Friday, October 12, 2012

Corporations Outline 2


Economic and Legal Aspects of the Firm
  1. Economic Backdrop
    1. Firm: the set of relations that arise when resources are allocated by the entrepreneur via commands to her employees rather than the set of relations that arise when an entrepreneur allocates resources via contract with outsiders
    2. Discrete contracting: the parties have no pre-existing obligations to each other; they negotiate a contract that anticipates and provides a rule governing all contingencies – nothing is left to be worked out in the future
    3. Relational contracting: response to the defects of discrete contracting; parties do not attempt to provide an answer to all contingencies at the time the relationship commences; this is an agreement to agree. The goal of this is to reinforce the relationship itself and will continue to deal in good faith.
  2. Agency Law (Rest. Of Agency law, p. 483)
    1. A firm is created by unifying the ownership and control f the team in the hands of one or more owners, referred to as the principal, while other team members agree to serve as employees, referred to as agents agent take the action for the principal
    2. Fiduciary Duty:
      1. A fiduciary is someone who is going to act in the best interest of another as opposed to their own best interest – it involves some type of trust relationship (i.e. a trustee, lawyer).
      2. A fiduciary duty will punish or prevent opportunistic behavior
      3. Instead of specifying in advance exactly what the agent can and can not do, fiduciary duty imposes a general obligation to act fairly.
    3. Restatement of Agency Provisions
      1. § 13: An agent is a fiduciary with respect to matters within the scope of his agency
      2. § 387: unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency.
    4. Community Counseling Services v. Reilly:
      1. Reilly was a sales rep for CCS- leaves and does work for three parishes that would have otherwise used the services of CCS. Reilly’s contract did not contain an agreement not to complete, but the Court finds Reilly breached his fiduciary duty by soliciting clients while still employed by CCS.
      2. Court looks at the fiduciary duty here as an implied contract.

You cannot be Jerry McGuire. Until you severe your relationship

    1. Hamburger v. Hamburger
      1. David was employed by his father and uncle; problems between David and uncle & uncle told him he’d be fired if he father died first. David met with one of the company’s suppliers, who helped him start his own business. Court finds that David did the logistical things by securing his own future, and there was no evidence that he tried to solicit business on his own behalf while still employed. He did not unfairly use customer lists b/c is was general knowledge
      2. Former employees can compete with former employers using general knowledge and skill w/o breaching a fiduciary duty

This case differs than the prior one because
the customers were known by the general public
He did logistical setup not taking the customers
Might have been sympathy from the court for the defendant
Corporation could have had employees file a NDA

    1. Northeast Ohio College of Massotherapy v. Burek
      1. Defendants were instructors at Northeast who left and started their own competing school, and students switched schools.
      2. Court finds that they didn’t breach a duty – they were independent contractor and fiduciary duty didn’t apply – independent contractors have a lot more leeway than agents would have – and SJ in favor of defendants was upheld.

Was it independent contractor or employee
Determines whether they had leeway and no fiduciary duty

    1. At-will employment:
      1. At C/L, an employer could fire an employee at any time – it is a private business and the business owner is the residual claimant (the one holding the bag). The owner is the one who ends up losing or gaining in the end.
    1. Foley v. Interactive Data Corp
      1. Foley is fired after expressing concern that his new boss is under FBI investigation. His theories of liability are (1) implied in fact contract – he couldn’t be fired in the way he was and (2) tortuous discharge; same as claim (3) plus public policy.
      2. Court finds that this doesn’t implicate public policy – Foley was fired b/c he told – but found that this was a private matter that doesn’t implicate public policy. Court says the case should go to trial to determine if there was an agreement to discharge for good cause based on a handbook but it wasn’t clear if he was included in it.

Duty to Creditors
Is the firm bound by the actions of the Agent
This is only true when the agency has conferred the authority to the agent

    1. Agency Law and relations with creditors
      1. Restatement of Agency, § 7 – Authority: Authority is the power of the agent to affect the legal relations of the principal by acts done in accordance with the principal’s manifestations of consent to him.
      2. Restatement of Agency, § 8 - Apparent Authority: the power to affect the legal relations of another person by transactions with third person, professedly as agent for the other, arising from and in accordance with the other’s manifestations to such third persons.
      3. Traditional common law rules are designed to protect a principal’s property interests. A third party who deals with an agent does so at his peril. The agent’s actions will bind the principal only if the principal has manifested his or its assent to such actions through actual authority or apparent authority.
        1. actual authority: occurs when the principal manifest his consent directly to the agent. May be expressly manifested or may be implied from the conduct of the principal. If actual authority exists, the principal is bound by the agent’s authorized actions, even if the party with whom the agent deals is unaware that the agent has actual authority, and even if it would be unusual for an agent to have such authority.
        2. apparent (ostensible) authority: arises when an agent is w/o actual authority, but the principal manifests his consent directly to the third party who is dealing with the agent. A third party will be able to bind the principle on this basis only if the third party reasonably believed that the agent was authorized
        3. inherent authority: springs from a desire to protect the reasonable expectations of outsiders who deal with an agent. This is a gap-filling device used by courts to achieve a fair and efficient allocation of the losses from an agent’s unauthorized actions.
    2. Blackburn v. Witter
      1. Blackburn is a widow of a dairy farmer who purchases stock from Long, an employee of Walston & Co, and discovers that the stock is fake. Long is the agent for Dean Witter (principal). Long was not authorized to sell fake stock, but Dean Witter gave Long the authority to sell stock and give investment advice, and was liable. “in short, it is difficult to see how appellants can accept benefits of the sale of the stock by Long as their agent and deny liability for fraudulent misuse of the money obtained by the sale of the stock.
      2. What if these parties had allocated the risk ex-ante? They would have allocated the risk to Long, but between the innocent parties (Witter and Blackburn) it would have been different – Witter might be in a better position to report and discover the fraud.

They found that Dean Witter is held responsible
Even though there appears to be no authority it seems the responsibility is on Dean Witter to be responsible for the
Least cost avoider

    1. Sennot v. Rodman & Renshaw:
      1. Sennot had little more idea than Blackburn that something was wrong. Jordan made the fraudulent actions, but didn’t have either the apparently authority or actual authority to do such; have to rely on his father, William, to find liability. But the Court didn’t think that William knew what was going on. Here Sennot had some idea that this was all under the table, whereas in Blackburn she might have just been negligent by not noticing different receipts, but didn’t have the same knowledge.

Court also found for the plaintiff
Father actively thwarted the plaintiff on resolving the issue
Father was also a Partner in the firm, raising the stakes

Partnership & Limited Liability Companies
  1. Partnerships and other non-corporate forms
    1. UPA § 202 (1997): the association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership. The sharing of gross returns does not by itself establish a partnership even if the persons sharing them have a joint or common right or interest in property from which the returns are derived.
    2. Formation of a general partnership requires no written agreement or governmental action.
    3. Under general partnership law default rules, if the partnership wishes to terminate its association with a partner, it may do so only by dissolving the partnership and paying the expelled partner the value of her interest in cash.
    4. Each partner owes a fiduciary duty to other partners.
    5. Joint Ventures
      1. Denotes a less permanent and less complete merging of assets and interests than does the label “general partnership” but partnership law generally applies to joint ventures
      2. Factors for status are: (1) two or more persons must enter into a specific agreement to carry on an enterprise for profit; (2) their agreement must evidence their intent to be joint ventures; (3) each must make a contribution of property, financing, skill, knowledge, or effort; (4) each must have some degree of joint control over the venture; and (5) there must be a provision for the sharing of both profits and losses.
    6. Bailey v. Broder:
      1. Court emphasizes that the parties must agree to share losses as well as profits in order to have a partnership.
    7. UPA (1997) § 401(a)(2) & UPA (1914) § 18(a) both provide that, unless otherwise agreed, partners share partnership losses in the same proportion as they share partnership profits.

  1. Fiduciary Duty
    1. Fiduciary duty of loyalty: act in the interest of who you owe the duty to; can breach this through conflicts of interest
      1. UPA §§ 103, 403, 404, 405
      2. UPA § 404(b): partners duty of loyalty
    2. Duty of care: focuses on the agent/partner – looks at their actions to see if they did a good job or should be able to be sued for negligence
      1. UPA § 404(c): partners duty of care – can’t sue if it is just ordinary negligence
      2. Doesn’t necessarily involve a conflict on interest like with duty of loyalty.
    3. Meinhard v. Salmon:
      1. Salmon had a lease from Gerry & enters into a joint venture and written agreement with Meinhard. Meinhard was to provide funds, and they would split the profits. At the end of the lease term, Salmon negotiates to renew the lease and gets some adjacent property as well which doesn’t involve Meinhard. Meinhard sues.
      2. Cardozo (majority) talks about the duty of finest loyalty. Might have been different in Salmon had told Meinhard, but here there was secrecy. But Cardozo does say “not honesty alone” which means that you may need more than just basic honesty.
      3. Argument in this case could be made that the parties intended only to take advantage of the particular lease, and the second lease was larger, different, and not part of the agreement.

Dissent says that this was not a partnership at all
RUPA regulates extensively the ability the ability to contract out of duty of care

    1. Ferguson v. Williams
      1. Ferguson and Welborn plan to do something with buildings – joint venture between them and Williams buys in but remains passive. The business later fails because of failings by the defendants. Court finds there is no liability – Plaintiff Williams is alleging negligence and there is no recovery allowed based on negligence. Problem with imposing a simple negligence standard is that it is hard to figure out what simple negligence is and it becomes too easy to prove negligence if and when a business failed. Also, here Williams chose to remain passive.

You have to be really grossly negligent in order to owe a duty of care to other partners
The plaintiff was passive you cannot just let the other partner work and jump in when things fail and say no.

  1. Management of the Partnership’s Business and Affairs
    1. UPA § 401(f): each partner has equal rights in the management and conduct of the partnership business
    2. UPA § 401(j): A difference arising as to a matter in the ordinary course of business of a partnership may be decided by a majority of the partners. An act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all the parties.
    3. Covalt v. High
      1. Covalt and High were both corporate officers and shareholders in CSI – C owned 25%; H owned 75%. Oral agreement for partnership. Following expiration of the initial term of the lease, CSI remained a tenant of the building; the corporation and the partnership orally agreed to certain rental increases. Covalt resigns from CSI and begins to work for a competitor although he retains his ownership in CSI. Thinks the rent for CSI should be raised – High doesn’t agree. T/C concludes that High breached fiduciary duty by not paying more; Court of Appeals reverses. Court finally says that Covalt knew there would be a conflict of interest upon entering into the agreement – Covalt’s only remedy is to dissolve the partnership.

If you are getting screwed in the partnership then leave the partnership. The court is not going to get involved in decisions that one chose to enter into
    1. UPA § 102: knowledge and notice; § 301: partner agent of partnership § 303: statement of partnership authority; § 306: partner’s liability – except as otherwise provided, all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law. § 603: Effect of partner’s dissociation
    2. RNR Investments v. People’s First Community Bank: People’s First makes a million dollar loan to RNR; RNR defaults and PF seeks to foreclose. RNR’s defense to the action is that the partner who signed the agreement didn’t have the authority to make this deal and PF should have read the agreement. The partner had agreed to limit his authority and didn’t have the actual authority, but the bank wins anyway. But the bank wins anyway b/c the limited partner had the apparent authority. Court found it was the obligation of the other partners to tell the bank and there was no constructive notice. The other option is to file under UPA § 303(e), and that would have served as constructive notice and allowed them to win.
This looks like apparent authority
He was a general partner and has a superagent status
No duty to dig up a partnership agreement
RNR could have prevented this by filing under 303 providing notice

    1. Haymond v. Lundy
      1. Lundy didn’t have the actual authority to pay the referral fees, but he had the apparent authority. The partnership was liable for the fee up to a certain percentage – the rest will come out of Lundy’s share of the partnership. Lundy breached the partnership agreement and these are the damages.
    2. UPA §301(a): Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course of the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular manner and the person with whom the partner was dealing knew or had received notification that the partner lacked authority.
  1. Partnership’s Liability for Partners’ Actionable Conduct
    1. UPA §305(a):a partnership is liable for loss or injury caused to a person, or for the penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership with authority of the partnership.
      1. Why have this and also 301(a)? 305 applies when a partner acts “wrongful”; 301 is about the ability of the partner to bind the partnership for acts which may exceed his authority but aren’t exactly wrongful (i.e. agreement to pay referral fee isn’t exactly wrongful, but exceeds authority). Both sections apply when the partner is acting in the ordinary course of business, but 301 adds in “business of the kind” – A plaintiff would always try to use 301 b/c it is broader.
    2. Vanacore v. Kennedy
      1. Kennedy is a partner with Ehrsam; K stole Vancore’s money that K was receiving as a trustee. V sues K, E, & the firm. Connecticut statute said that the partnership is liable if the partner is acting in the ordinary scope of business. Court find that the partnership is liable under this provision. This is similar to the ordinary course of business. The firm might try to argue that the ordinary course of business does not include dispersing funds – this is more of a banking function.

