA decision – permits corporation to adopt a bylaw providing for corporate
reimbursement of shareholder expenses incurred in connection with an election of directors

Shareholder Proposals

Right of Referendum  SEC Rule 14(a)(8) a shareholder referendum, shareholders should have a right to have
control over the agenda of an annual meeting or special meeting. The right of referendum is to put your proposal
on management’s ballot. Shareholder right that comes at no cost to the shareholder.

Two things for referendum to make its way onto the ballot: 1) Only one proposal, and 2) it has a word limit.
Do you have to be qualified in any sense? Yes, see below eligibility and procedures.

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Is the proposal substantively appropriate? If yes, it must go on the ballot. If not, the company must a copy of the
rejection letter to the SEC.

Operation of Rule 14a–8

Eligibility and Procedure:
 Proponent must have continuously held at least 1% or $2,000 worth of company voting shares
for at least one year. (individuals can create a group of people so cumulatively own $2,000 but
SEC thinking about getting rid of this)
 Proponent can only submit one proposal per shareholders meeting not exceeding 500 words
 The proposal must be submitted to the company no less than 120 calendar days before the date
of the company’s last year proxy statement
 Company can include proposal in proxy materials and can recommend shareholders vote
against it
 SEC No Action: If corporation does not include the proposal in the proxy materials, they must
notify SEC w/ proposal and explanation. SEC reviews and decides whether to issue no-action
letter or compel the corporation to include the proposal. No action letters have been deemed
not to be final orders under the APA and therefore SEC cannot be sued for a non-action letter

Proper Proposals (subject matter)

 State Law SEC v. Transamerica Corp.: A proper proposal is one that a shareholder may
properly bring to a vote under the law of corporation’s state of incorporation

 Non-Proper Proposals There are 13 grounds for exclusion of shareholder proposals under
Rule 14a–8(i) see pages 484–486 a) Protect centralized corporate management: 1,5, 7, 13; b) seek
to prevent interference with management’s solicitation of proxies: 8,9,11,12; c) seek to prevent
misguided proposals that are illegal, deceptive, or abusive: 2, 3, 4, 6, 10
1) Improper subjects of under state law – resolutions that are binding on the board.
Shareholders have no right to put forth referendum items that are beyond the
shareholder’s power so to get around the issue of binding action is to make a
recommendation via referendum. Such a recommendation is a precatory referendum,
courts and SEC have said this is fine. The other way around is to amend the bylaws
2) Proposals that are not significantly related to business  If the proposal relates to
the operations which account for less than 5% of the company’s total assets at the end of
its most recent fiscal year, and for less than 5% of its net earnings and gross sales for the
most recent fiscal year, and is not “significantly related to the company’s business” But
see Lovenheim
3) Proposals that deal with ordinary business operations (infringing on officers) –
these are exclusively within the province of the board (otherwise there would be endless
proposals)

Lovenheim  This case says that an issue of social, political, or moral importance is not in the ordinary course of
business for the purposes of SEC 14(a)(8) exclusions Langevoort, impact is minimal because it’s usually the case
that the social recommendations get voted down by the majority of shareholders if put on the ballot.

Lovenheim v. Iroquis Brands, Ltd.

- Facts Peter Lovenheim was a shareholder in Iroquois Brands, Ltd. Iroquois was preparing to send
proxy materials to its shareholders containing information about a shareholders meeting. Lovenheim
sought to include in the proxy materials a proposed resolution that he planned to offer at the
meeting. The resolution pertained to the allegedly inhumane procedures used to force-feed geese for
production of pate de foie gras in France, which was a type of pate imported by Iroquois. Iroquois
refused to include information on Lovenheim’s resolution in the proxy materials. Iroquois
defended its refusal based on the SEC rule that a corporation may omit a proposal from its proxy
statement “if the proposal relates to operations which account for less than 5 percent of
[Iroquois’s] total assets at the end of its most recent fiscal year . . . and is not otherwise
significantly related to [Iroquois’s] business.” Pate accounted for well less than 5 percent of
Iroquois’s business. However, Lovenheim maintained that his proposal could not be excluded because

16
 of the second part of the rule in that it cannot be said that the proposal is not otherwise significantly
related to Iroquois’s business. Lovenheim argued that the proposal had ethical or social significance.
- Holding In light of the history of the rule, the court holds that in light of the ethical and social
significance of P’s proposal and the fact that is implicates significant levels of sales, P had a likelihood
of prevailing on the merits with regard to the issue of whether his proposal is “otherwise significantly
related to the issuer’s business
- Analysis Court: there is ambiguity in the wording of the rule so we look at the history of the
shareholder proposal rule: SEC decision in the 70s said that the rule is not so closely tied to the
economic relativity of a proposal. Related business may compromise less than 1% of the profits or
assets but raise significant policy questions important enough to be considered significantly related to
the issuer’s business. Amendment was adopted with 5% rule but Commission said that proposals
could be included notwithstanding the economic threshold

Other Cases:
- The Medical Committee (Napalm) case: DC Circuit found that Dow Chemicals could not omit
shareholder proposal banning sale of Napalm unless guaranteed not to be used on human beings because
the Dow management had support making Napalm in spite of business considerations as opposed to in
support of them, their moral predilections could not be insulated from shareholder oversight
- Trinity Wall Street v. Wal-Mart case: Trinity Church submits proxy proposal regarding gun sales at
Wal-Mart, Wal-Mart omitted proposal from proxy materials. District Court ruled for church calling it
policy issues having to do with board governance. Third Circuit reversed explaining that it had to do
with what Wal-Mart put on its shelves, which is ‘ordinary business,’ and that the social policies do
not transcend the a company’s ordinary business

Shareholder Activism
Institutionalization
Every manager is a fiduciary of the fund they manage. They have a legal obligation to vote and a fiduciary
responsibility to vote wisely

Institutionalization  Today voters are increasingly institutions that manage money for other people under the
understanding that the institution is what invests in the public stock, giving the institution the right to vote.

Mutual funds  portfolio managers for manage funds and make investment decisions. Provides diversification.
Mutual funds make a good portion of their money by managing retirement savings. Set fee is the compensation
o Index investing  mutual fund invests in different indices, with fees close to 0%.
o Active investing  more closely managed funds but understood to be waste of money because
there are no bargains out there for stocks due to market efficiency

Hedge funds  Limits those who invest to the wealthy, therefore the risk limitations are off. Fee is 2%
management fee plus 20% of all the gains made by the fund if the fund out performs a certain benchmark

Pension funds  most employers give the opportunity to take portion of salary and put it in the pension account.
Only highly unionized professions still have pension funds

Insurgents & Incumbents

Who are the insurgents in a proxy fight? Hedgefunds and well-known individuals, big stock purchases
incentivized by the hope that value of the stock will go up. Activist hedgefund, however, buys a ton of shares in a
company and then they announce their presence to the management of the company and ‘we think you’re tanking
this company, so we want you to fire yourselves or we will fire you via a proxy fight.’ And here is the plan that we
are going to announce to the public tomorrow for how you can turn the company around – and we are going to
throw you out by getting enough votes to impeach you.

Example Innoviva  Adding seats to a board as a proxy contest, less aggressive than creating a
whole new plan for a company. Why just pursuing two board seats? Part of the strategy is just

17
 getting your two people on the board is a showing of strength. Once your people are on the board,
they have to be at the meetings and notified about the meetings.

Reimbursement  Incumbents have the right to have the reasonable expenses reimbursed by the corporation.

Insurgents other than management 14(a) 1) can solicit proxies from fewer than 10 investors. Limited to non-
incumbent solicitations. So long as you do no actually ask for vote. 2) If you prepare physical manifestations of the
solicitation, you may be freed up in your ability to do that, management can’t. 3) You can engage in public forms of
solicitation without delivering a proxy statement so long as you make clear you are not asking for the actual vote,
you are just campaigning.

Proxy advisory firm  institutional investors outsource due diligence for elections for the publicly traded
companies in America and advise how you vote

Policy  Are these structures good or bad? Shifting more power toward institutional investors and away
from incumbents. Do stock prices go higher over a successful insurgency? There’s little evidence that insurgence to
damage to share prices and therefore move toward insurgency is a good thing How else might we think about this?
The stakeholder model, what is the effect on other stakeholders? Usually the plan is to cut costs. Hedge funds
are experts in cost cutting

Reimbursement

State Reimbursement Rule: Essentially gives financial control over the voting mechanism to incumbent
management. Pro: doesn’t waste spending on unsupported shareholder initiatives. Con: discourages shareholder
activism and entrenches management

Rosenfeld  When the directors act in good faith in a contest over policy, rather than purely personal power
contest, they have the right to incur reasonable and proper expenses from corporate funds for solicitation of
proxies and in defense of their corporate policies, and are not obliged to sit idly by. The corporation does not
have a duty to reimburse the winners (insurgents) but the shareholders can do so by a majority vote.

Rosenfeld v. Fairchild Engine & Airplane Corp

- Facts In a policy-related proxy contest (as opposed to a personal contest for power) for a board of directors
election in Fairchild Engine & Airplane Corp., Fairchild’s treasury paid $106,000 in defense of the old
board of director’s position; $28,000 to the old board by the new board after the change to
compensate the old board for their failed campaign; and $127,000 reimbursing expenses that the new
board members incurred in their campaign. That reimbursement was ratified by a majority vote of
the stockholders. The policy question behind the proxy contest was the long-term and very expensive
pension contract of a former director, Carlton Ward. Rosenfeld brought suit to compel the return of the
above payments to the Fairchild treasury.
- Holding When the directors act in good faith in a contest over policy, rather than purely personal power
contest, they have the right to incur reasonable and proper expenses from corporate funds for
solicitation of proxies and in defense of their corporate policies, and are not obliged to sit idly by. The
corporation does not have a duty to reimburse the winners (insurgents) but the shareholders can do
so by a majority vote. Policy reasons: incumbent board as to have resources to defend position, otherwise
they cannot defend themselves against people acting out of their own self-interest.

Circumventing Incumbent Power

In a governance battle, is 14a–8 a tool? Insurgents often want a by-law can be passed that says that reimbursement
is mandatory. Is this permissible? By-laws cannot contain anything that interferes with the law or provisions of
articles of incorporation. Only the directors and the delegates have the power to take money and spend it, therefore
shareholders cannot pass a by-law mandating reimbursement. However, a year after this court decision, the DL
legislature reversed the decision saying that shareholders can pass a by-law mandating reimbursement to
insurgents.

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Staggered board: staggered board must be in the articles, and articles cannot be changed via the by-laws.
Insurgents have a much harder time winning against staggered boards because shareholders cannot amend the
articles via the by-laws. Many corporations, however, have had referendums to make suggestions at annual board
meetings of de-staggering boards.

Proxy access: Amend the by-laws to require directors to put the names of nominees onto the ballot suggested by
shareholders. The board can still decide who will be the final nominees.

Majority voting Can the by-laws provide that even if there is no contest, can we make it majority voting (more
favorable votes than unfavorable)? In theory, people could still run unopposed and still lose. Most director voting is
plurality.

Business Judgment Rule

Standards of Review
- Election (strict scrutiny)
- Business decisions by the board (rational basis/ business judgment rule)
- Decisions by the board that has no legitimate grounding and has no rational basis, is called waste

Business Judgment Principle  if there is a business judgment that so qualifies, the court will defer. The principle
creates a presumption that business decisions are outside the scope of judicial scrutiny. Judges lack the institutional
competence to determine what is in the best interest of the company.

Business Judgment Rule  Essentially a doctrine of judicial abstention Procedural and substantive: BJR is a
rebuttable presumption, therefore P has burden; BJR reflects view that directors are better than courts at making
business decisions. A rule of liability – reason for this is that it is the general idea that businesses succeed by taking
prudent risks. Another issue if we didn’t have the rule, but it would be hard to attract people into the role as director.
It is a standard next to impossible for plaintiffs to meet.

Derivative suits  Directors have a fiduciary duty to the corporation and its shareholders. If a court allows a
shareholder to control the lawsuit, then it becomes [name of shareholder] & [corporation] vs. Board of
Directors/named defendants. Success in achieving remedy: to the corporation and does not pay-out to the
shareholder other than the redress to right the wrong. No jury trials in derivative litigation because they only occur
in courts of equity/ chancery (or at least did so in common law in England)

Official Comment to MBCA § 8.30: Director has latitude to take action he or she “reasonably believes to be in the
best interests of the corporation.” Reasonable belief is subjective and objective: good faith determination and
reasonableness determination. “Best interests of the corporation” is extremely broad

Where the issue is one of duty of loyalty (DE Courts)  Business judgement does not apply (Van Gorkem)

Smith v. Van Gorkom

Langevoort on Van Gorkum: Business judgment rule only applies to business decisions worth of respect. Business
decisions predicated on gross procedural negligence deserves no respect or deference under the business judgment
rule whatsoever. Delaware Law: business judgment rule has changed to only apply to business judgment
- Facts Van Gorkum CEO of Trans Union, near retirement age. Van Gorkum meets Pritzker. VG offers
Trans Union to Pritzker. Stock is at $38. VG offers to Pritzker, $55 /share. VG calls a special meeting of
the senior management of TU without telling them why. VG tells them about the sale. Then there is a board
of directors meeting the next day, it is two hours, not a single question was asked, and there is unanimous
approval. Shareholders still have to vote to approve the merger – because mergers are fundamental
changes. If you’re a shareholder of TU, you will be cashed out of your shares as a result of the merger.
That’s about as fundamental as it gets – telling shareholders they no longer have an interest in the company
formerly known as TU.
- Holding Directors breached their fiduciary duty to their stockholders 1) by their failure to inform
themselves of all information reasonable available to them and relevant to their decision to recommend the

19
 merger, and 2) by their failure to disclose all material information such as a reasonable stockholder would
consider important in deciding whether to approve the offer
- Analysis
o Standard for BJR to Apply  Whether a business judgment is an informed one turns on whether
the directors have informed themselves prior to making a business decision, of all material
information reasonably available to them. The standard for a breach of duty of care  gross
negligence.
o 1) Bd. of Dir. did not reach informed business judgement
 1) Directors did not adequately inform themselves as to VG’s role in forcing the
sale of the company and in establishing the per share purchase price
 2) Were uninformed as to the intrinsic value of the company
 3) Were grossly negligent based on these facts in approving the ‘sale’ of the
company after only 2 hours consideration without prior notice and without
exigency or crisis
 8 Del.C. § 141(e) Directors are fully protected in relying in good faith on
reports made by officers. VG’s oral presentation not report because it lacked
substance was uninformed. Roman’s brief oral statement was not report b/c it
was not relevant to the issues before the board. A report must be pertinent to
the subject matter for which the board has been called upon to act and
otherwise be entitled to good faith, not blind, reliance.
 D’s rely on following factors of trial court:
 1) Magnitude of the premium between offer and market price
o Directors knew that the market consistently depressed the price of their
stock and substantial premium absence other sound valuation
information is not alone sufficient information to assess fairness of
offer price. Insider can rely on valuation reports of its management but
the board never asked the CFO to make such a report. Board just relied
on CFO’s statement that $55 was in the ‘fair price range’ and at the
bottom of such range for share price. Directors – had they informed
themselves to the information available – would have learned that VG’s
suggestion of $55 was not supported and couldn’t be relied upon in
good faith.
 2) Amendment to agreement re market test period: Record does not support
that the agreement was ever effectively amended to allow TU to put itself up for
sale to highest bidder to that the public action was permitted to occur. Thus, Ds’
argument that market test period and premium supported by market information
during test period foreclosed finding that Board acted impulsively fails. Also
Pritzker gave an exploding offer
 3) Collective experience of directors: Board’s unfounded reliance on premium
and market test undermines this argument. Singer case with similar facts is
instructive – court found gross negligence even where board had a lot of
experience and faced more emergency conditions
 4) Reliance on legal advice re liability: Threat of liability is not legal advice or
basis to pursue uninformed course. Advice as to the outside valuation or fairness
opinion is accurate but does not mean that board does not have to have adequate
information upon which to base their decision
o B) If not, whether directors’ actions taken subsequent to Sept. 20 were adequate to cure
infirmity in action taken Sept. 20
 Ds rely on overwhelming stockholder vote in favor of merger as curing any failure
to of Board to reach informed decision.
 A merger can be sustained, notwithstanding the infirmity of the Board’s action,
if its approval by a majority of shareholders is found to have been based on an
informed electorate. Lynch v. Vickers Energy – corporate directors owe their
stockholders a fiduciary duty to disclose all facts germane to the transaction
at issue

20
 o Applied: Uninformed ratification is not ratification. TU’s
stockholders were not fully informed of all facts to their vote. The
Board failed their burden to show that the shareholders were a fully
informed electorate. [court goes through statements that were false/
misleading/ unsupported in proxy materials]
Exculpation Clauses
In response to Van Gorkem states passed statutes allowing (may) corporations to include exculpation provisions in
their charters (amendments have to be done by shareholder vote), eliminating or reducing the liability for
personal monetary damages.

Example DGCL § 102(b)(7): not self-executing, the board must propose and shareholders must adopt the
provision. only applies to money damages. Votes in favor of 102(b)(7) have been overwhelming
Exculpation DOES NOT APPLY equitable relief (if no exculpation, Van Gorkem stands) (if plaintiffs can show
lack of good faith, the door is open to a successful lawsuit)
Exculpation Exclusions:
1) Breach of duty of loyalty – no clear line between loyalty and care duties, and loyalty &
bad faith not defined in the statute. P will try to characterize conduct a breach of duty of
loyalty.
2) Acts/ omissions not taken in 1) good faith or 2) intentional misconduct or a 3) knowing
violation of the law. Courts take “not in good faith” to mean conscious disregard for his
or her duties and is often the deciding factor for liability.
3) Under § 174 of this title [covers unlawful payment of dividends]
4) Any transaction which director derives improper personal benefit

Example MCBA § 2.02(b)(4): permits exculpatory provisions for certain fiduciary duties but does not extend
coverage to: 1) improperly received financial benefits, 2) intentionally infliction of harm on the corporation or
shareholders, 4) violations of criminal law, and 4) unlawful distributions, including dividends. Only applies to
money damages

#Indemnification
One party promises to pay the expenses of the other party. Officer must have acted in good faith. Corporate
statutes allow for permissive and mandatory indemnification. Every state had adopted such a statute. Some or all of
what defendants incur in the course of corporate or shareholder litigation are taken off the shoulders of the
individual and placed on the corporation.

Disinterested Directors If there are disinterested directors, then they will decide indemnification for other
directors

What if the entire board is sued? The board of directors has the right to hire a lawyer to determine whether
indemnification is proper

Permissive – Board has right but not obligation to indemnify officer. Both provisions cover a broad range of
corporate actors – directors, officers, employees, and agents. Standard of conduct is in good faith and a specified
reasonable belief. Primary difference is coverage.
DCGL § 145(a) – DIRECT SUITS third-party lawsuits, including class actions. Covers broad
indemnification of expenses and amount paid in damages or settlement to non-corporate clients
(covers every penny you spent) “Suit or proceeding if the person acted in good faith and in a
manner the person reasonably believed to be in or not opposed to the best interests of the
corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to
believe the person’s conduct was unlawful.”

DCGL § 145 (b) – DERIVATIVE LAWSUITS. Covers only expenses of derivative suit (legal
fees, not damages) Only applies if the individual is found not liable (which incentivizes
settlement) This section on its own does not allow corporations to indemnify directors for
judgment in settlement of derivative suits. “If the person acted in good faith and in a manner

21
 the person reasonably believed to be in or not opposed to the best interests of the
corporation and except that no indemnification shall be made in respect of any claim.”
If duty of loyalty  most you can hope for is legal fees covered because does not cover
bad faith

DCGL § 145(f) Corporations can make their own rules requiring indemnification in the bylaws
(which can also be amended at any time by the board of directors). A contract can be entered into
requiring the corporation to indemnify the board. The contract cannot conflict with the § 145(a)
“good faith”

Mandatory Immutable rule is that if the officer, director, or agent of the corporation is sued in their capacity as a
corporate officer/ official capacity, and the person is fully successful on the merits or otherwise, the board must
write a check for call costs incurred.

DCGL § 145 (c) Indemnification it as of right when the covered person has successfully defended an
action or proceeding arising from his or her corporate role – only covers mandatory expenses.

