BA principle of honestry and good faith

Document Sample
BA principle of honestry and good faith Powered By Docstoc
					                          BUSINESS ASSOCIATIONS 2006

  1. Analysis
        a. Identify the Issue (Contract/Tort)
        b. Identify the Legal Relationships Among Parties
                i. Principal/Agent (what kind of authority?)
               ii. Master/Servant (within scope of employment?)
        c. Identify Relevant Legal rules- action and legal relationship
  2. General
        a. General v. Special Agents (§ 3, power to bind in § 161A)
                i. Special- for a particular action
               ii. General- all other agency relations
        b. Disclosed and Undisclosed Principals
                i. Disclosed- existence and identity known (only principal)
               ii. Partially disclosed- existence known, but not id (both)
              iii. Undisclosed principal- neither existence or id (both)
  3. Contract (Principal/Agent; Authority; and Reliance)
        a. Principal Agent Relationship (RS 3d § 1.01)
                i. When the principal
               ii. Manifests assent to the agent
              iii. That the agent shall act on the principal’s behalf and subject to
              iv. Agent manifests assent or consents to act
        b. Authority and Reliance
                i. Actual (Express or Implied) (hinges on Agent’s POV)
                       1. Formed/Definition: (objective) (RS 3d § 2.01)
                               a. A manifestation by principal
                               b. Reasonable interpretation by agent
                               c. Leads agent to believe that is authorized
                       2. Created:         (RS 2d § 26)
                               a. Written or spoken words which lead to think
                                   authorized to act
                       3. Effect:
                               a. Has power to bind, although not necessarily the
                               b. Mill Street Church of Christ (implied authority to
                                   hire brother- based on past actions)
               ii. Apparent (hinges on third party’s POV)
                       1. Formed/Definition:
                               a. Power to effect relationship- arising from
                                   principal’s manifestations
                       2. Creation: (RS 2d § 27)
                               a. A manifestation attributable to principal
                               b. Reaches third party
                               c. Third party believes principal consents (reasonable)

                      3. Effect:
                               a. Power to bind, although not the right
                               b. Three-Seventy Leasing Corp. –actual employment-
                                  purchaser asked to deal with- reasonable belief
            iii. Inherent (solely from agency relation)
                      1. Formed/Definition (RS 2d § 8A)
                               a. Solely from the agency relationship- for the
                                  protection of those harmed in dealing with agent
                      2. Effect:
                               a. RS 2d § 195- Acts of Manager Appearing to be
                                  Owner (subject to liability- Watteu v. Fenwick)
                               b. RS 2d § 161- Unauthorized Acts of General Agent
                                  (principal liable if other party: 1) reasonable
                                  believes agent authorized; 2) no notice that not)
                                  (Kidd v. Thomas Edison)
                      3. Nogales Service Center (no holding out- confused
4. Tort (Master/Servant (control); During the Course and Scope of Employment)
      a. Definitions: (RS 2d § 2)
               i. Master: a principal who employs an agent to perform service in
                  his affairs and who controls physical conduct
              ii. Servant: agent employed by master to perform services and is
            iii. Independent Contractor: contracts with another to do something
                  but is not controlled
      b. Control: (whether servant or IC- RS 2d § 2):
               i. Extent?
              ii. Distinct Occupation?
            iii. Supervision?
             iv. Skill?
              v. Supplies?
             vi. Length?
            vii. Payment?
           viii. Regular employment?
             ix. Parties own beliefs?
      c. Scope: (RS 2d § 228)
               i. Of the kind employed to perform
              ii. Occurs substantially within the authorized time and space (frolic-
                  not liable v. minor detour- within)
            iii. Is actuated to serve master (if force- unexpected?)
             iv. If way outside- not liable
      d. Effect: (RS 2d § 219)- IC- not liable, servant- liable for tortious actions
5. Fiduciary Duties
      a. Duty of Loyalty (RS 2d § 387)
               i. Subject to a duty to act solely for the benefit of principal
      b. Duty of Care (RS 2d § 379)

                  i. Subject to a duty to act with standard care and with skill which is
                     standard in the locality