  1. Dissociations and Dissolution
    1. UPA § 601(1): A partner is dissociated from a partnership upon the occurrence of any of the following events: (1) the partnership’s having notice of the partner’s express will to withdraw as partner or on a later date specified by the partner.
    2. UPA § 801(1): A partnership is dissolved, and its business must be wound up, only upon the occurrence of any of the following events: (1) in a partnership at will, the partnership’s having notice from a partner, other than a partner who is dissociated under § 601(2 through 10), of that partner’s express will to withdraw as partner, or on a later date specified by the partner.
    3. § 802 – partnership continues after dissolution
      1. (a) subject to subsection (b), a partnership continues after dissolution only for the purpose of winding up its business. The partnership is terminated when the winding up of its business is completed.
      2. (b) at any time after the dissolution of a partnership and before the winding up of its business is completed, all of the partners, including any dissociating partner other than a wrongfully dissociating partner, may waive the right to have the partnership’s business would up and the partnership terminated. In that event (1) the partnership resumes carrying on its business as if dissolution had never occurred, and any liability incurred by the partnership or a partner after the dissolution and before the waiver is determined as if dissolution had never occurred; and (2) the rights of a third party accruing under § 804(1) or arising out of conduct in reliance on the dissolution before the third party knew or received a notification of the waiver may not be adversely affected.
    4. Dissociation doesn’t necessary mean dissolution – the partnership may still continue. Once dissolution occurs, the partnership must wind up its business, pay off its debts, and settle accounts with partners.
    5. Settling accounts: § 101(1); 401(a), (b), (d), (h); 807(a), (b)
      1. UPA § 401(a): each partner is deemed to have an account that is: (1) credited with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, the partner contributes to the partnership and that partner’s share of the partnership profits; and (2) charged with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, distributed by the partnership to the partner and the partner’s share of the partnership losses. if you are a capital contributing partner, it is assumed that you will get that money returned eventually when the partnership ends. § 401(b): each partner is entitled to an equal share of the partnership profits and chargeable with a share of the partnership losses in proportion to the partnership’s share of the profits. § 401(d): A partnership shall reimburse a partner for an advance to the partnership beyond the amount of capital agreed to contribute. § 401(h): A partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership.
      2. UPA § 807(a): in winding up a partnership’s business, the assets of the partnership, including the contributions of the partner required by this section, must be applied to discharge its obligations to creditors, including, to the extent permitted by law, partners who are creditors. Any surplus must be applied to pay in cash the new amount distributable to partners in accordance with their rights to distribution under (b). § 807(b): each partner is entitled to a settlement of all partnership accounts upon winding up the partnership business…
    6. Kessler v. Antinora:
      1. K &A entered into a written agreement to build and sell a house – K is contributing capital; A is providing labor. Agree to split the profits, K (60%), A (40%). They end up losing money, and K sues A to recover half of the money that he lost. The court rules in favor of A; although the statute says that that capital losses would be shared equally, the Court finds that the specific agreement between the parties trumps the statute.
      2. Court cites Kovacik v. Reed: that case has similar facts, but there was no real written agreement and therefore no language for the court to quote. When the parties have a capital providing and labor providing partner, you can say that they implicitly agree that they value their contributions equally.
    7. Labor contributing partner isn’t expected to share in the capital losses. The Court in Kovacik said that the capital contributing partner doesn’t compensate the labor losing partner and vice versa. This isn’t consistent with the UPA, but Kovacik said that there is a way to get around the statute when you agree to something else.
  2. Forced Liquidation After Dissolution Caused by Death or Non-wrongful dissociation
    1. UPA § 601: see above
    2. UPA § 603(b) Upon a partner’s dissociation: (1) the partner’s right to participate in the management and conduct of the partnership terminates, exception as otherwise provided in § 803; (2) the partner’s duty of loyalty under § 404(b)(3) terminates; and (3) the partner’s duty of loyalty under § 404(b)(1)&(2) and duty of care under §404(c) continue only with regard to matters arising and events occurring before the partner’s dissociation, unless the partner participates in winding up the partnership’s business pursuant to § 803.
    3. §701(a): if a partner is dissociated from a partnership without resulting in a dissolution and winding up of the partnership business under § 801, the partnership shall cause the dissociated partner’s interest in the partnership to be purchased for a buyout price determined pursuant to subsection (b). §701(b): the buyout price of a dissociated partner’s interest is the amount that would have been distributable to the dissociating partner under §807(b) if, on the date of dissociation, the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner and the partnership were wound up as of that date. § 701(i) – when partner can begin to take action
    4. § 807(a): in winding up a partnership’s business, the assets of the partnership, including the contributions of the partner required by this section, must be applied to discharge its obligations to creditors, including, to the extent permitted by law, partners who are creditors. Any surplus must be applied to pay in cash the new amount distributable to partners in accordance with their rights to distribution under (b).
    5. under the UPA (1997), any partner normally has the right to require that the partnership’s assets be liquidated via a judicially supervised auction only if the partnership is at will and has been dissolved by a partner’s expression of will to dissociate.
    6. Dreifuerst v. Dreifuerst:
      1. Ps and D were brothers who form a partnership. There was no written Articles of Partnership governing this partnership. Ps serve D with a notice of dissolution and wind-up of the partnership. Ps want in-kind distribution and not cash; D wants cash. Court doesn’t allow for the in-kind distribution; says there was to be a liquidation. UPA (1914) didn’t allow for in-kind distribution unless it was specifically agreed to.
    7. Creel v. Lilly
      1. Creel dies, and his estate can’t agree with that partner about how to determine and value the assets. Straight reading of the old UPA seems to require liquidation, but the court gets around the statute by looking at the specific partnership agreement.
    8. Meyers v. Cole
      1. Court found that it isn’t necessarily work for hire if a partner created copyrighted material

  1. Wrongful Dissociation
    1. See UPA § 601; § 602: partner’s power to dissociate; wrongful dissociation; § 701: purchase of dissociated partner’s interest; § 801: events causing dissolution and winding up of partnership business.
    2. Normally, any partner can withdraw from the partnership at will, force a liquidating judicial sale, and receive the net value of her partnership agreement in cash. Partners wishing to continue the business, absent agreement, must purchase the partnership’s assets for cash at the judicial sale. Conversely, a majority group of partners may force out another partner by collectively dissociating themselves from the unwanted partner. If it is a wrongful dissociation, it doesn’t force a dissolution of the partnership and a liquidation of the partnership’s assets.
    3. Page v. Page: Page brothers enter into an oral agreement and jointly own and operate a linen supply business. Lost money for eight years, then begin to operate at a profit. P wanted to dissolve the corporation; at the time the corporation owed P’s other corporation $47,000. P looks for declaratory relief. T/C said the partnership was to exist as long as it took to pay back the firm’s debt. The California Supreme Court disagrees, and says that although a partnership can be formed and continue until all debts are paid, but that isn’t the case here. P tries to argue that as long as the partnership is at will he can dissociate at any time; Court says he is still bound by UPA. Under the current UPA, the Court would reject this reasoning; under §602(b), a partnership is only wrongful if in breach of an express provision.
    4. Horizon v. Southern Oaks:
      1. Two nursing home companies formed a partnership to own a nursing home. T/C found that Horizon committed many breaches and ordered that the partnership be dissolved. Southern Oaks wants damages. Court found the partners was judicially dissolved as provided for in the agreement and therefore there was no wrongful dissolution, and therefore no damages. If a breach is wrongful, you get damages; here it might have been possible b/c §601(5)(ii) a partner committed a material breach. Under this agreement, irreconcilable differences was a permissible.
      2. UPA (1997) §801(5)(c) provides for judicial dissolution as well in the event that it “is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement”
    5. Under the UPA (1997), can’t have a wrongful dissociation in an at will partnership – would have to find a way to show that it is not at will.
    6. UPA (1997) § 601: A partner is dissociated from a partnership upon the occurrence of any of the following events: (3) the partner’s expulsion pursuant to the partnership agreement.
    7. Bohatch v. Butler & Binion:
      1. Bohatch was a partner at B&B. At some point, Bohatch began to suspect that one of the partners was over billing. Bohatch is ultimately fired. Here there was a specific relationship and at will partnership. Under §601(3), this is still a dissociation – it is just not wrongful and doesn’t force a liquidation. Under §701, they still have to buy her out. The Court finds that that partnership has the right to make business decisions. If the firm knew that they could be liable for expelling a good faith whistleblower, then the other partners could liquidate and dissociate themselves from her. The court found that the firm did not owe Bohatch a duty not to expel her for reporting suspected overbilling by another partner. The fiduciary duty that partners owe one another does not encompass a duty to remain partners or else answer in tort damages.

    1. Meehan v. Shaughnessy
      1. Two partners decide to exit the firm – there was an elaborate agreement about how they would be compensated if they chose to do so. Issue was whether they would get that compensation b/c of a claim of breach of fiduciary duty. The partners made arrangements and started their own firm, and Boyle was sent a list of clients and asked to identify who he’d take with him. He and the other partners took some cases this them, but continued to work before they left. The exiting partners did a number of things to set up their new firm, i.e. getting letterhead, leasing an office – the court found that you can do all the logistical things of setting up the firm w/o being in breach. Court found that the exiting partners handled their cases in the same way. Court did find breach of fiduciary duty was the way that they notified the clients that they were leaving and how they informed the partners – they were not entirely candid, delayed telling the partners who they would be taking, and sent out one sided letters to the clients. The result of the breach of fiduciary duty was that the burden will be on defendant to show that their breach didn’t cause the clients to go with them and the clients would have gone regardless.. For those that they are unable to show that, they have to compensate the firm for lost profits.

The Corporate Form & the Specialized Role of Shareholders, Directors, & Officers

  1. Introduction
    1. Corporation consists of three main groups: shareholders, directors, and managers.
    2. Shareholders: can vote, sell, or sue – their big responsibility is to vote for the board and they do this annually. See MBCA § 7.28. Also, a shareholder will generally have the right to vote as to whether a corporation can merge with another corporation.
    3. Directors: they are the managers, but not the daily ones. They are the managers of the corporation, but they delegate the daily responsibility to the mangers. MBCA § 801(b)
    4. Officers – MBCA § 8.41; DE § 142
    5. By-laws: contain the rules of the corporation – more rules about how the corporation should be run. They are pretty broad – how the company should be run, voting procedures, etc.
    6. Can vary the board of director’s authority by amendment the articles of incorporation. Shareholders can initiate changes to the bylaws under MBCA § 10.20
    7. Amendments to the articles of incorporation have to be initiated by the board of directors –the shareholders can vote, but not initiate. DE § 242(b)(1).
    8. MBCA § 10 – amendment to articles of incorporation
    9. MBCA § 2.01-2.06; DE § 101, 102

  1. Voting Rights and Annual Meetings
    1. Board members are typically elected annually, but it can be staggered so that the board doesn’t change every year.
    2. Cumulative voting: cumulative voting enables you to gang up all your votes on one candidate.. W/cumulative voting, a shareholder without a lot of power thinks that he is better off voting for one person onto the board rather than spreading it out and getting nothing.
      1. EX: If you have 10 shares and there are 9 spaces on the board, you can vote 10 shares for 9 spaces. With cumulative voting, you can vote 90 shares for one candidate.
      2. To elect X number of directors, a shareholder must have more than SX ÷ (D+1) See problem 3-5. S = total numbers of shares voting, not how many the shareholder owns.
    3. Under the Model Code, cumulative voting has to be specifically put in the articles of incorporation – assumption is that you don’t have it unless its specifically provided for. The same is true in Delaware.
    4. MBCA § 8.04: Election of Directors by certain classes of shareholders.
    5. DE § 141(d): the directors of any corporation organized under this chapter may, by the certificate of incorporation or by an initial bylaw, or by bylaw adopted by a vote of the stockholders, be divided into 1, 2, or 3 classes….
    6. MBCA § 7.21: voting entitlement of shares – except as provided in subsections (b) and (c) or unless the AOI provide otherwise, each outstanding share, regardless of class, is entitled to one vote on each matter voted on at a shareholders meeting. Only shares are entitled to vote.
    7. DE § 212(a): unless otherwise provided in the certificate of incorporation and subject to § 213 of this title, each stockholder shall be entitled to 1 vote for each share of capital stock, voting stock, or shares held by such stockholder…
    8. MBCA § 7.28: unless otherwise provided, no cumulative voting.
    9. DE § 214 – cumulative voting: the certificate of incorporation of any corporation may provide that all elections of directors of the corporation, or at elections held under specified circumstances, each holder of stock or any class or classes or of a series or series thereof shall be entitled to as many votes as shall equal the number of votes which (except for such provision as to cumulative voting) such holder would be entitled to cast for the election of directors with respect to such holder’s shares of stock multiplied by the number of directors to be elected by such holder, and that such holder may cast all of such votes for a single director or may distribute them among the number to be voted for, or for any 2 or more of them as such holder may see fit.
    10. Annual meeting and other forums for shareholder action
      1. MBCA §§ 7.01-7.07, 7.21
      2. DE §§ 211-213, 216, 222, 228
    11. Hoschett v. TSI International Software
      1. P filed an action seeking an order to require TSI to hold an annual meeting of its shareholders as required by DE § 211, and to make publicly available to shareholders a stocklist, as required by § 219. TSI defended on the ground that it received a written consent representing a majority of the voting power of the corporation that had “elected” five individuals to serve as a director of TSI until his or her successor is duly elected. Defendant says that it has satisfied the need to hold an annual meeting for election of directors. The court disagrees for the management and finds that it doesn’t allow for an annual meeting of shareholder to be waived by written consent. The current Delaware code reverses this case under § 211 and says that they are allowed to have a written consent & only need a majority to sign it – no reason to have a meeting when only a few people can and will vote. Under the MBCA, all shareholders have to give written consent and it wouldn’t apply in this case.

