Corps Outline Business Judgment Rule

Corps Outline 1 Business Judgment Rule - Requirements that a decision by a director or officer must meet before it will be upheld by application of the BJR o No self dealing  Director or officer has an interest in the transaction o Informed decision  Director or officer must have gathered at least a reasonable amount of information about the decision before he makes it  If he is grossly negligent he will lose protection o Rational decision  Director or officer must have rationally believed that his BJ was in the corp’s best interest  Does not have to be substantively reasonable, but must be at least rational - State actions to restrict liability of directors for breaches of the duty of due care o SHs may amend the articles of incorporation to eliminate or reduce directors’ personal liability for violations of the duty of due care  Delaware § 102(b)(7) Duty of Loyalty - Self-dealing transactions o Key player and corp are on opposite sides of a transaction o Key player has helped influence the corp’s decision to enter the transaction o Key player’s personal financial interests are at least potentially in conflict with the financial interests of the corp - General approach to self dealing situations o Was it fair? If it was, courts will usually uphold it o Was it waste? If it was, courts will usually void it at the request of a SH  This is true even if it was approved by a majority of disinterested directors or ratified by SHs o Middle ground, court will consider:  Approved by a majority of disinterested directors  Ratified by SHs - Three paths to make a decision okay with self-dealing o Disclosure plus board approval  What to disclose  Material facts about the conflict  Material fats about the transaction  Disclosure must be made  Disagreement on this  Delaware?  Interested director is what?  He or an immediate member of his family has a financial interest in the transaction Corps Outline  2 - - He or a family member has a relationship with the other party to the transaction that would reasonably be expected to affect his judgment about the transaction  Quorum  Has to consist of a majority of the disinterested directors, but not a majority of the total board  Even with approval by a majority of the disinterested directors, if the decision constitutes waste then such approval by the disinterested directors will serve only to shift the BOP to the P  What is waste? o Disclosures plus SH ratification  Fully informed  Something else? o Fair  Overall fairness  Determined by the facts as they were known at the time of the transaction Even indirect conflicts can cause a director to be interested – test is whether the director’s equity participation in the other party is big enough to expect his judgment to be affected o Being a director on the other side, not a SH, is usually not enough by itself to make one interested Corporate Opportunity Doctrine and Related Problems o Competition with the corporation – a director or senior executive may not compete with the corporation where this competition is likely to harm the corporation  May be validated, after full disclosure  Approval by disinterested directors  Ratified by SHs  Preparing to compete may also be a problem  After he has left the company it is not a violation of the duty of loyalty  But it may be not okay under trade secret protection or noncompetition agreements o Use of corporate assets  A key player may not use corporate assets if the use:  Harms the corporation or  Gives the key player a financial benefit  Corporate assets can be tangible or intangible  Approval or payment  No violation of duty of loyalty if it is: o Approved by disinterested directors after full disclosure o Ratified by SHs after full disclosure o Key player pays fair value for any benefit he has received Corps Outline 3 o The corporate opportunity doctrine – a director or senior executive may not usurp for himself a business opportunity that is found to “belong” to the corporation  Effect  Per se wrongful to the corporation  Corp may recover damages equal to the loss it has suffered or even profits it would have made had it had the chance to pursue the opportunity  Four tests for whether an opportunity is a “corporate opportunity”  Interest or expectancy o Interest – corp has an interest in an opportunity if it already has some K right regarding the opportunity o Expectancy – if its existing business arrangements have led it to reasonably anticipate being able to take advantage of that opportunity  Line of business if the opportunity is closely related to the corp’s existing or prospective activities  Fairness – court looks to the unfairness, on the particular facts, that would result if the insider took the opportunity for himself  Combination – combination of line of business and fairness tests – business opportunity only if both tests are satisfied  Factors to determine if it is a corporate opportunity  Opportunity offered to the insider as an individual or as corporate manager  Whether insider learned of the opportunity while acting in his role as the corporation’s agent  Whether the insider used corporate resources to take advantage of the opportunity  Whether the opportunity was essential to the corporation’s well being  Whether the parties had a reasonable expectation that such opportunities would be regarded as corporate ones  Whether the corporation is closely or publicly held o Case for finding a corporate opportunity is stronger in the case of a publicly held corporation  Whether the person taking the opportunity is an outside director or a full-time executive o More likely a corporate opportunity with a full-time executive  Whether the corp had the ability to take advantage of the opportunity o Not all courts consider this  Applicable to?  Usually only directors, full-time employees, and controlling shareholders Corps Outline  4 - Rejection by corp  If the insider offers the corp the opportunity and the corp rejects it then the insider may pursue the opportunity o But he must make full disclosure about what he proposes to do o Some courts allow ratification after the fact o Delaware?  