BA Velasco by gjmpzlaezgx

VIEWS: 4 PAGES: 63

									                 PART ONE: AGENCY & PARTNERSHIP

I. Introduction & Business Concepts
      a. Kinds of Businesses
              i. Sole Proprietorship
                     1. Business carried on by a single owner – the business is the
                         owner
                     2. No formalities
                     3. Controlled by the one owner (management)
                     4. Unlimited Liability
                     5. Direct (one time) taxation
                     6. Lifespan is coextensive with owner, debts live on
                     7. Exit  Sell assets
             ii. Partnerships
                     1. An association of two or more partners to carry on a
                         business for profit
                     2. No formalities
                     3. All partners are managers/owners, each share in
                         profits/losses
                     4. Unlimited liability, plus. (liable your and partners‟ acts)
                     5. Profit is divided among partners and reported individually
                     6. Lifespan is at the will of the partners, for the life of the
                         partners
                     7. Power to exit at any time; not necessarily the right to do so.
            iii. Corporations
                     1. A separate legal entity created by authority of law – doesn‟t
                         exist until you go through formalities
                     2. Formalities: Certificate of Incorporation, bylaws, issue
                         shares of common stock, directors elected at board
                         meetings, appoint officers regularly
                     3. Shareholders = Owners; Directors/Officers = Management
                     4. Liability limited to the amount of investment
                     5. Double taxation; corporate tax on profits and personal tax
                         on dividend income
                     6. Lifespan is indefinite; not tied to owners
                     7. Exit by selling shares. (harder in closed corp)
      b. Basic Business Concepts
              i. Business  any endeavor w/ a profit motive
             ii. Accrual Method  method of accounting that records revenue
                 when earned and expenses when incurred, rather than when they
                 are paid in cash
            iii. Risk  uncertainty, possibility that future returns will deviate
                 from expected returns
                     1. Leverage  use of debt in business
                             a. Leverage creates risk
                                      i. Potential for gain or loss



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                                     ii. Security Interest - an interest in an asset
                                         which secures payment of an obligation;
                                         allow the asset to be sold upon default to
                                         satisfy the specified obligation.
                      2. Covenants  Contractual obligation or prohibition (in loan
                         contract, binds borrower & gives lender element of control)
                            a. Indirect control to creditors
                                      i. Use of funds
                                     ii. Maintenance of business
                                    iii. Restrictions
                                             1. Limitation on taking of further loans
                                             2. Limitations on withdrawals
                                    iv. Control upon default
                            b. Reduce risk
II. Agency
       a. Basic Elements [Rest. Agency §1]
               i. Mutual consent (express or implied manifestation of consent)
                      1. Parties must agree to the elements of agency, not
                         necessarily agency itself.
              ii. Action on behalf of another
                      1. Motive is irrelevant
             iii. Control
                      1. Acts of agent contributed to principal, element of
                         subservience though not required to be total or continuous.
                      2. Veto power is not enough; there needs to be de facto
                         control to be considered control [Rest Agency § 14 O)
       b. Creditors & Agency [Rest. Agency § 14O]
               i. Gorton v. Doty - lent auto to coach to take team to football game
              ii. A. Gay Jensen Farms v. Cargill – court found agency relationship
                  between lender institution and debtor when the institution secured
                  a source of gain through the transaction and exerted control over
                  the debtor‟s business.
                      1. Touchstone was control over day-to-day operations
III. Authority - 4 types
       a. Actual Authority [Rest. Agency § 7]
               i. Defn: where an agent has express authority to bind the principal
                      1. Scope of authority is limited to what the principal wants
                         [Rest Agency § 33]
              ii. Elements (3):
                      1. Mutual consent  key issue in creation is manifestation of
                         consent from principal to agent
                             a. Objectively verifiable – written, spoken words or
                                 other conduct that when reasonably interpreted
                                 leads to a basis for belief
                             b. Subjectively established – such actions must
                                 actually cuase belief



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               2. Action on behalf of another
               3. Control
      iii. Implied Actual Authority
               1. Mill St. Church v. Hogan  painter had implied actual
                    authority to hire helper b/c of past practices
b. Apparent Authority [Rest. Agency § 8]
        i. Defn: where third party can reasonably infer authority from the
           conduct of the principal and agent
               1. Person is not actually agent but has power to affect legal
                    relations of the principal.
       ii. Creation
               1. Principal must have manifested consent to a third party
                        a. Can be accidental, a lie, uncorrected statements or
                            any conduct reasonably interpreted to be consent.
               2. Some courts are considering manifestations from the agent
                    to the 3rd party to qualify, so long as it was a reasonable
                    belief on the part of 3rd party.
      iii. Lind v. Schenley – supervisor told employee he would receive 1%
           raise. Court finds apparent authority to bind company 
           manifestation in telling & reasonable belief from 3rd party.
               1. Company can protect by making all emp K‟s in writing
c. Agency by Estoppel [Rest. Agency § 8B]
        i. Elements:
               1. Belief in agency relation by third party
               2. Reliance by the third party (change in position)
               3. Fault of principal
                        a. Cause or unreasonable failure to cure
       ii. Hodesson v. Koos Bros  plaintiff buys furniture from salesman
           who turns out not to be salesman
d. Inherent Agency Power [Rest. Agency §8A]
        i. Defn: when the authority would tend to arise as a natural incident
           of capacity of the agent (i.e., under “normal circumstances” of the
           job)
       ii. Created simply by the act or contract entered into by the agent –
           even if the action is expressly forbidden by the principal
      iii. Watteau  A can bind P on matters incidental to agency though
           not authorized for the particular transaction.
               1. An undisclosed principal who entrusts agent to manage a
                    business is subject to liability for actions taken by A which
                    are usual in such business. (doesn‟t matter if P didn‟t know
                    or P expressly forbid it.)
      iv. Kidd  Agent was charged to contract with singing artists but
           exceeded his authority and signed other artists as well. Court held
           artists had right to assume A had authority to bind P b/c A was the
           negotiator




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                       1. Secret Terms: If P gives A secret instruction imposing
                            limitations or secrecy, and 3rd party doesn‟t know, P is
                            liable to 3rd party for acts outside the secret authority
                            granted to A. [Rest. Agency § 160]
IV. Ratification [Rest. Agency § 82]
      a. Ratification
                i. Defn: The affirmance by a person of a prior act which did not bind
                   him but which was done or professedly done on his account. [Rest
                   §86]
                       1. in other words, the principal either expressedly or impliedly
                            approves of a past act by agent, making him liable.
                       2. Used when no actual, apparent, or inherent authority found
                            to exist at time of the agent‟s action.
      b. Affirmance – any one of the following will constitute affirmance
                i. Manifestation of an election by person to treat work done for them
                   as being authorized
               ii. Conduct by him justifiable only if there were such an election
              iii. Receipt of benefits, with knowledge of the facts, of something he
                   would not be entitled to without affirming the conduct.
              iv. Retention of benefits – constitutes affirmance unless he repudiates
      c. Botticello v. Stefanovicz  P bought land from H whose wife W had a
          half interest. Court found wife was right b/c she didn‟t ratify, nor was the
          action done on her behalf.
                i. There was affirmance b/c they received the benefits
V. Liability in Agency
      a. Master / Servant Relationship
                i. Employment
                       1. Master = Employer; Servant = Agent
                       2. Key is control over the physical conduct of the agent in the
                            performance of the service
      b. Independent Contractors [Rest. Agency § 2]
                i. Key – there is no control over the physical conduct of the agent in
                   performance of the service.
               ii. IC‟s can be agents (if the principal has control) or non-agents (if no
                   control)
      c. Servants v. IC‟s
                i. Rest. Agency § 220 lists factors to consider whether servant or IC
                       1. Exent of control (more = servant)
                       2. Whether it is a distinct occupation (if yes, IC)
                       3. Who supplies location and equipment (on your own = IC)
                       4. Length of time & relationship (more = servant)
                       5. Method of payment (regular = servant)
                       6. Parties belief
               ii. Relevance of Difference between S or IC is extent of vicarious
                   liability




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                     1. IC‟s  principal is laible for the actions of an ID when the
                        principal authorizes the conduct (i.e., they had a contract)
                     2. S‟s  P is liable for authorized conduct & unauthorized
                        conduct w/in the scope of employment.
                            a. Rest § 228 lists things in scope.
                            b. Liability is limited to scope of employment b/c it is
                                 fair and foreseeable
                     3. Vicarious Liability
                            a. Encourages responsibility
                            b. Cost Spreading  puts the burden on the company
                                 and they will spread the cost to all the customers
VI. Fiduciary Duties in Agency
      a. Defn: relationship of trust and confidence, more than just a legal bond,
         also a moral bond.
              i. An agent is a fiduciary with respect to matters w/in the scope of his
                 agency.
      b. Duties of Agent owed to Principal
              i. Contractual: legally enforceable pursuant to signed agreement; A
                 must act in accordance w/ agreement
             ii. Duty of Care:
                     1. Paid agent – standard care plus special skill (i.e., standard
                        care in that locality for that kind of work plus any special
                        skills he may have.
                     2. Gratuitous Agent – lower standard; act with skill & care
                        which is required of persons performing similar gratuitous
                        undertakings for others
            iii. Duty of Loyalty – agent must act solely for the benefit of principal
                     1. Accounting for profits
                            a. Profits made by agent in connection with his duties
                                 are the property of the principal.
                            b. Exception: gratuities given to agent are ok if
                                 standard practice
                            c. Reading v. Regan – soldier using uniform to
                                 smuggle
                            d. General Automotive - manager sent jobs elsewhere
                                 when P‟s shop couldn‟t handle & made commission
                     2. Non-Competition
                            a. Cannot compete w/ P as to subject matter of agency
                            b. Exception: A can act on own account if discloses
                                 all material info to P and has P‟s consent
                            c. Town & Country Home service v. Newberry
                                      i. You can compete w/ former employer
                                     ii. You cannot use confidential info to compete
                            d. Bancroft Whitney v. Glen
                                      i. Manager violated fid duty when took
                                         employees w/ him to start new company



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                                            (used confidential info such as salaries,
                                            experience, etc)
                                       ii. Law says person in manager‟s position owes
                                            duty to both new and old employer; must
                                            avoid conflicts.
                        3. Conflicts of Interest
                                a. Must be avoided.
                                b. Cannot act on behalf of adverse party w/o P‟s
                                    knowledge
                                        i. Except if P is fully informed; if A works for
                                            two P‟s, he must inform both of all material
                                            facts
                                c. See Glen for conflict of interest
                        4. Confidentiality:
                                a. Cannot use to A‟s benefit, on behalf of another, or
                                    even communite confidential information.
                                        i. Covers info given by P, acquired in course
                                            of or on account of agency or in violation of
                                            duties to P.
                                b. See Newberry above
          c. Duty of Principal owed to Agent
                 i. Contractual Duties
                ii. Indemnification: P has a duty to reimburse appropriate
                    losses/expenses incurred by A. Appropriate is based on:
                        1. Terms of agreement, or if no agreement,
                        2. When A makes necessary or authorized payments in
                            executing P‟s affairs or suffers a loss which, b/c of their
                            relationship, is fair for P to bear.
Partnerships

   I. Introduction to Partnerships
         a. Defn: A Partnership is an association of two or more owners, to carry on
            as co-owners, a business for profit. [UPA § 6(1)]
         b. Partnership Formation:
                 i. Elements of partnership formation:
                        1. Consensual association – this is consent to elements, not
                            necessarily explicit consent to a partnership.
                        2. Carry on as co-owners – most issues arise here
                        3. Business for profit – must have the intent to make a profit
                            (i.e., marriage doesn‟t count)
                ii. Interpretive Rules –
                        1. Joint interest in property is not enough by itself
                        2. Sharing of revenues is insufficient by itself (i.e., sales
                            commission)




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               3. Sharing of Profits, on the other hand, is prima facie
                   evidence, unless it‟s payment of debt, salary, interest, or the
                   like.
      iii. Partnership by Estoppel (UPA § 16)
               1. Elements:
                       a. Manifestation to 3rd party about existence of
                           partnership (like saying a non-partner is a partner)
                       b. Reliance by the 3rd party on this manefistation.
                                i. If it‟s a public situation, reliance is not
                                   needed.
                       c. Extension of credit to the partnership. Extension to
                           third party is not enough.
               2. Liability
                       a. An apparent partner is liable as if actual member if
                           the partnership is liable.
                       b. The actual partnership is liable if all the partners
                           consented to the arrangement.
                       c. If there is not consent by all the partners, the entire
                           partnership will not be liable, only those who
                           consented.
                                i. Consequently, an apparent partner will have
                                   the power to bind consenting partners to
                                   same extent as if he were a partner in fact.
               3. Young v. Jones – investors lost $ relying on financial
                   statements preparted by PW – Bahamas. Tried to recover
                   from PW – US b/c it they thought advice was from them.
                       a. Court found no partnership in fact nor partnership
                           by estoppel.
                       b. Should have tried apparent authority (good bet) or
                           agency by estoppel (harder)
c. Partnership Rights [UPA § 18]
        i. Equal shares of profits and losses. (equal is default)
               1. Fenwick (Partners compared w/ employees): owner tried to
                   claim secretary was partner. Court says no despite formal
                   contractual language b/c in fact no co-ownership, no
                   control, not subject to losses, not held out as partner.
               2. Southex Exhibition: (partners compared w/lenders): home
                   shows manager was not in partnership despite profit
                   sharing and labels b/c no joint control.
       ii. Equal control in management (equal is defaul)
      iii. All partners must consent to adding another partner.
      iv. No right to salary (rather a % share in the profits)
       v. Partnership Agreement can alter partners‟ rights.
               1. Only amongst partners; not to the outside world
               2. Not necessarily all powers and obligations




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             vi. Day v. Sidley & Austin – had an executive committee that made
                  decisions over many matters
       d. Partnerships & Agency
               i. Every partner is an agent of the partnership
                      1. Acts for apparently carrying on the business in the usual
                          ways are binding on the partnership
                               a. Unless 3rd party knows partner had no authority
                      2. Acts not apparently for carrying on normal business are not
                          binding
                               a. Unless act is authorized. If it‟s authorized,
                                   “apparent” doesn‟t matter. Default rule is that any
                                   partner has power to authorize.
              ii. Binding Effects: The partnership is charged with wrongful acts of
                  any partner [UPA § 13] when
                      1. Acting in the ordinary course of business of P, or
                      2. Acting w/ authority of co-partners
       e. Property Rights [UPA §24]
               i. Right in specific partnership property for partnership purposes (§5)
                      1. Equal right to use all partnership property
              ii. Interest in the partnership [UPA § 26 – profit/loss sharing]
             iii. Right to manage the partnership
             iv. Assignment of a Partner‟s interest [UPA § 27]
                      1. Can‟t sell managerial power or profit share b/c changing
                          partnership requires consent of all.
                      2. Conveys only interest in the partnership
                      3. Doesn‟t effect partnership
              v. Rights of Partners in Management [UPA § 18]
                      1. Default Rules: (can be changed by agreement)
                               a. Equal right to management
                               b. Disagreement on ordinary matters settled by
                                   majority vote [UPA § 18h]
                               c. Contravention of Agreement requires unanimity.
                      2. National Biscuit v. Shroud – absent majority vote to settle
                          disagreement, revert to the status quo, which is normally
                          that partner can act & bind the partnership
                      3. Summers v. Dooley – similar facts, different outcome.
II. Fiduciary Duties of Partners
       a. Introduction
               i. UPA is not clear on fiduciary duties, but Revised UPA gives an
                  exhaustive list.
              ii. Best statement of duty of loyalty- Meinhard v. Salmon – “owe to
                  one another…the duty of finest loyalty”
       b. Every partner owes a fiduciary duty to his copartners.
               i. Duty of loyalty
                      1. Account for profits & benefits




