CORPORATIONS RAMSEYER FALL 2004

Basics Control of the business tracks the business risk. If you take the business risk, then you get ultimate control of the business. The law sets this as the default option. Corporate law operates as default background rules. These rules can be contracted around. But these are the rules that most people would want. Investor concern That people will steal. Corporate law response (fiduciary duty) People owe a duty of loyalty to the corporation (they cant steal). (If you steal, you have to pay it back.) That people will be lazy and wont care. People owe a duty of care not to be negligent. (If you are, then you pay losses.) BUSINESS JUDGMENT RULE If you followed both fiduciary duties, and you still lost money, the court wont look at you. As an investor, you want your managers to make gambles.

AGENCY
Agency law is a gap-filler subject to modification by the parties. Basic framework: (1) Is there agency, (2) types of agents (3) principles of agency relationship (1) Is there agency? You have an agency relationship when A agrees to work on Bs behalf and be subject to Bs control. So you need: An agreement Some type of control over the agent Agent has to agree to work primarily on behalf of the principal. GORTON V. DOTY Wrongly decided case. Lady says HS coach can drive her car to a game as long as he drives it, not his football players. Is lady liable for coachs tort? We have to investigate: This case shows us what questions to ask: Is coach the ladys agent? If so, is he a servant agent as to impose liability for tort? GAY JENSEN FARMS V. CARGILL Cargill (a lender) exerts a lot of control over Warren (lendee). Court found Warren was an agent for Cargill because Cargill had so much control over Warren, like having right of first refusal to buy grain, right to entry. Difference between an agent and a supplier: the agent agrees to act primarily for the benefit of the principal. A supplier doesnt do that. Franchisee context MURPHY V. HOLIDAY INNS Court found Holiday Inns had no agency liability because they didnt have enough control: they didnt direct day to day operations, i.e. hiring/firing, rates, expenditures. (Using training, insignia, specifications dont count).

Key question: How much control does the supposed principal have over the supposed agent? (Dont look to what they actually thought was the relationship). (2) Types of agents Servant-type agent: the principal has the right to tell the agent both what to do and how to do it. (The principle has the right to control the physical conduct of the agent). Employees of a corporation are typically servants. A principal is liable for a servant agents torts, and the servant can bind the principal in contracts. Independent contractor type agent: This agent agrees to act on behalf of the principal, but is not subject to the principals control on how to do the task. An independent contractor can bind the principal in contracts, but the principal isnt liable for an IC agents torts. (Exception tort liability can be found if its an inherently dangerous activity or its a non-delegable duty mopping floors). Examples of servant type agents Employees of large corporations: the executives all the way down to the lower employees Examples of independ. contractor agents A person you would tell to go get tickets for you, if you didnt tell them how to do it. Or a lawyer.

Thinking about servant v. independent contractor problems: Principals dont control independent contractors because that would be inefficient. And the law doesnt want to impose tort liability on principals for torts of their independent contractors, because then principals would demand control. Also, independent contractors tend to work for employers part-time, so it doesnt make sense to hold employer liable. For instance, why isnt Kelloggs cereal liable for a Star Market slip-and-fall? Because Kellogg isnt the least cost avoider. You want to hold responsible the least cost avoider. Ask the questions: Who bears the risk of loss? Who controls the day to day operation? If the principal bears the risk of loss, more likely the court will find master/servant relationship and tort liability. HUMBLE OIL V. MARTIN The court found a master-servant relationship, and thus tort liability on Humble where Humble bore most of the costs of operation and controlled hours, furnished advertising (lease charged Humble with of the costs). The court here looked at the substance of the agreement. They looked at the factors of financial control (who pays the operating cost?), who owned the title on the merchandise/assets, who sets the hours, whether reports have to be filed. Compare with HOOVER V. SUN OIL, where the court found Barone was an independent contractor because Sunoco didnt have the same tie into the investment. Barone didnt write report, he set the hours, he assumed the overall risk of profit or loss. The equipment was owned 50/50 Barone and Sun Oil. He used Sun uniforms, went to Sun School, and got visited by Suns sales rep.

In HOOVER, unlike HUMBLE, the principal didnt share in the risk of loss, so they didnt share in the control, so no liability. BILLOPS V. MAGNESS CONSTRUCTION - examines the day-to-day control of a business of a franchisee to see if the agency relationship exists. Do you know from any part of the franchisee that youre dealing with anyone but the franchisor? Tort liability for servant agents: Principals arent liable for all torts of servant agents. The tort must be in the scope of employment. The factors of whether its in the scope of employment: Is it the kind of conduct the servant should be doing? Is it substantially at an authorized place or during an authorized time? Is it motivated at least in part for purpose of benefiting principle? If theres force involved, it has to be foreseeable. So if its not foreseeable, theres no liability. Principal is liable for detours, but not frolics. A detour would be an agent goes out of his way to get a sandwich to work through lunch (this would benefit principal). A frolic is a detour not for benefit of principal. (Going out of his way to get concert tickets). If they are returning from a frolic, I guess they are now benefiting the employer, and the courts have come out both ways as to liability. BUSHEY V. US Navy seaman comes back hammered and floods a dock. The court says that the government has to pay, because this is related to him being a seaman, plus its foreseeable. Here it was foreseeable that crew members crossing a dry dock would do damage, negligently or intentionally. It is immaterial that the precise action of the seaman was not forseen. MANNING V. GRIMSLEY Fans are heckling pitcher at Fenway, and he chucks a ball at them. The court finds that the heckling had the affirmative purpose to rattle pitcher so he couldnt perform employment duties successfully, and therefore was within the scope of employment and the Orioles could be held accountable. ARGUELLO V. CONOCO Court finds no agency between store clerk who discriminated and Conoco by examining the agreement between Conoco and the franchisee and seeing a lack of control. One the scope of employment question, they run it through the factors above and say that clerk wasnt presumptively outside the scope of employment because she acted in such an irrational and heinous manner (hurling racial insults at customers). The court lays out some extra factors: Extent of departure from normal methods, and whether the master would reasonably expect such an act. HYPOS for servant tort liability problems: (1) A cook throws a cat out of a cafeteria and it falls on some jewelry. Is the cafeteria liable? Yes, because this something hes supposed to do.

(2) Bouncer at a bar throws out a patron and uses a chokehold, which hes not supposed to use. Force is used, so is it foreseeable? Yes, so the bar is on the hook. Prohibiting force will not allow you to escape liability. (3) A mopper at a restaurant does a bad job and someone gets hurt. The restaurant doesnt escape liability because their agent did a poor job. Omission of doing things that employee was hired to do does not let employer escape liability. Agent versus sub-agent: You have a situation where Joe is CEO of Discount. Sally works at Discount. Sally is Joes agent. Discount hires Deloitte run by Funboy. Discount is Joes agent, but not his servant. Deloitte hires Bill. Bill is Funboys servant, and probably Discounts agent. When Discount hires Deloitte, they probably authorize Deloitte to hire others, who would be sub agents of Dicount. If Discount told Deloitte, dont hire Bill, and they did anyway, Bill isnt Discounts agent. But he is Deloittes agent. (3) Characteristics of agent/principle relationships (1) The ability of the agent to bind the principle/make the principle liable. (When is the principal liable for the agents acts?) On agency problems, go through these and see if you can find any of these types of authority) See below for definitions. o (1) Actual express authority o (2) Actual implied authority o (3) Apparent authority o (4) Inherent agency power o (5) Ratification o (6) Estoppel (2) Agents owe principals fiduciary duties. They are: (1) the duty of loyalty and (2) the duty of care. These duties are waivable. Duty of loyalty Agent cant deal with the principal as an adverse party in a transaction thats within the scope of his agency. (No side deals). You have to tell principal all facts that would affect his judgment. So theres a duty not to make secret profits (even when theres no harm, you have to disclose profits to principal. (You buy a book for principal at discounted price. You have to sell book to principal at discounted price, or tell the principal what you paid for the book). READING V. REGEM Principal is entitled to the unauthorized gains of an agent. It doesnt matter if the principal hasnt been harmed, or that the principal couldnt have profited himself. o So, if the assets of which he has control, the facilities which he enjoys, or the position which he occupies are the real cause of the agent getting the money, then he is accountable for it to his master. Duties on termination of the relationship. TOWN & COUNTRY V. NEWBERY Court finds liability for appropriating customer list, even though departing employees didnt contact customer until after leaving. Court says that customer list/preferences took a lot of effort and expenses to put together. Centers on fiduciary relationship. If unrelated 3rd party

followed a team around, then approached their clients, that would be fine. An employee can make arrangements to compete after they leave, but they cant use confidential knowledge from their last job. Duty of care a negligence standard. Act with standard skill and care. (1) Actual express authority When the principal expressly tells an agent to go out and do something. EX: A, go out and buy AOL Time Warners cable business. (2) Actual implied authority You look at the relationship between the agent and the principal. EX: To negotiate a deal, A needs a hotel to stay in. They can book this under actual implied authority, because part of the job of negotiating a deal is to stay in a hotel. MILL STREET CHURCH V. HOGAN Church hires guy to paint church, and he hires his brother as in the past. Brother falls and wants workers compensation. The court finds implied authority, as the guy had the authority to hire someone to help him. The hiring was incidental/necessary to the job. (3) Apparent authority If the principal engages in conduct that leads a third party to reasonably believe that the agent has authority, then the principal can be bound. So, you have to look at the relationship between the principal and the third party. People are entitled to rely on your public representations. EX: Principal says to third party: A has our full authority. Then principal says to agent: Dont buy this land. Then the agent buys the land from the third party. Principal is liable under apparent authority. An agent can create his own apparent authority if he makes statement to a 3rd party that is true at the time made. (EX: Guy says go buy this land. The agent says to 3rd party: we want this land. Then the guy says he doesnt want the land. But the 3rd party comes back and accepts. Here the agent made his own apparent authority). 370 LEASING V. AMPEX Joyce offers to buy from Ampex. Kays had apparent authority to accept Joyces offer, because Joyce was reasonable in believing Kays was an Ampex agent because Kays is an AMPEX salesman. (Kays was held out as having authority to close sales). LIND V. SCHENLEY INDUSTRIES Kaufman makes statement to Lind that he would get raise. Company caused Lind to believe that Kaufman had authority to offer raise because they said Kaufman would tell him his salary, and Lind was justified in assuming Kaufman had the authority. Reliance must be reasonable. (Dissent says look at the industry custom). (4) Inherent agency power A situation where a general agent binds a usually undisclosed principal to contracts that are within the usual scope of authority of agents of the same type, even where the agent has neither express authority or apparent authority. (Thus, this isnt based on manifestations of a principal, nor the principals consent.) EX: Joe buys pub from Larry, but lets Larry still manages it under Larrys name. Joe says dont buy booze from Fritz. Larry still does, and runs up huge debts to Fritz. Since Larrys pub is a bar, they commonly buy booze. Joe can still be held liable for Larrys debts.

