BIZ ORG OUTLINE

INTRODUCTION………………………………………………………………………………….
 1st quasi-corporations – came from the church
o Land, schools etc. all in name of this church organization
o The “monastery” owns the land – even after the death of the monk that formed it
 Charters more common in England given by king
o To form universities
o Civic projects – canals
o Conquer other lands and form colonies – ex. British East India Trading Corp.
o Corporate form becomes more prominent
o YET had limitations:
 Still had to convince parliament to give you the charter
 Only for a limited amount of time
 Govt. by right could change the provisions of your charter – w/o your
consent
o BUT balanced w/ certain distinct advantages:
 Unaffected by death of a partner/member
 Liability for debts limited to capital contribution
 w/o limited liability – you could be liable though you had no say
in the mgt of the corp.
 All the foundations came together today in the modern Corporation of the United States
o Got rid of limitations – federalism
o Each of fifty states could decide their own corporation law
o Making it as easy or difficult to incorporate as the state wanted - ex. New Jersey
was very easy in the beginning
o Now Delaware – is the easiest to incorporate – you have a right to incorporate the
right need not be given
 You choose the term of life of your business
 State law cannot change corporate charter

Duties
All jurisdictions have imposed 2 basic types of duties on directors
- Duty of care: Since directors are running corp for other people they have to do it in a
reasonably prudent manner
- Duty of loyalty: You can’t put your personal interest ahead of the corporate interest
- What liabilities flow and what protections exist

Specific problems
- One group puts up all the money and one group makes all the decisions
o So a conflict usually exists
- Special problems of closed corporations (owned by the same people who run them)
o No separation, but this isn’t always a good thing. It creates a different set of
problems.
 Things are a lot less formal
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- Dissolution – when you can dissolve corporations

Federal Securities Law

- Federal securities law – federal statutes govern the purchase and sale of securities
- So b/c of that, in addition to all the state law duties, you also have federal laws, rules and
regulations that you have to follow
- Specifically start by talking about duty to disclose (key federal law)
o Instead of governing the substance of transactions, Congress decided that they would
just required disclosure and if you deem it to be ok, then that is the only duty
- Insider trading: What it is and how it works
o See how this ties in w/ concepts in federal securities

Limited Liability Companies

- New entity adopted by all 50 states
- Statutes that govern this and b/c of their flexibility and advantages, many small business have
decided to use this form
- Mechanics and how they are different from corporations
- Unique issues that apply to LLCs and not all the other ones

Industrial Revolution (revisited): With a charter from Parliament, expensive long-term projects
could be funded. People could put money into the charter, and the project could be completed.
(Example: Colonizing Virginia). The company would have perpetual life and limited liability.
The person making decisions was not necessarily the person funding the project. The methods
chosen had significant limitations. Sometimes, a charter could only be granted for a certain
amount of time, and then the charter had to be re-authorized. This left room for misbehavior.

United States’ innovations: Anyone could begin a corporation. There was no dirty work involved
—anyone could start a corporation. This took out a lot of misbehavior and impediments that
people who weren’t well-connected had to go thru.

Example: The case that allowed corporations that were incorporated in one state to do business
in another state. This allowed states to compete with other states.
- With modernized statutes, huge corporations would go to different states to complete big
projects.
- This has made the U.S. the nation with the biggest economy.

CHAPTER 1 AGENCY…………………………………………………………………………..
Can be held liable for torts of your agent:
1. if authorized conduct
2. respondeat superior doctrine – have control and is doing work for you; subsets of agents
Scope of Employment – frolic and detour

Obligations principals and agents have to each other:

 principal to agent: compensation, indemnification,

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  Agent to principal: must turn over any secret profit made,

Partnership Law:
 Determining if partnership exists?
o Profit-sharing
o Ongoing business
o Management
o Who has right to assets of the business
o Lender/Creditor situation – vs. Co-partner relationship ---- determine where the
line can be drawn
 Joint Venture – ex. Shell Oil company – done for a specific purpose
o Set up in sophisticated way over what the specific rights of each party are
o One specific task
Running a partnership:
 Managed by the partners and not dependant on the amount of capital contribution of each
partner
 Points out that the UPA is the default unless prior agreement among parties has been
made
 Every partner is an agent of the partnership – binds the partnership – fiduciaries of each
other
 Die with a partner – dissolve when any partner leaves

Types of Authority
- When the principal actually/expressly tells the agent that he/she has the authority to do
something, the authority is created.
- If the authority is implied (you are told to accomplish something), then controversy may
arise. There are no direct instructions; you are just supposed to get the job done.
- Apparent authority: When the principal leads a third person to believe that the agent has
authority to do something, then the principal may also be liable.
- Inherent authority: A situation where doing something is such a part of your job as an agent
that the court will allow you to do it even though you don’t have any actual/apparent/implied
authority to do it.
- If the principal does something to confirm that they want to proceed with the obligation
(despite an opportunity to reject the obligation), then they are deemed to have acquiesced to
the action.
o For example, if I (as an agent for Loyola) buy a TV that exceeded the set price limit,
and Loyola takes it and hangs it in the Dean’s suite, they have accepted it.
- Estoppel: When a third party believes he/she is acting for the principal, but the agent is not.
When it would be unfair to allow the principal not to be held liable, then the principal is
estopped.

**Note: It doesn’t matter what kind of authority the court finds; if the court finds ANY
authority at all, then the principal is bound. If there is no authority, then the principal is not
bound.

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 When agents commit torts
- Servant agents vs. independent contractors
o In a master/servant agency relationship, the master has the right to control the
physical conduct of the agent.
 Pizza delivery guy is told exactly what he has to do (when to show up, where
to go, when to be back) to get paid.
 A master is only liable for his/her servant’s torts when the tort occurs during
the scope of the servant’s duties. If the actions are outside of the scope of the
servant’s duty, then the master will not be held liable.
o In an independent contractor relationship, the principal does not have the authority to
control the physical conduct of the agent.
 Attorneys are hired as agents for their clients. However, when they start
working on transactions, the client does not give a specific, detailed list of
what the attorney will do. The client just wants results. The means to the end
is up to the attorney.

Duties of Agents
Because agents are given authority and they can bind the principal in a certain way, the law
imposes duties on agents. They have a fiduciary duty to act in a certain way.
- The primary duty is loyalty. The principal should know about all of the benefits the agent is
receiving from his work with the principal.
o An agent may not enter into undisclosed actions with the principal.
o The agent should not do business with the principal.
o All of the things can be done with consent of the principal.
- The agent also has a duty of care. There is a reasonable duty of care.
o If the agent violates its duty of care, the principal can get damages. The agent should
also have to rescind transactions and disgorge hidden profits.
 The loss to the principal (from hidden profits) could cause great financial
harm to the principal. Therefore, there are sometimes substantial remedies for
principal plaintiffs if agents violated these duties.

Ending an Agency
There are many ways to end an agency. The easiest way to end an agent is at will. This means
that the parties end the agency with mutual consent.
- If you have a contract, and the term of the contract expires, then the agency can end.
- If you have a goal/purpose of the agency relationship, and it is accomplished, then the agency
is ended.
- Once the agency has ended, then the principal is no longer bound, and the agent no longer
has fiduciary duties to the principal unless confidences have been gained during the prior
relationship. If confidences have been gained during the relationship, a fiduciary duty still
exists after the agency is over.
o The dissolution of the agency should be express.

PARTNERSHIP…………………………………………………………………………………….
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Partnerships are default propositions imposed by law. If two people work together to make a
profit, then they are a partnership by law. They don’t have to expressly make an organization; the
government looks at their actions and intentions, and makes them a partnership. There is a long
list of factors that courts look at to determine if a partnership exists. It is a factual determination.

Unusual partnerships
- Employer/employee relationship: If you work at a small business, and half of your salary
depends on whether or not the business does well, there may be a partnership between the
owners of the company, and its workers.
o The more your salary depends on the company’s gains and losses, the more the
relationship begins to look like a partnership.
- Creditor/debtor relationships: When people put a lot of money into a company and demand
interest, a percentage of the profits, and a voice in decisions—a partnership may exist. The
more people get involved with a company, the more likely that they are part of a partnership.
o You go from “loaning money” to a person, to becoming part of a company. The
problem with this is that every partner becomes personally liable to the company.
 Banks make sure that they remain creditors, and not partners, to avoid
liability.

How partnerships are operated

Partnerships are managed by the individual partners and the state law in each state. The states set
out default rules:
- Each partner has one vote.
- Majority rules.
This is not the same thing that happens in corporations.
- The default rule in corporations is that the person with the most money in the company has
the most powerful vote (proportionally).
- Corporations also split money evenly among the partners. While it doesn’t seem fair that
people who put in more money get the same back as those who put in less money, there is a
remedy to this.
o The partners to the corporation may change the policy and receive more money, so
long as all parties are informed of this change.
The default rules require unanimity when:
- The rules to the partnership are changed
- New members are added
- Really big decisions require unanimity.

Partnership finances
If everyone gets equal share of the profits, they also get equal share of the losses. This may be
changed by agreement. If you have allocated profits in a certain way, it is logical to assume that
losses are allocated the same way.
- If creditors come after the partnership, several states require the creditor to exhaust all
partnership assets before coming after the partners’ personal assets.

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- Because partners are active in the organization, the law imposes high fiduciary duties on
partners.
o Principally, courts impose a duty of loyalty among the partners.
o This limits the way partners may act. They cannot usurp opportunities, they cannot
act selfishly.
o Duties of care
o Duties of disclosure

How partnerships end

- Whether the partnership is at will, or whether it’s been constituted for a term.
o If for a term, there are consequences. If you wrongfully terminate a partnership, you
give the other partners a right to continue the partnership.
 Under old law, if one person left the partnership, the partnership would
dissolve. The partnerships made rules within themselves that said that if one
person left the partnership, the existing partners would form a new, identical
firm/partnership.
 New law: Dissociation: A partner may dissociate him/herself from the
partnership without dissolving the entire partnership. The partnership does not
have to start over. The dissociating partner loses his rights in the partnership,
but may still receive his/her share of the partnership assets.
o If partners end at will, then there are no major consequences.
o Winding up: Liquidating, selling off everything, paying off debts (third party
creditors), and then paying off related party creditors. Then you pay off partners
according to their capitol accounts (in relation to how much they put in—so they get
their money back). If there’s any money left, you distribute it among the partners.
 After you divvy up all the money, then the partnership is finished.

Notes on Procedure: Forming an Organization

Mechanical View of Starting a Corporation (As Distinguished from Partnerships)

Every state has a statute requiring a prospective corporation to file an article of corporation. The
form asks you to name the corporation, the duration of corporation, and also other things that you
may want to add to the corporation. It can be one page long, or it can be many pages.
- You have to file the article with the secretary of the state in the state in which you wish to
become a corporation.
o You can still operate in another state, despite the state of corporation.

Substance of Starting a Corporation (Distinguished from Partnerships)

- People must put up the funding, or a contribution, to form the company. When people
contribute the capital to begin the corporation, those people become the shareholders of the
corporation.
- You can only lose the amount you put into the corporation when the corporation fails.
o For example, if you put $1M into a corporation that fails, you only lose $1M. You
aren’t personally liable for more than that.

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- The statute also gives the board of directors the power to make decisions. The shareholders
don’t have any say in the decisions, but they do choose the board members.
Board members do not complete daily activities, but rather elect others to carry out daily
activities

CORPORATE LAW……………………………………………………………………………….

INTRODUCTORY STATUTES (pertinent stuff in bold)

§ 154. Determination of amount of capital; capital, surplus and net assets defined. – at there
discretion!!
Any corporation may, by resolution of its board of directors, determine that only a part of
the consideration which shall be received by the corporation for any of the shares of its
capital stock which it shall issue from time to time shall be capital; but, in case any of the shares
issued shall be shares having a par value, the amount of the part of such consideration so
determined to be capital shall be in excess of the aggregate par value of the shares issued for
such consideration having a par value, unless all the shares issued shall be shares having a par
value, in which case the amount of the part of such consideration so determined to be capital
need be only equal to the aggregate par value of such shares…

§ 170. Dividends; payment; wasting asset corporations.

(a) The directors of every corporation, subject to any restrictions contained in its certificate of
incorporation, may declare and pay dividends upon the shares of its capital stock, or to its
members if the corporation is a nonstock corporation, either (1) out of its surplus, as defined in
and computed in accordance with §§ 154 and 244 of this title, or (2) in case there shall be no
such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year…..
(b) Subject to any restrictions contained in its certificate of incorporation, the directors of any
corporation engaged in the exploitation of wasting assets…may determine the net profits derived
from the exploitation of such wasting assets or the net proceeds derived from such liquidation
without taking into consideration the depletion of such assets resulting from lapse of time,
consumption, liquidation or exploitation of such assets.

§ 171. Special purpose reserves.

The directors of a corporation may set apart out of any of the funds of the corporation available
for dividends a reserve or reserves for any proper purpose and may abolish any such reserve.

§ 172. Liability of directors and committee members as to dividends or stock redemption.

A member of the board of directors, or a member of any committee designated by the board of
directors, shall be fully protected in relying in good faith upon the records of the
corporation and upon such information, opinions, reports or statements presented to the
corporation by any of its officers or employees, or committees of the board of directors, or
by any other person as to matters the director reasonably believes are within such other
person's professional or expert competence and who has been selected with reasonable care

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by or on behalf of the corporation, as to the value and amount of the assets, liabilities
and/or net profits of the corporation or any other facts pertinent to the existence and amount of
surplus or other funds from which dividends might properly be declared and paid, or with which
the corporation's stock might properly be purchased or redeemed.

§ 173. Declaration and payment of dividends.

No corporation shall pay dividends except in accordance with this chapter. Dividends may be
paid in cash, in property, or in shares of the corporation's capital stock. If the dividend is to
be paid in shares of the corporation's theretofore unissued capital stock the board of directors
shall, by resolution, direct that there be designated as capital in respect of such shares an amount
which is not less than the aggregate par value of par value being declared as a dividend and, in
the case of shares without par value being declared as a dividend, such amount as shall be
determined by the board of directors. No such designation as capital shall be necessary if shares
are being distributed by a corporation pursuant to a split-up or division of its stock rather than as
payment of a dividend declared payable in stock of the corporation.

§ 174. Liability of directors for unlawful payment of dividend or unlawful stock purchase or
redemption; exoneration from liability; contribution among directors; subrogation.
(a) In case of any willful or negligent violation of § 160 or 173 of this title, the directors under
whose administration the same may happen shall be jointly and severally liable, at any time
within 6 years after paying such unlawful dividend or after such unlawful stock purchase
or redemption, to the corporation, and to its creditors in the event of its dissolution or
insolvency, to the full amount of the dividend unlawfully paid, or to the full amount
unlawfully paid for the purchase or redemption of the corporation's stock, with interest
from the time such liability accrued. Any director who may have been absent when the same was
done, or who may have dissented from the act or resolution by which the same was done, may be
exonerated from such liability by causing his or her dissent to be entered on the books containing
the minutes of the proceedings of the directors at the time the same was done, or immediately
after such director has notice of the same.
(b) Any director against whom a claim is successfully asserted under this section shall be entitled
to contribution from the other directors who voted for or concurred in the unlawful dividend,
stock purchase or stock redemption.
(c) Any director against whom a claim is successfully asserted under this section shall be
entitled, to the extent of the amount paid by such director as a result of such claim, to be
subrogated to the rights of the corporation against stockholders who received the dividend on, or
assets for the sale or redemption of, their stock with knowledge of facts indicating that such
dividend, stock purchase or redemption was unlawful under this chapter, in proportion to the
amounts received by such stockholders respectively

Corporate Law: Background

 Stock is interest in corporation
 Shareholders invest money then in return receive a share in the profits of the company
 Ownership thus takes place – in that you have right to the economic gains of the
corporation

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  Corp. Managed by the Bd of Directors – only meet 4-6 times a year
 Officers run the day to day operations of the company

NATURE OF THE CORPORATION…………………………………………………………..

A.P. Smith Mfg. Co. v. Barlow: The board of directors made a philanthropic donation to
Princeton with shareholder funds. Holding: The gift was within the implied owers of the
corporation.
 Cannot be a “pet charity” of the Prez
 Must be in interest of the corporation
o Exception: 1930 New Jersey statute: Any corporation could cooperate with other
corporations and persons in the creation and maintenance of community funds
and charitable, philanthropic or benevolent instrumentalities conducive to public
welfare…so far as stockholders approve donations in excess of 1% of capital and
surplus.
 If contrary to the purpose of the corporation – then clearly can be attacked – despite a
statute that allows it
o It is a gray blurred line – we want ppl to make charitable contributions but still
should be in best interest of the corp. – essentially decided on a case by case basis
 Must still act in best interest of the company (increase good will etc.)
 If you incorporate in the state – you agree to be subject to that states corporation law ,
you are also put on notice that the law is subject to change, It does not matter if the
statute was not enacted until after corp. started
o Statutory amendments are applicable no matter what

Courts don’t like to step in…..

More on Donations to Charitable Organizations from Corporations
The money given at the decision of the board usually belongs to the shareholders. Shareholders
are not rich people. In some instances, this money belongs to janitors and school teachers.
- Directors are making decisions about using the money of lots of people (albeit a small
fraction of money from each individual) who may not all have the same interests.
Anonymous donations will not promote the reason of donations to boost a corporation’s PR (or
any of the other reasons for donations regarding benefiting the company).

Dodge v. Ford Motor .- Case shows that courts try to avoid interfering but will…if forced
 Henry Ford testified that he was not looking out for the best interest of the shareholders,
because he felt that they had gained more than enough from the company.
o This was a big mistake. A business corporation is organized and carried on
primarily for the profit of stockholders.
 Ct found he was not acting in best interest of corp. (he could have argued business
judgment rule but opted not to – corporate mind set)
 Drury says “court lost its nerve, the ongoing consequences – of ordering how the corp.
should run its business, ex. building plant or not” – ct does not presume to know more
than Ford .

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  Much easier for court – to order corp. to pay some amount of $ then have to ongoing
monitor their actions

More on dividends
The reason that boards have to be careful about giving out dividends is that there usually isn’t
enough money (rather than a surplus).
- The question that must be asked is: “Have we made enough money to give out dividends?”
o Once you give out dividends, you can’t get it back. Creditors cannot go after that
money. There may not be enough money to pay off debts.
- Each state has its own test, but there are usually two requirements:
o Is there an operating surplus?
o Is there any old money with which to make dividends? (Old money—money saved up
over the years that will not affect the corporation’s ability to pay off debts.)
- Dividend law focuses on the corporation’s ability to declare dividends and maintain itself.
Basic Things to Know about Financial Statements
There are 2 basic financial statements: Each shows different, but important things, about a
company.
- Balance sheet: Shows the companies assets and liabilities at a particular moment in time.
o All of the assets will be listed on one side, and all liabilities will be listed on the other.
o Retained earnings: All of the money (assets and liabilities) left over will be added up
at the bottom; the difference will be the retained earnings. This is the “balance” part
of the sheet.
- Income statement: Run over a period of time. You can have an income statement for the year,
quarter, monthly, etc….
o You list all the revenue brought in over the time period.
o Then the income statement subtracts the things you’ve paid out over the course of the
year (overhead costs).
o The income is the money you’ve made after you made after all of your bills have
been paid. It’s the money you’ve made after you’ve subtracted all of the costs of
building revenue.