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                      2. Refrain from dealing with the partnership where it creates a
                          conflict of interest
                              a. Note that merely furthering a partners interest isn‟t
                                  enough, it must be at detriment of partnership.
                      3. Refrain from competing w/ partnership.
              ii. Duty of Care – limited to refraining from
                      1. Engaging in grossly negligent or reckless conduct
                      2. Intentional misconduct, or
                      3. A knowing violation of the law.
             iii. Duty of good faith and fair dealing in the discharge of their duties
             iv. Examples:
                      1. Account for profits
                      2. Disclosure of information
                      3. Indemnification of each partner for liabilities reasonably
                          incurred during the ordinary course of business.
                      4. See RUPA §404
       c. After Dissolution
               i. No duty of care owed to former employees of firm – withdrawal
                  from partnership ends fiduciary duties (except for outstanding
                  obligations) – Bane v. Ferguson
       d. Grabbing & Leaving
               i. Duty of loyalty stands up until you‟re not working in firm –
                  Meehan v. Shaughnessy
       e. Expulsion
               i. Duty of loyalty not violated for being fired if can be fired for any
                  purpose. Must fire or expel in good faith.
III. Ending a Partnership
       a. Ending a Partnership under UPA § 30 – three steps:
               i. Dissolution  change in relation of partners cuased by any partner
                  ceasing to be associated with the partnership. (In RUPA, the
                  commencement of the winding up process. More flexible rule to
                  accommodate revolving partnerships)
              ii. Winding Up  the process of settling partnership affairs
             iii. Termination  end of partnership.
       b. Who can dissolve?
               i. All partners have power to dissolve, not necessarily the right
                      1. Right to dissolve in:
                              a. At will partnerships &
                                       i. Only when done in good faith – Page v.
                                          Page
                              b. As specified in the agreement
              ii. Automatic dissolution:
                      1. Term expires
                      2. Partnership becomes unlawful
                      3. Death or bankruptcy of partner
             iii. Judicial Dissolution: for reasons of



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                1.   Insanity
                2.   Inability
                3.   Serious misconduct
                4.   Unpredictability, or other equitable circumstances
                5.   Owen v. Cohen – dissolved b/c serious misconduct
                6.   Collins v. Lewis – no right to dissolve if partner is just not
                     good manager
c.   Effect of Dissolution on a partner
          i. Authority is terminated (except as to winding up)
         ii. Existing liabilities remain
        iii. Future liabilities only w.r.t. winding-up & certain innocent parties
d.   Winding Up
          i. Order of distribution of assets:
                 1. Creditors other than partners
                 2. Partners as creditors (loaned personal money)
                 3. Partners‟ return of investment
                 4. Partners‟ profits, if any
         ii. Fiduciary duties continue until termination – Monin v. Monin
             (company refused to deal with one ex partner at the behest of
             another ex partner – company has right to make their own decision,
             but court found fault with the way the company was pursued by
             man)
e.   Continuing Partnership
          i. Partners who have not wrongfully dissolved can continue [§38]
         ii. Continuation may be spelled out in partnership agreement
        iii. Effects on creditors [§17,41]
                 1. Continuing partners & partnership remain fully liable
                 2. Former partners liable for old obligations through wind up
                 3. New Partners:
                         a. Fully liable for new obligations, but
                         b. Old obligations to extent of partnership assets
f.   Ending a Partnership under RUPA - § 601
          i. Dissociation – change in partnership caused by partner ceasing to
             be associated in carrying on of the business. Same as UPA
             dissolution.
                 1. Does not necessarily result in dissolution and winding up.
         ii. Default rule: partnership continues
                 1. Exception: partners at will or term partnerships
        iii. In every dissociation, either:
                 1. Disassociating partner‟s interest must be purchased, or
                 2. Partnership is dissolved and wound up.
        iv. G & S Investments – had partnership buyout agreement.
                 1. Advantages: avoids litigation, allows business to continue,
                     avoids unpredictable judicial decisions
                 2. Disadvantages: price may not be set correctly, undermines
                     entire relationship.



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IV. Limited Liability
      a. Problems with BA –
              i. Sole proprietor problems: limited funding, unlimited liability
             ii. Partnerships – too many mangers, better funding, but unlimited
                 liability plus
      b. Limited Partnerships  partnerships with two types of partners, general &
         limited.
              i. General Partner – partner with the right to manage the business &
                 w/ unlimited liability.
                     1. Uniform limited partnership act § 403
                     2. Must be at least one general partner.
             ii. Limited Partner – partner w/ no right to manage the business but
                 with limited liability.
                     1. Note if limited partner takes control of business, he
                          becomes general partner – Holzman v. De Escamilla
            iii. Advantages
                     1. Greater access to funding, more efficient management
      c. Formation of Limited Partnership
              i. Select name (must contain words “limited partnership”
             ii. File Certificate of limited partnership
                     1. Contains minimal information
                     2. Provides notice of existence
                     3. Generates filing fees for states.
            iii. Optional: written LP agreement can supplant default rules
            iv. CANNOT be formed accidentally, unlike other partnership.
      d. Limited Liability
              i. Based on passive investor theory/status
                     1. MUST be a passive investor to be protected
             ii. History of increasing availability
                     1. Originally available only on case-by-case basis
                     2. Expanded for industrialization
                     3. Eventually available for all
            iii. Increasing diversity – originally only LPs & Corps, now LLC,
                 LLP, LLLP, etc
            iv. Advantages – encourages investment, fairness to passive investors,
                 & limits the cost to society of litigation
             v. Disadvantages – increased stakes for creditors & encourages
                 investors to engage in risky activities b/c the risk is externalized.

                       PART TWO: CORPORATIONS

I. Introduction
      a. Characteristics
              i. Two types – public & private. Can be a mixture (public corp held
                 by few shareholders)
             ii. Formalities – many required, such as filings, meetings



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      iii. Control – separation of ownership and management
                1. Officers are the true managers, but can lead to conflict of
                    interests
       iv. Liability - limited to investment (can‟t lose more than you put in)
        v. Taxation – double (once on corporate profits, once on dividends)
       vi. Lifespan – indefinite (not tied to owners)
      vii. Exit – sell shares. (harder if it‟s not a publicly traded corp)
b. Contractarian Theory  views the corporation as a web of contractual
   relationships among various stakeholders rather than as a separate legal
   entity owned by the shareholders (just a web of contracts)
         i. Employees
                1. Input: Labor
                2. Rights: fixed compensation, very little control
                3. Risk: Low
        ii. Trade Creditors (e.g. supplier of inventory who sells on credit)
                1. Input: Property
                2. Rights: fixed payment first, very little control
                3. Risk: Low
      iii. Debt Holders (i.e. bank loan)
                1. Input: Cash
                2. Rights: Fixed principal + interest; some indirect control
                3. Risk: moderate
       iv. Equity Holders
                1. Input: cash, property and/or labor
                2. Rights: residual profits; control
                3. Risk: high
c. Conflicts of Interest
         i. Key players – management & shareholders
        ii. Interests – normally aligned (profit)
      iii. Sometimes Interests diverge
                1. Shareholders may want to replace management (proxy
                    contest or hostile takeover)
                2. Management wants to insulate itself (defense tactics, state
                    of incorporation)
d. State of Incorporation
         i. Benefits to State  Fees & related service industries
        ii. Competition Among States (debate over whether good or bad)
      iii. Flexibility / innovation (state corp law should be able to change to
            meet needs of corporate environment)
       iv. Clarity / consistency  clear statutes & consistent judicial decisio
        v. Responsiveness / service – with state legis & officers responsive to
            your needs
       vi. Substantive content  actual laws themselves…are they good for
            you?
      vii. Race to the Bottom




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                      1. Competition among states leads states to pass increasingly
                          lenient corporate laws.
                              a. Burdens of bad laws are shared by all states, while
                                   benefits go to the one state who gets the fees
                              b. Favors corporations over others
                              c. Favors management over shareholders
                      2. Could say it‟s a race to the top  competition creates more
                          efficient sate laws
           viii. Delaware – winning race to bottom as the state of preference
                      1. Originally there were more favorable laws (less regulation)
                      2. Now there are legitimate benefits (iii through v in (d) above
                      3. Why does Del act moderately?  risks federal intervention
                              a. Push as much as can w/o getting fed gov involved
                              b. States like PA don‟t have to worry about this and
                                   thus blatantly act in favor of management
       e. Main Issues:
               i. Public Corporations
                      1. Many shareholders, none w/ controlling interest
                      2. Control issues:
                              a. Individual shareholders have little control
                              b. Small minority interests can have large influence
                      3. Conflicts of interest
                      4. Securities laws – continuous disclosure
                              a. Require that pub corps continuous disclosure of
                                   various information about corp
                              b. “under the microscope”
              ii. Closed Corporations
                      1. Small group of owners who have a real say in the business
                      2. Control Issues: large minority interests can have no
                          influence (b/c it‟s possible for one person to own maj)
                      3. Freeze-Out action taken by majority shareholders in a
                          close corp to frustrate expectations of minority
                          shareholders
II. Corporate Formalities
       a. Overview of formation
               i. Select name (must contain inc or related notation)
              ii. Select state of incorporation
                      1. Internal affairs doctrine  choice of law rule under which
                          courts look to state of incorporation to determine rights &
                          duties.
            iii. File Certificate of Incorporation – contains minimal information
                      1. Name, address, nature of business (make as broad as
                          possible)
             iv. Hold organizational meeting
                      1. Adopt bylaws




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                     a. Document, subordinate to charter, that governs the
                         internal affairs of a corporation
              2. Issue Shares
                     a. Before shares are issued, all that exists is the
                         incorporator/promoter
       v. Hold Shareholder Meeting to elect directors
      vi. Hold Board Meeting to appoint officers
b. Incorporation
       i. Who can incorporate?
              1. Anyone, including another corporation (DCGL 101a)
                     a. Parent corp – owns subsidiary corp
              2. Affiliates  anyone who controls, is controlled by, or is
                 under common control with, another (i.e., parent &
                 subsidiary, or co-subsidiaries.)
      ii. How do you incorporate?
              1. File Certificate of incorporation (DGCL 102 – pg 1404)
                     a. Name & address
                     b. Nature of business  can limit actions
                              i. Any business outside this „nature‟ is ultra
                                 vires; unauthorized; beyond the scope of
                                 power.
                     c. Authorized stock  number of shares that the
                         company can issue and classes and series of stocks
                         and their rights (normally want to authorize more
                         than you plan to originally issue – future options)
                              i. Common stock – security representing a
                                 basic ownership interest in the company
                                      1. General voting rights & residual
                                          profit sharing / dividends
                             ii. Preferred Stock – preference on dividends
                                 (issued prior to Common divs). Limited
                                 voting rights.
                     d. Par Value dollar value, specified in a corp‟s
                         charter, that establishes the minimum price for
                         which a share of stock may be issued and which is
                         set aside for the protection of creditors.
                              i. Par value is irrelevant now, many states
                                 have done away with it. Most lawyers put it
                                 at a penny if they have to account for it.
                     e. Names & Addresses of promoter
                              i. Lawyer & law firm
                             ii. Initial directors (if selected at time of incorp
                     f. Optional Items
                              i. Any rules you want to govern the corp
                             ii. Common rules




                                 14
                                        1. Preemptive rights – right of
                                            shareholder to purchase enough
                                            newly-issued shares to maintain her
                                            % ownership in corporation
                                        2. Special voting rights
                                            (supermajorities, etc)
                                        3. Limits on directors liable for breach
                                            of fiduciary duty
     iii. De-Facto Corporation Doctrine
              1. Court may treat an organization as a corporation even
                  though it‟s not b/c the promoters made a good faith effort
                  to incorporate and treated the business as a corp. Southern-
                  Gulf Main Co No 9 v. Camcraft
              2. Doesn‟t make much sense, as how do you make a good
                  faith effort to file the certificate but not do it?
      iv. Corporation by Estoppel
              1. Court can prevent third parties from denying corporate
                  existence if they acknowledged the corporate entity and
                  would earn a windfall by subsequently denying corporate
                  existence.
c. Organizational Meeting (DCGL § 108, pg 1416)
        i. Adopt Bylaws
              1. Minutes – what happened
              2. Resolutions – what was decided
       ii. Adopt stock certificate & corporate seal
              1. Don‟t have to have a stock certificate
              2. Book entry security  security represented by entry in a
                  register (i.e., no stock certificates)
              3. Corporate seal – now unnecessary and archaic
     iii. Elect directors / appoint officers
      iv. Issue Shares
              1. Fully paid & non-assessable share – share which has been
                  purchased from the issuing company and paid for in full,
                  and with respect ot which the issuing company cannot
                  demand more money from the shareholder
       v. Authorization to do business in other states
              1. Have to file in each state in which you wish to do business
      vi. Select fiscal year
     vii. Set annual meeting of shareholders
    viii. Approval of past acts
              1. Relieve the incorporator of potential liability by official
                  authorization or approval of his past acts
      ix. Any other business
d. Bylaws (pg 1406)
        i. Stockholders
              1. Voting rules have to be in the charter, but can be in bylaws



                                 15
                       2.  Meetings – need written consent in lieu of meeting
                       3.  Notice (for meetings) – can‟t be too early or too late
                       4.  Quorum (default is a majority needs to be present)
                       5.  Record date  date on which ownership is established for
                           purposes of shareholder voting.
                ii. Directors
                        1. Default is that each director is elected individually
                        2. Establishes number of directors
                        3. Establishes term for directors
                                a. Generally one year
                                b. Can be removed for no cause
                                c. Could have a staggered board (like US Senate), can
                                    be referred to as a classified board
                        4. Meetings
                        5. Quorum
                        6. Telephonic meeting / video conferencing
               iii. Board committees
               iv. Officers
                        1. Delaware is open for officers, NY has requirements
                v. Stock
               vi. Indemnification of officers and directors
III. Limits of Limited Liability
        a. General rules –
                 i. shareholders are not liable for corporate obligations
                ii. investor‟s liability is limited to his investment
        b. Piercing the Corporate Veil
                 i. Holding shareholders personally liable for obligations of corp.
                    Two Part Test:
                        1. Failure to respect corporate form
                                a. Failure to respect corporate formalities
                                          i. Failure to incorporate
                                         ii. Failure to issue shares
                                        iii. Failure to hold meetings
                                        iv. Failure to maintain records
                                b. Failure to maintain separate identities
                                          i. Unity and interest of ownership
                                         ii. Commingling of assets
                                        iii. Domination by shareholder
                                        iv. “alter ego” or “dummy” corp
                                c. Examples
                                          i. Walkovszky – inadequate capitalization
                                              alone not enough when corp followed
                                              corporate formalities. Looking for whether
                                              there‟s enough money to operate business,
                                              not whether there‟s enough to pay for
                                              injuries.