  1. Removal of Directors
    1. MBCA §§ 8.08-8.10:
      1. Removal by shareholders: MBCA § 8.08: (a) The shareholders may removed one of more directors with or without cause unless the AOI provide that directors may be removed only for cause. (b) if a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him. (c) if cumulative voting is authorized, a director may not removed if the number of votes sufficient to elect him under cumulative voting is voted against his removal. If cumulative voting is not authorized, a director may be removed only if the number of votes cast to remove him exceeds the number of votes not to remove him.
      2. Vacancy on board – MBCA § 8.10
    2. DE §§ 141(k), 223
      1. DE § 141(k): Any director or the entire board of directors may be removed, with our without cause, by the holders of a majority of the shares then entitled to vote at an election of directors, except as follows (1) unless the certificate of incorporation otherwise provides, in the case of a corporation whose board is classified as provided in subsection (d) of this section, shareholders may effect such removal only for cause; or (2) in the case of a corporation having cumulative voting, if less than the entire board is to be removed, no director may be removed w/o cause if the votes cast against such director’s removal would be sufficient to elect such director if then cumulatively voted at an election of the entire board of directors, or, if there be classes of directors, at an election of the class of directors of which such director is a part.
Whenever the holders of any class or series are entitled to elect 1 or more directors by the certificate of incorporation, this subsection shall apply, in respect to the removal w/o cause of a director or directors so elected, to the vote of the holders of the outstanding shares of that class or series and not to the vote of the outstanding shares as a whole.
      1. DE § 223: vacancies and newly created directorships
    1. How DE differs from MBCA
      1. DE adds members of staggered boards to the list of directors protected from removal – they can only be removed for cause, a powerful insulation for the boards of such companies.
      2. Second, these DE protective provisions preserve the shareholder’s power to remove even protected directors if done for cause.
      3. Third, a majority retains the ability to change the default rules and thereby permit removal in any of these situations by amending the articles.
    2. Adlerstein v. Wertheimer
      1. A was the founder of the corporation, but started having issues with the financial state of the company. The other two managers, M & W, find R to invest, but R won’t invest unless A is ousted. Have a meeting with the intent to oust A, and remove him as CEO, and then vote to give R a majority of the shares of the company, and then R is to vote A off the board. A could have been removed as the CEO regardless, since the board chooses the CEO and they were a majority of the board. They didn’t have the votes to remove him as director w/o having a new majority shareholder. A challenges the meeting saying (1) that it wasn’t properly convened (he loses on this point) (2) he wasn’t given notice and it violated the fiduciary duty owed to him (he wins on this point b/c he wasn’t given notice of what was on the agenda and the court finds this significant b/c he had a lot of power
      2. The bylaws contained a provision that you couldn’t use written consent, but it was unenforceable - in DE, can’t take away right to written consent in the bylaws – has to be the in the AOI.
    3. Problem 3-8
      1. MBCA
        1. Can remove w/o cause unless provided otherwise in the articles of incorporation - § 8.08
        2. Need to look to § 8.08(c) – if cumulative voting, a director may not be removed if the number of votes sufficient to elect him under cum voting is voted against his removal
        3. The board isn’t classified b/c it has to be done in the articles of incorporation and here they did it in the bylaws
      2. DE
        1. § 151(k)(2) – same rule with respect to cumulative voting
        2. § 151(k)(1) – can’t remove a classified board member w/o cause unless it is specified in the articles of incorporation

  1. Governance in Publicly Held Corporations
    1. The Efficient Market Hypothesis
      1. Weakest form: you can not develop a trading strategy based on the use of past prices that will enable you to develop a trading strategy based on the use of past prices that will enable you to beat the market return. In essence, the current market price is unbiased in that it has already incorporated the value of information from past prices and whatever causes the price to move tomorrow will be b/c of new information.
      2. Semi-strong: only inside information can help you to beat the market. This is the form that most people in this country subscribe to – the only information not reflected in the price is insider information and only those who can profit are those with the information. This is justified by the fact that we make insider trading illegal – we wouldn’t do so if we believed in the strong form.
      3. Strong form: anything that is happening or will happen won’t affect the price b/c it has already been reflected in the stock – any current information, public or non-public, any forecast about this industry or company, is already reflected in the price. Even if your trading strategy were based on nonpublic information, you would not be able to beat the market.
      4. If you believe in the EMH, you would want to invest in a wide variety of stocks and not sell them, and then you would avoid paying all the fees associated with buying and selling.
    2. Noise traders: people who trade on extraneous information that isn’t related to a particular company (i.e. the release of the bin laden tape)
    3. Chaos theory: chain reaction – there are impacts on the market that are hard to see –there may be some way to structure them if you can figure out what initially triggered the chain reaction
    4. Proxy voting: by executing a simple agreement appointing a “proxy” to act on his behalf, a shareholder need not be physically present to participate in a meeting.

  1. Shareholder Proposals
    1. Proxy regulations kick in for registered companies. A registered company is listed on a national stock exchange with more than $10 million in assets and 500 or more shareholders. Proxies are important because it serves as investor protection – tries to prevent shareholders from being taken advantage of.
    2. Shareholders are able to get over the hurdle of influencing management by being given access to the company’s proxy card. Shareholders can also choose to communicate with each other by getting a list of the shareholders under rule 14-a7.
    3. Rule 14a-3: prohibits any proxy solicitation unless the person solicited is first furnished a publicly filed preliminary or final proxy statement containing the information specified in Schedule 14A of the Exchange Act Rules. The required disclosure includes basic facts that informed voters would presumably possess. For example, Regulation 14A requires that the proxy statement disclose the time, date, and place of the meeting to which the solicitation relates, the revocability of the proxy, the solicitor’s identity and source of funds, and the identify of and basic information about candidates for directors (if relevant). 14a-3 also requires the proxy statement sent by management in connection with proxy solicitation for the annual shareholders’ meeting shall be accompanied by an annual report in prescribed form.
    4. Rule 14a-5: relates to the readability of the proxy statement. Specifies the type style (roman) and type size (normally 10 point), the manner in which material must be presented (where practicable, information should be in tabular form; all amounts should be stated in figures), and how information shall generally be presented.
    5. Rule 14a-4: regulates the form of the proxy that solicitors ask shareholder to execute. Like 14a-5, it also imposes readability requirements. The concern is to ensure that shareholders are given an opportunity to do more than grant the authority request by the solicitor. The proxy card must provide boxes whereby a shareholder may specify whether she approves, disapproves, or abstain with respect to each matter covered by the proxy. If the matter relates to an election of directors, the proxy card must clearly provide a method whereby the solicited shareholder may withhold authority to vote for nominees favored by the solicitor.
    6. Rule 14a-9: Catch-all provision designed to supplement and reinforce the specific disclosure mandates. This rule prohibits the making of false or misleading statements as to any material fact, or the misleading omission of a material fact, in connection with a proxy solicitation.
    7. Rule 14a-7: requires a corporation that is itself soliciting shareholders in connection with an annual or special meeting to provide specified proxy solicitation assistance to requesting shareholders. If a shareholder exercises her Rule 14a-7 rights, the corporation must elect either: (1) to provide the requesting shareholder with an accurate list of those shareholders and financial intermediaries from whom the corporation intends to solicit a proxy; or (2) to directly mail the requesting shareholder’s proxy material to shareholders and financial intermediaries.
    8. Rule 14a-8: under this, a qualifying shareholder may require her corporation to include a “shareholder proposal” and an accompanying supporting statement in the company’s proxy materials. A proponent is a “qualifying shareholder” if, at the time she submits her proposal, she has owned either at least $2000 in market value of 1% of the company stock for at least one year, and if she continuously owns such stock through the date of the meeting. Can only make one proposal per meeting.
      1. 14a-8(i) provides the basis for which a company may exclude a shareholder proposal can be excluded even if the procedural requirements are complied with.
        1. 14a-8(i)(5): Relevance. If the proposal relates to operations which account for less than 5% of the company’s total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.
    9. Lovenheim v. Iroquois: Court says that the meaning of not otherwise significantly related is that you don’t have to meet the 5% threshold if there is social or ethical significance. It could still impact the company by negative association even if it’s only a small part of the business and doesn’t have a direct economic impact.
    10. Bancorp Request for No Action Letter
      1. No action letters are submitted to SEC employees when there is a plan to do X,Y, and Z and want to find out whether it is illegal. Want the SEC to write back that if you do it they won’t recommended any action against you. This isn’t binding on the SEC. Reserve doing this for a situation where you only go forward if the SEC thinks that it is ok; if you plan on doing it anyway, better off not asking the SEC and finding out that they won’t not take action.
      2. In this case, a shareholder is asking that the directors be elected annually – under DE and MBCA, this has to be in the AOI, and in this case the AOI need to be amended. The AOI can only be amended if the board initiates the process. The company says that it will be a violation of state law to do this. SEC says that they can’t exclude the proposal from the proxy card – the shareholder is basically asking the board to ask the shareholders to vote on whether they’d want to have a change.

  1. Shareholder Access to Corporate Records and Shareholder Lists
    1. MBCA – provides absolute access to some records w/o showing a proper purpose. With a proper purpose, can get access to certain things.
      1. § 7.20: shareholder’s list for meetings
      2. § 16.01: Corporate Records
      3. § 16.02: Inspection of records by shareholders
        1. § 16.02(a): shareholder can inspect and copy, during regular business hours at the corporation’s principal office, any records under 16.01(e) if he gives written notice at least five business days in advance. These documents include the AOI (which are public, so not a big deal), bylaws, resolutions adopted by the board, minutes of shareholder meetings, all written communications to shareholders…
        2. § 16.02(b): shareholder can get other items if he meets the requirements of subsection (c), including (1) excerpts of the meeting of the board of directors, records of any action of a committee of the board of directors while acting in place of the board of directors on behalf of the corporation … (2) accounting records of the corporation; and (3) the records of shareholders
        3. § 16.02(c): A shareholder may inspect and copy the records described in subsection (b) only if: (1) his demand is made in good faith and for proper purpose; (2) he describes with reasonable particularity his purpose and the records he desires to inspect; and (3) the records are directly connected with his purpose.
      4. § 16.03: scope of inspection right
      5. § 16.04: Court ordered inspection
    2. DE
      1. § 219: list of stockholders entitled to vote; penalty for refusal to produce
      2. § 220: Inspection of books and records
        1. §220(b): any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose the corporation’s stock ledger, a list of its stockholders, and its other books and records, and to make copies or extracts therefrom. A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder. In every instance where an attorney or other agent shall be the person who seeks the right to inspection, the demand other oath shall be accompanied by a power of attorney or such other writing which authorizes the attorney or other agent to act on behalf of the stockholder….
    3. 1934 Securities Exchange Act
      1. § 14a-7: obligations of registrants to provide a list of, or mail soliciting material to security holders.
        1. Under this section, corporation has a choice of either mailing the proxy material for the shareholder (but at the shareholder’s expense) or providing the shareholder with a list of the shareholders.
    4. Conservative Caucus v. Chevron Corp
      1. P seeks a stockholder list in order to communicate with other stockholders about the alleged economic risks about D’s business activity in Angola. D tries to argue several reasons why the P’s reasons are improper, but court rejects them all. Court ultimately finds for P, and that Chevron had not borne its burden showing that P’s urging Chevron to cease to do business in Angola b/c of possible negative economic consequences of that activity is an improper purpose and that any other purpose is irrelevant.

Fiduciary Duty, Shareholder Litigation, and the Business Judgment Rule

  1. Introduction
    1. MBCA § 8.30: (a) each member of the board of directors, when discharging the duties of a director, shall act (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interest of the corporation.
    2. In the corporate setting, fiduciary duty has two functions. First, it instructs directors to be absolutely fair and candid in pursing personal interests. Second, it describes the bounds of acceptable conduct for directors in carrying out their individual and collective duty to manage the corporation. Directors have a duty of loyalty and a duty of care.
    3. Shlensky v. Wrigley:
      1. P is a minority shareholder of the Cubs – claims that the majority shareholder isn’t acting in the best interest of the Cubs by not installing lights and having night games & that he is motivated by personal opinion that baseball can’t be played at night.
      2. Court says that the plaintiff would have to prove fraud. Court found in this case that the director’s aren’t liable –it is simply a business judgment. Also appears that the court isn’t convinced that having night games would increase profits.
      3. The plaintiff here could always sell his stock – can also argue that he took the risk at the time he bought the stock. If you believe in the efficient market hypothesis, he is compensated by paying a lower price for the stock.
    4. Dodge v. Ford Motor Company
      1. Dodge brothers are complaining that Ford is going to lower the price of the cars and that will lead to lower profits for the shareholders; they were paying low or no dividends and paying other people by lower prices, higher salaries, etc. The Court initially says that Ford can’t treat the company as its own charitable organization. The court language sounds like they are going to rule against Ford, but in the end they defer to Ford’s judgment and find that there isn’t a breach of fiduciary duty – they do, however, force the company to pay dividends.
    5. MBCA § 8.31 – provides the standards of liability for directors
    6. Joy v. North
    7. NY Business Corp. Law § 717(b): Duty of Directors
      1. How do board members discharge their fiduciary duties to the corp? Why have a broader view of constituency?
        1. Want corporations to use their influence for the good of society. On the other hand, board doesn’t have an obligation to do so. Profits are important, and this in turn fuels a strong capitalist economy. Shareholders are the residual claimants, so it is important for them to think primarily of profits – they have the most to lose if the corporation fails.
      2. Why have flexibility in such corporate statutes?
        1. Benefits the community b/c it asks corporation to think of them in their decision. Benefits the board b/c it makes it easier to defendant themselves from shareholder suits. Also useful in takeover attempts – refusals can be framed in terms of benefits to the community “We didn’t want to merge b/c they would lay off workers, which hurts the community.”