The theory behind inherent agency power is that the risk of loss caused by misbehaving agents should fall on the principal, rather than unknowing 3rd parties. This is the power of an agent that derives solely from the agency and exists for the protection of 3rd parties. A general agent can bind the principal, so long as acts are things that usually accompany/are incidental to usual conduct of general agent, and the 3rd party doesnt know the agent doesnt have authority. (General agent=someone who doesnt need to get reauthorized for every action, versus special agent). Inherent agency power can also apply when an agent acts purely for his own purposes in entering a transaction which would be authorized if were done with the proper motive. WATTEAU V. FENWICK Principal buys bar, but the same guy still runs it. The supplier didnt know that principal didnt let him buy cigars. (Theres no actual authority, and no apparent authority because supplier didnt know about principal). Supplier is able to recover from principal. KIDD V. EDISON A singer sues Edison, because she thought that she was being signed for a full tour by Fuller, by Edison told Fuller that he should only sign her for what retailers would pay. Fuller is a general agent with inherent agency power. But its industry custom to sign up for a full tour (a way to find apparent agency). But old-school Hand doesnt want to use apparent authority (because Edison made no representations to singer). NOGALES SERVICE CENTER V. ARCO General agent case. (5) Ratification When an agent does something without authorization, but then the principal says, ok, good job, lets do that contract. The principal can also do something that indicates manifestation after the fact. You can have either (1) express ratification or (2) implied ratification (a harder issue). Elements: You must have someone purporting to act on behalf of principal. There is no authorization. Principal could have authorized action. There must be acceptance (express or implied). Principal must have all information about crucial aspects of the contract (BOTTICELLO). Principal must ratify all or none of the contract. BOTTICELLO V. STEFANOVICZ a husband leases a piece of land he owns with his wife. The court doesnt find he was acting as her agent, and so theres no ratification. For it to be ratified, its not enough that she receives proceeds from the deal, the deal had to be done originally for the benefit of the principal, and here there was no agency. (6) Estoppel Consider the HODDESON V. KOOS BROS case, where customer was bilked by a guy pretending to be a salesman in a store. The court held the store liable, 6

because a reasonable person would have thought he was an agent, and the store owner shouldnt be able to use the imposters lack of authority defensively to avoid liability. Agency Situation Examples: When is someone an agent? Look for the necessary fiduciary duties. Principal has a plumber and a stockbroker. Principal tells plumber to fix his pipes, and tells the broker to build a portfolio. In both situations, the principal isnt telling the person how to do the job. The broker is an agent, but the plumber isnt. Why? Must consider fiduciary duties. The brokerage industry cant work without people being able to trust their brokers through fiduciary duties, trusting that theyre not going to steal or be negligent. It doesnt make sense for a plumber to have the same fiduciary duty. Doesnt turn on the specifics of the situation, its only an agency relationship if it makes sense to classify the relationship this way. (Here it makes sense because in order for the broker-principal relationship to function, you need fiduciary duties.) Look at it backwards to forwards. If consequences of liability/fiduciary duty make sense, then the court will tend to find agency. Theres good reason have a fiduciary duty with your stock-broker, but not really with your plumber.

PARTNERSHIP
Basic Introductory Principles The law of partnership, which describes the economic relationship among the partners, is geared to the needs/circumstances of small firms. (Typically theres a personal relationship between the partners). Control follows risk: if someone stands to loose money in the partnership, theyre going to want some share in control over the business. Once parties agree to share in gains and losses and in control, they become partners. Partnership, with the Uniform Partnership Act and Revised UPA, is now statutory. The UPS/RUPA also set out relationships between partners and third parties that are generally mandatory. FORMATION OF A PARTNERSHIP What is a partnership? Basic requirements of a partnership is that 2+ people agree, explicitly or tacitly, to share in (1) profits and (2) control of a business. Under the UPA, profit sharing is prima facie evidence of partnerships, but splitting receipts is not. This is because caring about profits means you care about expenses, and that means you care about management and control. If two people are found to be partners: Each partner can enter into contracts for the partnership. All partners are liable for contracts entered into on behalf of the partnership 7

All partners are liable for negligence of other partners acting in the course of business.

FENWICK V. UNEMPLOYMENT COMPENSATION COMISSION Concerns the existence of a partnership or not. (Partners versus employees.) They consider the (1) intent of the parties, (2) whether theres sharing of profits and losses and (3) control of partnership property. The court finds no partnership because the element of co-ownership is lacking. Here theres profit sharing, which under the UPA is prima facie evidence of partnership: it can be rebutted by short swing it was payment for employment. Other factors include: ownership and control of property, language of the agreement, conduct to 3rd persons, rights upon dissolution. The burden of proving a partnership is on the party alleging its existence. MARTIN V. PEYTON Concerns the distinctions between partners and lenders. People (here called a trustee) lends a partnership a large amount of money and is entitled to a large percentage of profits. The trustees have veto power over some decisions, but cannot initiate transactions, and they cant bind the firm. The court says this a case of degree, and they think a partnership didnt exist. The clear intent of the parties was not to be partners. The profit sharing was in a set range. But there is profit sharing. Partnership by estoppel It is possible to create a partnership without intending to or knowing about it. Someone who represents himself or allows another to represent him as a partner is liable to anyone who accepts this representation. YOUNG V. JONES Plaintiffs gave invested in company that was audited by Price Waterhouse Bahamas, who didnt realize the company was a fraud. The plaintiff argues that PW holds itself as a partnership worldwide, and the audit letter only says PW. The court says theres no partnership, because control and profits are separate. The court says that the plaintiffs didnt rely on PW partnership representation when they invested. Partnership by estoppel requires reliance. FIDUCIARY DUTIES OF A PARTNERSHIP Fiduciary duties of partners Partners owe a principle of fairness to each other: the fiduciary duty. The principal is vague. Duty of loyalty o You have to give the partnership all the benefits that you get from working with the partnership. o You cant work against the partnership with someone that has an interest adverse to the partnership. o You cant compete with the partnership before its dissolution. (But you can make logistical plans on your 8

Duty of care o You have the duty of care: limited to refraining from grossly negligent or reckless conduct or intentional misconduct/law breaking. There seems to be a lower standard of fiduciary duty in a law firm context. (Partners can leave and then have their clients decide who they want to do their work).

In other words, the basic duties are: (1) A partner has to account for any profit acquired in a manner injurious to the partnership, like commissions or purchases. (2) A partner cant acquire for himself a partnership asset or divert to himself a partnership opportunity (3) He cant compete with the partnership within the scope of the business. MEINHARD V. SALMON Here Cardozo articulates a fairly high standard of fiduciary duty. Two men split a long-term lease on a hotel, but Salmon gets more profits because hes the manager. A renewable option comes up, and Salmon takes it himself. Cardozo says you cant do that because he came across this opportunity as a result of the partnership and his position within the partnership. It might have been OK if he had heard about it in another context, but probably not. Dissent says this is outside the partnership context. (Partnership was only to run this hotel). Depends on how you structure the fiduciary duty. Here Cardozo is using the nexus of the relationship test, which represents the strictest view of fiduciary duty. BANE V. FERGUSON Bane gets a pension as a retired law firm partner. The other partners run the firm into the ground, and he sues, saying they violated their fiduciary duty to him (duty of care) by being negligent in mismanaging the firm. Posner says that you dont owe a fiduciary duty to your former partner. Also, the duty of care is gross negligence, not just a normal negligence standard. The business judgment rule applies here. He contracted with the firm saying if the firm dissolved, they wouldnt sustain liability. Posner is holding him to what he negotiated. This is in strong contrast to the MEINHARD case. MEEHAN V. SHAUGHNESSY Two partners are leaving a law firm. They want to take clients with them. They are held liable for the manner in which they took them, not that they took the clients. You have to give your clients the opportunity to stay with the firm, and here the partners didnt explain to the clients that they could keep their business with the firm. How did they breach their fiduciary duty? Didnt notify their clients properly. They messed with their cases before they moved them, ie. not settling them before they moved them. (screwed over the old firm). Sending out notices to clients/planning the new firm on the old firms time. (But its not a problem to prepare to compete while still working for another partnership).

LAWLIS V. KIGHTLINGER & GRAY A lawyer hits the bottle again after his firm says no more second chances. They give him a chance, but after he comes back clean they later want to kick him out. He had signed an agreement allowing for not-for-cause dismissal. The court found no fiduciary duty breach. They basically just enforced the contract. This is a different conception of fiduciary duty, equating it more with contractual duty (they just give Lawlis what the contract asks for). These are highly sophisticated parties. Essentially the court is saying the fiduciary duty is only what you have from the contract. Summary: MEINHARD says you have to be good to the partnership, but it was probably wrongly decided. BANE and LAWLIS show that courts will enforce a contract. CONTROL OF A PARTNERSHIP (1) Partnership property (2) Management of partnership (3) Agency of partnership (4) Liability of partnership Unless otherwise agreed, all partners have equal rights in the management and conduct of the partnership business. UPA 18(e). Majority vote, one partner one vote decides any disputes. o Any difference arising as to ordinary matters connected with partnership business may be decided by majority votes of the partners. UPA 18(h). But the majority doesnt have the right to do anything that goes against any agreement between the partners unless its unanimous. o For example, the majority doesnt have the right to reduce a partners stake over his objection. o Also, if the partnership agreement limits the scope of the business, no changes in scope are permissible without the consent of all the partners. Considerations: If a partner with substantial personal assets objects, then they can leave the partnership. But more likely they would want a veto over some or all partnership decisions. For larger partnerships, a small group of partners typically is entrusted with the decisionmaking. (1) Partnership property The general rule is that the partnership owns property, and the partners own interest in the partnerships property. PUTNAM V. SHOAF A lady sells her part of the partnership in a seemingly unprofitable enterprise. Turns out the bookkeeper was stealing, and she now wants a piece of the found $68,000. (She would have sold for more, and it was her that was defrauded). The court says