PARTNERSHIP (the default business structure- RUPA applied)
  1. Definition:
        a. § 201- entity separate from partners
        b. § 202- association of two ore more persons for profit- person receiving
             share is presumed partner, unless (debt, services, rent, annuity, interest)
        c. Test: (character of profit sharing)
                  i. Control (co-management)
                 ii. Agreements to share losses
                iii. Contributions of property
                iv. Extent to which only renumeration
                 v. Parties own characterizations (Smith v. Kelley-holding out to
                     public not enough where no share of management/profit)
                         1. Martin v. Peyton (veto and profit sharing- not enough)
  2. Flexibility (§ 103)
        a. Relations are governed by the partnership agreement
        b. Restrictions: (eliminate loyalty or good faith and fair dealing (can id
             types); unreasonably reduce the duty of care)
  3. Dividing Profits:
        a. § 401- share of profits, chargeable with loss (capital accounts)
        b. Contribution:
                  i. Richert v. Handley (labor- not compensated)
                 ii. Kovacik v. Reed (labor is); § 401(h)- goes with Richert
  4. Management
        a. § 401(f): equal rights in management (Nabisco)
        b. § 401(j): disputes resolved by majority vote (participation, not way)
  5. Authority (Key: common law v. statutory- Smith v. Dixon (manifestation))
        a. Common law: look for third party’s awareness
        b. § 301(a)- each partner an agent- can bind unless:
                  i. No authority; and third party had knowledge
        c. § 301(b)- if not in ordinary scope- not bound
                  i. Rouse v. Pollard (club): actual or apparent authority
                 ii. Roach v. Mead (professional): more expansive view
        d. Statement of Partnership Authority (§ 303- can limit)
  6. Fiduciary Duties (Common Law and § 404)
        a. Common Law: Cardozo in Meinhard “joint adventurers, like copartners,
             owe to one another, while the enterprise continues, the duty of finest
             loyalty. Many forms of conduct permissible in a workaday world for those
             acting at arm’s length are forbidden by those bound by fiduciary ties”
        b. § 404: only duties- loyalty and care (limiting Cardozo)
                  i. Loyalty: 1) account for profits (partnership opp.); 2) refrain from
                     adverse interest; and 3) refrain from competition
                 ii. Care: refrain from grossly negligent or reckless conduct, or
                     knowing violation of law

       c. Process v. Motive (Gibbs v. Bam – notifications/timing crucial)
       d. Contracting Around? (Singer (non-compete)—manifestly unreasonable
          under § 103?)
7. Partnership Property
       a. Status
               i. § 204- qualifies when: 1) acquired in name; 2) transferred to
              ii. § 501- not a co-owner of property, partnerships owns
       b. Creditor’s Interests
               i. § 502- can receive share of profits and losses and residual
              ii. § 503- no dissociation or dissolution, no right to participate
                  (receives distributions, and share on winding up)
             iii. § 504- can go to court and get a “charging order” (lien) on the
                  transferable interest
8. Dissociation/Dissolution (big change from UPA)
       a. Events Causing: (§ 601)
               i. Express Will; Event in Agreement; Expulsion (agreement);
                  Expulsion by Unanimous Vote (if illegal); Application by
                  Partnership if (wrongful conduct, material breach, not reasonably
                  practicable to continue)
       b. Power to Dissociate: (§ 602) (Power v. Right) (Collins- all funds necess.)
               i. Always have Power, but if wrongful can be subject to damages
              ii. Wrongful, when: 1) breach; 2) if a term, express will; expulsion,
                  debtor in bankruptcy
       c. Effect of Dissociation: (§ 603) (Switching Section)
               i. If dissolution- Article 8, if continues- Article 7
              ii. Effect: right to participate and fiduciary duties cease
       d. Dissociation- Article 7 (shall purchase partner’s interest) (Cauble)
               i. Calculated: (greater of:)
                      1. Liquidation Value (fire-sale on assets)
                      2. FMV (some multiple of earnings)
              ii. Payment: (calculated from date of dissolution)
                      1. If wrongful (§ 701(h)), no right until end of term unless can
                          show that no undue hardship would result (interest)
                      2. If proper (§ 701(c)), need agreement within 120 days (and
                          if no agreement shall pay within this time period- what
                          considers proper amount, this can then be challenged)
             iii. Alteration by Agreement: Adams v. Jarvis (ok- but fiduciary owed)
       e. Dissolution- Article 8 (can contractually alter)
               i. § 801 (must be wound up, if:)
                      1. At will
                      2. Term
                              a. Express will of half
                              b. Manifested within 90 days after another partner’s
                                  dissociation by death or otherwise
                      3. Event agreed upon to trigger dissolution
                      4. Unlawful to continue;

