Biz Ass Outline

History
1 No Substantive regulation
2 Metaphor= off-the-rack suit (a public good)
3 Big challenge for this course = agency costs created as a result of the separation of
ownership and control (Berle & Means). How do deal with agency costs became a big
issue.
4 Major Trends = liberalizations and federalization. Delaware won the race to the bottom.
Only real competition is the federal government.
5 Historical Periods:
a. Colonial period: need for infrastructure, inefficient legal system, granting of
monopolies, cronyism, advent of general incorporation statutes
b. Industrial revolution: immense need for capital, invention of corporations,
limited liability and perpetual life, Delaware/NJ story
c. Depression and beyond- cycle of scandal and reform, increasing federal
intervention

Agency

Cargill- Principals are liable for the contracts of their agents; Resemblance test: about
architecture not fairness.
A principal-agent relationship exists between a creditor and debtor when the creditor
intervenes in the business affairs of the debtor. Principals don’t have to intend agency, they just
need to intend to be working together for the purposes of the 3rd party. Agency is created by
intent to work together. Here, Cargill exercised control over how warren operated their
business through daily communications, writing letters, advice, agreed to purchase grain...
ultimately “pathetic list: the court is putting together a lot of nothing to try to come to
something”- Illig. Cargill didn’t intend to be principal of warren. They tried to exert some
control over how warren was spending the money, even though warren didn’t implement the
control. So then what was Cargill doing specifically to be liable? Where was the scam? Cargill is
pulling the strings according to the court. When a creditor exerts control over the operations of
a debtor, a principal-agent relationship is created, and can thus be liable for their action.

1- Principal-agent relationship
a. Formation= intent
b. Management = per the contract
i. Authority is granted via the terms of the contract.
ii. What about when intent based with no contract?
c. Vis a vis 3rd parties
i. Principals always liable
ii. Agent only liable if principal is wholly undisclosed
2- Test for (involuntary) agent-principal relationship (RESEMBLENCE TEST?)
a. Mutual consent, voluntary both ways
b. Principal has affirmative control over the agent
 i. Game becomes issue of control, right answer is to talk about affirmative
control- but be a sheep and you’re ok.

Gizzi v. Texaco
Gizzi was a person who bought car who had breaks repaired by a guy who worked at a Texaco
with a car service center attached and the guy was wearing a Texaco shirt. Here so we could see
tort example, and example of a franchise.
Authority
Actual authority: Look into the head of the principal, their behavior and actions.
Implied Authority: Look into the head of the agent (might include incidental/inherent authority,
i.e. stuff that goes with the job).
Apparent authority: Look into the head of the 3rd party, customer, or plaintiff. Belief must be
reasonable. No belief is reasonable unless it includes a manifestation.

Mill street Church v. Hogan- implied authority to act within the scope of agency; look to the
intent of the agent and ask whether it was reasonable for implied agency
Church hired a guy who they had before to do some more repairs. Previously he had hired his
brother but this time church wanted someone else, but never explicitly told him he could not
hire his brother. No actual authority here, because church did not expressly give him
permission to hire his brother again. Implied authority is circumstantial proof of actual
authority, like here the church was pretty big so obviously a 2-person job. Here we look to
intent of bill, who was acting reasonably in believing that he had the authority to hire a helping
hand, and he didn’t know church only wanted him to hire the other dude. The agent was
thinking reasonably and thought he could hire his brother, so he had implied authority.

370 leasing v. Ampex- Apparent authority requires a manifestation from the principal to be
valid, and needs to be observable by the 3rd party. Manifestation could be anything.
Apparent authority here based on manifestations on the principal, making Kays the exclusive
contact, and the specific contact asking where they wanted them sent.

Watteau v. Fenwick- inherent authority for stuff that goes with the job
After purchase, new owners still hired original owners of the pub, but told original owners he
couldn’t buy cigars from other suppliers. No implied authority, no actual authority, manager
knew he wasn’t supposed to buy. No principal manifestation so no apparent authority.
However inherent authority became a catch all of some other cases that have authority but
can’t really be explained. Best explained as stuff that goes with the job.

RECAP
1- Contractual liability for principal
a. Existence of an agency relationship
b. Presence of authority for the agent to so act
2- Authority can be proven in different ways
a. Actual = inside the head of the principal
b. Implied = inside the head of the (reasonable) agent
 c. Apparent = inside the head of the (reasonable) third party... only reasonable if
based on a manifestation from the principal

Ratification
Boticello- ratification is authority after-the-fact, retroactive acceptance; if don’t object at first
reasonable opportunity, could be ratification through implied consent.
Farm owned in common by husband and wife. Guy wants to buy it, guy offers 75k wife says
won’t sell for less than 85k. End up with 85k lease with option to sell. Husband and his attorney
set up deal with buyer and his attorney. Eventually wants to buy. Wife didn’t sign anything
though so she says she never consented to sell the land. Buyer said they have to sell it because
husband was acting as the wife’s agent. Court says he is not an agent. Second argument is that
she ratified the contract after it was signed by her husband accepting the payment and some of
which going to her. Ratification is authority after the fact, retroactive acceptance. Must know
material facts and accept to them. She doesn’t have knowledge of the option to purchase.
Silence can be ratification if it is action. If at first reasonable opportunity you don’t object, could
be ratification through implied consent. Why was husband not an agent, with binding authority
to sell?

Hoddeson v. Koos Bros- courts might imply agency or authority in the name of equity; agency
by estoppel to prevent injustice
Women goes in to buy furniture, fake salesmen at the place fools her and takes her money
saying furniture is on the way. Not the best scam, something fishy. Court accepts argument that
it was an imposter for sake of appeal, although is very fishy. Court says there is some duty to
customer to prevent fake sellers. Agency by estoppel, basically duty to supervise the property
and make sure there was no imposter. How could be policed? Security cameras, uniforms. No
apparent authority here. Imposter not held out by the principal, but store allowed an imposter
to scam the woman due to negligence. But is there more? No way is an employee, or some
imposter off the street. We can see a range of possibilities here, should figure out what actually
happened. Clear that department store defendant thinks she’s pulling a scam because they’re
spending the money to litigate. Illig wants us to be able to step back and figure out what’s really
going on.

Partnerships
Martin v. Peyton- loan or partners? Lending relationships must be considered in it’s entirety.
Matter of degree: if lender takes control of business affairs and directly participates in profits
and losses, they have become partners.
For a creditor to become a partner in a firm, the creditor must be closely enough associated
with the firm so as to make it co-owner carrying on the business for profit. Here, creditors were
just watching their backs, not raise to the leveling of carrying on the business for profit. Here,
are they partners? Were they sharing profits? Yes, but there was a limit on how much they
could receive. So they have a collar, a ceiling and a floor on the profits they can receive. And
only getting 40% up to half a million, and if they don’t have enough money still owe 100k. Not
really in it together because no matter how much they make there is a cap on what the bank
can get back. In it together proven by sharing profits? Other ways? How were warren and
Cargill not partners?

Partnership management
There are statutes in partnership law, still based on common law mostly, but there are statutes
to codify it. UPA (uniform partnership act) passed in 1914. RUPA in 1993 (Revised Uniform
Partnership Act). RUPA updated again in 1997.

Smith v. Dixon- partner lacked actual/implied authority for ordinary action but retained
apparent authority because no one told the buyer
Partner acting with apparent authority can create binding contracts for entire partnership.
Family formed a partnership just by farming together. Son acting on behalf of the partnership
sells some land for 200k to a buyer. When the buyer wants to enforce the partnership, the rest
of the family doesn’t want the contract to be enforced. Every partner is both an agent and
principal for every other partner. Different than Boticello? How?

National Biscuit- if 2 partners disagree, normal course of business carries authority to still make
decisions
Partners are bound by other partners business decisions and sales unless limited by articles of
partnership. Partner says “I will not be bound by any more purchases of bread.” Other partner
goes out and buys more bread. Partner can make any business deals in ordinary course of
business. So buying bread was completely in ordinary course of business. Only 2 partner, one
says no, other says yes, so resorts to ordinary course of business, which means you can do deals
in ordinary course of business, so he can do the deal. A partnership is a contract, and we enter
into a contract, we can’t change terms without asking the others. One partner thought he
owned business, but he was only 50/50.

Meinhard v. Salmon- what’s good for the partnership, not what’s good for me; must offer
partner chance at new business deals if there is a sufficient nexus: time, purpose, function.
If you’re a partner, and other partner is out making binding decisions on you, you’re vulnerable,
like an orphan and trustee. Because of that shared vulnerability, there needs to be a fiduciary
responsibility. It was salmons duty to ask “what’s good for us”, not “what’s good for me?” Duty
is not to meinhard, not to himself, but to the entity. What is good for the entity was to renew
the lease, so had fiduciary duty not to cut out his partner, who had thus far bore the risk with
him... Cardozo says that when you got to the renewal, question a partner would ask is not how I
would get rich, it is how do we get rich? Imposes fiduciary duty because has power to bind the
partnership. Here, salmon was disloyal. Must be nexus between new opportunity in
relationship though. Time purpose function location can all be evidence of nexus between the
two. Nexus?

Recap
1- In partnership, we have fiduciary duty. Duty runs to the entity (partnership), not from
one partner to the other. You take care of the business, not a particular partner.
 2- Each partner is an agent of the partnership, each can act on behalf of partnership
when apparently carrying on in the ordinary course of business when they have
authority and the person knew it.
3- So even if you don’t have the authority, if the other party thinks you do, can make a
binding contract.
4- An act of a partnership which is not apparently for carrying on in the ordinary course
the partnership’s business binds the partnership only if the act was actually
authorized by all the other partners. (Can make terms of less than unanimous vote,
but must be agreed on unanimously).
5- Ordinary Course
a. Partner had authority per the statute
b. Actual authority can be taken away by other partners
c. But apparent authority would still remain unless communicated ot the other
party
6- Extraordinary dealings (non-ordinary course of business, diff type of business)
a. A Partner lacks authority per statute
b. All other partners must actually delegate power in order to create actual
authority
c. Being a partner does not convey appearance of authority

Imposters: Ordinary course, if the appearance is reasonable and has some manifestation from
the principal, can be binding.
Extraordinary transactions: no actual authority and no apparent authority since the
appearance would not be reasonable.

Partnership dissolution and Termination

Partnership is a creature of intent. If intent is to dissolve the partnership, then it’s done. May be
legal partnership, but once the intents gone, partnership is gone.