Advancement of expenses DCGL § 145: Requiring directors to post their own bond to fund litigation
expenses would create a huge divide between rich and poor directors. Advancement of expense provision
allows corporations to lend money to their directors or officer for expenses

Duty of Loyalty
If a decision/ transaction is tainted by a CONFLICT OF INTEREST involving one or more corporate directors,
the issue is looked at under the duty of loyalty: 1) § 102(b)(7) does not apply and 2) neither does the business
judgment rule

While the duty of care focuses on the board-decision making where director interests are aligned with those of the
corporation, the duty of loyalty arises when a director has personal interests that are contrary to those of the
corporation. The duty of loyalty is implicated by all director actions and is at the core of the entire jurisprudence of
fiduciary duties. *Typically, duty of loyalty actions do not involve the whole board. Therefore, there are usually
unconflicted directors who can act on behalf of the corporation [VS. duty of care where we are looking at the
board’s conflict as a whole]

Intrinsic fairness test: burden (Sinclair) is on parent company to prove, subject to careful judicial scrutiny, that its
transactions with the subsidiary were objectively fair. It applies where a parent and subsidiary, with the parent
controlling the transaction and fixing its terms, the test of intrinsic fairness applies, not the BJR. Intrinsic fairness
test will only be used when the fiduciary duty is accompanied by self-dealing. Self-dealing occurs when the
parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent
receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the
subsidiary [disproportionality]

Examples of conflict of interest

Primary breach of the duty of loyalty are self-dealing transactions: A transaction between the corporation and a
counter-party (X) where one or more of the directors has an interest in the counter-party. Langevoort: Tunneling is
an abuse of power in corporations where a person chooses the board of directors and engineers multiple transactions
 money ends up in company X and ends up in the person who chose the board of directors, it’s called looting

1. When a director buys or sells assets from the company

2. Director involved in transaction where he owns interest in the other corporation
3. Executive compensation

What taints would cause a lawyer to say that a board of director is not impartial?
- When the CEO/Chairman is the one with the conflict – those who are not impartial are those in the c-suite
and subordinate to CEO

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 - Director at a law firm who does a lot of work with the corporation – courts split on this
- Personal relationships Famous case is the Martha Stewart case. She picks all of the directors but they do
not lack independence

#Cleansing

Three ways to cleanse a transaction

1) Vote by disinterested and independent directors
a. Interest  Two instances
i. When a director personally receives a benefit as a result of, or for, the challenged
transaction, which is not generally shared by the other shareholders of his corporation,
and that benefit is of such subjective material significance to that particular director that it
is reasonable to question whether that director objectively considered the advisability of
the challenged transaction to the corporations and its shareholders
ii. When a director stands on both sides of the challenged transaction
b. Independence  whether the director’s decision resulted from that director being controlled by
another either by domination or beholden
c. Ultimate question is  whether there is such importance to the director that it is reasonable for
the court to question whether valid business judgment or self-considerations animated the
director’s vote
2) Go to trial and win on the merits—intrinsic fairness
3) Fully informed shareholder vote/ ratification
 Requires full disclosure and honesty
 MBCA and DE Similar law  in the end it’s all facts and circumstances

Conflict of Interest/ Duty of Loyalty structure:

1) Directors in question has the burden of proving fairness.

a. HOWEVER the taint of conflict can be cleansed (Van Gorkem) if as opposed to show
substantive fairness, the interested party shows procedural fairness, meaning that the question of
transaction was put entirely in the hands of independent directors.
i. If this is cured, then the BJR is reinstated and therefore rational basis test (DCGL).

2) Who is ‘clean’ enough to cleanse? DE says it’s a fact and circumstances question

Contemporary Statutory Approaches

- Statutes such as DGCL § 144 and MBCA §8.31 codify the common law development that conflict
transactions are not automatically invalid. They do not, however, specify when a transaction is valid.
o Subchapter F of MBCA uses a “safe harbor approach” which attempts to provide greater
perspective certainty and reduce judicial intervention.
- DGCL § 144 Provides that an interested director transaction will not automatically be void or voidable
solely because of the interest if either there has been:
 1) Informed disinterested board approval [plus disclosure],
 2) Informed shareholder approval [plus disclosure], OR
 3) The transaction is fair to the corporation (substantive fairness)
 *Situations where all of the directors are interested fall into this category
o BJR  If approval from either a disinterested board or informed shareholders are met, BJR
applies to review issues of gift or waste.
o “Solely” Statutory Language = A shareholder can still challenge a transaction that has been
properly approved by the board. “I am not challenging this solely because of the transaction, I am
challenging it because it is unfair”
- Interpreting DCGL § 144: 1) Should be judicial review for fairness only if there had been no prior
approval by an informed, disinterested decision maker (cleansing)– less room for judicial scrutiny but more
efficient. 2) Removing absolute prohibition against interested-director transactions without specifying when
such transactions are valid – relates more to putting the burden of proof on the plaintiff during litigation

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Benihana (B of D. Approval)  If the transaction was approved by the independent directors exercising their
business judgment in good faith, the board’s decision would be evaluated under the business judgment rule, and the
plaintiff will have the burden of proof. However, if the Court would find that the decision was made by a board that
was NOT comprised of a majority of independent directors, then the burden switches to the Defendants to show
that the transaction is entirely fair to the corporation.

Oracle (SLC Approval)  For a special litigation committee to cleanse a transaction, the members must be
independent of the defendants [they must also be directors] to the extent that there is no material factual question
regarding their independent

Martha Stuart Living (B of D. Approval)  Allegations of mere personal friendship or outside business
relationships standing alone are not enough to raise reasonable doubt as to director’s independence

Court Determined Fairness

Substantive Fairness [Fair Price Defined]
1. Substantive fairness focuses on a comparison of the fair market value of the transaction to the price the
corporation actually paid as well as the corporation’s need for and ability to consummate the transaction.
2. Terms of the Transaction: A fair price is any price within a range that an unrelated party might have been
willing to pay or accept for the relevant property, asset, service or commitment, following a normal
negotiation.
3. Benefit to the Corporation: Courts will determine whether the transaction was one that was reasonably
likely to yield favorable results.
4. Process of Decision: Fair dealing requires that the director make required disclosure at the relevant time
even if the director plays no role in arranging or negotiating the terms of the transaction.
a. Examples:
i. Director’s failure to disclose fully the director’s interest or hidden defects known to the
director regarding the transaction.
ii. The exertion by the director of improper pressure upon the other directors or other parties
that might be involved with the transaction.
Procedural Fairness [Fair Dealing Defined]
1. Courts focus on (1) the disclosure given to the corporate decision-makers, (2) the interest of the directors in
the transaction and (3) the effect of shareholder ratification.
2. Disclosure: Full disclosure of the interested director’s conflict and other “material” information concerning
the substance of the transaction is required.

Benihana of Tokyo, Inc. v. Benihana, Inc. (Del. 2006)

Big take away is that after a disinterested director vote in favor, transaction is cleansed by the conflict of interest
and the issue becomes of business judgement (rational basis standard) and the question becomes one of duty of care
rather than duty of loyalty.
Facts: Benihana’s restaurants needed renovation, but the company did not have the funds. Joseph recommended
that Benihana issue convertible preferred stock. Abdo (BFC board member), and a Benihana board
member, informed Joseph that BFC was interested in buying the stock. Abdo negotiated with Joseph for the
sale of the stock on behalf of BFC and made a presentation on behalf of BFC regarding its proposed purchase of
stock. He then left the meeting. The Benihana board (Ds) knew that Abdo was a director of BFC and Joseph
informed the Benihana board that Abdo had approached him about the sale on behalf of BFC. At the same
meeting, the Benihana board voted in favor of the sale to BFC. 2 weeks later, BOT’s attorney sent a letter to
the Benihana board, asking it to abandon the sale on account of concerns of conflicts of interests, the
dilutive effect on voting of the stock issuance, and the sale’s “questionable legality.” The board approved the
sale.
Holding: The Benihana board knew enough information about Abdo’s involvement in the transaction to
validate the sale. By the time the board approved the sale, it knew that Abdo was a director of BFC, that he was
the proposed buyer, and that he had made the initial contact about the purchase with Joseph. This is sufficient
information to deem the board knowledgeable on the material facts of Abdo’s interest. Therefore, because the
board approved the transaction (without Abdo’s vote), it is valid.

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 Rule: A transaction involving an interested director is valid if the material facts as to the director’s interest are
disclosed or known to the BOD and the board in good faith authorizes the transaction by an affirmative vote of
disinterested directors.
Analysis:
- Section 144:
o Provides safe harbor for interested transaction if “the material facts as to the director’s relationship
or interest and as to the contract or transaction are disclosed or are known to the board of directors
…and the board… in good faith authorizes the contract or transaction by the affirmative votes of a
majority of the disinterested directors
o Approval by disinterested directors requires courts to view the interested transaction under the
BJR which is a presumption that in making a business decision, the directors of a corporation
acted on an firm basis, in good faith and in the honest belief that the action taken was in the best
interest of the company
o Applied: the disinterested directors knew of Abdo’s role in the negotiations with B and so 144(a)
(1) is satisfied

Oracle Corp. Derivative Litigation:

Oracle creates special litigation committee to investigate and act on derivative suit regarding insider trading. The
two SLC members were two newly-directed directors (two Stanford professors when the board is very closely tied to
Stanford University). Court found SLC members not sufficiently independent of the defendants to decide to
terminate the derivative suit. SLC failed to demonstrate that no material factual question exists regarding its
independence (impartiality and objectivity). Stanford is so beholden to Oracle and its founders because of so
many contributions

Martha Stewart Living Omnimedia v. Stewart:

Plaintiff was required to make demand of the board because filing derivative suit for breach of fiduciary duties
because although P argues board is not sufficiently independent from the defendant, P had not alleged specific facts
demonstrating lack of independence. Allegations of mere personal friendship or outside business relationships
standing alone are not enough to raise reasonable doubt as to director’s independence. To create reasonable
doubt that plaintiff must plead facts supporting the inference that b/c of the nature of a relationship that the non-
interested director would be more willing to risk his or her reputation than risk the relationship with the interested
director

Disinterested Shareholder Approval

Common law (which many statutes codify): informed shareholder ratification created a presumption that the
transaction was fair. When interested directors owned majority shares, shareholder ratification generally did not shift
the burden to the plaintiff.

Vogelstein  Informed, uncoerced, disinterested shareholder ratification of a transaction in which corporate

directors have a material conflict of interest has the effect of protecting the transaction from judicial review except
on the basis of waste.

Harbor Finance  Because the affirmative stockholder vote was voted on by the overwhelming proportion of the
Republic electorate, BJR is involved and merger can only be attacked as waste.

Lewis v. Vogelstein
Facts Mattel adopted a compensation plan for the company’s directors including an option grant. Under the plan,
outside directors were entitled to a one-time option grant of 15,000 shares. In addition, the directors were
eligible for additional option grants on reelection. The plan was then presented to the company’s shareholders at
the annual meeting for a vote. The shareholders approved the plan. Harry Lewis brought a shareholders’ suit in
the Court of Chancery of Delaware against Mattel and its directors. Lewis argued that the directors had violated
the duty of candor by failing to disclose the estimated value of the stock options. Lewis further asserted that the
directors breached the duty of loyalty, because the option grants represented self-dealing and thus had to be proven
entirely fair to the corporation.

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Holding P’s complaint should not be dismissed b/c one time option grants sufficiently unusual to require waste
inquiry
Analysis
- Shareholder ratification generally: Principal novelty of shareholder ratification is that a claim that
ratification is ineffectual can rest on 1) the majority of those affirming the transaction had a conflicting
interest or 2) the transaction constitutes corporate waste, which can only be done by unanimous vote
- Informed, uncoerced, disinterested shareholder ratification of a transaction in which corporate
directors have a material conflict of interest has the effect of protecting the transaction from judicial
review except on the basis of waste.
- The waste standard: An exchange of corporate assets for consideration so disproportionately small as to
lie beyond the range at which any reasonable person might be willing to trade – essentially constituting a
gift. If there is any substantial consideration & transaction done in good faith, then no waste.

Harbor Finance Partners v. Huizenga

Facts Republic Industries, Inc. acquired AutoNation Incorporated (AutoNation). Although Republic's directors
(defendants) owned a large amount of AutoNation shares, the merger was approved by a majority of informed,
uncoerced, and disinterested Republic shareholders. The vote was not unanimous. Harbor Finance Partners was
a dissenting shareholder of Republic. Harbor alleged that the terms of the merger were unfair to Republic and its
public shareholders and that the shareholder approval was based on a materially misleading proxy statement.
Holding Motion to dismiss granted because the complaint only pleads facts at most that the merger was unfair and
not that it constituted waste
Analysis
- Because the affirmative stockholder vote was voted on by the overwhelming proportion of the
Republic electorate, BJR is involved and merger can only be attacked as waste. This requires that no
person of ordinary sound business judgment could consider the merger fair. A non-unanimous although
overwhelming vote, does not extinguish a claim of waste.
- Waste doctrine is not necessary to protect stockholders where they are fully informed and
disinterested. Stockholders can choose not to ratify the transaction. DL law places high burden on
Board to show ratification effect, which is hard to prove at the motion to dismiss stage. Waste doctrine is
not necessary to protect minority shareholders from oppression by majority shareholders. DL law requires
that only the votes of those stockholders with no economic incentive to approve a wasteful transaction
count.

Corporate Opportunity Doctrine

Corporate Opportunity Doctrine  Usurping a corporate opportunity is a breach of the duty of loyalty by the
usurper. Subset of duty of loyalty and forbids a director, officer, or managerial employee from diverting to himself
any business opportunity that belongs to the corporation. Generally, corporations can waive the protections of the
corporate opportunity doctrine.

Corporate rejection  Rejection that is fully informed, disinterested, and made by an independent corporation
decision maker allows a manager to take the corporate opportunity and bars the corporation from later claiming it

Remedies  Traditional remedy is the imposition of constructive trust on the manager’s new business—eliminates
messy valuation problems and assumes manger’s actual profits approximate corporation’s potential lost profits

CA Courts  work that happens ‘at night,’ using your own work and ideas, we will let you use the ideas for your
own business, rather than ascribing it to your day job company

Corporate opportunity Tests

Line of Business Test (Guth)

[more restrictive than interest/expectancy test]

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If a corporation has an opportunity which aligns with the fundamental knowledge of the corporation and the
corporation can logically and naturally adopt its business having regard for its financial position, then the
opportunity is within the line of the corporation’s business

Guth: [Mr. Loft buys Pepsi himself instead of allowing Loft Incorporations to do so. Pepsi was on the edge
of bankruptcy and then eventually exploded after being purchased. Court held that taking Pepsi for personal
instead of giving the corporation an opportunity was a breach of the duty of loyalty.]

A corporate fiduciary cannot take a business opportunity if [Broz]

1) It is one that the corporation can financially handle [most courts ask this question first] [is the company
solvent enough to bring this on]

Economic capacity: There are different ways of determining economic capacity but generally it is
seen as an indication that the corporation was not interested in the opportunity

2) It is within the line of corporation’s business and advantageous to the corporation [slightly distinct
from the third question because it can reference expansion rather than there’s an expectation right now that
they’d be interested in this type of work]

3) AND It is one which the corporations had an interest or a reasonable expectancy.

Broz  Under the line of business test, where 1) the corporation could not financially handle purchasing the
license, 2) the corporation was actively divesting itself of other licenses, and 3) the director action in the transaction
had no duty to refrain from competition with a corporation at the time, the director did not violate the corporate
opportunity doctrine

Broz Langevoort Takeaway: as an opportunity comes to you outside your capacity as a director for that
company, we can’t expect outside directors to not abide by their ‘day job’

Interest or expectancy Test (Litwin v. Allen)

Corporate opportunities are not limited to actual ownership: circumstances under which corporate right or
expectancy may arise are
1) Directors undertaken negotiations in the field on behalf of the corporation OR
2) Corporation needed the particular business opportunity to the knowledge of the directors OR
3) That the business opportunity was seized and developed at the expense, and with the facilities of the
corporation. Important factor has been the special and unique value to the beneficiary like property,
patents etc.

Broz v. Celluzar Information Systems, Inc. 1996

Facts Broz was a director of CIS. He was also the president and sole stockholder of RFBC, a competitor of CIS.
CIS had financial difficulties and begun divesting its cellular licenses. Mackinac — third party cellular service
provider— sought to sell one of its licenses. Mackinac thought that RFBC would be a potential buyer and contacted
Broz. The license was not offered to CIS. Broz spoke informally with other CIS directors, all of whom told him
that CIS was not interested in the license and could not afford the license even if it were interested. At about
the same time, a fourth service provider, PriCellular, had undergone discussions with CIS about PriCellular
purchasing CIS. PriCellular had also been in negotiations with Mackinac about purchasing the license in question.
PriCellular agreed on an option contract with Mackinac about purchasing the license. The option was to last until
December 15, 1994, but if any competitor offered Mackinac a higher price during that time, Mackinac would be free
to sell the license for that higher offer. On November 14, 1994, Broz, on behalf of RFBC, offered Mackinac a
higher price for the license and Mackinac agreed to sell to RFBC. Nine days later, PriCellular completed its
purchase of CIS. CIS brought suit against Broz, alleging that Broz breached his fiduciary duties to CIS by
purchasing the license for RFBC when the newly formed PriCellular/CIS corporation had had the option open to
make the same purchase.
Holding Facts do not support conclusion that Broz misappropriated a corporate opportunity – Broz did not have a
duty to formally present the opportunity to the board of CIS because based on at least one of the factors below, the

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corporation was not entitled to the opportunity
Analysis
Line of Business Test
1) It is one that the corporation can financially handle  CIS could not financially handle
purchasing the license
o 2) It is within the line of corporation’s business and advantageous to the corporation & 3) it
is one which the corporations has an interest or a reasonable expectancy  Yes, the license
is in CIS’ line of interest BUT for an opportunity to belong to the fiduciary’s corporation, the
corporation must have an interest or expectancy in that opportunity. CIS was actively divesting
itself of license – CIS had no interest or expectancy in the license
4) By taking such opportunity, the corporate fiduciary creates a conflict  Broz was not
obligated to refrain from competition with PriCellular and CIS was fully aware of Broz’s
conflicting duties. Broz did not usurp any opportunity CIS was willing to pursue.
- At the time Broz purchased the license, PriCellular had not yet acquired CIS and we cannot hold
him responsible for an uncertain and unpredictable business transaction

Board Oversight
Three main ways a fiduciary breaches good faith: 1) Intentionally acts with a purpose other than the interest of
the corporation, 2) intends to violate positive law, 3) intentionally fails to act in face of known duty to act

Standard of Conduct versus Standard of Liability

Standards of conduct  states how an actor should conduct themselves in a given activity or play a given
role vs. Standard of review/ liability  the test the courts should apply when reviewing actors’ conduct to
determine whether to impose liability
MBCA § 8.30  Standards of Conduct for Directors
1. MBCA = Must show actions not in good faith or a decision that the board did not reasonably
believe were in the best interests of the corporation, or a P can show a sustained failure to devote
attention to ongoing oversight or making an appropriate inquiry when facts or certain material
circumstances arise
2. Parties seeking to recover must also establish harm of the corporation & proximate cause
MBCA § 8.31  Standards of Liability for Directors

Federal Overlay: Sarbanes-Oxley Act Section 303 requires managers of public corporations establish and maintain
an adequate internal control structure and procedures for financial reporting, and include an assessment of these
controls in the corporation’s annual report

Modern Approach to Oversight and Good Faith

- DCGL § 102(b)(7): permits companies to limit liability for directors (exculpatory clauses) unless the
liability concerns actions taken not in in good faith
o Delaware Supreme Court stopped short of recognizing a duty of good faith independent from
that of care and loyalty
Graham  All directors have to prove to avoid liability is that the director did not have any reason to know
that there was wrongdoing (DE law for 20 years)

Caremark [Not good law anymore]  The board must use good faith judgment that the corporation’s
information and reporting system is in concept and design adequate to assure the board that appropriate
information will come to its attention in a timely manner as a matter of ordinary operations. Proper test is one
where there is a lack of good faith evidenced by systematic failure of a director to exercise reasonable
oversight (a high bar). A director’s inattention must be egregious for liability to attach. Directors are not expected to
oversee all actions of all employees, but, directors must make good-faith efforts to ensure that reporting and
informational systems exist.

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Stone v. Ritter  . Where directors fail to act in the face of a known duty to act… they breach their duty of
loyalty [Therefore 102(b)(7) doesn’t apply] by failing to discharge that fiduciary obligation in good faith. In the
absence of red flags, good faith in the context of oversight must be measured by the directors’ actions to assure a
reasonable information and reporting system exists and not be second-guessing after the occurrence of employee
conduct that results in an unintended adverse outcome.