  1. Fiduciary Duty of Care
    1. MBCA § 8.30
      1. Act in good faith
      2. In a manner director reasonably believes to be in the best interests of the corporation.
      3. The drafter’s didn’t incorporate a pure business judgment rule. Makes it hard to bring a suit against directors for making a bad decision. This provision sets the standard of care.
    2. Business Judgment Rule
      1. You can’t hold a director liable for making a bad decision. The presumption is in favor of directors that their decisions were made in good faith – the burden of proof falls on the plaintiff. Director’s don’t have benefit of hindsight when they make their decisions, so this justifies a higher standard of liability. Courts also don’t want to force businesses to avoid risk – if there were no risks, the economy would suffer
      2. Business judgment rule doesn’t shield directors from suits based on oversight – only if the suit is attacking their decisions.
      3. If board fails to inform itself (i.e. decision making process, not the decision itself), then it also can not shield itself using the business judgment rule.
    3. Francis v. United Jersey Bank
      1. Court said that it doesn’t matter if the defendant wasn’t aware of what was going on – can’t avoid obligation by not going to meetings or paying attention to what is going on.
    4. Hoye v. Meek
      1. There were GNMAs that were subject to repurchase, and they were declining in value over time. These were leveraged transactions – this means that they money was being borrowed to make the investments. Advantage of doing this is that hopefully you are getting a return while not tying up your other capital. If the asset increases in value faster than the interest payment, you are making money w/o actually having to invest any. However, in this case the value plummeted – they had to pay the money borrowed for the GNMAs, but the asset is worth much less. Guaranty continued to opt to roll over the investment through repurchase contracts – it was continually faced with the question of whether to sell the GNMAs at a loss as interest rates rose or hope that the loses would be offset in the future when the interest rates might decline.
        1. GNMA’s hold a bunch of mortgages, but they are at a fixed rate so when the interest rates rise, the value of the GNMA is lower b/c other people are getting a higher return. If interest rates are rising, not only is the value of the investment falling b/c it has mortgages at a fixed rate that is lower, the borrowed money was on a variable rate and they are paying more for the borrowed money.
      2. Meek is held liable for failing to supervise his son. Even though he was somewhat retired, he is Chairman of the Board and President of the company – the President is supposed to be in charge of daily management and not just board meetings. Best case against holding Meek liable is his role as an officer.
      3. The other directors also failed in their obligations by being unaware in these transactions, although these investments did not violate the company policy about investment. The board members might have a defense that they were relying on the CEO to take care of things, but they need to be able to spot these type of red flags on the financial statements.
    5. MBCA § 8.30(e): A director is entitled to rely, in accordance with subsection (c) or (d), on: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided; (2) legal counsel, public accountants, or other persons retained by the corporation as to matters involving the skills or expertise the director reasonably believes are matters (i) within the particular person’s professional or expert competence or (ii) as to which the particular person merits confidence; or (3) a committee of the board of directors of which the director is not a member if the director reasonably believes the committee merits confidence.
    6. MBCA § 8.31(a)(ii)(iv): (a) A directors shall not be liable to the corporation or its shareholders for any decision to take or not to take action, or any failure to take any action, as a director, unless the party asserting liability in a proceeding establishes that (2) the challenged conduct consisted or was the result of (iv) a sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention, by making (or causing to be made) appropriate inquiry, when particular facts and circumstances of significant concern materialize that would alert a reasonably attentive director to the need therefore…
    7. Smith v. Van Gorkom:
      1. Van Gorkom was the CEO and puts together a leverage buyout under which the shareholders would be paid $55/share. The board then approves the merger. The company had tax credits that it wasn’t able to take advantage of – these tax credits were an asset that could be taken advantage of if it could generate enough income. The Court doesn’t say that the proposed transaction would help the tax problem – the corporation was going to borrow the money, and would be liable for that, and it would potentially give them more tax credits.
      2. From a personal standpoint, Van Gorkom was getting ready to retire – the other board members were concerned about their jobs and it is hard to separate this all out from shareholders interests because they all have some personal stake.
      3. Court found that outside valuation was not required, but Van Gorkom should have talked to the board before the buyer.
      4. Court found that the directors were liable as well – they failed to disclose information to the shareholders.
      5. Court is careful not to say that an external valuation is required – here the directors didn’t even get an internal valuation. The directors also didn’t allow for the “courting” and to hear offers from other companies.
      6. Dissent: the directors were experienced business people and that should have reasonably allowed them to make the decision – they should know what their company is worth.
      7. Under the business judgment rule, the burden is on the P to show that the directors acted in bad faith- once the P is able to pierce through the business judgment rule protection, the burden shifts to the defendant to show that although they aren’t entitled to business judgment rule protection, the transaction was still fair
      8. Two aspects of fairness
        1. fair dealings
        2. fair price
      9. Court remands the case on the issue of fair price – doesn’t remand on fair dealings b/c that is the premise of the entire case. Market value is the value of one share, not the value of control of the company – that is why the selling price would be higher here than the market price of the share is.
    8. Statutory Exculpation Provisions
      1. Came in part as a response to Van Gorkom. In the AOI, can include some exculpation from fiduciary duty obligations.
      2. MBCA § 2.02(b)(4): (b) the article of incorporation may set forth: (4) a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which he is not entitled; (B) an intentional infliction of harm on the corporation or the shareholders; (C) a violation of section 8.33 [unlawful distributions]; or (D) an intentional violation of criminal law.
      3. DE § 102(b)(7): (b) …the certificate may also contain any of the following matters: (7) a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of the director: (i) for any breach of the director’s duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit…

  1. Duty to Monitor
    1. Illegal activity:
      1. Directors can’t insulate themselves by not knowing what is going on. There is also a “should have known” standard that is sometimes applied.
    2. In Re Caremark
      1. The liability is placed on the directors – they knew there had been a problem, and tried to remedy it to some extent.
      2. Test is set forth by the court, and although it isn’t the Supreme Court, most people follow this test:
        1. Plaintiffs have to show either (1) the directors knew or (2) should have known that violations of the law were occurring and, in either event (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure proximately resulted in the losses complained of.

  1. The Fiduciary Duty of Loyalty and Conflicts of Interest
    1. The duty of loyalty occurs in two classic settings (circumstances in which a director personally takes an opportunity that the corporation later asserts rightfully belonged to it; and (2) transactions between the corporation and the director, commonly called “conflicting interest transaction.” The core of this fiduciary duty is the requirement that a director favor the corporation’s interests over her own whenever those interests conflict.
    2. Corporate opportunity doctrine
      1. ALI Princ. of Corp. Governance § 5.05: (a) general rule. A director or senior exec may not take advantage of a corporate opportunity unless: (1) the director or senior exec first offers the corporate opportunity to the corporation and makes disclosure concerning the conflict of interest and the corporate opportunity; (2) the corporate opportunity is rejected by the corporation; and (3) Either (A) the rejection of the opportunity is fair to the corporation; (B) the opportunity is rejected in advance, or in case of a senior exec who is not a director, by a disinterested superior, in a manner that satisfies the standards of the business judgment rule; (C) the rejection is authorized in advance or ratified , following such disclosure, by disinterested shareholders, and the rejection is not equivalent to a waste of corporate assets.
      2. Northeast Harbor Golf Club v. Harris:
        1. Harris is president of a golf club, and there was land nearby offered for sale, and she purchased it in her own name, and didn’t inform the board members until she had paid for the land. She initially didn’t have any plans to develop the land until she bought more, at which time she decided she wants to develop the land.
        2. One way around the conflict of interest (in theory at least) is to provide a lot of disclosure and then wait for board approval.
        3. The court talks about different tests: The T/C held for Harris on the grounds that she wasn’t in the company’s line of business – their business is not land development. Another test is whether the corporation is able to act on the opportunity – here the corporation wasn’t financially able to take advantage. On appeal, the Court adopts the ALI test – Court doesn’t like the financial ability test b/c it allows insiders to manipulate whether they have the financial ability to take advantage. Also a problem with the line of business test – depending on how you characterize the line of business, it may or may not fall under this – Court rejects this as too broad.
        4. Court instead adopts the ALI test – there was no advance notice of full disclosure provided here. Under ALI, would offer the opportunity to the corporation, and then wait for it to be rejected.
      3. Broz v. Cellular Information Systems
        1. Broz is director of CIS, and also owned another business. He purchased some cellular licenses, which CIS didn’t want and couldn’t afford. CIS was currently being acquired by another company, who was also actively bidding for the license. While Broz didn’t make a formal disclosure, he did tell the CEO. Also, CIS isn’t in a financial position and at the time Broz took the action to purchase, CIS was being acquired. Court found the Broz didn’t owe a fiduciary duty to the acquiring company. Everyone knew that Broz had a conflicting interest – this wasn’t true with Harris. Also, Broz wasn’t a president; Harris was.
    3. Conflicting Interest transactions
      1. Arises when a director/officer is on both sides of a contract, and thus there is an inherent conflict of interest. Historically, all you would have to prove is conflict and that the contract would be void or voidable. Under modern corporate law, this per se rule has been universally rejected. Perhaps a better rule is that contracts are void/voidable if contracts are unfair to the corporation. Even if a truly disinterested board approves the transaction and everything is disclosed, shareholders can still sue for breach of duty of care – problem is that they still have to overcome the business judgment rule.
      2. MBCA § 8.60 provides definitions. § 8.61 provides of judicial action. § 8.62 provides directors actions. § 8.63 provides for shareholder actions.
        1. MBCA §§ 8.61*b(, 8.62, and 8.63 provide that a conflicting interest transaction may not be voided as a result of such conflict if the transaction is ratified by “qualified directors,” or by the vote of “qualified shares” or is fair to the corporation.
      3. DE § 144: interested directors; quorum
        1. DE law tends to focus on whether someone got any money out of the deal when looking at if they were disinterested. In essence, DE § 144 provides that no conflicting interest transaction shall be void or voidable solely by reason of the conflict if the transaction (1) is authorized by a majority of disinterested directors, or (2) approved in good faith by the shareholders, or (3) is fair to the corporation at the time authorized. It also codifies the common law requirement of complete candor and fair dealing by making director or shareholder approval effective only if the interested director has disclosed all material facts.
      4. Globe Woolen Co v. Utica Gas & Electric
        1. Globe owns mills; Maynard is the CEO. Maynard is also a board member of Utica, which is an electricity provider. The two companies enter into a contract – M demands certain aspects of the contract, so that it was disadvantageous to Utica.
        2. This is a conflicting interest transaction b/c Maynard is on both sides of the deal. His defense is at the board meeting, they approved the contract while M abstained from voting. Court said abstaining from voting is not enough – M should have disclosed changes that would occur from the transaction – he stood by and said nothing while everyone else voted.
        3. Could these contracts have been rescinded by Utica w/o resort to fiduciary duty principles? Could use unconscionability bargaining power of parties (procedural), fair dealing (substantive). Can also argue bad faith.
      5. Shapiro v. Greenfield
        1. conflicting opportunity – officer/director is on both sides of a transaction. Corporate opportunity individual has taken an opportunity that the corporation may want.
        2. MD statute here was similar to the DE code – both are very broad and don’t provide many bright line rules. Court remands the case for the T/C to evaluate whether Smith was interested simply b/c she was related to Shapiro – use test of whether the relationship would reasonably be expected to exert an influence on director’s judgment.
        3. if this had been decided under the MBCA, the court would have affirmed T/C decision – under the model code, a relative is automatically a “related person” and therefore an “interested person.” It is a per se rule, which the court refused to apply in this case.
      6. If as a plaintiff you can show conflict, then a test of fairness would apply, and not the business judgment rule. If the P can show conflicting interest transaction, the burden shifts to the defendant to show that it was entirely fair – both price and dealing.
      7. Sinclair Oil v. Levien:
        1. Sinclair owns 97% of the stock of Sinven, and there are some other plaintiff shareholders. Sinclair is a parent company. P is a minority shareholder and bring a claim b/c Sinclair had Sinven pay out dividends. Another claim related to a contract – that Sinclair forced Sinven into a contract with International, and Sinclair wouldn’t let Sinven sue Int’l after Int’l breached. Third claim is that Sinclair won’t allow Sinven to expand beyond existing markets.
        2. T/C found that all the directors of Sinclair are directors of Sinven, or at the very least all the directors of Sinven are elected by Sinclair. Court treats them as if this is a conflicting interest transaction. Court found that it was not enough alone that Sinclair owned 97% to show conflict of interest – need to show that the management is the same - being a controlling shareholder alone is not enough in DE.
        3. Court did find that a parent does indeed owe a fiduciary duty to its subsidiary when there are parent-subsidiary dealings, so Sinclair did owe a fiduciary duty to Sinven.
        4. P asserted that the court should apply intrinsic fairness to the issue of dividends. The Court didn’t agree – have to see whether there was self dealing on the part of Sinclair. Court said there wasn’t any self-dealing b/c the minority shareholders got the same benefits. The court applies the business judgment rule – once it is applied, have to show gross negligence, or use the Van Gorkom case and show the decision making process was flawed.
        5. Next claim was that Sinclair didn’t allow Sinven to expand – Court said it is not self dealing b/c there is no showing that Sinclair usurped any business opportunity, and Sinclair was just as harmed as the minority shareholders.
        6. Last claim is breach of contract – Sinclair benefited but minority shareholders didn’t b/c Sinclair is the entire shareholder of International. Need to look at the majority of the minority shareholder – has to be from a disinterested group in order to cleanse. Sinclair has to prove forcing Sinven not to pursue the breach was intrinsically fair, and Sinclair didn’t meet this burden.

    1. Special Problem of Stock option grants
      1. DE § 157: rights and options respecting stock
        1. § 157(b): …in the absence of actual fraud in the transaction, the judgment of the directors as to the consideration for the issuance of such rights or options and the sufficiency thereof shall be conclusive.
      2. MBCA § 6.24: share options
      3. Byrne v. Lord:
        1. in 1994, control of Pace’s board changed and there were two new directors who join a holdover director – the three of them are also directors of ABC. Pace’s board knows that it is in trouble and the regulator is going to take control of ABC, and the board is unwilling to stay unless they get increased compensation. The compensation given was stock options – between them, they got roughly 40% of the stock – this plan was devised by the board. They only had the option to buy the stocks – they didn’t get the stock immediately. The directors exercised their options not to long after – it took Madero a week, and the others shortly after.
        2. Stockholders challenge the stock option plan, claiming a breach of fiduciary duty. Court evaluates this by looking at the benefit to the company and if the stock option bears a reasonable relationship to that benefit – benefit prong and value prong
        3. Court found that the stock option plan didn’t relate to the value that the company was trying to get b/c they could exercise the options and then leave. There was nothing in the options that required retention.
        4. This was a conflicting interest transaction – the directors were on both sides. Court gets around the entire fairness test by applying the two prong test – the court doesn’t say the directors would never have to show entire fairness, but just get around it here.