                          5. Application for Judicial determination; (economic purpose
                              frustrated; actions make unreasonable to continue; not
                              otherwise practicable)
                          6. On application that equitable to wind up
                  ii. § 802: if all (including properly dissociated) waive right to
                      dissolution, will continue (un-do) (o/w just for purpose of winding
                 iii. § 803- can participate in winding up, if not wrongfully dissociated
                 iv. § 807- settlement of partnership accounts (jointly and severally
   9. Liability
          a. During (§ 306- joint and several liability)
          b. Departing: (8182 Maryland Associates, LP v. Sheehan)
                   i. § 703(b) liable for obligations incurred within two years of
                      leaving; if: 1) reasonably believed a partner; 2) no notice or
                      knowledge of dissolution
                  ii. Only liable for while a partner (not before joined firm)
          c. Other Issues:
                   i. Jewell v. Boxer (have to split fees as did pre-fissure)
                  ii. Bohatch, Butler & Binion (majority- need trust- can expel for
                      whistleblowing, concurrence- only if wrong)
   10. Limited Liability Partnerships (LLPs) (would be malpractice not to form)
          a. § 306- alters traditional J/S liability (obligation of the partnership)
          b. § 1001: Statement of Qualification (approved by vote or organized as
              such; pay fee and file this with SOS, including: name, street address of
              office, or if not in state- agent for service, and statement that wants LLP
          c. § 1002- LLP in name; § 1003- annual report requirement

  1. Definition:
        a. § 101(7): partnership formed by two or more persons and having one or
             more general and one or more limited partners
        b. Formed: Certificate of LP: (filed and executed with SOS)
                  i. Name of LP, Address of office or agent, name and business
                     address for each GP, and whether LLLP
  2. Flexibility (§ 105)
        a. Relations are governed by the partnership agreement
        b. Restrictions: (eliminate loyalty or good faith and fair dealing (can id
             types, if not manifestly unreasonable or pick % to ratify acts);
             unreasonably reduce the duty of care)
  3. Dividing Profits
        a. Contributions- any tangible or intangible (§ 501- broader than RUPA)
        b. Distributions- shared on basis of value received (§ 503- not per capita)
  4. Management/Authority/Liability
        a. Article 3: Limited Partner
                  i. No right or power to bind (§ 302)