Debt and Equity

Debt is what you owe; it’s an enforceable interest to pay back money. Equity is your investment.
With equity, your investment may be at risk, but you also have the potential to gain the profits of
the company.

Schlensky v. Wrigley – here owner argued Business Judgment and won – if you give them any
reasonable basis for actions – they’ll defer
 Wrigley testified – to reasons why he didn’t want lights –argued that it was in the best
interest and as majority shareholder he is entitled to do what he sees fit in operation of his
corp.
 Ct – says minority did not prove would be more beneficial -Example of the business
judgment rule – bds are there to run corporations, it is not the court’s job to run the corp.

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 o Thus courts do not second guess what bds do, as long as no evidence of fraud, bad
faith, or conflict of interest ---unless evidence to the contrary the court will not
change what the bd has decided
 Rebutting the business judgment rule – show that substantial conflict of interest – of
deciding if bd was acting in conflict – state what the conflict is an interest ----then
examine if it really was contrary to best interest. Only if bd acted blatantly against best
interest of corporation will bjr be successfully rebutted.
o Minority s/h cannot win the case on difference of opinion.
 Ct says complaining shareholder can just sell his shares – but he would be selling shares
for a lower price then he feels they are worth – b/c based on the bd’s actions the shares
are worth less – so not really a remedy (freezing out)

Court Deference in Similar Cases

- Courts will defer to board members unless it is not in the best interest of the shareholders, or
unless there is a conflict of interest.
- BUSINESS JUDGMENT RULE: If you can show that the directors lived up to their duties
(no conflict, good faith, best interest of the company), then courts generally will defer to the
boards.
o If fiduciary duties are breached, then the board will be held to a high level of
scrutiny.
- The law has resolved conflict by imposing duties on the board.
o The above cases show have boards may expand that mandate.
 Generally acting for the well-being of shareholders.

PROMOTERS AND THE CORPORATE ENTITY……………………………………………….

Formation of Corporation:
 The word promoter is a term for a person identifying a business opportunity and puts
together a deal forming a corporation as vehicle for investment by other ppl
 Have to list the “nature” of your business – can be essentially anything you want to put
 Determine how many shares are available to issue – you would not want to issue all stock
 List an incorporator – Duties:
o who signs and fills out paperwork
o “in charge” until bd of directors is elected
o Work out bylaws of the corporation - a more detailed description of the day to day
working of the corporation
 (the bd of directors can change bylaws – as opposed to putting things like
day to day in the charter – changes to the charter must be agreed to by all
the shareholders)
 THE POINT – if you comply with all of the statutory guidelines set out in the state and
other rules – then we will give you limited liability
o Includes the duty to treat the corporation as a distinct separate legal entity – (to
avoid piercing the corporate veil)

Opening Hypotheticals pp. 200-01

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Case 1: You are free to sell property in any way you like, so long as you are defrauding
someone. Ann is not obligated to answer any questions about the property, but if she lies about it,
she could be liable to fraud. Failure to answer questions is not a problem, deceit is a problem.
Sean may have to prove damages or detrimental reliance.
Case 2: Art (Agent) sells land to his client, Paula (Principal). If he is on the other side of the
transaction, and he doesn’t disclose that he is making a profit, then Paula would have a claim to
the profit he made. It doesn’t matter if Paula suffered damages or not. Paula recovers any profit
made by her agent if he fails to disclose that he is on the profiting side. It is a penalty that
prevents agents from making secret transactions.
- Section 388 of the RST of Agency (Second): Unless otherwise agreed, an agent who makes a
profit in connection with transactiosn conducted by him on behalf of the principal is under a
duty to give such a profit to the principal.
Case 3: Buyer Paula forms P Corp., which has the exact same power as Paula in case 2.
However, Paula cannot act unless she acts thru the corporation. Corporations are distinct and
separate legal entities under the law. Even though Paula is acting as a board member, it is not
Paula who is hurt by damages. The corporation is the entity that suffers.
Case 4: Art forms the corporation for Paula. The person who forms the organization (call
promoters) owes the same type of duties to the corporation that an agent owes to a principal. If
Art is the organizer of the corporation, he owes duties and must disclose any profits made to the
corporation.
- Part 2: Paula forms the corporation and Art sells the property to her. Art will not be liable for
failing to disclose interest in the transaction in this situation. Because Paula formed the
corporation, Art doesn’t have to return the profit.
o Recurring theme: Form matters.
o When a corporation is formed, certain allowances are made. You can for a limited
liability company, among other things. However, in order to obtain these protections,
you have to follow certain procedures.

Corporate commitment: You can’t come after individual persons just because they’re affiliated
with the corporation, unless it is specified otherwise.

Southern-Gulf Marine Co. No. 9 Inc. (owner) v. Camcraft, Inc. (builder)(1982)

 “One who treats an entity as a corporation by K’ing with and incurring obligations for,
is estopped from later denying the corporations existence”
 Nothing in record indicates that a substantial right of the defendant were affected by
plaintiff’s status – as incorporated outside US
o Agreement to purchase a ship – in the agreement it was said that the owner was “to be
incorporated”
 After incorporation – the board formally adopted and ratified the K
 Where the corporation was eventually incorporated has nothing to do with the
K at issue here – the pt is they are trying to breach the K to sell it somewhere
else for more money
 This case could have been prevent had Camcraft made Barrett personally guarantee
everything: “I am the sole owner of the corporation….”

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THE CORPORATE ENTITY AND LIMITED LIABILITY………………………………………
 Huge benefit to shareholders – liability capped at their investment
 As an invention of state law – require formalities
o franchise tax, holding annual meeting, separate bank accounts
o no commingling of corporate and personal funds
 especially a problem in smaller corporations
 Where you lose the right to limited liability:
o Piercing corporate veil to make sharholders personally liable – not treating
corporation as a separate entity
o If a common group of corporations – can bring enterprise liability claim – when split
the business into multiple brother and sister corporations all under common
ownership
 When court uses doctrine – it pulls together all the business assets to satisfy
the liability of any one subsidiary

Corporate Entity and Limited Liability

1. The Corporate Form
a. Characteristics of the corporation
i. Separate legal entity. A corporation is a separate legal entity (created by the
law of a specific state), apart from the individuals that may own it
(shareholders) or manage it (directors, officers, etc.) Thus the corporation has
legal rights and duties as a separate legal entity.
ii. Limited Liability. The owners (shareholders) have limited liability; debts and
liabilities incurred by the corporation belong to the corporation and not to the
shareholders.
iii. Continuity of existence. The death of the owners (shareholders) does not
terminate entity, since shares can be transferred.
iv. Management and control. Management is centralized with the officers and
directors. Each is charged by law with the specific duties to the corporation
and its shareholders. The rights of the corporate owners (shareholders) are
spelled out by corporate law.
v. Corporate powers. As a legal entity, a corporation can sue or be sued,
contract, own property, etc.
b. Limited Liability
i. Liabilities belong to the corporation itself. Because a corporation is held to be
a separate legal entity, the corporation normally incurs debts and obligations
in its own name that are not the responsibility of its owners (shareholders). At
the same time, the corporation is not responsible for the debts and obligations
of its owners (shareholders).
2. Exceptions to the limited liability rule. There are exceptions to the rule of limited liability. In
those exceptional situations, the court is said to “pierce the corporate veil” and to dissolve the
distinction between the corporate entity and its shareholders so that the shareholders may be
held liable as individuals despite the existence of the corporation.
a. Situations where the corporate veil may be pierced.

13
 i. Fraud or injustice. Where the maintenance of the corporation as a separate
entity results in fraud or injustice to outside parties (such as creditors).
ii. Disregard of corporate requirements. Where the shareholders do not maintain
the corporation as a separate entity but use it for personal purposes (for
example, corporate records are not maintained, required meetings are not held,
money is transferred back and forth and commingled between individuals and
the corporation, etc.). The rationale here is that if shareholders have
disregarded the corporate form, then the entity is really the alter ego of the
individuals and decisions are made for their benefit and not the entity’s—the
individuals should not complain if the courts likewise disregard this entity.
This is most likely to occur with close corporations.
b. Undercapitalization. A prime condition for piercing exists where the corporation is
undercapitalized given the liabilities, debts, and risk it reasonable could be expected
to incur.
i. Liability insurance as evidence of undercapitalization (Walkovszky v. Carlton)
c. Requirements of fairness. The veil may also be pierced in any other situation where it
is fair that the corporate form be disregarded.
i. Cannot differentiate between corporation and the individual (Sea-land
Services, Inc. v. Pepper Source)
ii. Volunteer creditor ignorant of unusually small equity financing
iii. Liability of parent to subsidiary (In Re Silicone Gel Breast Implants Products
Liability Legislation)
iv. No improper actions

Walkovsky v. Carlton
 The law permits the incorporation of a business for the sole purpose of enabling its
proprietors from escaping liability – this case is a prime example
 Plaintiff injured after being run down by cab – the corporation is inadequately capitalized
to pay for his injuries but had the minimum insurance allowed by law
o Stockholders have limited liability
o In this case – there was no evidence to support a piercing of the corporate veil
o Though the corporation that owned the cab that hit him is clearly liable – in this
case there is no reason to pierce corporate veil - to get to Carlton personally or by
enterprise liability to the other cab companies
o The relationships between the separate corporations – must show the distinction
between the corporations – must respect corporate formalities
o Factors:
 At the end of each month - each corporation writes checks to the other
ones for rent of garage, payment of drivers used by one corporation ---
must evidence the separation of the entities – by this clear internal
accounting practices
 How you hold yourself out to the public – here each corporation had
different name

14
  Separate bank accounts of each subsidiary corporation from the larger
holding company – instead of one huge account that all the smaller units
feed into
Notes:
 Three separate legal doctrines: enterprise liability, respondeat superior, disregard of the
corporate entity (piercing the corporate veil) – to get liability
 The presumption of limited liability is hard to overcome – their must be clear abuse to
warrant piercing the corporate veil
 Enterprise liability – get to all other corporations – operating under the same governing
structure ---- but did not pursue this theory fully – though it was the most promising
o This form looks sideways; it looks to each sister corporation for liability.

Sea-Land Services, Inc. (ocean carrier) v. Pepper Source

 Test for piercing corporate veil:
o Two requirements: must show both
 There must be such a unity of interest and ownership that the separate
personalities of the corporation and individual no longer exist
 Adherence to the fiction of separate corporate existence would sanction a
fraud OR promote injustice

No matter what, if you want to pierce the corporate veil, you must find (first) a unity of interest
and (second) some sort of injustice. This doctrine is a mechanism to find the shareholders
personally liable for the organization.

Factors showing unity of interest:

1. Failure to maintain adequate corporate records or comply with corporate formalities
2. Commingling funds
3. Undercapitalization
4. One corporation treating another corporation as its own

Factors failure to respect corporate form:

 No corporate meetings
 No articles of incorporation, bylaws or other agreements
 All corporations are run out of one single office
 “Borrowing” funds from expense accounts
 Different subsidiaries borrow from each other
 Also including use of corporate funds to pay personal expenses

Factors showing Fraud or Promote Injustice:

- Need not have both – one or the other is sufficient
- If we don’t pierce the corporate veil – then creditor won’t get paid BUT must be based on
some wrong that is beyond the creditors inability to pay but larger than that
o On remand – the trial court determined that there was in fact a greater injustice – and
found in favor of Sea–Land

15
***Brings up the issue – that when remanded to find this “greater injustice” – is almost always
found to have committed this greater injustice
 Very few cases where they can’t find an injustice
 Are possibilities where injustice element becomes more relevant – But Drury says he main
element is the unity of interest factor

§ 101. Incorporators; how corporation formed; purposes (anyone can incorporate)

a) Any person, partnership, association or corporation, singly or jointly with others, and
without regard to such person's or entity's residence, domicile or state of incorporation,
may incorporate or organize a corporation under this chapter by filing with the
Division of Corporations in the Department of State a certificate of incorporation which
shall be executed, acknowledged and filed in accordance with § 103 of this title.
b) A corporation may be incorporated or organized under this chapter to conduct or
promote any lawful business or purposes, except as may otherwise be provided by the
Constitution or other law of this State.
c) Corporations for constructing, maintaining and operating public utilities, whether in or
outside of this State, may be organized under this chapter, but corporations for
constructing, maintaining and operating public utilities within this State shall be
subject to, in addition to this chapter, the special provisions and requirements of Title
26 applicable to such corporations.

§ 102. Contents of certificate of incorporation.

a) The certificate of incorporation shall set forth:
1. The name of the corporation, which (i) shall contain 1 of the words "association,"
"company," "corporation," "club," "foundation," "fund," "incorporated," "institute,"
"society," "union," "syndicate," or "limited, – can’t be “bank” – or misleading
2. The address (which shall include the street, number, city and county) of the corporation's
registered office in this State, and the name of its registered agent at such address;
3. The nature of the business or purposes to be conducted can say “engage in any lawful
act” and by such statement all lawful acts and activities shall be within the purposes of
the corporation, except for express limitations, if any;
4. If the corporation is to be authorized to issue only 1 class of stock, the total number of
shares of stock which the corporation shall have authority to issue and the par value of
each of such shares, or a statement that all such shares are to be without par value. If the
corporation is to be authorized to issue more than 1 class of stock, the certificate of
incorporation shall set forth the total number of shares of all classes of stock which the
corporation shall have authority to issue and the number of shares of each class and shall
specify each class the shares of which are to be without par value and each class the
shares of which are to have par value and the par value of the shares of each such class.
The certificate of incorporation shall also set forth a statement of the designations
and the powers, preferences and rights, and the qualifications, limitations or
restrictions thereof, which are permitted by § 151 of this title in respect of any class or
classes of stock or any series of any class of stock of the corporation and the fixing of
which by the certificate of incorporation is desired, and an express grant of such authority
as it may then be desired to grant to the board of directors to fix by resolution or

16
 resolutions any thereof that may be desired but which shall not be fixed by the certificate
of incorporation. The foregoing provisions of this paragraph shall not apply to
corporations which are not to have authority to issue capital stock. In the case of such
corporations, the fact that they are not to have authority to issue capital stock shall be
stated in the certificate of incorporation. The conditions of membership of such
corporations shall likewise be stated in the certificate of incorporation or the certificate
may provide that the conditions of membership shall be stated in the bylaws;
5. The name and mailing address of the incorporator or incorporators;
6. If the powers of the incorporator or incorporators are to terminate upon the filing of the
certificate of incorporation, the names and mailing addresses of the persons who are to
serve as directors until the first annual meeting of stockholders or until their successors
are elected and qualify.
b) In addition to the matters required to be set forth in the certificate of incorporation by
subsection (a) of this section, the certificate of incorporation may also contain any or all of
the following matters:
1. Any provision for the management of the business and for the conduct of the affairs
of the corporation, and any provision creating, defining, limiting and regulating the
powers of the corporation, the directors, and the stockholders, or any class of the
stockholders, or the members of a nonstock corporation; if such provisions are not
contrary to the laws of this State. Any provision which is required or permitted by
any section of this chapter to be stated in the bylaws may instead be stated in the
certificate of incorporation;
2. The following provisions, in haec verba, viz:
a. "Whenever a compromise or arrangement is proposed between this corporation
and its creditors or any class of them and/or between this corporation and its
stockholders or any class of them, any court of equitable jurisdiction within the
State of Delaware may, on the application in a summary way of this corporation
or of any creditor or stockholder thereof or on the application of any receiver or
receivers appointed for this corporation under § 291 of Title 8 of the Delaware
Code or on the application of trustees in dissolution or of any receiver or receivers
appointed for this corporation under § 279 of Title 8 of the Delaware Code order a
meeting of the creditors or class of creditors, and/or of the stockholders or class of
stockholders of this corporation, as the case may be, to be summoned in such
manner as the said court directs. If a majority in number representing three fourths
in value of the creditors or class of creditors, and/or of the stockholders or class of
stockholders of this corporation, as the case may be, agree to any compromise or
arrangement and to any reorganization of this corporation as consequence of such
compromise or arrangement, the said compromise or arrangement and the said
reorganization shall, if sanctioned by the court to which the said application has
been made, be binding on all the creditors or class of creditors, and/or on all the
stockholders or class of stockholders, of this corporation, as the case may be, and
also on this corporation";
3. Such provisions as may be desired granting to the holders of the stock of the corporation,
or the holders of any class or series of a class thereof, the preemptive right to subscribe to
any or all additional issues of stock of the corporation of any or all classes or series

17
 thereof, or to any securities of the corporation convertible into such stock. No stockholder
shall have any preemptive right to subscribe to an additional issue of stock or to any
security convertible into such stock unless, and except to the extent that, such right is
expressly granted to such stockholder in the certificate of incorporation. All such rights in
existence on July 3, 1967, shall remain in existence unaffected by this paragraph unless
and until changed or terminated by appropriate action which expressly provides for the
change or termination;
4. Provisions requiring for any corporate action, the vote of a larger portion of the stock or
of any class or series thereof, or of any other securities having voting power, or a larger
number of the directors, than is required by this chapter;
5. A provision limiting the duration of the corporation's existence to a specified date;
otherwise, the corporation shall have perpetual existence;
6. A provision imposing personal liability for the debts of the corporation on its
stockholders or members to a specified extent and upon specified conditions; otherwise,
the stockholders or members of a corporation shall not be personally liable for the
payment of the corporation's debts except as they may be liable by reason of their own
conduct or acts;
7. A provision eliminating or limiting the personal liability of a director to the corporation
or its stockholders for monetary damages for breach of fiduciary duty as a director,
provided that such provision shall not eliminate or limit the liability of a director:
a. (i) For any breach of the director's duty of loyalty to the corporation or its
stockholders;
b. (ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
c. (iii) under § 174 of this title; or
d. (iv) for any transaction from which the director derived an improper personal
benefit. No such provision shall eliminate or limit the liability of a director for
any act or omission occurring prior to the date when such provision becomes
effective. All references in this paragraph to a director shall also be deemed to
refer (x) to a member of the governing body of a corporation which is not
authorized to issue capital stock, and (y) to such other person or persons, if any,
who, pursuant to a provision of the certificate of incorporation in accordance with
§ 141(a) of this title, exercise or perform any of the powers or duties otherwise
conferred or imposed upon the board of directors by this title.
c) It shall not be necessary to set forth in the certificate of incorporation any of the powers
conferred on corporations by this chapter.
d) Except for provisions included pursuant to subdivisions (a)(1), (a)(2), (a)(5), (a)(6), (b)(2),
(b)(5), (b)(7) of this section, and provisions included pursuant to subdivision (a)(4) of this
section specifying the classes, number of shares, and par value of shares the corporation is
authorized to issue, any provision of the certificate of incorporation may be made
dependent upon facts ascertainable outside such instrument, provided that the manner
in which such facts shall operate upon the provision is clearly and explicitly set forth
therein. The term "facts," as used in this subsection, includes, but is not limited to, the
occurrence of any event, including a determination or action by any person or body,
including the corporation.