                                         16
                              ii. Frigidaire Sales Corp v. Union (VELASCO
                                   LIKES THIS CASE). Set it up so corp was
                                   general partner, and limited partners were
                                   sole shareholders of corp. had effect of
                                   insulating LP‟s from liability. Court upheld,
                                   respecting form over substance.
              2. Some Injustice
                     a. Fraud
                     b. Other injustice
                               i. Undercapitalization: is the money invested
                                   into the corp enough to cover natural or
                                   foreseeable expenses? Judged at the time of
                                   incorporation
                              ii. Syphoning of funds: ex ante decision by S
                                   to take large amounts of $ in form of divs in
                                   light of anticipated losses. (like a huge
                                   lawsuit being filed against corp)
                             iii. Intentional scheme to evade responsibility:
                                   more than just trying to incorporate. More
                                   like a big elaborate scheme that will look
                                   fishy.
                             iv. Unjust enrichment
                     c. Examples:
                               i. Kinney Shoe – if there is “no” money at
                                   startup to cover costs & introduction, it is
                                   undercapitalized
                              ii. Court introduces third prong in this case:
                                   Would it be reasonable for this party to
                                   conduct an investigation of the credit of the
                                   corporation prior to entering the contract?
                             iii. Third prong is only really applied in banking
                                   situations
c. Related Theories
       i. Enterprise Liability  a legal doctrine under which a court may
          hold an entire business enterprise (i.e., all affiliates) liable for the
          obligations of a constituent corporation
              1. Lack of a separate identity (as between corporations. If it‟s
                  between owner/corp, it‟s piercing corp veil)
              2. Some injustice
              3. Examples:
                     a. Sea-Land Services – example of reverse piercing.
                          Owner was such a screwball that the court allowed
                          the plaintiff to go after the guy‟s corporations to pay
                          once they found the guy liable.
                     b. Reverse piercing is another word for enterprise
                          liability.



                                 17
                               c. Note that this is not piercing the corp veil  entire
                                    enterprise can be found liable w/o the owner being
                                    personally liable.
               ii. Direct Liability
                       1. In theory, owner can be liable for the owners own action in
                           respect to the business
                               a. Holding persons liable for what they do
                       2. In Re Silicone Breast Implants
                               a. Velasco Hates Case
                               b. By the Court‟s logic, enterprise liability would be
                                    the rule and not the exception.
                               c. Court generalizes many factors, and weighs some
                                    that shouldn‟t even be considered.
IV. The Purpose of Corporations
       a. What is the purpose?
                i. Profits for shareholders
               ii. Provide goods or services to public
              iii. Self-perpetuation
              iv. Society allows corporation  purpose is thus to benefit society
       b. Illustrative Cases
                i. Dodge v. Ford Motor – Court found that Ford had to run
                   corporation for profit to shareholders, not for social good. Must
                   put interest of the shareholders b/4 monetary interests, therefore
                   irrational dividend decisions cannot be upheld.
               ii. Shlensky v. Wrigley – court denied challenge by shareholders who
                   wanted lights installed to attract more customers; court deferred to
                   board and judgment of directors (who thought it would hurt
                   neighborhood) b/c it was a business decision.
                       1. Difference: In Wrigley the court says that corporations can
                           take into consideration socially beneficial or injurious
                           factors (i.e., don't just have to consider profit or shareholder
                           maximum value)
              iii. A.P. Smith v. Barlow – [S sued director alleging corp charter not
                   authorize charitable donations]. Courrt found charter is contract
                   btw S & state; state can change law and effect charter anytime
                   where justified by public interest.
                       1. Charitable donations to society trumps contractual rights
                               a. Adv of holding: more money can be given by corp
                                    b/c corp only taxed once, S can sell shares if don‟t
                                    like, easier to raise more $,
                               b. Disadv: Corp have no focus on charity, not good at
                                    determining how to spend it, difficult to determine
                                    what charity to give to, might anger S
                       2. Law clear that charitable donations are permissible (DGCL
                           122(9)
              iv. Statutes



                                          18
                     1. Delaware 122(9): no mention of corporate benefit.
                     2. Cal CC 207(e): regardless of specific corporate benefit
                         (general)
                     3. NY: irrespective of corporate benefit (doesn‟t matter)
                     4. Recent laws allow directors to consider any factors when
                         making business decisions – basically can do as they please
                         for the benefit of shareholders, employees, suppliers,
                         political lobbying groups, etc.
     c. Whose interest should be predominant?
              i. Shareholder have most incentive to take the best route for company
                     1. They all look at risk – positive & negative. Willing to risk
                         losing the corporation if they stand to make tons o‟ money
                             a. Shareholders don‟t bear all the loss, only the initial
                                 loss of stock value. (employees can lose jobs)
                                 shareholders are willing to gamble with the
                                 jobs/livelihoods of others.
                     2. Other groups (employees, directors, creditors) all they want
                         to do is avoid risk.
             ii. Credit Lyonnais Bank
                     1. When corp is near insolvency, the directors are not just
                         agents of the shareholders, but owe a duty to the corporate
                         enterprise.
                             a. Shareholders will be looking at equity (assets – liab)
                     2. Near insolvency
                             a. Creditors bear risk of loss, AND
                             b. Interests of shareholders and Directors/Corporation
                                 are not aligned.
V. Business Judgment Rule
     a. Business Judgment Rule: A legal doctrine that protects the substance of
         business decisions from judicial review.
              i. Directors are presumed to be informed, act in good faith, and in the
                 honest belief that the action taken was in the best interests of the
                 company. (i.e. no conflict of interest)
                     1. IF this is the case, they will be held without fault so long as
                         the decision was rational (not necessarily reasonable)
             ii. If court determines BJR applies, directors normally win
                     1. The only way to win when BJR applies is to show
                             a. Waste
                             b. Totally irrational, or
                             c. No win situation.
            iii. Winning strategy therefore is to challenge decision making
                 process, not substance.
                     1. Standard is Gross Negligence
            iv. Kamin v. American Express (NY)
                     1. Facts: Board declared special dividend to shareholders
                         causing large tax liability instead of liquidated bad



                                        19
                         investment. Shareholders brought a derivative suit
                         claiming waste of the corporate assets.
                     2. Held: declaring dividend is protected by BJR. Court will
                         only interfere if lack of good faith. The fact that a decision
                         was poor or less advantageous is irrelevant.
             v. Joy v. North
                     1. VELASCO THINKS THIS CASE IS WRONG
                     2. Limits of BJR
                             a. Cases where decision lack business purpose
                             b. Conflict of interest
                             c. No-win situation
                             d. Results from an obvious and prolonged failure to
                                  exercise oversight or supervision
                     3. Extremely rare to find no-win situation. Example: bank
                         has all the risk of loss but none of potential profit
                     4. Courts better at making procedural decisions than they are
                         at amking ex post facto substantive business decisions.
VI. Duty of Care
      a. Definition: Directors and officers have duty to perform functions “with
         the care that an ordinarily prudent person would reasonably be expected to
         exercise in a like position and under similar circumstances.
      b. Standard seems to be Gross Negligence
      c. This translates to
              i. Duty to inquire (when reasonable): basically they have to inquire
                 when things don‟t look right.
             ii. Reliance on others – should rely on others information & opinion
                 whenever it is reasonable to do so.
            iii. Duty to monitor
                     1. Francis v. United Jersey: director was totally ignorant of
                         what was going on in business; son stealing from clients,
                         etc. Court held director liable b/c she had a general duty to
                         monitor corporate affairs and policies.
                             a. Must bring bad stuff to attention of board
                             b. Must resign rather than be part of it
                             c. Must vote against it
                             d. Must talk to accountants, etc
                             e. Note: In cases of banks and insurances co‟s, clients
                                  may also sue for breach of fiduciary duty.
                     2. In re Caremark: S sued BOD for failure to monitor
                         employees which led to fines.
                             a. Test for breach of duty / failure to monitor
                                      i. Directors knew or should have known of
                                          violations
                                     ii. Directors took no steps in good faith effort
                                          to prevent or remedy situation.




                                        20
               b. Court says BOD not liable unless there is sustained
                   and systemic failure
                        i. In this case, the BOD only had to ensure that
                            an information reporting system was in
                            place so they would get necessary info.
                            They don't‟ have to institute a system of
                            corporate espionage
iv. Smith v. VanGorkum
       1. S claimed breach of duty of care when BOD approved
           merger agreement w/o reasonable reliance and
           consequently failed to receive best price per share. CEO
           offered it to friend at $55/sh; negotiations were not arms-
           length. Other directors were poorly informed; based
           decision on 20 minute presentation in a 2 hour meeting.
               a. But maybe not correct, as experienced directors
                   may have been able to make the decision that
                   quickly.
               b. Also found they didn‟t get the best price.
               c. Didn‟t determine the intrinsic value
       2. More Efficient Market Hypothesis
               a. Is there an intrinsic value that is more than market
                   value? Does it matter if you think corp is worth
                   $60/sh when the market will only pay $50/sh?
               b. Theoretically it might be worth $60, and someone
                   might give higher price someday, but someone is
                   offering you $50 now (market value at $35).\
               c. Problem here was while the offer they accepted
                   wasn‟t necessarily bad, they didn‟t try to find a
                   better offer. Court found this to be gross
                   negligence.
       3. Leveraged Buyout (LBO)
               a. Borrowing money to buy company & use profits to
                   pay debt.
                        i. If it works, you essentially get company for
                            free b/c it pays for iself & u put in no capital
                       ii. If it doesn‟t, you are stuck w/ debt
               b. If bank doesn‟t want to issue risky load, you can use
                   junk bonds. (high risk, high interest) If you have
                   too much risk, the bonds are not considered
                   investment grade quality (banks can‟t buy them)
                   these are junk bonds
       4. Summary:
               a. Sophisticated set of directors, selling for a very high
                   price, with an inconclusive market test.
               b. Most people don't even see this as negligence, but
                   court found gross negligence



                           21
                                        i. Fallout – less people wanted to be directors,
                                            insurance was hard to get, states passed laws
                                            allowing corps to eliminate duty of care
                                            (provision in charter)
              v. Cinerama: breach of duty of care –
                      1. When there‟s a breach of the duty of care, the directors
                          have to defend their actions under the strict entire fairness
                          test
                               a. Fair Price
                               b. Fair Dealings
                      2. Court decided it was fair despite breach of fid duty.
                               a. There is a duty of care, but directors aren‟t
                                   personally liable for its breach.
                      3. Court upholds VanGorkum (say they don't get protection of
                          BJR) and the entire fairness test applies
                               a. They‟re like rational basis & strict scrutiny
VII. Duty of Loyalty
      a. Defn:
               i. Duty of loyalty becomes an issue in the context of a self-dealing
                  transaction where a director of officer has personal (financial)
                  interest that is at least a potential conflict of interest with financial
                  interests of the corporation.
                      1. Self interested: director or officer
                               a. Has financial interest in org. on other side of trans.
                               b. Have management position on other side of trans
                               c. Is himself the other party in transaction.
      b. What happens?
               i. Director conflict
                      1. Default rule is Entire Fairness Test w/ burden on director
                      2. If there is fully informed, disinterested director approval
                          (other directors aware of conflict)
                               a. Sometimes it‟s EFT w/ burden on plaintiff
                               b. More often its BJR w/ burden on plaintiff
                      3. If there is independent shareholder approval
                               a. BJR, burden on plaintiff.
                               b. Approval is majority of disinterested shareholders
              ii. Controlling Shareholder Conflict
                      1. Default: EFT, burden on defendant
                      2. Independent Director Approval (assuming controlling
                          shareholder didn‟t appoint all directors)
                               a. EFT, burden on plaintiff
                      3. Independent shareholder approval
                               a. EFT, burden on plaintiff
             iii. EFT:
                      1. Transaction must be fair for corporation & shareholders
                               a. Fair Dealings



                                          22
                        b. Fair Price
                 2. Don't have to show that it‟s perfect, just fair.
                 3. Timing: when must it be fair?
                        a. Some states - at time of transaction (ratified later
                            provided the transaction was fair)
                        b. Delaware – transaction must be fair at the time it is
                            approved (no later ratification)
       iv. Should we allow conflicted transactions?
                 1. A conflict of interest doesn‟t mean something is wrong, it‟s
                    just the potential to be wrong
                 2. Having to prove everything is fair will require the courts to
                    look at the substance, which is not consistent w/ policies
                    behind the BJR (courts not qualified to make these
                    decisions)
                        a. Unless conflict is unavoidable, then courts have to
        v. Shareholder Conflict of Interest
                 1. Individual shareholders can act in their own interests
                        a. You have no fiduciary duty to other shareholders
                        b. This is in public corps – not as much in private corp
                 2. There are no conflicts of interest w/ shareholders
       vi. Main Conflict Situations
                 1. Salaries & benefits – management gets to set its own
                    salaries, but it‟s an everyday occurance b/c every company
                    has to set salaries
                        a. Use fully informed independent director approval –
                            form a salary committee
                 2. Business dealings w/ the director – director wants to
                    engage in some business dealing with the company
                 3. Derivative litigation – when shareholder wants to sue corp
                 4. Hostile takeovers or proxy contests.
c. Illustrative cases
         i. Bayer v. Beran (NY) – not improper to appoint relatives so long as
            it‟s w/in duty of care/loyalty. BJR doesn‟t apply unless complete
            loyalty/care
        ii. Zahm v. Transamerica – court found that Transamerica unfairly
            used its controlling share of the corp to profit at the expense of
            minority shareholders, thus violating its fiduciary duty, when it
            chose a course of action which would give minority shareholders
            nothing (when other, more profitable course for min. was
            available)
                 1. In other words, the majority shareholder secretly chose the
                    option that would benefit them at the expense of minority
                    shareholders, b/c the minority shareholdesr could have
                    traded in their stock for the class B stock had they known
                    what was going to happen.