              ii. No liability as a limited partner (§ 303- alters control rule or inter-
                  reliance provision of past acts, could still be liable in some cases)
      b. Article 4: General Partner
               i. GP agent of partnership with power to bind if in ordinary course of
                  business, unless not authorized and third party aware (§ 402)
              ii. LPship- liable for loss or injury caused by GP w/in scope (§ 403)
             iii. GPs are jointly and severally liable for all obligations of
                  partnership (unless incurred before joined)) (§ 404)
             iv. GPs have equal rights in management. Disputes decided by
                  majority vote of GPs (§ 406)
5. Fiduciary Duties
      a. LPs (very limited- § 305)
               i. No duty owed LPship; shall if working with/for (good faith, fair
                  dealing, and loyalty)
      b. GPs (§ 408)
               i. Only duties: loyalty and care
              ii. Loyalty: 1) account for profits (including partnership opp.); 2) not
                  adverse or on behalf of; 3) refrain from competition
                      1. In re USACafes (duty of loyalty- should have disclosed
                          payments to- BPractice- independent negotiating comm.)
             iii. Care: refraining from engaging in grossly negligent or reckless
                  conduct, intentional misconduct, or knowing violation of law
6. Dissociation
      a. Dissociation as LP (§ 601- locked in)
               i. Does not have the right to dissociate before termination
              ii. Caused by: will; event causing; expulsion by PA, expulsion
                  (unanimous vote if illegal); Judicial order; death
      b. Effect of (§ 602)
               i. Upon: no more rights, good faith continues (to prior deals); and
                  own a transferable interest (cannot get out)
              ii. Does not discharge from LP obligations
      c. Dissociation of GP (§ 603)
               i. Caused by: will; event causing; expulsion by PA, expulsion by
                  unanimous vote (if illegal), Judicial order, death
      d. Power to Dissociate as GP ( § 604)
               i. Power at any time to dissociate
              ii. Is wrongful if: breach of PA; before termination and by will,
                  judicial order, bankruptcy (may owe damages)
      e. Effect of Dissociation ( § 605)
               i. Right to participate, fid. duties end (for old transactions); may file
                  statement with SOS, and interest is only as transferee
      f. Power to Bind After Dissociation (§ 606)
               i. After GP dissociation, LPship is only bound if: would have bound
                  under § 402, and it is less than two years after dissociation and
                  other party has no notice and reasonably believes that is a GP
              ii. If bound- liable for damages

         g. Liability of Departing GP ( § 607)
                  i. Dissociation does not stop, may not be bound unless after
                     termination and: is liable to same extent, relies on that party as a
         h. Article 7: Transferable Rights and Rights of Creditors
                  i. Only thing transferable- personal property (not much value- § 701)
                 ii. No rights except to receive distributions as authorized
                iii. Should probably provide for a buy/sell (as no right to unwind the
                     deal); could sell- value??
         i. Article 8: Dissolution
                  i. Non-Judicial (§ 801)
                         1. PA or consent of all GPs and of LPs owning majority of
                             rights to distributions
                         2. After GP dissociates:
                                 a. If one + GP- consent to dissolve is given within 90
                                     days by partners owning majority of distributions
                                 b. If no GPs, passage of 90 days (unless new GP
                 ii. Judicial (§ 802)
                         1. On application by partner, court may order- if not
                             reasonably practicable to continue on
                iii. Administratively- SOS has authority
   7. Check the Box (Kitner Regulations)
         a. Old: IRS reaction to LPs with corporate GPs- based on corporate
             characteristics- “perpetual life, transferable interests, and LL”
         b. New: no longer focused on details of corporate structure- effect: if
             publicly held have to be corporation- if not – can chose how to be taxed
         c. LLLPs- LP with LLP as general partner

  1. Definitions
        a. Entity separate from owners (§ 201)
        b. Organization—one or more persons may organize a LLC, consisting of
             one or more members, by delivering the articles (§ 202) (existence begins
             upon filing)
        c. Articles (§ 203) must set forth: name, address of office, agent for service,
             whether term company (and term); member or manager managed; and
             whether one or more members is to be responsible for the debts
  2. Flexibility (§ 103)
        a. May enter into an operating agreement (need not be in writing) to regulate
             the affairs of the company and conduct between members
        b. Restrictions: (eliminate loyalty or good faith and fair dealing (can id
             types, if not manifestly unreasonable or pick % to ratify acts); also cannot
             unreasonably reduce the duty of care)
        c. Amending the OA requires consent of all members (§ 404(c)(1))
        d. Could provide for a BOD, etc…