Graham v. Allis-Chambers [NOT good law anymore]

Facts: Derivative suit alleging antitrust violations by 4 non-director employees. Suit alleged that director-
defendants had either actual knowledge or should have known of the facts of illegal activity putting them on
notice. This theory transformed into an argument that the Ds were liable for failing to institute a
monitoring system. Plaintiffs argued that 2 former FTC decrees against the company enjoining them for
price-fixing put the corporation on notice for such activity in the future
Analysis: Only 3 of the present directors knew of the decrees and understood that they had consented to
them only to avoid the expense of defending against them, which does not show knowledge of past or
future price-fixing.
Rule: Absent cause for suspicion of wrong doing, there is not duty upon the directors to install and operate
a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.
Directors can be liable for losses if they act recklessly

Caremark
(chancery decision but is famous by name)
Facts Company subject to 4-year investigation regarding compliance with healthcare provider
regulations. Derivative suit followed alleging breach of duty of care. The claim is that directors
allowed a situation to develop and continue which exposed the corporation to enormous legal liability
and that in doing so they violated a duty to be active monitors of corporate performance
Analysis:. Two bases of liability for a breach of the duty to exercise appropriate attention: 1)
Negligence as to a decision, 2) Circumstances arising from unconsidered inaction (failure to act):
The broad rule of Graham is not applicable to DL in 1996. DL court has made importance of Board
central. Timely and relevant information is a predicate for board’s supervisory role under Section 141
of DGCL.
Holding Here, the directors made at least minimal efforts → No failure of oversight.
1) RULE: The board must use good faith judgment that the corporation’s information
and reporting system is in concept and design adequate to assure the board that
appropriate information will come to its attention in a timely manner as a matter of
ordinary operations. Proper test is one where there is a lack of good faith evidenced by
systematic failure of a director to exercise reasonable oversight (a high bar).
 A director’s inattention must be egregious for liability to attach. Directors are
not expected to oversee all actions of all employees, but, directors must make
good-faith efforts to ensure that reporting and informational systems exist.
Stone v. Ritter
- Langevoort  conscious disregard of responsibility/ spite functional equivalent of a waste taste (as
long as the monitoring system is not a complete waste)
- Failure to monitor becomes duty of loyalty issue Takes failure to monitor cases out of the protection
of §102(b)(7) since this section doesn’t allow exculpation of the violation of duty of loyalty (which is bad
for directors).
Facts AmSouth forced to pay fines b/c of gov’t investigations about employees’ failure to file suspicious activity
reports required by securities regulations — employee failed to follow the BSA/AML policies and procedures
already in place. KPMG found that the AmSouth directors had established programs and procedures for
BSA/AML compliance, including a BSA officer, a BSA/AML compliance department, a corporate security
department, and a suspicious banking activity oversight committee. Shareholders brought a derivative suit
against AmSouth directors for failure to engage in proper oversight of AmSouth’s BSA/AML policies and
procedures.
Holding Caremark articulates the necessary conditions predicate for director oversight liability: a) the directors

29
utterly failed to implement any reporting or information system or controls; b) having implemented such a system or
controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of
risk or problems requiring their attention. In either case, liability requires showing that directors knew that they
were not discharging their fiduciary obligations. Where directors fail to act in the face of a known duty to act…
they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith In the absence of
red flags, good faith in the context of oversight must be measured by the directors’ actions to assure a reasonable
information and reporting system exists and not be second-guessing after the occurrence of employee conduct that
results in an unintended adverse outcome.
Analysis
- Central to P’s argument is whether the directors can be exculpated via the clause in the articles of
incorporation 
Disney  a failure to act in good faith requires conduct that is qualitatively different from, and
more culpable than, the conduct giving rise to a violation of fiduciary duty of care. Example
applicable is: [go back to book to get 1 & 2] 3) intentionally fails to act in face of known duty to
act demonstrating a conscious disregard of a duty to act
The failure to act in good faith is a subsidiary element/ condition of finding a breach of the
duty of loyalty. Doctrinal consequences: 1) Good faith is not a separate fiduciary duty from that
of loyalty and care; and 2) Duty of loyalty is not limited to cases involving financial or other
cognizable conflicts of interest
Defendants had robust monitoring system that complied with statutory requirements

Shareholder Litigation
Cause of Action  Loyalty — substantive cause of action, most likely to proceed because no BJR

Case of Action  Bad faith, substantive cause of action, most likely to proceed because no BJR
A failure to act in bad faith may be shown when a fiduciary acts with a purpose other than the best interests
of the corporation, or where the fiduciary acts with the intent to violate positive law [if officer or director
chooses to commit a crime, that’s bad faith per se]

If there is a question of whether a suit is direct or derivative  ask to whom the money should be paid
Example: Van Gorkem was a class action (direct) by the shareholders because money from the merger
when to the shareholders, therefore each shareholder as individually injured by not getting a big enough
check

Direct Suit
Shareholders suing directly on their own behalf to vindicate individual rights (often class actions)

Pros: Direct comes with procedural perks to derivative of no demand requirement and no power of board to seek
dismissal before trial
Cons: subject to federal security laws

Direct or Derivative?
- Almost all derivative suits are filed in DE.
- Following actions are treated as direct:
1) Protection of financial rights
2) Protection of voting rights
3) Protection of governance rights
4) Protection of minority rights
5) Protection of informational rights

Derivative Suits
Any shareholder can bring a suit on behalf of the corporation in which they hold stock

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Standing in DE: under most state law you 1) must have owned the stock at the time of the alleged wrongdoing and
2) you must continue to be a shareholder throughout the litigation

Rationale  The shareholder asserts the rights belonging to the corporations because the board of directors fails to
so

Foundational premise of derivative action is the lawsuit is of the corporation, but we are temporarily allowing
the plaintiff to take control of it

Restrictions:
FRCP 23.1  requires that the derivative suit fairly and adequately represent the interests of the
shareholder similarly situated in enforcing the right of the corporation
Related to res judicata  if there has been a resolution of the case by judgment, final order, settlement,
the case cannot be relitigated by anybody else. In derivative actions the consequence is that no other
shareholder can try to do better.

Demand
Before you can bring a derivative action, Ps must bring a demand on the board that will remedy this issue. The
demand usually takes the form of a letter to let them know what the wrongdoing is and requests relief. If P makes
that demand, the directors can either accept it or reject it.

Board Accepts  If they accept the demand and correct it, and it doesn’t go to court, then it is done.

Board Rejects & Demand Required  death sentence for the law suit

Board Rejects & Demand Excused Law of most states allows P to bring a derivative action without making a
demand but only if the demand would be futile [demand excuse situation]. Demand Futility Claim: Courts after
Aronson made clear that the demand futility test is disjunctive: Ps must allege particularize facts creating a
reasonable doubt that the majority of directors are disinterested and independent or that the underlying
transaction was the product of a valid exercise of BJR

Delaware vs. MBCA

Delaware In DE litigation, the first question in a derivative action  Has there been a demand on behalf of the
corporation? If not, has demand been excused? If demand is required but a demand has not been made, the court
defers to the judgment of the Board
o Does not have a universal demand requirement in all cases
o P must make substantial allegations that a majority of the board is unable to evaluate the
demand [Not enough if 1-2 of the directors cannot]
o Presiding Case = Aronson v. Lewis

MBCA § 7.40 & § 7.42 Has a universal demand requirement in all cases (similar to NYC) but it does not serve as
consequence as a matter of law, it is solely to put the directors on notice that a suit will be filed. The corporation is
then invited to create an SLC and as in NYC, as long as that committee merits the presumption of the BJR
(disinterested & independent) the court will defer to its recommendation. Once demand is made, shareholder must
wait 90 days for board to take correction action

DL Demand Parts 1 & 2

Part 1: Is demand excused or required?

Delaware—Aronson Test: Demand can only be excused where facts are alleged with particularity which
create a reasonable doubt that the directors’ action was entitled to the protections of the BJR. Court must
determine whether there is reasonable doubt that:
1) the majority directors are disinterest and independent,

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 2) or 2) the challenged transaction was otherwise the product of a valid exercise of BJ. Latter
inquiry – the alleged wrong substantively viewed against the facts alleged in the complaint.
Mere threat of personal liability for approving a questioned transaction, standing alone,
is insufficient to challenge either the independence or disinterestedness of directors

If demand is required  BJR applies

Part 2: If demand is excused (when demand on the board is excused as futile, the courts listen to SLC—but with
suspicion)

Delaware/ Zapata Test:

[Review of independence of SLC members]
1) No material doubt standard  Court should inquire into the independence and good faith of the
committee and the bases supporting its conclusions. Limited discovery may be allowed and the
corporations has the burden of proving independence, good faith and a reasonable investigation. There
can be no material doubt (like summary judgment) it must be obvious that the SLC is independent

[Review of SLC Decision]

2) De novo review  The court should determine, applying its own independent business judgment
(which is more akin to legal judgment), whether the motion should be granted. Court should weigh
how compelling the corporate interest is in dismissal when faced with a non-frivolous law suit

Auerbach (NY) Test

[Review of SLC Decision]
When a BOD delegates its authority to a committee of disinterested members (SLC), the official
determination of those members will be accorded due deference under the BJR as long as the decision does
not constitute waste

Einhorn Test (Wisconsin)

[Review of independence of SLC members]
Whether a member of a committee has a relationship with an individual defendant or the corporation that
would reasonably be expected to affect the member’s judgment with respect to the litigation in issue.
Factors to be considered [Langevoort says the court wants to look at all 7 factors] The test is created to
overcome any structural bias issues. It is a totality of circumstances analysis. The court must look at each
member of the SLC. Court wants to see compelling case of independent and disinterested, if this is
met, then they will follow the recommendation of the SLC, if not they will reject the recommendation
[Review of SLC decision  close to BJR]
1. A committee members’ status as a defendant and potential liability
2. A committee member’s participation in or approval of the alleged wrong doing or financial
benefits from the challenged transaction
3. A committee member’s past or present business or economic dealings with an individual
defendant
4. A committee member’s past or present personal, family, or social relations with individual
defendants
5. A committee member’s past or present business or economic relations with the corporation
6. The number of members on a special litigation committee
7. The role of the corporate counsel and independent counsel

Policy:
- It is a way for judges to filter derivative suits that have merit and those that don’t.
- Demand requirement is a way for judges to balance the board’s managerial prerogatives and the
desirability, in certain circumstances, of allowing shareholders to litigation on behalf of the corporation
- The Demand Requirement is a filter to separate cases where the board is disabled by conflicts of interests
from cases when the board can make good faith decisions
- Intended to protect the shareholders and the company from nuisance lawsuits

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 - Problems with Bringing Demand: If you make a demand, you are conceding that the board is capable of
making a good faith decision & you lose your ability to demand futility

Aronson v. Lewis (DE)

Court says you have to plead particularized facts – which means in your complaint – without discovery etc. You
must rely on shareholder information rights, § 220 of the DCGL gives shareholders the right to seek information
from books and records if they have a proper purpose, and proper purpose is fulfilled when a shareholder wants to
bring a lawsuit but needs information rights to particularize our facts
Facts Lewis owned stock in Meyers Parking System — a Delaware corporation. Fink was a director of Meyers
and owned 47 percent of its outstanding stock. Meyers’s directors approved a lucrative employment agreement
for Fink and made interest-free loans to him. Lewis brought suit against Meyers and its directors alleging that
the transactions were only approved because Fink had personally selected the directors of Meyers, and that
the transactions had no business purpose and were a waste of corporate assets. The complaint stated that no
demand was made on the board of directors to address the alleged wrongs because (1) the directors participated
in the wrongdoings; (2) Fink selected the directors and thus controlled the board; and (3) litigation brought by the
directors would require them to sue themselves, precluding effective prosecution. Meyers and its directors filed a
motion to dismiss based on Lewis’s failure to make a demand or to demonstrate that such a demand would be
futile.
Holding
Rule: Demand can only be excused where facts are alleged with particularity which create a reasonable doubt that
the directors’ action was entitled to the protections of the BJR. Court must determine whether there is reasonable
doubt that 1) the directors are disinterest and independent, or 2) the challenged transaction was otherwise the
product of a valid exercise of BJ. Latter inquiry – the alleged wrong substantively viewed against the facts alleged in
the complaint. Mere threat of personal liability for approving a questioned transaction, standing alone, is
insufficient to challenge either the independence or disinterestedness of directors P did not allege such facts
and so case is reversed and remanded to allow leave for P to amend its complaint.
Analysis
- BJR is bound to common principles
o 1) Its protections are only available to disinterested directors whose conduct otherwise meets the
test of BJR – if not, then BJR doesn’t apply to demand futility
o 2) Directors must be informed as to business decisions on the standard of gross negligence
o 3) BJR technically does not apply to failure to act but it may apply to a conscious decision to
refrain from exercise
- Control and domination: P does not plead particularized facts manifesting a direction of corporate
conduct in such a way as to comport with the wishes or interest of the corporation (or persons) doing the
controlling (this is the standard)
- Employment Agreement The complaint does not allege particularized facts showing that the agreement
was a waste of corporate assets

Special Litigation Committees

SLC is made up of independent directors who are not defendants in the derivative action and the SLC typically
hires independent lawyers and advisors who also become directors. The SLC investigates the claims in the
complaint, and then acts for the corporation to recommend to the court whether to allow the litigation to proceed

Termination When Demand is Excused

In response to a derivative suit, corporations often form a special litigation committee to consider whether it is in
the best interest of the corporation to take over the suit, allow it to continue, or to dismiss it

BJR  Where there is no conscious decision by directors to act or refrain from acting, the business judgment
rule has no application, making it impossible to apply the Aronson inquiry. [Apply Rales test]. BJR can only be
claimed by disinterested directors whose conduct otherwise meets the tests of business judgment.

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Early cases precluded review of SLC recommendations based on the BJR but later cases have scrutinized the
independence of the SLC members. “Structural bias” concern that SLC member might be influenced by other
directors, including defendants in the derivative action

Auerbach v. Bennett
New York Approach
Facts SLC investigated and concluded that none of the defendants had breached their duty of care or profits
personally from challenged payments.
Holding + Rule: When a BOD delegates its authority to a committee of disinterested members (SLC),
the official determination of those members will be accorded due deference under the BJR as long as the
decision does not constitute waste. BJR. SLC is disinterested, thorough report written up, SLC’s decision is
okay.

Zapata Corp v. Maldonado Delaware Supreme Court

Delaware Approach
Facts: P alleged that certain actions constituted a breach of fiduciary duty and that demand was excused
because a majority of the directors had benefited from the challenged decision.
Holding (rejecting Auerbach approach) – instituting two-part test
 1) No material doubt standard  Court should inquire into the independence and good
faith of the committee and the bases supporting its conclusions. Limited discovery may
be allowed and the corporations has the burden of proving independence, good faith and
a reasonable investigation. There can be no material doubt (like summary judgment) it
must be obvious that the SLC is independent
 2) De novo review  The court should determine, applying its own independent
business judgment (which is more akin to legal judgment), whether the motion should be
granted. Court should weigh how compelling the corporate interest is in dismissal when
faced with a non-frivolous law suit
Einhorn v. Culea
Wisconsin approach
Facts A shareholder brought a derivative action. A special litigation committee was created pursuant to
Wisconsin law to determine whether the derivative action was in the best interests of the corporation. The
parties disputed whether the special litigation committee was composed of independent directors as
required by statute.
Holding A corporation may create a special litigation committee composed of independent directors to
determine whether a derivative action is in the best interests of the corporation.
Analysis
Wisconsin Statute  SLC can comprise of two or more independent directors appointed by a
majority vote of independent directors present at a meeting of the board of directors. If the committee
acts in good faith, conducts a reasonable inquiry upon which it bases its conclusions and
concludes that the maintenance of the derivative action is not in the best interests of the
corporation, the circuit shall dismiss the action.
Test: Whether a member of a committee has a relationship with an individual defendant or the
corporation that would reasonably be expected to affect the member’s judgment with respect to the
litigation in issue.
Factors to be considered [Langevoort says the court wants to look at all 7 factors] The test is
created to overcome any structural bias issues. It is a totality of circumstances analysis. The court must
look at each member of the SLC. Court wants to see compelling case of independent and
disinterested, if this is met, then they will follow the recommendation of the SLC, if not they will
reject the recommendation
8. A committee members’ status as a defendant and potential liability
9. A committee member’s participation in or approval of the alleged wrong doing or financial
benefits from the challenged transaction
10. A committee member’s past or present business or economic dealings with an individual
defendant
11. A committee member’s past or present personal, family, or social relations with individual
defendants

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 12. A committee member’s past or present business or economic relations with the corporation
13. The number of members on a special litigation committee
14. The role of the corporate counsel and independent counsel

Alternatives
What would be a good reason for an SLC to advocate for dismissal even if they report a breach of fiduciary duty?
Even though there might be probable cause, that litigation is fact intensive and expensive and may not cover the
recovery

Avoidance of embarrassment is a good reason to not go forward with a lawsuit recommended by the SLC in NYC
(like if the corporation used bribes)

Insurance

Ways to avoid personal liability: 102(b)(7) exculpation, indemnification, insurance. Corporations will often buy
several insurance policies, creating a tower of policies for when one policy maxes out of covered liability

Parts of D&O (director and office) Coverage

1) Reimburses the corporation for its lawful expenses in connection with indemnifying its directors
and officers, thus encouraging indemnification by corporation
2) Covers claims against individual directors & officers acting in their corporate capacity, thus
reducing their exposure when the corporation is unwilling or unable to indemnify, up to the limit that
has not been indemnified .
3) D&O coverage may cover amounts paid in judgment or settlement in a derivative suit. May cover
conduct that does not satisfy statutory indemnification requirements

D&O Exclusions and Coverage Denial

1) Intentional Wrongdoing Plaintiff trial lawyers will threaten a finding by jury or judge of intentional
wrong doing which an insurance company won’t cover
2) Bad Faith is coverable, until the case steps over the line into wanton wrongdoing (fraud) D&O
insurance does not apply to dishonest, fraudulent or criminal conduct. Some policies require a
judgment finding which incentivizes to settle without receiving a judgment.

Policy Implications:
Law firms drive derivative litigation, as long as the law firm is reasonably equipped and has had
success in the field, we will not ask a lot of named plaintiff other than choosing a good firm. Lawyer’s
interest in settlement motivates lawyer to settle cheap and move onto the next case and deploying the
law firm’s resources again to settle again, taking your 20–30% chunk, and moving on, and so on and
so on
Agency costs of litigation There is not much financial gain for plaintiffs in class action or derivative
suits. The biggest financial incentive is held by the plaintiff’s attorneys who will get a chunk of the
settlement. The attorneys – agents of the principle – have an incentive to bring meritless but annoying
lawsuits to get a settlement or accept a less than great settlement so that they can ensure some income.
The two questions the attorneys are is 1) is there sufficient evidence of wrong doing to get through the
pleading stage, and 2) whether there is sufficient evidence of damages. The lead plaintiff in a class
action case is identified by the one who has the most to lose.
Attorney’s Fees In derivative suits, the corporation is required to pay whatever fee is awarded on the
grounds that it has derived a benefit from the successful prosecution
Lodestar approach: Number of hours*attorney hourly rate = lodestar. Lodestar can be adjusted
up and down based on the contingent nature of the work or the fraction that it represents of total
recovery. (may incentivize attorneys not to take early settlements to increase hour)
Percentage approach: % of total recovery. (may incentivize attorneys to settle a case very early
as to not expend as much time on it and are deterred from including non-pecuniary benefits in the
settlement because they will produce no monetary value in the fees

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Executive Compensation
Triggers duty of loyalty  any transaction between the corporation and the board of directors where a director has
a material interest (and the CEO is always on the board). So, how does this affect executive compensation? You can
cleanse conflict of interest transactions with disinterested and independent directors.

Challenging Executive Compensation

1) Fairness Review if not approved by independent and disinterested directors (no BJR)
a. Executive Compensation as Self-dealing Transactions Executive compensation cases are
usually brought to court as a form of self-dealing
i. When an executive is sufficiently senior that he can influence the decision on his
compensation, we have a transaction that presents all the traditional dangers of self-
dealing: since the executive is to some extent on both sides of the transaction, there is
a risk that the corporation will not be treated fairly
1. Courts typically look to the “fairness” of the transaction, and are influenced
by the fact that there has (or has not) been approval by disinterested
directors and/or ratification by shareholders. Executive compensation is
subject to a special type of judicial review even though it is self-dealing
2) BJR Applies and P Must Show Waste OR Bad Faith
a. BJR Applies if:
i. A majority of the disinterested directors have approved it, following disclosure of all
material facts about it OR
ii. The shareholders have approved it [all of them], following disclosure of all material
facts about it
b. Defining Corporate Waste
i. Delaware → There is only waste if what the corporation has received is so inadequate in
value that no person of ordinary, sound business judgment would deem it worth that
which the corporation has paid.
1. Courts only find waste when: Examples: Issuing stock without consideration
or using corporate funds to discharge personal obligations
c. Bad Faith Intentional dereliction of duty, a conscious disregard for one’s responsibilities.
bad faith: [Court finds this to be bad faith] because there is a space of conduct between intent
to harm and negligence and legislature has recognized this conduct in DCGL Section 102(b)(7)(ii)
(Disney)

Compensation Committee  Compensation committee usually hires outside consultants to help them determine
how to set up the compensation system (determination of salary, stock options, etc.)