                                 23
           2. Problem wasn‟t that shareholders didn‟t know about
               liquidation, just that they didn‟t know what the corp was
               worth b4 liquidation.
           3. Conflict of interest was when majority shareholder didn‟t
               disclose the value or the intent to liquidate, the screwing
               the minority shareholders b/c they didn‟t have the
               opportunity to convert
iii.   Lewis v. SL & E: Company set up dummy corporation to sign
       lease – if default, it wouldn‟t hurt main company. Conflict of
       interest  didn‟t have interest in charging rent b/c they owned
       both companies.
           1. When there‟s a conflict of interest, the BJR can‟t apply.
           2. Court held absence of fair rent meant shareholders were
               entitled to upward adjustment of book value.
iv.    Sinclair Oil Corp v. Levien (Delaware)
           1. Sinclair owned 97% of subsidiary. Sinven paid out huge
               dividends to Sinclair and minority shareholders. Dividends
               were in excess of Sinven‟s net earnings. Minority
               shareholders of Sinven sued
           2. Court holds that not breach of loyalty b/c minority got fair
               share; didn‟t benefit at minority‟s expense
           3. Selfishness is OK as long as it‟s not self-dealing
           4. Court also found that directing opportunities to Sinclair and
               not Sinven was OK under BJR
 v.    Fliegler v. Lawrence : Ratification
           1. Del law allows conflicted transactions to be made by non-
               conflicted parties. Shareholder ratification automatically
               invokes the BJR and the burden is on the plaintiff to show
               the transaction amounted to waste
                   a. This is shareholder approval, not necessarily
                       “disinterested” shareholder approval
                             i. This means if conflicted parties have
                                majority, they can ratify their own conflicted
                                transaction.
                   b. Court said entire fairness applies even if the
                       transaction is ratified.
                             i. So why ratify?
                                    1. Vote counts as evidence of fairness,
                                        not dispositive, but still pretty good
                                    2. Burden of proof shifts – instead of
                                        the def having to prove that it‟s fair,
                                        the plaintiff will have to prove that
                                        its unfair. Plaintiff bears burden if
                                        the shareholders ratified the decision.
vi.    In re Wheelabrator Tech Shareholder Litigation




                             24
                     1. If Fully informed disinterested shareholders give approval
                         it voids the duty of care claim.
                             a. If you ask for shareholder vote, you have a duty to
                                 fully and fairly disclose all relevant information.
                             b. Van Gorkum – why didn‟t shareholder approval
                                 extinguish duty of care claim there? (they weren‟t
                                 fully informed)
                             c. Burden of Proof:
                                       i. Controlling stockholder + fully informed
                                          disinterested shareholder approval = EFT,
                                          but shifts burden to plaintiffs to prove trans
                                          was not fair.
                                      ii. Directors normally have burden to prove in
                                          “duty” cases that the decision was “fair”
                                     iii. Why are the tests different?
                                              1. Potential for greater influence by
                                                  controlling shareholder.
                                     iv. This was a director transaction, not
                                          controlling shareholder – court says there
                                          was no evidence that 22% was controlling.
                                          51% would be presumed.
VIII. Corporate Opportunities
      a. General Rule: A fiduciary should not take an opportunity that belongs to
         the corporation for their personal benefit.
              i. He can take the opportunity if discloses to the rest of the corp that
                 there is a conflict of interest and a corporate opportunity, nad the
                 corporation fairly rejects the opportunity.
      b. Opportunity: Consider these factors
              i. Line of Business – closer the relation the more likely it‟s an
                 opportunity. Might have to be same line of business.
             ii. Interest or expectancy – like an extension of a lease; expected to be
                 able to extend lease and didn't get it.
                     1. CEO buying land w/ oil underneath it
            iii. Source of Opportunity – used corporate assets & time to develop
                 or discover; it‟s more likely to be a corp opp.
            iv. Party Involved: in order of most problematic (officers, directors,
                 employees, shareholders (assuming it‟s not controlling shareholder
             v. Fairness – consider all the circumstances
      c. Duty Issues Arising from Opportunities
              i. Directors have greater duty than agents
             ii. Example:
                     1. Barber (agent) hears of other shop for sale, can quit & buy
                         w/o informing.
                     2. Director of barber shop is in different boat; had to inform
                         other directors and they had to decide as a group if the shop
                         should buy the other shop.



                                        25
                      3. NOTE: director votes – the interested director‟s vote
                           doesn‟t really count (disinterested approval)
      d. Illustrative Cases:
               i. Broz v. Cellular Information Systems: (Pro-Director) Where the
                  director believes that the corporation is not entitled to an
                  opportunity, there is no reason to present the opportunity to the
                  board. Presenting it to the board would just be safe harbor
              ii. Energy Resources Corp v. Porter: (Not Pro-Director) required any
                  opportunity to be presented to board b4 conflicted party can take it.
                  Even when opportunity would refuse to deal with corporation,
                  conflicted party must disclose or try to fix opportunity/corp prob.
IX. Shareholder Action
      a. Direct v. Derivative Litigation
               i. Direct Action  lawsuit initiated by injured person or on her own
                  behalf.
              ii. Derivative Action  lawsuit initiated by shareholder on corp‟s
                  behalf against 3rd parties (often management) b/c of management‟s
                  failure to take action against 3rd parties.
                      1. Atypical to have litigation on behalf of someone
                      2. Allowed b/c that person cannot sue
                      3. Problems:
                                a. Corp should be able to say whether or not they want
                                    to sue, not shareholders.
                                         i. Management would have to make this call
                                        ii. Shareholders not supposed to run business
                                b. Can‟t allow each and every shareholder to make
                                    decision
                                c. Shareholders may not understand all the issues
                                d. Shareholders may have vendettas had have personal
                                    interests.
             iii. Illustrative Cases
                      1. Cohen v. Beneficial  derivative suit b/c management
                           apathy.
                      2. Eisenberg v. Flying Tiger  issue is whether direct or
                           derivative action. Test: look to the injury and ask if S is
                           personally injured. Loss of vote or influence = direct
                                a. VELASCO thinks this case is wrong; thinks it
                                    should have been a derivative action b/c injury was
                                    to corporation. Really was attacking a merger,
                                    which is a derivative action.
      b. Incentives
               i. Shareholders have very little incentive to sue
                      1. If they do sue, they would have to incur expenses of the
                           litigation & the corporation would get the benefit.
                                a. This is problem for people who like derivative act.
              ii. Elements



                                        26
               1. Litigation expense – unpredictable
               2. Contingent fee  fee charged for lawyer‟s services only if
                   the lawsuit is successful or favorably settled out of court,
                   usually representing a percentage of the award.
                       a. Contingent fees make shareholders more willing to
                            sue b/c it limits the incentive not to sue.
               3. Award of atty‟s fees
                       a. Normally attorney will be awarded fee if successful
                       b. Normally will get full fee regardless of recovery
               4. Indemnification provisions
                       a. If directors don‟t have to pay the judgment but are
                            going to be indemnified by the corporation, you
                            have problems.
      iii. Strike Suits  lawsuit initiated not w/ intention of winning on the
           merits, bt w/ intention of obtaining profitable settlement.
               1. Weak case, but the potential for jury to give you lots of
                   money.
               2. Entrepreneurial Theory – attorney acting as businessman
                   w.r.t. lawsuit, making investment decisions with her time
                   and taking the risk of profit and loss.
               3. Courts and the corporate world think derivative actions are
                   strike suits
                       a. b/c Shareholders rarely win in court (BJR)
                       b. Settlements: small dollard recovered
                                i. Counter to this is structural relief is often
                                    granted, small dollar amount is relative,
                                    some changes in management.
c. Statutory Solutions
        i. Expenses
               1. Award if successful – litigation costs (including attorneys
                   fees) will be awarded if successful.
       ii. Security
               1. Some states require that the shareholder post security for
                   the corporations expenses
                       a. It is rare that the shareholder will be liable if the
                            corporation wins, but it is there in case.
               2. NY says you need to post but not if you own 5% of stock /
                   $50K.
      iii. Standing
               1. Contemporaneous ownership rule  rule of standing
                   providing that, in order to initiate a derivative action, a
                   plaintiff must have been a shareholder at the time of the
                   action complained of
                       a. Argument that this does not make sense:
                                i. All shareholders can have a real interest.




                                 27
                               b. Some states (like NY) require that you are a
                                   shareholder at the time of action and at the time of
                                   lawsuit.
X. The Demand Requirement in Derivative Litigation
      a. Rule: Before a shareholder can bring a derivative action he has to bring it
         up before the board of directors
               i. Board then must decide whether it makes sense to sue.
              ii. If they say no, the court may look into those reasons
             iii. Exceptions: Irreparable Harm
                       1. If there will be IH from making the demand, they don‟t
                          have to make it. i.e., if time is a factor
             iv. Policy Issues:
                       1. Disincentives for shareholders to sue: COSTS
                       2. Incentive for atty‟s to sue
                       3. Hard to win a derivative action; courts not sympathetic b/c
                          it‟s a corporation right not a shareholder right.
      b. Demand Futility:
               i. If there is a conflict of interest, it would be futile to ask the board
                  to sue itself, so demand requirement is excused.
                       1. Helps to avoid litigation costs
                       2. Not all states allow demand to be excused for futility
                       3. i.e., majority of board is interested/conflicted in transaction
              ii. Once you make demand, you waive right to claim futility
                       1. Board‟s refusal of demand is treated under BJR
                       2. Can challenge refusal in court, but must show waste,
                          wrongful refusal, etc
             iii. Approach:
                       1. Any demand will likely be rejected and then subject to BJR
                       2. Arguing demand futility will require particularized
                          allegations, but probably the best route.
             iv. If demand is excused for futility, the BOD must prove that the
                  transaction was fair
      c. Illustrative Cases
               i. Grimes v. Donald  (Demand Futility in DELAWARE)
                       1. Must prove demand to be futile or have case dismissed.
                          It‟s not enough, alone, that:
                               a. They (directors) all participated in the action
                               b. They all approved of it
                               c. They failed to take corrective action
                               d. They are allegedly „controlled‟ by one board
                                   member or shareholder
                       2. Allegations must be made in the pleadings (b4 discovery)
                               a. i.e., more than just notice pleading
                               b. Use tools at hand – inspection rights, public info
                       3. Grimes test




                                         28
                       a. Pleadings must establish reasonable doubt that
                            directors are disinterested and independent or the
                            challenged transaction was a product of valid BJR
                                 i. i.e., duty of loyalty & duty of care
      ii. Marx v. Akers (Demand Futility in NEW YORK)
               1. Test in NEW YORK
                       a. Majority of directors are interested, and
                       b. Directors failed to inform themselves to a degree
                            reasonably necessary about the transaction, or
                       c. Directors failed to exercise their business judgment
                            in approving their transaction
               2. In this case, majority of board wasn‟t interested, so
                   probably wouldn't have lost demand
               3. Difference b/t New York & Delaware
                       a. New York doesn‟t require reasonable doubt
                                 i. Del – does the plaintiff have a reasonable
                                    doubt?
                                ii. NY – plaintiff must have reasonable belief
                                    that board lacks independence (HARDER)
               4. Demand was futile, so board must prove EFT
                       a. But court puts burden here on plaintiff to allege
                            particular facts, where normally it would be the
                            corp having to show that it was not conflicted.
                       b. Why not here? Court realizes in cases like these,
                            where the issue is director compensation, applying
                            the EFT would subject nearly all similar
                            transactions to judicial review.
d. Special Litigation Committees (SLC)
       i. Defn: A committee of independent directors appointed to
          investigate a S‟s allegations of demand futility in derivative lit
               1. Basically, corporation can commission a committee of
                   disinterested parties to review the transaction and approve
                   to avoid litigation
      ii. Auerbach v. Bennett (NEW YORK litigation committee)
               1. (auditor issued report corp made massive bribes, some
                   directors involved, S sues for breach of fid duty
               2. New independent directors formed SLC to investigate and
                   decide whether corp should take legal actions against
                   directors
               3. Court upheld SLC, basically under deferential BJR
                       a. Can‟t look at substance, only procedures.
               4. NOTE: problem in SLCs is structural bias – directors, even
                   if disinterested and new, will likely be biased towards one
                   another and won‟t find against them.
                       a. If not BJR, all such decisions would be made by
                            courts



                                29
                              b. NOTE: NEW YORK is very deferential to corps
             iii. Zapata Corp v. Maldonado (DELAWARE SLCs)
                      1. Delaware is more likely to question the decision
                      2. Notes problem of structural bias
                      3. Court applies its own independent business judgment to
                          review the substance of the decision
                              a. Justification: balances interests, goes to spirit of
                                 corp law, helps avoid structural bias
                              b. Criticism: contrary to BJR which says court won‟t
                                 second guess business decisions
                              c. Raises questions of BJR validity  if it‟s not good
                                 enough here, why elsewhere?
XI. Executive Compensation
       a. Growing Problem:
               i. Top execs get too much money
              ii. Disclosure of compensation packages is poor
             iii. Gap between exec & workers is growing; gap has grown from 40
                  times as much in 1970s to 140 times in 1990s, est to be 500 soon
             iv. Court‟s don‟t know what to do
       b. Compensation levels are clearly protected by BJR
               i. Concern is structural bias
              ii. Conflicted vertically when top officers/execs are directors;
                  conflicted when directors are directors for other corps
                      1. Probably not arms-length negotiation
                      2. But have to pay $$ to get top execs
                      3. But that causes salaries to spiral out of control
             iii. One solution is to pay based on performance
                      1. But choose wrong factors and you could be screwed.
                      2. Compensation would be based on short term performance
       c. Brehm v. Eisner
               i. Duty of care question  basically, CEO was fired and got $140
                  million in compensation; derivative suit argued breach of duty
                  when corp puts itself in that situation
              ii. BJR applies to executive compensation issues
                      1. Plaintiffs try to argue waste / irrational
                      2. Court says has to be unconscionable, not just a really dumb
                          decision.
                      3. Example of extreme deference to corporation & form
XII. Indemnification & Insurance; Inspection Rights
       a. Indemnification & Insurance
               i. Indemnification: reimbursement of a loss or expense incurred by
                  another. Specific to this situation, reimbursement of litigation
                  costs incurred by director, officer, or employee (paid by corp)
              ii. Statutory Provisions
                      1. DGCL § 145
                              a. Allows indem in direct actions (suing CEO directly)



                                       30
                               i. Must have been acting in good faith of corp
                              ii. If it was criminal case, must have believed
                                  that actions were lawful
                      b. Allows indemnification in derivative actions (suing
                          CEO on behalf of corp)
                               i. Similar requirements to (a)
                              ii. If defendant is liable to corp, court must
                                  approve indem as fair and reasonable
                      c. Requires indem if defendant is “successful on the
                          merits or otherwise”
                      d. Requires specific authorization for any indem
                          payment under (a) or (b)
                      e. Allows advancement of expenses (paid in advance)
                      f. Allows additional rights
                      g. Allows liability insurance (even when
                          indemnification is not allowed)
                               i. Allows directors/officers insurance when
                                  indem is not allowed
      iii. Waltuch v. Conticommodity Services
              1. Law only allows corporation to indemnify when defendants
                  were acting in good faith
              2. Power to indemnify is lmited to good faith
              3. Success is vindication as far as court is concerned
      iv. Citidel Holding Corp v. Roven
              1. Limit on advancement of funds – must be reasonable
              2. Basically the purpose is to protect you in advance for things
                  you will be indemnified for. So there‟s a presumption that
                  you‟ll be indemnified
b. Inspection Rights
        i. Generally, Shareholders can demand to see basic corporate records
              1. Charter, bylaws, minutes of board mtgs, list of shareholders
       ii. Why allow?
              1. Why should only one slate of candidates have access to
                  voters?
      iii. Standard for allowing shareholder access
              1. Request has to be for a “proper purpose”
                      a. Economic interes
                      b. Valuation issues
                      c. Takeovers
                      d. Proxy contests
              2. Requests that would not be proper
                      a. Possible goodwill concerns
                      b. Political Activism
      iv. Derivative litigation
              1. In theory is positively related to the corp and the inspection
                  rights would be a proper purpose



                                31
               v. State ex rel Pillsbury v. Honeywell
                      1. Moral arguments are nto good enough for inspection rights.