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no. The right to use/possess/benefit from property of the partnership only comes by being in the partnership because it is the partnership that owns the property. This effect works the other way. If she sold and a host of new liabilities are found, then she wouldnt be liable either. (Same principle that if you sell land and then they find oil). (2) Management of partnership Absent an agreement to the contrary, all partners have equal right to manage and control the partnerships business. Any difference in opinion arising to ordinary areas of the partnership business can be decided by a majority vote of partners. NATIONAL BISCUIT V. STROUD Theres two partners, so theres no possible majority, and partners are still able to bind each other. The default rule is in the absence of a majority, all parties have an equal right to manage and control, and only a majority can restrict a partners authority. SUMMERS V. DOOLEY Summers wants to hire an additional employee, Dooley doesnt. So Summers pays the employee out of his own pocket, and then sues to collect half of his expenses from the partnership. He argues that even though Dooley didnt consent, he retained the profits created by the employee and he ratified it. The court says no. Dooley didnt sit idly by while all this happened. It would be unjust to make him pay for an expense incurred individually and not for the benefit of the partnership but for the individual partner. DAY V. SIDLEY AUSTIN Sidley Austin has an executive committee that has the power to merge with other firms. (This is a very highly centralized partnership structure, as set out by the partnership agreement, and partners can structure their relationships anyway they want). Sidley Austin has decided to delegate decision-making this way, and that is their prerogative. The court defers to the agreement when sophisticated parties are involved. (3) Agency of partnership Every partner is an agent of the partnership, and the act of every partner in the usual business context binds the partnership. (The scope of business is a factual determination). If someone is held out by the partnership as a partner, they have apparent authority, even if the partnership has agreed they arent going to be agents. The partner has the power to bind the partnership only in the scope of business. If power to bind is eliminated or reduced, it is only effective if its told to the person doing business with the partnership. (4) Liability of partnership Each partner is personally liable for the full amount of partnership debt. Some states have created limited liability partnerships (LLC) to protect partners from personal liability. PARTNERSHIP DISSOLUTION (1) Duration of Partnership (2) Transferability of Partnership

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(1) Duration of Partnership A partnership ends when one of the partners dies. Any partner has the right to bring about a discontinuation of the partnership. Winding up is the process of producing a cash fund to pay off partnership debts. This can be accomplished through: A going out of business sale (sell all assets). Sell the business as a going concern to an outsider. Sell to all the other partners. Sell to one of the other partners. A partnership agreement can include a duration of the partnership clause. Under partnership law, a partner is allowed to withdraw, even if his withdrawal violates the partnership agreement. But there are consequences: The other partners can either wind up the business or continue to operate the business or defer payment of his share. o Wind up: they liquidate assets, money is distributed to partners according to their shares. The withdrawer gets his share, but he is liable to the other partners for damages caused by his wrongful withdrawl. o Continue: Withdrawer is no longer liable for debts incurred after his withdrawal, though debts before withdrawn are still on him. He gets his interest, but no goodwill, and his interest is reduced by damages hes liable for by virtue of his breach. o Defer payment: they can continue to use the partnership property and not pay the withdrawer his share until the end of the agreed-on duration, but they have to post a bond to guarantee payment to the withdrawer and to protect withdrawer from creditors for pre-dissolution obligations. These can be avoided by continuation agreements or buy-out agreements. With buyout agreements, the issues are: (1) trigger events, (2) option to buy versus obligation to buy, (3) price, (4) method of payment, (5) debt protection. Fiduciary duties in dissolution: (1) each partner has a duty to wind up and complete the unfinished business of the dissolved partnership. (2) no former partner may take any action with respect to unfinished business which leads to purely personal gain. G&S INVESTMENTS V. BELMAN One partner becomes incapacitated and later dies. Plaintiff (estate) argues that filing suit dissolved the partnership, but the defense says that when he died, they could kick him out under the partnership agreement. So if suit dissolves it, then they use the standard method of determining the amount his share is worth, which is fair market value. The agreement (applies if it dissolved when he died) says they use his capital account. Court sides with defense because if suit dissolved partnership, whats the point of the suit?

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The advantage of using capital account measure in terms of partnership agreements is that its easier to determine (fair market value requires appraisers, accountants and lawyers). JEWEL V. BOXER Splitting up the assets of a law partnership. The UPA default rule for splitting up cases is that fees from cases in progress at dissolution are split up according to each partners share of the former partnership, even if a partner is substituted for the partnership as attorney of record. Attorney salary and overhead costs can be deducted from this. The policy keeps lawyers from fighting over best cases at dissolution. But it also can encourage neglect to pre-dissolution work (youre only getting part of a share), but theres fiduciary duties to cover that. MEEHAN V. SHAUGHNESSY (PART 2) Lawyers take clients away from old firms. In accordance with the agreement, the lawyer had to pay any expenses that the old firm incurred before the client leaving. For those clients taken improperly, the court applies the default UPA rule. (2) Transferability of Partnership The idea behind partnership is delectus personae (choice of person), which means you pick who you want to work with. That said, partnership interests arent transferable; a person cannot substitute another person for himself without the consent of all the other partners. (Of course this can be modified by the parties). Partnerships and Corporations Compared: Partnership Unlimited Liability {Not really big deal; can just buy insurance for partnership. K creditors, can just make Ks under which you are not liable}. Not Freely Transferrable Default rule that partnerships need unanimous consent know that partnerships contract around this all the time. Limited Life Ends any time one partner quits. Can contract around this, put in clause that partnership survives. Flexibility Infinitely flexible Management Decentralized but in reality, large law firms do not have majority votes, power gets centralized. Corporation Liability Limited to money invested. Attractive to someone who is trying to cabin liabilities Conversely, for small corp., have to personally guarantee debt. Freely Transferable Default arrangement that you can buy and sell corporate shares. {But can limit transferability of corporate shares}. Unlimited Life Endures forever formally, but in real life corporation lives with people. With a little work, corporations can be flexible too. Centralized can certainly make arrangement uncentralized.

PRELIMINARY CORPORATE ISSUES

Introduction and Basics

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(1) Why we want corporations The corporate form is attractive to people who want to passive investments, because: (1) Investors in corporations have limited liability. (2) Equity interests (shares) have a secondary market and are liquid (3) Corporate law is a model form contract with little modification required, so shareholders dont have to negotiate at the outset. (4) Centralized corporate management means people can manage through agents (managers), dont have to worry about another shareholder binding the corporation. (2) The basic corporate structure The structure concerns three groups: Shareholders own residual/equity interest in corporation (after creditors). They have no liability for the debts of corporation. Shareholders control corporation only by electing directors. Directors responsible for hiring/firing officers. Officers responsible for the day to day operations of a corporation. Theres broad delegation of authority here, from shareholders through directors to officers. The shareholders cant control day to day operations. This delegation is protected by the business judgment rule. (3) Formal formation of a corporation You want to incorporate. So you pick a state to incorporate in (which states laws you want to apply to you). You file the Articles of Incorporation (the Charter) with the states Secretary of State. It doesnt say the type of business you want to do (it may change), it does say how many shares youre authorized to issue, and the par value. This is hard to amend because it needs the majority of the directors and the majority of the stockholders You also make the bylaws, which says where youll have your meetings, how many officers, etc. Needs a majority of either the board or the shareholders to amend. Limited liability and its exceptions (1) The definition of limited liability and piercing the corporate veil (2) Distinction of tests applied in torts and contract cases (3) Methods for piercing the corporate veil: (1) The definition of limited liability and piercing the corporate veil Limited liability means shareholders are not liable for debts incurred in the operation of the firm. (Losses limited to amounts invested in corporations). It is the corporation that incurs the debts. Exceptions usually relate to misuse of the corporate form.

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Piercing the corporate veil means holding shareholders liable for debts of corporation even though they havent agreed to accept liability. Shareholders are in danger of personal liability for debts if they: Use the corporation for fraudulent purposes, or injustice requires the veil to be pierced. Injustice doesnt mean uncollected judgment, but it can include unjust enrichment. They themselves disregard the separate character of the corporate entity. o (1) Failure to maintain corporate records/comply with formalities o (2) Co-mingling of assets o (3) Undercapitalization o (4) One corporation treating the funds/assets of another as its own. (2) Distinction of tests applied in torts and contract cases Both elements are needed in a contract case (see IN RE SILICONE): unity of interest such that the separate personalities of the individual (or other corporation) and the corporation, and adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. In a tort case (see IN RE SILICONE), you probably dont need the second prong. Gross undercapitalization, by itself, is not enough, to pierce the corporate veil and find shareholders liable. (3) Methods for piercing the corporate veil: Corporation is part of a larger corporate combine that is doing business. Pierce the veil to hold the larger combine liable. Corporation is a dummy for individual stockholders. Pierce the veil to the individual stockholder. WALKOVSKY V. CARLTON Plaintiff is injured by a taxi owned by Carlton. Carlton owns a bunch of different cabs, and each two cabs is a separate, undercapitalized corporation. All of the cash from each corporation has gone up to Carlton. Its not enough that the corporation was set up to avoid liability. Thats why corporations are often set up. Theres no evidence that Carlton is doing business in his own capacity, shoveling funds in and out of the corporation. Hes taking money out as dividends. Formalities are important here. The court says Carlton isnt liable; its up to the legislature to demand higher minimum insurance for taxicabs. In practice, courts are more willing to recognize limited liability against individuals than against corporations. SEALAND V. PEPPER SOURCE Marchese, owner of Pepper Source and a few other corporations, makes arrangements with SeaLand to ship peppers, then dissolves the corporation to stiff SeaLand. SeaLand sues all of Marcheses corporations and him. (Theyre able to go after his other corporations because theyre all just extensions of him, too).