Business Judgement Rule usually applies in these cases

b. Executive pay is generally a matter of business judgement. May be problems of self dealing but under
duty of loyalty, courts usually don’t use a fairness standard of review.
c. However, sometimes there are not enough disinterested directors so courts can assess fairness.
d. If it is under the BJR → have to prove “waste.” [decision is so egregious that you are giving
corporate assets in return of nothing.]
e. The business judgement rule can be overcome if board action lacked a “rational” business purpose.
i. Argument: The transaction wholly lacks consideration, or “waste” or “spoliation” of
corporate assets.

Issues with executive compensation

- Giving perverse incentives to get the maximum amount of compensation at the harm of the company
- Income inequality
- Conflicts of interest

Compensation often comes in the form of a Restricted stock grant or stock options. What do these structures
do? Prime incentive of executive is to get the stock price increased which may encourage fraud/ manipulation

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Life Cycle of Disney Case
 Plaintiff could argue that the conduct rises above gross negligence to be a breach of the duty of care, citing Van
Gorkem, but then 102(b)(7) was passed (exculpation)
 Plaintiff may argue for duty of loyalty  but Ovitz is not on the board so there is no conflict  they then decide
to make the argument about Eisner, that bringing in Ovtiz is was to enrich Eisner
Defense  Motion to dismiss for failure to state a claim upon which relief can be granted & motion to dismiss for
lack of demand, arguing that demand is required.
Plaintiff  No demand is excused. Standard: are there particularized facts in in the complaint giving rise to a
reasonable belief, that the majority of the directors are disinterested, independent, and otherwise has the protection
of the BJR.
Chancellor  Duty of Loyalty: Eisner & Ovitz were not friends, there’s no reason to think he was just hiring a
friend for his own benefit, and Eisner owns the most Disney stock, and therefore there is all the reason to believe
that he has the interest that is best for the company in appointing successor. Court grants motion of dismiss because
no loyalty issue. Demand: Out of an abundance of caution, the court does the demand excused analysis for each
member of the board, to avoid reversal.
Plaintiff  decides to go the bad faith route (conscious disregard of responsibility)

In Re Walt Disney Company Derivative Litigation

Langevoort  compensation package loaded with stock options and restricted stock (OEA). A board cannot create
an agreement with an employee without the ability to terminate them and for any reason, as a way to preserve
business judgment discretion. Core of these agreement is the concept of ‘the buyout,’ if we fire you with or
without cause, we will buy you out. Usually two provisions: No Fault Provision buy-out for x is a large sum
on money, if Fault Buy-out  then usually a small fixed sum
Facts Disney hired Ovitz as its president. The board of director’s compensation committee approved an
employment agreement with Ovitz, which contained a non-fault termination provision providing that if Ovitz
left his employment with Disney through no fault of his own, he would receive a severance package. At its
meeting, the compensation committee considered information that, in the event of a non-fault termination, Ovitz
would receive the value of his salary of $1 million per year and the value of his annual bonus payments of $7.5
million for the rest of the contract term, a $10 million termination fee, and an acceleration of his options for three
million shares which would be immediately exercisable at market price. The committee was also informed that the
option portion of Ovtiz’s severance package could have reached a value of $92 million if Ovitz was terminated
without cause after one year of employment. The committee also knew that Ovitz was leaving a very lucrative
position to work for Disney, and by doing so was sacrificing commissions of $150 to $200 million. Fourteen
months after he was hired, Ovitz was terminated on a non-fault basis, and received approximately $130
million under his severance package
Holding Court of Chancery found that the committee’s processes fell short of best practices but did not dip below
duty of care standard to reach gross negligence. The record shows that the committee was so informed that the
magnitude of the severance package could reach $92 million if they terminated Ovitz after one year without cause.
And there was no breach of the duty of good faith
Analysis
- Due Care Determinations
1) Court of Chancery was right under Delaware law and has proscribed in the charter that the
compensation committee could approve compensation packages rather than the full board
2) Court of Chancery found that the committee’s processes fell short of best practices but did not dip
below duty of care standard to reach gross negligence. The record shows that the committee was
so informed that the magnitude of the severance package could reach $92 million if they
terminated Ovitz after one year without cause.
3) Directors were informed of all information reasonably available when they elected Ovitz as
president and therefore was not grossly negligence
- Good Faith Determinations
 Three categories of bad faith
 1) Subjective bad faith – classic bad faith, intent to do harm [Intent
requirement reiterated in Stone v. Ritter

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  2) Lack of due care – gross negligence (Van Gorkem) without more cannot
constitute bad faith, only breach of duty of care
 3) Intentional dereliction of duty, a conscious disregard for one’s
responsibilities. bad faith: [Court finds this to be bad faith] because there is
a space of conduct between intent to harm and negligence and legislature has
recognized this conduct in DCGL Section 102(b)(7)(ii)
- Waste Claim P who fails to rebut business judgment doctrine is not entitled to remedy unless transaction
constitutes waste No Waste/ BJR Applies: Payment of contractually obligated amount cannot
constitute waste unless the contractual obligation was itself wasteful. The approval of the NFT
provisions of the OEA had rational business purpose [incentivizing Ovitz to leave CAA] and do not meet
the high standard of waste

Insider Trading
Insider Trading = Occurs when a corporate “insider” (generally an employee or director of the corporation whose
shares are being traded) buys or sells the corporation’s stock, at a time when he knows material non-public
information about the company’s prospects

Generally, federal securities laws bar only that insider trading that occurs as the result of someone’s willful breach
of a fiduciary duty

Annual Report to Shareholders, 10-K  There is no duty to disclose any information unless an obligation is
created, the main creator of which is the SEC

State Law

1) State law has some relevance in close corporations where special facts are basis for fiduciary liability, 2) useful
to understand federalism dynamic

Special facts doctrine [Goodwin] Where a director personally seeks a stockholder for the purpose of buying
his shares without making disclosure of material facts within his peculiar knowledge and not within reach of the
stockholder, the transaction will be scrutinized and relief can be granted There is no duty to disclose before trading
in impersonal market

NYC & DE  there can be a derivative suit that seeks to recapture the earnings of the insiders because insider
trading is a form of the violation of the duty of loyalty. What stands in the way of demand is that it will be hard
to show particularized facts that the board is not independent, that is so because insider trading is generally an
isolated practice. In which case, demand is required.

CA  most intense with regulating insider trading, which follows on how they do not fully follow the internal
affairs doctrine

Goodwin v. Agassiz
[majority rule in state law issues, closed corporations usually]
Facts Goodwin owned stock in Cliff Mining Company. Exploration on some of Cliff’s property was undertaken in
1925 in an attempt to find copper deposits. In March 1926, Agassiz and MacNaughton (defendants), directors of
Cliff, learned of a geologist’s theory regarding the existence of copper deposits in another part of Cliff’s
property. The defendants thought that if the geologist’s theory was correct, Cliff’s stock would go up. Soon
thereafter, in May 1926, the initial exploration was stopped because it was unsuccessful. At that time, Goodwin,
with no knowledge of the geologist’s report, sold his stock in Cliff through a broker. The stock ended up being
bought by the defendants. Goodwin brought suit against the defendants on the ground that the defendants’
nondisclosure of the geologist’s theory to Cliff’s stockholders was improper. The nondisclosure did not harm
Cliff, but Goodwin claimed that he personally would not have sold his stock if he had known about the geologist’s

38
theory. The trial court dismissed Goodwin's complaint, and Goodwin appealed.
Holding Directors committed no wrong when they did not disclose the theory of the report before buying P’s stock
– P was not a novice investor
Analysis Directors do not have a position of trustee toward individual stockholders. We do not want to deter people
from board positions because they have to disclose everything to person on the other side of the transaction. [special
facts doctrine] Where a director personally seeks a stockholder for the purpose of buying his shares without
making disclosure of material facts within his peculiar knowledge and not within reach of the stockholder, the
transaction will be scrutinized and relief can be granted

Federal Law

SEC Rule 10b-5 prohibits insider trading—prohibits any fraudulent or manipulative device in connection with the
purchase or sale of a security [bars most insider trading]

SEC Rule 16-b prohibits insider trading (disgorgement liability); Section 16 of SEC Act: only applies to specified
insiders and only stock held for 6 months or less

Chiarella & O’Hogan (SCOTUS)  fiduciary obligation is source of insider trading

Chiarella/ Classical Theory 10b–5 violation can only occur when there is a duty to disclose arising from a
relationship of trust and confidence (fiduciary duty) between the parties to the transaction, such as the
relationship that the Court said corporate insiders have to corporate shareholders. Silence in connection with the
purchase of sale of securities may operate as a fraud actionable under § 10(b)…. BUT when an allegation of fraud is
based upon nondisclosure, there can be no fraud absent a duty to speak. A duty to disclose under § 10(b) does
not arise from the mere possession of nonpublic market information. [Defendant did not have a relationship
with the sellers of target company’s securities, not a fiduciary, agent]

Dirks  Extends classic theory to tippers and tippees (when an insider tells information to a family or friend etc.
who then trades on the information). Tipping as an insider can breach fiduciary duty if the insider will benefit
directly or indirectly from the disclosure. Tippee violates 10b–5 if she knows or should know that there has been
a breach

O’Hagan/Misappropriation theory  Misappropriation theory: trading on the basis of material nonpublic

information is a breach of duty owned to the source of the information. Violates 10b–5 even though
misapprorpiator dues not owe a duty with the person with him she trades. The victim is the principle (Grand Met),
there must be fraud, there is fraud here because they are deceiving the principle by using the information without
telling Grand Met what they are doing

Chiarella v. United States

[Newly appointed conservative Supreme Court gets a chance to speak to insider trading]
Facts Chiarella was employee for printing company that handled documents concerning corporate takeovers.
The companies to be acquired were redacted until the final draft of the takeover agreements. In one instance,
Chiarella was able to discover the companies involved in a takeover bid through the information provided in
the draft takeover agreement. He then traded on this information, which was not public, and enjoyed earnings of
$30,000. When it was discovered he was trading on nonpublic information, the United States (plaintiff) brought
charges against him for violation of § 10(b) of the Securities Exchange Act of 1934, prohibiting fraud in the
purchase or sale of securities, based on Chiarella's nondisclosure of information. At trial, Chiarella testified that the
information he used in the stock trading was confidential, and that he obtained the information by deciphering the
documents that the companies had provided to his employer.
Holding Silence in connection with the purchase of sale of securities may operate as a fraud actionable under §
10(b) despite absence of statutory or legislative history addressing legality of nondisclosure. When an allegation of
fraud is based upon nondisclosure, there can be no fraud absent a duty to speak. We hold that a duty to disclose

39
under § 10(b) does not arise from the mere possession of nonpublic market information. Justice Powell says when
we go back to cases like Hodgekis, the minority rule — special facts doctrine — when a fiduciary is disloyal and
fails to disclose informational advantage, there is fraud. Chiarella is off the hook because he does not have a
fiduciary duty because he is buying stock in the target firm not the bidding company. Game is finding the fiduciary
nexus, running from trader to those who sold the stock to the trader and that chain is a set of links all
categorized by fiduciary duty.
Analysis Court of Appeals theory: the use by anyone of material information generally not available is fraudulent
because such information gives certain buyers or sellers an unfair advantage over less informed buyers or sellers
Defects: 1) not all financial unfairness constitutes fraud, 2) element to make silence fraudulent due to a duty to
disclose is absent in this case Defendant did not have a relationship with the sellers of target company’s
securities, not a fiduciary, agent —10(b) only applies to fraud based upon nondisclosure,

United State v. O’Hagan

[Misappropriation Theory]

Langevoort: Is the misappropriation theory valid? And does it allow prosecutors follows insider trading outside the
classical theory (Goodwin)? This case is factually similar to Chiarella. Misappropriation theory is an alternative
theory for prosecutors to use to go after insider trading. In misappropriation theory  the victim is the
principle (Grand Met), there must be fraud, there is fraud here because they are deceiving the principle by using the
information without telling Grand Met what they are doing
Facts O’Hagan was partner in the law firm that represented Grand Met in its tender offer to Pillsbury common
stock. The possibility of the tender offer was confidential and not public until the offer was formally made by
Grand Met. However, during the time when the potential tender offer was still confidential and nonpublic,
O’Hagan used the inside information he received through his firm to purchase call options and general stock
in Pillsbury. Subsequently, after the information of the tender offer became public, Pillsbury stock skyrocketed and
O’Hagan sold his shares, making a profit of over $4 million. SEC initiated an investigation into O’Hagan’s
transactions and brought charges against O’Hagan for violating § 10(b) and § 14(e) of the Securities Exchange Act
Holding Criminal liability under § 10(b) may be predicated on the misappropriate theory.
Analysis
- Section 10(b) proscribes 1) using an deceptive device, 2) in connection with the purchase or sale of
securities, in contravention of rules prescribed by the Commission
- Misappropriation theory  a person commits fraud in connection with a securities transaction when he
misappropriates confidential information for securities trading purposes, on breach of a duty owed to the
source of the informant, based on a fiduciary-turned-trader’s deception of those who entrusted him with
access to confidential information
1) Deceptive Practice: If the fiduciary discloses the source that he plans to trade on the nonpublic
information, there is no ‘deceptive practice’ and thus not §10(b) violation
2) “In connection with the purchase or sale of a security” occurs when without disclosure to his
principal, he uses the information to purchase to sell securities – he deceives the source of the
information and members of the investing public

United States v. Black

Facts: Canaidan billionaire, Conrad Black and member of board of publicly traded company, Hollinger.
Engineered sale of subsidiary of Holligner worth hundreds of millions of $$$ sold to acquirer. Price is paid
to Hollinger. Terms: $5 million of purchase price represents payment for H’s agreement not to compete in
anyway with sub. H passes $5 to Mr. Black & others (this is a secret).

Under DE law  breach of duty of loyalty  BJR suspended Burden of proof is on proving
party to show intrinsic fairness/ cleansing (SLC)/ is demand excused or required? In this case,
the board did not know about transaction (they were duped) which also means demand is required
because it also mean they were independent and disinterested

Federal Law (SEC)  No 1-1 on federal law for insider trading as with DE law. Affirmative
legal obligation to name manager s and disclose conflict of interest transactions they entered into
with the company the value of which is greater than $120,000. If you lie about it, then it becomes

40
 a fraud and an omission. In the Black case the SEC brought an enforcement action against
Black, no BJR under SEC regulations. SEC usually will not settle a case unless D waives
indemnification

DOJ  Indict Conrad Black for willful violation of federal securities law punishable by 20 years
in prison. Black convicted

How might news be discovered if there is no duty to disclose? 3 phenomena:

1) Short sellers  people who think stock price is going to drop, to engage in sales of securities even
though they don’t own any (borrowing securities from a broker and sell them, then you buy them back
at a lower price of what you sold them for and return them to the broker). Short-sellers don’t just hope
the stock is going to go down, they make it go down by releasing the bad news causing stock to drop.
Interesting question is whether this is insider trading.
2) Whistle blowers  Revealing what is going in in ways that make the company vulnerable.
Whistleblower has 10–30% of SEC enforcement judgment
3) Social media  Keeping up with corporate chatter.

Structures
Hypothetical Lawyer contacted by three people who want to go into business together. One is an engineer with
expertise in line of business, another familiar with financials, and third person who doesn’t want to take part in
active management but has a lot of capital to contribute.

What form should the enterprise take?

a. Three alternatives to corporation
i. General Partnership (GP)
1. Pro:
a. Egalitarian
b. Flexibility
c. Taxes (GP not a person in the eyes of the law, aggregate of activity of
individual partners, not formation of distinct legal entity – which also
explained why there’s no limited liability).
2. Cons:
a. Fragile
b. Liability  personally liable to the full extent of their wealth
c. Risky (see liability)
ii. Limited partnership (LP)
iii. Limited Liability Company (LLC)

DE Law  LLC is premised on freedom of contract. Gov’t distancing themselves. LLC can have anything it wants
as long as it is good under K law

Can LLC eliminate fiduciary duties? Yes in DE: Many states say no but DE has said clearly that as long as the
operating agreement is clear and all fiduciary duties are being disclaimed, that will be given effect. Implied in every
contract, however, is good faith and fair dealing. And even in DE, you cannot relax the liability of someone who
acts in good faith. In the corporate setting, there must be a way of remedying disloyalty

Corporation
Centralized management in the board of directors. Shareholders have limited liability and cannot force corporation
to buy back their shares

1) Formation: Filing articles of incorp.

2) Liability: Shareholders have limited liability
3) Management: Centralized board of directors

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 4) Financial rights: no right to profits unless via dividend. Directors & execs. no right to compensation
unless provided in contract
5) Existence: perpetual
6) Dissolution: Voluntary and must be agreed by board and maj. of voting shares approve. Shareholders
have no right to demand payment for shares. Favors prerogative of the majority because power is
centralized in management, all of whom can be elected by the majority shareholder
7) Transferability of interests shareholders can sell stock without consent of corporation or shareholders
8) Mergers must be approved by board of directors of both corporations and the shareholders and articles
of mergers is filed

General Partnership
Association of two or more persons to carry on as co-owners a business for profit. All partners are personally liable.
GPs can enter into GP contract, but presumption is that partners have equal power.
1) Formation: Private contract
2) Liability: Joint and several liability and partners have ability to bind GP
3) Management: management is vested in all partners, changes via majority vote of partners but major
changes require uniform consent, partners can bind GP because they are agents
4) Financial rights: partners equally share in profits and losses to their share in profits. Partners have no
right to compensation unless otherwise agreed
5) Existence: for term or at will
6) Dissolution: Major consequence  At-will GP dissolved (no lock in) with withdrawal of any partner.
The partner can demand business be liquidated and net proceeds distributed to the partners. Minority
partner can withdrawal and cause dissolution which lends itself to opportunistic behavior
7) Transferability of interests all current partners must consent to the transfer of a GP interest and
admission of a new partner. Partner can transfer financial interest in GP and transferee can share in
partnership’s profit without a voice in management.
8) Mergers approval by GPs, nothing needs to be filed

Limited Partnership
Providers of capital can be brought in who will be passing investors, there must always be at least one entity that
had unlimited liability for limited liability partners’ debt. IRS said that this type of partnership gets partnership tax
structure. LP is always seeing a tax shelter

1) Formation: requires filing a certification naming the officers and identifying general partner
2) Liability: GPs have unlimited liability; LPs have limited liability and under RULPA, such liability is
not affected by participation in LP management
3) Management: Under most recent ULPA, limited partners do not lose liability for participating in
management. LPs have voting rights as specified in the agreement and general partner is agent of LP
and can bind it
4) Financial rights: financial sharing directly proportional to capital contributions
5) Existence: business continued upon death, bankruptcy or voluntary withdrawal of a limited partner.
6) Dissolution: LP only dissolved with withdrawal of GP
7) Mergers approval by GPs and LPs

Limited Liability Partnerships

Only LLP is liable for business organizations. All partners have limited liability
1) Formation:
2) Liability: General partnership structured like a corporation so the corporation is liable for unpaid debts
to the LP but the individual officers are not personally liable (except for tort and K obligations)

Limited Liability Company

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Investors are called members and have limited liability. Management specified in operating agreement and can
have decentralized member management or centralized manager management. Contractual flexibility and can be
taxed as a partnership (which means no corporation tax).
1) Formation: files articles of organization and members enter into an operating agreement
2) Liability: limited liability for all members and managers of its obligations and individuals can
participate fully in management. Complete limited liability. Design management; tax benefit of
partnership; limited liability. So why would you ever not want to be an LLC? If company ever expects
to go to public, they must be in corporation form.
3) Management: control is given to whoever is assigned the role 1) Member-managed: members have
authority to make management decisions and act as agents to the LLC. 2) Manager-managed:
someone designated by contract as the one who makes the business decisions – members not agents
and only make major decisions, managers are agents and make most business decisions
4) Financial rights: statutes vary, generally required for distributions be approved by all members unless
agreed otherwise
5) Existence:
i) Partnership model: RULLCA unilateral withdrawal of a member by express will does not
result in dissolution
ii) Corporate model (and DE): prevents member from withdrawing or resigning unless
permitted by the LLC agreement
6) Mergers merger plan approved by all members and documentation must be filed, one LLC survives
the merger and one ceases to exist

Representing Corporations

Attorney-client relationship:
- Lawyers must get informed consent when clients have a conflict of interest or withdraw
- Lawyers must keep the client reasonably informed and comply with requests
- Lawyer must inform client of a situation requiring client’s informed consent
- Lawyer must consult with client about objectives
Entity vs. Aggregate
- Entity Theory  lawyer only represents corporation. If individuals present information to the lawyer
before incorporation of corporation, courts find that the entity theory is retroactive – lawyer’s pre-
incorporation involvement is a representation of the entity-to-be-formed, not the individual
- Aggregate Theory  assumes lawyer represents both the entity and the participations. More likely
when they are very few participants and they believe lawyer represents them individually

Reasonable expectations: lawyer must make an effort to explain whether he represents only the entity or the
individuals as an aggregate, courts have found payment by the entity as an indicator that the attorney represents the
corporation

Pre-Corporation Contract Problem

Both parties know there is no corporation

1) Promoter contracting for the benefit of a corporation not yet formed is personally liable on
the contract in absence of an agreement otherwise. Promoter is not discharged from liability
because the corporation is organized and receives the benefits of the contract, even where
corporation adopts K. Question is of intent and factors include: 1) form of signature, 2) action
of third party, 3) partial performance, 4) novation
 Novation: enter contract on behalf of a corporation to be formed, gets the other party
to commit a deal and when the corporation is formed, the corporation becomes a
substitute to the party (novation)
 Option K: Another solution is to create an option to bind the other party to enter the
contract on certain terms when the corporation is formed, this works as a matter of k
law

43
 2) Statutory approach MBCA § 2.04  all persons purporting to act as or on behalf of a
corporation, knowing there was no incorporation under this Act, are jointly and severally liable for
all liabilities created while so acting
3) Academic studies Even though MBCA sought to abolish the judicial doctrines, courts continue to
infer LL when parties assume in good faith a corporation exists

Both parties mistakenly believe corporation exists

1) Judicial Doctrines
 De facto corporation: courts infer limited liability if: 1) the promoters in the would-be
corporation made a good faith effort to incorporate, 2) the promoters were unaware that
the incorporation had not happened, and 3) promoters used the corporate form in
transaction with third party
 Corporation by estoppel: prevent personal liability of promoter when contracting party
assumed only recourse would be against interest of businesss assets

Reinstatement after Administrative dissolution Effect of reinstatement after administrative dissolution is

retroactive recognition of the corporation and its limited liability.