              PART THREE: FEDERAL SECURITIES LAW

I. Introduction to Federal Securities Laws
      a. History
              i. Security  an instrument that evidences the holder‟s ownership
                 rights in an organization (e.g. stock), or the holder‟s creditor
                 relationship with an organization (e.g. bonds), or the holder‟s other
                 financial rights (e.g., options)
             ii. State securities regulation
                     1. Common law fraud  didn‟t provide enough protection for
                         the sale of securities; hard to prove fraud
                     2. Blue sky laws  state securities laws
                             a. EX: “merit regulation” – state laws which rated
                                 investments as too speculative
            iii. Stock market crash of 1929 & Great Depression led to creation of
                 fed laws
            iv. Federal securities regulation – three basic parts:
                     1. Mandated Disclosure
                             a. In selling securities, companies have to give
                                 adequate and accurate information to investors
                             b. Done by filing detailed reports to government
                                 which are distributed to investors
                     2. Antifraud Rules:
                             a. Company is liable if the disclosure is inaccurate or
                                 incomplete
                     3. No Merit Regulation:
                             a. You can sell any security you want to so long as
                                 investors are properly informed
      b. Federal Securities Laws
              i. Securities Act of 1933
                     1. Primary Markets  the market for securities sold by
                         issuers to investors; an initial public offering (IPO)
                             a. Securities must be registered and prospectus
                                 delivered b4 selling securities to public (public
                                 offerings only; private aren‟t covered).
                                      i. Must file detailed report (registration
                                          statement) with SEC
                                              1. SEC only reviews for adequacy, not
                                                  accuracy. Must declare it effective
                                                  or lacking
                                     ii. Prospectus is then delivered




                                        32
                                      1. Sort of a sales document with
                                           information about the offering
                                      2. Contains a copy of the registration
                                           statement
                             iii. There may be exemptions available
                      b. Issuer is liable for any misleading statements or
                         omissions of material fact (i.e., deception)
                               i. Tougher than common-law fraud
                              ii. Standard prohibits false statement of
                                  material fact (no lies)
                             iii. Standard prohibits misleading statements of
                                  material fact (no half-truths)
                             iv. Standard prohibits misleading omissions of
                                  material fact (nothing left out)
      ii. Securities Act of 1934
             1. Secondary Markets: Market for securities traded by
                  investors among themselves (e.g., NASDAQ, NYSE)
                      a. Same structure as above; different implementation
             2. Focus is on issuing company, not selling investor
                      a. Must file periodic performance reports
                      b. Must file additional reports under certain
                         circumstances
                      c. Liability for manipulation or deception
                               i. Includes any communication from company
                      d. Individual Liability: no lies or misrepresentations,
                         but also no mandated disclosure
             3. Also regulates securities industry generally; includes
                  brokers, analysts, etc.)
     iii. Securities & Exchange Commission: agency oversees sec industry
     iv. State law concerned w/ form over substance, while federal law is
          more concerned with substance.
             1. No race to the bottom competition as with states and corp
                  laws b/c there is only one fed gov and it has preempted
                  field
c. Valuation
       i. Commodities: products that are abundant & fungible; produce
             1. Easier to price b/c many buyers & sellers, measure supply
                  and demand
      ii. Special Goods: rare or unique items
             1. More difficult to price, but still capable of valuation
     iii. Corporation as a whole is special good, but shares of stock are
          commodities
     iv. Strong Market:
             1. Strong Liquidity  have to be able to buy & sell quickly
             2. Availability of Information  so u can analyze b4 hand
             3. Efficiency  ability to buy and sell cheaply



                               33
       v. There are strong markets for public corporations
               1. Confident traders; strong market
      vi. Closed Corporations do not have strong markets
               1. Not enough info, not publically traded (illiquid)
d. Efficient Market Hypothesis: (EMH) Theory that in a strong market such
   as US capital markets, prices quickly reflect all available information
        i. Price may not be accurate
               1. Combined efforts of all investors analyzing information
                  creates an equilibrium price
       ii. Weak Form of Efficient Market Hypothesis (WEMH)
               1. Current prices reflect all past price information
               2. Can‟t beat market by looking at trends
                      a. Falling or rising price not good reason to sell;
                          current price already reflects that.
                      b. You can‟t do better than you‟re supposed to do
                          (can‟t get greater return than what market is
                          offering)
               3. Generally accepted as true
      iii. Semi-Strong Form of Efficient Market Hypothesis: (SSEMH)
               1. Current prices reflect all publicly available information
               2. Can‟t beat market through analysis
                      a. Information from financial statements, trends,
                          industry, etc is already reflected in stock price
                      b. This doesn‟t mean prices are accurate (there is non-
                          public, material information)
               3. Widely accepted as more-or-less true
                      a. Very few mutual funds can consistently beat market
      iv. Strong Form of Efficient Market Hypothesis: (SEMH)
               1. Current Prices reflect all available information, pub & priv
                      a. Says that insider trading should not be profitable b/c
                          price already reflects inside information
                      b. Basically assumes insider trading has already
                          happened so price already reflects it
               2. Insider Trading:
                      a. Use of non-material, nonpublic information in
                          trading the shares of a company by a corporate
                          insider or other person who owes a fiduciary duty
                          with respect to such information.
               3. Not Accepted as True
                      a. If it were true, public announcements wouldn't
                          make difference (they do)
                      b. It would also suggest people couldn‟t make money
                          on insider trading (but they do)
                      c. Looking at stock price over time, it doesn‟t just
                          jump at the moment of announcement, leading to




                                34
                                   the belief that t here were some leaks & insider
                                   trading going on.
               v. Equilibrium level of disequilibrium
                       1. Analysts must analyze in order for the market to be
                           efficient, but once they do so, they are useless b/c they
                           can‟t beat the market. Basically, analysts can only really
                           hope to make enough $ to analyze
              vi. Ramifications for Security Law
                       1. If strong form is true, omissions are not so important b/c
                           the price already reflects what is really happening
                       2. If weak form is true, public disclosure is most important
                           thing b/c information is necessary
                       3. If semi-strong form is true, getting information into the
                           hands of public is not so important.
             vii. Diversification  process of reducing risk by investing in multiple
                   opportunities.
            viii. Lessons from EMH
                       1. Don‟t try to beat the market. Period.
                       2. Even if someone can beat the market, you can‟t.
                       3. Invest in index funds
                               a. Basically a “buy & hold” strategy; buy stocks on
                                   the NASDAQ or S&P 500 and hold on to them.
                               b. Actively managed funds (typical mutual funds)
                                   have higher trading/management fees
II. Rule 10(b)(5) – Exchange Act
       a. Purpose: broad antifraud rule under the Exchange Act
                i. Single most fundamental provision of fed securities laws
       b. Structure: Forbids these acts in connection w/ purchase or sale of sec
                i. Devices, schemes and artifices to defraud
               ii. Practices which operate as a fraud or deceit
              iii. False or misleading statements or omissions of material fact
              iv. Note: similar to, but broader than, securities act
       c. Enforcement:
                i. Intended to be enforced by SEC
               ii. Courts have found implied private cause of action
                       1. Not clear that Congress or SEC intended this
       d. Elements of cause of action:
                i. Scienter: intent to deceive (or recklessness, lower courts say yes,
                   SCOTUS hasn‟t touched issue). Fraud, in other words.
               ii. Materiality: relevance/significance. Must be important enough to
                   effect a decision
              iii. Purchase or Sale:
              iv. Causation:
               v. Reliance: Plaintiff must have actually been deceived (subjective)
       e. Illustrative Cases




                                        35
 i. Basic Inc. v. Levinson: (former shareholder sues corp claiming
    that corp repeated denials regarding its participation in merger
    negotiations were material misrepresentations)
        1. Issue 1: What is material?
                a. An omitted fact is material if there is 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”
                b. Probability Magnitude Test: (2nd Circuit)
                          i. Look at the probability and magnitude of the
                             event to determine materiality
                             (PxM=Expected Value)
                         ii. Consider facts such as size or corp, value,
                             etc
                c. Duty to Disclose
                          i. Silence absent duty to disclose is not
                             misleading, hence illegal, under 10(b)(5)
                                  1. A “No Comment” policy is
                                      recommended but must be consistent
                                      (don‟t let it imply yes or no)
                         ii. Any statements must be accurate, though
        2. Issue 2: Was there reliance?
                a. Fraud-on-the-market Theory: Misleading
                    statements will therefore defraud purchasers of
                    stock even if the purchasers do not directly rely.
                    (i.e., will effect the market as a whole)
                          i. Casual connection between fraud and
                             purchase in such case is no less significant
                             than in case of direct reliance on misstate
                         ii. i.e., derivative reliance; relying on market,
                             and market was defrauded. Rebuttable.
                b. Fraud must be in connection w/ sales or securities
                          i. Problematic in this case b/c
                             misrepresentation wasn‟t connected w/
                             purchase or sale of securities. It was made
                             to maintain the status quo during merger
                             negotiations. Court ignores this; seems to be
                             a very broad interpretation that anything
                             could lead to a purchase or sale.
ii. Santa Fe Industries v. Green: (shareholder sued b/c SF merged w/
    subsidiary to freeze out minority shareholders. Corp told
    shareholders shares were worth $125, Green believed worth $722.
        1. Court held plaintiff should have brought state claim b/c no
            allegations of manipulation or deception as required by
            10(b)(5).



                          36
                       2. Implications: important b/c one of first to limit expansive
                          growth of 10(b)(5) actions.
                              a. Allegations of breach of fid duty not necessarily
                                  enough
                              b. Definitely no cause of action w/o scienter
                              c. In other words, can‟t claim it was unfair, only that
                                  you were deceived
                       3. Criticism: dissent believes majority should have dismissed
                          b/c no breach of fid duty; didn‟t have to be activist & limit
                          scope of 10(b)(5)
                       4. Going Concern Value: appraisal value. Different from
                          market value b/c it considers these things:
                              a. Market price of shares just b4 transaction
                                  announced
                              b. Net assets of the company
                              c. Earnings valuation of the company – most
                                  subjective, requires looking at
                                      i. Avg earning of corp for some period, and
                                     ii. Court chosen „multiplier‟ to determine net
                                          present value of that stream of earnings
III. Insider Trading
       a. Defn: Use of material, nonpublic information in trading the shares of a
           company by a corporate insider or other person who owes a fiduciary duty
           w.r.t. such information.
       b. Illustrative Cases
                i. Goodwin v. Agassiz: (prior to securities law, used for historical
                    purposes w.r.t. state securities law)
                        1. CEO‟s duty was to corp, not random shareholder
                        2. No harm to corp b/c insider trading (hence not illegal)
                                a. Stock market money doesn‟t effect corp
                                b. Indirect harm is loss of goodwill
                                         i. i.e., could make it hard to do another
                                            primary offering
               ii. SEC v. Texas Gulf Sulphur: (corp discovered promising ore site
                    but told employees to keep quiet so corp could keep buying at low
                    price; employee bought lots o‟ stock
                        1. Disclose or Abstain Rule: anyone in possession of material
                            insider information must either disclose it, or if he cannot
                            in order to protect corporate confidence, or he chooses not
                            to do so, must abstain from trading in or recommending the
                            securities concerned while such information remains
                            undisclosed.
                        2. Probability magnitude Test – probability of event occurring
                            times magnitude of impact = materiality
                        3. Misleading Statements
                                a. Needs to be connected to trading



                                        37
                 b. Rule doesn‟t require trading by speaker, just that the
                     fraud needs to be connected with the purchase/sale
                           i. i.e., if it causes someone to purchase/sell
                          ii. basically, any false or misleading statement
                              followed by trading by the purchaser is
                              enough to bring action.
                 c. BJR does not apply (this is a federal matter)
                 d. This is not the law anymore
iii. Chiarella v. United States:
         1. Held: liability for insider trading requires more than just
             possession of information; must have fid duty & scienter
         2. If breach of fid duty is deceptive it is actionable under
             federal securities law, not because it is a breach of fid duty
             but b/c it is deceptive
                 a. EX: if fid duty gives rise to obligation to disclose,
                     and no disclosure is made, it might be deceptive.
         3. Non-Fiduciaries do NOT violate 10(b)(5) by engaging in
             insider trading
iv. Dirk v. SEC: (Dirk told by insider that corp was engaging in
     fraudulent practices. SEC busted corp w/ Dirk‟s help, then SEC
     sued Dirk for disclosure of information to investors even though
     neither he nor his company owned that corp‟s stock)
         1. SEC‟s purpose was only to censor Dirk, didn‟t think he was
             a bad guy
                 a. SEC theory is that once you receive inside info, you
                     are an insider – Court rejects argument b/c feels
                     SEC trying to get rid of Chiarella
         2. Inheriting Fiduciary Duty
                 a. Insider breaches fid duty to shareholders, and
                 b. Tippee knows or should have known of this breach
                 c. NOTE: need an unbroken chain; each link must
                     pass the test.
         3. Breach of Fiduciary Duty - needs to be personal benefit
             (money or equivalent)
                 a. Direct to you
                 b. Indirect to friends or family
                 c. NOTE: personal benefit requirement is unique to
                     federal securities laws; not in state breach claims
 v. United States v. O’Hagan: (partner in law firm working on GM
     tender offer deal to buy shares of Pillsbury)
         1. Tender Offer: public offer to buy shares at premium
             conditioned on ability to buy specified % of total
             outstanding; often part of takeover attempt
         2. Classic Theory under Chiarella:
                 a. Need deception to find breach of fid duty




                          38
                             b. Applies to personal insiders and accountant,
                                 attorneys, & anyone else with access
                             c. Classical theory would say attorney had fid duty to
                                 buyer (GM), but attorney bought shares of P stock,
                                 to whom he owed no duty.
                     3. Misappropriation Theory (SEC wants to expand 10-b-5)
                             a. A person commits actionable fraud under 10(b)(5)
                                 when he misappropriates confidential information
                                 for securities trading purposes, in breach of duty
                                 owed to source of information
                             b. Court says by using confidential GM information to
                                 his advantage, he breached duty to GM
                             c. Loophole: Can disclose that you‟re going to use
                                 info for your own purposes & be in the clear, but
                                 doesn‟t work with classical theory
                     4. Rule 14(e)(3)
                             a. No trading w/ any material nonpublic information
                                 regardless of fiduciary duty
                             b. Court says delegation of authority under 14(e)(3)
                                 gives the SEC authority to proscribe rules to prevent
                                 deception. Authority under 10(b)(5) was limited to
                                 strictly to illegality and punishment of deception;
                                 this authority is a little broader.
                             c. Rule 14(e)(3) is limited to tender offers
IV. Proxy Solicitations
      a. Shareholder Meetings
              i. Shareholder Apathy: not much incentive to attend sh meetings
                     1. Can authorize people to vote on your behalf
                     2. Management always seeks authorization to vote your share
                             a. Need a quorum to conduct business
                     3. If someone else asks you, they are opposing management
             ii. Proxy
                     1. One who is authorized to act as a substitute for another, esp
                         in corp law, a person who is authorized to vote another‟s
                         shares
                     2. The grant of authority by which a person is so authorized;
                     3. The documents granting the authority; i.e., the agent, the
                         authorization or the instrument
            iii. Proxy Contest: competition to obtain voting rights; common in
                 takeover attempts
            iv. Proxy Solicitation: attempt to obtain right to vote shareholder‟s
                 shares; most often conducted by management
             v. Proxy Statement: document required by federal law to be
                 delivered in connection w/ proxy solicitation
      b. Scope of Proxy Rules
              i. Exchange Act § 14(a) delegates authority to SEC



                                       39
          ii. Regulation 14A governs every solicitation of a proxy for registered
              securities
         iii. Solicitation
                  1. Very broad definition; basically any request for proxy
                  2. Exceptions:
                          a. 14d-2(b): shareholder conversations aren‟t proxy
                              solicitations if under 10 persons
                          b. 14a-1(1)(2)(iv): institutional investors can just say
                              what they want to do
c.   Proxy Materials
           i. Proxy Statement: serves mandatory disclosure requirements
          ii. Proxy Card: Description of Solicitor
                  1. b/c shareholder may presume it‟s management
                  2. Blank space for date
                          a. It‟s illegal to solicit an undated or postdated proxy
                              b/c proxies are revocable
                  3. Separate identification of matters to be voted on (discretion
                      is an option)
d.   Delivery of Proxy Materials
           i. Delivery to shareholders
                  1. Shareholders must be provided w/ proxy statement b4
                      solicitation (or really even b4 talking to them at all)
                          a. Exception: Rule 14a-12
                                   i. Allows discussion of the situation b4 proxy
                                       statement is given
                                  ii. Must give them proxy card or statement if
                                       they ask or b4 you actually solicit proxy.
          ii. Filing with SEC
                  1. Preliminary proxy statement
                  2. Final proxy statement
                  3. Other written materials
e.   Other Matters
           i. Opposing Solicitations
                  1. Shareholder proposals may have to be included in
                      management‟s proxy
                  2. Proxy contest: Have to spend their (takeovers) own money
                      to do that; sometimes can be reimbursed if successful.
                          a. Either mail at insurgent‟s expense or provide
                              shareholder list
                  3. State law always gives right to get shareholder list
                          a. No conflict; federal is optional, state mandatory.
          ii. Antifraud provisions
                  1. Information must be clearly presented
                  2. Civil liability for false or misleading statement or omission
                      of material fact
f.   Illustrative Cases



                                  40
              i. J.I. Case CO. v. Borak: First case to recognize private right of
                 action under 14(a)(9)
             ii. Mills v. Electric Auto-Lite: (Petitioners trying to nullify merger
                 after proxy statement didn‟t disclose director conflict)
                      1. Basically, to win the petitioner must be able to show that
                         the omission was material, that he relied upon it, and that it
                         was the causation of the injury (i.e., vote)
            iii. Virginia Bankshares v. Sandberg: (minority SH sued claiming
                 statements made by corp that $42/share was “high value” were
                 deceptive and actionable under § 14(a)
                      1. Not deceptive if they actually believed it.
                             a. To prove someone didn‟t believe their opinion, the
                                 statement must be objectively false or misleading,
                                 not just that they believed it to be unfair.
                      2. This is an example of a Freezeout
                      3. Need to show loss causation and not just transaction
                         causation.
                             a. i.e., the reliance on the misleading statement caused
                                 the loss, not that the reliance on misleading
                                 statement caused the transaction to take place.
                             b. EX: must be able to prove that electing the director
                                 caused the loss or the merger alone caused the loss.