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The court examines the corporations, and finds that Marchese has completely disregarded the corporate entity, shuffling funds in and out, co-mingling assets etc. No question the unity of interest prong is satisfied. Sea-Land says not piercing would promote injustice (the second prong). This means something less that an affirmative showing of fraud. This does not just mean an uncollected judgment (which would collapse this prong of the test). This means that some wrong, beyond a creditors inability to collect would result: unjust enrichment, intentional scheme to heap liabilities on asset-poor corporation. (On remand they find injustice/fraud prong because Marchese lied to Sea-Land). IN RE SILICONE GEL BREAST IMPLANTS PRODUCTS LIABILITY LITIGATION (Fake titties). This case concerns subsidiary corporations. Bristol Myers is the sole shareholder of MEC (a wholly owned subsidiary). When corporation is so controlled to be the alter ego of its stockholder, the corporate form may be disregarded if justice needs it. Theres substantial domination of MEC here by Bristol. They have: Same board of directors (not a problem if everyone wears the correct hats) Consolidated tax returns Bristol paying for legal services, accounting and product testing, and not charging for it. Fraud? Theres no fraud, but this is a tort action, so we dont worry about fraud. (Would worry about it in a contract context). Delaware law doesnt require it if the first prong is found. o Distinction between contract cases and tort cases in requiring the second prong. (In contract cases, the injured party could have asked for assurances from the parent. In tort cases, the injured party couldnt do that). o Formalities and fraud matter in a contract case, because people choose who to do business with. They can look at the formalities that have been undertaken. But if the creditor is tricked, then thats another matter. o Undercapitalization matters more in tort cases. You dont choose your tortfeasor. But a creditor can see if a firm is undercapitalized for itself. (Unless theyre tricked). The real kicker in this case is that Bristol held itself out as supporting the product in order to increase the confidence in it. It now cant its responsibility after doing that. Derivative suits (1) What is a derivative suit (2) Derivative suits versus direct claims (1) What is a derivative suit As a legal entity, corporations can sue/be sued. A derivative suit is when a shareholder sues over a corporate officials violation of duties he owes the corporation. But the lawsuit is

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the corporations right (shareholder derives the right to sue from the corporation) because it is the corporation that has been harmed, and any recovery accrues to the corporation. Therefore, the derivative suit is a two-part suit. The shareholder sues the corporation to force them to sue a third party. This is because the board decides whether to pursue the suit, under the business judgment rule that the court will defer to. If the board is disinterested, the court will say thats a business judgment call and defer to the board. But if the board has a conflict of interest (as in theyre one of the people to be sued, and they dont sue), then the shareholder has the right to challenge that conflicted decision. If the plaintiff wins, the corporation pays the plaintiffs legal expenses (the shareholder has benefited the corporation). Because they have been abused by plaintiffs attorneys, derivative actions are subject to special rules now, generally making it harder to sue derivatively. (2) Derivative suits versus direct claims A direct claim would be if an officer goes to the corporate shareholder list and screws you out of your shares (the loss is to the shareholder directly), and the recovery goes to the shareholder. The way to distinguish is ask the question if the action affects the stock price. If yes, then its a derivative suit, and the recovery goes to the corporation). A loss of voting capacity or to enforce dividend payments is a direct claim, while a duty of loyalty or a duty of care claim is derivative. EISENBERG V. FLYING TIGER Concerns the difference between a direct claim and a derivative claim. As the result of a reorganization/merger, a guy now has stock in a holding company rather than the company itself. He claims his voting rights have been harmed. Court says if the injury is to the corporation, thats derivative, but if its to the individual stockholder, thats direct. The role and purpose of the corporation (1) Corporate philanthropy Corporations can make donations if the corporation benefits as a result of goodwill. (Dont really hinge on goodwill argument, which would knock out anonymous donations). Most states have statutes allowing for corporate donations, but they vary in how they need to be justified by the profit motive. (This obviously concerns which state you incorporate in). This information can also be placed in the corporate charter/bylaws. SMITH V. BARLOW A shareholder sues trying to block a donation to Princeton. The court upholds the donation, saying its business judgment (theres no fiduciary duty violation). This case might be different if corporate officers are getting kickbacks from the university like football tickets. This can be justified by (1) the world is a better place for it (Court doesnt consider this) and (2) its good PR (which knocks out anonymous donations).

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(2) The profit motive If youre running a corporation, youre holding money in trust for shareholders, and you need to use that money to make more money, your avowed purpose. ALI Principle of Corporate governance: Corporation should conduct business with view to enhancing corporate profit and shareholder gain. The corporation can account for ethical considerations and devote reasonable resources to philanthropy. DODGE V. FORD This is an unusual case, because the court forces the company to issue dividends. Ford decides not to issue dividends that year, and Dodge brothers sue. Ford wants to raise wages and expand the business instead. (He might be trying to not feed Dodges competitor business with Fords dividends). The court construes Fords plan as a charitable one, and says he cant run the business that way because its not all his money. (He admitted in court that they are making too much profit). This case is cited for the principle that corporations should be making money (not cited for forcing dividends). This case is just beyond what is acceptable. SHLENSKY V. WRIGLEY Plaintiff is a minority shareholder in the Cubs. Wrigley doesnt want to play games at night because he says baseball is a day game, even though night games would be more profitable. The court says unless theres a showing of fraud, conflict on interest, illegality or negligence, its business judgment rule. (Hypo: if Wrigley owned 80% of the Cubs and 100% of the White Sox, that would be a conflict of interest and Wrigley would lose for screwing his minority Cubs shareholders.)

FIDUCIARY DUTIES
The fiduciary duties are the duties of care and loyalty. If you meet your duties, as in you make your decision without Fraud (duty of loyalty) Conflict of interest (duty of loyalty) Illegality (duty of care) Negligence (duty of care), The court will apply the business judgment rule and defer to your decision. (The duty of loyalty and the duty of care are procedural prerequisites to the business judgment rule). So these duties are more about the process of making the decision, rather than the decision itself. Policy reasons for wanting it this way (applying the business judgment rule): Its in the shareholders interests for the directors to accept reasonable risks (which not applying the BJR could chill). Courts are bad at evaluating the risk/return calculus that directors/managers face Directors cant spread out their liability across firms. (1) The duty of care (2) Active versus passive negligence and the duty of care

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(3) The duty of loyalty (3a) Corporate opportunity doctrine (4) Dominant shareholders and fiduciary duties (5) Ratification (1) The duty of care The duty of care means that corporate officers and directors are expected to perform duties with the ordinary care someone would exercise with their own money. It is the skill, diligence, and care that a reasonably prudent person would exercise it similar circumstances. The duty of care seems to create a negligence-based liability to the corporation that can in theory be enforced by derivative action. But the cases where liability has been found, corporate officials have been suspiciously inattentive to an impending disaster where the court thought there was a conflict of interest. So the reality may be that courts will impose liability only when they think the official had a hidden conflict of interest that explains why his behavior was knowingly inattentive. It can be viewed as an agency relationship, with the shareholders as principal and the directors as agents. KAMIN V. AMERICAN EXPRESS AmEx bought a bunch of stock in a company, which later tanked from $30M to $4M. So they give the stock out as a dividend, which pisses off minority shareholders because they could have sold the stock at a loss and had tax savings. (Shareholders have to pay taxes on the dividend). The Board decides to do this to help keep AmExs stock price up. The board meets all its fiduciary duties in this case, so the court applies the business judgment rule. It was just a bad decision, and negligence isnt shown by showing another course of action is more profitable. The shareholders complained so the Board discussed it, gathered information, just as they should. A possible problem: 4 of the 16 directors had compensation tied to stock price. The court says thats not enough to dominate the board. This isnt sufficient to cast doubt on the business judgment. BREHM V. EISNER Ovitz gets a fat severance package. Decide whether they should hold members of board personally liable to the corporation for lack of due care. (1) That the old board approved a severance package and never calculated how much it would cost in total (a violation of due care). But theres a presumption that the old boards actions were a proper exercise of business judgment, and the protection for a board that relies in good faith on an expert advising the board. o Ways around this: (1) didnt rely on the expert, (2) their reliance wasnt in good faith, (3) they didnt reasonably believe the expert was competent, (4) expert wasnt selected with care.

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o Think about the waste test: an exchange so one sided no business person of ordinary judgment could conclude the corporation received adequate compensation. o The size and structure of executive compensation are inherently business judgment matters. Board is responsible for considering only material facts that are reasonably available. (2) That the new board fired Ovitz without cause, wasting money by making them pay out even more. The new board didnt want litigation over this, and thats business judgment (Complaint dismissed). FRANCIS V. UNITED JERSEY BANK Old drunk lady is found liable for breaching duty of care for missing that her two sons, also directors, were robbing the company blind. There is an objective standard of competency. If you dont meet it, then you shouldnt be a director. The court will look at size/nature of a corporation to determine the level of reasonable care. You need at least a rudimentary understanding of the business. (She cant use lack of understanding as a defense again, she shouldnt be a director in that case). If she had examined the financial statements, she would have known shit was fucked up. She should have been on notice. (Here she had a fiduciary duty to creditors because the company is bankrupt. Normally you only have contract duties to creditors). Affirmative duties of directors: (FRANCIS) (1) Acquire at least a rudimentary understanding of the business of the corporation. (2) Obligation to keep informed about the activities. (3) Maintain familiarity with the financial status of the corporation by a regular review of the financial statements. This review might give rise to further investigation. (4) Upon discovery of an illegal course of action, a director has a duty to object, and if the corporation doesnt correct the conduct, to resign. (2) Active versus passive negligence and the duty of care Liability can be put on the board of directors for active negligence (see above), or passive negligence, the failure to act in situations where due attention would have prevented the loss. For active negligence, if the decision rationally came, and was in good faith, then you apply the business judgment rule. As for passive negligence, without reason for suspicion, directors have the right to rely on the integrity of their employees. (Cannot be held liable for relying on employees). There should be an information/reporting system, that will assure that relevant information will reach the board. To find liability, there has to be systematic failure of oversight. A director is never able to vote for something illegal. (The law doesnt require you to maximize your profit, like a situation where you have independent contractor instead

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of employee truckers so they can speed. You are not required to do this to get around the law). IN RE CAREMARK INTERNATIONAL Company decides to pit directors of hospitals against each other for promotions. Leads to bribes to doctors for referrals. The board approved a settlement for $20M to make this go away. Shareholder sues derivatively. The court finds no director liability, because the directors werent breaking the law, just the people below them. (3) Duty of loyalty You have a decision made by a corporate official, or a transaction between a corporate official and the coporation. Theres either: No conflict of interest. Here the business judgment rule applies, and the burden is on the plaintiff to show waste. (Absent fraud/illegality/conflict of interest, the decision was so outrageous as to show waste). Waste is very difficult to show no reasonable person would think it was a good transaction. A conflict of interest. Theres either: o Disinterested ratification Youre right back to above, having to show waste. o No ratification The burden shifts to the defendant to show that the transaction was fair and reasonable. Conflict of Interest No Yes Yes Ratification by Directors N/A Yes No Burden of Proof Plaintiff Plaintiff Defendant Proof Waste BJR Fair and reasonable

(Notice the business judgment rule is yielding to the duty of loyalty. This is because the BJR assumes directors dont have a conflict of interest). It used to be shareholders could void any contract with a director. Now they can void only if its not ratified by a disinterested party and its not fair. (This loosens up a directors ability to steal but they are also allowed to make advantageous contracts.) This rule works against public companies because they dont need advantageous financing contracts (financing not a problem), but they are concerned about theft. To summarize, a directors self-dealing transaction (conflict of interest) isnt voidable if it is: Approved by disinterested directors after full disclosure of the conflict OR Approved by the shareholders after a similar disclosure OR Approved by a court as fair. BAYER V. BERAN The president of a corporation hires his wife to appear in advertisements. The question: is that a duty of loyalty violation? There is definitely a conflict of interest, but the director shows it was fair and reasonable (she was appropriate for the ad, she didnt cost too much, etc.). What should have happened: director should have disclosed the conflict of interest, left the room, and let the board vote on it.