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****LAYS OUT ALL THE SUPPLETIVE PROVISIONS YOU CAN ADD TO
OPERATING AGREEMENT
§ 103. Execution, acknowledgment, filing, recording and effective date of original
certificate of incorporation and other instruments; exceptions – deals in detail with the
requirements of filing – who signs what etc.

§ 104. Certificate of incorporation; definition.

The term "certificate of incorporation," includes not only the original certificate of
incorporation filed to create a corporation but also all other certificates, agreements of
merger or consolidation, plans of reorganization, or other instruments, howsoever
designated, which are filed pursuant to §§ 102, 133-136, 151, 241-243, 245, 251-258, 263-
264, 303, or any other section of this title, and which have the effect of amending or
supplementing in some respect a corporation's original certificate of incorporation.

§ 105. Certificate of incorporation and other certificates; evidence.

A copy of a certificate of incorporation, or a restated certificate of incorporation, or of any
other certificate which has been filed in the office of the Secretary of State as required by
any provision of this title shall, when duly certified by the Secretary of State, be received in
all courts, public offices and official bodies as prima facie evidence of:
(1) Due execution, acknowledgment and filing of the instrument;
(2) Observance and performance of all acts and conditions necessary to have been observed
and performed precedent to the instrument becoming effective; and
(3) Any other facts required or permitted by law to be stated in the instrument.

§ 106. Commencement of corporate existence.

Upon the filing with the Secretary of State of the certificate of incorporation the
incorporators constitute a body corporate, by the name set forth in the certificate, subject to
subsection (d) of § 103 of this title and subject to dissolution or other termination of its
existence as provided in this chapter.

§ 107. Powers of incorporators.

If the persons who are to serve as directors until the first annual meeting of stockholders
have not been named in the certificate of incorporation, the incorporator or incorporators,
until the directors are elected, shall manage the affairs of the corporation and may do
whatever is necessary and proper to perfect the organization of the corporation, including the
adoption of the original bylaws of the corporation and the election of directors.

§ 108. Organization meeting of incorporators or directors named in certificate of

incorporation.
(a) After the filing of the certificate of incorporation an organization meeting shall be held, ,
at the call of a majority of the incorporators or directors, as the case may be, for the
purposes of adopting bylaws, electing to serve or hold office until the first annual
meeting of stockholders or until their successors are elected and qualify, electing
officers if the meeting is of the directors, doing any other or further acts to perfect the

19
organization of the corporation, and transacting such other business as may come before the
meeting.
(b) The persons calling must give least 2 days' written notice
(c) Any action permitted to be taken at the organization meeting of the incorporators or
directors, as the case may be, may be taken without a meeting if each incorporator or
director, where there is more than 1, or the sole incorporator or director where there is
only 1, signs an instrument which states the action so taken.

§ 109. Bylaws.
(a) The original or other bylaws of a corporation may be adopted, amended or repealed by
the incorporators, by the initial directors if they were named in the certificate of
incorporation, or, before a corporation has received any payment for any of its stock, by its
board of directors. After a corporation has received any payment for any of its stock, the
power to adopt, amend or repeal bylaws shall be in the stockholders entitled to vote, or, in
the case of a nonstock corporation, in its members entitled to vote; provided, however, any
corporation may, in its certificate of incorporation, confer the power to adopt, amend or
repeal bylaws upon the directors or, in the case of a nonstock corporation, upon its governing
body by whatever name designated. The fact that such power has been so conferred upon the
directors or governing body, as the case may be, shall not divest the stockholders or
members of the power, nor limit their power to adopt, amend or repeal bylaws.
(b) The bylaws may contain any provision, not inconsistent with law or with the
certificate of incorporation, relating to the business of the corporation, the conduct of its
affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers
or employees.

§ 151. Classes and series of stock; redemption; rights.

(a) Every corporation may issue 1 or more classes of stock or 1 or more series of stock
within any class thereof, any or all of which classes may be of stock with par value or stock
without par value and which classes or series may have such voting powers, full or
limited, or no voting powers, and such designations, preferences and relative,
participating, optional or other special rights, and qualifications, limitations or
restrictions thereof, as shall be stated and expressed in the certificate of incorporation
or of any amendment thereto, or in the resolution or resolutions providing for the issue of
such stock adopted by the board of directors pursuant to authority expressly vested in it by
the provisions of its certificate of incorporation. Any of the voting powers, designations,
preferences, rights and qualifications, limitations or restrictions of any such class or series of
stock may be made dependent upon facts ascertainable outside the certificate of
incorporation or of any amendment thereto, or outside the resolution or resolutions providing
for the issue of such stock adopted by the board of directors pursuant to authority expressly
vested in it by its certificate of incorporation, provided that the manner in which such facts
shall operate upon the voting powers, designations, preferences, rights and qualifications,
limitations or restrictions of such class or series of stock is clearly and expressly set
forth in the certificate of incorporation or in the resolution or resolutions providing for
the issue of such stock adopted by the board of directors. The term "facts," as used in this
subsection, includes, but is not limited to, the occurrence of any event, including a

20
determination or action by any person or body, including the corporation. The power to
increase or decrease or otherwise adjust the capital stock as provided in this chapter shall
apply to all or any such classes of stock.
(b) Any stock of any class or series may be made subject to redemption by the
corporation at its option or at the option of the holders of such stock or upon the
happening of a specified event; provided however, that immediately following any such
redemption the corporation shall have outstanding 1 or more shares of 1 or more classes
or series of stock, which share, or shares together, shall have full voting powers.
Notwithstanding the limitation stated in the foregoing proviso: - gives detailed certain
kinds
(c) The holders of preferred or special stock of any class or of any series thereof
shall be entitled to receive dividends at such rates, on such conditions and at such
times as shall be stated in the certificate of incorporation or in the resolution or
resolutions providing for the issue of such stock adopted by the board of directors as
hereinabove provided, payable in preference to, or in such relation to, the dividends
payable on any other class or classes or of any other series of stock, and cumulative or
noncumulative as shall be so stated and expressed. When dividends upon the preferred
and special stocks, if any, to the extent of the preference to which such stocks are
entitled, shall have been paid or declared and set apart for payment, a dividend on the
remaining class or classes or series of stock may then be paid out of the remaining assets
of the corporation available for dividends as elsewhere in this chapter provided.
(d) The holders of the preferred or special stock of any class or of any series thereof
shall be entitled to such rights upon the dissolution of, or upon any distribution of the
assets of, the corporation as shall be stated in the certificate of incorporation or in the
resolution or resolutions providing for the issue of such stock adopted by the board of
directors as hereinabove provided.
(e) Any stock of any class or of any series thereof may be made convertible into, or
exchangeable for, at the option of either the holder or the corporation or upon the
happening of a specified event, shares of any other class or classes or any other series of
the same or any other class or classes of stock of the corporation, at such price or prices
or at such rate or rates of exchange and with such adjustments as shall be stated in the
certificate of incorporation or in the resolution or resolutions providing for the issue of
such stock adopted by the board of directors as hereinabove provided.
(f) If any corporation shall be authorized to issue more than 1 class of stock or more than
1 must …be stated on the face or back of the certificate which the corporation shall issue
to represent such class or series of stock, …Except as otherwise expressly provided by
law, the rights and obligations of the holders of uncertificated stock and the rights and
obligations of the holders of certificates representing stock of the same class and series
shall be identical.
(g) different rules if – issuing stock be resolution

§ 152. Issuance of stock; lawful consideration; fully paid stock.

The consideration, as determined pursuant to subsections (a) and (b) of § 153 of this title, for
subscriptions to, or the purchase of, the capital stock to be issued by a corporation shall be
paid in such form and in such manner as the board of directors shall determine. The

21
board of directors may authorize capital stock to be issued for consideration consisting of
cash, any tangible or intangible property or any benefit to the corporation, or any
combination thereof. In the absence of actual fraud in the transaction, the judgment of the
directors as to the value of such consideration shall be conclusive. The capital stock so
issued shall be deemed to be fully paid and nonassessable stock upon receipt by the
corporation of such consideration; provided, however, nothing contained herein shall prevent
the board of directors from issuing partly paid shares under § 156 of this title.

§ 153. Consideration for stock. – is determined by the board

Subchapter II. Powers

§ 121. General powers.
(a) In addition to the powers enumerated in § 122 of this title, every corporation, its officers,
directors and stockholders shall possess and may exercise all the powers and privileges
granted by this chapter or by any other law or by its certificate of incorporation, together
with any powers incidental thereto, so far as such powers and privileges are necessary or
convenient to the conduct, promotion or attainment of the business or purposes set forth in
its certificate of incorporation.
(b) Every corporation shall be governed by the provisions and be subject to the restrictions
and liabilities contained in this chapter.

§ 122. Specific powers.

Every corporation created under this chapter shall have power to:
(1) Have perpetual succession by its corporate name, unless a limited period of duration is
stated in its certificate of incorporation;
(2) Sue and be sued in all courts and participate, as a party or otherwise, in any judicial,
administrative, arbitrative or other proceeding, in its corporate name;
(3) Have a corporate seal, which may be altered at pleasure, and use the same by causing it
or a facsimile thereof, to be impressed or affixed or in any other manner reproduced;
(4) Purchase, receive, take by grant, gift, devise, bequest or otherwise, lease, or otherwise
acquire, own, hold, improve, employ, use and otherwise deal in and with real or personal
property, or any interest therein, wherever situated, and to sell, convey, lease, exchange,
transfer or otherwise dispose of, or mortgage or pledge, all or any of its property and assets,
or any interest therein, wherever situated;
(5) Appoint such officers and agents as the business of the corporation requires and to pay
or otherwise provide for them suitable compensation;
(6) Adopt, amend and repeal bylaws;
(7) Wind up and dissolve itself in the manner provided in this chapter;
(8) Conduct its business, carry on its operations and have offices and exercise its powers
within or without this State;
(9) Make donations for the public welfare or for charitable, scientific or educational
purposes, and in time of war or other national emergency in aid thereof;
(10) Be an incorporator, promoter or manager of other corporations of any type or kind;
(11) Participate with others in any corporation, partnership, limited partnership, joint
venture or other association of any kind, or in any transaction, undertaking or arrangement

22
which the participating corporation would have power to conduct by itself, whether or not
such participation involves sharing or delegation of control with or to others;
(12) Transact any lawful business which the corporation's board of directors shall find to
be in aid of governmental authority;
(13) Make contracts, including contracts of guaranty and suretyship, incur liabilities,
borrow money at such rates of interest as the corporation may determine, issue its notes,
bonds and other obligations, and secure any of its obligations by mortgage, pledge or other
encumbrance of all or any of its property, franchises and income, and make contracts of
guaranty and suretyship which are necessary or convenient to the conduct, promotion or
attainment of the business of (a) a corporation all of the outstanding stock of which is
owned, directly or indirectly, by the contracting corporation, or (b) a corporation which
owns, directly or indirectly, all of the outstanding stock of the contracting corporation, or (c)
a corporation all of the outstanding stock of which is owned, directly or indirectly, by a
corporation which owns, … and make other contracts of guaranty and suretyship which are
necessary or convenient to the conduct, promotion or attainment of the business of the
contracting corporation;
(14) Lend money for its corporate purposes, invest and reinvest its funds, and take, hold
and deal with real and personal property as security for the payment of funds so loaned or
invested;
(15) Pay pensions and establish and carry out pension, profit sharing, stock option, stock
purchase, stock bonus, retirement, benefit, incentive and compensation plans, trusts and
provisions for any or all of its directors, officers and employees, and for any or all of the
directors, officers and employees of its subsidiaries;
(16) Provide insurance for its benefit on the life of any of its directors, officers or
employees, or on the life of any stockholder for the purpose of acquiring at such
stockholder's death shares of its stock owned by such stockholder.
(17) Renounce, in its certificate of incorporation or by action of its board of directors, any
interest or expectancy of the corporation in, or in being offered an opportunity to participate
in, specified business opportunities or specified classes or categories of business
opportunities that are presented to the corporation or 1 or more of its officers, directors or
stockholders.

Roman Catholic Archbishop of San Francisco v. Sheffield: Sheffield pays the monastery for a
dog. He was supposed to pay in installments, and after two installments, he received no dog. The
monastery said that it would not send the dog, that Mr. Sheffield would have to pay more
handling fees, all of the installments would have to be paid before delivery, and that Mr.
Sheffield could not get his money back. Mr. Sheffield sued the Roman Catholic Church—the
Archbishop of San Francisco, the Pope, the Vatican, the Canon Regular of St. Augustine (the
order that sells the dogs), and Father Cretton. The court threw out the case.

Walking thru each entity, what do you have to show to hold each one liable?
- The priest: The priest was the bad actor.
- The order: You would have to show that, because the order owns the place, the priest is an
agent of the order. The order is the principal.

23
- The Vatican: If you can show that the Vatican was involved, then you can hold them directly
liable.
o If the order is the Pope’s dog-selling order (appointed by the Pope), then the Vatican
can be the principal, and the order the agent.
o You could also pierce the veil to show that the religious order had such a unity of
interest, which you have to hold the parent liable.
 You would have to show that the Vatican didn’t respect formalities of the
different entities; commingling of assets; etc.
- The Pope: The Pope is in a good situation, as he is an individual who is the head of the
company. He would be like the CEO. He is one further step removed from the company; he
is merely an officer of the parent. Officers are usually not personally liable for the
corporation.

Corporation Notes:
 When one corporation owns all of the stock in another corporation – owner is the
“parent” corporation and other is “subsidiary”
 Reasons to form this way:
o Another layer of liability protection
o Not liable for debts so can take on riskier ventures
o Parent must not become directly liable by virtue of its participation in the
activities of the subsidiary

In re Silicone Gel Breast Implants Products Liability Litigation (1995) – SUBSIDIARY ISSUE
 Bristol Meyers as the sole shareholder of Medical Engineering Corporation not entitled to
Summary Judgment
 Must determine if Corporate Control – is such that they are alter ego
o As parent corporation – a certain amount of control is expected
o Only warrants piercing if acting as an alter ego
TEST:
 Many Factors in determining if alter ego – and based on the totality of the
circumstances:
o The Parent and subsidiary…
 Common directors or officers
 Common business departments
 File consolidated financial statements and tax returns – Drury says
irrelevant!!!
o The Parent…
 Finances the subsidiary
 Caused the incorporation of the subsidiary
 Pays the salaries and expenses of the subsidiary
 Uses the subsidiary’s property as its own
o The Subsidiary…
 Operates with grossly inadequate capital
 Receives no business except that given to it by parent
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  Does not observe the basic corporate formalities
o Daily operations are not kept separate
 A showing of fraud or like misconduct has not been required in Delaware courts

Plaintiff’s theories from the case: Plaintiff’s theories:

- Piercing the corporate veil: The court tried to find evidence of substantial domination, which
is really the unity of interest test. The court looked at a series of factors (totality of
circumstances, page 226) which would evidence substantial domination.
o The court found that the majority of the circumstances had been met by BM.
o BM really wanted the public to think that the breast implants were BM’s product.
- Injustice aspect: The courts weighed the difference between a contract and a tort.
o If you signed a contract with MEC, why should you be able to get money with BM?
o For torts, the bar is lowered as to how egregious the injustice has to be. You didn’t
choose to work with MEC, you just got the implants.
o Parties to contract willingly get involved, so there is a higher standard.
- Direct liability: You could use a negligent undertaking approach.
o BM didn’t just advertise, they also tested and researched the product. When you go
out and advertise/test, you have to realize that a third party is relying on your actions.
o Court: BM didn’t negligently advertise, so you can only get them on the inspection.
- What theory does fit isn’t discussed. Fraud or apparent authority.
o If BM is doing things to make patients believe that BM has signed off on this, then
you may have an agency claim.
o MEC was BM’s agent. They were acting under apparent authority.

NOTE on Limited Partnerships:

 New business form allowed for – use as tax shelters
 Forming a limited partnership with a corporation as sole general partner – leaves no
individual liable for debts of the partnership – However limited liability will not attach if
clients do not respect the form to make it effective
 Structure of Limited Partnership?
o General partners
 Unlimited liability
 Responsible for control and mgt.
o Limited partners
 Limited liability
 In order to maintain limited status – must not participate in the active control
and mgt of the partnership

Frigidaire Sales Corporation v. Union Properties, Inc. (1977)

 Limited partners do not incur general liability for the limited partnerships obligation simply
b/c they are officers, directors, or shareholders of the corporate general partner
 Two limited partners have formed a corporation and act as officers, directors and
shareholders of Union Properties – that formed Commercial Investors, Commercial Investors
is a corporation that is a partnership in which defendants are limited partners
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 No allegation of improper behavior in setting up the limited partnership in this way
 Respondents scrupulously separated their actions as so not to involve the two – and the
petitioners knew in what capacity Baxter and Mannon were acting
 DRURY says: this case shows that if you respect formalities the court will uphold the
corporate form – did not pierce veil

Veil Piercing NOTES:

- If you, as a shareholder, expect the corporate formalities, existence—no commingling…then
it is likely that a court will respect the separate corporate identity.
- If you don’t respect the formalities, the court may impose personal liability on the
shareholders. Once that’s a possibility, all of the courts will look for:
o Unity of interest
 Undercapitalization
 Lack of formality
 Commingling
o Injustice. They will all look for injustice, or an additional problem; some more than
others.
- Veil piercing is not the only way to get at other people outside of the corporate entity.
o Direct liability: BM case
o Defrauding
o Background principles of agency law
o Enterprise
- All of these are exceptions to the rule, which is that shareholders are NOT personally liable
to the share of the debts. In the rare instances where the rule is not enforced, the above
exceptions may apply.

THE DUTIES OF OFFICERS, DIRECTORS, AND OTHER INSIDERS …………………...