  1. Special Aspects of Derivative Litigation
    1. Direct suit: suit by a shareholder of group of shareholders for person injuries – shareholder is alleging harm to himself as a shareholder – there aren’t many of these under state law.
    2. Shareholder derivative suit: board should have brought suit itself and the money recovered, if any, goes back into the company – basis is the directors owe their fiduciary duty to the corporation & their duty to the shareholders derivatively. This suit is a mechanism that allows shareholders to sue on behalf of the corporation. Reason for allowing it is that the directors aren’t going to sue themselves, and they aren’t likely to sue former board members either.
    3. Demand requirement:
      1. MBCA § 7.42:
        1. No shareholder may commence a derivative proceeding until: (1) a written demand has been made upon the corporation to take suitable action; and (2) 90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected or unless irreparable injury to the corporation would result by waiting for the expiration of the 90 day period.
      2. MBCA § 7.44(d): if a derivative proceeding is commenced after a determination has been made rejecting a demand by a shareholder, the complaint shall allege with particularity facts establishing either (1) that a majority of the board of directors did not consist of independent directors at the time the determination was made or (2) that the requirements of subsection (a) haven’t been met.
      3. DE:
        1. demand is not required, but instead have to show demand futility
        2. See Aronson for two part test
      4. ALI Principles § 7.03:
        1. (a) before commencing a derivative action, a holder or director should be required to make a written demand upon the board of directors of the corporation, requesting it to prosecute the action or take suitable corrective measures, unless demand is excused under subsection (b). The demand should give notice to the board, with reasonable specificity, of the essential facts relied upon to support each of the claims made therein.
        2. (b) demand on the board should be excused only if the plaintiff makes a specific showing that irreparable injury would otherwise result, and in such instanced demand should be made promptly after commencement of the action.
    4. Aronson v. Lewis
      1. Fink had been given loans by the company, and the complaint charged that these transaction had no valid business purpose and were a waste of corporate assets b/c the amounts to be paid to Fink are grossly excessive and he performs little or no service. P’s complaint is that Fink had appointed all the board members and this would make demand futile.
      2. Would including the directors as defendants show demand futility?
        1. it would encourage the P to list all the directors as defendants.
      3. Court said that the P’s complaint that the board had ties to Fink wasn’t enough – P has to plead with particularity that the board is interested or that they don’t have the protection of the business judgment rule
      4. Test to show demand futility in DE: Court must decide whether, under the particularized facts alleged, a reasonable doubt is created that: (1) the directors are disinterested and independent, and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.
      5. In order to show futility, need to show that the directors have some personal, financial conflict – just showing Fink is a majority shareholder is not enough.
    5. Under the Model Code, need to make demand. The board is going to refuse demand (not sue themselves). The plaintiffs then have to show that demand is wrongful under § 7.44(d), which sounds a lot like Aronson.

  • Demand
  • Refuse
  • Refusal wrongful (7.44(d))
  • Claim on merits
  • Demand futile
  • Aronson 2 part test or
  • Claim on merits

    1. Brehm v. Eisner
      1. P isn’t happy about an employment agreement approved by the Old Board. P also isn’t happy that the new board allowed Ovitz to be terminated on a no-fault basis. This wasn’t a conflict of interest transaction in terms of self-dealing because the contract is an employment agreement and no one is on both sides. This is really a claim of duty of care – P still needed to show demand futility, and did so by showing that Eisner was too tied to Orvitz and the board was too tied to Eisner. The court dismisses the claim on the issue of conflict of interest with prejudice.
      2. With regards to the duty of care claim, P claims that the board never should have approved the contract. The court does point out that the board was relying on expert advice from Crystal, who was a compensation expert. The substantive due care claim relates to the actual decision – that agreeing to the contract constituted waste. Court basically says that there is no such thing as substantive due care – need to show waste – that you gave away corporate assets.
      3. Court also wasn’t impressed by the fact that the plaintiffs got their information from a newspaper – they could have gotten it from public documents, or requested documents under DE § 220 as long as it’s a proper purpose (if a company can show the suit is frivolous, then the court might not think it’s a proper purpose).
    2. In Re The Limited
      1. Wexner is the CEO of the Limited and controls 25%, and is also trustee of the Children’s trust. The Trust had options for shares and The Limited was required to maintain $350 million in a trust. There was a put option – trust held the option to force the companies to purchase its shares at $18.75 at any time prior to 1/31/06. Company had the call option to purchase shares for $25.07 after 7/31/06. Company had a lot of cash and wanted to invest – it is not uncommon for companies to repurchase their own shares. Board decides to purchase $15 million shares. Plaintiffs claim the company did it because Wexler wanted the deal to go through b/c he didn’t want the company to exercise the call option b/c the stock was trading around $40.
      2. P was able to show that there was enough interested directors and demand was excused. Court looked at this subjectively – looked at whether these directors would be interested under these circumstances looked at employment and how much reliance there was on the company, and consulting fees. Court found that some directors interested, some not. Looks at each individually.
      3. Court finds that plaintiffs can’t make the corporate waste claim – P is trying to say the recession of the redemption agreement along with purchasing the shares is problematic.
      4. What about the fact that the company gave up the valuable call option? The stock price could change between then and the time when they could exercise the call option.
      5. P is allowed to continue on the claim of duty of loyalty b/c they were able to prove that the board was interested. The reason that there are other claims is just in case the P was unable to prove that there were interested directors.
    3. Zapata Corp v. Maldonado
      1. Shareholders are complaining b/c the board voted to move up stock repurchase options so they didn’t have to pay taxes. P had already brought this case as a derivative on demand excuse – that suit is already in progress. There is a change in the membership of the board b/c the litigation takes so long, and the board decides to create a committee to see if the suit is in the best interest of the corporation. In reviewing the committee, first, the court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries. The corporation should have the burden of proving independence, good faith, and a reasonable investigation, rather than presuming independence, good faith, and reasonableness
    4. Timeline
      1. In DE:
        1. Could do demand (although not required), but in most cases would use demand futile approach. If demand is refused, the shareholders would have to concede the interest. Would then become a breach of duty of care claim. Would also have to claim demand was wrongfully refused, and that would be judged based on business judgment rule.
        2. Normally, will have a situation in which no demand is made shareholder files suit
          1. Shareholder will first have to show demand futility (Aronson 2 part test)
          2. Then substantive claim as well. Want to plead a case that isn’t protected by the business judgment rule (duty of loyalty; duty of care cases not covered – i.e. failure to monitor; conflict of interest)
        3. Then might get a motion to dismiss by an independent committee
        4. Court will look at the independence of the committee & reasonable investigation. Step 2 will be the Court makes it own determination regarding the decision the dismiss
          1. Reasonable investigation will be based on the Van Gorkam test
      2. Under MBCA:
        1. Demand is required - § 7.44
        2. After demand is rejected, shareholder files suit
        3. Plead § 7.44(d) and also plead substantive claim
        4. Attempt to dismiss by independent committee
        5. § 7.44(b) – establish independence
        6. § 7.44(a) is like the first part of Zapata – but there is no second prong show that it is not in corp’s best interest for suit to continue
        7. § 7.44(e) – if a majority of the board of directors (this isn’t the committee) does not consist of independent directors at the time the determination is made (the dismissal), the corporation has the burden of proving § 7.44(a). § 7.44(e) is addressing structural bias.

Close Corporations

  1. Contracting Around Law
    1. MBCA § 7.32: shareholder agreements
    2. MBCA § 8.01: requirements for and duties of board of directors
    3. MBCA § 8.24(c): if a quorum is present when a vote is taken, the affirmative vote of a majority of directors present is the act of the board of directors unless the AOI or bylaws require the vote of a greater number of directors.
    4. DE § 141(a) & (b); § 350-354
    5. McQuade v Stoneham:
      1. Agreement between majority shareholder (S) and two minority shareholders (McQ & McG) – the two minority stockholders agree to buy stock from S; S assures them that they will get to keep their director and officer positions. Court says at least part of this contract is unenforceable – can’t create a contract that binds a director. The part of the agreement that S will keep them as officers takes away his power to change the directors since normally an officer is an employee at will. Can’t limit the director’s discretion in their decision making.
    6. Clark v. Dodge
      1. Clark agreed to disclose a secret formula to Dodge in exchange for Dodge’s promise that he would retain Clark as an officer and director. Court upholds the agreement as enforceable. Unlike McQuade, there was no attempt here to sterilize the board. Here there is discretion retained by Dodge as to whether he had to retain Clark as officer – Clark would only be retained so long as he did his job well.
      2. In McQuade, there wasn’t 100% of the shareholders who agreed. Here, there was 100% agreement and no board sterilization. If it is a non-unanimous shareholder agreement and there is a requirement to maintain all directors, McQuade would govern. Clark gave a big loophole – as long as all the shareholders are involved, then it will be upheld.
    7. Zion v. Kurtz
      1. Zion and Kurtz entered into a shareholders agreement providing that Group (the company) would not engage in any business or activities w/o Zion’s consent – this agreement came about as part of the transactions surrounding Zion’s purchase of a minority interest in group – and Zion is essentially given veto power over management decisions plus shares. Kurtz makes business decisions w/o consulting Zion – the suit is essentially about the breach of contract. Kurtz argues that the contract is unenforceable b/c it didn’t comply with the special statutory provisions in DE
      2. Court upholds the agreement anyway – if they had complied with the statute, it would be enforceable. Court found that no one was harmed by this since K & Z were the only two shareholders, and if the contract was unenforceable, then it would allow K to get money for the shares but not be bound to the veto power.
      3. Dissent: shareholder agreements of this kind are void as against public policy as a general rule. This contractual provision, if enforced, would effectively shift the authority to manage every aspect of the corporate affairs from the board to plaintiff, a minority shareholder who has no fiduciary obligations with respect to either the corporation or its shareholders.
    8. Blount v. Taft:
      1. Eastern (the company) had three groups of shareholders – Blounts (41%), Tafts (41%), McGowan (18%). The groups sat down to write new bylaws – the executive committee would have three people, one from each family, and the bylaws say that if anyone is hired, has to be unanimous consent. Then have another meeting where they incorporate a new bylaw that was based on a majority vote, and doesn’t say anything about hiring. Court have that the first agreement, § 7, is a shareholder agreement, but § 4 said that you can amend the bylaws through majority vote, and the Tafts and McGowans had a majority vote.
    9. Ringling Brothers Case
      1. Two minority shareholders agree to vote together – the agreement contained a provision for what would happen if they didn’t agree (they would go to a third party arbitrator). Despite the fact that this agreement gave the third party arbitrator the right to vote shares he didn’t own, the court upholds it anyway.
    10. MBCA
      1. § 7.22: proxies
      2. § 7.30: voting trusts: (a) one or more shareholders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust (which may include anything consistent with its purpose) and transferring their shares to the trustee….
      3. § 7.31: voting agreements: (a) two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for this purpose. A voting agreement under this section is not subject to the provisions of section 7.30. (b) a voting agreement created under this section is specially enforceable.
    11. DE
      1. § 212: voting rights of stockholders; proxies
      2. § 218(a): voting trusts: one stockholder or 2 or more stockholders may by agreement in writing deposit capital stock of an original issue with or transfer capital stock to any person or persons, or entity or entities authorized to act as trustee, for the purpose of vesting in such person or persons, entity or entities, who may be designated voting trustee, or voting trustees, the right to vote thereon for any period of time determined by such an agreement, upon the terms and conditions stated in such agreement….
      3. § 218(c): an agreement between 2 or more stockholders, if in writing and signed by the parties thereto, may provide that in exercising any voting rights, the shares held by them shall be voted as provided by the agreement, or as the parties may agree, or as determined in accordance with a procedure agreed upon by them.
    12. Ramos v. Estrada
      1. Holding: a corporate shareholders’ voting agreement may be valid even though the corporation is not technically a close corporation
      2. Broadcast and Ventura each could elected certain members of the board Broadcast group within themselves had agreed to vote together – if the majority of Broadcast wanted to vote for X, they would all vote for X. Estrada deflects and votes opposite of Broadcast, and voted along with Venture to oust Ramos as president and replace him with a member of Ventura. T/C found that Estrada couldn’t vote her shares differently than Broadcast. Estrada tries to argue on appeal that the agreement wasn’t enforceable b/c it was done by proxy, and the proxy expired.
      3. Court found that this wasn’t a proxy agreement b/c each shareholder was still casting their own votes. Estrada tries to raise some kind of contract theory that would allow her to rescind, but the court doesn’t allow this – Even though they weren’t designated as a close corporation, the court found that it was ok since they acted like one, and this isn’t a McQuade case; it was just an agreement to vote together to maximize voting power.