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LEWIS V. SL & E Six children own SLE, and three of them own LGT. SLE leases land to LGT at below fair market value. The three owners of SLE that arent owners of LGT sue. There is a conflict of interest here, and no disinterested ratification. They were unable to show it was fair and reasonable. (3a) Corporate opportunity doctrine Per the American Law Institute Section 5.05 Definition of a corporate opportunity: (1) (Applies to both directors and officers): something you learn about at work, or something you learned about using corporate resources. (2) (Applies to executives, not directors): If its closely related to a business in which the corporation is engaged or expects to be engaged. (4) Dominant shareholders and fiduciary duties Generally shareholders dont have fiduciary duties to a corporation. But if youre a dominant shareholder, the court can impose fiduciary duties on you, in certain situations: When a shareholder dominates the board of directors (the directors are agent of the majority shareholders), and the director runs the corporation for the majority at the expense of the minority, you can impose fiduciary duties. Where a shareholder has direct involvement, they can be liable independent of directors. SINCLAIR OIL V. LEVIEN Sinclair owns 97% of a subsidiary, Sinven (operations in Venezula). Sinclair says apply the business judgment rule, plaintiff says intrinsic fairness. The court says Sinclairs relationship with Sinven must meet the intrinsic fairness test. For the court to apply the intrinsic fairness test, you need A fiduciary duty (applied here because Sinven isnt independent of Sinclair (all the directors are associated with Sincair)). Self-dealing, where the parent receives something from the subsidiary to the exclusion/detriment of the minority stockholders. And then you ask: is this fair? Intrinsic fairness means: A high degree of fairness A shift in burden of proof to the defense (In other words, Sinclair has to prove under careful judicial scrutiny that its transactions with Sinven are objectively fair.) A minority shareholder brings three claims: Sinven paid out too many dividends. The court says we have to see if theres selfdealing to apply intrinsic fairness. (Fiduciary duty prong met). The court says that

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since everyone got dividends in proportion to their shares, self-dealing hasnt been met. Sinclair took Sinvens business opportunities. No, says the court. The plaintiff cant show any business opportunities, and theres no self-dealing, so they apply the business judgment rule. Sinclair broke contracts with Sinven. Here theres self dealing, and Sinclair loses because Sinclair got products at a better price to the detriment of Sinven of the minority shareholders.

ZAHN V. TRANSAMERICA Stands for the principle that when youre a shareholder and voting as a director, you have to look after the interests of all stockholders, not just yours. (If theres a conflict between classes of stock, you have to favor the junior-most security.) (5) Ratification FLIEGLER V. LAWERENCE Only 1/3 of disinterested shareholders vote for something. Only a majority is needed according to the statute, but the court reads the term disinterested shareholder into the statute. The Delaware statute (144(a)) No contract between a corporate and one/more of its directors/officers is void or voidable if: (1) Director ratification: material facts are disclosed and the board has an affirmative vote of a majority of the disinterested directors, even though the disinterested directors are less than a quorum, OR (2) Shareholder ratification: material facts are disclosed and the contract/transaction is specifically approved in good faith by the shareholders, OR (3) The contract is fair to the corporation as of time it was authorized, approved or ratified, by the board, a committee, or the shareholders.

DISCLOSURE
(1) Basics and SEC requirements (2) Section 11 liability (1) Basics and SEC requirements The 1933 Securities Act is a disclosure statute, requiring large companies/those companies trading on the markets to disclose a bunch of information. Section 5 requires before a security is offered for sale: (Section 5) A registration statement (security cant be sold until the registration statement has taken effect after the SEC approves it). A prospectus (an abbreviated version of the registration statement) The SEC doesnt look at whether the security is a good investment, just that the necessary disclosures are made. Two types of exemptions under the act: Exempt securities in general, exempt securities never have to be registered. 23

Exempt transactions these are one-time exemptions: (1) transactions by anyone other than the issuer / underwriter / dealer or (2) transaction by an issuer not involving a public offering.

Definition of a security: investments in common pools where the return comes primarily from the work of others. (This is a very broad definition of a security). Policy objection to these requirements: No one can read the prospectus and get an idea of the risk involved. Investors would demand this information anyway. (2) Section 11 liability Under Section 11, individuals who work on these disclosures can be held liable for material misstatements in the registration statement and prospectus. Requirement for liability: The statements have to be material. Material statements are what an average prudent investor should be informed about before investing in a security. (Including, would he adjust the price paid for the securities?) The people that can be held liable under section 11(a): Everybody who signed the registration section Every director of the company issuing the security Every expert who certified part of the registration as having been prepared by them. Every underwriter. Section 11 divides registration statements into expertised and non-expertised portions. Defenses under Section 11(b): Expertised part of statement o Experts have the defense of reasonable belief and reasonable investigation (due diligence). o The statement doesnt represent the experts statement. o Non-experts will not be liable unless they have reason to think the statements in this section arent true. Non-expertised part of the statement o Experts have no liability for things they didnt work on. o Defense of reasonable belief and reasonable investigation. Lawyers are not experts for the purposes of Section 11(b) liability. ESCOTT V. BARCHRIS CONSTRUCTION Question of whether misstatements are material. 1961 numbers havent been audited, so the court says theyre non-expertised. Profits overstated were clearly material, but saying profits increase 275% instead of 256% isnt material. 11(b) defenses of individuals involved: Founders/owners/directors of the company are held liable. (Being dumb isnt a defense).

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Treasurer was found liable because he couldnt close his eyes to the facts and rely on experts to find it/sign off on it. The outside director is also liable, even though he never saw a finished registration statement. As a director, hes responsible for the figures because hes presumed to know when he becomes a director, and he should have checked the non-expertised version. (Reasonable investigation is expected of him) The lawyer/director should have checked these things that are easily verifiable.

WEST PRUDENTIAL SECURITIES (This cases deals with non-causation.) Hoffman is a bad broker, lying to everyone about Jefferson Savings being acquired. Suit is brought on behalf of everyone who bought Jefferson stock while Hoffman was lying, saying that his lies caused the price of the stock to increase greatly. Judge Easterbrook rejects the fraud on the market theory. He says that the price reflects information about stock, and since these were lies, people who price stocks would figure this out, because demand for stocks is perfectly elastic, and if the stock rose above the correct price, there would be no demand. Easterbrook is really trying to nip securities class actions in the bud. POMMER V. MEDTEST (material versus non-material). Medtest is selling securities, and tells a buyer that they have a patent for the process, when in fact that they dont (they get the patent later). The court looks at the question from an ex ante perspective and finds that Medtest can be held liable because had the investor known Medtest didnt have the patent, they would have paid less because the expected value of the company would be less.

INSIDER TRADING
(1) Rule 10(b)(5) (2) Basic model of insider trading (3) Who is an insider? (4) Tippee Liability (5) Temporary Insider Doctrine (6) Misappropriation Theory (7) Short-Swing Profits (1) Rule 10(b)(5) Insider trading is now mostly a federal issue, with Rule 10(b)(5) adopted in 1942. Its unlawful for any person, directly or indirectly, to (1) employ and device/scheme to defraud (2) Make any untrue statement of material fact or to omit a material fact necessary to not be misleading (3) engage in any act/practice/course of business which operates as a fraud in connection with the purchase or sale of any security.

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Overall, insiders cannot take advantage of information intended for internal corporate purposes. (2) Basic model of insider trading An officer/director with insider information must abstain or disclose. This means you either have to disclose the informationallowing it to be incorporated into the stock priceor abstain from trading in these securities. (TGS). Materiality requirement is very low for insiders. If youre trading on the material, its assumed to be material. SEC V. TEXAS GULF SULPHUR Mining company discovers minerals. They start buying up the land around the strike (not a problem). Before the company announces the strike, the directors start buying a shitload of stock. Two important holdings: (1) The TGS insiders violated 10(b)(5) when they traded on material non-public information (2) The corporation violated 10(b)(5) for issuing an inaccurate press release that caused some shareholders to sell their shares at an undervalued price. o This is because of the in connection with part of the statute. They didnt release it in connection with the purchase/sale of a security, but the court reads the statute as anything that will affect stock price. (3) Who is an insider? (1) Fiduciary duty approach Certain individuals at a corporation owe the shareholders fiduciary duties, and if they trade with shareholders on inside information, they violate those duties. The policy behind is that insider trading is a fraud because of the failure to disclose, and you only have to disclose to someone to whom you owe a fiduciary duty. But fiduciary duties are waivable, so shouldnt the ban on insider trading be waivable? CHIARELLA V. U.S. Defendant works at a printer and trades on tender offer information he gets as a result of his job. The Supreme Court said that his conduct wasnt a violation because he wasnt an insider. The court concluded that the duty to abstain comes from the relationship of trust between a corporations shareholders and its employees. Since the defendant didnt have a relationship of trust with the shareholders of the corporations whose shares he traded (the target of the takeover), he didnt have to disclose or abstain. Burgers dissent kick started the misappropriation theory, related to the level playing field approach. It argues that the defendant had violated a duty to the acquiring theory because he had misappropriated information. It didnt matter that he didnt have a relationship with the target, misappropriation was enough to equal a 10(b)(5) violation. (2) Level playing field approach A wider approach than fiduciary duty. We need to create a zone for trading where everyone has access to all information. This means that outsiders that trade on inside information are liable. This seems overly harsh. This will 26

inhibit stock research/analysis. If you want people doing stock research, you cant ban trades where one person has more information. Policy considerations: The fiduciary duty approach won out in CHIARELLA, but the SEC prefers the level playing field approach and they effectively overruled with 14(e)(3). (4) Tippee liability A tippee is only liable under 10(b)(5) when an insider breaches a fiduciary duty, as in, the insider personally benefits from the tip. DIRKS V. SEC Dirks receives inside information from an officer in a corporation that he had no connection with. He disclosed the information to investors, who traded on it. The court held no 10(b)(5) violation. Recipients of inside information dont always have a duty to disclose or abstain. We have to look at the source of the information, and see if the insider breached a fiduciary duty. o The test to see if the insider breached his fiduciary duty is to see if the insider personally benefits, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to the stockholders. o This case only looks at the duty of loyalty, narrowly interpreted. (In theory if you get inside information as a result of a duty of care breach, you couldnt trade on thatlike hearing bankers talking about a takeover target. But DIRKS seems to say otherwise, because those bankers arent getting a benefit). The court denies the SECs proposal that anyone who knowingly got non-public information from an insider has a fiduciary duty. (Court says this will inhibit analysts). (5) Temporary insider doctrine: temporary insiders versus arms length transactions If someone (1) enters into a special confidential relationship in order to do business with a corporation, AND (2) has been given access to information strictly for corporate purposes, he is a temporary insider with a fiduciary duty to the shareholders. (This includes underwriters, accountants, lawyers and consultants). DIRKS, footnote 14. For this duty to be imposed, the corporation must expect the outsider to keep the disclosed nonpublic information confidential, and the relationship must at least imply that duty. Arms length transactions: This doesnt apply if someone was approached as an outsider. DIRKS, footnote 22. EX: WALTON V. MORGAN STANLEY. Morgan Stanley investigates a company on behalf of its client for a takeover bid. During this, they get nonpublic material information of the target. After the takeover didnt go through, they traded on the information. It is assumed that MS knew the information was confidential. The court said MS got the information as a result of arms length negotiations, and there was no fiduciary relationship and thus no liability.