The Obligations Of Control: Duty Of Care

§ 141. Board of directors; powers; number, qualifications, terms and quorum; committees;
classes of directors; nonprofit corporations; reliance upon books; action without meeting;
removal.
a) Every corporation shall be managed by or under the direction of a board of directors,
except as may be otherwise provided in this chapter or in its certificate of incorporation.
b) The board of directors of a corporation shall consist of 1 or more members, each of
whom shall be a natural person. The number of directors shall be fixed by, or in the
manner provided in, the bylaws, unless the certificate of incorporation fixes the number
of directors, in which case a change in the number of directors shall be made only by
amendment of the certificate. Directors need not be stockholders unless so required by
the certificate of incorporation or the bylaws. The certificate of incorporation or bylaws
may prescribe other qualifications for directors. Each director shall hold office until such
director's successor is elected and qualified or until such director's earlier resignation or
removal. Any director may resign at any time upon notice given in writing or by
electronic transmission to the corporation. A majority of the total number of directors

26
 shall constitute a quorum for the transaction of business unless the certificate of
incorporation or the bylaws require a greater number…
c) All corporations incorporated prior to July 1, 1996
d) The directors of any corporation organized under this chapter may, by the certificate of
incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders,
be divided into 1, 2 or 3 classes; the term of office of those of the first class to expire at
the annual meeting next ensuing; of the second class 1 year thereafter; of the third class 2
years thereafter; and at each annual election held after such classification and election,
directors shall be chosen for a full term, as the case may be, to succeed those whose
terms expire. The certificate of incorporation may confer upon holders of any class or
series of stock the right to elect 1 or more directors who shall serve for such term, and
have such voting powers as shall be stated in the certificate of incorporation…
e) A member of the board of directors, or a member of any committee designated by the
board of directors, shall, in the performance of such member's duties, be fully protected
in relying in good faith upon the records of the corporation and upon such information,
opinions, reports or statements presented to the corporation by any of the corporation's
officers or employees, or committees of the board of directors, or by any other person as
to matters the member reasonably believes are within such other person's professional or
expert competence and who has been selected with reasonable care by or on behalf of the
corporation.
f) Don’t need to meet, consent thereto in writing to act
g) Unless otherwise restricted by the certificate of incorporation or bylaws, the board of
directors may hold its meetings, and have an office or offices, outside of this State.
h) Unless otherwise restricted by the certificate of incorporation or bylaws, the board of
directors shall have the authority to fix the compensation of directors.
i) special rules if corp. doesn’t issue stock
j) Any director or the entire board of directors may be removed, with or without cause, by
the holders of a majority of the shares then entitled to vote at an election of directors,
except as follows:
1. Unless the certificate of incorporation otherwise provides, in the case of a
corporation whose board is classified as provided in subsection (d) of this section,
shareholders may effect such removal only for cause; or
2. In the case of a corporation having cumulative voting, if less than the entire board is
to be removed, no director may be removed without cause if the votes cast against
such director's removal would be sufficient to elect such director if then cumulatively
voted at an election of the entire board of directors, or, if there be classes of directors,
at an election of the class of directors of which such director is a part.
Whenever the holders of any class or series are entitled to elect 1 or more directors by
the certificate of incorporation, this subsection shall apply, in respect to the removal
without cause of a director or directors so elected, to the vote of the holders of the
outstanding shares of that class or series and not to the vote of the outstanding shares as
a whole.

§ 142. Officers; titles, duties, selection, term; failure to elect; vacancies.

27
a) Every corporation organized under this chapter shall have such officers with such titles
and duties as shall be stated in the bylaws or in a resolution of the board of directors
which is not inconsistent with the bylaws and as may be necessary to enable it to sign
instruments and stock certificates which comply with §§ 103(a)(2) and 158 of this title.
One has the duty to record the proceedings of the meetings of the stockholders and
directors in a book to be kept for that purpose. Any number of offices may be held by the
same person unless the certificate of incorporation or bylaws otherwise provide.
b) Officers shall be chosen in such manner and shall hold their offices for such terms as are
prescribed by the bylaws or determined by the board of directors or other governing
body. Each officer shall hold office until such officer's successor is elected and qualified
or until such officer's earlier resignation or removal. Any officer may resign at any time
upon written notice to the corporation.
c) The corporation may secure the fidelity of any or all of its officers or agents by bond or
otherwise.
d) A failure to elect officers shall not dissolve or otherwise affect the corporation.
e) Any vacancy occurring in any office of the corporation by death, resignation, removal or
otherwise, shall be filled as the bylaws provide. In the absence of such provision, the
vacancy shall be filled by the board of directors or other governing body.

Kamin v. American Express Company – Business Judgment Rule

 Amex bought DLJ (a public securities firm) shares at $30M. It is now worth $4M. Amex
could either declare dividends and give them to shareholders, OR sell the stock and divvy out
the cash. Amex will end up with the same amount of cash, but their financial statements will
show that they make less money. Amex distributed the money to stockholders, showing that
Amex made more money. The stockholders were upset about this because, making more
money on the books means writing a bigger check to the IRS (lost $8M). Amex’s reasoning
was that, if they declared that they made more money, then the stock value would either be
maintained or it would increase. (“If we tell everyone we made more money, the stock value
will be worth more.”)
o The loss is still strictly on paper – not in actual cash loss
 Ct unwilling to step in to tell the board how to run the company in absence of fraud, bad
faith, oppression, arbitrary action, or breach of trust – Followed the Business Judgment Rule
 Action of the board was w/in their power and this matter was specifically addressed in a
special board meeting – in which the bd voted to act as they did here
 No Conflict of interest here (to warrant a higher std) - If a minority of the bd has some part of
their compensation tied to the performance of the company – its not enough to be a conflict
of interest – as to warrant the ct interference in affairs and contrary to the Business Judgment
Rule
 How can you show that there wasn’t a serious conflict here?
o There was a good faith element.
o The board showed, by affidavits and other evidence that they reviewed the plaintiff’s
complaints before the decision was made, and that they still felt that their (the
board’s) decision was best.

Standards for when the court will interfere with directors’ boards/Business Judgment Rule:
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 Decision
 Free of conflict among board members (that would affect their loyalty to the company)
 Good faith
 Informed basis
 Deferred interest

NOTES - A Little Background Info:

What is a Merger? What is a Leverage Buyout (LBO)?
 Mergers are transactions that are specifically authorized by state law
o Ex. In Delaware – there are certain conditions laid out:
 Three step process:
1. board adopts a plan for merger
2. shareholders approve it
3. after both approve the two companies file the document affecting
the merger
o once filed it becomes effective
o Default Rule – need 2/3 majority vote of shareholders to get merger
 Other terms could be agreed to in charters
o Consequences of filing:
 One Corp. is “the surviving corp.” and one is the “disappearing corp.” –
upon filing:
 the disappearing corp. no longer exists
 the surviving corp. takes over all assets of both corp.’s
 the surviving corp. becomes liable for all debts of disappearing
corp.
 ex. Hibernia and Capital One – Capital One became Hibernia

Leverage Buyout – refers to merger but specifically refers to the way you pay for it
 particularly by having leverage – a large sum of money
 you borrow large sum of money from bank or other lender to outright cash payout on the
corporation you plan to buy
 and over a span of 10 years you pay bank the lending institution – while theoretically
turning huge profits in your newly formed company
 risky – if don’t get paid in running company – you owe lender all the money you
borrowed
 lenders make up the chance and risk they take by setting the interest rate higher and
higher to compensate for the risk they take
 Though the payoff – if works – repays your loan and are debt free in a few years
 Note: if the corporation goes bankrupt – bank loses – not a basis for piercing the
corporate veil

Smith v. Van Gorkom RATIFICATION BY STOCKHOLDERS CLEARS ERROR

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Trans Union was making 100s of millions of dollars, but couldn’t get any tax breaks. Van
Gorkom (VG), who was the CEO of Trans Union decided that a buy-out could solve this
problem.
 Tax breaks: your company can get tax credits based on certain premises. For example, if
a movie company comes to Louisiana, then Louisiana will release them of certain tax
rates.
o You can sell your tax credits. So, instead of letting the tax benefits sit there and
waste, you can sell them to other companies. However, some federal tax credits
are non-transferable.
o Trans Union needs to find a company with a large amount of tax liability can buy
Trans Union and use their tax credits toward Trans Union.
 Gorkam decided that $55 a share would be the appropriate amount to sell the company
for.
o They came up with this number by figuring out how difficult it would be to pay
back the debt of buying the company.
o They didn’t look at how prosperous Trans Union was, how likely it was to grow,
etc.
o They just wanted a range that would make buyers interested.
 Did the directors act in accordance with the business judgment rule? No.
o The BJR presumes that directors act on an informed basis, in good faith, and in
an honest belief that their actions are for the good of the company.
 The board was poorly informed. There is no fraud or bad faith. All
reasonably material information available must be looked at prior to a
decision. This is a duty of care. And the directors are liable if they were
grossly negligent in failing to inform themselves.
 The directors were grossly negligent in the way they acted in the
first board meeting that approved the merger. While an outside
opinion is not always necessary, there was not even a single
opinion given by inside management. The Van Gorkham opinion
could have been relied on had it been based on sound factors; it
was not and the board members did not check it.
 Essentially the court transferred the liability to the board – to act in the best
interest of the corp.
Legal Issues:
 The court determined that the board did make a decision – can’t argue arbitrarity, or
conflict of interest, no evidence of bad faith – only remaining element: Were they acting
on an informed basis? – the courts analysis centers around this issue
 Simple negligence is not enough re: the Business Judgment Rule – must be Gross
Negligence in order to not be protected
 The court held the Board Members personally liable
 Had there been a report – to the board –Gorkom would be liable – and not the
board
 Del RS – giving board the power to control the corp. – stating then they
can rely on reports given by officers of corp.

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  Gave an oral presentation – not report
 Board cannot rely on what he told them
 Under the Business Judgment Rule, there is no protection for directors who have made an
unintelligent or unadvised judgment.
 It was held that the directors of Trans Union breached their fiduciary duty to their
stockholders (1) by their failure to inform themselves of all information reasonably
available to them and relevant to their decision to recommend the Pritzker merger; and
(2) by their failure to disclose all material information such as a reasonable stockholder
would consider important in deciding whether to approve the Pritzker offer.

Aftermath of Van Gorkham

State legislatures started to react. They were concerned about not understanding what the case
meant. This was a strictly a procedural case. How did the board go about informing itself?
However, at the time, the worry was about directors’ liability.
 States passed statutes that allowed corporations to amend its articles of incorporation to
protect directors from liability. In general, you can exempt directors from personal
liability from breach of duty of care.
 Even if the members are rich and lazy, if they meet 6 or 8 times a year, every
meeting will be worth 100s of millions of dollars. It isn’t fair that they can lose
everything over one bad decision.
 The state is not requiring this. It is up to the corporation.

How these cases work (standards): The court will not look into the substance of what the court
has done. The court asks if the board made a business decision. Was there a conflict of interest?
 If there was a decision, and there was no conflict, then were the board members acting in
good faith? On an informed basis (big issue on Van Gorkham case above)? Did they
reasonably believe that what they were doing was in the best interest of the company
(Ford case)?
 If you satisfy all of the above requirements, then the court refrains from looking at
the substance of the transaction. It will defer to whichever decision the board
made.

NOTES ON PROXIES:
 Shareholders primary mechanism for participating in corporation is by voting
o If you want to, you can show up and vote in the meeting
 Corporation sends you info – telling you what they plan to vote on at the meeting
o You can allow CEO or other officer to vote on your behalf or you can return the
proxy materials – indicating what you would like them to do (“yes” to this
merger and “no” to buy out etc.)

Note Case: Cinerama v. Technicolor, Inc.

If Court rejects the Business Judgment rule the ct applies the “entire fairness test” which is based
on 2 tests - the “fair price” and “fair dealing test”
- Entire Fairness to Shareholders TEST:
 Was it a fair price – by whose standards?
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  Was it fair dealing – who benefited? Under whose direction etc.?

Brehm v. Eisner: Ovitz was a very successful agent with lots of opportunities. Michael Eisner,
the CEO of Disney, made Disney very successful, and then fought and kicked out all of his
competition (he was having trouble retaining successors). Eisner enticed Ovitz to come to Disney
by offering a salary of $1M, a bonus, and stock options.
- Ways for Ovitz to be terminated:
o The contract runs out, but Disney decides against offering a new contract ($10M
severance).
o He quits, or Disney fires him for good cause, he gets no money.
o If he is terminated for no good cause:
 $10M severance, 7.5M x the number of years left in the contract, and the A
stock options.
o He used this contract to protect himself from Michael Eisner.

Did the Old Board hire Ovitz on an informed basis?

o No.
o The expert said, in retrospect, that they should have acted differently in making the
decision. Hindsight is not enough to find a breach in the duty of care.
- Even when the Board makes sloppy judgments, it can still have the benefit of the business
judgment rule, so long as it follows the correct procedure.
- 1996: New Board Issues: The plaintiffs didn’t show that they had cause to fire Ovitz, and
decided not to use it.
o The Board could have made a business decision to support firing Ovitz (litigation
fees, bad publicity, etc.)
o What really happened was that Eisner and Ovitz worked out the termination
agreement without consulting the board.
 If you ignore a duty to act, then courts will step in and find you in breach of
duty of care?
 The court did not find that the New Board breached a duty of care.
- The court found that, while the board didn’t make the best decisions, it didn’t breach its
fiduciary duties.

Good faith reliance: in good faith reliance – then their actions are protected under the business
judgment rule
o If board breached fiduciary duty it results in personal liability of the directors for lack of
due care in the decision making process and for waste of corporate assets
o Board members must avail themselves of material facts
o The court says that the large amount of money – is material
o Unaware – is not an excuse – the info was reasonably available and material

Were they in bad faith?

- To show bad faith:
o Intentional dereliction of their duties in the face of a duty to act

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 o Acting without adequate information
- There is a rebuttable presumption that the directors properly exercised business judgment and
good faith relied on expert

In order to survive Rule 23.1 motion to dismiss, plaintiff must allege particularized facts that if
proven show:
- Directors did not in fact rely on expert
- Reliance was not in good faith
- Did not reasonably believe experts advice was w/in experts professional competence
- Expert not selected with reasonable care – fault attributable to the directors
- Subject matter not provided was so obvious that it was grossly negligent not to notice by bd.
- Decision by board was so unconscionable as to constitute waste or fraud
Nothing to this effect was found – thus dismissal was warranted
- Size and structure of executive compensation are inherently matters of judgment
- The point it was a business decision to act in this way, albeit a bad one – no liability as a
result.

After Disney: Statutes were created to allow corporations to eliminate directors’ personally
liability except for…[named 4 categories]. Disney now has a charter provision that does not hold
directors liable for breach of fiduciary duties. Therefore, if you find that the board didn’t act on
an informed basis won’t get you any money. However, if you can find that the board acted in
conflict, or in bad faith, then the directors may be held personally liable.

Francis v. United Jersey Bank

 Widow inherits company as director– sons run it and steals funds the corp. was supposed to
be holding in trust for its clients
 Court found she was competent to act and she never made any attempt to discharge her duties
as a director
 Her liability requires finding:
 DUTY - had a duty to the clients of corp., that she breached that duty
and their harm was proximately caused by her breach = PERSONAL
LIABILITY
 WHAT STANDARD? - Required to act as an ordinarily prudent person
would in the circumstances
o Reasonable care std dependant on – the type of corporation, its size
and financial resources (ex. bank director higher std than normal
business owner)
 General rule: director should acquire at least a general understanding of the
business - directors cannot set up a defense of lack of knowledge needed to exercise
due care
 It was a breach of fiduciary duty – she needed only to read the financial
statements to discover the breach
o Still only liable if she caused harm :
 Yes she did – did not resign until shortly before bankruptcy

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Only allowed to claim business judgment rule if you make a decision – here the director simply
existed – did not act – no “business judgment” to protect

Substantive issues:
- Mrs. P should have known by looking at the financial statements that the sons were
commingling funds.
- Had she raised an objection to the commingling of the funds at a board meeting, the sons
could have voted her off.
o You don’t have to show that her speaking up would have stopped it. You just have to
show that she took some affirmative action to stop the stealing.
- The court didn’t expect her to step in and take control of the company, or learn business right
after her husband died. However, the court did say that if you accept election as a director,
the law will impose minimal standards.
o You have to read financial statements.
o You have to have meetings.
o She had to just at least try to stop the problem.
- How close do you have to be to insolvency when you have to care about creditors? Are you
breaching your duty by thinking about creditors?
o (When u aren’t insolvent – should you try to salvage what you have and mitigate loss,
or should you reinvest and keep trying to keep the company afloat?) Usually if you
still have balance sheet – there’s no fiduciary duty problems with trying to recover for
shareholders.
- There is a risk/reward scale – shareholders are at one end and creditors are on the other.
o Shareholders: greater risk, greater gains. When you buy stock in a company there is
no guarantee that you’ll get that money back.
o Creditors: You have legally enforceable contract with creditors for money. If u don’t
pay them the can sue you. Os they have to a lower risk than shareholders. They also
get the benefit of a much lower reward. If creditors want protection they have to
negotiate for those.
 Can only receive what they originally K’ed to receive – not able to receive
damage payments as a result of insolvency
 The basis: these creditors enter into detailed contracts to make these deals and
must take on the risk themselves to K with clauses for each type of situation,
failure to do so is the burden of the creditor
 The Corporation must recognize - that they owe duties to others other than
shareholders

Notes on Derivative suits:

 Def. Derivative suit – way for shareholders to sue on behalf of the corporation
o Typical suit – is when officers and directors are involved in some type of fraud –
against the corporation
o Corporation brings suit against these officers
o Still does not prevent the board or directors from controlling the Corp., - so
shareholders make demand to bd to file suit on behalf of corp.

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 o If Board is involved in wrongdoing – make “demand futility” still make demand but
recognize futility – then bring suit
 Derivative claim is brought by company – thus the plaintiffs represent all possible
shareholders – even those absent - this suit will cut off any further claims by any other
shareholders in the action

In re: Caremark – Not suing the board – suing the directors!

Caremark is health care organization that is forbidden from remunerating doctors for referrals.
However, they do hire consultants and research doctors to better the company. They probably
hire doctors who refer patients to Caremark to also do research and consult for the company.
This puts them in the gray area of the law.
- Caremark is aware that they are walking a line.
o They could have made a policy to refuse to pay any doctors who refer patients to
them.
o They should have distinguished between referrals and paid research and consulting.
Issue
 Did directors breach their duty by failing to adequately supervise?
 Parties proposing the settlement have burden of proving:
o It was a board decision – how are bds decisions reviewed?
 if ill advised (negligent) and failure to act when action would have
prevented the loss
 Settlement (the corporation was indicted for mail fraud and settled for $250M to
extinguish liability; suit by shareholders resulted) was fair and reasonable:
o In order to show breach of due care?
o Directors knew, should have known, took no steps, failure proximately resulted
 Knowing violation of statute – no evidence – that directors knew about the violations
 Failure to Monitor – test is “sustained failure to exercise the oversight function” not
simply one oversight
o If arrangements are made – to protect against these type of situations, presumed in
good faith- then courts will not interfere
o However, if bd’s fail to act at all, those protections are not going to be afforded to
the bd

How does the court introduce and apply the BJR here?
- If you do not correctly monitor risk, the court will not respect the BJR.
- So, when do you know when to monitor things? What has to happen for a board not to live
up to this duty?
- This isn’t a situation where Caremark was ignoring things.
o This was evidence that they should have been aware of compliance programs. There
was readily available information about compliance programs. This is proof that the
corporation was aware of the need for monitoring.
- Once you have recognized that you need to monitor important decisions, and you decide on a
process, the court will respect the BJR.