8182 Maryland Associates-

3 partners signed a lease for 2 floors of parking spaces soon as their building was ready.
Building was built, one of the original 3 partners left and many more were added and left at
points in time. Eventually the firm went belly up and the landlord wanted payment for parking
spaces. So all of the individuals who were at one time partners are sued for payment as jointly
and severally liable. Court says that when someone joins or leaves, it forms a new entity? New
approach is that partnership is an entity that continues despite partners coming or going.
Same idea, different metaphysical conception of a partnership. Whether momentarily
disappears and becomes new or continues the whole time, same outcome. So, what about
the other partners who came and left? Still on the hook. Deals made before dissociation, still
liable unless novation is bought. All partners on the hook for stuff that happened while they
were there, does this include entire contract for the parking garage for partners who came
and went?

Page v. Page-
2 brothers throw down money to make a business. The brother who is trying to leave has some
money and experience: has several other dry-cleaning businesses. The other brother says you
cant get out because it was a term partnership, for a specific period of time, but the court
doesn’t agree. He said they have an agreement that they wouldn’t quit, not that can’t quit: Says
you promised not to quit until the term ended. Statute tells us that would work, but is that this
deal. Real possibility is that older brother is pulling out just before business gets profitable, but
how does he benefit? Would have to pay off other half, but here the younger brother doesn’t
have the money so they would have to sell and split 50/50. Here, older brother would win the
auction for the business because has better information about the business than any other
investor. Scam is that brother is taking advantage of his younger brother and is basically saying
ill buy you out whether you like it or not. Just Meinhard elaborated? Legal principal is that even
something like dissolving a company could be a fiduciary problem.

Transfer of Partnership Interest

Can’t force others to be partners with strangers. Cant sell membership rights, just rights to
receive profits.
Recap
Fiduciary duties:
1- Concept barrowed from the law of trusts
2- Two levels of conduct (spheres of behavior)
a. The crowd (marketplace)- ordinary rules of contract law
b. Partnerships- partners must act with “the punctilio of an honor most
sensitive...” so heightened fiduciary duty. Must be in it together, must care
about your partner like your brother or sister.
3- Duty runs to the benefit of the partnership (as an entity, not individual partners)
4- Extends to any business with a reasonable nexus of relation (don’t need a lot of nexus)
5- Requires more than just obeying the rules; cant follow rules if in a way that just
advantages self, still violates fiduciary duty.
Dissolution:
1- RUPA permits a partner to be “dissociated” voluntarily or not
a. The partnership continues as is (with at least 2 partners) as long as they keep
behaving like partners
b. The dissociated partner is entitled to her share of the partnership’s value
c. This is a practical departure from the logic of partnerships as contracts
2- RUPA also provides for a partnership to be dissolved without wound
3- The economic aspects of a partnership interest may be transferred, but not the
interest itself (can’t force someone to be partners with someone else)

Richert v. Handly
Business where one was buying a bunch of acreage of timber, the other partner would harvest
it with his machinery. Richert was trying to invest from afar while handly would actually
perform the chopping down of the trees. Richert is asking for his 26,842 investment minus the
10k he put in, so 16,842. He then wants to split the losses of 9,825, so 4,912 each. So, this
16,842 minus the split losses of 4,912 would leave 11,929 for Handly to pay out. Since Richert
took 10k back in premature profit, then his investment in timber 26,842 left him 16,842 he was
out, and then the 6061 they split in loss left 10,781 he was owed from Handly.

Kovacik v. Reed- CA Supreme Court misread statute in order to value labor.

Recap
1- Partners economic interests are represented by capital accounts
a. Add contributions
b. Subtract withdrawals
c. Add proportionate share of profits
d. Subtract proportionate share of losses
2- Working partners’ contributions of sweat equity are not assigned any value.
3- Unlimited liability is baked into the math.
4- Don’t become partners!

Practice question:
1- Both contribute 15k
2- First year profit 8k
3- Rosie withdraws 6k
4- Second year profit 12k
5- Rosie withdraws 6k
6- Lose 4k
20k profits, 16k profit after losses taken. Rosie withdrew 12k total. Rosie owes 4k.

Choice of Jurisdiction
Pretty much everyone uses Delaware, but might do it in state you’re focused on. Reasons?
Well-educated judges with lots of experience doing corporate law. Cutting edge statute.
Extensive case law, which creates predictability. Excellent staff. Network externalities:
everybody goes there so is common language and efficient and convenient, and is very
transparent, also signals that the corporation is on the right track.

Choice of Entity
Corporations v. Partnerships.
Formation: Partnerships are intent based; Corporation requires state sanction-need someone
to be there receive process
Duration: Partnerships do not survive the existence of the human partners, even only 1 partner
is dead partnership. RUPA allows someone to dissociate, but doesn’t live forever. Corporations
have perpetual life, and can only be terminated by state sanction.
Management: Flat- all partners have equal voting rights. Partnerships count heads for
management, not the money or any type of shares. Corporations are hierarchical: there is a
board of directors and officers, there is a pyramid structure, employees report to managers,
who report to upper managers, reports to chief, who reports to board of directors. Traditionally
corporate statutes would have president, secretary and require them to be different people.
President is chief executive officers (CEO); vice president is chief financial officer (CFO);
treasurer is chief operating officer (COO); secretary is chief information officer, and now there
are usually divisions, with presidents for different areas to control operations in that
geographical area that report to CEO.
Ownership and Control: In partnership, owners are controllers, agents are the principals,
partners have a residual claim and own the business but also run the business. No agency cost.
Corporations have separation between ownership and control, where one group does
operations and controls the business, while the other group owns.
Liability: Partners are jointly and severally liable for partnership debts. Corporations are
shielded from liability, shareholders have limited liability by corporate shield. Corporations are
an entity unto themselves, can only liable for what they own, not what the shareholders own.
Taxation: Partnership: single layer of tax, aka flow through tax because money flows right
through and partners just get taxed on their income. Corporation: Double taxation, on profits
and on distribution of profits to owners because they have to pay income tax.

Combinations:
S-corporations: Flow-through tax entities if they satisfy certain conditions. Similar to
partnership taxation with slight differences. Better for smaller corporations, mom and pop
style. All other reasons, they are a corporation. Downside is have to abide by 4 rules: limited
number of shareholders (no more than 100), no entities as shareholders, no non-US types as
shareholders, only one class of stock. These are creatures of the tax codes. In contrast, normal
corporations are called C-corporations. Certificate of incorporation, Officers, shareholders, by-
laws, resolutions are decisions.

Limited Partnership (LP): Like general partnerships, but only one partner has unlimited liability.
Limited partners have limited liability, but the general partners have unlimited liability so all
their private assets can be on the line. Traditionally, limits partners couldn’t be involved in
management, but it is more lenient. Limited partners enjoy corporate style limited liability.

Limited Liability Partnership (LLP): No general partners. Partners retain limited liability, except
for their own mistakes. Like for a law firm, if one lawyer is guilty of malpractice he had
unlimited liability for his mistake, but the other partners are shielded. Partner. Certificate of
formation. Partnership agreement.

Limited Liability Company (LLC): creatures of state law, allows flow through tax so company
isn’t taxed on profits and owners just pay income tax. All members enjoy corporate style limited
liability. Best of both worlds because gets flow through taxation and limited liability.
Partnership statutes essentially give 2 choices: member managed or manager managed.
Member managed is like a partnership, where owners are the operators. Manager managed
essentially means hierarchy where owner and controls are separate. So, if there is a board of
managers, looks a lot like a corporation. Certificate of formation. Operating Agreement.
Partners are “members.”
“B” Corporations (benefit corporation): essentially a corporation with a beneficial purpose. Will
usually lay out beneficial purpose, environment people or employees etc. Operate not only for
shareholders, but for the beneficial purpose.

Who wants to form what?

Corporations: NYSE, start-ups. J-curve. Net operation losses are tax free until starts making
profits because losses form tax credit. If the company doesn’t pay any taxes, easier to make
profit off through buying stock.
Partnerships: No one... ever!
Limited Partnerships (LP’s): funds... stacks entities, attached to LLC usually as entity to manage/
be liable for LP’s. Limited partners play passive role in the limited partnership, managed by
owner/general partner, usually an LLC itself. Why not just be an LLC?
Limited Liability Companies (LLC): Lawyers, accountants.
S-Corporations: Small Businesses-but why not just be LLC? Limited liability in both, basically
same 1 layer taxing, some restrictions on who can be owner. Maybe payroll tax benefits?
LLC: non-growth businesses.
B Corporations: posers (lol).
Who cares? In real life, LLC owners have to sign on loans received so they’re still liable.
Corporations can hire their owners as managers and pay them non-taxed salary as an expense
and only have single layer of tax.

Recap
Formation: intent based vs. state sanction
Duration: do no survive death vs. survive death only terminated by state sanction
Management: flat/heads vs. money-based/not heads
Ownership and control: united vs. separate
Liability: joint-and-several liability vs. limited liability
Taxation: single layer of tax vs. double taxation

Dodge Bros v. Ford- Business Judgement Rule Assumes Management knows best, judges aren’t
necessarily business savvy so can’t second guess management; business inherently has risks, so
risky behavior is not evidence of bad business practices;
Dodge bros sue henry ford because they were minority shareholders. Henry ford started the
business and had large majority of the stock. They did very well financially. Dodge bros were
suing for dividends, saying that so much money was created, some should be distributed as
dividends, but minority shareholders didn’t have ability to force dividends. Dividends are
declared by the board of directors. Essentially, they were saying it was a violation of good faith
duty to shareholders, if has so much money some should be paid out. So, what is company for?
Big ATM machine for shareholders? Business judgement rule: absent bad faith, fraud, conflict
of interest, gross negligence, absent some terrible thing, judges wont second guess business
decisions. Ends up being a battle between accountability and discretion. The wallstreet rule: if
you don’t like what’s going on, sell your stock. Judge says there is a difference between
incidental expenditure benefits for humanity, but said it’s not okay to have a general purpose to
benefit mankind over others (shareholders). Business is primarily for the benefit of the
stockholders, not society at large. Case is often cited for saying corporations sole purpose
should be maximizing shareholder value. “Other constituency” statutes. Vicinity of Insolvency-
duty switches to liquid credit holders instead of the shareholders.

AP Smith Manufacturing- businesses still owe some duty to society; culture has decided they
are only to maximize shareholder profit, not case law or statutes
Company gives away money, shareholder sues saying that it is the shareholders money. What
should the managers be doing? Charitable-giving-is-chill statutes, attitudes are perhaps
different though. But, in this case, business leaders are showing that they still think
corporations owe some duty to society. But what about today? Cultural issue. Law saying
primary benefit is shareholders, there are charity statutes, but culture has decided corporations
are for profit only.