3. Contributions/Dividing Profits
      a. Any form- tangible or intangible (§ 401)
      b. Sharing of and Rights to Distributions: (§ 405)
               i. Any distributions before winding up- equal shares
              ii. No right to receive or be required to take in kind
             iii. If entitled to distribution- creditor status
      c. Limited if: 1) would not be able to pay all debts, or assets would be less
          than sum of liabilities and preferential rights (§ 406)
4. Management (2 choices: 1) Member Managed and 2) Manager Managed) (§ 404)
      a. Member (like partnership)- everyone has equal say in management and
          decide disputes by majority vote (before ULPA allowed for LLP big)
      b. Manager (like limited partnership)-managers manage/members- few
          rights- each manager has equal rights- disputes- majority vote of managers
      c. Where designated: (§ 203)- filed with state in which going to operate (if
          manager managed- provide address of one initial manager)
               i. Proposed revision- RULLCA- no longer require making the
                   decision between member or manager managed (get around
                   301(a)- statutory apparent authority- below)
5. Authority : (§ 301)
      a. Member Managed (can informally allocate authority throughout)
               i. Each member is an agent if in ordinary scope, unless had no
                   authority and the party dealing with was aware (this is statutory
                   apparent authority- no requirement of manifestation)
              ii. If not in ordinary course- only if authorized
      b. Manager Managed
               i. Member is not agent solely by being member in this format
              ii. Members can still have apparent authority- but need the
                   manifestation (and the party must have reasonable belief)
      c. Making the Decision
               i. A lot of LLCs elect to be manager managed and eliminate statutory
                   apparent authority
6. Fiduciary Duties (§ 409)
      a. Member Managed
               i. Only duties member owes- duty of loyalty and care
              ii. Loyalty: 1) account for profits (including corp. op.); 2) refrain
                   from adverse party or on behalf; and 3) compete
             iii. Care: grossly negligent, reckless conduct, or knowing violation of
             iv. Good Faith and Fair Dealing: shall comport with
                       1. Castiel- ganged up on to take over- although not explicitly
                           prohibited- breached fiduciary duty)
      b. Manager Managed
               i. Member (if not manager)- no duty as member
              ii. Manager- same as a member under member-managed
             iii. Member if manager- same as manager
             iv. Relieved of liability by law for violations- if in OA

7. Dissociation and Dissolution
      a. Events Causing: (§ 601)
               i. Express will; Agreed upon event; transfer of interest; expulsion per
                  OA; expulsion by vote (if illegal); on application, if judicially
                  expelled, debtor status, etc..
      b. Power to Dissociate: (§ 602) (has power, not right- may owe damages)
               i. Wrongful if: breach of OA; before term is over: express will,
                  judicial determination, or debtor status
      c. Effect of: (§ 603)
               i. Interest (must cause to be purchased)
                      1. At-will- must cause to be
                      2. Term- if dissolves before, Art. 8 applies, if does not Art. 7
                           applies- must cause to be purchased at end of term
              ii. Obligations
                      1. Right to participate and fiduciary duties cease
      d. Purchase of Member’s Distributional Interest (Art. 7)
               i. Shall purchase if:
                      1. Member-at-will- FMV at date of dissociation
                      2. Term-FMV determined at expiration of term (still at risk)-
                           RULLPA has proposed altering this
              ii. Must deliver offer within 30 days w/ Statement of A+L, latest
                  balance sheet, and explanation of offered price
             iii. If set by OA- over, if not paid within 120 days can bring action
      e. Winding Up (Art. 8)
               i. Must be wound up if: OA, Consent of number in OA, event that
                  makes illegal to continue, application by a member upon entry of
                  judicial decree, application after judicial decree that equitable to
                  wind up (§ 801)
              ii. Can continue if all waive right (§ 802) o/w continues for wind up
             iii. If not wrongfully dissociated- right to participate (§ 803)
             iv. Distribution of assets (§ 806)- pay creditors, then members (return
                  capital, then excess profits in equal shares)
8. Liability
      a. A member or manager is not personally liable for the LLC debts (§ 303)
      b. If member or manager subjects LLC to liability by act not appropriate to
           winding up- liable to LLC (§ 804)
      c. Known Claims Against LLC (§ 807)- may dispose of if:
               i. Notify claimants in writing (information required, mailing address
                  to respond to, deadline for claim, statement that will be barred if
                  not received by x date)
      d. Other Claims (§ 808)- may publish notice and request bring claims
               i. Must: be published once in newspaper of general jurisdiction in
                  county located, information about claims, and will be barred if not
                  by x, if not within five barred)