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 o The court won’t look at the detail. If you know it’s important and you have a structure
that provides you with the information you need and follows the law, then you’re
okay.
o If you make a rational decision of good process on how to set up compliance, the court
will defer to you.
- The court held that it was an appropriate settlement. To win, the plaintiffs would have had to
prove that Caremark failed to monitor. Caremark monitored, but their decision and process
wasn’t perfect. Imperfection is not necessarily breach of a duty of care.

Duty of loyalty……………………………………………………………………………..

§ 144. Interested directors; quorum

a) Contracts are not void just b/c one director has some tie to another corporation your
doing business with if:
1) The material facts as to the director's or officer's relationship or interest are
disclosed or are known to the board of directors or the committee, and the board
good faith authorizes the contract or transaction by the affirmative votes of a
majority of the disinterested directors; or
2) The material facts are disclosed or are known to the shareholders entitled to vote
thereon, and the contract or transaction is specifically approved in good faith by
vote of the shareholders; or
3) The contract or transaction is fair as to the corporation as of the time it is
authorized, approved or ratified, by the board of directors, a committee or the
shareholders.

Business Judgment Rule:

 Hindsight is 20/20 – it may have been best plan at the time
 Board is supposed to be experts in their field – more so then judges
 We want boards to take risks – if they don’t then we stay at status quo – no great payoff
without great risk --- if no business judgment rule – bd’s would be personally liable for
any failure

DUTY OF LOYALTY OF……..

A. DIRECTORS AND MANAGERS……………………………………………………………
- What constitutes conflict? What are the legal standards for determining whether this conflict
affected the company.
o If a conflict exists, the courts will no longer give blind deference to the board.
 It will look deeper to see if the board of directors breached their conflict of
duty.
- If you fail to follow the steps – then you have the burden of proving you operated in a fair
and loyal way, w/o conflict

Bayer v. Beran: 1944

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 Business Judgment Rule – protection device – only in most unusual and extraordinary cases
that directors are held liable for negligence in the absence of fraud, improper motive and
personal interest
 BUT – SPECIAL EXCEPTION FOR DIVIDED LOYALTY - loyalty or conflict of interest
should not be a question in making business decisions re: fiduciary duties
 When directors deal with Corporations in which they are a member – where any of their
contracts or engagements with the corporation are challenged the burden is on the director
not only to prove the good faith of the transaction but also to show its inherent fairness
from the viewpoint of the corporation and those interested therein
 Conflict accused:
o The allegations state – that the directors were motivated by a non-corporate purpose
in causing radio program – president’s wife
 Though advertising – as all matters for the business judgment rule – would not be any
issue if wife was not involved - due to conflict – held to the fiduciary duty analysis
 No breach of fiduciary duty on part of directors
o Served legitimate purpose and the company received full benefit

Lewis v. S.L. & E., Inc.:

 The ISSUE: entered into stockholders agreement – under which each child not a
shareholder of LGT was required it sell their SLE stocks for book value – present day -
only willing to buy for book value – artificially low
o Far below mkt value
 Directors of both companies had ignored SLE’s separate existence
 Donald refused to sell his shares and commenced this shareholders derivative action
Defendants breached fiduciary duty by wasting the assets of SLE by grossly undercharging
LGT
 Directors of SLE were also officers, directors and shareholders of LGT – burden on
defendants to show actions were fair and reasonable – CT used a duty of loyalty analysis
 Business judgment rule presumes no conflict - here there is conflict of interest so defendant
must show actions were fair and reasonable – failed
*one corp. cannot exist solely to the benefit of another

Valuation Methods for valuing companies, ie stocks :

 Book Value – the amount on the balance sheet – what you bought it for – minus depreciation
o Source of Enron problems – showed money but didn’t show the losses
 Market Value – the amount that someone in the marketplace would be willing to pay for –
limited to those that would be interested, not necessary accurate value – just what someone is
willing to pay a willing seller
o If there are more people vying for the company, then the price of each share will go
up.
 Inherent Value – in generating revenue – this value is the amount the company is worth –
that in purchasing it you are still going to get returns – the life long value/worth of the
company (getting money in the future is less valuable then getting money today
o The time value of money is a major factor
37
 o The more likely that the money will continue to come in, the more the company is
worth
 (ex) A well-established – tested company – worth more than a start up
company
o The two factors – projecting how much they’ll make and projecting how much risk is
involved (risk that you won’t get paid as a creditor)
 Asset Value – what the pieces of the company are worth – the parts
o Risks for companies – some are worth more in pieces then as a whole = hostile
takeovers
 Capitalized earnings—try to figure out how much the company is worth by using balance
sheets
o Van Gorkham used this method
 Add up assets, add up liability and subtract the two from each other to get the
shareholder equity.
 Discounted cash flow method: Look into the future and try to figure out how much the
company will be worth. How much is the ongoing enterprise really worth? And then ask
yourself how much you would pay for that today?
o Opportunity costs? Waiting? Time value of money?
o Risks involved? How likely you are to get the projected dollar figure amount?

DUTY OF LOYALTY RE:

B. CORPORATE OPPORTUNITIES…………………………………………………………….
Broz v. Cellular Info Systems, Inc.: There was a chance to buy a cellular license from Mackinac
—Michigan 2. Broz found out in his personal capacity that the license was for sale. He was
interested in buying it (as president of RFBC). He consulted other members of the board at CIS.
CIS was not even in the running for the license; they were not interested in buying it.
 Corporate Opportunity Doctrine – implicated only when fiduciary’s seizure of an
opportunity results in conflict between duties to corp. and self-interest of the director
- If you disclose all of the information to the board, and the board allows the action, then a
shareholder cannot later challenge the transaction.
o Safeguard: Present the opportunity to the board before personally taking the
opportunity.
 Broz acted in CIS best interest at all times
 Broz only sought to compete with outside entity – Pricell
 Broz was under no duty - thus No Breach

DUTY OF LOYALTY RE:

C. DOMINANT SHAREHOLDERS………………………………………………………………
 Controlling shareholders are considered to owe fiduciary duties – like a board member to
minority shareholders
 They essentially have all the votes to select directors and bd members - control the corp.
with their huge number of votes

38
In re eBay, Inc. Shareholders Litigation: What is spinning? It is a practice that involves
allocating shares of lucrative initial public offerings of stock to favored clients. Goldman Sachs,
a company which took eBay public, rewarded eBay by allowing the officers and directors of
eBay to participate in other company’s public offerings. When you have $5M at the end of the
day, it starts to look like Goldman Sachs is bribing companies to invest with their bank.
- eBay’s second problem with spinning: eBay doesn’t understand why the directors get so
much money, but not eBay personally (or as an entity).
o What is eBay’s claim to the money? The directors have a fiduciary duty of loyalty.
Accepting IPO shares breaches that loyalty because those shares should be a
corporate opportunity, not a personal opportunity.
- What makes a corporate opportunity?
o Did eBay have the corporate opportunity to invest in these IPO stocks? Yes.
o Line of business? Yes.
o Corporate Interest/expectancy? Yes.
o Conflict? Yes.

Sinclair Oil v. Levien:

 If you dictate who’s on the board and what the corporate policy will be, then you have
created a fiduciary duty to the shareholders. A controlling shareholder is treated by all courts
as the same (as far as their fiduciary role) as directors.
 The business judgment rule did not apply b/c of the self-dealing and higher fiduciary duty to
other shareholders
 The test applied – is the intrinsic fairness test – the burden of proof is on the majority
stockholder to prove, subject to judicial scrutiny, that its conflicting transactions were
objectively fair
o The basic situation for the application of the rule is when the parent has received a
benefit to the exclusion and at the expense of the subsidiary.
 Dividends issue (BJR) :
o How can you distribute dividends? Out of earnings, or out of past earnings. If you pay
out less dividends than earnings, then you’re okay.
o Sinclair won on the BJR. Plaintiff had to show that the dividend payments were the
result of unfair motives and amounted to waste. It failed to do so.
 What about corporate opportunity?
o Corporate Opportunity claim – no wrong-doing found - no liability of shareholder for
breach of duty
o The claim was that just because Sinven was an oil and gas company called Sinclair
Venezuela, it could still drill for oil in other places, and Sinclair didn’t let them.
 The court did not buy this argument. By using a narrow definition of what the
corporate interest/expectancy of Sinven is, the court found that there was no
business/corporate opportunity.
o If there’s no corporate opportunity, then there’s no duty of loyalty problem.
 Did Sinclair breach its contract with Sinven? Sinclair has one subsidiary that makes oil
(Sinven) and another that buys that oil from Sinven (International).

39
 o The buying subsidiary paid for the oil late, and didn’t buy as much as it had originally
agreed to buy.
o The intrinsic fairness test will be used here, because Sinclair will be getting more out
of the contract than Sinven.
 The court held that the defendants could not meet the intrinsic fairness test. It
held that Sinven would have to be reimbursed for the unfair business.

Zahn v. Transamerica NEED HELP WITH REDEMPTION/CONVERSION THEORY

 Transamerica started buying stock in AF. They eventually became the dominant shareholder
for both classes. They have the ability to elect everyone on the board. Transamerica knew
that a Tobacco leaf had increased dramatically in value (from $6M to $20M). The Tobacco
leaf was a hidden asset. Transamerica wanted to gain access to the leaf by liquidating AF.
o They first tried to redeem all of the Class A stock. They voted on the action, and the
Class A guys got knocked out of the company.
o Transamerica caused AF to liquidate, and they kept everything that was left.
o The Class A shareholders were upset about this, and they decided to sue.
 Class A sued Transamerica on 2 theories:
o Transamerica should have just liquidated the company, instead of redeeming the
stock and kicking Class A out. They argued that Transamerica owed Class A a
fiduciary duty.
 You have to act in the best interest of the shareholders. There are some Class
A shareholders, and some Class B shareholders. When you’re talking about
distributing money among shareholders, then it is your discretion to exercise
rights or not to exercise rights.
 They weren’t put through the intrinsic fairness test. Class A knew at the outset
that the board had the power to redeem.
 Acting rationally, this is how it would work:
o You would try to redeem. Class A would argue for conversion, then you would
convert.
o The problem here is that Transamerica did not disclose the information about the
tobacco leaf, so Class A didn’t fight the redemption.
o The duty of loyalty requires that the board give all of the various constituencies the
information they need to make a rational decision and exercise their rights.
o This is the distinction you make when you’re working among shareholders.
 Well settled – directors may not declare or withhold the declaration of dividends for the
purpose of personal profit, or by analogy, take any corporate action for such a purpose
– treated maj. as directors
 Derelict in their fiduciary duty – the stock holders are to be given the money owed to them in
case of calling in as per their stock purchase agreement

DUTY OF LOYALTY RE:

D. RATIFICATION…………………………………………………………………………….

In Re: Wheelabrator

40
Several claims: Ct systematically struck down each argument finding for the board – no violation
 Disclosure claim – 3 hours deliberation with attorneys and investment banker advice – then
issued proxy statement detailing every reason they acted the way they did
 Fiduciary duty - approved by non-interested shareholders as well as uninterested board then
approved by full board
 Duty of Care Claim – Followed Gorkum – stating that if for some reason board didn’t do all
they could – then any error is cured once approved by the shareholders – which it was here
 Duty of Loyalty Claim – 2 category’s of complaint:
o (a) interested transaction – between corp. and directors – not voidable if approved by
majority disinterested shareholders – which we had here
o (b) duty of loyalty arising out of transaction between corp. and controlling
shareholder –
 Entire Fairness Claim - Parent –subsidiary merger – the directors have burden of proving
that the merger was entirely fair BUT where merger is conditioned on a majority shareholder
vote – and it is attained – the std is still entire fairness but the burden shifts to the plaintiff to
demonstrate that the merger was unfair

PROBLEMS OF CONTROL………………………………………………………..
SHAREHOLDER VOTING CONTROL……...

§ 146. Submission of matters for stockholder vote.

A corporation may agree to submit a matter to a vote of its stockholders whether or not the
board of directors determines at any time subsequent to approving such matter that such
matter is no longer advisable and recommends that the stockholders reject or vote against the
matter.

Stroh v. Blackhawk Holding Corp.

 Ownership of stock means that the proprietary rights are given to participate (1) in the
control of the corp. (2) in its surplus or profits OR (3) in the distribution of assets
 In absence of fraud, Corp.’s can place any restrictions they want – as long as they don’t deny
voting power
o Can prefer one class over another
o As long as the mgt and control aspect didn’t change any other provision will hold
Note:
With all of these requirements why would you want to buy class B stock?
 If you have class A stock
 Or if you are the Prez of company – you have all power with less financial stake

State of Wisconsin Investment Board v. Peerless Systems

 No requirement that stockholders attend meetings
o That is what proxy is for – they don’t have to attend
o Less costly – don’t have to pay – for both small and large investor
o If there were fraud, abuse or other inequitable conduct affecting the propriety of vote
are not exposed until after the meeting – they wouldn’t have a remedy

41
 Methods of review:
o The Board members have a fiduciary duty to the shareholders. The Board was
supposed to be running the company on the shareholders’ behalf, and SWIB claims
that it wasn’t.
o Blasius Rule:
 Did the board act to thwart the shareholder vote?
 If so, the board has the burden of demonstrating a compelling justification for
its actions.
o If Blasius rule doesn’t hold (If the board did not act to thwart the shareholders), then
BJR.
 If there is a conflict, then you have to go thru the fairness analysis.
Note: if there is a duty of loyalty question – generally you apply the intrinsic fairness test - to
determine if the directors actions were intrinsically fair (by the sum total of all of their actions).
This test is essentially used in circumstances where a certain transaction is in question
o here there is no “transaction” at issue and therefore the Basius test is more applicable
o both tests apply the burden shifting element - here to show compelling reason for
their actions

PROBLEMS OF CONTROL RE:

CONTROL IN CLOSELY HELD CORPORATIONS……………………………………………

Closely held corporation is a legal entity with certain defining characteristics. It has relatively
few shareholders that are active in the business. There is not a ready market for the shares. If you
have those 3 things, then you are a closely held corporation.
- There are some states that allow for you to elect to be a closely held corporation if you meet
the requirements.

Ringling Bros Barnum & Bailey Combined Shows v. Ringling - you can pool your voting
rights….
 Shareholders are entitled to confer voting rights on others while still retaining
ownership interest in their stock
o Stockholders by agreement – can bind themselves – it was her agreement as long
as terms are lawful and it will be treated as a normal K issue….you will be liable
if you breach
o Shareholders, in their roles as shareholders, can limit their abilities to vote in
certain ways by agreement. These agreements are contracts. These contracts will
be enforced according to their terms. If the terms do not allow for proper
enforcement provisions, then the court will act hamstrung by drafting of the
contract. The courts take what the parties to the contract have done, and they
implement it.
o Pooling K’s are valid but there are only valid to the extent that the terms of the
agreement are enforceable between the parties – must be clear enforceable, better
if written terms
o

42
Normal Voting Criteria:
Plurality voting is the default way – each of stockholders vote for their own nominees – the
majority stockholder always wins
Cumulative voting was used in Ringling – multiply the number of positions available times the
number of shares that you have – then you can vote your shares anyway you’d like – ex. you can
give all 40 votes to one director – to ensure that at least one of your choices is elected

McQuade v. Stoneham: McQuade is a magistrate, and not allowed to be a director in a business,

so the case is thrown out. Aside from that, the issue is: Can directors elect themselves?
 Directors may not by agreements entered into as stockholders abrogate their independent
judgment
o Directors duty is to the corporation and not to each other
o A K is illegal and void so far as it precludes the board of directors at the risk
of incurring legal liability from changing officers salaries or policies or
retaining individuals in office except by consent of the contracting parties

Clark v. Dodge: Bd members owe fiduciary duty to all minority shareholders – they cannot
breach that duty – here the appointing for life of a director may or may not be a breach of that
fiduciary duty
Test – what is the damage suffered or threatened – Who specifically will be damaged as a
result?
 Less likely a breach in a closely held corporation as here in Clark
 More likely a breach in large corporation with lots of minority shareholders
o So protect your ass – in order to appoint directors and allow them to keep their job
it must be based on continuing adherence the corporation’s interests over other
interests and other merit based – reasons to be able to stay
Note: State Action in Response:
o States sought to ensure that illegal K’s to get director positions do not occur – in state
statutes they require that minority shareholders have a say in who becomes directors
o Second, the states have sought to place more emphasis in employment K and less in
shareholders agreements. The employment K is then approved by all the stockholders –
becomes enforceable that way.
Disadvantages:
Must have term of employment K – leaves you exposed at the end of your K – to being
terminated – if other stockholders turn on you
Must discuss exactly what behaviors are not allowed – in order to be a breach of fiduciary duty –
not really the best way to start your new job

Galler v. Galler – Cts far less likely to find voting agreements illegal when no minority
shareholder to protect:
 THE KEY here – there is no minority shareholder that will be subject to injury – here we
have a closely held corporation with only one minority shareholder that “did not object” – the
ct was not worried about them
 To pay for the wives for life after their death is essentially their version of a
life insurance policy – said its ok
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  As long as the stated purpose as it was here – is stated up front and not
secretive - it’s valid
 The term – for the life of the directors – is not on its own invalidated by
anything in the corporation act

Ramos v. Estrada
 Group A – formed a voting pool agreement that they would meet and decide as a group to
vote their shares together and the remedy for breach would be forfeiture of their shares –
w/payment by the other shareholders
 The party here breached - the agreement was valid – it essentially mirrored the statutory
provision that allowed it
 Further the remedy here was a fair remedy – and these sophisticated parties agreed to be
bound by it
 They breached and they lost their shares – as they had agreed to

Notes on Pooled voting agreements:

 Acting as shareholders in entering to agreements to vote as a group – ct said is fine
 If 100% of shareholders agree to vote the same way – then ct will uphold it
 BUT if less then 100% of the shareholders agree to vote a certain way:
o It is gray area
o Depends on the terms agreed to
o Is their representation of the minority shareholders?
o If less then 100% is represented and you are in the management – you must be
extremely careful in not violating fiduciary duties
 The test will be determining if they lived up to their fiduciary duties

PROBLEMS OF CONTROL RE:

ABUSE OF CONTROL…………………………………………………………………………

Wilkes v. Springside Nursing Home, Inc. – Before Wilkes could make nice with the other three
men, they eliminated Wilkes from the corporation (more or less squeezed him out). They cut his
$100/week for “maintenance work.” The maintenance work was really just a way for the
directors to pay themselves through the company.
- There was no business reason for this. They just didn’t like him anymore. The used the
corporate machinery to eliminate his position in the enterprise. He is no longer an employee,
and he no longer receives dividends. However, he still has a 25% shareholder status (which is
essentially worthless).
- Wilkes sued for breach of fiduciary duty. (see test below)
THE TEST [FOR CLOSE CORPORATIONS]:
 Does the court apply the strict Donahue standard? No. They tinkered with it by making up a
2-part test.
o Part 1: Is there a business purpose? If no, then the duty has been breached. The court
found that there was no business purpose here.
o Part 2: If yes to part 1, then you have to prove that there was a less harmful
alternative.
44
 o The court wanted a middle grounds (intermediate level) for this sort of case.
o The point – unfair to let majority freeze out the minority – so the court develops
these special rules for close corporation (its most prevalent there)
o Important - What did these stockholders and directors think they were going to
get out of the agreement? (Drury says)
 The court looked to the fact that the four of these guys went into a corporation together with
certain expectations of fiduciary duty. It thought that the other three men were abusing their
control in the corporation, and the court interpreted a rule to acknowledge and sanction those
actions.