Recap
1- Corporate social responsibility
a. Corporations are to be managed primarily for the benefit of stockholders
b. Partisans on the right just repeat only and hope the MBA’s have managed
accordingly
c. Partisans on the left agree and expect the populace to rise up and storm wall
street
2- In reality managers have discretion to do almost anything they want, whether good or
bad for society at large.
3- Big battle from here on out: Discretion vs. accountability
4- What is society’s “reasonable expectation” in 2018?
Dodge v. Ford continued:
Was ford just avoiding paying high taxes, and hiring himself at manager at a high salary so the
dodge bros couldn’t get money to start their competitor. Here, duty runs to the ford motor
company, giving money to the dodge bros technically is bad for Ford, makes ford stock more
valuable by having no competition with dodge.

Wiswall v. G & R Plank Road- corporations used to be limited to the scope of their purpose, but
not in modern times;
Plank road company, what did they do wrong to get sued? They bought some stagecoaches to
deliver mail for the government, doing service to go back and forth with the mail on the roads
they built. Business said they were “effecting a communication by means of a plank road to the
city of Raleigh.” Court said no. Although statutes and case law say you can only do the original
purpose, the way the modern world works is corporations own vastly different companies in
different industries. How? Put in charter that business operates for “any lawful purpose.”

Corporate Formation
Cooper and Lybrand v. Fox-
Fox was going to create a company, goes to Cooper and Lybrand and doesn’t pay them. Why
are they suing fox? They call cooper a promoter. Why did they need a promoter to set up a
company? They lived when they needed a special legislative statute for a company to be
formed, when they needed a promoter to make sure all the different parts of the company
could come together. Novation is agreement to pay the debt, so promoter can get a novation
from the company to help create it.

Cranson v. IBM- de facto corporations if everyone is under the impression that it is a

corporation but there was some formalities issue when creating.
Attorney drafts documents, they are signed, attorney messes up when he goes to a bar and
leaves the documents in his case and the company never gets formed technically. So, they sue
the corporate officer who signed the document that never got turned in by the attorney. Court
says it is a de facto corporation. They also use estoppel to prevent suing the officer as opposed
to the business because both parties thought it was a corporation.

Nature of Corporations
Trustee’s of Dartmouth- first SCOTUS take on what a corporation is, fiction of law
Governor of NH is trying to take over the private college of Dartmouth. Governor wants to take
the reins, Dartmouth is pushing back saying government can’t do that. All of the trustees,
original students and teachers are gone, so like partnership where all the partners are gone.
Says government cannot impair the obligations of a legal contract, and the corporation was a
contract. Says governor has no constitutional right to change the nature of their legal private
contract. So what is a corporation? They say it is an artificial being that is a real thing, not a
collection of people, which stands alone. It is not a human being, but is an artificial being, which
exists only in contemplation of law. One collective body under a special name that possesses
certain immunities and privileges.

Citizens United- second SCOTUS take on what a corporation is, actual person
Federal law prohibited corporations and unions could use general treasury funds to make
independent donations to particular political candidates. Court says political speech is subject
to strict scrutiny, as it shouldn’t be burdened based on constitutional principles, so government
must have compelling interest that is narrowly tailored to meet the compelling interest.
Majority says citizens united corporation have free speech rights, take it as a given and talk
about impeding free speech. Doesn’t overrule or even engage the Trustees of Dartmouth
reasoning about artificial being, they just assume that corporations have free speech rights. Illig
says the dissent is wrong too that the corporate is purely a concession of the government.
What is it then? Entity for public good?

Recap
Corporation: collective of individuals in one body endowed with certain protections, as if it
were a real person.
Citizens United just makes assumptions about what a corporation is without any solid reasoning
as to why.

Corporate Management
Statutes grants authority to board of directors, board of directors grants authority to the
officers, more actual and apparent authority the higher up you get, but no one has actual
authority unless granted by the board of directors. Board of directors does dividends, hiring and
firing of officers, other things.

Drive-in Development-
Guarantee by parent of tastee freeze, but they claim they don’t have the authority to make the
guarantee. Mr. Moranz made the guarantee agreement and he is chairman of the board of
directors, highest person in the company. So how could he not have authority? What power
does chairman of the board of directors have? None really, can call meetings but in terms of
representing the company he has absolutely no power. How? The key is that the power is in
the board, not in any one board member. He was the chairman of the board, but the board
has the power, not the chairman. Board of directors can assign the authority. So it is really
just an agency problem. Does he have actual authority? No. Is there apparent authority? Yes,
the secretary gave him authority. Secretary probably has incidental authority to say what
resolutions were adopted. So, if you’re doing business, ask for secretary certify.

Lee v Jenkins- any reasonable director would have known he didn’t have implied authority
based on board resolution
Jenkins get the company in the 1920’s. Yardley recruits Lee from the old company enticed by a
pension plan in question. Did Mr. Yardley have the authority to do the deal? Someone
witnessed Yardley make the deal to hire Lee. Yardley was the president of the company,
chairman of the board, substantial stockholder, and trustee, because he was son in law of the
owners. If he has all these titles, how can he not have the authority? Any of his individual titles
has no authority, only the board. Real question is if the president has authority? No actual
authority based on board resolutions and bylaws. Does president have apparent or inherent
authority to hire employees with things like pension. How do we know? Requires a
manifestation by the principal. What is the extend of the president’s authority here? Apparent
authority for acts arising in the usual course of business, but when it is something
extraordinary, need to go back and get some actual authority to make the decision. How do you
know if it is extraordinary or ordinary course of business? Fact specific inquiry. Here, they say
pension isn’t as big of a deal as lifetime employment. Board has the sole power to pay
dividends. Stockholders are in the top position, and their permission is needed to change the
authority. Stockholders rights: “Stock holders can sue, sell, and answer questions when asked.”

McQuade v. Stoneham- courts originally reluctant to enforce shareholders agreements

NY giants baseball team a long time ago. Stoneham has a huge majority of stock. They have a
written shareholders agreement, meaning a contract between shareholders. They have a falling
out, guy McQuade who owns minority share is replaced as a director. McQuade claims
Stoneham replacing him wasn’t using his “best endeavors” to keep McQuade as treasurer in
violation of the shareholders agreement. Court said that shareholders have to substitute their
best judgement to keep someone on the board: directors owe fiduciary duty to the entity, not
to one another, so has a duty to benefit their entity and use best judgement to do so. Directors
cannot agree away independent judgement, can’t pre-commit themselves to decision
because violates fiduciary duty to try hard, but that being said hard to find who’s injured.
Clark v. Dodge- shareholders agreements are good because they let you tailor the off-the-rack
suit to the needs of the company;
Same court as Stoneham 2 years later, opposite result. What’s changed? Here, all the
shareholders agreed to the shareholders agreement, so they are just getting what they asked
for. Shareholder agreements are good because they let you tailor the off the rack suit to the
particular company, so they are very strongly enforced.

Recap
1- Corporate Formation
a. Charter, meeting of shareholders, meeting of directors, bylaws
b. Courts may be sympathetic with mistakes
c. Best argument is estoppel
2- Corporate management
a. Shareholders have no management power except to vote when asked
b. Directors have no management power except as a collective group
c. Shareholders must approve changes to the fundamental deal-
mergers/dissolutions
d. Directors must approve major decisions and payment of dividends
e. Officers and managers have authority that varies depending upon their
title/role/seniority
3- Shareholder agreements
a. At first courts were nervous about them because judges didn’t want to change
the statute...
b. Now, we love them!
Other points:
4- If you are small and start a corporation, need a share holders agreement maybe with
clause for the agreement to disappear when the company gets big.
5- If you open corporation, there is charter and now shareholder agreement.
6- If you open LLC would have operating agreement or partnership agreement with the
same thing from a shareholders agreement. What kind of things? Maybe a limitation on
transfer, maybe voting agreements, maybe noncompeting agreements, maybe
liquidation plans, maybe buyout options, might set share price, there are common
things.

Ringling Bros (famous case)- cumulative voting;

Ringling has 315 shares, Haley owns 315, North has 370 shares. Haley and Ringling have an
agreement to work together to combine their votes, and if they don’t agree to arbitrate to
come to a conclusion. An agreement between 2 shareholders in a closely held corporation to
vote jointly is binding and enforceable as a contract; an appropriate remedy is to reject and
invalidate the vote in question. Why cumulative voting? Gives minority shareholders more
power to make decisions because they can concentrate their vote on certain positions that
matter to them. Shareholder may exercise wide liberality of voting, not objectionable that for
personal gain of based on their whim or caprice.
Stroh v. Blackhawk Holding Corp- 2 classes of stock, where class B can’t get dividends but
effectively has all voting power, and class A can get dividends but will always be outvoted by
other class, is valid; one class has to have normal stock rights, others can have special rights.
A limitation on a class of stack that prevents the stock from receiving dividends does not
invalidate the stock; so can create classes of stock that does not receive dividends. Here, class B
stock could vote in corporate matters but could not receive dividends, Court said all good.
Statute says have to have on “plain vanilla” class of stock, that is completely normal. Here, class
A stock was normal and had all normal stuff.

Business Roundtable v. Securities and Exchange Commission- A rule promulgated by the

Securities and Exchange Commission (SEC) is not valid unless the SEC has considered the rule’s
effect upon the efficiency, competition, and capital formation of companies.
Proxy basically assigns person to vote in place of absent shareholders, and this SEC law is
regulating that to make it easier. Clearly, stockholders do not pick managers in an election, the
directors pick the directors because it would be silly waste of money to campaign for a
shareholder to become a director and change the company.
SEC rule 14a-11 was made to make it easier for shareholders to run, because it requires
company to include in company proxy slate of opposing directors too. However, the risk is that
any political company could nominate 1 directors and then flood proxy card with political
candidates. They make rule to prevent this requiring that the shareholders who get their proxy
on the card be at least 3% shareholder for 3 years. What is wrong? Rule didn’t help the little
guy, only the big money stock holders who have a shit load in the company. For publicly traded
companies, securities laws manage relationship between shareholders and management. 2
ways: 1- criminal offense to lie to shareholders; 2- requires lots of disclosure.

Shareholder Voice
Only way to hostile buy company now is to offer so much money they can’t say no. Otherwise
SEC rules and court cases prevent hostile takeovers. Idea was that the “barbarians at the gate”
were evil and going to be bad for the country. But now, if company is managed really shitty, no
possibility of hostile take-over firing them. Really no effective remedy to shitty management.
Shareholders not picking management, directors are picking themselves. Solution is Wall-street
rule: if you don’t like what management is doing, sell your stock. When you invest in a
company, you are picking the management team to take your money and grow it. Can’t really
switch management, if you buy stock for a company you’re buying their management.