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(6) Misappropriation Theory The theory in general: any person who trades in securities for profit and uses confidential information misappropriated in breach of a duty to the source of the information, thats a 10(b)(5) violation. (As opposed to the classical theory of insider trading above). It premises liability on fiduciary-turned-traders deception of those who entrusted him with access to confidential information. The misappropriation theory seeks to protect securities markets against abuses by outsiders. This turns a lot of the time on the internal rule of the source. If getting/releasing of the confidential information is a contravention of an internal corporate policy or some other fiduciary duty, then its misappropriation. The theory started with Burgers dissent in CHIARELLA. In response to CHIARELLA, the SEC created Rule 14(e)(3), which said that if you trade on inside information from either the acquirer or target in a tender offer context, thats insider trading. (Doesnt matter how you get the information, or any duties owed to anyone). Rule later upheld in OHAGAN as reasonably designed to prevent fraudulent trading on material non-public information in the tender offer context. (Even though it doesnt require specific proof of a breach of duty). US V. CHESTMAN (1991) Owner of public company says hes going to sell at a large markup. Tells sister, who tells her daughter, who tells daughters husband, who trades on the information. The court recognizes misappropriation theory, but it says in the absence of evidence that husband participated regularly in confidential business discussions, the familial relationship between husband and wife/wifes family alone wasnt enough to give rise to needed breach of fiduciary duty. SEC response to CHESTMAN: Rule 10(b)(5)(2) which provides a non-exclusive list of 3 situations where a person has a duty of trust or confidence for purposes of misappropriation theory: (This can be applied when someone has misappropriated information and then tips someone else). (1) A duty exists whenever someone agrees to keep information in confidence (2) A duty exists between 2 people that have a pattern of sharing confidences so that the recipient knows/reasonably should know that the speaker expects the recipient to maintain confidentiality. (3) A duty exists when you get the material nonpublic information from a spouse, parent, child or sibling. CARPENTER V. US (1987) Wall Street Journal columnists advice has short-lived effect on stocks. He tells his friends which stocks hes going to tout before the column goes out. Hes convicted under securities and mail fraud statutes, but court splits 4-4 on the misappropriation theory. US V. OHAGAN (1997) Upheld Rule 14(e)(3) and endorses misappropriation theory. OHagans firm (hes not working on the case) helping GrandMet buy Pillsbury, and he

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trades in Pillsbury stock (the target). He obviously owes no fiduciary duty to Pillsbury in the classical theory sense. His violation is based on a breach of duty to the acquirer, via the firm. He misappropriated information because his firm had a rule against trading on this information. (7) Short Swing Profits Rule and Statute Rule 16(b): Officers, directors and 10% shareholders that trade the firms stock within a six month period must give the profits of trading to the corporation. Its a prophylactic rule against insider trading that is very over and under-inclusive. But its easy to apply. The SEC doesnt enforce this, derivative suits enforce it. The recovery goes to the company. Solving short-swing profit questions: Question 1: Does 16(b) apply? Is it a public company? 16(b) only applies to companies that fall under the 1934 Act, namely publicly traded companies, companies with assets over $5 million, with more than 500 shareholders. Question 2: Does the 6 month time period apply? Are the transactions within a 6 month time period? Are there matching sales/purchases? Is it an equity security? All the transactions have to be completed within 6 months. There has to be transactions that can be matched up. Considering 16(b) across stock classes: o Any shareholder that owns 10% of any class is subject to 16(b). But for liability purposes under 16(b), purchases of different classes of stock cannot be matched up. The securities traded must be equity securities. (This means stocks/convertible debentures, but not bonds). Question 3: Find the director/officer/10% shareholder. For directors/officers, they have to be one at either the purchase or sale. For 10% stockholder, the stockholder has to be a 10% stockholder at both the time of purchase and at the time of sale. (So if youre moving above the 10% level or below the 10% level, 16(b) wont apply). RELIANCE ELECTRIC (dropping below 10%) and FOREMOST-MCKESSON (going above 10%). An 10% shareholder can spit his sales, so long as they are not legally tied to each other and are made at different times to different buyers. Convertible debentures: to figure out if someone qualifies as a 10% shareholder when they have convertible debentures, act like they cashed them in and what that would do to the percentage of stock they own. o EX: take the number of shares theyre convertible to, and divide that by the total number of outstanding shares, plus the number of shares that theyre convertible to (add the numerator to the total shares outstanding). Question 4: Calculating liability: Maximize the liability under 16(b).

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You must match up the sale(s) and purchase(s) so as to maximize liability. EX: Buy 1: 10 shares @ $20. Buy 2: 10 shares @ $60. Sell 1: 20 shares at $30. Dont look at overall -$200, you see he made $100 by matching up Buy 1 with Sell 1. Consider options: look at the structure of options: Are they a stand in for ownership or a genuine option?

Question 5: Consider the underlying principle/policy goal of 16(b). In KERN COUNTY LAND V. OCCIDENTAL PETROLEUM, a takeover fell through and theres an agreement that the stock of the company who attempted takeover will be bought after 6 months after the stock has been converted (within 6 months) to guard against the takeover. The court ruled that the stock conversion wasnt a sale for the purposes of 16(b). o Company that attempted takeover wasnt trying to make short-swing profits. We have to look at why we have 16(b). o The court said the involuntary nature of exchange, coupled with the absence of possibility of speculative abuse means 16(b) should not apply in this case. o This transaction cant serve as the vehicle for abuse/fraud that Congress was trying to prevent.

PROXY FIGHTS
(1) Proxy fights in general (2) Reimbursements (3) Shareholder lists (4) Shareholder proposals (1) Proxy fights in general Shareholders are permitted to give another person a proxy, which transfers to the other person the right to vote the shareholders shares in the manner indicated on the proxy at a shareholder meeting. (Shareholder can change mind up to the moment of the election). In an election, management can push their slate of directors and also the authority to vote on other issues requiring shareholder approval (like amendments to the articles of incorporation, appointment of independent auditors, etc). A proxy fight is when a group of dissident shareholders tries to gain control of the corporation by soliciting proxies to unseat incumbent/management-supported directors. Proxy fights are expensive and went out of favor when takeovers became more popular. But now with poison pills aimed at defending takeovers, theyre back. Proxy fights are about policy, not individual business decisions. You cant have a proxy fight to overturn a business decision (those are protected by the business judgment rule). You have a proxy fight to unseat the current board of directors with X policy and replace them with your directors with Y policy.

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Proxy fights cannot be about personality conflicts between particular personnel. In LEVIN V. METRO-GOLDWYN MEYER, they considered that the two groups had divergent business policies.

Management has access to the corporate treasury/organization to defend proxy fights. This means management can spend the corporations money on special lawyers, advertising and other costs associated with soliciting proxies. LEVIN determines that the amounts used by MGM management werent excessive. In theory, management could use excessive money. The court in LEVIN/courts in general will only be concerned that people are fully informed about the merits of the each side of the proxy fight. 14(a) of 1934 Act prohibits people from soliciting proxies in violation of SEC rules. The definition of solicitation is broad. But a shareholder avoids SEC filing requirements if he doesnt solicit proxies for himself - 14(a)(2). A pension fund that has a shareholder proposal can campaign without filing because theyre not soliciting proxies. This rule requires disclosure from both sides of proxy fight to shareholders that may be relevant to shareholders decision. Management needs to include an annual report, and everyone needs to disclose conflicts of interest. Parties soliciting proxies need must file with the SEC 14(a)(6). Management can either turn over the shareholder list or mail the insurgent proxies out itself. (Management usually mails). 14(a)(7). (This will not prevent access to shareholder list under state law). (2) Reimbursements Incumbents can charge the corporation for expenses incurred in proxy fights. The expenses have to be reasonable and in disputes over policy (see above). ROSENFELD V. FAIRCHILD ENGINE & AIRPLANE CORP - the insurgents won and the court sustained reimbursement of both sides for costs incurred in policy proxy fight. Corporate directors can make reasonable/proper expenditures in defense. Stockholders can reimburse successful contestants (here insurgents) for reasonable expenses subject to court scrutiny. Court will disallow expenses for personal power, individual gain, or private advantage that arent in best interests of corporation/stockholders. So if the insurgents win, then they can be reimbursed by affirmative shareholder vote. But they are risking their own money in a proxy fight. If insurgents lose, they get no reimbursement. The policy is to discourage frivolous proxy fights. (If they win, they only gain a fraction of value that they createan economic disincentive for proxy fights.) There are policy considerations. The directors must be able to spend to keep shareholders appraised of the situation, and we dont want to discourage people from becoming

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directors by making them pay for this themselves. But there is a duty of loyalty problem here ignored by the courts: incumbents are using corporate funds to keep their own jobs. (3) Shareholder lists Federal requirements versus state requirements: Rule 14(a)(7) (see above) gives management the shareholder list or mail out option for insurgent proxies. Federal law wont infringe on your abilities to get a shareholder list under state law. Many states allow a shareholder to get a shareholder list if the shareholder needs it for a legitimate business purpose. CRANE CO. V. ANACONDA CO. New York rule says a stockholder can get the list if theyve been a shareholder for 6 months and own more than 5% of the stock if they file an affidavit saying theyre using it for business of corporation, and that theyre not selling lists. This case has a broad interpretation of what is a legitimate business purpose. Shareholders will be affected by any situation that affects the value/well-being of the corporation. Here Crane was trying to communicate with shareholders about a tender offer. Courts are generally ok with requests of this type. Shareholder list concerns: You dont want competitors to get shareholder lists after buying a few shares, and you dont want mass marketers getting them either. The shareholder needs to show a proper purpose reasonably related to his interest as a shareholder. (Economic interest). So state statutes divide reasons to get shareholder lists into two categories: Good Reasons Evaluating your investment (the corporation hasnt paid out dividends in a while). Talking with other investors about what is going on at the firm Contacting other investors to buy their stock. (CRANE) Bad Reasons Personal benefits that dont relate to the management of the firm (i.e. selling the list). Trade secrets Impressing your views on other shareholders (PILLSBURY)

STATE EX REL PILLSBURY V. HONEYWELL The court found that shareholder wanting the company to adopt his anti-war views wasnt germane to his interest as a shareholder. Honeywell is a big munitions manufacturer for US government. Court says that wanting to impress his views on the shareholders isnt a good reason to compel production. He could have more effectively argued that the company had a bad public image, and that affected him as a stockholder (lower his stock price). This would be an economic interest that the court would look for. Compelling books versus shareholder lists: There can be different standards for compelling production of the finances/books to shareholders and for shareholders lists. EX: the Delaware statute says: For the books, the burden is on the shareholder to show a proper purpose. 32

For the shareholder list, the burden is on the corporation to show an improper purpose on the shareholders part.