Corp is unable to take advantage  Courts are split  Delaware? Other duties of controlling shareholders o Duty of complete disclosure  When a controlling SH or group deals with the non-controlling SHs, it owes the non-controlling SHs a duty of complete disclosure o Parent/subsidiary relations – when the controlling SH is another corp, essentially the same rules apply  Dividends – when the parent corp controls the parent’s dividend policy, usually self dealing  But as long as dividends are paid pro rata to all SHs, courts will usually uphold Shareholder Suits - Requirements for a derivative suit o He must have been a SH at the time the acts complained of occurred o He must still be SH at the time of the suit o He must make a demand upon the board requesting that the board attempt to obtain redress for the corp  Must be written  This may be excused  Some states require a demand on the SHs too – Delaware? - Demand o Excused  Excused where it would be “futile” – if the board is accused of having participated in the wrongdoing  DELAWARE – demand will not be excused unless P carries the burden of showing a reasonable doubt about whether the board either:  Was disinterested and independent or  Was entitled to the protections of the BJR  Difficult to meet this burden of showing reasonable doubt b/c:  P must plead facts showing reasonable doubt toward either of the 2 things with great specificity  Also it is usually not enough for P to charge the board with a violation of duty of due care, usually P must allege a breach of duty of loyalty and allege it with specificity o Required and refused Corps Outline  5 If demand is required and the board rejects it, the result depends partly on who the D is  If D is unaffiliated 3d party – P will almost never be permitted to continue his suit after the board has rejected it  If it is a suit against an insider – P will have to show either: o That the board somehow participated in the alleged wrong o Directors who voted to reject the suit were dominated or controlled by the primary wrongdoer o Independent committee  Corps today usually respond to P’s demand by appointing an independent cmte of directors to study whether the suit should be pursued  Usually the cmte will conclude that the suit should not be pursue  DELAWARE – takes 2 steps  Court asks whether the cmte acted independently, in GF and with reasonable procedures o If answer is no to any of these then court will allow suit to proceed  Even if answer to all questions is yes then the court may apply its own independent BJR about whiter the suit should be permitted to proceed o This step will only be applied in a “demand excused” case Structural Changes, Including Mergers and Acquisitions - Merger-type deals o Generally – SHs of little corp will end up mainly with stock in big corp as their payment for surrendering control of little corp o Types of mergers  Statutory mergers – follow procedures in state corporation statute – one corp merges into another with the disappearing corp ceasing to have any legal identity and the surviving corp continuing its existence  Stock-for-stock exchange – big corp makes a separate deal with each little corp SH, giving each SH stock in big corp in return for the SH’s little corp stock  Stock-for-assets exchange – big corp gives stock to little corp and little corp transfers substantially all of its assets to big corp, then little corp dissolves and distributes the big corp stock to its own SHs  Triangular or subsidiary mergers  Forward triangular merger – acquirer creates a subsidiary for the purpose of the transaction Corps Outline  Reverse merger – acquirer’s subsidiary merges into the target, rather than having the target merge into the subsidiary 6 - - Sale-type transactions o Sale-type – little corp SHs receive cash or bonds, rather than big corp stock, in return for their interest in little corp  Asset-sale and liquidation – little corp’s board approves a sale of all or substantially all of little corp’s assets to big corp, and the proposed sale is approved by a majority of little corp’s SHs, then little corp conveys its assets to big corp and little corp receives cash from big corp, then little corp will usually dissolve and pay the cash or debt to its SHs in proportion to their shareholdings  Stock sale – no corp level transactions take place, big corp buys stock from each little corp SH for cash or debt  After big corp controls all or a majority of little corp stock it will cause little corp to dissolve or cause it to be merged into big corp  Tender offer – common form of stock sale o Big corp publicly announces that it will buy all or a majority of shares offered to it by little corp SHs  Big corp may privately negotiate purchases also Protection for shareholders o Appraisal rights  Give a dissatisfied SH a way to be “cashed out” of his investment at a price determined by a court to be fair  Usually have to have the right to vote to have ability to get appraisal rights  Delaware does not give appraisal rights to SHs of a corp that sells its assets  Procedures for getting appraisal rights  Notice – corp must notify SH that he has appraisal rights  Notice of payment demand by holder – holder must then give notice to the corp, before the SH vote, that he demands payment of the fair value of his shares o Also the SH must not vote his shares in favor of the transaction  SH must deposit his shares with the corp  Corp pays the SH  Valuation of dissenter’s shares  Fair value must be determined without reference to the transaction that triggers the appraisal rights  No minority or nonmktability discount – most courts do not discount the value of P’s shares to reflect that P held a minority or non-controlling interest  DELAWARE block method o Consider three factors Corps Outline 7 -  Mkt price just prior to the transaction  Net asset value of the company  Earnings valuation of the company o Delaware no longer requires use of this method o Delaware courts now accept additional evidence of valuation  Such as – value studies prepared by the corp and expert testimony  Exclusivity  Appraisal rights are the exclusive remedy available to an unhappy SH in some, but not all circumstances  Illegal – may be enjoined  Deception – SH can attack the transaction instead  Unfair – usually is the exclusive remedy o But if unfairness is due to SD then the court may grant an injunction o De facto merger doctrine – DELAWARE rejects it o Judicial review of substantive fairness – courts will sometimes review the substantive fairness of a proposed acquisition or merger – this is much more likely when there is a strong self-dealing aspect of the transaction  Arm’s length combination  If the buyer and seller do not have a close pre-existing relationship at the time they negotiate the deal, courts will rarely overturn the transaction as being substantively unfair  In DELAWARE the person attacks the transaction for substantive fairness must: o Bear the burden of proof on the fairness issue AND o Show that the price was so grossly inadequate as to amount to “constructive fraud”  Rarely will P be able to satisfy the double-barreled test  Self-dealing  If the transaction involves self-dealing, the court will give much stricter scrutiny  In DELAWARE the proponents of the transaction must demonstrate its entire fairness Freezeouts o Meaning – transaction in which those in control of a corp eliminate the equity ownership of the non-controlling SHs o Techniques whereby the controlling SHs, legally compel the noncontrolling holders to give up their common stock ownership o Squeezeout – coerce the SHs to give up their shares o Types  Cashout – leading type of freezeout merger  Insider causes the corp to merge into a well-funded shell, and the minority holders are paid cash in exchange for their shares, in an amount determined by the insiders Corps Outline  Short-form – if big corp owns 90% or more of little corp Tender offers o Offer to SHs of a publicly-held corp to exchange their shares for cash or securities at a price higher than the previous market price o 5% owner – any person who “directly or indirectly” acquires more than 5% of any class of stock in publicly held corp must disclose that fact on a statement filed with the SEC 8 -