RECAP
1- Voting Procedures and techniques
a. Cumulative voting
i. Great for smaller businesses so minority shareholders don’t get rolled
100% of the time.
b. Voting trusts and voting agreements
i. Modern view is that these are a public good, so upheld.
ii. Can even create securities that are only voting rights and no economic
rights
 c. Classes and series of stock
i. As long as there is one “plain vanilla” class, there can be other weird
classes of stock
ii. Shareholders have to vote for amendment to add series or class of stock
if not in certificate of incorporation
iii. Common to have preferred stock “with rights and privileges board may
determine” from time to time, which is like a blank check to crate classes
of stock.
2- Reality = the wall street rule
a. Large numbers of small percentage shareholders make it difficult to act without
proxies
i. Hundreds of shareholders all over the country is common, so voting is
often done by proxy
ii. Proxy is assigning a person to vote for you
iii. Proxy is also the sheet of options with 400 words about them
b. Securities regulations increase the expense of communicating with shareholders
i. To protect against fraud, raises cost of being a shareholder because they
have elections that can come out of stockholder’s funds
c. The result is no shareholder democracy

Corporate Dissolution
“It’s hard” - Illig
In Re Radom & Neidorff-
Courts have the discretion to order a corporate dissolution where competing interests are
preventing efficient management and impeding the corporations purpose, if dissolution would
benefit the stockholder and not injure the public; build mechanism to leave in shareholder
resolution and way to resolve dispute.
They vote to dissolve, 50/50 tie because equal shares. Another way to dissolve is to go to a
judge. Court says that you can’t dissolve companies just because you’re not getting along with
the other owner. Could he sue her for mismanaging the company like Meinhart suing salmon? Is
she violating fiduciary duty of loyalty to maximize profits? Could sue her for that. Why is it so
hard to shut down corporations? Losses of jobs and tax revenue. Also wants to keep
corporations going to help shareholders get the financial game they gambled for. Should sue for
minority shareholder oppression, but it is 50/50. Still, both owe each other fiduciary duties.

Corporate Accounting
Always read the footnotes. Look at MDA (management discussion analysis) if it is a publicly
traded company. 3 financial statements:
1- balance sheet,
a. Assets liabilities and shareholder equity
b. Want to have more stuff, fewer bills.
c. Important one for corporate law
2- income statement
a. Money made and spent over time
 b. Depreciation and amortization
c. EBIT and EBITDA
3- cash flow statement
a. Inflows and outflows of money over time
What do we need to open Cardozo’s pizza?
1- Assets
a. Food cart 15,000
b. Equipment 10,000
c. Cash 500
d. Supplies 300
e. Ready Slices 50
f. Total Assets: 25,850... not necessarily what they have because equipment is
deteriorating, used equipment, supplies lose value.
2- Liabilities
a. Bank Loan 8,000
b. Salaries 1,000
c. Current Bills 850
d. Total 9,850
3- Equity
a. What is left over:
b. 16,000
c. What the shareholders take home, what we are interested in.
d. Difference between assets and liabilities.
Things that are missing:
1- Don’t put things made or invented on your balance sheet, just assets and debt. Mickey
mouse isn’t in the balance sheet, but the logo and idea is worth a lot. Secret recipes,
code, ingenious ideas and inventions are not on balance sheet. Balance sheets always
underestimate tech companies, entertainment companies.
2- Employee culture
3- Good Will
4- Balance sheets aren’t updated to market trends and changes in value, but they do
include inflation and amortization
5- More analogous to a stream, stream of income; like ATM machine.

MG Bancorporation-
Southwest Bancorp eats up another bank. Battle over how much company is worth. Buyer side
said 41$ a share is fair, seller side said 85$ a share is fair. They hire bankers to come in and give
opinions about worth. Legal lesson is what method of appraisal is good in Delaware, here
whatever the bankers say. There is no specific test for worth of companies, Delaware judges
want cutting-edge.

Ways to value company:

1- Comparative Publicly Traded Company Analysis
a. Identify comparable companies
 b. Identify appropriate multiples
c. Identify appropriate time periods
d. Consider certain financial fundamentals
e. Add Control Premium
i. Price will be more for shares that will give majority control
ii. Control is worth a lot; shares have more value if they contribute control,
control is being bought as well
iii. Minority discount qualities are small portions that don’t bring control
with them
iv. So, when you see a similar company and share price, if buying a company
have to add control premium
v. Control is really just another stick to add to the bundle that increases
value
2- Discounted Cash Flow Analysis
a. Project future net cash flows for a certain number of years (estimate stream)
b. How much would you pay for a stream of income?
c. Have to estimate what the future incomes would be worth today if safely
invested
d. Present value =
Recap
1- Financial Statements
a. Balance Sheet is not fair market value
b. Missing is reputation, inventions and employee culture
c. Assets-liabilities=shareholder equity
2- Company Valuations
a. Lots of subjectivity
b. Many different ways to calculate- use them all
c. Keep track of the control premium / minority discount (same thing)
Par value: minimum price a stock can be sold for.
Authorized share: voted on by board of directors.
Outstanding shares: have not been bought yet.
Stated Capital: how much money they have came from investors, stock buyers. Fixed number.
Paid in Capital: how much came in from selling above par value.
(Earned) Capital Surplus: Profits from the company. Assets – liabilities – stated capital – paid-in
capital = capital surplus.
Book value: capital surplus divided by shares.

Corporate Accounting
Stokes v. Continental Trust co- modern rule is no preemptive rights unless explicitly negotiated
for; court just chose remedy of money for loss of preemptive rights but probably different today;
know how stated capital, paid-in capital, surplus capital, and book value works.
A stockholder has the right to vote in proportion to the number of his shares, and this right
cannot be curtailed by the directors, officers, or other shareholders of the company.
Stokes has 221 shares out of 5,000 total shares of the company, at par value 100 dollars each,
book value 309. Blaire wants to take over continental bank, says if continental added 5,000
additional shares, they would buy the 5,000 shares at 450$ per share. Why not just go in and
say we want to buy half of the company? Not cheaper, would be easier to buy 2,500 at
whatever price they could get them for. Board of directors has to make the decision to sell to
Blaire by authorizing 5,000 more shares, and then sell them to Blaire. Selling them 5k shares at
450 each would make the book value of each share 379$. Original stated capital would be
500,000 because 5000 shares at 100$ each. Blaire investment would add another 500,000 to
stated capital, because the par value stays the same. Original paid in capital would be 0,
because all bought at par. Blaire investment paid in capital is 1,750,000 because that’s how
much they’re paying above par value. Ultimately, new Capital surplus would raise from around
1 million to over 3 million. After Blaire investment, book value went from 379 to 550$! So why
is stokes suing if he gained lots of money, even after the deal? His voting power decreases, he
wants preemptive rights. Court vindicates his preemptive rights by giving him some money, but
would probably be different today. Today, no preemptive rights unless they are negotiated for.

Klang v. Smith’s Food- redemption if a company buys its own stock; can swell the debt and
shrink equity, increasing per share value and then people will overpay based on price going up
and stock price will keep going up. The redemption dividends must come from Earned (capital)
Surplus; lots of flexibility in in determining selling price. Redemption could be the source of a
fiduciary duty problem.

Torres v. Speiser-
Redemption case. They sell some shares, over time decide to buy some back. When you buy
them back, called treasury shares, when company owns shares of ownership of the company.
Management can do what they want to with them, and don’t even have to do it at par value
because they already got par value. Investors don’t like treasury shares because unpredictable.
Often the board retires the shares, so now greater number of shares authorized but unissued.
Just learning how redemption works?

Equity Linked Investors- preferred stock carry advantages relative to common stock, but
company is managed primarily for the benefit of the common stockholder; preferred stock can
get paid back first in liquidation line
Technology start up company losing money, issues preferred stock for venture capitalists who
want to invest. The preferred stock half way between debt and equity, so they get bumped up
in the line if liquidation is to occur. Preferred stock great for venture capitalist, because the idea
guy founders should lose all their money if it fails, preferred stock could bring liquidation rights
where investors still get paid off still even if goes belly up bankrupt and liquidate. Company
convinces someone to give 30 million more to continue developing the product, then preferred
stock holder bring a suit trying to force liquidation while there is still enough for them to get
some. Here, common stock holders and management have nothing to lose, get nothing if it fails
so why not try some crazy last ditch effort with what’s left of their money. Preferred
stockholders think management is gambling with their money, so preferred stockholders want
judge to say they have duty to manage the company for the preferred stockholders. Court says
no, the company is to be managed for the benefit of the common stock holder.

Katzowitz v. Sidler-
Authorized 1000 shares. Paid 500 for 5 shares. They stop being friends, 2 try to squeeze out
katzowitz. They issue another 75 shares for 7500 dollars, the 2 of them get 2500$ checks from
the company who them offers them 25 shares for 2500$, which they accept. The third guy takes
his 2500 and doesn’t put back in. Eventually the company goes bankrupt and divvies up their
money, says he only has 5 shares and they have 30 each. Here, shares were totally legal, but
was a scam to disenfranchise the partner that they knew wanted no part of further investment,
so made scheme to loot the company without him. Court says violates fiduciary duty.
Finance Recap
1- Corporate Finance
a. Equity is subdivided among stated capital, capital surplus, and earned surplus
b. Dividends and redemptions may only be funded from surplus
c. Surplus may be calculated other than book value
2- Terms and Acceptance
a. Preferred stock, cumulative voting rights, redemption, treasury stock, par value
b. Authorized, issued, and outstanding shares

Close Corporations
Close corporation factors:
1- A small number of stockholders
a. No more than 7, usually less than 5
2- No ready market
3- Substantial majority stockholder in the management, direction and operations of the
corporation (shareholders are the managers, ownership and control are the same)

Donahue v. Rodd Elec- typically no fiduciary duty among shareholders, but shareholders in close
(small) corporations owe each other fiduciary duty like partners owe one another; somewhat of
a shock, added a caveat in the next case of legitimate business purpose
Shareholders in close corporations owe one another strict duties of care and loyalty, similar to
the duties owed among partners in partnerships.
Plaintiff holds 50 shares, is minority stakeholder, 1 other stockholder is defendant and owns the
rest of the stock, 200. 200 stock guy handed them down to kids who now have 100 each, 50
shares guy dies and widow gets. 200 shares has majority, decides to buy some of the 200 stock
back as treasury stock. The 50 shares widow goes to court and sues to get her shares bought at
the same price. Dividends have to be done equally, but not redemption purchases. Why?
Redemptions reduces value of company, but gives the shareholders a bigger piece of the pie on
dividends. If they move in unison proportionately, no one is harmed. So, if the price is right, are
allowed to redeem some shareholders and not others. Her 20% stock ownership was just
dividend potential, and here that can be completely illusory because they can just hire
themselves and pay themselves salary and have no dividends leftover to avoid a second layer
of tax. Fiduciary duties imposed by court when corporation is so small that minority
shareholders have no control, and no market (exit), so must be remedy. Redemption doesn’t
have to be equal as long as everyone benefits, but she says here she had no benefit: they
basically had 100% control before, and now they still do, and she had 0% control and dividends
before, and still does. Court makes comparison to partnership, and says in close corporations
there is a fiduciary duty like partners share with one another in partnerships. Court creates
cause, minority shareholder oppression. Fiduciary duty not to take advantage of another
person’s situation in small corporations.