Drury said that this whole case could be decided by corporation law instead of a partnership law
analysis that the court decided to use:
 Here they must show that they had a reasonable business reason – business judgment rule
– for their actions
 If there was no basis after an “intrinsic fairness test” – through a duty of loyalty analysis
– then they are liable to him for his damages

Ingle v. Glamore Motor Sales, Inc.

 An at-will employee – his agreement left no term for his work
 He agreed to be a shareholder on the agreement that if he “leaves – for any reason” they
buy back his shares
 He’s fired and they buy back his shares – does not assert that he was not paid a
reasonable price
 Ingle sued for breach of fiduciary duty. The court distinguished between Ingle as a
shareholder and Ingle as an employee—thus finding no fiduciary duty.
 Courts are wary to step in and give any reimbursement – when the stocks are bought
back, there is no nexus between how he got hurt as a shareholder and as an employee
o There was no injury as a shareholder – he was paid a fair price for his stocks and
accepted the money
o And there was no breach in firing him – as he had no employment K
 If there is a clear contract, the court will apply the terms of that contract. Unlike Wilkes,
there was advanced planning in the initiation of the corporation. This case stands for the
fact that, even though there are higher standards in the fiduciary relationship of close
corporations, that standard does not extend as far as other relationships, such as the
employer/employee relationship.
o If you can divorce employment from shareholder status, then the court will not
interfere with employment law rules just because you happen to be an employee
and a shareholder.
o Drury’s suggestion: When you do advanced planning, decide on terms that you
actually agree on.

Sugarman v. Sugarman
 Close corporation owned by family – was there freeze out???

45
  Breached his fiduciary duty: paying himself excessive salaries; offering minority stock a
grossly inadequate price; excessive pension payments
Evaluation of the complaints:
1. The court conceded that Leo paid himself too much money. It may be an indicator that he
may be attempting to freeze out, but it isn’t a problem by itself.
2. The fact that he didn’t give jobs to J, M and J isn’t evidence that he was freezing them out.
3. The pension he gave to his father (at the exclusion of everyone else) was bad, but there
wasn’t a legal problem with it.
4. There was no problem with Leo’s decision not to pay dividends.
5. The lowball offer was also meritless.
- The court held that, while the complaints were not individually evidence of freezing out, all
of the complaints together met the showing of bad faith. While there isn’t a list that must be
met to show bad faith in a freeze out, there was enough evidence to be sufficient for bad
faith.
- Leonard will have to pay J, J, and M personally because the court found enough things to
show intent to freeze out.
o Remember that the situation will be much better if you can show more than
generalized grievances. The goal is to get the money back into the corporation.
Smith v. Atlantic Properties Inc. – Woflson refused to declare dividends for two years, and
wanted Atlantic’s earnings spent on impairs and improvements to its properties (despite the fact
that only the most basic repairs were made, and no plan to schedule improvements were made).
Because of the failure to declare sufficient dividends over the years, the IRS assessed penalty
taxes against Atlantic, as warned by plaintiffs.
 Penalty assessments by the IRS were assessed for three years
 Found against the Dr. - that his motives were based on his dislike of other shareholders and
not for the real improvement of the land
 In finding that Dr. had breached fiduciary duty – used Donahue case – in comparing a closely
held corporation to a partnership and holding each director as a fiduciary of the others – duty
of utmost good faith and loyalty
 Kind of a twist here on the conventional minority stockholder – here with the 80% provision
the others were treated as if minority – because their shares could not outvote his – no
instrument for tie breaking
 DR. knew the danger yet still failed to act in the best interest of the company here –
breached duty of utmost loyalty here
o Wolfson claims that the property needs a lot of repairs. However, if he had actually
used the money for repairs (instead of just letting it sit in the company), then they
wouldn’t have had the tax penalties. There is no evidence that he sincerely initiated a
plan to carry out the repairs.

Side note: It is cheaper for very rich people to hold on to their money to avoid paying taxes on
that money. Wolfson was letting the money sit in the corporation to avoid tax on dividends.

Synopsis and Comparison/Contrast of the Past 4 Cases

Wilkes Ingle Sugarman Smith
What went 1. The majority s/hs 1. Ingle was not 1. Sugarman paid 1. Blocked Dividends
46
wrong? took away a minority treated well as an himself too much. 2. No alternative
s/h’s money. employee. 2. He cut off all
2. They gave him a low dividends to the
ball offer for his whole company.
stock (evidence that 3. He refused to hire
they were trying to s/h.
freeze him out). 4. He gave his father an
unfair pension plan
(too much).
5. He lowballed the s/hs
when trying to
purchas stock.

What could 1. Should have made it 1. Employee 1. Should have 1. If he had put up a
they have done clear that the money should have compensated real alternative to the
differently? was for the work. made an themselves properly. dividend plan, then he
You only get paid as employee 2. Should not have might have been okay.
long as you’re agreement. made a low ball offer, You don’t want to look
working. or any offer for that like you’re acting on a
2. Should have followed matter. selfish interest. You
formalities. It would want to show that
have been more there’s a genuine
likely that P would disagreement.
not have confused the
intent of the
corporation.
3. Should not have
made an offer for the
shares.

What sort of 1. A more formal 1. An employment 1. Needed a s/h holder 1. Needed a s/h
planning employment agreement that agreement. agreement.
documents agreement contract. covered what 2. Should have
could have The s/h benefit rights he had to followed up with an
been prepared should have been carry on would agreement
and entered considered to be have been good. regarding deadlocks
into in ancillary. 2. If Ingle didn’t in voting.
advance? 2. A s/h agreement understand what
would also have been the true
beneficial. intention of the
a. A buy/sell s/h agreement
provision was, he should
would have have made
been helpful changes to the
too. contract. The

47
 wording was
pretty clear. If
that wasn’t
what he meant,
he shouldn’t
have agreed to
it.
IN ALL THESE CASES IF THEY HAD HAD A BUY SELL AGREEMENT COULD HAVE
AVOIDED THIS PROBLEM
 UNDER WHICH THE PARTIES WOULD AGREE IN ADVANCE ON A FIXED
PRICE THAT WOULD BE PAID IF EMPLOYMENT CEASED AT ANY TIME
 MAKE SPECIFIC PROVISIONS FOR WAY THAT TERMINATION OCCURS:
o Higher price if laid off etc.
o Can only be fired for cause etc.

LIKE AN EXAM HYPOTHETICAL…..

Jordan v. Duff and Phelps, Inc.: Jordan moved companies to appease his wife. The new job had
better pay too. When he quit, the company never told him that it was negotiating a merger.
Instead, the company told Jordan that it was buying back the stock, and gave him the option to
work until December 31, because the stock would be valued as more.
 As employee with Duff – the agreement was if “he left for any reason there was a buy back
agreement – at book value
 To show rule 10b-5
o Material misrepresentation or omission ---- yes this was material – the potential and
entering into sale of corp.
 Material if a reasonable investor would find the info important in making their
buying or selling decision
 Info about pending merger is material
 Especially here – since they valued the company at 50 million – would mean
huge profits for shareholders
 To tie it in here – Jordan could have stayed – he resigned; he wasn’t
fired – if he had stayed he would have gotten the money
o Others: “In connection with a purchase or sale”; Reliance; Scienter; Causation
 Key here – when do companies have the duty to speak?
o Only two times when required to disclose –
 1st if there is some other legal requirement to bring out this information -----
issuing of proxy statement and they ask for it
 2nd the fact they were engaged in a transaction – they were purchasing shares –
there is a duty to disclose (if they are going to buy securities then they must
disclose)
o You don’t always have to disclose everything you know about yourself. There is
something about a company that affects its value that no one else knows about.
 However, if there is a duty to disclose, then you have to disclose. In Jordan,
the source of the duty is the fact that the company (control s/h on board) owe
their minority s/h disclosure (knowledge of what’s going on in the company).
48
- The court allows the case to go on to trial, and tells Jordan what he has to prove to win the
case on remand:
o He must establish causation.
 He must prove that he would have turned down the job offer when he
learned about merger negotiations.
 He would have continued working even after the negotiation fell apart.
 He would have stayed with the company for 2 more years until the deal
would have gone thru.
o He must also prove that the company knowingly made a misrepresentation or
omission.
- Dissent: He was an at will employee – they could have just as easily fired him as he resigned

PROBLEMS OF CONTROL RE:

SECTION 5: CONTROL, DURATION AND STATUTORY DISSOLUTION…………………..
Sect. 275 and 278

Alaska Plastics v. Coppock – can’t bring freezing action – until you are frozen out
 Ex-wife gets half-shares in former husbands shares – they offer her low $ for the shares she
refuses
 She can only receive a remedy for her portion in 4 ways:
1. by a provision in the articles of incorporation or by laws that provide for the purchase
of shares by the corporation contingent upon some event such as death of the
shareholder or transfer of the shares
2. shareholder may petition the court for involuntary dissolution of corp.
3. upon some significant change in corporate structure – ex. merger
4. or upon a finding of breach of fiduciary duty between directors and shareholders and
other corporate holders
 Then goes through analysis to each –
1. does not apply
2. dissolution or liquidation are very extreme remedies – here facts don’t warrant
o case law does tell us – however that courts instead can use an equitable
remedy that is less drastic than liquidation
o Remand the case – to determine if she suffered retaliatiory oppressive conduct
in order to justify he equitable remedy
3. statutory appraisal – in Alaska:
4. remedy available upon merger/consolidation with another corp. or upon sale of
substantially all corporation’s assets
o two cases – Donahue and Ahmanson – transaction by one group of
shareholders that benefits them and no other shareholders – should be subject
to judicial scrutiny
 When does a court have the right to dissolve a company?
o When extreme remedy is warranted.
o When a shareholder can show fraud, oppression or illegal dealing.
 What does Coppock have to show to prove oppression?

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 o Fees were paid to directors and not to her
o They didn’t invite her to meetings
o They went on company paid trips, and didn’t pay her
o Courts are looking to what each party’s reasonable expectation was/should have been.

Meiselman v. Meiselman: NCGS Statute 55-125(a) allows a court to order dissolution where
such relief is “reasonably necessary for protection of the rights and interests of the complaining
s/h. The court may, as an alternative to dissolution, order a buy-out of the complaining s/h’s
shares.
- The complaining s/h need not establish oppressive or fraudulent conduct by the controlling
s/h. Instead rights and interests under the statute include reasonable expectations, which
include expectations that the minority shareholder will participate in the management of the
business or be employed by the company, but limited to expectations embodied in
understandings, express or implied, among the participants.

Haley v. Talcott: Haley and Talcott, each 50% owners of an LLC, were at an impasse. Haley
argued that dissolution was necessary, whereas Talcott argued that Haley was limited to an exit
mechanism provided in the LLC’s operating agreement, even if such exit mechanism was not
equitable regarding Haley’s interest. Rule. Where co-equal members of an LLC are at an
impasse, can no longer carry on the LLC’s business, and are in disagreement about whether to
discontinue the business and how to dispose of its assets, and where an exit mechanism in the
LLC’s operating agreement is inequitable, dissolution is necessary.
- The court didn’t apply the contract because it would not provide Haley a way out of the
mortgage. Haley wants to use the dissolution statute.
o Delaware LLC Act permits courts to decree dissolution of an LLC whenever it is not
reasonable practicable to carry on the business in conformity with an LLC agreement.
o It wouldn’t be unreasonable for the court to just say, “You’ve made your bed, now lie
in it.” However, because all of the terms of the statute are met, then the court looks
into the fairness of the situation.

Pedro v. Pedro – Family business sells leather products. Each of the member of the family
owned a 1/3 of the company. Alfred discovered a $300K discrepancy between internal
accounting records and the TPC accounting account. The other brothers were being shady.
 Partners in close corporation owe fiduciary duty includes dealing openly, honestly and fairly
with other shareholders.
 But here they had an agreement – under the SRA – there was an agreement that because he
was no longer a shareholder, the other two brothers just pay him the fair book value
 The brothers were found to have breached their fiduciary duty. The court awarded Alfred
$1.3M for the value of the share of his stock. They also gave him the fair vale of his stock.
o They also awarded Alfred the value of his contract.

Stuparich v. Harbor Furniture – liquidation is only given in extreme cases

 Wife and son are employees of closely held corp. - two sisters bring suit against the
grandfather company (now owned by son)
 Plaintiffs – the CEO’s sisters were both on the board of directors of the company
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 Dispute re: future voting shares would be divided – instead of fighting it out – plaintiffs just
stopped going to meetings
 Plaintiffs still continued to receive monthly dividend payments – receiving more than
$800,000 since 1984
 Under Corporations Code 1800(b)(5) – “liquidation is reasonably necessary for the
protection of the rights and interests of the complaining shareholders”
o This section permits any shareholder of a close corporation to initiate involuntary
dissolution
 This is limited to corporations w/ 35 or fewer shareholders
o But ONLY it is when the rights of a substantial number of the shareholders are
affected
o Distinguished Precedent –
 Stumpf – granted appeal by one son – for dissolution – but in that case the
stockholder received no salary, dividends or other revenue from his
investment
 Bauer – second case – the minority shareholders had gone into business in
direct competition with West Coast – the court found that based on this action
in bad faith – that the court was justified in granting dissolution
 Is dissolution reasonably necessary to protect their rights or interests?
o NO Distinguished from both cases noted in that – the plaintiffs continued to receive
dividends and there was no bad faith.

PROBLEMS WITH CONTROL RE:

SECT. 6 – TRANSFER OF CONTROL……………………………………………………….

Notes on Corporations:
 In contrast with LLC (you sell your shares to someone else – the other partners must approve
new partner) – Corporation shares are freely traded – no approval of the other shareholders is
necessary in order to gain control
 You can buy control - Just b/c you are the majority shareholder – doesn’t change the rules of
corporate shares

THE POINT : you can receive a premium for controlling stock – but must uphold your fiduciary
duty in the sale of assets – such as directors/board positions
o You can protect your self with K’s but courts will only give you the protection you
K’ed for

Perlman v. Feldmann: Korean war; steel shortage

 Derivative action brought by minority shareholders – alleging illegal action – in sale of their
controlling shares
 Feldman – was a fiduciary – both as a director and dominant shareholder – to minority
stockholders, there was no outright fraud in this situation – his actions – did not meet the
high std – expected of a fiduciary
o If you own less than 51% of stock you can still – have control – if no one else owns
more than you – and all others are shared by minority shares
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 Feldman earned a control premium – you pay more for controlling shares
o And minority received less then Feldman
 Minority asserts that he was not only selling his shares – but he was also selling – assets of
the company – selling “seats on boards etc.
 The court decides the premium was illegal and Feldman had to share it

NOTES on electing Boards – each corp. decides on their own how to elect the board:
 But most elect boards in staggering terms – in which you can’t replace all of the board
 If staggered you can only replace the board members up for vote
 You can’t replace board whose term is not up
 Effective way to discourage hostile takeovers – promotes friendlier takeover situations
 Drury says – though could easily be abused – the board controls the company – but may not
own it
 If terms are too long the director is not subject to vote for many years – thus the owner has
essentially lost control (vote for board is the only way shareholders exert control)
Each state sets terms allowed for directors: LA limits to 5 year terms

Zetlin v. Hanson Holdings, Inc.

 “Absent looting of corporate assets, conversion of corporate opportunity, fraud or other acts
of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that
controlling interest at a premium price.”
 While minority shareholders are entitled to protection against abuse by controlling
shareholders, they are not entitled to inhibit legitimate interests of the other stockholders.

Notes and Questions on Control Premiums: One reason to pay for a control premium is that you
want to take some of the earnings of the company for yourself. If you buy the control stock at a
little more than the market value is worth, then you can pay yourself more salary. That decreases
the total that is divided out among all the other shareholders. The increased salary comes out of
the pocket of the minority shareholder. Being the control shareholder allows you to allocate more
of the money to yourself.
- This is not necessarily good policy. You could freeze out minority s/h, and there is no
remedy if the majority starts taking the money and is not doing a good job.
- However, there is another rationale for control premiums. The other possibility is that,
instead of allocating more money to yourself (because maybe you think you can use these
assets in a valuable way), then you can increase revenue.
o The same thing happens if you bring the costs down. You have a bigger pie for
everyone to split, and everyone makes out ahead of where they would have been.

Essex Universal Corp. v. Yates

 Majority stockholder – contracts to sell his stock to Essex. In K, along with transfer of stock
in their agreement, he brought to the table the resignations of the current board and election
of board of his choice
o It is illegal to sell corporate office or management control by itself

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 o But if he is selling a substantial % of the stock – he could have elected a majority of
the board – thus may be legal
 In reviewing the board – they are elected to 3 year terms (to prevent hostile takeovers) –
Essex would not have had the power to replace the board at the time of closing, even as
majority shareholder
o Have each directors elected/resign one at a time so that they maintain control of the
board while replacing all Yates directors with Essex directors
 If they are transferring majority stock - There is nothing wrong per se in the fact that he got a
premium price over market price
o It is legal to give and receive payments for the immediate transfer of management
control to one who has achieved majority share control but would not otherwise be
able to convert that share control into operating control for some time
o If they are purchasing the majority of the shares – there is nothing wrong with K
containing provision for immediate replacement of directors
 Places the burden on the minority asserting illegality of the transaction

Frandsen v. Jensen – Sundquist Agency, Inc. – Right of first refusal case – What if people want
to plan out which rights they have if they leave? This is an issue of how such a contract might
work and whether it is enforceable here. Jensen started with 100% ownership. He gave 52% to
his family, sold 8% to Fransen, and smaller chunks to other non-family members. Frandsen
enters into a shareholder agreement which gives him the right of first refusal (if the majority
shareholders want to sell part of their stock, they have to offer it to Frandsen first), and if the
majority actually sell the shares, they have to buy out Frandsen.
- Jensen negotiated a merger with First Wisconsin Bank (not a sale, did not offer shares of
stock for sale, but actually sold the bank). The smartest thing they could have done would
have been to sell their assets to FWC. This is what they eventually did; they just shared
assets.
o If Jensen had offered to sell shares, then it would have violated Frandsen’s shareholder
agreement.
- Issue: Is selling assets close enough to the sale of shares to violate Frandsen’s right of first
refusal?
o Frandsen argues that there is no difference between a merger and a sale of shares. On a
sell of shares, on day one Jensen will own a certain number of shares, and on day two
he’ll have a pile of cash.
 He argues that they are putting form over function.
o Jensen argued that advanced planning should be enforced as written.
o The court agreed, Frandsen should have written what he meant. Frandsen’s right of
first refusal was not triggered by the merger action.