  1. Partnership Analogy & Enhanced Duties
    1. A corporation is set up to be perpetual – if someone exits, the business keeps going. Just b/c two shareholders don’t agree in a corporation doesn’t mean that it has to be resolved – in a partnership you would seek a dissolution.
    2. Zidell v. Zidell
      1. Emory Z and Arnold Z each own 37.5% of the shares; Jack owns the other 25%. There was friction, which increases when Emory gets ½ of Jack’s shares; Emory and his son Jay now have a majority interest in each of the corporations. Friction further increases when Emory has his salary increased, but doesn’t do the same for Arnold. Arnold resigns. Prior to Arnold’s resignation, the corporation had paid no dividends; when he resigns, the corp starts to pay dividends, but Arnold claims they are too small.. T/C agrees.
      2. On appeal, the court says that you should use the standard of bad faith and essentially applies the business judgment rule. Finds that this is not bad faith, and reverses T/C. Dividends are usually something that the court tries not to get involved in and applies the business judgment rule, although there are cases will the court will award dividend payments.
      3. P also tries to argue that even if the decision was bad, the process in making it was. Court also rejects this – the board were the day to day managers and knew the ins and outs of the company. In a case like Van Gorkam, the directors have outside jobs, but where these people ran the business every day.
      4. Could try to argue that there is a duty of loyalty problem b/c the board members voting for the dividends are also receiving them, but this is not self dealing b/c ALL shareholders are getting the same payments.
    3. Donahue v. Rodd Electrotype Co:
      1. Corporation is in a state of harmony for a few years; ended when the Ds learned that the Rs had the corporation purchase some stock back from Harry R. D is a minority shareholder and wants the same number of shares purchased back from them.
      2. Under traditional corporate law, would have to see if there is a breach of fiduciary duty and a conflicting interest. This is not a corporate opportunity – next need to see if its is a conflicting interest transaction. Could argue that it really isn’t a conflicting interest b/c Harry R retired prior to the transaction, although this deal was likely in the works before he retired. But his family members were also part of the transaction – it is not absolutely clear that it’s a conflicting interest and the business judgment rule would apply. If it’s a duty of loyalty claim, then the test for determining if there is a breach is entire fairness (fair dealing and fair price). Here there was no indication that the stock purchase price was way off, but need to see if the board had enough information to make the decision. But the court looks at this as a close corporation, like a partnership, and not like corporation. The idea that if you give the opportunity to one person it has to go to all (Meinhard) – the duty of finest loyalty.
      3. If the duty of finest loyalty is applied, then you can’t meet that standard unless everyone is given the same opportunity. The Court said that if you give a buyout to one retiring partner, all the people should get the same opportunity, although there is the problem of how to fund this.
      4. Here the court is using a partnership analogy w/o applying any of the consequences of partnership law.
    4. Wilkes v. Springside Nursing Home:
      1. Wilkes owns 25% of the corporation, and there are three other shareholders, who at some point oust Wilkes – they take away his salary and don’t re-elected him as director. Wilkes wins – this isn’t really the business judgment rule – the Court instead looks at whether the decision serves a legit business purpose.
      2. Majority would have to show that their actions have a legit business purpose and there was no alternative – in that case you can do things to harm the minority. Here the court finds that they didn’t have a purpose for what they did and they got rid of Wilkes for personal reasons.
      3. If this corporation had instead been an at-will partnership and the majority acted wrongfully, Wilkes could force a dissolution or buy out the others and continue the business.
    5. Hetherington & Dooley, Illiquidity and Exploitation
      1. Impose a statutory, mandatory buyout that would allow a shareholder to be bought out if he was unsatisfied after a mandatory two year holding period. This provides that you can’t just get out b/c you want the money – this contemplates the shareholder wanting to exist. Critics of this rule say that it takes away the right of shareholder to fashion their own rules.
    6. Nixon v. Blackwell:
      1. Case involved a buyout option available to employee shareholders, but not available to other classes of shareholders. Option provided for independent evaluation, and it was funded by life insurance. T/C finds that directors breached their fiduciary duty by not treating all the shareholders equally. This is a conflicting interest transaction b/c directors are on both sides, and some are benefited but not others. DE Sup. Ct. finds that all shareholders don’t have to be treated equally, and this is based on the plan of the founder of the company. Court looks at the expectation of the parties. Court applies the test of entire fairness – just as the trial court did – but finds that the transaction is entirely fair.
      2. Suspicion is that DE is pro-management and therefore is more pro-majority

  1. Involuntary Dissolution & Buyouts
    1. MBCA § 14.30: grounds for judicial dissolution
      1. straightforward dissolution statute; (2) shareholder can seek dissolution for a number of reasons, including deadlock or waste
    2. MBCA § 14.34: election to purchase in lieu of dissolution
      1. Grants the defendant corporation the right to avoid a court-ordered involuntary dissolution by electing to repurchase the complaining minority’s share for fair value. Gives the majority rather than the minority the right to determine whether buyout will occur. once a shareholder institutes dissolution suit, corporation could end litigation by buying back the shares; not all jurisdictions have this automatic buyout provision
    3. In Re Kemp & Beatley, Inc.
      1. Gardstein and Dissin are seeking dissolution b/c they are no longer receiving any share of the company’s earnings – they had previously been receiving compensation and dividends.
      2. NY statute says that the court must determine whether the provision for involuntary dissolution when “the directors or those in control of the corporation have been guilty of oppressive action toward the complaining shareholders”
        1. to determine oppression, court looks at the expectations of the shareholders. Uses an objective standard – would look at the expectations of a reasonable shareholder, not this particular shareholder.
      3. Court finds that there was oppression – it was a longstanding policy of the corporation to pay dividends, and the parties expected to have a job. Doesn’t automatically award dissolution. Court will ultimately order a dissolution, but first will allow the other shareholders to buy out the person at a fair value.
    4. Gimpel v. Bolstein
      1. Family owned dairy business; Robert was fired for embezzling from the company, and he never denies the charge. He sues alleging oppression and waste oppression is commonly used b/c it is so broad, and waste is used b/c it can force a dissolution.
      2. Robert makes 3 allegations: (1) he has been excluded from “corporate participation”; (2) the profits of the corporation are distributed to the majority interests in the form of salaries, benefits, and perquisites, with no dividends being declared; whereby Robert derives no benefit from his ownership interest; and (3) he has been excluded from examination of the corporate books and records which he is entitled to examine, completing his freeze out from the corporation.
      3. The court defines oppression in two different ways (1) as a violation by the majority of the reasonable expectations of the minority; and (2) as burdensome, harsh, and wrongful conduct; a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members; or a visible departure from the standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely. The reason for having the two tests is that not each case is the same, and need to look at each on an individual basis.
      4. Even if Robert’s claim was to be evaluated on a reasonable expectations test, he wouldn’t fare very well – first of all, he’s an embezzler, and second, he didn’t buy the shares, he interested them, so its difficult to know his expectations.
      5. Under the burdensome test, Robert again fails – it is not clearly wrongful for the victim of embezzlement to fire the embezzler and exclude him.
      6. Court refuses to award dissolution, but does say that he can have full access to the corporate records. Also the corporation has the option of paying dividends or buy out his stock. So he wins in that sense, but loses b/c no dissolution.

  1. Share Repurchase Agreements
    1. Agreement whereby the corporation will repurchase the shares of a non-continuing shareholder. This is in response to any dispute that may arise when the majority and minority shareholders no longer agree. Share repurchase agreements are generally treated as full contingent contracts – courts will generally enforce the terms even if events subsequent to the execution make the purchase price substantially less than the then fair value of the to-be-acquired shares, unless some compelling equitable reason exists not to enforce the agreement.
    2. Concord Auto Auction v. Rustin
      1. Three sibling shareholders each own 1/3 of two corporations – they had a stock purchase and restriction agreement which provides that all shares owned by a shareholder at the time of his or her death be acquired by the two corporations through life insurance policies specifically established to fund this transaction. Dispute arose after the accidental death of Cox b/c Rustin (on behalf of the estate) failed to tender the shares as required by the agreement. Rustin doesn’t want to sell for the amount in the agreement b/c he thinks the shares are valued too low, and says that Powell and Thomas, the other two shareholders, failed to effect both the annual meeting and annual review of the share price, and if they had the share price would have been higher. Rustin argues that the explicit provision requiring a yearly price review clashes with the provision that the price will remain in effect until changed.
      2. Court applies a contract analysis to determine if there was a clash between not having a shareholders meeting and the share price remaining the same and finds that there was not. This is probably contrary to their expectations – they probably expected to receive what the shares were actually worth, but would want the money to come out of the life insurance policy and not their pockets and they probably would have increased the insurance policy to pay for the higher price of the shares.
      3. If Cox had been terminally ill, asked for a meeting, and never got it, then there would be a much stronger argument for bad faith. Here Cox’s death was accidental and they weren’t sitting around waiting for him to die to get out of paying more. Also, they were not statutorily required to have the meeting – it was discretionary.
    3. Gallagher v. Lambert
      1. Gallagher is an at will employee in a close corporation; he purchased 8.5% interest in the company stock that was subject to a mandatory buy-back provision – if his employment ended for any reason prior to Jan. 31, 1985, the stock would return to the corporation for book value. G was fired right before the buy back price for his shares would increase to fair market value.
        1. book value focuses on the historic value of the assets – what the value was when they were booked and doesn’t take into consideration the actual value
        2. fair market value is supposed to give the value of all the assets today
        3. book value is not always less than the market value, although it generally is.
      2. G was an at-will employee and could be fired at any time – the court said that he didn’t have a right to employment w/o the opportunity to be fired – the agreement itself contemplated him leaving. They had contracted for him not getting the full value of his investment and getting only book value, and court upholds agreement.
    4. Pedro v. Pedro
      1. 3 brothers – each own 1/3 interest. They have a falling out after Alfred claims that there are discrepancies in the books and Alfred is ousted. T/C awards Alfred damages for the amount he would have gotten under the retirement agreement, fair value of his shares, and lost wages. Appellate court affirms T/C - the court brings in fiduciary duty concepts and says that you can’t contract around all fiduciary duties. This case is different than Gallagher b/c here Alfred had an expectation of lifetime employment. Alfred ends up getting more for his shares than he would if there had been no breach – he gets fair market value rather than book.

  1. Limited Liability Companies
    1. LLCs rely heavily on the contract between the parties, and this results in few default rules in the statutes.
    2. Elf Atochem North America v. Jaffari
      1. Elf owns 30% of Malek, LLC; Jaffari owns 70%
      2. The LLC agreement had an arbitration clause – Elf is arguing that this suit is derivative and the LLC statute permitted derivative suits. Here the LLC never signed the agreement, but clearly Elf and Jaffari had signed it as individuals and they are the only two owners. An LLC can be set up where the managers are the owners, or more like a corporation where the managers are separate – regardless, the managers are the ones who would sign the agreement.
      3. Court rejects the argument that the LLC hadn’t signed, and further finds that the agreement specifies any claim would go to arbitration, and even if the suit is derivative it is still brought by a member. Court notes that there is a strong public policy in favor of arbitration, and relies heaving on the private agreement in reaching its decision.
    3. VGS v. Castiel
      1. Virtual, the LLC was formed by one person – two more later join and the LLC is managed by a 3 person board, with Castiel, the founder, entitled to remove 2/3 of the board and could essentially prevent any board decision that he didn’t like. Castiel, Quinn, and Sahagen comprised the board. Q & S make a deal by themselves (w/o C knowing) and merged the LLC into VGS, causing the original LLC to cease to exist. Sahegan is now the majority shareholder in the new corporation that is controlled by him and Quinn.
      2. The LLC agreement didn’t expressly state whether the Board of Managers must act unanimously or by majority vote. Castiel’s first argument is that there had to be unanimous consent for a merger b/c that is implied in the agreement. Court rejects this argument – the agreement is silent on this issue – if unanimity was required, then each of the manager would have veto power, but the agreement specifically gave the minority veto power in certain circumstances.
      3. Castiel prevails regardless – Q & S did the merger by written consent with a majority, which is permitted under the statute, but the Court finds that there is a duty of loyalty that was owed to C. C would have been able to block the merger, b/c he had the power to remove Q immediately. Court won’t allow Q &S to use the “without notice” provision in the statute to do something that they otherwise would not have been able to do.
      4. The court not saying that you can only use written consents if everyone is notified – the court is just imposing a fiduciary duty requirement.
    4. McGee v. Best
      1. P is a former employee of defendant McGee, Best, Frank,& Ingram, LLC. He is fired, and brings a bunch of claims. The Operating Agreement for the LLC contemplates that Plaintiff, Frank, and Best would be employees of the LLC. P has taken position that the employment agreement is invalid. T/c estopped this argument. Court says that the agreement doesn’t give any form of fixed employment, and doesn’t provide for anything other than “at-will.” P tries to claim a breach of fiduciary duty – statute says that the fiduciary duties run to the LLC, not to the members. Court does remand, however, for a determination of buyout.
      2. Some cases take the fiduciary duty more seriously than this court did.

Rights of Outsiders

  1. Dividends and Distribution
    1. Par value: used to be the price for which the stock was sold. Early corporate codes grabbed onto this idea and said that it would be used to determine what amount of money had to be held onto by the corporation. If the code specifies that a corporation has to maintain the par value of its shares in its equity, the corporation will lower the par. The concept of par value has now become separate from the value of the shares. Today par value is still used b/c people have used it for many years. In statutes like DE (not MBCA), par value can still be significant
    2. Minimum Initial Capitalization Requirement
      1. MBCA § 6.21: issuance of shares
      2. DE § 153: consideration for stock
      3. DE § 154: determination of amount of capital
    3. Quality and Valuation of Consideration Paid for Shares
      1. MBCA § 6.21
      2. DE § 152: issuance of stock; lawful consideration
    4. Limits on Distributions to shareholders
      1. MBCA § 6.40: distribution to shareholders
      2. DE § 154: determination of amount of capital
      3. DE § 170: dividends; payment; wasting asset corporations
      4. DE § 244: reduction of capital
    5. Klang v. Smith’s Food & Drug
      1. Board voted for share repurchase; P filed suit saying (1) that SFD’s balance sheet constitute conclusive evidence of capital impairment and (2) that even allowing the board to go behind the balance sheet to calculate surplus does not save the transaction from violating DE § 160. § 160 says that a corporation can’t repurchase its own shares if it would impact capital. Here the Board had revalued the corporate assets, and the Court found that the board did so under appropriate methods.
    6. Problem 6-1
      1. (a) DE §170: can pay dividends out of profits or out of surplus. This would be violating DE code; the surplus is 20K and the dividends were 100K. to figure out surplus, need § 154: [stated] capital is the portion of equity that can’t be touched.. Under the statute, if the board does not enter a resolution stating how much of the consideration paid for the shares will be the stated capital, then it will be equal to the par value of the shares. The board may by resolution say that only a certain amount of the price of the shares will be stated capital. Why not say that the par value is zero or $.01 in DE? DE code says that if you have no par value, then stated capital is consideration paid for the shares, and that would be very high. Easiest thing to do is to set a low par, which will be used to determine stated capital. MBCA 6.40: no par under the MBCA – § (c)(2) here the assets would become 940K and is the same as the liabilities and could do it under the model code. Under (c)(1), your balance sheet might balance but still have a liquidity problem – here they don’t really have one b/c there is plenty of cash to cover the current liabilities. Directors could be in trouble if the fixed assets are incorrectly valued b/c the way it is the liabilities and assets just balance. As long as the distribution won’t make the equity negative, it is ok – it can be zero, just not negative.
      2. (b) under DE law, § 174 provides 6 year statute of limitations; MBCA § 8.33 provides 2 year statute
      3. MBCA 6.40(c) – liquidity issue – need to make sure that the corporation is able to pay off its current liabilities as they come
    7. par value is totally arbitrary and what is whatever the corporation chooses – in a Model Code J/D, there is no reason to assign par value to your shares