Wilkes v. Springside Nursing Home- majority shareholders in a close corporation owe minority
shareholders strict duty of utmost good faith and loyalty, unless a legitimate business purpose
can be demonstrated to justify the breach; gives business opportunity to show legitimate
reason for their action; if they show legit purpose, plaintiff again has opportunity to show
that there was another way to get to the same result without injury to the minority.
4 equal shareholder/owners, they decide they hate 1, 3 gang up on the 1. They freeze out the 1
person by firing them from salaried spot, raising salaries so as to make it so no dividends,
effectively forcing that person out of the company. 1 guy sues for breach of fiduciary duty.
Court said even small corporations need flexibility enough to fire people in best management
of the business and have fiduciary duty to do a good job.
Nixon v. Blackwell- Closed corporation directors owe a fiduciary duty of fair, but not necessarily
equal, treatment to all shareholders; says no close corporation fiduciary duty other than
fairness
Similar issue to the last 2 cases. Delaware says no heightened fiduciary duties. So why not
Delaware? They favor big corporations, and say you can still opt in to be a close corporation.
Delaware’s position is that you should be able to buy fiduciary duty rights or not, if you want
close corporation fiduciary duty, typically will charge more for the extra stick in the bundle.
So, you can chose which one you want, tailored to the needs or wants of the corporation.

Recap
There are lots of ways to obey the law but unfairly disadvantage oneself. Could pass law to
make each scam obsolete, but instead court just makes general rules like fiduciary duty: “Play
nice.” You have a fiduciary duty to act in benefit of the partnership/company entity, and it’s not
cool to unfairly advantage oneself over others.
Minority Shareholder Oppression:
1- Applies in close corporations
2- Few shareholders, no market, substantial overlap of ownership and control
3- Provides a cause of action under a partnership style duty
4- Defense = legitimate business purpose, but must be least intrusive mechanism
5- Remedy depends on equity and circumstances, usually choses lowest stake remedy
6- Delaware is the outlier in making corporations not closed unless they specifically chose
to be treated as such by opting in at time of incorporation; perhaps Delaware
inhospitable to close corporations because pay less taxes.
Fiduciary Duties of Management:
1- Stakes are larger because more money at stake, more fleshed out case law.
2- Can sure anyone, but board is most common: “why would you sue the janitor.”
 3- Shareholders began suing for breach of fiduciary duty under diversity actions, federal
court ruled pro-management every time interpreting Delaware law very pro-
management.

Business Judgement Rule

Business Judgement Rule:

1- Presumption that the board acted:
a. On an Informed basis,
b. In Good Faith, and
c. In the honest belief that the action was in the best interests of the corporation
(or at least that it was not opposed to the best interest of the company, so
defendant directors win if it’s a tie).
d. Defeating this presumption is the major hurdle, outcome determinative.
2- The Presumption is rebuttable, but then management has a chance to respond, showing
intrinsic fairness. However, settlement happens if the BJR presumption is rebutted,
basically if you beat the presumption the plaintiff wins.
a. Intrinsic Fairness: fair price, fair dealing.

Smith v. Van Gorkam- Rebuttable presumption that a business decision made by a

corporation’s board of directors is fully informed and made in good faith and is in the
corporation’s best interest. The presumption is rebuttable by gross negligence: here
shareholders were not adequately informed. This case was overridden by Delaware statute
passed shortly thereafter, but still illuminates what is not best practice. Thus, still completely
changed the culture and practice, still good law for corporations who don’t opt out of Fiduciary
duty of care via Delaware 102b7.
Van Gorkam, chief executive officer at Trans Union is about to retire, so sought out another big
corporation and offered to sell the entire corporation to them for 55$ a share. Basically, Van
Gorkam invited a hostile takeover and set the price at a relatively low offer. Some didn’t like the
55$ number, sued, saying they didn’t try hard. Federal courts used business judgement rule and
said board were fine. Delaware Supreme courts said otherwise. Complaint said the board was
grossly negligent in approving the sale, based on only a 2-hour meeting with no supplemental
notes or copy of the contract, but gave a 20-minute oral summary. CFO said 55$ was in the
right range, but on the low end; no one outside of management was invited to check the price.
Management never told board how they came to that number. One lawyer who was on the
board said they could be sued if they didn’t accept the 55$ number. Really couldn’t have done
much worse according to Illig, no legal or financial advice or any transparency at all. However,
Illig said the practices were defended by law review articles. They were following pretty
standard procedure, so if this is violation, many corporations would be in violation. Their board
of directors had lots of experts who could have reasonably figured out how much the company
was worth. 2- these were the experts you hired. But if you take the expert is the expert
argument to its logical conclusion, they are insulated from any... How do we know if 55$ is the
right number? Test is supposed to be gross negligence. What is desired is an action style
scheme where you get multiple bidders to pay best price, has to be fair and opened and not
rigged. But bidding works with picking a low number first, and working up from there. So what’s
wrong with the 55$ estimate? Fair market value of 38, so the 55$ per share includes control
premium. That means 17$ per share extra, making the stock worth 45% more per share upon
sale, premium. Can then look up other deals and see the average amount of premium gained
and compare to be sure they got a good deal. This decision was met with a tsunami of criticism,
saying worst decision ever. Delaware code was passed to undo and keep Delaware pro-
management.

Del. Code §102(b)(7)

In certificate of incorporation may also contain:
1- A corporation may waive the director’s personal liability for violations of the duty of
care in the certificate of incorporation (basically all corporations do this now). But, a
corporation may not waive:
a. Duty of loyalty
b. Bad faith, intentional misconduct, knowing violation of the law
c. Improper dividends.

Van Gorkam case, 102(b)(7) will protect you. Decision making duty cases.
Caremark case, no 102(b)(7) protections. Duty to investigate cases.

In Re Caremark International Inc.- there is duty of care in Delaware, but many companies
(maybe all) waive duty of care in the certificate of incorporation; Directors of a corporation
have a duty to make good-faith efforts to ensure that an adequate internal corporate
information and reporting system exists; stands for proposition that top management has to
pay attention to what the company is doing, inciting bad behavior by ignoring duty to
investigate.
Company involved in medical stuff, pretty clear they’ve been bribing doctors for referrals, hit
with big fine after federal criminal investigation with multi-million-dollar fine. Shareholders sue
for corporate inaction, not accused for making a poor decision, accused of not knowing what is
going on in the company and failing to act when they should act. Board hires and fires and
evaluates, high agency cost if they suck. Stock options and monitoring are ways to reduce
agency cost. Shareholders hires board to keep their eye on management, they’re supposed to
watch and seek out information. Fits with our theory better: we expect the board to be
investigating, that’s the only thing they really do and is their function in the corporate scheme.
That’s why no outcry over this case holding and is very supported.
“the board must exercise good faith judgement that the information reporting system is
adequate...”

Recap
1- Duty of Care
a. The process, not the result, is at issue
b. Gross negligence standard
c. Van Gorkum was surprising and controversial, everyone assumed great
deference to be given to management, lead Dealware to pass 102b7.
 2- Delaware 102(b)(7)
a. Permits a charter provision that waives personal liability of directors for
violations of duty of care (really only for money damages, other remedies are
hard to find)
b. Cannot waive duty of loyalty, good faith, dividends, no intentional illegal activity
Business Judgement rule:
1- Presumption that the board acted
a. On an informed basis
i. Basically, not gross negligence, not high bar.
b. In good faith
c. In the honest belief that the action was in the best interest of the corporation
(or at least that it was not opposed to the best interest of the company, so tie
goes to management).
Fiduciary Duties Trinity:
1- Care
a. Decision
b. Caremark case: pay attention so you don’t encourage bad behavior.
i. Caremark becomes a loyalty issue so as to avoid Delaware 102(b)(7)
statute and thus can’t be waived, but added intent aspect, so only liable
for “utterly failing to institute any controls” or “consciously ignoring the
system in place.” Basically, only if you’re consciously not following your
own process, it is a conscious disloyal mistake.
2- Loyalty
a. Conflicts of interest
b. Corporate Opportunities
c. Caremark now considered duty of loyalty to avoid 102(b)(7).
3- Good faith

Cinerama- point is if you show gross negligence and rebut business judgement rule, you win.
Shareholders sued board, were successful in showing gross negligence, but then the company
had a chance to rebut. Once I’ve shown gross negligence as plaintiff, I’ve rebutted business
judgement rule so now get trial, basically the threshold burden has been met. Then you check
for fair agreement and fair price, but usually settles at this point. Most tests boil down to duty
of loyalty and duty of care. Business judgement rule is a very high hurdle, intrinsic fairness is
not. Practical effect is that if I can get over the first wall, second wall is easy, so P is gunna win
and they settle.

Duty of Loyalty
Conflicts of Interest:
Lewis General Tires- conflict of interest
Lewis General Tire, sues SLE inc. Dad set it up where there is a company that does tires, LGT,
and another company leases the land, SLE inc. Dad hands down shares to kids: all 6 kids got 1/6
of SLE property company, 3 got 1/3 of the tire company. Property company SLE had been
leasing to tire company for years below value they could have, but makes sense because same
owners. SLE brings claim that the company isn’t making the most it can out of the rent being
paid, wasting company assets, want more money. So really the 3 who only had shares of real
estate company wanted more out of their company, higher profit, but would come at expense
of LGT tire company because they’re paying higher rent so less profit for them. The money to
SLE gets split 6 ways, tire company money gets split 3 ways. Conflict of interest? Usually
directors make decisions for the companies best interest, but some of the directors in CLE have
a conflict of interest, because they’re negotiating on both sides of the deal in the rent.