The New York statute says the burden is on the seeker to show a proper purpose for the shareholder list. (4) Shareholder proposals These are proposals concerning the corporation that usually small groups of shareholders want to communicate to the shareholders at large. They usually have to do with politics (disinvestment in apartheid South Africa, etc). The SEC allows companies to eliminate these proposals under some circumstances: (1) If the proposal is about running the business on a day to day basis, or the about the business the corporation is in (shareholders arent supposed to tell directors how to run the motherfucker, if they dont like it go vote in new directors). People get around this requirement by asking for a corporation committee to study the problem (the proposal writers just want attention to their problem) (2) If the proposal violates proxy rules, as in its misleading. (3) If the proposal got less than 3% support the previous year. (4) If the proposal doesnt concern something that makes up 5% of assets and 5% of earnings and is otherwise not significantly related to the companys business. Per LOVENHEIM, significantly related is not limited to economic significance. (It can concern ethics and morals). LOVENHEIM V. IROQUOIS BRANDS Very small part of Iroquois business is selling pate, and pate production involves cruelty to geese. The court says that though the pate production makes up but a small part of Iroquoiss operation, it implicates a significant level of sales because it has ethical and social significance and can be seen as otherwise significantly related to Iroquoiss business. It seems PR can come into the determination. If Iroquois gets bad PR because of this small thing, that can impact its sales across the board.

CONTROL ISSUES
(1) Shareholder voting agreements in general (2) Shareholders binding directors (3) Abuse of control in closely held corporations (4) A better solution: buyout agreements (5) JORDAN and closely-held corporations (6) Transfer of control (NOT COVERED IN CLASS) (7) Sale of control (NOT COVERED IN CLASS) (1) Shareholder voting agreements in general In general, shareholders can bind themselves as shareholders. They can vote their selfinterest, and in general they have no fiduciary duties to the corporation, so they can vote for spite or conspire to keep another shareholder out of power.

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The types of voting agreements (now widely judicially accepted). (1) Voting trust You put the stock in a trust, and appoint a trustee to vote the shares. Stockholder still gets economic benefits. (Separate the voting right from economic right). These may only last 10 years. (2) Vote pooling agreement An agreement to vote shares a certain way, enforced by an arbitrator (upheld in RINGLING BROS). Often used to gain a new recruit by making the recruit the arbitrator. (3) Irrevocable proxy same as a vote pooling agreement, except it has to be accompanied by some sort of interest (i.e. employment with the corporation, lender to the corporation that can vote stock). Useful in recruiting/keeping a valuable employee. (4) Different classes of stock this intends to dilute or inflate the voting power of certain groups. Usually in the form of voting and non-voting stock. (STROH V. BLACKHAWK has ordinary stock and voting stock). In both public and closely held corporations, shareholder voting agreements are generally valid. Groups can vote their shares so as to obtain the advantages of concerted action. Ramseyer says that while these can look fucked up ex post, there was a reason they were put in at the time. STROH V. BLACKHAWK Corporation has two types of stock, ordinary stock and voting stock arranged in such a way that people owning less than majority of corporations value still control the corporation. (Divide the control and economic interests). Court says that this arrangement different from one-share one-vote is fine: there is value in stock with only the control interest. RINGLING BROS V. RINGLING Court enforces a vote pooling arrangement where two sisters sign contract to vote their shares together, and in the event of a disagreement, they will go to an arbitrator to decide. When one does not vote according to what the arbitrator says, the court says the sister breached the contract and throws out her votes. This is not a voting trust, because the arbitrator isnt voting the shares for the sisters. He arbitrates, and then they have a contractual obligation to vote that way. Bizarre remedy: rather than enforcing the contract, the court throws out one sisters votes. The contract did specify specific enforcement. (2) Shareholders binding directors There is a general rule that shareholder-level agreements cannot bind the directors. Were looking at agreements where the shareholders agree what the board is going to do, rather than just agreeing on how to vote for the board, and then letting the board do its job. Policy reason for this: once you start agreeing to do certain things when you become a director, you are chiseling away at the fiduciary duties you owe all the shareholders. If you let a majority of the shareholders bind the board, then it can harm the minority shareholders. In other words, directors owe fiduciary duties to all shareholders, shareholders cannot bind directors in exercise of independent judgment. Theres an exception to the general rule. If:

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Unanimous exception - The shareholder-level director-binding agreement is unanimous, the agreement is enforceable (this means all shareholders). (CLARK) No complaints exception - Minority shareholders do not complain about the shareholder-level binding agreement, the agreement is enforceable. (GALLER)

Not all states follow the no complaints exception. Many state statutes require: (1) Unanimous votes (CLARK) (2) A closely held corporation (3) That shareholders have fiduciary duties similar to director fiduciary duties. (Presumably so majority cant fuck over the minority shareholders). These statutes make sense in that they allow closely-held corporations to attract really good employees. The rule: MCQUADE V. STONEHAM Theres a shareholder agreement saying who is going to be officers in the corporation, as well as how much they are going to be paid. (These matters are normally decided by the board). The court finds the agreement invalid to the point that it forces the directors, at the risk of legal liability, not to change officers/salaries. (This does not affect the ability of the corporation to make employment contracts, as long as theyre made by the board because the board will think about all the shareholders.) Also think of the shareholders as a layer and the board as a layer. This agreement crossed the boundary between the layers. The unanimous exception: CLARK V. DODGE Clark owns 25% and Dodge owns 75%. Their agreement says that if Clark discloses the companys secret formula to Dodges son, Dodge will keep Clark as general manager. Clark discloses, Dodge fires him. The court enforces the contract. Court gets around MCQUADE by saying normally these agreements are void because we want the fiduciary buffer of the board protecting all the shareholders, but here all the shareholders are in on the agreement (its unanimous) so its valid. The rationale for board protection of all stockholders has disappeared. The no complaints exception: GALLER V. GALLER Company is owned by Galler brothers and Rosenberg (who has a tiny bit of stock). The Gallers make a contract saying if one brother gets hurt, his widow will be protected by electing each other to the board and issuing dividend payments to the widow. Even with Rosenberg there, it is ok to agree to vote each other on the board, because that is the concerted power of voting (see above). But unless Rosenberg signs on to the agreement, under MCQUADE/CLARK the agreement is unenforceable. The court carves out another exception by saying it turns on whether Rosenberg complains. The rule is that even if the shareholder-level agreement isnt unanimous, if the minority shareholder doesnt object then its fine. o Of course, one side could just buy off Rosenberg to complain/not complain. The courts usually dont incentivize this type of behavior, but they do here.

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RAMOS V. ESTRADA Two competing groups, Broadcast and Ventura, combine to form a TV station. Broadcast group, which includes Ramos and Estrada, has a shareholder level agreement to pool their votes. (Penalty for breach of agreement is forced sale of shares). As a director, she votes for a Ventura candidate for president (no violation of the agreement, because shes voting as a director and its a shareholder-level agreement and no exception exists). Broadcast retaliates by not naming her a director, and she retaliates by not voting with them as shareholders. Court enforces the agreement and forces her to sell her shares. But Broadcast is using the contract to punish her for how she votes as a director (she had every right to vote for who she thought was best as president thats her fiduciary duty to the shareholders). So this is a backdoor around MCQUADE to contract the directors. Court cites the California statute on statutorily closed corporation. California statutorily-closed corporations statute says you can bind directors with shareholder-level agreements to agree to make a person an officer. But it has to be declared a statutorily closed corporation: (1) contract has to be unanimous and (2) shareholders have fiduciary duties to each other. (3) Abuse of control One problem in closely held corporations is freeze-outs, where an investor may be fired as an officer and receives no dividends. Since it is a closely-held corporation, theres also no way for the investor to sell off his stock (no market for this stock). To deal with this, shareholders in a closely-held corporation have a fiduciary duty to deal with each other in good faith. WILKES V. SPRINGSIDE NURSING HOME Have 4 investors owning 25% apiece. They all work for the corporation, getting no dividends but getting paid in salary. Due to a falling out, they freeze out one of the investors. (The court points out that in closely held corporations, the salary someone draws is typically their only return on the investment.) Court says majority shareholders in a closely-held corporation have a strict obligation to deal with the minority with the utmost good faith and loyalty. They have a two part standard for dealing with freeze-outs: If shareholders in power may show that their decision was based on a legitimate business purpose, and therefore didnt violate their good faith fiduciary duty. Frozen-out shareholder can respond by showing that the business purpose could be accomplished in another, less onerous, way, then the majority shareholders violate their good faith fiduciary duty. o Corporations will have to balance a legitimate business decision with a different decision that might not be as practical. Policy considerations of this rule: (1) It requires directors to consider how a minority shareholder will be affected by a business decision. (2) Restricts the corporations ability to fire a minority shareholder/officer for a difference in opinion. 36

(3) This is a less strict fiduciary duty standard than in partnerships: Range of fiduciary duties to co-owners: Partnerships Closed Corporation Public corporation Strict fiduciary duties Good-faith standard Shareholders owe no to your co-owners between shareholders fiduciary duties to each other (except like in SINCLAIR) Is this rule a good idea? Its an awkward fit outside the freeze-out context. (How do you determine who breached the fiduciary duty to whom? Ramseyer would limit the determination to the SINCLAIR case, and apply the business judgment rule if there is no self-dealing. Showing the limitation of the rule: SMITH V. ATLANTIC PROPERTIES Shareholders have an agreement giving them all a veto over corporate decisions. Smith wants to reinvest the profits, the others want to pay a dividend, so the one vetoes the decision. They pay a tax on unreasonable corporate profits because they dont pay a dividend. The court found that his veto on the dividends was the reason they got taxed, and he violated is fiduciary duty of good faith to his fellow shareholders. Ramseyer: In the absence of self dealing, this is just a business disagreement, with self-interested parties making self-interested decisions. He would hold them all accountable or none of them, either way they all split the loss. Possible solution: state statutes that allow any shareholder of a closely-held corporation to dissolve the corporation. PROS: It forces other shareholders to negotiate a fair value for the outgoing shareholders stock CONS: It costs some going concern value. (4) A better solution: buyout agreements As WILKES sucks in situations besides freeze-outs, a better way to protect minority shareholders in closely-held corporations is with buyout agreements that protect shareholder identity and investment liquidation. We want a middle ground between the lack of transferability of a partnership and the complete transferability of corporations. (1) We want to protect the shareholders ability to determine the identity of co-investors by imposing sale restrictions. (Dont want your co-shareholders selling to people you cant work with). Require the exiting shareholder to get consent from the other shareholders to sell. Give other shareholders the right of first refusal. (2) We want to allow the unhappy shareholder to liquidate his investment. (Forced transfers). The exiting shareholder can have an agreement with the corporation or other shareholders that they will buy the shares.