  1. Piercing the Veil
    1. Three factors:
      1. control
      2. control used to commit fraud, injustice, or wrong
      3. proximate cause to harm
    2. note: no court has pierced the corporate veil of a public corporation to get to individual shareholders
    3. Contract cases:
      1. In these types of cases, parties have assessed their risks before making the bargain. Thus, piercing the corporate veil in these cases will allow P to collect a windfall. This is different than in tort claims, where the injured party has not consented to tortuous conduct.
    4. Consumer’s Co-op v. Olsen
      1. Olsen incorporate ECO, but was employed elsewhere. The officers of ECO were Olsen and his parents. He changed his personal acct over to a corporate one, but no personal charges were made to it. ECO was losing money, and Consumer’s was one of the creditors. Lower Court pierced the veil and found that Olsen was in control.
      2. Problems with the control test in the context of a close corp is that there is no separation of ownership and management, and it seems more likely that shareholders will have control.
      3. There was undercapitalization here, but the Court found that it wasn’t fair to put too much emphasis on this b/c it is a small business. While the Court thinks that at some point no more credit should have been extended, the court finds that this is offset by the fault of P (i.e. P violated its own policy of extending credit even when previous payments were late, and knew that ECO’s business was failing.
      4. Although formalities will never be dispositive, undercapitalization is something that the court will take very seriously generally look at capitalization at the outset, rather than looking at it in an ongoing, continuous way.
        1. look to whether the corp is created as a shall to commit fraud
        2. monitoring capitalization continuously is much more difficult- also, the business judgment rule seems to preclude this kind of scrutiny
        3. don’t want to change the nature of the corp – but if the nature of the business does change, then capitalization could be relevant once again
    5. KC Roofing Center v. On Top Roofing
      1. On Top became RNR which became RLN. On Top had purchased supplies from KCRC. Payments not made, so KCRC sued.
      2. Court here pierced the corporate veil to get to Russell Nugent. Russell controlled everything, similar to a close corp. There did appear to be fraud/injustice – he kept forming corporations, and when they started going bankrupt, he would just form a new corp to avoid the debt – it isn’t fair for him to keep walking away from the debt. He also appeared to be taking money from the corp.
      3. Court seemed to balance idea of giving windfall to P vs. not giving windfall to P b/c he undertook some risk.
    6. Tort cases
      1. Tort cases are different in part b/c the corporate entity has never provided insulation for an individual committing a tortuous act even if the individual purported to be acting as an officer or otherwise in the name of the corporation.
    7. Western Rock v. Davis
      1. Fuller owned all of WR’s equipment and was very much in control. Surrounding properties were being damaged by corp’s blasting. Corp had no insurance for blasting, yet they continue to do so, & get sued.
      2. Court pierces the corporate veil. Fuller seemed to have control over the corp., and he definitely had control over the blasting. Was there fraud/injustice/wrong? He continued blasting, even though he knew that it was causing damage.
    8. Baatz v. Arrow Bar
      1. Ps were seriously injured by a drunk driver, McBride, who had been drinking at the Arrow Bar. Baatz alleged that Arrow Bar served alcoholic beverages to McBride prior to the accident while he was already intoxicated.
      2. Owners here didn’t serve drinks and the didn’t hold the license (the corp. held the license), and there couldn’t be relief under the statute, b/c the statute provided that a person holding a license could be held liable for serving alcohol to drunks.
      3. P’s attempt to pierce the corporate veil and ignore the corporate form, and treats Ds as equal to the corporation. Court doesn’t pierce the corporate veil here. D probably incorporated to avoid this kind of liability, but they didn’t buy any insurance and the corporation had no assets, so it does seem to be a little bit more problematic.
    9. Craig v. Lake Asbestos
      1. This is a piercing case in which the shareholder is a corporation. Control (the first part of the test) becomes much harder to prove when trying to pierce through to a corporate shareholder. This was a personal injury case brought by a worker who was exposed to asbestos. Court found that a corporation’s control over its subsidiary was insufficient to establish the company’s tort liabilities of its subsidiaries.
    10. Kaycee Land v. Flahive
      1. This involved the issue of whether courts should pierce when an LLC is involved. Court found that an LLC can be pierced in the same manner as that of a corporation. Most other courts have pierced an LLC in the same way that it would if the firm was a corporation.
      2. Here, the defendant tried to argue that the state LLC statute prevented piercing. The court disagreed on the grounds that the statute was silent on this issue. But need to check whether the particular state’s LLC statute prevents piercing.

  1. Defective Incorporation
    1. MBCA § 2.03(a): unless a delayed effective date is specified, the corporate existence begins when the articles of incorporation are filed.
    2. MBCA §14.20- grounds for administrative dissolution
    3. A corporation is created upon the filing of the AOL, and continues to exist until dissolved whether by (1) voluntary action of directors and shareholders( MBCA §§ 14.01-14.05), (2) involuntary dissolution by administrative decree (§ 14.20), or (3) involuntary dissolution by judicial decree (§ 14.30).
    4. Contracts to benefit a non-existent corporation occur in two settings – before incorporation occurs, and during periods when a corporation has been dissolved by the state for failure to pay taxes, make required annual reports, etc.
    5. RKO v. Graziano
      1. RKO entered into an agreement with Jenofsky and Graziano. J&G fail to complete the settlement, and RKO sues for enforcement. The AOI had been filed prior to the scheduled settlement date, and J said he shouldn’t be liable b/c of a paragraph saying that upon incorporation,, the agreements are between the seller and corp. Court rejects this – says the contract is ambiguous and looks to the intent of the parties. Under J’s interpretation, no one would be liable. Court said that the individuals would be liable until the corporation is formed and ratifies the agreement.
    6. Timerbline Equipment v. Davenport
      1. P rented equipment to Ds – the Ds hadn’t complied with the incorporation rules and therefore weren’t incorporated. Court finds that Davenport is liable under the lease and Dr. Bennett also held personally liable.
      2. Bennett tries to defend that (1) it’s a de facto corporation – this exists when you did everything required by the statute, but there is a technical problem and (2) corporation by estoppel – prevent someone from arguing that there is no corporation (i.e. where Ps intended to entire into agreement with the corporation).
      3. Court finds that corporation by estoppel didn’t apply in this case.

Changes in Control

  1. Mergers
    1. MBCA: § 11.01, 11.02, 11.04, 11.07
    2. DE: § 251, 253, 259-261
    3. Hewlett v. Hewlett-Packard Co.
      1. Contemplation of combining the two businesses – result was that the shareholders in the two original corporations would own shares in the new company – they were not going to be cashed out. HP directors and Compaq directors initially decide that this is a good idea, and if they think it should go forward, then it would go to a shareholder vote.
      2. P’s claim is the HP management overstated the progress that was being made on the integration process, and that HP management was overly optimistic about the substantive results that the integration process would create. P wants the vote to be set aside. P is not claiming a breach of fiduciary duty.
      3. Court find both contentions to be w/o merit. It is unlikely that a Judge would set the vote aside – the shareholders had approved, and there had been significant time and work done to merge the companies, so P has an uphill battle to begin with. P’s claim of voting buying fails b/c the evidence is weak and circumstantial.
      4. Court finds that P has to prove a knowing, material misrepresentation – in effect, the business judgment rule.
    4. Sale of Assets:
      1. MBCA: §12.01, 12.02
      2. DE: §271
      3. Asset sales differ from mergers in several ways. First, the corporation selling assets does not automatically go out of existence upon consummation of the sale. Second, the selling corporation need not transfer all its assets, as will occur in a merger. Third, the liabilities of the selling corporation will not necessarily pass to the purchasing corporation by operation of law.
    5. Compulsory Share Exchanges
      1. MBCA §11.03, 11.04
    6. De Facto Mergers”
      1. if the corporation tries to act in a way to deny shareholders voting rights or appraisal even though it is essentially a merger, courts will sometimes find that it’s a “de facto” merger.
    7. Applestein v. United Board and Carton
      1. Epstein owns Interstate – agrees to sell his shares of Interstate for shares of United. Interstate would then become a subsidiary, but in effect would just be a shell. Epstein will own 40% of United – he was getting shares that had been authorized but not yet sold.
      2. Statute in question here gave no appraisal rights to the acquiring corporation b/c it wasn’t a merger, and the acquiring shareholders sued for appraisal rights they are claiming it is essentially a merger.
      3. Court agrees with the shareholders that their appraisal rights can’t be taken away by terming it differently – this is more than a share exchange.
    8. Hariton v. Arco Electronics
      1. Arco and Loral are both NY corps; Arco is going to sell its assets to Loral in exchange for 283,000 shares. Arco would then dissolve and issue the Loral shares to Arco shareholders. The result is essentially a merger. Arco shareholders were given voting rights, but shareholders sue for appraisal rights.
      2. Court said that the statute allowed Arco to do this under § 271, and it is just as legal as a merger, so no appraisal.
    9. Cash out mergers and business purpose test:
      1. In DE, controlling shareholders have to prove a valid business purpose for a cash out merger under Singer
      2. Current standard is Weinberger (see below)
    10. Coggins v. New England Patriots Football Club
      1. Sullivan organized a corporation that owned the Patriots; he is ousted, borrows money, ousts hostile directors, and elects new ones. He owns 100% of the New Patriots, a shell corp, and mergers Old Patriots into the New Pats, giving the other shareholders a case out merger. P is a fan and shareholder, and doesn’t want to see – he sues saying the dominant shareholder has a fiduciary duty to the minority. The court agrees, but since the merger happened 10 years before, it would be hard to unravel. Coggins will get the present value of the stock at the time of the litigation. He is getting recessionary damages.
      2. Business purpose test: court thinks that there was no legit business purpose here – there was really a breach of duty from the majority to minority. Sullivan was just trying to further his own interest by borrowing the money.
    11. Weinberger v. UOP
      1. Signal was looking how to invest cash – they owned 50.5% of UOP and wanted to increase their ownership – at the time, UOP is trading for $14/share – Signal thought it would be a good investment to pay up to $24/shrae, but doesn’t tell UOP. Lehman Brothers come up with $21/share, which is agreed to by the shareholders. Shareholders don’t know that Lehman did this all in a matter of 4 days and that the feasibility report said $24.
      2. When directors are on both sides, apply entire fairness fair price and fair dealing. It all relates back to bargaining and negotiating. Here the court finds NO fair dealing. As to fair price, DE had the block method, but that changed in this case. Court said that they are going to look at all relevant factors.
      3. Hard to tell here if the P’s win or lose court does find a lack of fair dealing, but remands for a determination of price (essentially damages).
      4. Ways to change this structure so that there is fair dealing?
        1. don’t use overlapping directors to conduct a feasibility study
        2. hire an outside investment banker not currently working for one of the parties
        3. full disclosure
    12. MBCA § 13.02(d): can challenge a complete corporate action if it was procured as a result of fraud or material misrepresentation.
    13. The MBCA is similar to Weinberger – Weinberger says generally appraisal rights unless fraud – doesn’t say that absent fraud you only get an appraisal remedy. Weinberger can be read as more flexible than model code.
    14. Cede v. Technicolor
      1. Technicolor was into film processing and decides to go into the one hour photo business. Stock increased at first, then failed. Perelman was a controlling stockholder of MAF and crafts some sort of two step takeover. Creates a subsidiary and organizes a merger of Tech and the subsidiary.
      2. Dissenting shareholders say that the plan should be taken into account when valuing shares – here Perelman starts changing the business prior to the mergers.
      3. Statute - § 262(h)- says that you can’t benefit from the merger, but doesn’t say you can’t benefit from the tender offer
    15. Stringer v. Cara Data Systems:
      1. Involved a squeeze out merger – majority shareholders in CDS give their shares to Car Data systems, and makes CDS a subsidiary, and they use their majority power to create a merger between the two. Minority shareholders sue, alleging the entire transaction was designed to squeeze out the minority. Relevant statute was similar to the model code, saying that you may not challenge the action unless it was fraudulent. Court doesn’t think P could recover here b/c his action was not about fraud, but how much money they get, and that is why they have the appraisal remedy.
      2. If this was under Weinberger: doesn’t sound like there was any attempt to make any arms length dealing, so may violate fair dealing. Weinberger could be interpreted to say that the remedy is appraisal unless fraud is shown. Also might be able to get recessionary damages, but that isn’t clear.