Things we should take away from these cases:

1. Shares of sock in a company are freely transferable.
2. If you are a controlling stockholder, you may have a fiduciary duty to your minority
stockholders. Those duties may impose limitations on your duty to freely transfer your stock.
3. Those limitations are:

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 a. Simply transferring your control premium is not a violation of your fiduciary duty,
but selling corporate assets are.
b. The control premium means that, once you take over you’re going to get to do stuff.
That is separate from a corporate asset that gets sold. The court is still unclear about
where the line is drawn between corporate asset and control premium.

More Notes:
- Is getting the new directors on the board – the basis of the control premium? Or is this illegal
behavior in selling an office of director on the board?
o Idea is – if you are getting something extra – you can’t pay someone to get it separate
o Can only transfer this right if you are the controlling shareholder, b/c you are allowed
to do it otherwise
- Would be improper to pay off directors to act in a certain way etc.
- Becomes an analysis between if you are actually in control and can transfer this management
control, and other end of spectrum, where you are not in control but instead pay board
members to resign to replace your directors
- All comes down to if you have enough control to act in this manner anyway….
- Control shareholders are free to sell their stock – even if majority shareholder
- You can sell control, but you cannot sell assets of company as in director positions in the
absence of control to do so
- Problem becomes: when these stockholders try to privately K around these rights of the
majority shareholders (Frandsen)

DISCLOSURE AND FAIRNESS ……………………………………………………

 Two types of trading in corporate securities (stocks and bonds):
o (1) primary mkt – the issuer (the company that created them) sells them to investors
 Ex. IPO
o (2) secondary mkt – investors trade among themselves, w/o any significant
participation of the original issuer
 Ex. NYSE
 Regulation became necessary post – great depression era:
o Securities Act of 1933 – focuses on primary mkt
 Uses a transactional disclosure model – mandates disclosure by issuers in
primary mkt
 Two goals were – mandating disclosure of material information to investors
and prevention of fraud

1934 Act
 If your company has already gone public, what are your obligations? You have to make
public disclosures about yourself. You are required to file an annual report (10k).
o A 10K gives you a detailed description of the business, all the property they own,
indebtedness, list of material liabilities. It’s a thorough description of the entire
company.

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 o On every quarter, you have to file a 10-Q. The 10-Q updates the 10-K. On the
next quarter, you update the information that has happened since the last 10-Q
update.
o If something big happens between the quarters, you have to file an 8-K. You have
to file the report within 4 days if something really big (they’re listed on the 8-K)
in the time between the quarters.
o The idea is that the public will make purchase/sell decisions on an informed basis.
 The 1934 Act also created the SEC (Securities Exchange Commission). This is mostly a
level that creates rules regarding securities.
 The 1934 Act also allows proxies (let’s you stand in at an annual meeting or other
meeting when you can’t be there).
o This is a big deal because public corporations don’t actually expect shareholders
to fly in to come to the meeting.
 § 16 tries to stop insider trading: (1) requires executive officers and directors and large
shareholders to report every time they trade in the company stock w/in 2 days; (2)
prohibits officers, directors and shareholders from making profit on purchase of sale w/in
6 months of each other; also company is allowed to sue any shareholder to recover that $;
(3) prohibits executives from selling stock short; short selling is selling stock you don’t
own to be delivered later
 §10 b-5→ the antifraud provision; single most important section in any of the securities
laws; requires that when corp are discussing they don’t make any material mistake or
omission; if do then held liable under this section; it applies to everybody
o The threshold issues (regarding 500 shareholders and $10M in assets—see below)
does not apply here.
 5 commissioners confirmed by senate and a staff (lawyers, accountants etc.)
o Functions of staff:
 Provides interpretive guidance to private parties raising questions about
the application of securities laws to a particular transaction
 Advises the Commission as to new rules and existing rules and it
investigates and prosecutes violations of the securities laws

1933 Act
This act explains how a corporation can offer securities. It is a disclosure based statute, and the
idea is that anytime anyone sells securities anywhere, you either must register it with the SEC or
find a loophole that exempts you from registering. There are two big exemptions that keep you
from having to register.
- Two big exemptions:
o For transactions that don’t involve an issuer, underwriter, or dealer, registration is not
necessary.
 An underwriter is a person who purchases securities with the intent to re-
sell.
 A dealer is someone whose business is affecting transactions and securities.
o When you have a hand full of people (5-6) who start up a business and you sell them
shares of stock in your company. That act is a transaction in securities and you will

55
 have to register that with the SEC unless the offer is not public. Generally, if you have
5 or 6 people and they all know each other and they are the only people that the stock
is offered to, then they don’t have to register with the SEC.
- The first time you register with the SEC, you have to disclose all material information about
your company. It is really expensive and takes a lot of time (You need underwriters,
attorneys, etc….). With all of this hassle, there are 2 primary reasons that people make their
corporations public.
o If you’ve been the owner of a corporation for a long time, your entire net worth is
wrapped up in the company. You want to diversify your holdings by selling pieces of
your company.
o There’s also a lot more capital (money) available to people if they can go into the
public market.
- There are steep penalties imposed on misrepresentations.

DISCLOSURE AND FAIRNESS RE:

A. DEFINITION OF SECURITY………………………………………………………………..

First must determine if the thing is a security or not?

 If so, must comply with registration requirements of Securities act
 Important for anti-fraud provisions of the Act

§2(1) of Securities Act:

 1st a list specific instruments including “stock” “notes” “bonds”
 2nd general, catchall phrases – evidence of indebtedness, “any instrument commonly
known as a security”

Robinson v. Glynn: Geophone was a corporation that became a corporation when Robinson
invested with it. Glynn had CAMA technology, which he believed would be a great cell phone
innovation.
- Robinson loans Glynn $1 million to run a field test on the CAMA technology. If the tests
came out okay, Robinson would cancel the $1M debt and invest $25M in the company.
- Glynn tells Robinson that the field test went well, but he never actually tested the CAMA
technology. He told Robinson that the field test was good, but never mentioned that the
CAMA technology was never tested.
- You can only sue under Securities law when you’re dealing with a security.
- What is a security?
o Robinson claims that it can be defined as both an investment contract and a stock.
 Robinson didn’t actually buy stock. Characteristics of buying stock weren’t
all met.
o Robinson also had a membership interest certificate that calls it a security on the back.
If you’re dealing with actual shares of stock in a corporation, those shares will be
listed as securities.
- In these cases, follow this line of questioning:
o Is there an investment contract? If there is an investment contract, then you have a
security. You must start by proving that you have a security.
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Precedent:
 SEC v. WJ Howey: def. INVESTMENT CONTRACT
o “An investment K for purposes of Securities Act means a K, transaction or scheme
whereby a person invests his money in a common enterprise and is led to expect
profits solely from the efforts of a third party.”
o Three requirements: must have all 3
1. an investment of money
2. in a common enterprise
3. with profits to come solely from the efforts of others
 United Housing Foundation v. Forman
o SC guidelines for “non-traditional” classifications
o Must have the 5 most common features of a stock:
1. the right to receive dividends contingent upon an apportionment of profits
2. negotiability
3. the ability to be pledged or hypothecated
4. voting rights in proportion to the number of shares owned
5. the ability to appreciate
 Landreth Timber Co. v. Landreth
o SC said did not require Howey test for non-traditional stock
 Commercial transaction requirements:
o Either horizontal commonality requiring a pooling of investors contributions and
distribution of profits and losses on a pro-rata basis among investors
o Or Vertical commonality – requires investor and promoter be involved in
common enterprise
Were profits “solely from efforts of others?”
 The test is to determine how much control the limited partner exerted – in Delaware limited
partner can remain limited yet exercise substantial control
 Thus the answer comes from the operating agreement to determine type of transaction

DISCLOSURE AND FAIRNESS………………………………………………………………

B. REGISTRATION PROCESS
 Securities Act – prohibits sale of securities unless the issuer registers them with SEC
 §5 imposes three rules:
o A security may not be offered for sale through the mails or by use of other means of
interstate commerce unless a registration statement has been filed with SEC
o Securities may not be sold until the registration statement has become effective
o The prospectus (disclosure doc – can’t sell until SEC approves the prospectus) must
be delivered to purchaser before a sale
 Two exemptions to registration requirements:
o It exempts some securities entirely and exempts some transactions in securities not
otherwise exempt
o These are highly specialized – are transactional exemptions

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Doran v. Petroleum Management Corp.: Doran is investing in oil wells. PMC is a limited
partnership that Doran is investing in. PMC asked 8 people to join in the partnership. The wells
were doing well, but they were overproduced and were shutdown for a year. Financially, this
harms Doran because he had agreed to pay a note of $113,000 that he had agreed to pay for
another company.
- What legal remedy would Doran have because of this misrepresentation?
o Doran claims that this interest was a security which PMC didn’t register with the SEC.
Doran wants rescission. People care about rescission rights when the company is
doing poorly. You have the right to sell your shares back to the company are the rate
you paid for them.
 Issue: Whether the sale was part of a private offering exempted by Section 4(2) of securities
act, from the registration requirement
 Was it a public offer? (if yes, then no exemption; if no, follow factors)
o Number of offerees – relationship to each other and to the issuer
o Number of units offered
o Size of offering $$$ - Relatively modest financial stakes
o Manner of offering – Offer free of public advertising or intermediaries such as
investment bankers or securities exchanges – the sophistication of the offeree is a
huge factor
 Appoint a representative to advise them to protect your investment, so that
they cannot later assert that as a defense
 B/c must provide them with sufficient information in order to make a
reasonable decision on whether to invest or not. Doran was not given enough
info to make a reasonable decision
 The point –to require registration is to require that the investors are
aware of all the pertinent information of the company – prior to purchase
of security
 By not filing, you are exempting from providing this info. In order to do so,
must demonstrate that the investors were adequately informed and
sophisticated enough to understand what they are agreeing to

Safe Harbor created by the SEC – that allows a company to fulfill these rules Regulation D
and if you meet all these requirements – then you are given exempt status
o Guaranteed exemption – if follow their rules
o Safe from an analysis of those 4 factors by a court
o SEC essentially says we won’t mess with you if you follow these specific rules

Securities Act §11 is the principal express cause of action directed at fraud committed in
connection with the sale of securities through the use of a registration statement
 It must be in the statement – thus does not apply to exempt offerings
 Twist – it is the defendant who must prove that he did not cause plaintiffs injuries – no
need to establish prima facie causation
 No Privity requirement – anyone remotely involved could be made a defendant

§12(a)(1) – imposes strict liability on sellers or offers for sales made in violation of §5
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 Most common remedy is rescission of the K – the buyer can receive the consideration paid,
plus interest, less income received on the security

§12(a)(2) –imposes private civil liability on any person who offers or sells a security in interstate
commerce, who makes a material misrepresentation or omission in connection with the offer
or sale, and cannot prove he did not know (can prove ignorance) of the misrepresentation or
omission and could not have known even with the exercise of reasonable care
 Plaintiffs prima facie case has 6 elements:
1. Sale of security
2. Through instruments of interstate commerce or mail
3. By means of prospectus or oral communication
4. Containing an untrue statement or omission of material fact
5. By a defendant who offered or sold the security
6. Which defendant knew or should have known of the untrue statement
 Need not prove reliance (detrimental)
 Only applies in primary market

Every transaction you have to either register or find an exemption

Here they must register – as it is a public offering – b/c they are registering these sect. 11 claims
become an issue

Escott v. BarChris Construction Corp.: Barchris – not doing well as a company. They have some
indication that boom has peaked but they are still selling debentures like it's still growing
exponentially. In their registration – all their figures were overstated. They messed up big things
on both financial statements. But their errors are all in the same direction (indicating it wasn't
just an accident). Overstated assets understated liability.
This is a section 11 claim. Section 11 says that, if you make material misrepresentations in a
registration statement, then liability will flow.
- Plaintiffs burden:
1. Did registration statement contain false statements of fact or omit facts which should
have been stated in order to prevent misleading?
2. Were the falsely stated facts – material?
o Material defined as limits the information required to those matters as to which an
avg prudent investor ought reasonably to be informed before purchasing the security
registered
o These are matters that an investor needs to know to make an intelligent informed
decision whether or not to buy
o Not concerned with minor inaccuracies – or matters of no interest
 Ex. if the numbers are wrong – this is most likely material
 Not simply a statement of opinion etc. – this was a clear – calculable error
o If plaintiffs show 1 and 2, the burden shifts – have defendants stated affirmative
defenses? – it is then the Defendants burden

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If any material part of the registration statement is not true, can any person acquiring that
security may sue? Pretty much anyone involved (anyone that signed, directors, issuers etc.)
EXCEPT:
- The exception to the general and far reaching liability of – the “possible defendants” section
of 11 – is found under 11(b)
o No person other than the issuer shall be liable provided that they sustain the burden of
proof and show – that any part of financial statement not purporting to be made by an
expert, he had after reasonable investigation, reasonable ground to believe and
did believe that the statements therein were true and that there was no omission to
state a material fact
o Reasonable investigation – is defined under sect. C – the std of reasonableness shall
be that required by a prudent man in the mgt of his own property
- Higher std for attorney/director – on duty of due diligence
o Results in a conflict of interest between acting for your client – the company and your
duty to act as a director
o Courts are not sympathetic to attorneys that place themselves in this type of situation
- If experts that certify the portions of the registration statements are wrong are liable for
damages to plaintiffs that result – but board is free of liability

DISCLOSURE AND FAIRNESS

C. RULE 10B-5……………………………………………………………………………………
STAT: 34 ACT §10, RULE 10b-5
 Rule applies when not clear if private right of action exists
o Foundational case for application of private action
 Most important – private right of action under Exchange Act §10(b) and Rule 10b-5
o Exchange Act 10b
 It shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of interstate commerce or of the mails, or of any
facility of any national exchange…
 (B) to use or employ, in connection with the purchase or sale of any
security registered on a national securities exchange or any security
not so registered, any manipulative or deceptive device or
contrivance in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the
public interest or for the protection of investors
o Rule 10b-5
 It shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of interstate commerce or of the mails, or of any
facility of any national exchange,
 (a) to employ any device, scheme or artifice to defraud
 (b) to make any untrue statement of material fact or to omit to state a
material fact necessary in order to make the statements made, in the
light of the circumstances in the light of the circumstances under
which they were made not misleading or

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  c) to engage in any act, practice, or course of business which operates
or would operate as a fraud or deceit upon any person in connection
with the purchase or sale of any security

You want to make sure that your registration statement is accurate and complete. If there is a
misrepresentation, everyone (including the company) is presumed to be liable. If everyone who
signed the registration statement can prove that they didn’t know about the material
misrepresentation, and that they investigated the statement to the point necessary to protect them
from liability.
- The structure of the statute presumes liability once a material misstatement has been found.

Transition between 1933 Act cases and Rule 10B-5

10B outlaws the use of a manipulative device in the sale of securities. 10B-5 makes it unlawful
for any person to employ any device, scheme, or artifice to defraud; to make any untrue
statement of a material fact or to omit to state a material fact necessary in order to make the
statements made, in the light of the circumstances under which they were made, not misleading,
or; to engage in any act, practice, or course of business which operates or would operate as fraud
or deceit upon any person.
- 10B-5 doesn’t provide any definitions or standards. These things have developed thru a series
of cases. Furthermore, 10B-5 cases have been some of the most prominent cases in securities
law.

Basic Inc. v. Levinson – class action under 10b-5: Combustion is trying to buy Basic. The people
who sold their shares relied on misstatements that Basic claimed it was not in merger
negotiations.
 Former shareholders sold their shares after Basic made public statements that it was not
engaged in merger negotiations (remember factors: material misrepresentation or omission in
connection with purchase or sale, reliance, scienter, and causation).
o Adopted “fraud –on the –market” theory – creates a rebuttable presumption that
respondents relied on petitioners material misrepresentations (instead of having each
member of the class prove reliance) – noting w/o presumption it would be impractical
to certify the class
 S. Ct. granted writ and affirmed the following:
o Materiality definition – an omitted fact is material if there is a substantial likelihood
that a reasonable shareholder would consider it important in deciding how to vote
 Role is not to treat as simple children unable to comprehend but rather filter
out useless info they would not find significant
 Secrecy is not a factor in determining materiality
 Rejected “bright line rule argument” – ease of application - is not a factor
 Materiality “will depend at any given time upon a balancing of both the
indicated probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company activity” it
depends on the facts

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  Materiality depends on the significance the reasonable investor would
place on the withheld info (pretty broad) its all the factors together –
no single factor
 The Defendants were arguing for the agreement and principles test. Materiality has two parts
to it: the possibility that it will happen and the magnitude of the event.
o It’s very difficult to know if you’ll ever reach a deal on a merger. If the company
meets an agreement in principle with another company, then it has to disclose the
deal.
o The court held that mergers would not be treated separately. Instead, it decided to
weigh the discussions regarding the merger. This was going to be a huge deal, but
how likely was it to actually occur?
 Levinson didn’t have to lie, but they could have refused to comment on the
merger negotiations.
 The standard in this case is the fraud on the market theory. If you are trading stocks that are
listed on an active market, people rely on that market for the integrity of the stock price. If
you give material misrepresentations to that market, then it alters the integrity of the price
and hurts the market, then you’re hurting those who rely on your misrepresentation.