Sinclair Oil v. Levian- A parent corporation must pass the intrinsic fairness test only when its
transactions with its subsidiaries constitutes self-dealing; Business judgement rule not violated
from subsidiaries
Sinclair is Oil Company, and Sinven is Venezuelan subsidiary that Sinclair Oil owns 97% of, 3%
owned by government members who allow Sinclair to extract the oil. Typical way to operate
with subsidiaries where oil is extracted from. Sinven 3% shareholders realize they’ve been had,
unhappy with the management and think dealings between Sinven and Sinclair are unfair.
Sinclair had so much control over Sinven, all the officers for Sinven work for Sinclair so conflict
of interest, and Sinven is being used for Sinclair’s best interest. How does court evaluate the
decision making? It’s reasonable that the board of Sinven is playing both sides, Sinven is owned
by Sinclair, so not unreasonable that Sinclair gets to tell Sinven what to do. 2 possible standard:
Business judgement rule, and intrinsic fairness rule. Management would win business
judgement rule. Intrinsic fairness test might go to the minority shareholders. Delaware doesn’t
use the more pro-management rule because there is a conflict of interest because duty of
loyalty cannot be waived. Self-dealing test: Is there no self dealing? Business judgement rule. Is
there self-dealing? Intrinsic fairness rule. So what is self dealing? Self-dealing is non-pro-rata
gain... Decisions must be neutral for the good of the business, and they will increase
proportionally... if 3% are being harmed at 97% shareholders gain, self-dealing. 3 issues: 1-
excessive dividends: not self-dealing because the dividends are being paid proportionally to
shares held. 2- Allocation of opportunities: is failing to seek opportunities in other places, so
that Sinclair just gives it to other subsidiaries, unfairly impacting any? No, they all move
proportionally. 3- Breach of contract claim: Sinven is owed money from another subsidiary, but
parent company is voting not to sue, so in this case the 3% is never getting their share, but
when the other subsidiary keeps the cash it goes to Sinclair, so the 97% shareholders are still
receiving it. Rental decisions impact shareholders differently, board would have had to justify it,
but they didn’t here.

Zahn v. Transamerica Corp.- Directors may not declare or withhold the declaration of dividends
for the purpose of personal profit.
Complex deal. Transamerica at the end of WW2, thinks the value of tobacco is going to go up
because tobacco companies had given free cigarettes during the war so there were going to be
a lot more smokers. Transamerica goes to another company, fisher, with a bunch of tobacco,
they go and buy control the of the company instead of just buying the tobacco. After they buy
ownership, they hollow it out and pass over all the assets to Marlboro. So after the assets
transfer to Marlboro the company just becomes a pile of cash with no assets. Transamerica is
now sitting on a lot of money in the corporate shell of a company that is now fisher, want to
cash out and get money out of fisher and back to Transamerica. But they have complex share
holder stock arrangement. Problem is Tranamerica caused fisher to redeemed shares first for
80$ a share, then pay out all the money. Had the subsidiary not bought back the shares first, it
would have just been liquidated, which would have cause 240$ per share, much more than 80$
per share they got. Subsidiary could either redeem the shares and liquidate or just liquidate,
which one they chose has a disparate impact on minority shareholders. Therefore is self
dealing, because Transamerica is on both sides of the deal. Where is the scam, why did
Transamerica buy the tobacco instead of Marlboro, probably saw they could extract money
from the shareholders, pay more for the company and then just steal money from the class A
shareholders. Chose strategy that gave less to the Class A shareholders, so bad.

Corporate Opportunities- the other duty of loyalty

Broz v. Cellular Info-
Broz is president of RFB cellular company, also sits on board at CIS cellular company. CIS is
regional company trying to buy a bunch of smaller cell company but fails, is being bought up, so
CIS brings on Broz from RFB as an expert. RFB is trying to buy Michigan-2, another company,
Originally, CIS was not going to buy, was in business of selling, but then Pricellular buys CIS, and
then CIS wants to buy Michigan-2 but too late because RFB already bought it. CIS sues and says
there is a conflict of interest, Broz was on both boards so he breached his fiduciary duty to CIS.
If Broz votes for CIS to buy it, might violate duty to RFB because they want to buy it, and vice
versa. Not really conflict of interest thought, court frames it as a corporate opportunity. As a CIS
director, he learned about potential Michigan-2 purchase. Usurped corporate opportunity CIS
had in advantage of RFB. Courts remedy is to make it a trust for the other company. How do we
know what a corporate opportunity is. He discovered the opportunity on his individual behalf.
Lists out some factors. Is it the same kind of business? Would it be valuable to company? Was it
offered to the person in their independent dealings? What it comes down to is whether the
corporation has an interest or reasonable expectancy.

Waiver- applies to duty of loyalty?

Cookies Food Products-
Minority shareholders bringing a suit against herring, he owns a more successful business that
pushes out the struggling Cookies Bar-B-Q, has a bunch of problems bad food bad marketing
and distribution. His trucking company is delivering Cookies Bar-B-Q sauce, his control in
cookies makes sure they hire his trucking fleet. He says yeah he is benefitting more than others
because he owns share of trucking company, but says it is intrinsically fair because they knew
and waived his duty of loyalty.

Delaware Code 144:

An interested-party transaction is not voidable solely due to the conflict of interest if:
1- The material facts are disclosed or known to the board or one of its committees and
the disinterest members approve of the transaction in good faith
2- The material facts are disclosed or known t the shareholders and the shareholders
approve the transaction in good faith
 3- The transaction was fair to the corporation at the time it was approved by the
board/committee/shareholders (basically you can always prove it’s intrinsically fair
and that’ll be good enough).
What does solely mean though?
Underlying common law sense of waiving the duty, court is struggling: if you come in and say it
is void just because on both sides of the deal, takes extra things to make it voidable. Common
law still required good faith, honesty, and fairness. Illig says different words to basically go back
to business judgement rule. Not enough to get the committee to approve, have to be acting
generally good. Here it was a good deal all around, so even though he was on both sides of the
deal, it was a good deal. Would be better decision if they said hey the truck deal is fair, so he’s
not taking advantage.

Recap:
Fiduciary Duties:
1- Duty of Care
a. Decision-making cases- having some process is key
b. Caremark- Duty to investigate = loyalty + scienter (pay attention)
c. System of controls by which monitor the company to ferret out bad things from
happening, Caremark? (actually the loyalty cases, because they added scienter
requirement... willful ignorance becomes not bad process, but refusal to have a
process, if it is a loyalty problem, changes application of Delaware law).
2- Duty of Loyalty
a. Conflict of Interest Transactions
b. No benefit of the Business Judgement Rule if a “self-dealing” transaction
3- Structure of Delaware Law
a. The initial filter or test is outcome determinative: once the test is determined,
the outcome is determined, so that once the test to be applied is determined,
winner of case is determined

Duty of Good Faith

In Re Walt Disney- Intentional dereliction of duty and a conscious disregard for one’s
responsibilities is an appropriate standard for determining whether fiduciaries have acted in
good faith.
Some guy is fired without cause, and there are 5 lawsuits about bad faith. Good evidence that
the board of directors didn’t know this guy made 130 million in 14 months, then fired without
cause. Start out with duty of care, and say that substantively the business decision was
ridiculous. They spend pages explaining why this is a stupid horrible decision, “hard to imagine
any substantive due process worse,” but then they rule no violation of due care. Process was as
bad as court can imagine. Court said we can imagine any worse, but even this is not actionable.
All but saying as a practical matter that no set of facts will show violation of due care. Delaware
doesn’t help Disney shareholders even though they sucked. What comes up is the odd
comment that the court is saying “you’re so bad, but it’s not a violation of duty of care” but
dicta says I suppose you could be so careless that it was bad faith, which cannot be waived by
102b7. Up until Disney, we never had any definition of what duty of good faith looked like. So,
what is good faith? Subjective bad faith: motivated by intent to do harm. Bad-faith: gross
negligence. Also something in between: intentional dereliction of duty, conscious disregard,
gross negligence. Spectrum: subjective bad-faith where you intend harm on one end of
spectrum, gross negligence on the other end. There might be room for recklessness in
between, maybe conscious disregard of duty of care.

Stone v Ritter- Directors can be liable for failure to engage in proper corporate oversight if they fail to
implement any reporting or information system, or having implemented such a system, consciously fail
to monitor or oversee its operations. Good faith violation is conscious disregard of caremark duty to
investigate.
Failure to report cash transactions records, shareholders sued management saying they acted
badly in their oversight and cost the company 50 million dollars. Here we get the final answer
about what good-faith is. Takes Caremark standard and imports it into good faith, and puts
good faith sort of as a category of loyalty. Says there is not 3 fiduciary duties, only 2 because
good faith is part of loyalty. A caremark style case saying caremark can get around 102b7 by
being a loyalty-good faith case.

So, we started with 3 fiduciary duties. Care: decision making and caremark case. Loyalty:
conflicts and corporate opportunities. Caremark rule became a part of loyalty, and good faith
becomes part of loyalty too. So end up with 2 duties. Care, covered by 102b7 and protected by
Disney saying even the worst imaginable decision making isn’t going to be actionable. Loyalty
now is Caremark duty to investigate, conflicts, corporate opportunities, good faith. Really
comes up with 2 things within good faith: good faith is like requiring to be a good team mate,
also say it could be like conscious disregard of Caremark duties. Consciously disregarding of
duties is bad faith: if you fail to answer the danger phone when obviously calling, you are
consciously disregarding. Good faith is not just heightened duty of care, not recklessness, but
could be some intentional or conscious disregard of duty to investigate issues. Litigators then
have to argue conscious disregard, intentional wrong doing for company. So, you can sue under
care even with 102b7, but need unbelievably bad facts.

Have to keep track of attitude of court. Court will not punish managers for violation of duty of
care. Van Gorkum still exists, very eroded by Disney, but who would opt in to duty of care.
Judges won’t let you get anywhere for duty of care claims. Even if they do opt into duty of
care, the managers still get BJR. If you sue for breach of duty of loyalty, court will be more
willing. If you sue, need to frame it as a conscious disregard of duty. Gets around 102b7
because on the loyalty side, and might get the benefit of the caremark duty to investigate.
Court wont protect managers for self dealing, which is conflicts and corporate opportunities,
but then there is good faith and caremark, which tend to blend together.

Federal Fiduciary Duties

Don’t mind shady shit as long as you disclose it is the Delaware Mantra. Crash during bush
speech at Walstreet. The passed Sarbanes-Oxley Act of 2002. Some thought it went too far by
requiring more than federal disclosure rules. Could argue that this is a federal duty of care and
loyalty.
Federal Duty of Care:
1- CEO & CFO must assess and report on the company’s internal control structure:
basically, give your control mechanism of the company a grade-score under threat of
criminal perjury, potentially criminally liable, would require intent and be low chance
to ever get criminal punishment. Sounds like Caremark.
2- CEO and CFO must return any incentive compensation or trading profits received
during the 12 months following any accounting statement.
a. Every quarter, publicly traded companies have to disclose their financial results
or be civil and criminally liable. If they discover someone has done something
wrong, they have to go back and fix the statements, and pay back any
compensation or trading profits that resulted
3- So, there is a duty of care in Delaware. Van Gorkum, but then 102b7 allows waiver,
but then the federal statute has at least a limited duty of care.