  1. Hostile Control
    1. In a hostile takeover, lack the support of the board of directors, but the shareholders think that the transaction should go forward. P is saying that the transaction should have gone forward, or should have dealt with it differently. A hostile takeover is similar to a friendly takeover in that the shareholders have the same statutory rights. Prior to a hostile merger, there is often a tender offer first where someone is trying to gain control of the board in order to approve the merger. Tender offer price is significantly higher than the market value – willing to pay a premium b/c you are trying to buy control. It is consistent with EMH, which says the value is of one share, not the value of control, and the value of control is going to be higher than the value of one share
    2. White knight: if someone is trying to acquire your company, then you try to find a white knight – someone who you do want to be acquired by. Management likes the white knights b/c they generally allow them to keep their jobs.
    3. Empire building: idea that some acquirers just want to own a lot of stock
    4. Greenmail: pejorative term for a target’s repurchase of its own shares from a raider where the target pays a premium for the shares to induce the unwanted suitor to go away.
    5. Cheff v. Mathes: (ex of greenmail)
      1. Maremont want going to change the nature of the business – there would be a RIF and a change in how the business was conducted. Board decides that the corporation should borrow substantial sums of money to buy back the stock.
      2. The board had the authority to buy back its own shares. The real issue was fiduciary duty – court looks at whether it’s a breach of the duty of loyalty, but its not a classic situation of conflicting interest or taking a corporate opportunity. Duty of loyalty problem here is that some directors are employees and are structurally biased b/c they might lose their job as a result of a merger
      3. Court applies the test of deference – but doesn’t give as much deference as the business judgment rule. The directors satisfy their burden by showing good faith and reasonable investigation (i.e process – Van Gorkom) – directors won’t be penalized for an honest mistake of judgment if the judgment appeared reasonable at the time the decision was made
      4. Burden of proof is now on the defendants – with the business judgment rule, burden on the plaintiff.
      5. While this is still good law, the court elaborated in Unocal about defensive tactics

    1. Unocal Corp v. Mesa Petroleum
      1. Case involved a well known takeover architect who launches a hostile takeover. Mesa made a two-tiered, front loaded tender offer. They had already owned 13%. 1st step: made an offer for 37 % at $54/share; 2nd step: squeeze out merger, and shareholders will get promise to pay from the corporation – a bond worth $54. The bond is a debt – if the corporation goes bankrupt, entitled to use for face value of the bonds. This is different from equity – in that case a shareholder has shares, and if the value goes to zero, shareholder is screwed. But a bond can’t increase in face value; a share can.
      2. Unocal Board doesn’t like this and comes up with their own plan and is going to do a tender offer for $72/share for 49% of the shares, giving bonds. This is a fiduciary care case – trying to prevent the buyer from gaining total control.
      3. Two Part test (p. 273)
        1. board perceives some threat to the corporations ongoing existence
        2. response to the threat is reasonable, with burden of proof on D.
      4. result of applying the test is that the court finds the board responded reasonably and the shareholders otherwise wouldn’t receive good value for their shares.
    2. Revlon v. MacAndrews
      1. Pantry Pride is trying to acquire Revlon and makes an initial offer of $47.50. Board adopts a poison pill and their own tender offer. PP offers more; Revlon gets a white knight. PP keeps offering more, and says they will engage in fractional bidding. R denies and accepts the white knights offer. PP brings suit.
      2. Court finds that the initial response by Revlon is reasonable – the initial offer by PP was too low. Also examines whether board breach when R started talking to F – Can’t argue that they were protecting the noteholders, b/c they already had contractual protection.
      3. As to the auction – no matter who won, the company would no longer exist at this point, the directors duty was to get the highest price. Once the board has determined acquisition is inevitable, duties shift to getting the highest price.
      4. Revlon duties are worse for the directors – once they apply, hard to justify using defensive tactics.
    3. Paramount Communications v. Time Warner
      1. Time and Warner have been talking for years about a possible merger, and emphasized structuring the deal in a way for Time to remain functioning. Paramount comes along and is interested in Time and makes an all cash, all shares bid of $170/share. Time rejects this offer – Time and Warner rearrange their transaction so Time could take over Warner and Time shareholders wouldn’t vote. Paramount makes an even higher offer, and Time rejects.
      2. Shareholders argue that Revlon duties should apply. But here, Time is able to convince the court that in its transaction with Warner it wasn’t going to be broken up and they would maintain their culture. While the court doesn’t over-rule Revlon, it does say Revlon doesn’t always apply.
      3. 2 circumstances which may implicate Revlon duties
        1. when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break up of the company.
        2. Where, in response to a bidder’s offer, a target abandons its long term strategy and seeks an alternative transaction involving the break-up of the company
      4. Under Unocal
        1. Was there a threat: P tries to argue that there was no threat; P was making a good offer and can’t show under Unocal that there was a threat unless the price was bad. Court rejects this – can show a threat if it is changing how a corporation fundamentally operates
        2. Reasonable: yes
    4. Paramount Communications v. QVC
      1. Paramount begins to negotiate with Viacom- cement their deal with various provisions that make it more difficult to walk away from the deal: no shop, termination fee, and stock options to V. 8 days after the announcement of P-V, QVC approaches P to merge for $10/higher than V. V announces a 2 tier offer – P finally determines that the final QVC bid is not in its best interest and merges with V.
      2. P tries to argue that Revlon doesn’t apply b/c there is no liquidation. Court finds that the sale of control is enough – here control was going to transfer. The majority shareholder of V would have control of the merged corporation, whereas before shareholders of P had shares in a widely held public company with no single controlling shareholder.
      3. Court sustains the injunction of the no shop provision and stock options grant. Could be there to ensure that V doesn’t get screwed. It is possible that they are contract provisions and would be reviewed under business judgment rule

Time Warner
2 part test: D has the burden of proof of (1) threat/danger; and (2) did the board reasonably react to the threat
If break up is inevitable, then the board must seek the highest price
Revlon only applies where board is actively seeking to sell the company or abandons long term strategy
Allows the board to respond to a takeover threat – they are not forced to acquiesce
This is how P would like to characterize the case

Federal Law

  1. Disclosure
    1. General purpose of securities law is disclosure; not intended to be a regulatory scheme. Not designed for force companies to avoid risky investments, or adopt a particular management style. Proxy rules are generally disclosure rules – i.e. if you are a public company and solicit proxies, then you need to provide full disclosure about what you are soliciting about.
  2. Proxy Regulations
    1. § 14(a): Solicitation of Proxies in Violation of Rules and Regulations: it shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or permit the use of his name to solicit any proxy or consent or authorization in respect of any security registered pursuant to section 12 of this title.
    2. Rule 14a-9: False or Misleading Statements
(a) no solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false of misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false of misleading
(b) the fact that a proxy statement, form of proxy or other soliciting material has been filed with or examined by the Commission shall not be deemed a finding by the Commission that such material is accurate or complete or not false or misleading, or that the Commission has passed upon the merits of or approved any statement contained therein or any matter to be acted upon by security holders. No representation contrary to the foregoing shall be made.
    1. J.I. Case Co. v. Borak there is a private cause of action
      1. P is a shareholder in a company that was merging, and he sued to enjoin merger. Injunction denied and merger consummated. P brings suit and wants there merger void and damages.
      2. Issue in the case really comes down to whether federal law allows for a private suit to be brought – no doubt that the SEC has the authority to prosecute claims.
      3. Court finds that private parties have a right under §27 to bring suit for violation of §14(a) of the Act. A right of action exists as to both derivative and direct causes.
      4. Court makes a strong policy argument – the SEC is not a supervisory agency, only enforcement, and want private citizens to also be able to enforce the law.
      5. This case has been criticized as an example of judicial activism at its worst. §14(A) doesn’t say whether or not there is a private right to enforcement, and §27 talks only about jurisdiction, not who gets to sue.
    2. TSC Industries, Inc v . Northway, Inc
      1. An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.
    3. Virginia Bankshares, Inc. v. Sandberg (Part I)
      1. Merger between parent and wholly owned subsidiary. FABI owned 100% of VBI, and VBI owed 85% of FABV – want to get rid of the minority 15%. Solicited proxies from minority shareholders and are sued for false/misleading statements relating to price. Ds defend by saying that the statements were opinions, not facts – Court disagrees. Statement is factual as stating a basis for their opinion, which was false.
      2. D also tries to argue that the proxy had other facts in it that would help shareholders determine fair value, and so any misleading statement was diluted. Court says that in theory, looking at a proxy as a whole can dilute/neutralize any misstatement, but not here – shareholders will focus on recommendations of the board.
      3. This part of the case is about the defenses that can be made after P proves material misrepresentation.
    1. Negligence enough; don’t need to show recklessness.
Reliance, Causation & Remedy
    1. Mills v. Electric Auto-Lite Co
      1. Asserted wrong is that a corporate merger was accomplished through the use of a proxy statement that was materially false or misleading. Here the misrepresentation was an omission – “you didn’t tell us the board was appointed by the acquirer” – structural bias argument.
      2. Where there has been a finding of materiality, a shareholder has made sufficient showing of causal relationship between the violation and the injury for which he seeks redress, if, as here, he proves that the proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link in the accomplishment of the transaction.
        1. this is a more objective test.
    2. Virginia Bankshares (Part II)
      1. One way to cleanse a transaction of conflict of interest is to get a vote of disinterested shareholders.
      2. The cleansing action won’t work if there is fraud involved. Sandberg is arguing that there wasn’t full disclosure and the board misrepresented that the share price being offered was high/fair.
      3. Attempts to bring 14a-9 claim was not successful.
    3. Wilson v. Great American Industries
      1. P’s complaint is that the material misstatements induced them to exchange their shares of Chenango common stock for new preferred stock in Great American. Ds owned 73% of Chenango stock, over the 2/3 necessary under NY law to approve a corporate merger.
      2. Although proxy was not legally required in this case, when defendants choose to issue a proxy plaintiffs have the right to a truthful one. When they voted by proxy, gave up appraisal rights.
      3. Court found that the plaintiffs should be entitled to the profits attributable to the extra stock they would have received had the proxy provided a fair exchange ratio.

  1. Antifraud Rules
    1. Rule 10b-5: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national security exchange,
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which the were made, not misleading, or
(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
    1. Kardon v. National Gypsum Co:
      1. Private cause of action established
    2. Birnbaum v. Newport Steel Corp
      1. Shareholders are unhappy that they weren’t able to sell their shares at the premium price that other shareholders got.
      2. The rule involves the actual purchasers or sellers, not potential ones.
      3. absence of a similar provision [express right against corporate insiders] strengthens the conclusion that that section was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule X-10b-5 extended protection only to the defrauded purchaser or seller. Since the complaint failed to allege that any of the Ps fell w/in either class, no recovery.
    3. Superintendent of Insurance v. Bankers Life and Casualty
      1. Manhattan Casualty is 100% owned by Bankers life. Banker sold its shares to Begole for $5 million. The $5 mil came from the assets of Manhattan. Manhattan sold bonds to a purchaser, who gave the money to Begole to buy the shares. Bankers life (the shareholder) is not harmed by this transaction; the creditors of Manhattan are the ones who are really harmed b/c Manhattan is essentially liquidated.
      2. Manhattan is trying to make a 10b-5 claim hinging on the sale of bonds; Court allows it to go forward.
      3. This has to do with a misappropriation, b/c Manhattan got nothing for the bonds, not really with fraud, and is probably not what the SEC had in mind.
    4. Blue Chip Stamps v. Manor Drug Stores
      1. Re-affirms Birnbaum as rightly decided – the virtue of the Birnbaum rule, simply stated, in this situation, is that it limits the class of plaintiffs to those who have at least dealt in the security to which the prospectus, representation, or omission relates.
      2. Ps received a prospectus offering shares of Blue Chip that included overly pessimistic statements about the company. This is securities fraud under 10b-5 – it is a misstatement of value that is linked to the sale of securities.
      3. But the court says that it has to be an actual purchases, not just someone who thought about it. If the court were to allow potential purchasers, it becomes too easy for someone to say that he would have purchased and can’t really tell how true that is.
    5. Santa Fe Industries v. Green
      1. SF owned 95% OF Kirby – DE law allowed for a freeze out merger w/o shareholder vote – it is a short form merger b/c the majority owns at least 90%. Kirby’s assets are worth $640/share, but Morgan Stanley says that market value was only $125/share. SF offers $150/share to Kirby, but discloses the appraisal value of the assets.
      2. P claims that given all the facts, the transaction was unfair. Court says that this seems to be a claim of breach of fiduciary duty, and that is not covered by 10b-5. the transaction, if carried out as alleged in the complaint, was neither deceptive nor manipulative and therefore did not violate either §10(b) or Rule 10b-5.
      3. Black and Stevens refuse to join in Part IV of the opinion, which focuses more broadly on what 10b-5 meant to address.
Misrepresentation or Omission of a Material Fact
    1. Basic Inc v. Levison (Part I):
      1. Basic made three public statements denying that it was involved in merger negotiations and these were clearly misleading statements. P brings suit claiming that they sold their shares b/c there was no merger going on.
      2. This is a case where there is an affirmative misrepresentation. D’s are saying that this wasn’t important lies and therefore not actionable.
      3. 3rd circuit test is that a merger isn’t material until there was an agreement in principle (price and structure) – Supreme Court REJECTS this test – it doesn’t capture all the material info. 6th circuit said that it becomes material as soon as a misrepresentation is made about a merger. Supreme Court rejects this test b/c all misrepresentations become material.
      4. Court adopts a test of materiality – same basic test of in TSC Industries “an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”
    2. 10b-5 doesn’t impose a duty to disclose – only says that if you make a misrepresentation and its false , then it is actionable, or if a statement is made and it later becomes false, it is actionable if it is not corrected.
    3. In Re Time Warner Securities Litigation
      1. Time Warner took on large debt, and management of the new corporation was seeking a strategic partnership. Here the company didn’t make any affirmative misrepresentations b/c none of the statements are untrue. Claim is that company failed to disclose problems it was having with the strategic alliances and violated 10b-5.
      2. Court said that these discussions could go either way and they aren’t necessarily misrepresentative in itself. 10b-5 doesn’t require affirmative disclosure unless it is used to correct statements that have already been made. Fact that there were difficulties didn’t make anything previously said untrue and not a violation of 10b-5.
      3. P also says that Time didn’t disclose that they were looking at other alternatives (issuing new stock). Court said that the failure to disclose this was potentially actionable – Time was trying to address the particular problem by seeking out strategic alliances, but didn’t say they might issue new stock.
    4. Safe Harbor: created a safe harbor that allows management to make forward looking statements.
    5. Ernst & Ernst
      1. P invested in a fraudulent scheme – P was trying to sue the company’s accounting firm for aiding and abetting. P claims that accounting firm failed to discover the “mail rule” and this is negligent.
      2. Rejects idea that Congress intended negligence.
      3. Look to the statute – “manipulative or deceptive device” – needs to be something more than negligence.
      4. Several lower courts found that recklessness is enough.
    6. Novak v. Kaskas
      1. P brought action alleging that Ann Taylor and its execs had mislead the public with respect to its inventory – it was accounting for all inventory the same.
      2. PSLRA says little about scienter – requires particularity of facts giving rise to strong inference that D acted w/requisite state of mind. Need to show motive and opportunity.
    7. Basic Inc v. Levison (Part II)
      1. Fraud of the market theory – fraud is reflected in the price. If you don’t accept this theory, then you have to show reliance on the fraud.

Interested in learning how to get the top grades in your law school classes? Want to learn how to study smarter than your competition? Interested in transferring to a high ranked school?

No comments:

Post a Comment

The Evolution of Legal Marketing: From Billboards to Digital Leads Over the last couple of decades, the face of legal marketing has changed a l...