Control Mechanisms
Closely-Held Corporations
Closely-held corporation: Two major approaches
1) MBCA  does not define closely held corporation because it doesn’t matter, it is not defined as a
separate legal entity—presume all corporations are alike but expressly authorize close corporations to
adopt governance structures that vary from traditional model
2) Delaware DCGL §§ 341–356  if you have only a certain amount of shareholders and you want to
be a closely-held corporation, you have to elect to do so in the articles—gives closed corporation status
only after meeting certain tests and elects close corporation status

Giants food corporation (DE) 

Founded through two families with equal power. Lawyers said they needed more guidance about who would have
power in the event of a dispute. Lawyer: 2 classes of Giant stock - AL common stock given to the first family—
stock has the right to elect 2 of the 5 directors. AC Stock  give it all to the Cohens and allow them to elect 2 of the
directors. Who elects the 5th the director? If there is a deadlock on the board, lawyer will show up and cast the final
vote There ends up being in litigation and each side says that they have to go after the lawyer to have them on his
sides. Cohens offer the lawyer CEO and chairman of the board. Other family sues  DE court says they don’t
find a problem. Courts should not second guess good lawyers who know what they’re doing. Corporations in the
end is enabling. Class voting is standard now, having your lawyer be the tiebreaker is not one which people
agree. It’s not uncommon to see an arbitration. If this were a general partnership, there would be a dissolution.

JKL Hypothetical
Justin wants to give $200,000 but does not have the entire amount and Kathy wants to give $100,000  want to be
main manager; Lorenzo gives $100,000 and wants to be a passive investor
Justin will have 40% of the common stock
Kathy the same will have 40%
Lorenzo will have 20%
Who yields the power? No one

One thing people would want in Lorenzo’s position is to enter into a vote pooling agreement or voting trust 
goes to Kathy, either of us can be ganged up on, but if we commit ourselves to one another then we will always win.
Voting trust  take the two who have decided to form the alliance, have them irrevocably transfer all of their
shares to a trust. Someone has to be named the trustee and they have all the power to cast the controlling vote. This
becomes a major way – 60% voting block – that never loses. The trustee will always be in control

Four key documents

44
Generally assumed that a good lawyer will think in terms of those four documents and setting and solicit and explain
to the clients what the best way to handle the documents might be. You must understand the downsides of corporate
structure.
1. Articles of incorporation
o Super Majority Voting Provision Veto-rights  parties want the power to say no. You use super
majority voting provisions. But anyone who uses veto power abusively breaches a fiduciary duty
 Con: Let’s say Lorenzo wants half of the seats in his control  creates a deadlock with
Lorenzo with 2 and K and J with one each. Veto-rights  deadlock (Atlantic Plumbing)
 Atlantic Plumbing RoL: A minority stockholder in a close corporation that
requires a unanimous vote for corporate action may not repeatedly vote against
an action for personal reasons if the action would be in the best interest of the
corporation.
2. Vote-pooling agreements: formation of an alliance
3. Shareholder agreement  articulates what the shareholder responsibility is, for example making Kathy
the President. At common law, this wouldn’t be allowed because the role of the president is for the board of
directors. However, the law has changed in every state—DL (only shares reflecting maj), Model Act
(unanimous consent): it is ok if the parties agree among themselves. It is a contract
o Con: Choosing someone as CEO or President but the person ends up not being a
good leader, the parties are still in a contract. To get around, the K might say “we will
use our best efforts to make Kathy President… but if not in the best interested…”
Downside is that it does not protect Kathy
4. Share transfer  in the event that shares are sought to be sold to a share party or shares moved by a
will, shall be limited in the following way… buy-outs etc.
o Con: Transfer limitations  If the rule is x cannot sell shares to someone else, the
shares will become illiquid and the owner will be stuck with them

Bylaws  probably don’t want to put governance decisions in the bylaws because all it takes is a majority of
shareholders to change the bylaws

Voting Arrangements

Three non-mutual options for board representation: 1) ensure compete board representation (cumulative), 2)
give some or all shareholders ability to veto board decisions (super-majority), 3) dispute-resolution mechanisms
(irrevocable proxy/vote pooling)

Cumulative voting:
Minority shareholders multiply the number of shares owned by the number of directors up for re-election and
shareholders may cast all votes for one candidate or allocate them in any manner among the candidates.
Pros for Minorities: Ability to say I don’t have to vote for 5 people, I only want to vote for one
person because I am dedicated to have that person appointed to the board. Placing all of your votes
on one person rather than one person per share. If you own minority shares, it gives you more
power because you can concentrate your votes. Gives people who have enough votes to nudge
themselves into the race
In Practice: Most states corporations must opt-in to cumulative voting
Pros: prevents self-dealing by board members, diversity of thought.
Cons: creates factions on the board.
Undermining cumulative voting: 1) stagger the board, 2) decrease board size

Class Voting:
Dividing voting stock into classes, each of which is entitled to elect on or more directors, rights of different classes
may be adjusted in several ways. One issue with class voting is what happens when the a director dies and is the sole
holder of the stock – who fills the vacancy?

Voting Trusts:

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Separate economic ownership and voting rights—shareholders convey legal title to their stock to a voting trustee or
a group of trustees pursuant to the terms of a trust agreement. The transferring shareholders – now beneficiaries of
the trust – receive voting trust certificates in exchange for their shares

Irrevocably Proxy:
Shareholder loses control of her vote for the period of the proxy. Agency law recognizes an irrevocable grant of
agency power couple with an interest in the corporaiton. Most courts (including DE) now allowed irrevocable
proxies without any consideration. MBCA allows irrevocable proxies as long as proxy has an interest, interests
include when proxy is: 1) given to a pledgee, 2) a person who purchased or agreed to purchase the shares, 3) a
creditor of corporation who extended it credit under terms requiring the appointment, 4) an employee of the
corporation whose employment contract requires the appointment, 5) a party to a valid agreement

Voting Pooling Agreements:

Goal is to bind some/all of the shareholders to vote together – in a particular way or pursuant to a specified
procedure

Ringling Bros.: DL Supreme Court recognized voting pool agreement between two minority
shareholders, whom together formed a majority voting bloc, but said that arbiter to whom the
decision went if there was a disagreement only had the power to recommend who to vote for but
did not have the power to compel the vote, making the voting agreement toothless and forcing the
court to disqualify the stock at issue

Supermajority Voting
Usually comes up when minority shareholders condition their investment in a close corporation on veto rights over
some or all of the decisions of the majority. Requires that a supermajority of directors or shareholders approve all
or certain specified actions.
One approach is to require unanimous approval, but most approaches require 80% approval.
Jurisdiction dependent [Some allow it, others don't]

Smith v. Atlantic Plumbing Mass. App.

[example of super maj./ dealock] Two different stories by the court  Wolfson is acting spiteful toward the
investors, which means that his behavior was in bad faith, which is a per se violation of the duty of loyalty
Facts Wolfson, Smith, Zimble, and Burke each owned 25 percent of the outstanding shares of Atlantic. Atlantic’s
bylaws stated that no corporate action could be taken without an affirmative vote of 80 percent of the
outstanding stock. This provision effectively meant that any decision could be vetoed by one of the four
partners. When Atlantic began to turn a profit, Smith, Zimble, and Burke wanted to declare dividends. Wolfson,
however, repeatedly voted against declaring dividends, instead wanting to devote the funds to repairs on the
property. The plaintiffs agreed to devote a moderate amount of the funds to repairs, but maintained that declaring
dividends was the correct approach. Eventually, Atlantic accumulated so much profit that they were in excess of the
IRS limits, which provided that at a certain point of profit, corporations must declare dividends. Wolfson still
refused to vote in favor of declaring dividends and because of the 80 percent provision, Atlantic was not able to do
so. The IRS accordingly assessed penalties against Atlantic for seven straight years, with Wolfson still refusing to
give in. After about four years of the IRS penalties, the plaintiffs brought suit, seeking reimbursement to
Atlantic from Wolfson for the IRS penalties
Holding Wolfson’s actions were unjustified risks of precisely the tax penalties that were eventually imposed and
were inconsistent with a duty of good faith and loyalty. No specific plans to make repairs on property. 3
shareholders win. He owed the company a fiduciary duty since his vote had blocking power.
Rule: A minority stockholder in a close corporation that requires a unanimous vote for corporate action may not
repeatedly vote against an action for personal reasons if the action would be in the best interest of the corporation.

Contractual Transfer Provisions

JKL Hypothetical Continued  what happens to the class of stock if one dies. The stock passes to his or her heirs.
If there is no will, the law of the state will determine what to do with the property/stocks. More likely than not the
shares go to Lorenzo’s family (if L is the one who dies).

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Purposes of Legality and Transfer Provisions  Closed-corporations want to decide who their co-shareholders
are and need to make arrangements to restrict transferability. 1) Ensure the desired balance of control that might be
undone if shares are transferred to another, 2) Can create a market for otherwise illiquid shares

Transfer restrictions are usually in the bylaws or articles to ensure new-comers are bound

Concord  very strict interpretation of transfer provision --- benefit from transfer provision does not create a
fiduciary duty

Type of Transfer Provisions:

Right of first refusal  shares must be offered to the corporation or remaining shareholders at the same
price and terms as to the outside offer. The right, if given to shareholders, is given in proportion to their
respective holdings

First option provision  offer to corporation or shareholders is made at a price fixed my agreement,
avoiding issues like if the outside offer is a gift

Consent  transfers condition on consent of board of directors

Liquidity rights of shareholder withdrawing

Sale option  sales to corporation conditioned of specified event (like death) Most common
arrangement in the event of death
Buy-sell agreement (almost universal) compels the corporation (entity or redemption
agreement) or remaining shareholders (cross-purchase arrangement) to purchase the shares of
another at the occurrence of a specified event.
Ensuring Capital:1) regularly set aside money for the issue, 2) purchase life insurance
on the lives of shareholders equal to value of the shares, 3) defer payment via promissory
notes
What’s the drawback? The company does not have enough money to buy back the
shares. Often though these agreements are tied to a life insurance policy and so the
buyback is funded by this (of course this only works about death).
What happens upon retirement? How much should the heirs and owner to the estate
should they be paid (this is a difficult question)? There is no market price because it’s a
private company, you have to tie the price to the benefits of the stock. Generally they
should be paid a fair price—Langevoort: Wtf does that mean.

Dissolve Corporation: MBCA §14.30 → Court can dissolve a corporation based on: Director deadlock,
shareholder deadlock, crimes both those in control, waste of assets.

Concord Auto Action, Inc. v. Rustin

Facts Cox and his siblings, Powell and Thomas, each held one-third of the shares of two corporations, Concord
and E.L. Cox Associates, Inc. The three entered into a stock repurchase agreement in February 1983. The
agreement provided that the corporations would acquire all the shares of stock of any of the shareholders on
the event of his or her death. It set repurchase prices for each company’s stock which were to “remain in full
force and effect…until so changed.” Elsewhere the agreement provided that the share prices “shall be reviewed
at least annually no later than the annual meeting of the stockholders,” beginning with the meeting to be held in
February 1984. They further agreed that “all parties may, as a result of such review, agree to a new price . . . .” The
February 1984 meeting was not held. In March 1984, Cox died accidentally in a fire. The share repurchase price
had not been reviewed and remained at the original level. At the time of Cox’s death, the market value of his
shares was roughly twice the value assigned in the repurchase agreement. The executor of Cox’s estate, refused
to tender Cox’s shares under the terms of the agreement. Concord and Advance sued for specific performance.
Rustin argued that the annual review of the repurchase price was mandatory, and that since no review had

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occurred, Powell and Thomas were required to now reassess the stock’s value. He further claimed that specific
performance would be inequitable since the share prices had increased so significantly.
Holding Absent a duty to guarantee the occurrence of the annual meeting or review, Court cannot find that Powell’s
failure to upgrade the share price constituted a fiduciary breach. Specific performance to convey will not be refused
merely because the price is inadequate or excessive.
Analysis
- There must be an annual review of the share price, but in the absence of such review, the existing
price prevails. Later in the contract, it is clear that Rustin was obligated as administrator of Cox’s estate to
tender the shares for repurchase
- Agreement is the best evidence of the parties’ intent, Rustin does not provide evidence that the parties
meant to review the price annually
- The court strongly disfavors judicial intervention of the type requiring setting a share price
- Parties were not even obligated to increase share price after an annual review, and Powell did not
have the sole responsibility to calling the annual meeting, that she benefits from the current low
share price does not create a duty

Oppression & Freezeouts

Types of Freezeouts:
Case 1  majority cuts off minority shareholders from any financial return, leaving them with illiquid stock that
generates no income
Freeze-outs: minority is forced to sell out at less than fair value because there is no market for
minority stock in close corporation. This can be achieved by depriving minority stockholder of
corporate office and employment (Wilkes)

Case 2  majority exercises control to frustrate preferences of the minority

Note: A short-form merger is a “freeze out”

Example: Parent owns 80% of the subsidiary and owns 100% of another company (give it the amount of
consideration needed). Parent can cause those two to merge, forcing the 20% minority shareholders to get cash or
shares of the parent company.

Factors on how to approach close corporations: 1) Some courts treat close corporations like partnerships, DE
treats them like any other corporation subject to centralized management and majority rule. 2) Whether legislature
has included in its corporate statute provisions aimed at protecting shareholders in close corporations

JKL Hypothetical continued: Assume JKL have gone easy on protective measures and decide on majority rule,
everyone gets to cast votes on all matters in proportion to the shares they hold, so who is in power? What happens
when the corporate governance structure leads to one of the founders to say ‘I’m being screwed.’ To what
extent are shots challenging breaches of fiduciary duty different in the closed corporation context?
Hypothetical with Wilkes: Suppose Kathy is fired and Wilkes applies: what does the lawsuit look like?
Kathy will introduce evidence that shows why she should not have been fired. Courts have to decide whose
story about Kathy being a good CEO is right. The BJR is used by courts to step away from business
decisions. MA says judges are in the middle of this

Wilkes (Massachusetts)  Principle: in closely held corporation, the entity of the corporation, should not matter.
The formality of a large corporation makes less of a difference when you have a closed corporation. Closed
corporations should be thought of as incorporate partnerships  where every partner owes a personal fiduciary duty
to every other partner. Thus, if something goes bad, then you don’t need a derivative suit. You are talking about
harm directly to the person bringing the complaint. The norm of equal dignity unless there is a compelling reason,
you must treat every shareholder equally.

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 Wilkes Test:
If a shareholder has not been equal dignity [the worst is freeze-out] alleged by the person booted out, the burden of
proof goes to the defendants to persuade the court that they had a valid business purpose. Not the business judgment
rule. [The court never has to get to part 2 of the test]
1) Breach of fiduciary duty  Donahue, stockholders in closed corporation owe same fiduciary duty as
partners, good faith & loyalty.
o When minority shareholders in a close corporation bring suit against the majority, alleging breach
of strict good faith duty owed to them by the majority, we must carefully analyze the action taken
by the controlling stockholders in the individual case  1) [majority has burden] whether the
controlling group can demonstrate a legitimate business purpose for its action. 2) When business
purpose advanced by majority  [burden shifts to minority] minority must show that the
objective could have been achieved via less harmful means to the minority
3) Damages  court must consider whether the corporation was dissolved at time of this litigation

Nixon (DE)  Closely-held corporations should not be treated differently, bring a derivative action under duty of
loyalty or care. There is no rule of equal treatment]

Equal Rights of Shareholders

Wilkes v. Springside Nursing Home, Inc.

Massachusetts approach (but has been followed by many states) [Equal opportunity approach]
Facts Wilkes, Riche, Quinn, and Connor were the four directors of the Springside Nursing Home, Inc. each owning
equal shares and having equal power within the corporation. Relationship between Wilkes and the other three
directors soured. When Springside became profitable, the defendants voted to pay out salaries to themselves,
but did not include Wilkes in the group to whom salary would be paid. Then, at an annual meeting, Wilkes was
not reelected as director and was informed that he was no longer wanted in the management group of Springside.
Over the course of these events, Wilkes faithfully and diligently carried on his duties to the corporation. Wilkes
brought suit against the defendants for breach of their fiduciary duty owed to him.
Holding This was a majority designed a freeze-out for which there was no legitimate business purpose. If a
shareholder has not been equal dignity [the worst is freeze-out] alleged by the person booted out, the burden of
proof goes to the defendants to persuade the court that they had a valid business purpose. Not the business judgment
rule. [The court never has to get to part 2 of the test]

Compare with: Merolda v. Exergen Corp.Merolda fired after making comment about President’s affair
with majority shareholder. Merolda said employment was prefaced on investment in corporation and he
owned a lot of shares and therefore you need to treat me with the respect required by Wilkes. MA Supreme
Court: No breach of fiduciary duty, no formal connection between owning shares and employment, the
corporation did not buy back the shares at a significant financial advantage. Court says Plaintiff has to
show abuse against him in the capacity as a shareholder not just employer. He did not suffer any harm in
his role as shareholder—plaintiff got a profit on his shares and still get a job. This is not like Wilkes
because there is no evidence that the corporation distributed profits to shareholders in the form of
salaries.