               PART FOUR: CONTROL TRANSACTIONS

I. Shareholder Control
      a. Shareholder Voting –
             i. Common voting issues
                   1. Electing and removing directors
                   2. Amending charter or bylaws (need approval of BOD and S)
                   3. Approving certain major transactions, like mergers
                   4. Other matters submitted for shareholder vote
                   5. Do NOT have a general right to manage. (that lies w/ BOD)
            ii. Voting Standard:
                   1. General Rule: Need majority of shares present to win
                          a. This includes proxies
                   2. Special Rule: majority of all shares.
                          a. Absent count as „no‟ votes
                          b. e.g., mergers
                   3. Plurality Vote: the most votes, whether or not a majority
                          a. e.g., election of directors. Can‟t vote “no”
                   4. Quorum: minimum voters needed present to be official
                          a. Default rule is half, but can go down to a third
                   5. Charter may modify rules as they see fit
                          a. Legal Requirement – sets a minimum; can‟t lower
                          b. Default Rule: can adjust it downward.



                                       41
      iii. Wisconsin Investment Board v. Peerless: (DELAWARE)
           management adjourned meeting in accordance w/ bylaws.
           Apparently did so to prevent vote (thought they‟d lose) so as to
           vote later when more favorable
               1. Blasius Test: (exception to BJR)
                       a. Plaintiff must establish that BOD acted for primary
                           purpose of thwarting exercise of a shareholder vote
                           (difficult test)
                       b. BOD then must rebut by showing compelling
                           reason for their actions.
                                 i. Examples of compelling justifications:
                                        1. Combat other interference w/ vote
                                        2. Fraud on the part of S or proxies
               2. Duty to disclose: BOD under Del law has fid duty to
                   disclose fully and fairly all material information w/in
                   board‟s control when seeking shareholder action
b. Control:
        i. True Control = 50% + 1 vote. Always win
       ii. Effective Control = less than 50%
               1. Not all shares are always present, so just need majorit of
                   present shares
               2. Influence is important – opposing significant minority
                   shareholder may be difficult
c. Electing Directors
        i. Default Rule: Each director elected separately
               1. Each share is entitled to one vote per director
               2. Majority shareholder (50%+1) can elect all directors
       ii. Change from Default (common examples)
               1. Supermajority Voting: requires supermajority to elect
               2. Cumulative voting: All electors considered to have voted
                   together. (i.e., 10 people running, 5 open spots for D, take
                   5 with highest vote totals)
                       a. Each share is entitled to multiple votes. If 5 spots
                           open, each voting share is worth 5 votes.
                       b. Number of directors that can be elected by a
                           minority shareholder: N=[(X)(D+1)]/S
                                 i. S = total shares outstanding
                                ii. X= number of shares controlled
                               iii. D=total number of director spots
               3. Class Voting: each class of stock has certain voting rights
                       a. e.g., class A has 2 votes/share, B has 1 vote/share
                       b. Could say that each class is entitled to vote
                           separately on some or all matters, e.g. approval of
                           action requires 50.1% of class A and 50.1% of B
                       c. Only certain classes are entitled to vote on some or
                           all matters;



                                 42
                               i. e.g. only common stock may vote for
                                  directors. (preferred often can‟t)
                              ii. e.g. common stock elects half, preferred half
d. Power Arrangements:
       i. Classified Shares: gives different profit and voting rights to
          different classes of stock.
              1. Note: splitting voting/profit like this will cause corp to lose
                  tax-favored S-Corp status
              2. Common set up would be to have experts get the voting
                  stock and financiers get the dividend stock
      ii. Proxy: require that majority owner (99%) seeking profit gives
          proxy to owner (1%) seeking control (i.e., expert) but maj gives
          expert proxy to vote all shares.
              1. Normally revocable at will, but
              2. If done for consideration, it is an enforceable contract
     iii. Voting Trust: plan in which shareholders transfer their shares to a
          trustee for the purpose of creating a voting block
              1. This is an actual transfer of shares; original holders usually
                  still get dividends
              2. Control by agreement or in one party
              3. Problem: limited to 10 years by courts (thought it sneaky)
     iv. Pooling Agreement: plan in which shareholders agree to vote their
          shares together; similar to voting trust
              1. Shareholders retain their shares
              2. Control is by agreement
              3. Problem is enforcement; courts are more accepting.
e. Management Entrenchment
       i. When management ends up with a significant amount of shares,
          enough for control
              1. Stock options to execs can lead to this situation
      ii. Control over proxy mechanism
              1. Management has power to solicit your proxies; expensive
                  for others to oppose, management wins on plurality
              2. Rational apathy – shareholders don‟t really care
     iii. Class voting:
              1. Exchange offer for new shares with high voting rights but
                  low dividends
              2. Gives general shareholders higher divs at expense of voting
                  rights, so management gets stock w/ voting rights
     iv. Capped Voting:
              1. Holdings beyond certain point carry reduced voting rights.
                       a. E.g., 100 shares, 100 votes; 1,000 shares, 150 votes
              2. Prevents hostile takeovers; even if you have 90% of the
                  company, your votes are capped at a certain amount.
                  (could even hold 90% of stock but only 200 out of 200,000
                  votes)



                                 43
                     3. Downside is that management reduces its voting power
             v. Shareholder Activism
                     1. Officers appointed by directors, directors elected by
                         shareholders. In theory, shareholders have ultimate control
                     2. Burle-Means thesis (glossary): says that officers ultimately
                         have the final say, as they run the day-to-day business, set
                         the agenda, and have little responsibility to directors
                             a. Could even say that officers choose the directors
                                 (they set meetings, choose who is on ballot, and the
                                 shareholders essentially endorse their choices)
            vi. Activist companies
                     1. Institutional Investors are rising; they tend to have more
                         shares and tend to pay more attention. This could thwart
                         this theory, as these big shareholders can exercise more
                         control.
                             a. But corporations can choose not to deal with these
                                 companies, so they won‟t be as quick to oppose
                                 management.
II. Closed Corporations
       a. Generally
              i. Harder to sell shares than with public corp; no market
             ii. Freeze-out  action taken by majority shareholders in closed
                 corporation to frustrate the expectations of the minority
                 shareholders.
                     1. Withhold dividends to all shareholders (usually coupled w/
                         majority S giving himself a raise)
                     2. Deny employment to minority shareholders (w/o divs,
                         especially in closed corp, this is only other way to make $
                         on corporation)
            iii. Increasing trend among courts to treat closed corporations as
                 special
                     1. Sometimes they will waive rules (Clark v. Dodge)
                     2. Sometimes they will impose fid duties on majority
                         shareholder to minority shareholder
            iv. In General: when no one else is injured, and all shareholders agree
                 to do something, courts will normally allow it in closed corps
       b. Legislative Trends
              i. Building more flexibility into general corporation law; basically
                 allow for management of corporation by shareholders; makes it
                 more like partnership but with corporation limited liability.
             ii. Special Closed Corp Laws
                     1. Special laws address two problems:
                             a. Parties are not aware of technical requirements of
                                 corporation law (laws allow them flexibility)
                             b. Risk of piercing corporate veil




                                       44
                2. Delaware Closed Corporation Statute (most statutes are
                    public corp statutes)
                        a. Requirements:
                                  i. No more than 30 shareholders
                                 ii. No registered IPO
                                iii. Must have transfer restrictions which
                                     prevent free alienation of shares
                                iv. Must choose to be governed by this statute
                        b. Most closed corps don‟t fall under this
                3. New York: permits provisions restricting the power of
                    BOD in management or transferring all or any part of such
                    management
c. Federal Law:
         i. Closed Corps can avoid double taxation by becoming S corp
                1. Which is essentially a closed corp that chooses to be taxed
                    as a partnership rather than a corporation
        ii. Requirements for S-Corp Status
                1. Unanimous Consent of Shareholders
                        a. But only need majority to terminate
                2. No more than 100 shareholders
                3. All shareholders must be individuals, estates or trusts
                        a. Not another corporation (subsidiary)
                4. No shareholder can be non-resident alien
                5. You can only have one class of common stock
       iii. Common tactic of corporations
                1. Why subject yourself to double taxation?
                2. Most corps that can elect S status, do so.
                3. Downside is that the corp gets taxed on anything it makes,
                    whether or not you take it out. Therefore any reinvestment
                    would be after-tax, not before-tax as with regular corp
d. Illustrative Cases:
         i. Ringling Bros Combined Shows v. Ringling: (7 directors to be
            elected by 3 shareholders; they can choose 2, 2, and 3,
            respectively. Two S entered into pooling agreement to oppose
            third – 4 votes (2+2) opposed to 3
                1. Agreement didn‟t meet requirements of voting trust, but
                    court allowed it anyway b/c closed corporation, no
                    violation of fid duty, and minority S were vulnerable.
                2. Pooling agreement gives up right (not power) to vote.
                3. Voting trust – lose the power to vote
        ii. McQuade v. Stoneham: (plaintiff was minority S, officer, &
            director until fired in violation of agreement with other S)
                1. Court found K invalid and unenforceable b/c while
                    shareholders may agree to vote together, they may not K in
                    manner which interferes w/ directors power to exercise
                    their independent judgment in mgn of corp affairs.



                                45
                       2. Pooling agreements in NY:
                               a. Cannot have Pooling Agreement among directors
                                   telling them what to do.
                               b. Basically, shareholders cannot contract to force
                                   director to do something; that‟s an interference with
                                   directors duties.
              iii. Clark v. Dodge: (two sole S entered into K to continue plaintiff‟s
                   position as mng & dir; plaintiff was ejected and didn‟t receive $)
                       1. Court finds K to establish who directors are is OK when all
                           shareholders agree, even though interferes w/ dir‟s power
                           to manage corp
                       2. NOTE: same court, two years later than McQuade.
                       3. This is contrary to corp law which favors form over
                           substance. Exceptions like this favor substance.
              iv. Galler v. Galler: (two brothers, B&I , owned corp. Entered into
                   pooling agreement to provide for widows. B dies & I does not
                   abide by agreement. B‟s wife sued & won. Followed Clark)
                       1. “Where no complaining minority interest appears, no fraud
                           or apparent injury to the public or creditors is present, and
                           no clearly prohibiting statutory language is violated, we can
                           see no valid reason for precluding the parties from reaching
                           any arrangements concerning the management of the
                           corporation which are agreeable to all
III. Abuse of Control [closed corporations]
       a. Wilkes v. Springside Nursing Home: [Mass] (4 friends establish corp for
          nursing home business, relations strained, one wanted to sell, others freeze
          him out.)
                i. General Rule: “Stockholders in closed corporation owe one
                   another substantially the same fiduciary duty in the operation of
                   the enterprise that partners owe one another”
               ii. Two Part Test for analyzing breach of fid duty in these cases:
                       1. Controlling Group must have a legitimate business purpose
                       2. Action must be least restrictive means to accomplish goal
                               a. Makes it more than BJR, but still less than meeting
                                   EFT. (VELASCO thinks this may be more
                                   restrictive than EFT in some respects)
       b. Ingle v. Glamore Motor Sales, Inc.: [NY] (sales manager for corp received
          and exercised stock options; maj later exercised buyback provisions and
          forced Ingle out. He claims breach of fid duty)
                i. Court limits fiduciary duty of majority shareholders:
                       1. “we only want to impose the fid duty when the
                           shareholders are essentially like partners”
                               a. in this case, Ingle was more like employee, so court
                                   said ok, even though it was a freeze-out
               ii. Courts are less willing to protect shareholders when they planned
                   ahead but things didn't work out the way they wanted.



                                        46
                     1. More likely to protect when they didn't plan ahead at all.
      c. Nixon v. Blackwell: [DELEWARE]
              i. Deleware is not likely to help shareholders that didn‟t plan ahead
                     1. “It would be inappropriate judicial legislation for this Court
                          to fashion a special judicially created rule for minority
                          investors when there are no negotiated special provisions in
                          the certificate of incorporation, by-laws, or stockholder
                          agreements.”
      d. Smith v. Atlantic Properties: [MA] (4 equal S made K requiring 80% vote
         to pass w/ each having veto power. One refused to pay divs and rest sued
         after IRS penalized corp for excessive holdings)
              i. Court generally won‟t interfere when shareholders have made an
                 arrangement.
             ii. Interference may be appropriate when parties are truly stuck. Here
                 they could have dissolved and rid themselves of the problem.
      e. Jordan v. Duff and Phelps: (plaintiff & others wanted to sell stock, closed
         corp didn't tell them about prospective merger, they sold, merger occurred
         and made stock very valuable. Sued)
              i. Court held that closed corporation has duty to disclose material
                 facts.
             ii. Special facts doctrine: CC buying their own shares from
                 shareholders have a duty to tell S of any special facts it knows (i.e.,
                 CC has inside information and has fiduciary duty)
IV. Corporate Dissolution
      a. Methods of corporate dissolution:
              i. Shareholder vote (often requires supermajority)
             ii. Charter Amendment (Can limit life of corporation)
                     1. Requires board and shareholder approval to include
            iii. Judicial Dissolution
                     1. Generally court are hesitant to dissolve
                              a. it‟s a profitable business & has opportunistic
                                  behavior
                     2. Could be used to help minority shareholders in freeze-out
                          situation
                              a. But if too easy, minority could take control easily
                                  from majority
                     3. Mitigating factors that should give comfort to courts to
                          allow dissolution
                              a. Dissolution does not mean the end of the business
                                       i. Salvage value/liquidation value v. going
                                           concern value
                                               1. Salvage value  value of a business
                                                  if its assets are sold individually;
                                                  usually less than going concern
                                                  value.