Federal Duty of Loyalty:

1- Prohibits personal loans to executives
a. Often make loans not expecting money to get back, basically just money out of
the shareholders pockets...
2- Requires a code of ethics for senior officers
NYSE Rules:
Not a regulator, but is a service provider.
NYSE Duty of Care:
1- Requires CEO to certify in writing as to no violations
2- Requires the board to appoint independent audit, compensation, and nominating
committees
NYSE Duty of Loyalty:
1- Requires a majority of directors to be financially independent
2- Requires a code of business conduct and ethics
Basically, says behave nicely, call us if you have questions. Would be a third layer of rules,
wouldn’t really give money damages but could get de-listed from NYSE but that would tank
company and this is rare to have anyone that unprofessional to be de-listed. Essentially is a
trading post for selling of things, same things for publicly traded stock. Doesn’t let everyone in,
because gotta maintain quality, so not just anyone can hawk their wares at the NYSE trading
post. Gets good customers by getting good quality. NYSE just requires professionalism,
accessibility of stock to be a “listed” company. “listed company manual.” Broker is person who
goes to the trading post for us to buy things.

Recap
Duty of Loyalty:
1- Can be waived on a case by case basis
2- Must satisfy the statute and be in good faith
3- Duty of Good-faith is now a subset of loyalty

Duty of Good Faith:

 1- Now a subset of the duty of loyalty.
2- A loyal state of mind / conscious disregard for duties.
3- Maybe still a backdoor around DL-102b7 for a duty of care claim?

Federal Sources of Fiduciary Duties

1- Apply to publicly traded corporations
2- Sarbanes-Oxley
3- Has own duty of care and loyalty and good faith.
NYSE rules add a third layer of rule making.

Lemon Effect:
NYSE contains premium because no risk. Since premium is payed for New York stock, everyone
wants to sell their stock on the NYSE. So they make it difficult to be in the club to maintain the
integrity of the club and maintain the premium. They have the incentive not really to enforce
the rules but make it seem like they’re enforcing the rules. However, they’re still a layer of rule
making. Avoids lemon effect, reducing value of stock because some might be bad.

Piercing the Corporate Veil

If there is limited liability, how do we pierce the veil?
Walkovszky v. Carlton- A creditor cannot pierce the corporate veil without a showing that there is a
substantial unity of interest between the corporation and its shareholders. In order to maintain a cause
of action piercing the corporate veil, the plaintiff must allege that a shareholder used the corporate form
to conduct business in his individual capacity. Maybe: courts will pierce the corporate veil when
necessary to prevent fraud or achieve equity;
This guy was walking on the side walk, ran over and killed by a taxi. Taxi driver Mr. Marchezi
“ran down” some guy. Can sue the driver, but he’s a taxi driver and doesn’t have much money.
So, they can sue the company under respondant superior, as he was employed by a taxi cab
company for negligence. Taxi corporation didn’t have much either. Each taxi carried 10k
insurance, minimum required by state law. Seon Cabs owns 10 little cab companies, each one
had 2 cars, but was functionally one big company with Seon’s one owner being the boss of all
the employees. He wants to sue Seon, but doesn’t find any money. So, they sue equity holder
Carlton, where all the cab company’s money is going, single owner. What evidence do we have
that he wasn’t playing fairly, or not playing make believe? Says on paper there’s 10 companies,
but there is really one work force. Illig talks about making taxi repair company and temp hiring
agency owned by Seon to avoid the problem. Why should we hold him liable? When is court
going to pierce the veil legally and hold the owner liable? Prevent fraud, achieve equity. Court
said he’s pursuing the wrong theory, all his evidence is horizontal company to company, not
vertically between Seon and the owner/operator. “Majority opinion said finding him liable in
this case, would have effectively meant we were going to find all shareholders liable. So what?
What’s special about a corporation is perpetual life, Dartmouth doesn’t talk about limited
liability. Allows capital to be formed. Amount of capital needed to fund industry was enormous.
Limited liability allows us to tap wealth of upper middle class for industry.” People would only
invest in things were they work and have expertise, but new advancement and industry need to
be funded by people who don’t have that expertise.
Sea-Land Services- When a company’s owner does not take care to observe the formal separation
between himself and his business, the business’s creditors can collect their debts directly from him.
Pierce the Corporate Veil when: Unity of ownership and interests, and fraud or injustice. Unity of
ownership and interest requires showing that: under-capitalization and either failure to follow corporate
formalities or co-mingling of funds.
Sea-Land services was shipping company, Pepper source was using them to ship peppers.
Pepper source goes under owing lots of money. They want to sue pepper source but there’s no
money. Contract instead of a tort in this case. Contracts are more likely to be voluntary
relationship. There was comingling of funds, he payed alimony and child support and parrot
insurance, so there was undercapitalization and comingling of funds. P has met burden that far,
but remanded, because must plead some fraud or injustice. Not being paid is not inherently
unfair. Have to plead more than just I didn’t get paid, also breach of contract alone is not
unjust. As business person, must calculate in possibility of breach.
Test the court uses:
1- Unity of Interest and Ownership
a. You’re not playing the game of pretend, blending self and company.
b. Requires:
i. Under-capitalization; and either
1. Failure to follow corporate formalities
2. Co-mingled the funds
2- Fraud or Injustice
a. Injustice much more likely

Kaycee Land and Livestock- An aggrieved party may pierce the LLC veil in the same manner as it
would pierce the corporate veil.
LLC’s can have their veil pierced in the same manner as Corporations. When we say corporate
formalities, we mean the formalities of the company. Piercing the veil is an equitable remedy, so the
lack of express statutory authority to do so is not a bar to doing so. Furthermore, there is no reason, “in
either law or policy,” that LLCs should be treated differently than corporations in this context.
Accordingly, piercing the LLC veil can be an appropriate remedy if the facts of the case so warrant.

In Re Silicone Gel- Where a parent corporation directly controls the functions of a subsidiary and
markets the subsidiary’s products using its own name, it can be held liable both through the subsidiary
and directly for injuries caused by that product.
Common directors between the multiple companies owned by a parent corporation. Bristol Meyers
owns all of the companies completely, it is chill. One of the companies is a bio-engineering company
(MEC) that makes breast implants that starts harming women. While courts generally seek a finding of
fraud in veil-piercing cases based on contract, the rules are less stringent for cases based in tort,
because a plaintiff in tort does not enter into a relationship with the defendant willingly. In this case,
MEC’s relationship with Bristol fulfills almost all of the factors for veil piercing, as Bristol controlled
MEC’s board, made employment and financing decisions, and made the final decision to pull the breast
implants from the market. MEC was undercapitalized, and while there is no evidence that MEC was
committing a fraud on their creditors, that element is less important because the plaintiffs here are
judgment creditors. So: Bristol Meyer was parent company owning many subsidiaries including medical
engineering company making breast implants, they harm people get sued don’t have enough money.
Subsidiaries didn’t have enough money, so wanted to pierce the corporate veil and go up the ladder to
Bristol Meyer Squibb. Bristol Meyer makes choices where to put money based on best proposal by its
subsidiaries. What did Bristol Meyers do wrong? 1- They had a bank of Bristol Meyers, required all of
the subsidiaries to use the same bank and put their monies in the same account. But, not comingling
because kept distinct in the books and records. However, Bristol Meyer’s kept all the interest from the
money pile, they should have allocated proportionally to the subsidiaries who put in the pot of money.
2- Put their name on the box, used Bristol Meyers name to sell and a guarantee, giving the impression
that you’re really doing business with Bristol Meyers.

Recap- Piercing the Corporate Veil

1- Piercing the corporate veil
a. Unity of ownership and interests. Centralized administration and pooled resources.
2-part inquiry:
i. First, either:
1. Failure to follow corporate formalities, or
a. Meetings, records, minute books
2. Comingling Funds
a. Separate bank accounts
ii. Undercapitalization
1. If you’re getting sued and don’t have enough money
b. Fraud or injustice
i. Fairness
2- Must plead fraud or injustice + plead appropriate facts for piercing
3- Same rules apply to LLC’s but with less formality

Equitable Subordination
Fairness, judge says it’s fair to push you lower

Costello v. Fazio- Under the doctrine of equitable subordination, a corporate insider’s claims against a
bankrupt corporation may be subordinated to those of the company’s other creditors if the insider’s
claims cannot be justified within the bounds of reason and fairness; equitable subordination can be
invoked judicially if an equity holder attempts to sneak ahead in line of bankruptcy payment can get paid
with unsecured creditors.
Plumbing company started as a partnership. Each partner put in drastically different amounts: Fazio 43k,
Ambrose 6k, Leonard 2k. The partnership was struggling financially, so Fazio and Ambrose withdrew
some 88 percent of the business’s capital and they incorporated the company. The excess of the 2k each
invested became debt owned to them, so Fazio was owed 41k debt, Ambrose 4k debt owed. Because
they were owed debt, was not going to be double taxed, plus it was their way of securing their
investment, and the debt must be paid first so they were bumping themselves up in line in front of
Leonard, who was owed no debt. They’re hoping as re-characterizing their investment as debt, they
are making themselves unsecured creditors, and getting some of that payout in bankruptcy, bumping
themselves up. If unsecured creditors are not fully paid after the secured creditors, Fazio and Ambrose
were trying to bump themselves up and be paid off with the unsecured creditors. Court said no, that’s
not fair. They did equitable subordination to protect the creditors. Fazio and Ambrose were still
lenders and getting paid before Leonard, but not until the unsecured creditors get their full share first.

Corporate Law Meets Civil Procedure

How does it work? Why does it matter?
2 types of corporate lawsuits:
1- Direct Suit
a. Plaintiff, maybe shareholder, sues the board
2- Derivative Suits
a. Plaintiff doesn’t sue directors directly, causes company to sue the directors.
b. The company is the victim of the breach, company sues board of directors.
c. The company gets the money if the board has to pay, maybe trickles down through
dividends or through injunctive dividends.
d. Technically 2 lawsuits, suing the company, to make them sue the board.
3- Close corporations behave a bit differently because less people, just give money to the
wronged shareholder instead of the company.

Gall v. Exxon- derivative lawsuit;

Foreign bribery, a bunch of federal suits against Oil companies where federal courts tried to interpret
Delaware law, think its very pro-management, changed a bit with Van Gorkum. Here, issue was how
Exxon responded to the lawsuit. Exxon Board established a special litigation committee to determine
how to deal with the suits. Exxon is doing their due diligence to cover their ass basically. They saw the
lawsuit and said it was against Exxon’s interest to maintain any legal action. Exxon special litigation
committee said we’ll take over the law suit, it sucks, let’s dismiss it. They wrote 82-page report with over
100 witness interviews saying wow this lawsuit sucks, Exxon should not sue the board. Seems to be
complete theatrical. However, it is possible legal fees would be more than damages sometimes, or don’t
want to damage relations with the board, or bad press, might be unlikely to win, or too time consuming
or injurious to morale. So, there might be some legit reasons not to bring the lawsuit. However, could be
a complete theatrical scam by the board to have the company not sue them. Can we trust shareholder
to sue though? Not elected so not clear who they represent, could have ulterior motives, are often
unsophisticated. So big deal to give reins of company to share holder, but would also be huge to say
companies can decide not to sue their own boards with fictitious special litigation committees. Federal
court said Delaware loves managers, we’re interpreting their laws, so going to have trial about whether
the special litigation committee did their job properly, not about sleazy foreign bribery. A corporate
committee’s decision not to bring a cause of action might not be protected by the business judgment
rule if the plaintiff in a shareholder derivative action alleges that the committee did not act
independently or in good faith. Gall alleges that members of the special committee may have been
involved in the wrongdoing that is the basis for this action, or interested in the transactions in a way that
would impair their business judgment, thus calling into question whether the special committee acted
independently and in good faith. In light of this allegation, summary judgment dismissal is premature.
Instead, Gall should be permitted to conduct discovery into the independence and good faith of the
special committee. Intent, motivation, and good faith are all issues that cannot be determined on
summary judgment.