Nixon v. Blackwell
[Traditional Approach (DE). Case is more important for policy statement not for the facts. Closely-held corporations
should not be treated differently, bring a derivative action under duty of loyalty or care. There is no rule of equal
treatment]
Facts E.C. Barton & Co. (Corporation) (defendant) was a closely-held Delaware corporation. Upon founder E.C.
Barton’s death, all of the Class A voting stock passed to employees, and only Class B non-voting stock passed to
Barton’s family. The Corporation offered to repurchase Class B stock through a series of self-tender offers. The
Corporation also set up an Employee Stock Ownership Plan (ESOP) that allowed employees to cash out or
receive Class B stock on termination or retirement. The Corporation had a right to repurchase Class A stock
on an employee’s death or retirement. The Corporation also entered agreements with top executives giving it the
right to convert their Class A shares to Class B should they leave their roles, so new Class A shares could be issued
to their replacements. Further, the Corporation took out life insurance policies on those executives benefiting

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the company. The Board resolved to use employee life-insurance benefits to repurchase Class B shares from
employee estates. Fourteen Class B stockholders sued the Corporation and the directors alleging that the defendants
(1) tried to force minority stakeholders to sell by paying only minimal dividends, (2) breached fiduciary
duties by approving undue compensation, and (3) breached fiduciary duties by discriminating against non-
employee stockholders.
Issue Whether the board in a close corporation breached its fiduciary duties by failing to provide liquidity rights to
non-employee minority shareholders while providing such rights to employee shareholders
Holding Trial court erred as a matter of law in holding that liquidity afforded to employee stockholders by the
ESPO and the key man insurance requires equal treatment to non-employee stockholders.
Analysis
- Because Ds were on both sides of transaction  Ds have burden of showing entire fairness (No BJR)
- Trial court overlooks three factors: minority stockholders were not a) employees of the corporation, b)
entitled to share in an ESOP, and c) protected by specific provisions in the certificate of incorporation
bylaws, or a stockholder’s agreement
- If we held that corporate practices like ESOP must apply equally to non-employee stockholders  we
would be engaging in judicial legislation
- Should there be any special rules to protect minority shareholders for closely-held DE corps? Not
necessary, a minority shareholder can bargain for protections in her stock purchases

Statutory Remedies (Oppression)

Oppressive actions (Kemp) those that substantially defeat the reasonable expectations by minority shareholders
in their commitment to the corporation (reasonable expectation can be to capitalize on your investment in the long-
run, there is a reasonable expectation that you will be given something fair as long as you hold stock)

Dissolution under Kemp (corporation shall cease to exist) if oppression, the dissolution totality of the
circumstances analysis, can both sides be protected and satisfied? 1) Petitioner sets forth prima facie case and then
2) defendants carry the burden to dissuade. All orders of dissolution should allow corporation to buy back
shareholder’s stock at fair value.

Dividends under Brodie  Remedy should be to fulfill the reasonable expectation. In this case, a buy-out
significantly exceeded the reasonable expectation of the plaintiff. Quantifiable deprivations should be met with
money damages. Most precise way of making plaintiff whole is appropriate dividens  how much is appropriate?
Brodie says, judge decides. [Langevoort—Dividends are highly discretionary though, why is the judge making the
decision?]

Three questions under MBCA § 14.30

1) When is majority conduct oppressive?
2) If oppression, what is appropriate remedy?
3) If buy-out under § 14.34, what is the fair value of the stocks?

Involuntary dissolution statutes craft broad protections for minority shareholders who complain of oppression by
majority shareholders  comments urge courts to limit cases to genuine abuse rather than instances of acceptable
tactics in a power struggle for control of corp.
Under the doctrine  courts have used involuntary dissolution statute to create liquidity and financial
rights for minority shareholders whose reasonable expectations have been frustrated by majority
opportunism

Matter of Kemp v. Beatley, Inc.

[New York Courts (majority approach)]
Facts Dissin and Gardstein held a combined 20.33 percent of the stock of Kemp & Beatley, Inc. a New York close
corporation. Both were long-time employees of Kemp & Beatley and held significant management positions.
During their employment they and the other shareholders received either dividends or extra compensation in
proportion to their stock holdings each year (because it can be deducted from income as a business expense, making
income tax less, the goal was to make net income equal to revenues in order to avoid taxes). Dissin resigned in

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1979, and Gardstein was terminated in 1980. After Dissin and Gardstein left, the company began to make its
annual distributions on the basis of service rendered to the corporation, rather than stock ownership. As a
result, Dissin and Gardstein no longer received annual distributions. Dissin and Gardstein petitioned the court
for dissolution of the company, arguing that the controlling shareholders had frozen them out via fraudulent and
oppressive conduct.
Holding When the majority shareholder of a close corporation award de facto dividends to all shareholders except
class of minority shareholders, such a policy may constitute oppressive actions under Section 1104–a Business
Corporation Law dissolving of the corporation. Lower court did not abuse discretion by concluding that dissolution
was the only means by which petitioners could gain fair return on investment. Utilizing a complaining shareholder’s
reasonable expectations as a means of identifying and measuring conduct alleged to be oppressive is appropriate –
disappointment not enough. Oppression only arises when majority conduct defeated expectations that were
objectively reasonable under the circumstances and central to the petitioner’s decision to join the corp.
Analysis
- Defining “oppressive actions” Oppressive actions  those that substantially defeat the reasonable
expectations by minority shareholders in their commitment to the corporation (reasonable expectation can
be to capitalize on your investment in the long-run, there is a reasonable expectation that you will be given
something fair as long as you hold stock)
- Remedy: Dissolution (corporation shall cease to exist) if oppression, the dissolution totality of the
circumstances analysis, can both sides be protected and satisfied? 1) Petitioner sets forth prima facie case
and then 2) defendants carry the burden to dissuade. All orders of dissolution should allow corporation to
buy back shareholder’s stock at fair value.
- Bad-Faith exception: a minority shareholder whose own acts, made in bad faith and take with a view
toward dissolution, is not entitled to dissolution

Brodie v. Jordan
Facts Brodie, Barbuto, and Jordan were the three directors of Malden, a Massachusetts corporation. Each held
one-third of the shares of the corporation. As Walter got older and wanted to be less involved, he requested
multiple times that Barbuto and Jordan buy out his shares. They refused. Neither the articles of organization nor
corporate bylaws called for a buyout obligation upon request. Eventually Walter was voted out as president and
director of Malden and died five years later. Walter’s executrix inherited Walter’s shares in Malden. Upon her
requests, the defendants repeatedly failed to provide her with various company information. In addition, Brodie
nominated herself as director, but was voted down by the defendants. Brodie also requested that the defendants
buy out her shares, but they again declined. Brodie brought suit for breach of fiduciary
Holding There was a freeze-out: Superior Court found reasonable expectations of plaintiff frustrated: excluding
her from corporate decision-making, denying her access to company information, hindering her ability to sell shares
on open market.
Analysis
- Donahue makes stockholders in closed corporation like partners with a fiduciary duty to other shareholders,
where the duty is breached when there is a freeze-out situation  majority frustrates minority’s reasonable
expectations of benefit form their own shares
- Remedies: Remedy should be to fulfill the reasonable expectation. In this case, a buy-out significantly
exceeded the reasonable expectation of the plaintiff. Quantifiable deprivations should be met with money
damages.

Capital Structure
Capital structure refers to the right side of the balance sheet: debt & equities

Equity Link  When there are multiple classes of equity, the fiduciary obligation of the board of directors is owed
primarily to the common shareholders, not the preferred.
Langevoort: if you are taking preferred stock, you will not get any protection from the court in terms of
clashes between the stocks. The voting (common) stock is the class the directors are obligated to pay
attention to

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Venture Capital Deal: VC firms usually asks for preferred stock with voting right in exchange for its capital, and
usually is convertible to common stock if VC is successful

JKL Hypothetical:

JKL corporation acquires widget for ~$2 million

Kathy commit $200,000 for 40%
Justin commits $200,000 and gets 40% common stock  he only has $100,00 and write a promissory note to pay
the rest of the money to JKL
Escrow: Lawyer says ok but we are putting in half of the 40% of the common stock you acquire into an escrow
account that you will have access to upon payment of the note

Where are we going to get the rest of the money?

1) Lorenzo  $100,000 for 20% of the common stock and I have $500,000 more but I am too nervous to put
$600,000 for common stock because common stock can be risky. How can Lorenzo invest his $6k in a safer
way for Lorenzo?
a. You offer Lorenzo to make a loan or get protected equity (preferred stock)
i. Preferred Stock
1. Economic right to dividends over that of the common stock, if dividends are being
paid out
2. Con: Dividends is discretionary and courts apply BJR to the decision to distribute
dividends
ii. Debt
1. Pro: Tax stand point in the interest of JKL to make this a loan instead of a preferred
stock investment. Paying interest in the loan is an expense deducted from revenue for
purposes of income tax.
2. Con Consequence to the company is that it may not be able to pay the interest,
sending it into bankruptcy. The more risk you build in the more heightened the in-
fighting it becomes
3. Con: Other creditors, like the bank, will not like that they will have to split the
income upon liquidity with Lorenzo
a. Way to get around this is to put a provision in the loan agreement with the
bank to agree to any other creditors the corporation wants to include
b. Loan agreement:
i. Prevent companies from giving complete loyalty to the common
shareholders (Equity Link) there shall be no loans without the
bank’s permission OR
ii. A right of the bank to force the corporation into paying the entire
loan amount on an accelerated timeline based on certain ratios
(usually liability ratios), which usually forces the corporation into
bankruptcy because it is in a precarious financial position
4. Subordinated loans: Lorenzo and banks give loans but bank’s rights to pay-out is
superior to Lorenzo’s
2) Remainder of money comes from a bank (debt)
3) Widget brothers (sellers) are motivated enough to sell that we are willing to take a note for a 10 year pay out of
the remainder purchase price (legally enforceable promise to pay back the money: debt).

Capital Mechanisms

Procedurally

Authorized shares  shares authorized by articles of incorporation but not yet issued

Authorized, issued, or outstanding  authorized and sold

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Authorized, issued, but not outstanding  corporation repurchases shares (treasury shares)

MCBA  shareholder approval required if corporation issues for consideration other than cash/ cash equivalent,
shares with voting power equal to more than 20% of voting power outstanding immediately before issuance

Issuing Shares  Board must amend articles with approval of majority of shareholders with outstanding voting
shares if it seeks to issue more stocks than authorized in articles

Board approval is required get loans, no other governance procedure

All the rights and responsibilities associated with a class of equity must be specified in the articles of
incorporation (requires board of directors & shareholder approval)
With respect to every class of equity, the articles have to specify the maximum number of shares that can be
issued with respect to that class

Common Shares

- Voting: Usually voting rights and right to receive net assets of corporation in dissolution or liquidation
- Board Election: Exclusive power to elect corporation’s board of directors
- Dividends: All income that remains after corporation satisfies debts and preferred shares goes to common
shares in the form of dividends
- Security: Common shareholders seen as primary beneficiaries of fiduciary duties
- Risks:
o Common shares are the first to lost investment in the event of liquidation
o Corporation has no duty to repurchase common shares

Preferred shares

- Type of contract between shareholder and corporation

- Dividends Economic rights senior to customarily assigned common shares, usually dividends stated as a
fixed amount paid annually or quarterly. Preferred shares have right to receive specified amounts upon
liquidation, but not before creditors
- Permanent Capital: Preferred shares may represent permanent commitment of capital, but if not
corporation can repurchase shares
- Voting rights: Deemed to have voting rights = to common shares unless articles say otherwise
- Fiduciary Duties: Courts found generally preferred shares not owed fiduciary duty unless they rely on
shared right with common stock but not when relying on K rights

Debt Securities
- Taxes Debt is deducted from taxable income, but preferred stock gives managers more flexibility
- Bonds typically fixed by indenture contract specifying rights// obligations.
- Principal must be repaid either at date of maturity or in increments
- Debt contract might include provisions, known as covenants or negative covenants, requiring borrower to
refrain from certain actions jeopardizing bond holders
- Bonds can be redeemable at a callable or fixed price usually set above the principal
- Convertible debentures allow bonds to be converted into common stock
- Corporation’s board of directors do not need shareholder approval to issue debt securities unless articles
say otherwise
- Insider debt? Bankruptcy court will recharacterize debt taken by shareholders as equity to make it less
likely inside debtholders will receive anything in bankruptcy process.
- Deep rock doctrine  courts subordinate claims of insider creditors below outside creditors when insider
have not invested adequate capital in corporation
-

Options

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 - The right to buy or sell a share at a set time and price
- Known often as contingent claims because value is dependent on variety of factors
- Call option  right to buy shares (corps. usually only use this type of option)
- Put option  right to sell shares
- Strike price/ exercise price  price specified in an option contract
- Maturity date/ expiration date  date specified in an option contract

Equity Linked Investors, L.P. v. Adams (DE)

Facts Genta Incorporated was owned by preferred and common stock shareholders. The corporation was on the
edge of insolvency. If liquidated, it would probably be worth less than the $30 million liquidation preference of the
preferred stock. However, Genta had several "promising technologies" in research, and these technologies would
bring in a large amount of money if they turned into commercial products. The Genta board tried to find new
sources of capital to continue the business with a hope of developing commercial products from its
"promising technologies." The board believed in good faith that securing additional capital was in the best
interest of the common stockholders. The preferred stockholders, on the other hand, sought to cut their losses by
liquidating Genta and distributing most of the assets to the preferred shareholders. Later, Genta borrowed on
a secured basis about $3 million from a third party, allowing the corporation to purse its business plan for a
further period. In exchange, the third party received warrants exercisable into half of Genta's outstanding stock.
Equity-Linked Investors, L.P, one of Genta's preferred stockholders, brought suit.
Holding Board did not violate business duty by choosing the economic interests of common stockholders over the
preferred shareholders. Preferred stockholders have right via contract. Generally, where this is a conflict, board must
prefer common stock. Directors were independent and acted in good faith as to the loan transaction and were well
informed. Thus, they breached no duty owed to company or holders of equity securities. Whether a company should
be liquidated is an issue of business judgment.

Par Value

The lowest price set forth in the articles of incorporation that the share can be sold at (can be $0)

Klang  In a state that still uses par value, courts will not require generally accepted accounting principles to be
used in calculating the equity on a balance sheet

Klang v. Smith’s Food & Drug Centers, Inc.

Facts Smith’s Food & Drug Centers, Inc. entered into a complex merger and share repurchase agreement with
another supermarket company. Prior to granting final approval of the agreement, SFD’s board retained an
investment firm to issue an opinion on the impact the agreement would have on SFD’s solvency. Klang (plaintiff)
brought a class action lawsuit, purportedly on behalf of the holders of SFD common stock. He alleged that the
transaction violated Delaware General Corporation Law (DGCL) § 160 because it caused an impairment of
capital. Specifically, Klang argued that SFD’s balance sheets were conclusive evidence of impairment, and further
that their off-balance-sheet calculations were done improperly.
Issue In a state that does legal capital, still uses par value (like DE), do the equity lines on the balance sheet have to
reflect generally acceptable accounting procedures?
Holding No, BJR applies defer to board’s wisdom in absence of evidence of bad faith
In cases alleging impairment of capital under section 160, the trial court may refer to the board’s measurement of
surplus unless a plaintiff can show that the directors failed to fulfill their duty to evaluate the assets on the basis of
acceptable data and by standard which they are entitled to believe reasonably reflect present values. Essentially BJR
Analysis
- Statute: A corporation may not repurchase its shares if, in doing so, it would cause an impairment of
capital under 8 Del.C. § 160. A repurchase impairs capital if the funds used in the repurchase exceed the
amount of the corporation’s “surplus,” defined by 8 Del. C. § 154 to mean the excess of net assets over the
par value of the corporation’s issued stock.
o It is unrealistic to hold a corporation to be bound by its balance sheets for purposes of
determining compliance with § 160, therefore a corporation can revalue properly its assets
and liabilities to show a surplus and conform to the statute

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 - Section 150 does not provide formula for calculating surplus, only factors that must be use. Firm’s opinion
adequately took into account all of SFD’s assets and liabilities

Dividends
You cannot may dividends until you make profits, you can only pay dividends through income other than paid-in
capital. Only the par value goes into the paid-in capital portion of the balance sheet, which cannot be paid out as
dividends.

MBCA A corporation cannot pay dividends that would render the corporation insolvent (MBCA)
Most statutes prohibit corporations from making distributions that will render them unable to pay debts or
make them essentially insolvent. No body tries to prevent gambles, MBCA tries to limit payouts out the
bank to protect creditors

DE (dividends) no dividend can ever take place unless there is a board meeting, clean accounting opinion, this
benefits lawyers

DE (stock purchase) repurchase of shares is treated the same was as a distribution and subject to same
restrictions

CA  requires corporation’s balance sheet assets equal a specified percentage of its balance sheet liabilities

Unlawful distributions  Directors can be held personally liable for unlawful distributions

Getting around par value problem  Corporations can get around all of this by amending the articles of
incorporation to change the par value, expanding the surplus and minimizing ‘cushion’ for creditors

Kamin  Question of whether or not a dividend it so be declared or a distribution of some kind should be made
exclusively a matter of BJ for B. of D.

Kamin v. American Expres Co.

Shareholders: rather than distributing $4 million in DLJ stock as a dividend, AmEx could sell the stock, save $8
million in taxes, and then distribute $12 million as a dividend (tax reality)
Board: advised by accountants that if DLJ stock distributed as a dividend, rather than sold, AmEx would not have to
reduce its reported its reported income for 1975 to reflect its loss on its investment. It could bypass income
statement and reduce retained earnings by $29.9 million – the book value of stock its distributing (accounting
fiction)
Facts American Express authorized dividends to be paid out to stockholders in the form of shares (share dividends)
of Donaldson, Lufkin and Jenrette, Inc. (DLJ). Kamin, et al. minority stockholders in American Express, brought
suit against the directors of American Express, alleging that the dividends were a waste of corporate assets in that
the stocks of DLJ could have been sold on the market, saving American Express about $8 million in taxes. The
American Express directors filed a motion to dismiss the case.
Holding BJR controls, we defer
Analysis Question of whether or not a dividend it so be declared or a distribution of some kind should be made
exclusively a matter of BJ for B. of D. There is no evidence of bad faith or dishonesty by the board and claims of
non-independence of board directors is speculative at best

Piercing the Corporate Veil

Piercing the veil refers to when courts allow creditors to recover directly from shareholders. Exception to general
rule of limited liability and arises when the corporation lacks sufficient assets to satisfy a plaintiff’s claim and P
seeks to hold shareholders personally liable [Doctrine similar in concept as respondeat superior]

Walkoszky 

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 - Two scenarios
o 1) Corporation is a fragment of a larger corporate combine which actually conducts the business
 only larger corporate entity is financially responsible
o [Must show this] 2) corporation is a dummy for its individual stockholders who are in reality
carrying on the business in their personal capacities  stockholders personally liable

Radaszweski (applies Collet test)  Record devoid of facts showing ‘something more’ than a mere error in
business judgment that resulted in subsidiary’s bankruptcy but that is required under Collet to hold the parent
company liable

Collet Test

Three requirements under Collet formulation [majority rule] – Common law test for piercing the corporate
veil. Equitable doctrine, so decided by judge, not jury.