                                        47
                                      2. Going concern value  value of a
                                          business if sold as a business; usually
                                          higher than salvage value
                              ii. Sale as a going concern
                             iii. Alternative forms of relief
      iv. Illustrative Cases
               1. Alaska Plastics, Inc. v. Coppock: (divorcee of director got
                   shares but BOD failed to notify of annual meetings, paid no
                   dividends, and permitted no involvement in the business.
                   Essentially, she was frozen out.
                        a. Court doesn‟t step in; dissolution is only for
                           instances where there is serious misconduct.
                        b. Also, she was a shareholder, not a partner, which
                           weighed against them owing her a fiduciary duty.
               2. Pedro v. Pedro: (Brother/director with 1/3 interest fired by
                   other brothers for failing to cure book discrepancy. By
                   firing him, they force him to sell at 75% of book value
                   instead of intrinsic value, and he will not be employed)
                        a. Court found that K contemplated his lifetime
                           employment, so he was awarded salary till 75 and
                           fair market value of shares.
                        b. Criticism: no real market for shares, so probably
                           not worth that price.
               3. Stuparich v. Harbor Furniture Mfg: (2 sisters quit when
                   CEO brother & maj shareholder wouldn‟t sell losing
                   furniture business which gave him high salary. Sued for
                   dissolution)
                        a. Court found for defendant corp; liquidation is only
                           appropriate remedy when it is reasonably necessary
                           for the protection of the rights or interests of
                           shareholders.
                        b. Court says that in cases of self dealing (i.e., both
                           sides of transaction) the defendant must prove it‟s a
                           fair transaction (EFT!)
b. Judicial Dissolution
        i. Any shareholder can seek dissolution, but most states have sum
           minimum % of shares required to seek judicial dissolution.
       ii. Situations where judicial dissolution is appropriate
               1. Waste of corporate assets
               2. Oppressive conduct by majority shareholders
                        a. Standard varies from state to state
                        b. High standard: need burdensome, harsh or
                           wrongful conduct along with a violation of specific
                           rights of a minority




                                 48
                              c. Middle standard: breach of fiduciary duty of good
                                 faith and fair dealing along with subtle forms of
                                 misconduct.
                              d. Frustration of reasonable expectations
                                      i. In closed corps, complaining shareholder
                                         need not establish oppressive or fraudulent
                                         conduct by controlling shareholder(s)
                                     ii. Reasonable expectations include
                                         expectations that the minority shareholders
                                         will participate in the management of the
                                         business or be employed by the company
                                         but limited to expectations embodied in
                                         understandings, express or implied, among
                                         the participants.
V.   Transfer of Control
       a. General Rule w.r.t. buying and selling shares (from Zetlin v. Hanson
          Holdings):
               i. “It has long been settled law that, absent looting of corporate
                  assets, conversion of a corporate opportunity, fraud or other acts of
                  bad faith, a controlling stockholder is free to sell, and a purchaser
                  is free to buy, that controlling interest at a premium price.”
              ii. Can‟t sell at a premium if you know the purpose is a known looter
                  or a suspected looter.
                       1. Tough question, though, as how do you really know?
                           Probably a reasonableness standard
       b. Sale of Directorship
               i. Shareholders can vote however they want for directorship (i.e.,
                  selfish reasons are OK)
              ii. Elected director will have fiduciary duties to all shareholders.
                       1. But, the BJR protects a lot, all but waste and self dealing
             iii. Should you be able to buy a directorship?
                       1. There are egalitarian concerns, but
                       2. Rational apatheic: people should only keep the rights they
                           want.
       c. Transfer of Control
               i. Perlman v. Feldman: Only one Buyer chosen & had to pay for
                  steel now, even though they wouldn‟t get it until a year later,
                  allowing the seller to essentially have an interest free loan)
                       1. Court found controlling S breached fid duty b/c could have
                           expanded operations – usurped a corporate opportunity.
                       2. NOTE: only good for historical purposes; no precedent
              ii. NOTE: (Adolf Burley) It has been argued that a controlling
                  shareholder can not sell his shares at a premium unless all can
                  share in the premium and not for your own personal benefit
                       1. b/c one share is suppoed to be one vote, but with 51% of
                           shares, the rest essentially have no vote.



                                        49
            iii. Essex Universal Corp v. Yates: (Controlling S w/ 28% contracted
                  w/ plaintiff to sell shares and 8 of 14 directors would be replaeced
                  by buyer‟s men. Price of S went up and defendants tried to back
                  out and make more money per share)
                      1. Court found contract enforceable b/c it was buyers right to
                          replace directors
                      2. Selling control: You can only sell control if you have a
                          controlling interest –
                              a. You know you have control by how you exercise it
                              b. Whether or not directors listen to him
                              c. Can‟t technically sell control, but it is allowed if
                                   you are selling a controlling interest.
             iv. Frandsen v. Jensen-Sundquist: (Defendant originally tried to
                  obtain corp, but rather than doing so, they bought the bank which
                  was corp‟s major assent. Minority shareholders sued)
                      1. Right of First Refusal – an agreement providing that, before
                          a shareholder can sell shares to a third party, other
                          shareholders would have the right to buy the shares at that
                          price. Reasons:
                              a. So as not to get stuck w/ someone you don‟t want in
                                   a closed corporation
                              b. If it‟s a good price, you might want it
                      2. Take-Along Right: an agreement providing that, before a
                          shareholder can sell to 3rd party, other shareholders have
                          right to sell their shares at the same price. Reasons:
                              a. Approval of who the person is selling to
                              b. Min shareholders can take advantage of premium
                      3. Why have both?
                              a. New market for shares, esp. in closed corps.
                              b. If good price, buy it for yourself. If bad price, you
                                   can sell your own shares.
                      4. NOTE: These only cover sale of shares, not sale of assets
                              a. This was a sale of assets case.
                              b. Because it was not a corporate law issue, and rather
                                   a contract issue, formalism was not required b/c
                                   contractual law is interpreted as the meaning of the
                                   partites.
VI. Acquisition of Control:
      a. Acquisitions
               i. Defn: a general term that refers to a business combination of any
                  type (e.g., merger, stock purchase or asset purchase)
              ii. Takeover: any attempt by acquiror to gain control of targer
            iii. 3 Ways:
                      1. Stock purchase  an acquisition in which an acquiror buys
                          the stock of the target from the shareholders.




                                        50
                      a. A + B = A + B (two separate corps b4 and after;
                         target becomes a subsidiary)
                      b. Shares were purchased directly from shareholders;
                         target company is not involved
                      c. Approval needed: None (individual decisions)
              2. Asset Purchase  an acquisition in which the acquiror
                  buys the assets (and maybe liabilities) of the target (just
                  about all assets)
                      a. A = A + B (one new co takes on the assets of both
                         old
                      b. Target company is involved;
                      c. Approval needed: Directors & Shareholders
                      d. Shareholders get say in whether their assets are
                         sold, but S of other company don‟t have say over
                         whether their corp buys assets
              3. Merger  an acquisition in which an acquiror and a target
                  combine into one surviving company.
                      a. A + B = AB
                               i. Like a marriage; can be the original
                                  company or a totally new one
                      b. Approval of both companies‟ directors and
                         shareholders b/c both companies are affected
                      c. 3 possible outcomes:
                               i. Constitutent corporation – corporation party
                                  to a merger
                              ii. Surviving Corporation – constituent
                                  corporation that survives a merger
                             iii. Resulting corporation – new corporation
                                  formed as a result of a merger
b. Merger Procedures
       i. DCGL § 251
              1. Prepare merger agreement
              2. Approval of directors of each company
              3. Approval of shareholder of each company
                      a. True majority needed for both – 50% +1 of all
                         shares/votes
              4. File with Sec. of State
              5. Dissenting shareholders have appraisal rights
                      a. Appraisal rights – the right to forego the contractual
                         consideration in a merger (or similar transaction)
                         and to receive instead the fair value of the shares
                               i. Shares are sold to the company
      ii. What if merging corporations are incorporated in different states?
          Follow both, especially the one that is more strict for each part.
c. Consideration in a merger
       i. Standard Merger:



                                51
              1. Consideration is shares in surviving corporation
              2. Number of Shares depends on value of constituent
                 corporation.
                     a. EX: if A is worth $100 mil and B worth $50 mil,
                          the ration will be 2 to 1. (so every share from A is
                          worth twice a B share in the new company.) this is
                          very simplified example, also have to take into
                          account premiums paid, amount of shares
                          outstanding, etc
      ii. Legal Possibilities:
              1. Law provides that a merger agreement can have any
                 consideration. (securities, cash, property, vodka!)
                     a. Shareholders from each corp don‟t have to get the
                          same thing
              2. Different Consideration
                     a. Cash-Out Merger  a merger in which one
                          company‟s shareholders received cash instead of
                          shares in the surviving corporation
                               i. Similar to a stock purchase. C-O requires
                                  approval of BOD; SP gives choice to Ss
                              ii. Shareholders being cashed out are often
                                  from the target corporation.
                     b. Merger of Equals – both companies simply
                          combine; no real acquiror or target
d. Appraisal Rights
       i. Most states allow the option to seek appraisal: makes more sense
          b/c more fair to dissenting shareholders who voted against merger
          to have court determine fair value of s
              1. NOTE: must have voted against the merger to have
                 appraisal rights
      ii. Delaware:
              1. Generally, appraisal rights are available to all shareholders
                 entitled to vote in a merger proceeding. Exceptions:
                     a. No appraisal rights for Ss of corp that sells its assets
                     b. No appraisal rights for publicly traded corp
                     c. No appraisal rights in stock-for-stock exchange
     iii. Procedure (DEL)
              1. Company must give notice of appraisal rights
              2. S must demand appraisal before the vote
              3. S are not given appraisal rights if they voted for the merger
              4. S must petition for appraisal rights
              5. Court determines value of the shares.
                     a. Fair value may be less than merger consideration –
                               i. § 262(h) – fair value is value of shares
                                  standing alone.




                                 52
                                        1. Cannot take into account synergistic
                                            gains
                                        2. Synergy  advantage that results
                                            when a combination is greater than
                                            the sum of its parts
                                ii. Acquiror often pays a premium to get target
                                        1. Premium is used to persuade Ss
                               iii. Even if the fair value = merger
                                    consideration, you then have to deduct the
                                    cost of the appraisal.
                       b. When should you NOT seek an appraisal?
                                 i. NOT when you are quivering over value
                                ii. Wise person only seeks appraisal when you
                                    are really getting taken advantage of (like
                                    stock worth $50/sh and the merger is going
                                    at $25/sh)
e. Loopholes – ways to structure transactions to get around limitations (i.e.,
   form over law/substance)
        i. Cash-out merger: want to merge, but you don‟t want each
           corporation‟s shareholders to be shareholders of new corp
       ii. Triangular Merger: merger between one company and a subsidiary
           of another
               1. Acquiror merges its own subsidiary w/ target. Often the
                   subsidiary is a shell corporation, created only to merge with
                   the target.
               2. Advantages  you can avoid a shareholder vote of the
                   acquiror corp
                       a. Only the target and the acquiror/subsidiary have to
                            approve. Subsidiary approval is easy; need BOD of
                            parent corp as owner)
                       b. Often used when acquiror knows it doesn‟t have the
                            support of its shareholders b/c paying a premium etc
      iii. Short Form Merger  a procedure under some states‟ laws where
           a parent corp can merge with a subsidiary w/o a shareholder vote
               1. EX: do a triangular merger and then a short-form merger.
                   This would put the corporations in exactly the same place
                   as if they just merged normally, but this was without a
                   shareholder vote.
f. Practical Considerations
        i. Key: M=merger, SP=stock purchase, AP=asset purpose,
           TM=triangular merger, SFM=short form merger.
       ii. Liability
               1. M: joins two companies‟ liabilities
               2. SP & TM: keeps liabilities separate
               3. AP: parties can (generally) decide.




                                 53
                              a. Can buy half liabilities, can buy known liabilities,
                                 etc. Why? Maintain business relationships / PR
                                      i. MAIN REASON: you pay less for the
                                         company (net cost compared to gross cost)
              iii. Structure:
                       1. M & AP: One surviving company
                       2. SP & TM: Two surviving corps
              iv. Ownership:
                       1. M, TM & AP: acquiror gets 100% ownership
                       2. SP: acquiror may get less than 100%
                               a. Everyone may not agree to sell to acquiror; plus
                                   there are just always those that don‟t know/sell
                               b. To avoid: SP 51%, create a subsidiary and then do
                                   a triangular merger and cash-out the minority
                                   shareholders.
               v. Appproval:
                       1. M: both sets of directors and shareholders. Hard to get
                       2. TM & AP: both sets of directors; only target‟s shareholders
                       3. SP: consenting shareholders; not directors. Target
                           company is not involved.
              vi. Appraisal Rights:
                       1. Delaware: Only for M
                       2. Some states: M, TM & AP
             vii. Consquences:
                       1. Renegotiation of contracts
                               a. Not a problem with SP or TM
                               b. With M and A contracts will have to be
                                   renegotiated, etc.
                       2. Nontransferable rights
                               a. Merger – some rights transfer (as operation of law)
                                   but there may be non-transferable rights under Fed
                                   Law
                               b. Asset purcase – important to take into consideration
                       3. Tax & accounting consequences
VII.   De Facto Mergers and Freeze-Out Mergers
       a. De Facto Mergers – transactions which are not styled as mergers but
           which essentially are mergers may be treated as mergers for purposes of
           shareholder votes and/or appraisal rights.
                i. Farris v. Glen Alden Corp [PA] – (Reorg K in AP form w/
                   defendant taking target assets & liabilities in exchange for acquiror
                   stock to target Ss. Target then dissolved)
                       1. Court says statutory language does not get rid of de facto
                           doctrine. Completely ignored plain meaning of statute.
                       2. Legislatures here and in other states are trying to get rid of
                           statutory merger




                                        54
               3. Legis even said “we want to get rid of de facto mergers”
                    but court didn‟t give two shits.
       ii. Hariton v. Arco Electronics [DEL]
               1. This is the majority rule: transactions in AP form will not
                    be considered entitled to merger treatment based on
                    substance. Corp law looks to form.
                        a. PA and NJ are outliers
b. Freeze-Out Mergers
        i. Defn: a merger in which minority shareholders are forced to
           receive cash for their shares and to lost their status as shareholders
               1. Basically, an involuntary cash-out merger
               2. Forced buy-out is the problem, not the solution
               3. Note difference from Freeze-Out, where minority Ss
                    expectations are frozen out due to lack of dividends,
                    employment, etc. There the shareholders WANT to sell,
                    but can‟t. Here they don‟t want to sell, but have to.
       ii. Should they be permitted?
               1. Some shareholders who don‟t agree are forced to give up
                    their shares.
               2. The appraisal remedy just gives them cash, even though
                    this is what they are trying to avoid in the first place. So
                    these shouldn‟t be a problem
      iii. Illustrative Cases:
               1. Weinberger v. UOP [DEL] (defendant acquiror got
                    majority interest in UOP, where plaintiff was min
                    shareholder. Then acquiror decided to buy all of remaining
                    s in UOP. 2 dir made report that purchase up to $24/sh
                    would profit acquiror. Majority sh offered $21. Majority
                    of minority approved, plaintiff voted against. Legitimacy
                    Test is essentially Entire Fairness Test:
                        a. NOTE: THIS IS THE BEST DESCRIPTION OF
                             THE EFT
                        b. Burden is on majority to show trans was fair, AND
                        c. A fair deal was given to minority S
                                 i. Fair dealing: embraces questions of when
                                    the transaction was timed, how it was
                                    initiated, structured, negotiated, disclosed to
                                    the directors, and how approvals of dir and S
                                    were obtained.
                                ii. Fair Price: relates to the economic and
                                    financial considerations of the proposed
                                    merger, including all relevant factors:
                                    assets, market value, earnings, future
                                    prospects, and any other elements that affect
                                    the intrinsic or inherent value of a
                                    company‟s stock.