Zapata v. Maldonado- A corporate board of directors cannot dismiss a derivative lawsuit based
solely on the fact that a committee composed of disinterested members found that the litigation
is not in the corporation’s best interest. Plaintiff must say “Sue yourself board,” board says
“nah,” judge says “BJR they did their best.” To escape this issue, cannot demand them to sue
themselves. Erinson following forms one big test with Zapata.
Derivative suit is a shareholder suing the company, to force the company to sue the board. In
order to force a company to bring a derivative suit, must first make a demand to the board.
They going to require a “demand” on the board, where you tell them that they should sue
themselves. If the board chooses not to bring the lawsuit, even considering good faith effort,
now the board has made a decision to satisfy Van Gorkum gross negligence, and would be suing
about their decision making in not bringing the case. They also have 102b7 protecting them,
because their decision not to sue was made under duty of care, and even if not under 102b7,
they have BJR so court will assume they made real effort to determine if they should bring it or
not. So, do not demand, because it’s over at that point. So you have to tell the judge I didn’t ask
the board to sue itself, they say why not, and you say is it is futile and pointless. Problem is, we
have business judgment rule that presumes management acting properly, but there is also this
other standard of entire or intrinsic fairness which puts burden on the management to prove
they actually looked at stuff... so maybe doesn’t completely trust management, but also doesn’t
completely trust shareholder. Creates 2-part test to be middle ground between BJR and making
management prove intrinsic fairness.
2-part test:
1- SLC must prove it acted Independently and acted in good faith (Special Litigation
Committee). Burden is on the SLC, not the plaintiff. Not talking about independence and
good faith of the board or wrong doer, were doing about good faith of the special
committee.
a. No financial relationship relating to the matter.
2- Court applies its own business judgement rule. Even if they proved they acted
independently and in good faith, judge can still choose not to dismiss it.

Recap
1- Equitable Subordination
a. The court may use its equitable powers to subordinate debts that appear to be
more like equity
b. No Real Test
c. Purpose is to avoid scams regarding taxes and dissolution order
2- Zapata
a. Federal courts assumed Delaware would be 100% pro-management, but got it
wrong
b. Demand is excused as futile

2-part test:
1- SLC must prove it acted Independently and acted in good faith (Special Litigation
Committee). Burden is on the SLC, not the plaintiff. Not talking about independence and
good faith of the board or wrong doer, were doing about good faith of the special
committee. SLC is ALWAYS going to be able to prove this step, so goes to step 2.
2- Court applies its own business judgement rule. Even if they proved they acted
independently and in good faith, judge can still choose not to dismiss it. Judge is actually
in the best position to determine if there would be a winning lawsuit, because they’re
the judge. Very inflammatory to Delaware.
Zapata Recap:
1- Demand is required from shareholder to board before bringing a derivative lawsuit.
 2- Demand is excused if it is futile.
3- If a special litigation committee tries to intervene in determining if there should be
litigation:
a. The SLC bears the burden of proving its independence, good faith, and
reasonable investigation, no financial stake in the outcome.
b. The judge applies step 2: the judge applies her own independent judgement to
decide whether the suit is meritorious.
4- After doing the Zapata 2-step test and satisfying them to make lawsuit, board still has
BJR and 102b7.

Erinson v. Lewis- wants to remove Zapata step 2, but just builds a gate to get to Zapata: you
must prove futility by casting reasonable doubt that the board will respond with independence
(and due care and good faith).
In Aronson, burden is shifted to Plaintiff shareholder to show lack of good faith or loyalty by
reasonable doubt. It is not enough to say board will just be suing themselves so it is futile like in
Zapata, must show some particularized facts to cast reasonable doubt to get to Zapata 2-part
test. Need particularized facts that cast a reasonable doubt on management/boards good
faith or independence. Particular facts should cast reasonable doubt that management can
act in good faith or independently, so that it will be futile to make demand. If so, then Zapata
2-part test.

So gotta accomplish 102b7 demands, then gotta prove it would be futile to make demand on
board by casting doubt on the management’s ability to be independent or act in good faith. If
they get that far, get to Zapata’s 2 part test. If passes all these hurdles, can litigate, but still
has business judgement rule, and then if you overcome that there is indemnification. Not
intended to be fair.
Hurdles:
1- Demand the board sues. They wont, they win on BJR.
2- Don’t demand and go to court and claim futility, must first cast reasonable doubt that
board would act in good faith or independently, so would be futile to demand. Then,
goes to Zapata 2-part test. Then goes to facts, where BJR still applies.
a. So gotta get through Aronson burden, which effectively eliminates step 2.

Know Lawsuit Paths: with demand or without demand

Indemnification
Waltuch v. Conticommodity-
If you are found to be liable of breach of fiduciary duty and company is the victim, no
indemnification. Here, guy incurs like 2 million in legal fees protecting himself in lawsuits
against conticommodity, he is successfully indemnified from damages from the lawsuit. He is
suing to indemnify himself for the 2 million he spend getting himself removed as a party. Illig
says system is sort of rig and the big thing is whether attorney’s fees are paid in advance. But, if
you do win indemnification on merits or otherwise, he must be indemnified.
Delaware 145a-
“A corporation shall have the power to indemnify any agent or employee against expenses
including attorney’s fees... if the person acted in good faith and in a manner the person
reasonably believed no opposed to the company’s best interests.
Basically:
a- Indemnification is permitted if the person acted in good faith and loyalty
b- Indemnification for derivative suits is permitted if good faith, legal action
c- Indemnification is mandatory if successful on the merits.
d- The board must make a determination.
e- Expenses may be paid in advance if undertake to repay.
f- When is permitted may be made mandatory.
g- The company can purchase D and O insurance even if bad faith or illegal action
a. Insurance doesn’t pay out if there is bad faith, so maybe not worth much.

Illig Office hours

Agency: ordinary course and extraordinary course for corporations. If in the ordinary course
of business. Like 3 types of agency, but statutory. Apparent authority to conduct ordinary
course of business basically.

Classes of Stock: can make up any class you want as long as there is one plain vanilla. Some
stock has to have voting power, but not all stock.

In close corporations, we’re copying partnership fiduciary duties and implying them among
shareholders.

Corporate Opportunity:
“when I’m walking around in the world, I have different hats I am wearing for different roles.
Illig is an agent of U of O. When Illig is in Vegas, he is not U of O, he is just Illig. What it comes
down to is interest or expectancy. Interest is literally I own it or I have an option to buy it.
Expectancy is what we care about, softer version. If I go to a dealership to sell a car at very
cheap, if the salesperson I approach takes the deal instead of the company, the car company
can sue the employee saying you were buying it for us. However, if you offer a person to sell
them a car, not knowing they work at a dealership, not a corporate opportunity. Also like real
estate, brokers can possibly buy the house personally instead as part of the real estate
company. Did you call the broker because you were trying to communicate with the
company, or is he some buddy you know. Broker should go to the boss and say do we wanna
buy it? You gotta ask. They might argue that lack of money doesn’t matter cause they can go
to a bank and ask for money. Expectancy can be helped along by ordinary course of business.
Unable to exploit also shows that they don’t have an expectancy. One real exception is asking
permission, needing board to approve unanimously.
Good-faith: we don’t have the answer of the specifics. Take away that it is now part of duty
of loyalty, but it might not matter that much. Good faith seems to be 2 things: 1- state of
mind of loyalty, like good team spirit; 2- an act so reckless or careless as to constitute bad
faith- conscious disregard of duties. If you intend to harm company, that is bad faith. Always
remember judges are Delaware. Conscious disregard is like caremark duty to investigate, not
consciously disregard or consciously not set up information recording system. Function of
board is to monitor management, cant question their decision making, but can question their
monitoring or caremark duty to investigate.

Easy to write essay questions about conflicts of interest, corporate opportunities. Question
about caremark would be more like what the hell is going on: evolving.

Conflict of interest: waiver/ratification if:

1- Disinterested board member vote,
2- approve knowing all the material facts,
3- entire fairness/intrinsic fairness: fair dealing and fair price.
Seldom if ever litigated. In addition to being fair or in addition to ratification, have to show it
is honest or good Illig says, really meant to be Zapata step 2, opportunity for judge to see
through the scam.

Aronson is really 1 step case asking when a demand is required. Zapata 2 steps come up when
there is a SLC, there we talk about the actual independence and good faith, not of the board,
but the SLC. Aronson asks whether can cast reasonable doubt that the board is good faith and
independent.

Corporation formation:

1 share of stock: minority discount; controlling share, bump up in price for control premium.

Test might include math about partnerships.

Cases to know:
Meinhart v. Salmon, Van Gorkum/Caremark, Zapata-Erinson, Donahue, Ford v. Dodge.

MA:
Lots of trucks, not asset purchase.
Dotcom: stock deal? Don’t trust the judge to get it right on the merger, lots of possible anti-
assignment provisions with advanced detailed patents with dotcoms.
Don’t want shareholders to vote? Asset purchase.
Equal dignity to all 3 venues: legislature approved of 3 methods, some have different outcomes.
As long as your following the rules of the path you picked, good to go.
Stock purchase for IP, also faster, want the corporate veil to remain in-tact.
Asset purchase helpful if want no liabilities but want the assets.
Corporate veil:
With lots of shareholders usually no piecing the corporate veil, because their record keeping
becomes more sophisticated. Really just for close corporations. Argument for getting rid of
limited liability for small businesses: need limited liability so farmer can invest in railroad, small
farm will only have farmers investing so they will know, maybe don’t need the limited liability.

Outcome determinative:
BJR; duty of loyalty self-dealing test; Erinson-Zapata; whether demand is excused or not; if you
got facts that are going to protect you, why didn’t you bring them up earlier.

Mergers and Acquisitions

Looks to 3 things:
1- Authority
a. Friendly management, unfriendly shareholders, asset purchase.
2- Alienability
3- Liability