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To determine the cost of the buyout agreement, you can appraise (expensive), use book value, or contract out a price. (5) JORDAN and closely-held corporations JORDAN V. DUFF & PHELPS Guy is leaving a company, has an agreement to sell his shares back to corporation when he leaves. They convince him to stay a little while to get a high book value, then right after he leaves they announce a merger and the stock is worth a bunch more. The CEO never disclosed to him that there was a merger in the works. The question turns on whether Jordan could have acted on the information and stayed on for the merger. If he can stay on because they cant fire him for no reason, then he could have acted on the information and the director had fiduciary duty to him (as a shareholder) to disclose the information. (The courts holding). If hes just an at will employee, then he couldnt act on the information because they could have just fired him and then would have no duty to disclose. Close corporations buying their own stock, like knowledgeable insiders of closely held firms buying from outsiders, have a fiduciary duty to disclose material facts. (6) Transfer of Control A control premium is where you pay more than market price for a large bloc of shares. How can they charge more than market price / why are control premiums allowed? Because it would cost more to buy a large block on the open market. You are paying someone for their stock and for the assembly service of putting the bloc together. Also if someone plans to turn a company around, then they will pay a little more in anticipation of gains. o Someone will also pay extra in order to loot the corporation at the expense of the minority shareholder. But were going to allow control premiums and then deal with looting as it occurs. ZETLIN V. HANSON HOLDINGS A controlling shareholder is free to sell, and a purchaser free to buy, a controlling interest at a premium price. Thus, minority shareholders dont get the opportunity to share in any premium paid for a controlling interest. Exceptions: Looting an independent violation of SINCLAIR Conversion of a corporate opportunity. Protections against transfers by shareholders must be negotiated strictly. The court will not read them into a contract, nor infer from other protections contained in a contract. (Right of first refusal, tag along provision). FRANDSEN V. JENSEN-SUNDQUIST AGENCY Minority shareholder (Frandsen) has an agreement with majority bloc of shareholders that if they want to sell, he has the right of first refusal to buy their shares and if he doesnt buy the majority blocs shares, they have to buy his shares at the same price theyre selling their majority bloc for. (tag-along provision). Frandsen has these protections to ensure he gets a piece of the control premium. 38

But here the majority bloc merges, it doesnt sell its shares. The court says thats outside his protections, because just because he has those rights doesnt imply that he can enjoin the merger. PERLMAN V. FELDMAN In a time of a market shortage, the CEO/Chairman sells his stock in steel producer to an end user of steel. The end user wanted to buy the company to get steel cheaper. The price included a substantial premium based on his ability to decide which end users get steel in times of market shortage. The court holds that its not OK for a fiduciary to siphon off an advantage of the corporation for his own personal benefit (at the expense of the minority shareholders). This asset (market decision) cannot be used for the benefit of the majority. It has to be used to benefit all shareholders. This could also be put in a SINCLAIR context: You should be able to use control of the company to buy the companys products at a lower price. (7) Sale of control If you sell control of a corporation, it must be accompanied by sale of sufficient voter control. This is because people enjoying management control hold it on behalf of the shareholders, and they cant treat it as their personal property buy and sell. In other words, its illegal to sell corporate office itself. ESSEX UNIVERSAL V. GATES This case stands for the above proposition and also the matter of a staggered board. Here, the guy sold a controlling stake and got a premium for instant control of the board, which the buyer would have otherwise gotten in 18 months due to staggered board elections. The question is then is it legal to get give/receive payment for the immediate transfer of management control to someone that has voting control but wouldnt get management control for a while? Court says thats fine. Its better for the economy that way because it makes it easier to transfer corporate control to new interests. (People would buy and sell as much if they didnt get instant control). Theres no reason to make them wait.

TAKEOVERS/MERGERS
(1) Types of mergers (2) De facto merger doctrine (3) Freeze-out mergers (4) Takeovers in general (5) Takeover defensive tactics and the legal systems response (6) Fiduciary duties in the takeover defensive tactics context (1) Types of mergers There are three types of mergers: (1) Statutory merger A type this merger is accomplished by a procedure set down by state law. It is very flexible It requires: o Approval of majority of shareholders and directors of both corporation

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o Dissenter/appraisal rights shareholders who vote against the merger are entitled to demand cash for fair value of their shares. (2) Short term merger B type A buys enough of Bs shares to gain control. These are transactions between A and Bs individual shareholders, so Bs board isnt involved and doesnt have to approve, and theres no dissenter rights. o Often, this purchase is then followed by a statutory merger using a short form. (3) Assets-acquisition merger C type A buys all of Bs assets. A deals with Bs board, not Bs shareholders. o Advantage: A will not be liable for Bs unforeseen liabilities. o State law varies on the requirement of a shareholder vote and the availability of an appraisal right.

Appraisal rights are the right of a shareholder to be paid in cash for fair market value of shares when your company merges, and are a state statutory right. Usually only apply to close corporations (if its a public company, you can just sell shares on the open market.) The rationale is that people shouldnt be required, when they expect to own A, to own new company B. The problem is that companies have to have a lot of liquid cash in mergers to pay these off. (2) De facto merger doctrine When a transaction is cast in an unusual form, a court may preserve legal characteristics that would have flowed from the use of a more natural form. Rationale: We want to protect shareholders expectations in a type of firm, as well as the shareholders investment. Criticism: They should take this information into account in the purchase price. FARRIS V. GLEN ALDEN Glen Alden being acquired by the much larger List. They structure it as Glen Alden buying assets of List, making Glen Alden the surviving corporation in order to avoid having appraisal rights. Glen Alden shareholder complained saying it was a de facto merger, and he was entitled to appraisal rights. Court agrees. Delawares response to the de facto merger doctrine: HARITON V. ARCO ELECTRONICS: Fuck this. Were going to limit this de facto merger doctrine by saying the sale of assets transaction statute and a merger transaction statute are equal in dignity, and you can use either one to accomplish your desired end. In effect, the decision is left to the parties to choose between a statutory merger and a practical merger. Thus appraisal rights are largely voluntary. (3) Freeze-out mergers A freeze-out merger is a device a majority can get rid of a minority and gain 100% of a corporation.

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Delawares test for freeze-out mergers: From WIENBERGER. The majority has a fiduciary duty to the minority. (1) If the minority shareholders allege self-dealing (like in SINCLAIR) in the cash out, like fraud, misrepresentation, etc., then: (2) The controlling shareholder has the burden to prove the transaction was fair. In DE, all this means is that the price and procedure are fair. BUT (3) If the conflict of interest is disclosed/ratified by disinterested board members, then the burden is on the minority shareholder to show unfairness (easier than waste). Mass.s test for freeze-out mergers: The business purpose test. From COOGINS V. NE PATS. The majority cannot merge solely for the purpose of freezing the minority out; there has to be a legitimate business purpose. (1) Defendant has burden of proving first that merger was for a legitimate business purpose. Repaying defendants personal indebtedness is not a legitimate purpose (COOGINS) (2) Defendant has burden of proving that the merger was fair to the minority considering the totality of circumstances. The circumstances are: Purpose of the merger Adequacy of disclosure in connection with the merger Fairness of the price. (4) Takeovers in general Takeovers are either friendly (supported by management and the directors) or hostile (not supported by management/directors). Tender offers and coerciveness: Buyers can sometimes coerce shareholders to tender their shares using a two tier tender offer. In tier one, the bidder tenders for 50% or a share that ensures de facto control at a higher price. In tier two, they merge out all the remaining minority shares at a lower price. This causes an incentive for shareholders to tender up front because they dont want to lose out on the higher price. This works because its hard for shareholders to coordinate with each other. Williams Act disclosure in tender offers: Federal legislation that applies to tender offers and requires: Disclosure of a purchase of more than 5% of a corporation within 10 days. (Can buy as much as you want within that 10 days.) Disclosure of plans and financing. Locks in the tender price. They cant change it for some people/institutional investors. Buy shares on a pro rata basis, rather than first come first serve. So if you need 50% and you get 75%, you buy 2/3 from each person who tenders. Have to hold tender offer open for 20 days. (5) Takeover defensive tactics and the legal systems response Previously, the use of takeover defensive tactics would be approved by disinterested directors and be protected by the business judgment rule. But now, led by DE and the UNOCAL decision, weve moved to an intermediate standard of judicial review for

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cases involving defensive tactics. (Because we want to guard against people just trying to keep their jobs rather than looking after the shareholders). Stricter than business judgment but less strict than intrinsic fairness. So after UNOCAL, courts have asked whether the defensive measure was adopted in good faith (after reasonable investigation and deliberation), and whether the defensive tactic was reasonable in relation to the threat posed by the bidder. This means theres: (1) The threat review: the court must first assess the nature of the threat. (The threat is the reasonable grounds to believe theres a danger to corporate policy). (2) The proportionality review: the reasonableness of the defensive tactics in light of that threat. (6) Fiduciary duties in the takeover defensive tactics context The courts impose different duties on inside and outside directors of the target corporation for the purposes of this context. (CHEFF). Outside directors: You have the burden to show: (1) Duty of loyalty: you made good faith and reasonable investigation into what??? (CHEFF). (2) Duty of care: the response chosen was reasonable considering the threat posed (UNOCAL). If you show these things, you get the business judgment rule. Inside directors and directors with conflicts of interest: You have the burden to show inherent fairness of the transactions to the corporation. If you do, then you get the business judgment rule, muthafucka! (Substantial shareholders arent automatically insiders). Revlon duty: Once its clear that a company is going to be sold, the directors fiduciary duty switches to the maximization of shareholder value. Before the switch, its OK to resist under CHEFF/UNOCAL. After the switch, you have to find the highest price. When does Revlon apply? (When is the switch?) REVLON duty applies when: When the board is starting/seeking a bidding war Board put the company up for sale Board departed from its long-term strategy (Seeks breakup of the company). Notice that the corporation has initiate much of this.

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