                                  55
                            d. There were some directors on board of acquiror and
                                target; did valuation study and shared results only
                                with acquiror. This caused breach of duty.
                            e. NOTE: in freeze out merger, there is necessarily
                                self dealing, so it will always invoke the EFT which
                                must be satisfied unless trans is ratified by fully
                                informed, disinterested shareholders.
                                     i. Here they weren‟t disinterested.
                                    ii. NOTE that shareholder vote isn‟t
                                        necessarily informed, disinterested
                                        shareholder approval
                    2. Coggins v. New England Patriots [Mass] (100% owner of
                        voting stock buys up remaining S from nonvoters so could
                        reimburse cost of buying up voting stock.)
                            a. Court explicated rejected EFT used in Del above
                                and added a “legitimate business purpose” prong to
                                the freeze out merger test.
                            b. Found no legitimate business purpose here
                            c. Is there ever a valid business purpose for a freeze
                                out merger?
                                     i. This case: owner had to have 100%
                                        ownership so he could negotiate with NFL
                                        (league rule). Court says not valid.
                                    ii. Basically, if this isnt‟ it, one doesn‟t exist.
                    3. Rabkin v. Philip Hunt Chem Corp [DE] (Olin agreed to
                        purchase maj of Hunt. Sale contract said any more Olin
                        purchases of stock in next year would be at $24/sh. Olin
                        announces intent to merge corps, but waits until after K
                        deadline so as to buy shares cheaper. This is DE, so EFT
                        without LBP prong.
                            a. Court says this case failed the EFT – not fair
                                dealing b/c misconduct in playing with timing of
                                transaction.
                            b. But price was otherwise fair.
                            c. Things that are normally OK may not be OK for
                                people with fid duties.
                                     i. Basically, under the K only it was OK to
                                        wait and pay when the shares would be
                                        cheaper, but these directors also had a fid
                                        duty to the target company, and they
                                        screwed that company by waiting until the
                                        contract expired and they could by the
                                        shares for less.
VIII. Hostile Takeovers
      a. Introduction




                                        56
       i. Hostile Takeover: A takeover that does not have the support of the
          directors of the target
              1. Not exactly hostile to shareholders
              2. Normally done by a stock purchase
                      a. Tender offer: once you have 10% via open market
                           purchase, you make a tender offer for 51% of corp
                      b. Freeze out merger to get 100% of the company
              3. Shareholders like takeover (get premium), management
                  dislike (lose control/job)
b. Reasons for Takeovers
       i. Undervaluation
              1. Market value of the shares is less than fair value
              2. Eff Market Hyp says this is doubtful, not nec. untrue
      ii. Synergy  the advantage that results when a combination is
          greater than the sum of its parts.
                      a. If true, this would result in a net gain to society
              2. Economies of Scale  the reduction in unit costs generated
                  by buying or producing in volume; often results from the
                  fact that fixed costs are divided over a large number of
                  units
              3. Economies of Scope  the reduction in unit costs
                  generated by producing similar or related items; often
                  results from the fact that assets or skills may be transferable
                      a. EX: computer parts co can acquire a computer
                           factory
              4. Financial Synergy  the advantage that larger companies
                  have over smaller companies in raising money.
                      a. Internally – large company can earn a lot and
                           support itself.
                                i. Using retained earnings to support new
                                   products
                      b. Externally – cheaper to borrow or sell securities on
                           a larger scale than for a smaller scale.
                      c. Financial Synergy led to the rise of conglomeration
                           – the process of internal diversification.
                                i. Expansion into unrelated lines of business
                               ii. Negative of this is that it leads to a lack of
                                   focus
                              iii. Diversification can be a bad thing in that
                                   some companies can be doing poorly/some
                                   well and the poor performance can be
                                   hidden and there would be no pressure for
                                   improvement.
     iii. Agency Costs  the costs associated with an agency relation; i.e.,
          the risk that the agent may pursue her own interests instead of
          those of the principal.



                                 57
                     a. Stems from separation of owners and management
                     b. Hard for shareholders to remove management
                     c. Takeover can help reduce agency costs.
              2. Inefficient management
              3. Excessive Compensation
              4. Self-aggrandizement – management is tempted to improve
                 size over profits.
                     a. Management likes bigger size b/c it gives them
                          power and prestige
                     b. Shareholders obviously would rather have profits.
     iv. Wealth Transfers  a shift in wealth from one group to another,
          often without a net benefit to society.
c. Reasons for Defense (officers/directors opposing takeovers)
       i. Generally: most of these reasons are easy to claim but hard to
          prove
              1. Who gets to decide?
                     a. Management runs business
                     b. Shareholders vote to remove mgt and sell shares.
                               i. If mgmt can prevent hostile takeover, it
                                  limits S rights to sell shares
      ii. Coercive Offers
              1. If hostile offer is coercive and shareholders really don‟t
                 have a choice it is appropriate for management to step in.
              2. Best Example is a two-tiered front loaded tender offer:
                     a. Tender an offer at a premium, seeking control but
                          not full ownership, with the explicit or implicit
                          promise of a subsequent freeze-out merger offering
                          inferior consideration to remaining shareholders
                     b. Even if shareholders want to say no, they have to
                          say yes for fear of a worse deal.
              3. Coercive offers have become more subtle as courts were
                 generally pretty distrustful of them
                     a. EX: $50 in cash or $50 in bonds on back end
                     b. Shareholders wanted protection from them
                     c. Don‟t really exist anymore b/c they can be resisted
                     d. NOW: All cash, all-shares offer  offer to buy any
                          and all shares for cash, with the promise to follow
                          up promptly with a cash out merger at the same
                          price in cash.
                               i. No coercion here, despite management
                                  claims
     iii. Undervaluation
              1. (pay less than shares are worth, but EMH makes this
                 implausible)
              2. good deal for acquiror, but not for target shareholders




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              3. Courts protect this for a reason b/c management has a better
                   idea of what the company is worth
      iv. Opportunity Loss
              1. Management, acting in shareholders interest, can claim this
                   is a good deal, but we can get a better deal
              2. Way to get around this  auction.
       v. Incompatibility
              1. i.e., management argues that it‟s not a good business
                   decision for a potato chip co to buy a microchip corp
      vi. Other constituencies
              1. Unfair to employees, creditors, government, society,
                   community, enfironment
     vii. Entrenchment – efforts by management to resist ouster, as by a
           hostile takeover
              1. Of course management can not give this as a reason
d. Takeover Defenses (The “How”)
        i. Previously considered:
              1. Other constituency statutes
              2. Staggered boards  a board of directors structured so that
                   only a fraction of its members is elected each year for
                   multi-year terms; a.k.a., classified board
                        a. Don‟t actually do much b/c once takeover is
                           accomplished, directors don‟t really want to be on a
                           board where they have to resist the owner of the
                           company
              3. Voting rights
                        a. Ways that make it difficult or impossible for some
                           one to take over the company
       ii. Additional Mechanisms:
              1. Greenmail  the repurchase by a target of its own shares
                   from an acquiror at a premium (hostile buys 10% and
                   threatens to buy all; company has to pay premium to get
                   shares back and stay them off)
                        a. Shareholders hate this…instead of getting the
                           premium they are paying the premium
                        b. Management is forced to pay greenmail to get you
                           to go away.
                        c. Paying greenmail makes you vulnerable to more
                           greenmail threats (they know you‟ll pay)
              2. Crown Jewel Defense – a takeover defense in which the
                   target sells its most valuable assets in order to become less
                   attractive to the acquiror.
                        a. Similar to shooting yourself in the foot
              3. Share repurchase – the reacquisition by a company of its
                   own shares from the public.




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       a. Do this to drive the price up & make it more
           expensive for acquiror to acquire
       b. Reduce the supply of willing sellers in the market
       c. Increase the management‟s relative position
4. White Knight Defense – a takeover defense in which the
   target convinces a friendly third party to make a superior
   offer
                i. Not a better deal for shareholders, if White
                   Knight gets advantages
       b. Termination Fee – a fee to be paid to a friendly
           would-be acquiror should the proposed transaction
           not be consummated.
                i. Only if the White Knight loses so the bad
                   acquiror would have to pay
               ii. Justified b/c it would cost the White Knight
                   money to win the fight.
       c. Lock-Up Option: a provision in an acquisition
           agreement designed either to preclude a competing
           bidder from acquiring a company or to provide
           compensation to the original bidder in case it loses
           in a bidding contest.
                i. EX: White Knight would get extra shares if
                   the hostile bidder wins
       d. No-shop provision – a provision in an acquisition
           agreement that limits the target‟s ability to deal with
           other potential bidders.
                i. Acquiror agrees not to deal with anyone else
5. Golden Parachute – a large severance pay contract for top
   management that is triggered by a change in control
       a. Management is giving itself an exit payment by
           directors.
                i. Considered part of the compensation
                   package
6. Posion Pill (PREMIER DEFENSE)  a takeover defense
   in which shareholders of the target (other than the acquiror)
   are granted the right to acquire securities (or other assets) at
   a significant discount. With this, you CANNOT complete
   a hostile takeover.
       a. Gives everyone (all other shareholders) all of the
           money/assets and leaves hostile acquiror with
           nothing but the name.
       b. Three ways around (elimination of) poison pill
                i. Negotiate a better deal w/ management (not
                   hostile, poison pill doesn't kick in)




                  60
                               ii. Get court to order redemption of poison pill
                                   rights. (order mgmt to do this as part of
                                   fiduciary duty)
                              iii. Launch a proxy contest to replace board,
                                   who will then remove the poison pill.
e. Illustrative Cases
        i. Cheff v. Mathes [DE]: (Other corp began buying D‟s stock. D‟s
            pres thought takeover really bad, so bought back stock at premium.
            S sued, claimed pres was self-interested in transaction / keeping
            job).
                1. Rule: Redemptions cannot be used by directors to prevent
                    a corporate raid if the sole purpose is to keep the directors
                    in office.
                        a. Doesn‟t apply if the corporate raid is a threat to the
                            corporation‟s interest as opposed to the director‟s
                            interest.
                        b. DE seems to use a modified BJR here
                2. Test: BOD must prove that reasonable grounds to believe a
                    danger to corporate policy and effectiveness existed.
                        a. Good faith, and
                        b. Reasonable investigation
                3. Court held for pres b/c acquiror was known corp looter.
       ii. Unocal Corp v. Mesa Petroleum [DE]: (Unocal, D, faced w/
            hostile TO by Mesa, P. used two tiered, front loaded offer for 37%
            of Unocal followed by a freezeout merger. A known corporate
            destroyer (greenmailer) financed the tender offer. Board made
            selective exchange offer, plaintiff S sued b/c breach of fid duty)
                1. Held: there was no breach of duty – board acted in
                    shareholder‟s best interest. Only a majority of outside
                    independent directors acted, and they did not stop the
                    tender offer, just removed the coerciveness
                2. Defense Actions: All board defense actions are subject to
                    enhanced scrutiny b/c of the “omnipresent specter” that the
                    Board is acting in its own best interest. This enhanced
                    scrutiny requires that directors show they had “reasonable
                    grounds” for believing a danger to the corporate policy and
                    effectiveness.
                3. Court proposes new “enhanced scrutiny” test:
                        a. Board must perceive the bidders‟ action as a threat
                            to corporate policy (Cheff Test)
                        b. Must show that the BOD‟s action is proportional to
                            the threat.
                                 i. (poison pill is always considered reasonable)
                4. Threats:
                        a. Coercive offers
                        b. Inadequate offers



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                                   c. Risk of non-consummation
                                   d. Quality of securities being offered
                          5. Present Case: Fed securities law requires tender offer must
                              be offered to all shareholders
                                   a. Discriminatory offers are illegal under Fed law
                          6. Medium amount of discretion is given to the BOD
                 iii. Revlon, Inc. v. MacAndrews [DE]: (Pantry Pride corp attempted
                      hostile takeover of Revlon. Revon‟s BOD took defensive actions,
                      including a White knight who eventually got lock-up of key assets
                      and a no-shop provision. Despite everything, tender offer became
                      inevitable. PP got injuction prohibiting BOD of Revlon from
                      continuing defensive measures. BOD sued)
                          1. Held: injunction was affirmed. Directors are allowed to
                              take defensive measures when they feel a takeover bid is
                              not in the corporation‟s best interest w/o violating their
                              fiduciary duties. But once dissolution or sale becomes
                              inevitable, their duties shift and they are then responsible
                              for getting shareholders the best price.
                                   a. Sale was considered inevitable…either white knight
                                      or hostile would take over
                          2. RULE: The Unocal standard becomes moot once the sale
                              is inevitable…there is no longer any reasonable
                              justification for defenses. BOD must attempt to get best
                              price for shareholder
                                   a. What is inevitable? When there is definitely an
                                      auction or white knight out there. Rarely the case.
                                   b. What is best price? Auction is best way, but some
                                      defensive measures will work also.
                                   c. Here the defenses were used to make sure the white
                                      knight won, which is contrary to duty to find the
                                      best price.
                          3. Difference from UNOCAL:
                                   a. Revlon standard is pretty tough – forces them to sell
                                      for the best price.
                                   b. Under unocal you have the ability to say NO to the
                                      deal. Corps want to stay here.


Notes from last class

   I. Summary
         a. LLC – limited liability company. Similar to corporation, but not actually a
            corporation. An “unincorporated” business. LLC law is really just a mix
            of corporate and partnership law. Basics
                i. Must file certificate of formation (charter)




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               ii. Operating agreement – sets forth structure and terms of limited
                   liability. Like the partnership agreement or the bylaws.
              iii. Members are the owners. (partners, shareholders)
              iv. Managers are the designated managers of the LLC
               v. Flexibility  the LLC is the culmination of the contract theory of
                   corporations.
                        1. Operating agreement can make it as much like or dissimilar
                            to a corporate as you want.
                        2. You can decide on limited liability, lifespan, units of
                            ownership (transferable/non)
                        3. Even fiduciary duties can be specified in the op agreement.
                            Probably some limits.
              vi. Other doctrines (like de facto corporations or piercing) still apply
             vii. Problems:
                        1. Fewer default rules
                        2. Smaller body of case law (risk, uncertainty)
                        3. Public businesses are taxed as corporations anyway
      b. Some states require certain types of businesses to become partnerships
          (like law firms).
                i. Some states have developed PC‟s – corporations for professionals
               ii. LLP‟s – partnership w/ limited liability among the partner. You
                   have limited liability w.r.t. actions of your partners (like torts)
II. Wrapup
      a. Great deal of flexibility arising in BA law. LLC‟s are the culmination of
          that flexibility.
                i. Traditional view: mandatory rules – things you have to do, duties,
                   etc.
               ii. Contractarian view: corporate law is really about enabling rules.
                   It‟s not about telling you what to do, it‟s telling you how to do
                   things. Law has been moving this way.
              iii.




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