REVIEW Rule 10B – prima facie:

 Material Misrepresentation/ omission
o If a reasonable investor would find the information important in making investment
decisions
o For mergers – they use the same test – and add to it a test of:
 Magnitude
 Probability
o Avoid liability – by saying no comment – at all times – don’t make any
representations at all
o Certain times when you have to disclose info about your corp. BUT not a separate
legal duty to provide info w/o other basis for doing so.
 If required by SEC in specific instances
 Dealing in securities info – with insider info – non public info
 If involved to mergers and trades
 Duty to update – misinformation
 Reliance
o Traditional – show actions in buying or selling securities – and the loss or gain as a
result
o New – The “Fraud on the Market Theory” –
 In big mkt – price is decided by info (all info changes directly affect the
mkt price)
 Settled law that reliance is presumed on fraud on the mkt doctrine
 Causation
o Loss causation – show what the difference was between regular mkt fluctuation and
the fluctuation caused by the misrepresentations

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  Difference between the Harm caused by the misstatement and the extra cost
you paid based on the misstatement
o Must be more than “but for” causation – must show the loss
 Must show that the loss cannot be attributed to other factors – but rather just
caused by the misstatement
 Must Be In Connection with the Purchase or Sale of a Security
 Scienter – they must make misstatement knowingly or recklessly
o Not knowing you are breaking the law – just that you know that you are lying in
making your false statement

West v. Prudential Securities – class improperly certified

 The theory as applied in Basic – centers around idea that false info when presented to the
public mkt through sophisticated parties – it directly effects the Market
o oral frauds have not been able to be certified as a class – there was no “public”
statement
o Prices are not effected by non-public information dissemination. Here the volume or
particular investors would not effect the mkt in such a fashion. There was no link was
demonstrated
 Remanded to determine causal connection if any:
o Barclay model may help – as it shows that all trades affect the mkt – even non-public
 Barclays show the mkt is efficient – and thus is moved by any information -
but must show here other source of rise in price – other than Hofman’s
statements

Judicial Limitations on Actions under Rule 10b-5:

 Standing: Must have standing court dismissed plaintiff that had neither bought nor sold
shares
 Scienter: Must have made false statement with intent to deceive, manipulate, or defraud
 Secondary Liability and Scope of Interpretation: SC said there is no implied private right of
action for those that aide and abet violations of rule 10b-5 – which severely limited the
scope of secondary liability (much less remedy)

Santa Fe Industries v. Green: not a fed action under 10b-5: Kirby wants to acquire Santa Fe
(they already own +90% of the company). They had Morgan Stanley do an appraisal of the
company, and found that the assets were worth $640/share, but they only offered the minority
shareholders $150/share. The minority shareholders, by statute 253 had the right to petition the
court of chancery for a decree ordering the surviving corporation to pay them the fair value of
their shares. Instead of seeking the chancery court, the minority filed this suit in federal court.
 A breach of fiduciary duty by majority stockholders, w/o any deception, misrepresentation or
nondisclosure does not violate the rule
o Court says this was not manipulation:
 Manipulation refers to wash sales, matched orders, or rigged prices that are
intended to mislead investors by artificially affecting market activity
 “manipulative” here’s intent is protect unknowing investors
 There was no misrepresentation or deception.
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 o Private cause of action should not be implied where it is not in furtherance of
Congressional purpose – to protect unknowing investors in the mkt
 The point is to ensure full and fair disclosure – these plaintiffs were given all
the information freely
 This won’t always happen (a breach of fiduciary can, in some instances,
violate 10b-5). The court was avoiding making controlling federal law here.
Breach of fiduciary duty claim – is not sufficient to bring action under 10(b)(5) claim –
plaintiffs remedy is in state court on duty breach (no fed question)

A call option means that you have the right to buy a share of stock at a certain price. A put option
is just the opposite: “I have the right to share you X at a certain price per share.”
- The theory behind granting executive stock options is that, if your company does well, then
your stock price is lower than the market value, and you have an opportunity to make money.
If the company doesn’t do well, then you don’t make money. You should just let your option
expire.
- It’s supposed to be risky for either side.

Deutschman v. Beneficial Corp. :

 10(b) of Securities Exchange act of 1934
o THE RULE – prohibits the use of “in connection with the purchase and sale of
any security – use of any manipulative or deceptive device or contrivance of such
rules and regulations as the SEC may prescribe”
 Options are subject to two types of deceptive practices:
1. insider trading
2. affirmative misrepresentation – seems to satisfy all the requirements
o based on Sect 10-b – defendants do not deny that there were misstatements that if
proven would be material misrepresentations
 Is there standing – yes – SC has recognized option K’s as securities
o the only limitation that SC has put on this action is the requirement that the
plaintiff be a purchaser or seller of security
 no need to have privity with the person making the misrepresentation
o limits plaintiffs to those who have at least dealt in the security to which the
prospectus, representation or omission relates
 the market for option K’s is in direct correlation with the mkt price of
the stock
 has shown MUST PROVE: (reliance, scienter, causation)
 The policy of the rule is to protect investors – not to decide which investors to protect

INSIDERS RE:
INSIDE INFORMATION …………………………………………………………………………
STAT: 34 ACT §§20A&21A, RULE 10b5-1

Goodwin v. Agassiz (1933) – you take your own risk in stock exchange

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o Directors in commercial corp. stand in relation of trust to the corp. and are bound to exercise
the strictest good faith to its property and business BUT are not trustees toward individual
stockholders
o Can’t put all parties on level field of knowledge, experience or skill
o Test: when buyer seeks out stockholder to buy his shares w/o disclosing material facts w/in
his knowledge and not in knowledge of seller the transaction will be strictly scrutinized – but
in the absence of fraud – no breach of duty
o State law today: Special circumstances test: In general, it’s okay to trade under state law.
However, if special circumstances are present (i.e., personal relationship with duty to
disclose, or if the two officers had approached the seller and entice him to trade), then courts
will attach liability.
o Holding in this case: Defendants were not guilty of fraud, they committed no breach of duty
owed by them to the Cliff Mining Company, and the company was not harmed by the
nondisclosure of the geologist’s theory, or by their purchase of stock or by shutting down
exploratory operations.
o There is no liability here.

SEC v. TX Gulf Sulphur (1969) Insider trading analysis: Rule 10b-5; TGS did exploratory
drilling and found valuable minerals. They kept the results of the finding secret because they
wanted to preserve the opportunity for the company to buy up the land without driving up prices.
- First claim:
o Rule 10b-5: “it shall be unlawful for any person, directly or indirectly, by the use of any
means or instrumentality of interstate commerce or of the mails or any facility of any
national securities exchange,
1. to employ any device, scheme, or artifice to defraud
2. to make any untrue statement of material fact, or to omit to state a material fact
necessary in order to make the statements made, in the light of the
circumstances under which they are made, not misleading, or
3. to engage in any act, practice, or course of business which operates or would operate
as a fraud or deceit upon any person in connection with the sale or purchase of any
security
- How do the legal rules apply to the fact that the insiders bought stock before the information
was released to the public? 10B-5: Go thru steps
o Anyone who, trading for his own account in the securities corporation, has access
directly or indirectly, to information tending to be available only for a corporate
purpose and not for the personal benefit of a none may not take advantage of such
information knowing it is unavailable to those with whom he is dealing.
o Anyone in possession of material inside information must either disclose it to the
investing public, or if he is disabled from disclosing it in order to protect a corporate
confidence, or he chooses not to do so, must abstain from trading in or recommending
the securities concerned while such inside information remains undisclosed.
 There is no legal rule that forces you to disclose just because there is
something important going on.
 There are good business reasons for that (i.e., buying the land).

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  Material Inside Information: An insider is not always foreclosed from
investing in his own company merely because he may be more familiar
with company operations than are outside investors.
o The basic test of materiality is whether a reasonable man would attach importance in
determining his choice of action in the transaction in question.
o If there is a chance that the objective contemplation might have a big effect on the
value of the corporation’s stock or securities, then it is material information.
o Balancing test: Whether facts are material within Rule 10b-5 when the facts relate to
a particular event and are undisclosed by those persons who are knowledgeable
thereof will depend at any given time upon the balancing of both the indicated
probability that the event will occur and the anticipated magnitude of the event in
light of the totality of the company activity.
- Rule: If you are an insider and owe a fiduciary duty to a corporation and you know material
non-public information, then you have to either disclose the information to the public or
abstain from trading.
o How long does he have to wait to trade? The information has to be absorbed before
you can trade. It puts the insider at more risk, the closer the time comes before you
trade.
o Here, any trading before 10AM of the morning of the big press release was illegal.
 If you trade at 10:01, you could still be liable. This would not be adequate
time for a trade to occur.

Was the insider information material?

More tests for materiality:
o Encompasses any fact in reasonable and objective contemplation MIGHT affect the value of
the corporations stock or securities
o Whether a fact is material will depend at any given time upon a balancing of – the
probability that event will occur and the anticipated magnitude of the event
o Another factor: materiality based on how insiders acted ---- they thought it was material

2nd claim: Corporation is liable for public statement

Common Corporate defense: Press release was not issued “in connection with” the purchase of a
sale or security and alternatively SEC failed to prove it was false, misleading or deceptive:
“in connection with” :
o the point was that the rule was to protect the investing public and secure fair dealing
o Congress’s intent: only that the device employed, whatever it may be, be of a sort that would
cause reasonable investors to rely thereon
o It is unnecessary for the company to be engaged in the purchase of securities to meet the “in
connection” requirement – companies owe duty to public

Rule 10b(5)(1) – gives specific description on what “trading on the basis of material non-public
information”
o If you know about and you trade – than presumed to be acting in compliance with Rule 10(b)
(5)1

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o Make a self-executing plan: If you plan ahead – and state a year long plan of what you want
to buy and sell – you give this plan to a 3rd party to carry out w/o making any changes you
are protected later if your actions are questioned
o As long as you don’t change plan

Can a company be held liable just for issuing the early press release? What if the release is
misleading?
- Analysis: Fraud on the market theory
o Material misstatement/omission
o ICW purchase/sale
o Reliance
o Scienter
o Causation
- Where you reckless when you released the statement/omission?

The SEC used this elements list in proving their SEC federal action:
o By working at a securities firm – you don’t need to publish all research in connection with
advising individual client
o As CEO of company/major stockholder of company you owe a fiduciary duty to your
company as well as to all other stockholders
o If however you are acting as the CEO of a corp. and you know material non-public
information that you do not disclose and you act on it : buy purchasing, buying shares or
tipping off others to act – liable

Cts and SEC have failed to agree on a theory that holds this action as unlawful – the point is that
there should be an even playing field.
o Ex. Santa Fe v. Green – suit under breach of fiduciary duty argument – here in 10b-5 cases –
there was no deceptive practices – so the court said no fiduciary duty
o Drury said – its confusing now – b/c other cases say that mere breach of fiduciary duty
analysis – is sufficient to form an action for insider trading
o Kind of conflicting case law now

Note Case:
o Chiarella v. US: employee at printing company hired by Corp. – learned insider info about a
company they were acquiring
o Ct let him off b/c ct held that fiduciary duty is a necessary element of insider tradin
o Chiarella owed no duty to the acquiring company
o In response to this case: the SEC passed rule – to try to stop this situation by holding third
parties liable despite absence of fiduciary duty

Dirks v. Securities & Exchange Commission (1983): Secrist informs Dirk that Equity Funding of
America has engaged in vastly overstating the selling of life insurance and mutual funds (and
urged Dirk to verify and announce publicly). Dirk investigated this issue and found that it was
true. He tried to contact the newspapers, he told him company’s clients, etc.
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o Did he violate the anti-fraud provisions of fed securities laws?
o The duty to disclose under 10b-5 does not arise merely from possession of material non-
public info --- there must be a fiduciary duty
o TEST: In order for tippees to be found liable, you are not de facto forbidden from
training. If the tipper breached his or her fiduciary duty in telling you, and the tipper
was looking for a personal benefit, then you’re probably liable.
 Secrist wasn’t breaching his fiduciary duty and he wasn’t telling Dirk this
information for his personal benefit.
 No gain, no breach of fiduciary duty.

There is a weighing of factors in what the liability will be: must determine
___________________________________________________________
| | |
Goodwin employees w/
fiduciary duty level playing field
(worst) and tippees (best)

Dirks case – expanded rule for fiduciaries to tippees – you are in violation – if your insider was
breaching his fiduciary duty in telling the tippee

Liability of fiduciaries of the insider:

Rule 10b-5(2) – SEC description when you inherit duty to refrain or disclose – held liable as a
tippee if you act:
o After expressly told that you are supposed to keep something confidential
o In situations when routinely exchange confidential info – its understood to stay
confidential
o If you are part of the same nuclear family

United States v. O’Hagan: O’Hagan was an attorney for Dorsey and Whitney. Grand Metro hired
D&W to represent them regarding a potential tender offer for the common stock of the Pillsbury
Company. They took precautions to keep the potential tender confidential. While D&W was still
representing Grand Met, O’Hagan bought lots of call shares and shares of Pillsbury common
stock. He made a $4.3M profit.
o Two theories put forward:
o Classical theory/ traditional theory – targets a corporate insiders breach of duty to
shareholders with whom the insiders transact
 Rule 10b-5 are violated when a corporate insider trades in the securities of his
corporation on the basis of material non-public information – trading on this
info – qualifies as a deceptive device
o Misappropriation theory – outlaws trading on the basis of nonpublic information by a
corporate outsider in breach of duty owed, not to a trading party, but to the
source of the information. They do not necessarily have fiduciary duty – but are
outsiders who have access to the information. – you breach the confidence of the
source of the info
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 
thus your defense to this theory is – full disclosure to the person that gives you
the information
 the theory involves – “feigning fidelity” to the source of the information –
thus full disclosure – cures the “deceptive device”
o You’re not an insider, you’re a misappropriator (takes care of cases like Santa Fe)
o The SEC defines when an insider is not trading on the basis on misappropriated information.
o 10b-5(1) is supposed to aid planning for investors or anyone who may come into
material non public information.
 You cannot trade when you know you have material non-public information.

O’Hagan – extends this liability to fiduciaries of the insider – who acts on info entrusted in him –
with out disclosing to your fiduciary

SEC rule 14e-3 does not require a breach of fiduciary duty analysis
o the court will not overturn unless it is arbitrary and capricious – so it is lawful
o 14e-3 – was the SEC’s answer to Chiarella

Analysts Role in Insider Trading:

o There are no special rules – regular ppl who investigate and determine if ppl should buy or
sell stock – research all day long – each company and produce reports on recommendations
on what stockholders should do
o Most is public info – they just have a lot more time to do it
o Regulation fair disclosure case - You can’t disseminate material non-public information –
subject to liability

THE DUTIES OF OFFICERS, DIRECTORS AND OTHER INSIDERS RE:

SHORT SWING PROFITS………………………………………………………………….

Penalty for insider trading – 16(b) officers and directors and 10% shareholders must pay to the
corporation any profits they make w/in a 6 month period from buying and selling stock
o If there is a profit – it’s recoverable
o The point – they must be doing something illegal – why else would they be buying and
selling so quickly
o Must Fill out form .indicating that you are a beneficial owner of stock – 10% and up
Part 1 – insiders – officers, directors and 10% shareholders – you must disclose and trading with
the shares in the company
Part 2 – must pay to the corporation any profits they make w/in 6 month period from buying or
selling
****there are new rules now – Sarbanes Oxley has made other requirements

If someone is buying and selling in a short amount of time, then there may be a reason to be
suspicious. This is why insiders must disclose all over their moves. They must also return all
profits made from buying and selling within a six month profit to the company.

Who is an inside trader?

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- $10 Million in assets; +500 in shareholders
- Officer
- Director
- 10% of shares

Reliance Electric v. Emerson: Emerson, owner of 13.2% of a corporation’s shares, disposed of

its entire holdings in two sales, both of them within six months of the purchase. The first sale
reduced Emerson’s holdings to 9.96%, the second disposed of the remainder.
- Emerson argued that, the second sale did not occur when Emerson was a 10% shareholder,
but rather a 9.96% shareholder, and therefore that sale does not violate Section 16.
- Reliance argued that the apparent immunity of profits derived from Emerson’s second sale is
lost where the two sales, though independent in every other aspect, are interrelated parts of a
single plan.
- Holding: A plan to sell that is conceived within six months of purchase clearly would not fall
within Section 16(b) if the sale were made after the six months had expired, and we see no
basis in the statute for a different result where the 10% requirement is involved rather than
the six month limitation.

Under Section 16, you don’t ask yourself what they were trying to do or whether it was fair. It is
a strict application of the facts of the statute.
- Even though Emerson was a 10% shareholder days before its second sale, Section 16 doesn’t
apply because it was not a 10% shareholder at the time of the sale.

Foremost McKesson v. Provident Securities Co.

o Intent was to prevent – short swing profiteers – “insiders”
o Whether a person purchasing securities that put his holdings above the 10% level is a
beneficial owner? (had holdings then bought more)
o But last sentence of 16(b) says that it shall not be construed to cover any transaction
where such beneficial owner was not such both at the time of the purchase and sale or
the sale and purchase of the security involved
o The court held that in a purchase-sale sequence – beneficial owner must account for profits
only if he was a beneficial owner before the purchase
o It would not be consistent with the perceived distinction to impose liability on the basis of a
purchase made when the % of stock ownership requisite to insider status had not been
acquired

Kern County Land v. Occidental Petroleum

o One company sought to take over another – the other company merged with a third company
in an effort to avoid this takeover attempt
o The acquiring company had purchased more than 10% of the company that now was merging
o The acquiring company made agreement w/3rd company to sell their recently purchased
stocks in an effort to avoid being a minority shareholder in the other company
o The New company now files suit seeking profits made when they agreed to sell their shares
of the merging company – b/c all was w/in six month period

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o Here the court reasoned that the penalty should not apply – this was clearly not an insider
information type of situation – the kind of activity that rule 16 was trying to avoid
o In fact the other company hated the first company and even merged in an effort to get away
from them
o Ct would not apply the penalty here
Drury says – now as a practical matter Sect. 16 – is more of a limit on a day to day basis rather
then large scale issues of abuse:

Problems pg 523
1. if CEO buys and sells – and makes profit w/in 6 months – he must disgorge the profit
applies to all officers in the company and 10% shareholder
o directors and Ceo’s are held to higher std – if they profit w/in 6 months – must disgorge –
no matter - if they resign after purchase etc.
o shareholders std is different – they can get by with “tiered” approach to avoid having to
disgorge their profits – if they are not 10% shareholder in second sale – no liability

Shareholders get to do whatever they like: buying and selling – as long as they stay under the
10% LIMIT
o any purchase and sale w/in 6 months counts toward the profit ---- it does not have to be in
that order – can be a sale then a purchase (if you make a profit)
o you can make a sale then – 5 months later purchase and sell – if you have profited with in
that time you have to disgorge it to company

Ex. Jan. 1 sold for $50 a share then buys 300,000 shares – then buys enough shares to get her to
10% - no liability here – b/c she was not a 10% shareholder prior to the sale

3. B buys 100,000 shares on March 1 at $10 a share – On April 1 buys 700,000 shares at $90 per
share – On May 1 sells all of it – 800,000 shares at $30 a share ---- lost a ton of money on the
deal = 24million dollar loss
o but this all happened in a 6 month period – but anyone can match up the lowest
purchase price with the highest amount of shares sold (Drury lowest number of shares)
o 100,000 x 10 = 1,000,000 + 700,000 x 90 = 6300000 = 7.3 million bought
o he bought at 10 and sold at 30 --- so $20 per share profit times 100,000 = 2 million

o match up lowest priced purchases with highest priced sales

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