1) Control  complete domination of all finances, business practice, and policy, so that the corporate entity as no
mind of its own

2) Control used by D to commit fraud or wrong, perpetrate the violation of statutory or other positive legal duty, or
dishonest and unjust act in contravention of P’s legal rights
Undercapitzalization has become a proxy for this element because it creates an inference that the parent is
either deliberately or recklessly creating a business that will not be able to pay its bills or satisfy its
judgment against it [Court: insurance fulfills financial responsibility policy underlying second prong – it is
common business practice or insurance to be purchased through an agency wholly owned by parent
company]

3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of
When to Pierce
Courts generally look at whether:
1) There is a unity of interest and ownership between the corporation and shareholder being used, and
2) Whether there was deceit or wrongdoing, or some element of unfairness or wrong that goes beyond the
mere fact of the creditor’s inability to collect. Often the question is whether the defendant abused a
privilege of the corporate limited liability

Other Factors:
1) Corporation Closely Held
2) Defendant actively participated in the business [this is also part 1 of the test  always must find control]
3) Insiders failed to observe corporate formalities, like holding a board meeting, taking board minutes
4) Insiders commingled business and personal assets
5) Insiders did not adequately capitalize the business [very common]
6) Insiders deceived creditors

Policy
Economic arguments of encouraging investment by providing limited liability does not apply in closed corporations
where ownership and management not separated

Torts v. Contract
Courts do not routinely distinguish between piercing the veil in torts than contracts. Commentators think that it
should be harder to pierce the veil in contract cases because you can protect yourself beforehand. Any big seller to a
corporation would ask about the corporation’s assets to make sure they have equity to pay damages in the instance
of a breach. If the contracts claim doesn’t succeed, then a party can go forward with a fraud or misrepresentation tort
case. In fact, rate of piercing is higher in contract cases

Alternatives to Piercing the Veil

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 1) Doctrine of fraudulent conveyance  courts can set aside transactions 1) with intent to defraud creditors;
and 2) constructively defraud creditors. This is done through the Uniform Fraudulent Conveyance Act
(UFCA) Bankruptcy judge can pierce the corporate veil if there is a whiff that they were only done to hide
assets from creditors
a. Limitations: 1) Must show specific finding of fraudulent transaction, 2) UFCA only allows court
to set aside specific fraudulent conveyances (not total liability), which may not satisfy creditor’s
entire claim
2) Doctrine of equitable subordination  only applies in federal bankruptcy proceedings subordinates
corporate insiders’ claims to those of outside creditors
i. Must be showing of fraudulent conduct, mismanagement, or inadequate capitalization.
ii. Doctrine only alters normal priority of claims against corporate resources

Walkoszky v. Carlton
Facts William Carlton owned a large taxicab business. Carlton was a controlling shareholder of 10 different
corporations, each of which held title to two cabs and no other assets. Each cab carried $10,000 in car liability
insurance, which was the minimum required by state law. John Walkovsky alleged that he was struck and injured by
a cab owned by Seon Cab Corporation, one of Carlton’s entities. Walkovsky sued Carlton, Seon Cab Corporation,
and each of Carlton’s other cab corporations, arguing that they all functioned as a single enterprise and should be
treated accordingly. Carlton moved to dismiss the complaint as to him personally for failure to state a cause of
action.
Holding Complaint falls short of adequately stating cause of action against D in individual capacity
Analysis Pleadings only allege the first set of conduct  it is barren of any sufficiently particularized statements
that the D and his associates acted in their individual capacities to do business, shuttling personal funds in and out of
corporations without regard to formality and to suit their immediate convenience  this perversion of privilege
would justify imposing personal liability on individual stockholders

Radaszweski v. Telecom Corp. [NY]

Facts Radaszewski injured in automobile accident when the motorcycle he was driving was struck by a truck driven
by an employee of Contrux, Inc. Contrux, Inc. is a wholly owned subsidiary of Telecom Corporation. When
Telecom formed Contrux, it contributed loans, not equity, and did not pay for all of the stock that was issued.
Telecom did provide Contrux with $1 million in basic liability coverage, and $10 million in excess coverage.
Contrux’s excess liability insurance carrier became insolvent two years after Radaszewski’s accident. A
question of jurisdiction turned on whether Radaszewski could pierce the corporate veil and hold Telecom liable for
the conduct of its subsidiary, Contrux. Telecom argued that the corporate veil could not be pierced on the basis
of undercapitalization, because of the insurance it had provided to Contrux.
Holding Record devoid of facts showing ‘something more’ than a mere error in business judgment that resulted in
subsidiary’s bankruptcy but that is required under Collet to hold the parent company liable
Analysis
Three requirements under Collet formulation [
1) Control  complete domination of all finances, business practice, and policy, so that the
corporate entity as no mind of its own
2) Control used by D to commit fraud or wrong, perpetrate the violation of statutory or
other positive legal duty, or dishonest and unjust act in contravention of P’s legal rights
iii. Undercapitzalization has become a proxy for this element because it creates an inference
that the parent is either deliberately or recklessly creating a business that will not be able
to pay its bills or satisfy its judgment against it
1. Assets were medallion, taxis themselves, and insurance up to $10,000
2. D argues Contrux is not this because it has liability insurance even though
the insurance company is now insolvent
3. Court: insurance fulfills financial responsibility policy underlying second
prong – it is common business practice or insurance to be purchased
through an agency wholly owned by telecome
3) The aforesaid control and breach of duty must proximately cause the injury or unjust loss
complained of

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[COMPARE]  Cabney [CA]: Cabney opens a public swimming pool and incorporate the swimming pool within a
corporation and gives it no assets. Another corporation is created to own the public swimming company and lease it
to the operating company. Child drowns at the pool because no lifeguards. Deemed a violation of the operating
company that has no assets. The plaintiff goes after Cabney and says there is nothing to this corporation but you. All
profits were transferred to you immediately. The asset of the land has been put somewhere else. Supreme
Court of CA said this can be a piercing of the veil.

Corporate Groups

Alter-ego doctrine (Gardemal): allows imposition of liability on a corporation for the acts of another corporation
when the subject corporation is organized or operated as a mere tool or business conduit. Used when there is a
showing of blended identities and blurring of formal and substantive lives. Important consideration is whether the
corporation is underfunded/ undercapitalized. Purpose: corporations cannot avoid liability by abusing corporate
form, it is an equitable remedy.

Single business enterprise theory (Gardemal): When corporations are not operated as separate entities, but
integrate their resources to achieve a common business purpose, each constituent corporation [sibling corporations,
other subsidiaries] may be held liable for the debts incurred in pursuit of that business purpose. Same purpose as
alter-ego doctrine

Gardemal v. Westin Hotel Co.

Facts Gardemal and her husband, John, travelled to Cabo San Lucas, Mexico to attend a seminar held at the Westin
Regina. Westin Regina is managed by Westin Mexico. Westin Mexico is a Mexican corporation and a subsidiary
of Westin Hotel Company, a Delaware corporation. John went swimming and was swept into the ocean by a rogue
wave and thrown against the rocks. John drowned. Gardemal brought wrongful death and survival actions
against Westin and Westin Mexico under Texas law, alleging that her husband drowned because Westin Regina's
doorman negligently directed them to the beach and failed to warn them of the dangerous conditions. Although
Westin and Westin Mexico were closely related through stock ownership, common officers, financing
arrangements, etc., the two corporations strictly adhered to their corporate formalities. Further, Westin
Mexico was sufficiently capitalized. Westin moved for summary judgment, claiming that it was a separate
corporate entity and thus should not be liable for acts committed by its subsidiary.
Holding Plaintiff pleads insufficient evidence to show Westin Mexico was the alter-ego of Westin or that they were
a single business enterprise
Analysis
1. Alter-ego: Westin Mexico is not alter-ego of Westin despite shared officer, stock ownership,
financing arrangements because Westin Mexico: has its own bank account and complies with its state
of incorporation rules, which is Mexico; Little evidence on record that Westin Mexico is under
capitalized
2. Single Enterprise: Again no evidence of blending corporate identities—use of the same trademark
and reservation system is not enough
3. Plaintiff has not shown she has suffered harm

OTR Associates v. IBC Services Inc.

Facts OTR Associates owns a shopping mall in New Jersey. It leased space to Samyrna, Inc. (the franchisee), a
franchisee of International Blimpie Corporation. Blimpie wholly owned a subsidiary named IBC Services, Inc..
IBC was created for the sole purpose of holding the lease for the space occupied by the franchisee. IBC had no
assets except the lease and no income except the rent payments by the franchisee. IBC did not have its own business
place and employees, and Blimpie retained the right to approve and manage the lease. The transaction happened in
this way: IBC entered into the lease with OTR, and then with OTR's consent, IBC subleased the space to the
franchisee. OTR’s partners believed that they were dealing with Blimpie instead of IBC and did not discover the
separate corporate entities until after the eviction. The persons who approached OTR and asked to rent space in
the mall were wearing Blimpie uniforms, the tenant identified in the lease was “IBC Services, Inc. having an
address at c/o International Blimpie Corporation, 1414 Avenue of the Americas, New York, New York,” and
the letters sent to OTR bore the Blimpie logo. Later, the lease was terminated due to continued late payment of
rent. OTR sued Blimpie for unpaid rent in the amount of $150,000. The trial court found for OTR. Blimpie

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appealed.
Holding Facts present textbook circumstances mandating piercing corporate veil
Analysis
Corporate-subsidiary rule: Where a corporation holds stock of another, not for the purpose of
participating in the affairs of other corporation, in the normal and usual manner, but for the purpose of
control, so that the subsidiary company may be used
Two-part test (Collet):
b. 1) Parent dominated the subsidiary that it had no separate existence but was merely a conduit for
the parent
i. IBC was dominated by Blimpie
c. 2)The parent abused its privilege of incorporation by using the subsidiary to perpetrate fraud or
injustice or otherwise circumvent the law
i. Most important fact was that the plaintiff’s partners through they were dealing with
Blimpie and did not know of separate corporate entities until after the eviction
ii. IBC intentionally and affirmatively made OTR think it was Blimpie
iii. Leasers in Blimpie uniforms, IBC’s address in the lease was at Blimpie, letters to OTR
were on Blimpie letterhead
iv. Separate corporate shell may have been perfect at Blimpie avoiding lability, but in
every functional and operational sense, the subsidiary had no separate identity
Environmental Liability

Two approaches to environmental regulation:

1) Hold corporations responsible for externalizing costs
2) Hold individuals responsible

Focus is on the Environmental Response, Compensation and Liability Act—passed in 1980 to remedy toxic
waste sites and create liability scheme in which responsible parties pay for the costs of remediation
Scope  CERCA imposes costs of owners and operators of facilities dumping hazardous chemicals
Person  corporations and other orgs.
Owner or operator  means only A person owning or operating a facility
Recently, courts have interpreted “owner and operator” broadly to impose liability on parent
companies for dumping activities of their subsidiaries

What state law applies in control situations? The law of the state in which the operation occurs

Owning (Bestfoods) normal law on piercing the veil applies [normal PVC doctrine] normal property law, stops
with subsidiary  indirect liability

Operating (Bestfoods)  Nothing in the statute’s terms bars parent corporations from direct liability for its own
actions in operating a facility owned by its subsidiary  this is direct liability
Under CERCLA any person who operates a polluting facility is directly liable for the costs of
cleaning up the pollution. What constitutes direct parental operation? Operator must manage,
direct, or conduct operations specifically related to pollution. The inquiry should be on
whether the parent company operated the facility and if there is evidence of such. Whether,
in degree and detail, actions direct to the facility by the agent of the parent alone are eccentric
under accepted norms of parental oversight of a subsidiary’s facility

United States v. Bestfoods

Facts Ott Chemical Company operated a manufacturing plant in Muskegon, Michigan, which polluted the site with
hazardous chemicals. In the 1960s, Ott became a wholly-owned subsidiary of Bestfoods. Ott and Bestfoods had
some common directors and officers, and Bestfoods exercised significant control over Ott’s general business
operations. One Bestfoods employee, G.R.D. Williams, played a large role in dealing with the environmental risks
caused by the Muskegon plant; Williams was an employee of Bestfoods only, and not of Ott. In the 1980s, the EPA
began to remediate the property and sought contribution from owners and operators pursuant to the CERCLA. Ott

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had dissolved by this time, but Bestfoods was one of several companies sued for contribution. The district court
found that Bestfoods was directly liable under CERCLA as an operator of a hazardous plant because of the
degree of control it exercised over Ott’s operation. Among other factors, the court cited the many directors and
officers common to the two companies. The appellate court reversed, holding that a parent could only be liable for a
subsidiary’s operation of a plant if state law piercing requirements were met, or if the parent and subsidiary operated
the plant as a joint venture. The United States appealed.
Holding The corporate parent could not be held indirectly (or derivatively) liable, unless the corporate veil could be
pierced. However, the corporate parent that actively participated in, and exercise control over, the operations of a
subsidiary may be held directly liable in its own right as an operator of the facility
Analysis
- Owning  normal law on piercing the veil applies [normal PVC doctrine] normal property law, stops with
subsidiary  indirect liability
o One circumstance is where parent company is the alter-ego of the subsidiary
- Operating  Nothing in the statute’s terms bars parent corporations from direct liability for its own
actions in operating a facility owned by its subsidiary  this is direct liability
- District court failed to recognize that it is appropriate for directors of a parent corporation to serve as
directors of its subsidiary, and that fact alone may not serve to expose the parent corporation to liability for
its subsidiary acts. Gov’t would have to show that the officers and directors were acting in their
capacities as Bestfoods officers/ directors and not as those of the subsidiary

Corporate Control
Sinclair  A dividend declaration by a dominated board will not inevitably demand the application of the intrinsic
fairness standard, but if such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard it
the proper standard

Sinclair Oil Corp v. Levien

Judicial approach to intra-group dealings between parents and its partially-owned subsidiary and between group
affiliates—Delaware
Facts S1 owned about 97 percent of the stock of its subsidiary, S2. S1 caused S2 to pay out $108 million in
dividends, which was more than S2 earned during the time period. The dividends were made in compliance
with law on their face, but S2 contended that S1 caused the dividends to be paid out simply because S1 was in need
of cash at the time. In addition, in S1 caused S2 to contract with S3, another S1 subsidiary created to coordinate S1’s
foreign business. Under the contract, S2 agreed to sell its crude oil to S3. S3, however, consistently made late
payments and did not comply with minimum purchase requirements under the contract. S2 brought suit
against its parent, S1, for the damages it sustained as a result of the dividends, as well as breach of the
contract with S3.
Holding BJR and not intrinsic fairness test should have been applied to the dividend payments because the
transaction was not self-dealing
Analysis
- Intrinsic fairness/ Dividend  APPLICATION A proportionate amount of the dividends were received by
minority shareholders of S2 and S1 received nothing at the exclusion of S2  thus, not self-dealing
- BJR Analysis Facts complied with BJR, P must prove waste. APPLICATION S2 says that it was drained
of cash and therefore prevented from expanding, but S2 has not shown that business opportunities which
came to S2 independently were taken or denied from S1. Therefore, absent fraud or gross overreaching, the
expansion of other subsidiaries must be upheld
- Breach of Contract  agree with Chancellor that S1 breached K
o Self-dealing  S1’s act of contracting with its dominated subsidiary was self-dealing. S1 received
products produced by S2 and the minority shareholders of S2 were not able to share in the receipt
of these products
o Intrinsic fairness  S1 must prove that causing S2 not to enforce the K was intrinsically fair to
the minority shareholders of S2  S1 has failed to do so

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Duties of Cont. Shareholders

Harris  While a person who transfers corporate control to another is surely not a surety for his buyer, when the
circumstances would alert a reasonably prudent person to a risk that his buyer is dishonest or in some material
respect not truthful, a duty devolves upon the seller to make such inquiry as a reasonably prudent person would
make, and generally to exercise care so that others who will be affected by his actions should not be injured by the
wrongful conduct

Controlling  Generally, courts will find a shareholder to be controlling if they own more than 50% of the voting
power of a corporation or if they own less than 50% but exercise control through de facto influence of the board

Sharing of Control Premium  Controlling shares are sold at a command premium because of the benefits
associated with them. Corporate law leans that it should be easy to transfer control shares so that they can get the
shares into the people who value them most

Harris v. Carter
[Controlling shareholders owe duty of reasonable prudent person to do due diligence on sale of shares]
Facts Harris was a minority shareholder in Atlas Energy Corporation, an oil-and-gas company. The Carter
group, a group of Atlas's shareholders who owned 52 percent of Atlas's stock, entered into a stock-exchange
agreement with Mascolo. Pursuant to the agreement, the Carter group would exchange their Atlas shares for
Mascolo's shares in ISA. Additionally, the agreement provided that the Carter group would resign their positions at
Atlas directors and ensure that Mascolo and a group of his designees would be appointed in their place. The
agreement described ISA as a company engaged in the insurance field and contained Mascolo's representations and
warranties that ISA owned all the stock of two life-insurance companies, which was allegedly untrue. During
negotiations, Mascolo provided the Carter group with a draft financial statement indicating that ISA had an
investment in a third life-insurance company, which was also allegedly untrue. Atlas's CFO examined the financial
statement and raised concerns about its accuracy, but the Carter group never followed up on those concerns. After
Mascolo purchased the Carter group's stock, Atlas's newly appointed board of directors (i.e., Mascolo and his
designees) took actions including changing Atlas's name to Insuranshares of America, Inc., reducing Atlas's
authorized capitalization, purchasing all outstanding shares in ISA using Atlas stock, and entering
negotiations to sell all of Atlas's oil properties. Harris brought an action against the Carter group, Mascolo, and
Mascolo's designees. Among other allegations, the complaint asserted that the Carter group owed a duty of care
to Atlas to take reasonable steps to investigate Mascolo's legitimacy before they sold control of the company
to him and that they breached this duty by failing to conduct even a basic investigation into the suspicious
aspects of the transaction before entering into the agreement. The defendants moved to dismiss.
Holding While a person who transfers corporate control to another is surely not a surety for his buyer, when the
circumstances would alert a reasonably prudent person to a risk that his buyer is dishonest or in some material
respect not truthful, a duty devolves upon the seller to make such inquiry as a reasonably prudent person would
make, and generally to exercise care so that others who will be affected by his actions should not be injured by the
wrongful conduct
Analysis Carter motion to dismiss: whether a controlling shareholder or group may under circumstances owe a
duty of care to the corporation in connection with the sale of a control block of stock
o Two principles well-established principles
 1) A shareholder has a right to tell his or her stock and in the ordinary case owes no duty
in that connection to other shareholders when acting in good faith
 2) When a shareholder presumes to exercise control over a corporation, to direct its
actions, that shareholder assumes a fiduciary duty of the same kind as that owed by a
director to the corporation

Perlman v. Feldman
[this case is a total anomaly, general rule in the united states is that shareholder can share control block for however
much they want as long as they do not think the buyer will breach their fiduciary duty, Harris]
Facts Feldmann was the majority stockholder in the Newport Steel Corporation. During the Korean War, there
was a severe shortage of steel supply, making Newport very valuable. Feldmann, taking advantage of the shortage,
sold his controlling interest to Wilport Company for a premium price. Newport stockholders brought a

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derivative suit against Feldmann seeking accounting for and restitution of Feldmann’s gains in the sale. The
plaintiffs contended that the premium Wilport paid included a corporate asset—the ability to control production of
steel in a time when supply was very low. They argued that this power was held in trust for Newport by Feldmann
as its fiduciary.
Holding To the extent that Feldman obtained such a bonus from the sale, he is accountable to the minority
stockholders who sued. Case is remanded to decide the value of plaintiff’s stocks
Analysis

- Corporate misappropriation theory: Corporate opportunities of whose misappropriation the minority

stockholders complain need not have been an absolute certainty in order to support this action against
Feldman – if there was a possibility of corporate gain, they are entitled to recover
- Defendants had the burden of proof in establishing the [intrinsic] fairness of their dealings with trust
property
- When the sale necessarily results in a sacrifice of this element of corporate good will and consequent
unusual profit to the fiduciary who has caused the sacrifice, he should account for his gains

Sale of Corporate Office

Usual practice for when a buyer acquires a controlling block of shares is for the existing directors to resign and to
have the vacancies filled by new directors chosen by the buyer. But directors, elected by all the shareholders, cannot
sell their corporate office.

Selling corporate board seats as part of stock sale  (Essex) Established New York law that you cannot sell a
corporate office or management control by itself. However, if the sale was for substantive percentage of stock
which by virtue carried power to elect majority of directs, then it was not a simple agreement for the sale of
office.

Essex Universal v. Yates

Facts Yates was president and chairman of the board of directors of Republic Picture Corporation. Yates
agreed to sell stock to Essex Universal Corporation the equivalent to owning share control. The stock purchase
agreement called for the immediate transfer of control of the board through a resignation of the majority of
Republic directors and the election of directors of Essex’s choosing in their place. Ordinarily, only one-third of
Republic’s directors were elected at each annual meeting [staggered board], thus Essex under normal circumstances
would not have been able to take managing control officially until about 18 months after the sale, when it had
elected enough of its own directors. When the time came for Essex to tender payment to Yates, however, Yates
said that he did not want to go through with the deal. Essex brought suit.
Holding
Analysis
- Republic had a staggered board  was it legal to accelerate the transfer of management valid under
NY public policy? There is no reason why a purchaser of a majority control should not ordinarily be
permitted to make his control effective from the moment of the transfer of stock – don’t want to discourage
these transactions
- Burden of proof is on the plaintiff attacking the transaction. Plaintiff has to show circumstances which
would have prevented Essex from electing a majority of the Republic board in due course, not enough to
raise hypotheticals. Plaintiff must show that there was at the time some concretely foreseeable reason why
Essex’ wishes would not have prevailed in shareholder voting in due course – he must show that there as at
the time of the contract some other organized block of stock of sufficient size to outvote the block Essex
bought

Concurrence (Friendly, J.): Stockholders are entitled to reasonably expect that empty director seats should be
filled by the remaining directors in the exercise of their fiduciary duty to the corporation. A mass resignation of
directors, only to be replaced by individuals predetermined by the buyer is beyond those reasonable expectations.
[Oppression test?] Accordingly, contrary to the majority’s opinion, a clause such as the one in this contract where
the purchased interest is not more than 50 percent of the corporation should be invalidated as a violation of public

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policy. However, the “unexpected character” of such a holding would make a retrospective application inappropriate
and thus such a holding should not be applied to this case, but only applicable moving forward.