           e. Countryman v. Farmers Cooperative (explosion kills worker- Countryman
              liable because is the manager of the cooperative and one of agents
                   i. Entity is respected but if personally participate in tort- will be
                      liable (vicarious)
                  ii. Ex. taxi cab owner- incorporate- still liable for own tort

  1. Historical Perspective
        a. “Ownership has been separated from control; and this separation has
             removed many of the checks which formerly operated to curb the misuse
             of wealth and power” – Brandeis in Liggett (explaining historic fear)
        b. Limited in the amount of authorized capital, scope of business and
             duration (major purpose- limited liability
  2. Process of Incorporation
        a. Process/Organization
                   i. Location (either in DE or home state- race to the bottom?- internal
                      affairs rule- function of state law (CA objects))
                  ii. Process (3 steps)
                          1. Prepare articles (§ 2.02)
                          2. One incorporator signs (§ 1.20(f))
                          3. Submit for filing (§ 2.01)
                iii. Incorporators (§ 2.01)- one or more persons may act as by
                      delivering to SOS for filing
                 iv. Articles (§ 2.02) include: name (deceptively similar- on the
                      record), state number of shares and classes, agent for process or
                      home office, and address and name of incorporators
                  v. Filing Duty of SOS (§ 1.25)- made clear only ministerial role
                 vi. Powers and Purposes
                          1. General Purposes (§ 3.01)
                                   a. Purpose of engaging in any lawful business (unless
                                       more restricted by agreement)
                          2. General Powers (§ 3.02)
                                   a. Same powers as individual (lays out list)
                vii. Organizational Meeting- lawyers script, vote on initial matters and
                      form structure (first step after filing)
               viii. Organization of Corporation (§ 2.05) (§ 7.32 could reduce rigidity)
                          1. Directors Named: directors shall hold at call of majority of
                               directors, shall hold organizational meeting (appoint
                               officers, etc…)
                          2. If Not Named: incorporators shall hold at call of majority
                               of incorporators:
                                   a. To elect directors and complete organization
                                   b. To elect board who shall complete organization
                 ix. Bylaws (§ 2.06)- shall adopt, may contain any provision not
                      inconsistent with AOI or law