Mergers & Acquisitions

Types of Mergers

1) Statutory merger, 2) Triangular merger, 3) Sale of assets, and 4) Tender offer

Surviving company: P/ Company ceasing to exist: T/ Subsidiary of P: S

1) Statutory Merger: Requires

a. Designates which corporation it to survive the merger
b. Describes the terms and conditions of the merger
c. Specifies how shares of T will be converted into shares of P
d. Sets forth any amendments to P’s articles of incorporation necessary to effectuate the plan of the
merger
e. Must be approved by both corporations’ boards and shareholders
f. One corporation immediately ceases to exist once the merger is filed with the secretary of state’s
office
2) Triangular Merger P creates subsidiary S. S merges with T so that either corporation survives. If S
survives, it is a forward triangular merger. If T survives, it is a reverse triangular merger. At the time
of the merger, the consideration transferred to the T shareholders and their T stock is cancelled. After the
merger P has a wholly-owned subsidiary, that has the assets and liabilities of T.
a. Pro: Protects P from assets/liabilities of T.
b. DL Voting: Only S’ and T’s shareholders vote on the merger, not P’s
c. Voting under MBCA: Same as when two corporations merge: P’s shareholders must vote if: 1)
the merger results in dilutive share issuance, where P issues new shares with voting power equal to
at least 20% of the voting power that existed prior to the merger, or 2) merger changes number of
shares they hold after the merger or otherwise fundamentally changes rights. Appraisal: [same]
Surviving company shareholders only have appraisal rights if they are entitled to vote on the
merger and their shares do not remain outstanding afterward
3) Sale of Assets P can buy T’s assets using consideration of its own stock, cash etc. High transaction costs
but avoidance of liabilities of T.
a. Voting: Boards must agree, then shareholders of T.
b. Liabilities: P may become liable for T’s liabilities if the asset purchase violates Fraudulent
Conveyance Act (piercing corporate veil); some statutes or common law may make P liable for
T’s liabilities if there is “successor liability,” if this is the case, then a lawyer may choose the
triangular method instead
c. MBCA: T shareholders have appraisal rights subject to market out, same dilutive shareholder rule
applies to P shareholder. However, P shareholders do not have appraisal rights because they retain
their stock
d. DL: appraisal for T shareholders not available. P shareholders have no voting or appraisal rights
in an asset purchase because the transaction is like that of any issuance of stock to purchase
assets… it is board discretion
4) Tender Offers P offers to purchase T’s shares directly from T’s shareholders either for P stock or other
property. P can acquire control of T without approval of T’s board. No appraisal rights, T’s shareholders
can individually refuse the tender offer. P shareholders do not have a say unless there is a dilutive effect or
P needs authorization to issue more shares for consideration to T. P shareholders do not have appraisal
rights because shares are not reduced in the transaction. P can engage in a ‘second-step’ transaction, like a
statutory merger, after the tender offer to get rid of minority T shareholders.

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 a. Hostile tender offers are not that common today because of takeover defenses. More
common approach is to have buy shares in target company after corporation has taken
control of target company’s board

Shareholder Rights

For dissenting shareholders, statutes create an opt-out for some fundamental shareholders at which point the
corporation must pay a fair price for the minority shareholder’s shares. Appraisal sets a floor on the value of the
minority shares before the merger when the majority approves fundamental changes that affect the minority’s
interests. Three clear points on appraisal statutes:
1) Every corporate statute authorizes shareholders to demand appraisal as to certain fundamental changes
and to require the corporation to repurchase their stock in cash for its fair value
2) Corporation statutes vary from state to state on when shareholders have voting and appraisal rights
3) Sometimes shareholders have voting rights in a transaction, but not appraisal rights

Voting Rights in a Statutory Merger

DL: statutory merger must be approved by absolute majority of both corporations’ shareholders unless it is a
whale-minnow merger where the outstanding shares of P does not increase by more than 20%

MBCA: statutory merger must be approved by simple majority of shareholders of corporation that ceases to
exist. Remaining corporation’s shareholders must vote if: 1) the merger results in dilutive share issuance, where
P issues new shares with voting power equal to at least 20% of the voting power that existed prior to the merger, or
2) merger changes number of shares they hold after the merger or otherwise fundamentally changes rights

Appraisal Rights

Appraisal only valuable if judge says merger price did not reflect share’s proper value

Market out exception (Generally): assumes shareholders dissatisfied with terms of merger do not need a judicial
valuation remedy if there is a public market for their stock because market price will reflect value better than one
determined by a judge

MBCA: Generally makes appraisal available only to the shareholders of the company ceasing to exist and only
those who are entitled to vote on the merger and not subject to ‘market out’ exception. Surviving company
shareholders only have appraisal rights if they are entitled to vote on the merger and their shares do not remain
outstanding afterward
Market out: Prevents shareholders from corporation ceasing to exist to getting appraisal if their stock
was publicly traded before the merger and they receive cash or marketable stock in the merger
Exception does not apply in conflict of interest transactions such as: squeeze out merger
involving 20% or more shareholder; management buyout where insider group has power to elect
¼ or more of the board

DL: Shareholders of corporation ceasing to exist can get appraisal rights even if not entitled to vote unless ‘market
out’ exception applies. Surviving corporation’s shareholders get them if they were entitled to vote and ‘market out’
exception doesn’t apply
Market Out: No shareholder, from either company, can get appraisal if the stock was publicly traded
before and after the merger. DL distinguishes between shareholders of corporation ceasing to exist who
were forced to take cash and those who chose their consideration.
Exception Those forced to take cash can get appraisal rights in DL but not under MBCA

Materiality

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Basic Inc  Merger negotiations where there’s strong likelihood the merger is going forward are covered by 10b-5.
There is no valid justification for artificially excluding from the definition of materiality information concerning
merger discussions, which would otherwise be significant to the trading decision of a reasonable investor. Whether
merger discussions in a particular case are material depends on the probability (look at indicia of interest in
transaction at the highest corporate levels e.g. board resolutions, instructions to investment) of the event occurring
the magnitude of the transaction (size of two corporate entities, potential premiums over market value)

Basic Inc. v. Levison

Shareholders have the right to recover damage to the value of their shares due to Basic Inc.’s lie
Facts In 1976, Combustion Engineering, Inc. had discussions with directors of Basic Inc about a possible merger
between the corporations. Over the next two years, Basic made three public statements denying that it was
engaged in any merger negotiations. Allegedly in reliance on those statements, the plaintiffs sold their stock in
Basic at artificially low prices. The plaintiffs then brought a class action suit against Basic and its directors,
alleging that the false public statements violated SEC Rule 10b-5.
Holding There is no valid justification for artificially excluding from the definition of materiality information
concerning merger discussions, which would otherwise be significant to the trading decision of a reasonable
investor. Whether merger discussions in a particular case are material depends on the probability (look at indicia of
interest in transaction at the highest corporate levels e.g. board resolutions, instructions to investment) of the event
occurring the magnitude of the transaction (size of two corporate entities, potential premiums over market value)
Analysis
- Standard of materiality: there must be a substantial likelihood that the disclosure of the omitted fact
would have been viewed by a reasonable investor as having significantly altered the total mix of
information made available.
o Where corporate development in target’s fortune is certain, materiality plainly applies
o Where the development is contingent or speculative in nature (like merger negotiations), the
materiality is difficult to determine
- Under Fed Sec Reg, there is no BJR for lying

Judicial Review of Mergers

BJR applies to merger transactions

Shareholders can bring suits based on violation of duty of loyalty (bad faith, re Disney), or gross-procedural
negligence (Van Gorkem), chance of waste is pretty small. Gross procedural negligence is enough to enjoin a
transaction, the relief being sought is often equitable relief. 102(b)(7) only exculpates against damages, monetary
relief, but 102(b)(7) has no bearing on equitable relief. If you have evidence of bad faith (like Disney) then you
would be able to get around damages and equitable relief

Conflict Transactions

Regular judicial review of conflict transactions:

When the court identifies a conflict of interest, the BJR temporarily does not apply, 102(b)(7) goes off the table,
burden of proof shifts to the interested party to demonstrate intrinsic fairness. Intrinsic fairness is both a look at the
process (fair process) and the result (fair price). Next, the defendant can show fairness by cleansing, and if cleansing
occurs, the BJR is reinstated. The plaintiff can then show waste, gross-procedural negligence, or bad faith.

Weinberger (cash-out merger) 

P demonstrates conflict + defect in bargaining process
D shows (1) fair price and (2) fair process
BJR reinstated if: (1) shareholders and independent directors approve; (2) special committee has
independent directors; (3) special committee empowered to hire own advisors and say no; (4)
careful consideration; (5) informed minority shareholder vote; (6) no coercion of the minority;
If not all of the above are true (i.e. they only show independent director or shareholder approval), then
burden shifts to P to show fundamental unfairness.

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DE: In the context of a controlling shareholders ‘going private’ merger, where the two protections of Kahn apply—
1) approval by independent special committee and 2) vote by majority of shareholders unaffiliated with controlling
shares—the BJR applies (M&F Worldwide)

Corwin: transaction involving non-controlling shareholder that is approved by a fully informed and uncoerced
vote of the disinterested shareholders will be reviewed under the BJR, this was later extended to tender offers in In
re Volcano

Three Types of Freezeouts

Cash-Out Merger: Parent corporation uses its control of the subsidiary’s board and its voting majority to
arrange a merger between the partially owned subsidiary and a wholly-owned corporation of the parent (or
the parent itself), minority shareholders receive cash or appraisal
Tender offer followed by merger: Bidder corporation makes tender offer conditioned on acquiring
specific % of corporation’s stock (historically ~90%).
Sale to outside buyer: Parent corporation arranges for subsidiary to be merger with outside buyer and
parent corporation and minority shareholders receive consideration

Cash-Out Merger (Weinberger)

What are the fiduciary duties of the parent corporation when it cashes out minority shareholders?

DE’s Pre-Weinberger Approach: merger made for the sole purpose of freezing-out minority stockholders is an
abuse of the corporate process. Singer established that a shareholder dissatisfied with the terms of a cash-out merger
could challenge it by alleging that the merger was unfair and shift the burden to the controlling shareholder to show
fairness

Weinberger Review (direct suit b/c it hurt the shareholders)

- Minority shareholders sue based on conflict of interest, burden shifts to Signal to prove intrinsic fairness,
the court says that the merger is subject of the entire fairness test, fair dealing and fair price. The
shareholders of UOP win
Takeaway 1: Everyone with a slight conflict of interest has to be totally out of the room for the merger
negotiations!! The case could have easily come out differently if they had appointed an independent
negotiating committee—every good corporate lawyer should have known to appoint an independent
negotiating committee
Takeaway 2: Votes cannot have a cleansing effect unless and until the truth is told to all company’s
shareholders
Takeaway 3: Temptation is to say that BJR is reinstated, but members of the negotiations committee can
never be independent enough to warrant BJR, instead, burden of proof goes to plaintiffs to show
unfairness
Remedy: Appraisal is not the exclusive remedy when the shareholders can show that they were lied to
regarding the negotiations

Short-Form Merger

DCGL § 253 authorizes “short form merger” between P and S if P owns at least 90% of S’s stock
—P files certificate setting forth its stock ownership and terms of the merger, as set by P’s B. of
D. P must advise S’ shareholders of merger and of appraisal rights
Glassman (DL): entire fairness test does not apply to short-form mergers, appraisal is the only
remedy. § 253 authorizes a procedure at-odds with reasonable notion of fair dealing
Medium-form merger: § 251(h) eliminates need for shareholder approval if 1) target is listed on
national securities exchange and 2) bidder owns specified % as to give entitlement to vote on the
merger (usually majority)

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 Tender Offer
Remember: DE if you succeed at getting 50.1% of the shares via tender offer, you can make it that day to remove all
the current directors and then appoint whomever you want

Shareholder/bidder first makes tender offer directly to minority shareholders to gain requisite
percentage of shares and then does a ‘back-end’ merger, where the new controlling-shareholder
squeezes out the minority shareholders

Standard of Review—DE says that because the decision to accept the tender offer is voluntary,
minority shareholder do not have right to fair price. DE court will look at structure and disclosure
to shareholders but not entire fairness of offer

Challenging Proxy Statements

SEC rules § 14(a) require information for proxy solicitation to be full and complete. § 14a-9 bar false or misleading
statements

Implied Federal Cause of Action

- Courts fashioned cause of action for Rule 14a-9, tracks traditional fraud elements: P must show 1) a false or
misleading statement, 2) of material fact, 4) upon which shareholder voters relied 4) causing them to suffer
losses
14a-9 actions not widely used anymore, most shareholders now turn toward state fiduciary
protections… but all of the cases involved challenges to corporate merger, which traditionally received
deferential review under state law
Duty of Disclosure under State Law In 1970s, state court began to care about disclosure  DE Lynch: articulated
duty of candor [duty of disclosure] borrowing from federal proxy action—duty is often used to challenge mergers by
alleging misleading proxy statements

Takeover Contests
Judicial Review

Three approaches:

1) Courts apply the BJR

a. Transaction approved by majority of disinterested and independent directors  BJR
b. Corwin  BJR applies when a transaction has been approved by a fully-formed, uncoerced
majority of disinterested shareholders
2) Courts apply intermediate scrutiny  Standard for under the duty of loyalty: was the decision to serve
self-interest or in the best interest of the company? (Unocol vs. Mesa Petroleum)
3) Strict scrutiny  Once a company is officially ‘for sale’ antitakeover measures are given much more
scrutiny because once for sale, the directors must act to the benefit of the shareholders (Revlon v.
MacAndrews).

Unocal Proportionality Test: Intermediate Standard of Review

Two prong proportionality Test:

1) Whether the board has reasonable grounds for believing a threat to the corporation existed  this
prong is fulfilled by showing good faith and reasonable investigation (care portion)

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 2) Whether the defensive measures taken were reasonable in relation to the threat perceived  and were
motivated by a good faith concern for welfare of corporation, court must look at nature of takeover bid
and effect on the corporation.
If these prongs are met  BJR applies

Revlon: Strict Scrutiny

Revlon applies when there is a foreseeable change in control. Langevoort  Revlon is triggered without the need for
any hostile threat. All that is necessary is that control is leaving the hands of dispersed shareholders and going to
some person or entity that will be in a position to exercise that control, who thus can be expected to pay a premium.

When (Revlon’s) board allowed for negotiations with a third party, this was a recognition that the company was for
sale. The directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting
the best price for the stockholders at a sale of the company. As such, A no-shop provision is improper once the
role of the board is auctioneer

Devices

Classified Boards
Classified boards allow boards to become staggered.
DE  § 141 boards can become staggered into at most 3 classes through either amending the bylaws or
articles of incorporation
MBCA  classified boards must be done through the articles

Classified boards make takeovers more difficult because each election the insurgent can only elect a minority of
shareholders, thus not obtaining control of the board until at least the section election cycle.

Poison Pills

[If board cannot identify true threat (like coercion) the pill must be taken back]
Poison pills are devices that dilute the stake of the potential acquirer, thereby making the acquisition less attractive
because it becomes too expensive. Traditionally labeled as a shareholder rights plan, the corporation issues
additional rights attached to outstanding shares. The right cannot be traded and initially have little value. Rights
plan creates a triggering event (like buying % of corporation’s shares) whereby other shareholders have the right to
buy more shares, diluting the prospective acquirers shares.

DCGL § 157  Gives corporations the right to issue additional rights unrelated to issue and sale of shares
Moran  § 157 gives the board of DE Corp. authority to adopt a shareholder rights plan.

Procedurally:
- Board can issue the rights without shareholder approval
- Board can create a poison pill even after a potential acquirer has emerged, unless the articles say otherwise
- Board has the right to redeem the rights for usually a nominal price

Share Repurchases
Directors can authorize repurchase of shares from a potential acquirer. Greenmail is when the purchase is at a
premium, essentially acquirer backs off the acquisition only for a premium

Lock-Ups
Agree to transactions with a third-party bidder to lock-up some or all of the value sought by the original bidder.

Unocol Corp. v. Mesa Petroluem Co. (DE)

Facts Mesa Petroleum Co. owned 13 percent of Unocal Corporation’s stock. Mesa submitted a “two-tier” cash
tender offer for an additional 37 percent of Unocal stock at a price of $54 per share. The securities that Mesa
offered on the back end of the two-tiered tender offer were highly subordinated “junk bonds.” To oppose the Mesa
offer and provide an alternative to Unocal’s shareholders, Unocal adopted a selective exchange offer, whereby

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Unocal would self-tender its own shares to its stockholders for $72 per share. The Unocal board also
determined that Mesa would be excluded from the offer. The board approved this exclusion because if Mesa was
able to tender the Unocal shares, Unocal would effectively subsidize Mesa’s attempts to buy Unocal stock at $54 per
share. In sum, the Unocal board’s goal was either to win out over Mesa’s $54 per share tender offer, or, if the Mesa
offer was still successful despite the exchange offer, to provide the Unocal shareholders that remained with an
adequate alternative to accepting the junk bonds from Mesa on the back end.
Holding If the board of directors is disinterested, has acted in good faith and with due care, its decision in the
absence of an abuse of discretion will be upheld as a proper exercise of business judgment.
Analysis
- 141(a)  respective management of the corporation’s business and affairs. Corporation may deal
selectively with its shareholders, provided that directors has not acted out of a sole or primary purpose to
entrench themselves
- Board’s takeover determination carries heightened risk of self-interested actions which calls for a
judicial determination beyond the BJR (two-prong test)
- Directors’ participation in the stock exchange does not disqualify them as disinterested because they
receive the same benefit as the rest of the shareholders

Revlon Inc v. MacAndrews & Forbes Holdings

Facts Pantry Pride to acquire Revlon, Inc. and offered $45 per share. Revlon determined the price to be inadequate
and declined the offer. Despite defensive efforts by Revlon, including an offer to exchange up to 10 million shares
of Revlon stock for an equivalent number of Senior Subordinated Notes (Notes) of $47.50 principal at 11.75 percent
interest, Pantry Pride remained committed to the acquisition of Revlon. Pantry Pride raised its offer to $50 per share
and then to $53 per share. Meanwhile, Revlon was in negotiations with Forstmann Little & Co. (Forstmann)
(defendant) and agreed to a leveraged buyout by Forstmann, subject to Forstmann obtaining adequate
financing. Under the agreement, Revlon stockholders would receive $56 per share and Forstmann would assume
Revlon’s debts, including what amounted to a waiver of the Notes covenants. Upon the announcement of that
agreement, the market value of the Notes began to drop dramatically and the Notes holders threatened suit against
Revlon. At about the same time, Pantry Pride raised its offer again, this time to $56.25 per share. Upon hearing this,
Forstmann raised its offer under the proposed agreement to $57.25 per share, contingent on two pertinent
conditions: First, a lock-up option giving Forstmann the exclusive option to purchase part of Revlon for $100-
$175 million below the purported value if another entity acquired 40 percent of Revlon shares. Second, a “no-
shop” provision, which constituted a promise by Revlon to deal exclusively with Forstmann. In return,
Forstmann agreed to support the par value of the Notes even though their market value had significantly declined.
The Revlon board of directors approved the agreement with Forstmann and Pantry Pride brought suit, challenging
the lock-up option and the no-shop provision.
Holding Revlon’s defensive measures were inconsistent with the directors’ duties to stockholders, which was a
breach of the duty of care and not entitled to the BJR
Analysis
- Lock-ups and related agreements are permissible under DE law where their adoption is untainted by
director interest and other breaches of fiduciary duty
- Types of defensive mechanisms undertaken by the board
o 1) Rights Plan (poison pill): shareholders receive the right to be bought out by the company at a
substantial premium upon a triggering event. Plan was reasonable but effects were rendered moot
when the board redeemed the rights in October 3rd meeting
o 2) Corporations plan to exchange its own stock, measured by the Unocal standard.
- However, when the Revlon’s board allowed for negotiations with a third party, this was a recognition
that the company was for sale. The directors’ role changed from defenders of the corporate bastion
to auctioneers charged with getting the best price for the stockholders at a sale of the company.
o Revoln improperly favored the right of the notes holders over those of the shareholders
o Fortsmann bid had a destructive effect on the auction process  principle interest was to protect
the noteholders over the shareholders
o A no-shop provision is improper once the role of the board is auctioneer

Final class notes:

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 More than possible to make the argument that system of corporate law and norms has done too good a job at
aligning incumbent interest’s w/ shareholder interests, that desire to please the market, attracts more than its share of
attention. Under those circumstances, is it possible to make the opposite argument? Problem is not incumbent
insensitive to shareholders.

First Amendment (Citizens United) Notion that shareholders will be abused, therefore should not be a robust first
amendment right to corporate speech.
Kennedy: don’t want to worry about abuse because shareholders already have tools to protect themselves

To the extent that concern about the issue in Citizen United has to do with corporations law, the corporations part is
way over-stated. We should be using other forms of analysis to get to the right answer.
Better argument to Citizens United is that the corporation is just too powerful and has the power to overwhelm
voices among citizens.

Kennedy: Kennedy’s idea that regulation will help disclosure of corporations is a false premise because of the
amount of lobbying in DC

Langevoort: Citizens is a bad decision because of the degree of transparency in reality, we created an opportunity
whereby shareholders have no idea what the executives are doing as to voting expenditures, campaign contributions
etc. Corporation may have a cause of action under RFRA if plaintiffs pierce the corporate veil

Hobby Lobby: much of the reasoning, like in Citizens, is that the corporation is nothing more than the people that
inhabit it. Corporation can have a cause of action under RFRA if plaintiffs pierce the corporate veil

There are many corporations who are discriminated against because of diversity of executives  should they have a
a cause of action under the civil rights act? It’s a debate

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