b. Ultra Vires Doctrine
        i. Common Law: Ashbury Ry. Carriage & Iron Co. v. Richie (sell
           supplies- ran train- court held not authorized- and let out)
       ii. § 3.04: Ultra Vires Doctrine (case: 711 Kings Highway-marina)
               1. Validity of corporate action may not be challenged on the
                   ground that lacked power to act, except:
                       a. Holder trying to enjoin corp., corporation against
                           agent, AG against corporation (§ 14.30)
      iii. Purpose of Business
               1. Sullivan v. Hammer (10 MM to Art) within authority- (BJR
                   applied- no self interest, no domination, etc…)
               2. ALI § 2.01- should have purpose of holder gain
                       a. May devote a reasonable amount of resources to
                           public welfare, humanitarian, educational, etc…
               3. MBCA § 3.02(13)- specifically authorizes
c. Promoter Liability
        i. Definition: “who, in conjunction with the founding and organizing
           of the business of an issuer, directly or indirectly receives in
           consideration of services or property, ten percent or more of any
           class of security” SEC Rule 405
       ii. Effect: Stanley v. How (§ 326 of RS 2d- corporate analogue)
               1. Edwin Boss for MN corporation to be formed (purported
                   agent for a non-existent principle becomes a party)
               2. Antebellum, Inc. by Edwin Boss, President
      iii. Best Practice: form corporation before move, or put in language to
           ensure not personally liable (or get a novation- if catch)
d. Defective Incorporation
        i. Common Law: (Stokes)
               1. Valid Law
               2. Attempt to Organize
               3. Actual User of Franchise
               4. Good Faith Attempt to Incorporate and Conducting
                   Business on the Basis of the Belief
       ii. § 2.04: Liability
               1. All persons purporting to act, knowing there was no
                   incorporation, are J/S liable
                       a. Robinson v. Levy (knew dealing with corporation,
                           but still able to recover against individual because
                           not filed)
                       b. Frontier Refining v. Kunkels (what happens if
                           corporation not formed- partnership????)
               2. Three situations common:
                       a. Enters in with reasonable belief filed
                       b. Mailed but not filed (Cantor)
                       c. Person dealing with knows not filed but insists on
      iii. Estoppel (equitable concept)

                      1. Robertson- would be estopped from claiming no
                          corporation, but still not protected
                      2. Cranson- attorney forgot to file- both sides thought so- ok
3. Disregard of the Corporate Entity
      a. Piercing the Corporate Veil- in what circumstances will the court ignore
          the entity and hold the shareholders liable (almost always- closed corps-
          UFTA might apply, if personally guaranteed- ok, tort v. contract)
               i. State Variation:
                      1. DE- very tough to disregard
                      2. TX- Canterbury- can be pierced for constructive fraud- (a
                          jury question- breach of legal or ethical duty)- TX codified
                          to avoid adverse effects on TX corporations
              ii. Traditional Test: (Baatz- ‘will disregard when continued
                  recognition would “produce injustices and inequitable
                      1. Fraudulent representation by corporate directors
                      2. Undercapitalization
                              a. To meet expected business obligations (Baatz)
                              b. If purpose is to run insolvent- will be (DeWitt)
                              c. What counts? (Radazeski- invalid insurance)
                      3. Failure to follow formalities
                              a. Alter ego or instrumentality (indirect evidence of
                                 invalid purpose?)
                      4. Absence of records
                      5. Commingling of business and personal assets
                              a. Corporate creditors have a valid expectation that
                                 will have assets to pay- if you pay personal
                                 obligations with- strong interference
                      6. Used to promote fraud, injustice or illegality
                      7. Domination (Fletcher v. Ajax)
                              a. Simply isolating business assets not enough- need
                                 to show acted as single business entity (same cash
                                 management, control, dominant presence, and
                                 promotion)- still did not pierce
                              b. 2d Cir- more aggressive approach- domination
                                 alone may pierce
      b. Reverse Piercing – want to use corporate assets to repay individual debts
               i. Sweeney v. Kane- house incorporated- could pierce
      c. The Deep Rock Doctrine- does not pierce- uses equity powers in
          bankruptcy to subordinate inside creditor to outside (Pepper v. Litton)
4. Successor Liability- want to avoid assuming the other corporation’s liabilities
      a. Nissen Corp v. Miller- corporate that acquires all or part of the assets of
          corporation does not acquire unless:
               i. Expressly assumes, consolidation or merger (de facto merger?),
                  successor in mere continuation, or fraud
      b. Recent Amendments:

               i. § 14.07: Other Claims Against Dissolved Companies
                      1. Dissolved corporation may publish notice of dissolution
                          and request people bring claims (will cut off after 3 years)
              ii. § 14.08: Court Proceedings
                      1. Allows corporation to go to court and have a guardian ad
                          litem appointed to determine the value of future claims
                          (discounted present value- insurance/assets to cover)
             iii. § 14.09: Directors Duties
                      1. Shall cause the corporation to make reasonable provision
                          for the payment of these claims
5. Corporate Finance
      a. Types of Capital:
               i. Debt: borrowing (repayment with interest)
                      1. Insiders- planning device- can take out earnings in the form
                          of interest rather than dividends (corporate veil/deep rock?)
                      2. Outsiders- leverage (if it works- power of other $)
              ii. Equity- ownership (entitled to share of earnings and residual)
                      1. Initial contributions, new investors, retained earnings
      b. Shares
               i. Definition: “units into which the proprietary interests in a
                  corporate are divided” (investment banks help shape) (§ 1.40)
              ii. A corporation may create an issue with different classes of stock
                  with different preferences, limitations and rights (AOI must lay
                  out- classes, number of auth. shares, and limitations) (§ 6.01(a))
             iii. One class must have: 1) unlimited voting; 2) residual (§ 6.01(b))
             iv. At least one share in each class must be outstanding (§ 6.01(c))
      c. Rights of Shares
               i. Common v. Preferred
                      1. Common- voting and right to residual
                      2. Preferred- high dividend, no voting, or claim on residual
                      3. Comments to § 6.01- “as the distinction between common
                          and preferred stocks is shadowy, avoided using these terms,
                          and instead established scheme of generality”
              ii. Special Rights
                      1. Dividend Rights
                              a. Cumulative- if not paid, carries over
                              b. Non-Cumulative- if not earned, not carried over
                              c. Partially Cumulative- cumulative to the extent they
                                  are earnings in a year, and non-cumulative to excess
                                  dividend preference
                      2. Voting- if payment missed, gain voting rights
                      3. Liquidation Preference- a specified price per share- payable
                          at dissolution before anything is paid to the common
                      4. Redemption Rights- redeemable at the option of the
                          corporation at price established in AOI (may use to regain

                      5. Conversion Rights- convertible at the option of the holder
                          into common shares- at a fixed ratio in AOI (can gain from
                          long term appreciation)
                      6. Participating Preferred – entitled to specific dividend, but
                          allows shares in profits
                      7. Protective Provisions
                              a. Sinking Fund- requires corporation to set aside a
                                  certain amount each year to redeem preferred stock
             iii. Classes- may issue different classes (with different characteristics
                  and levels of priority- § 6.02)
             iv. Series- “one or more series within a class”- it is expensive to
                  amend articles- so allow creation of a class of preferred shares that
                  contain no financial terms- the carving out of a series from a class
                  of “blank shares”
6. Issuing Shares
       a. Par Value
               i. Definition: the arbitrary dollar amount assigned to shares of stock,
                  which after being assigned, represents the minimum amount for
                  which each stock can be sold (originally to prevent fraud)
                      1. Hanewald- par 100, paid 0- even though have LL- will
                          have to make up this gap
              ii. Problems:
                      1. Watered stock- (issued for property less than par)
                      2. Bonus stock- free (Hospes)
                      3. Discount stock- (sold less than par)
       b. Issuance
               i. § 6.21: Issuance of Shares
                      1. Power to issue granted to BOD
                      2. May issue for any tangible or intangible benefit, including
                          cash, promissory notes, services performed (very broad-
                          compared with MBCA (1969)- and shareholders could
                          attack evaluations- not anymore; DE still bars promissory)
                      3. BOD has a responsibility to determine the adequacy of
              ii. § 6.22: Liability of Shareholders- non recourse (unless under par)
       c. Preemptive Rights
               i. Common Law: (Stokes)- preemptive right to maintain proportional
              ii. § 6.30- “opt-in”- default is that not provided (may provide in AOI
                  that have)
             iii. If provided: uniform terms and conditions to give each holder fair
                  and reasonable opportunity (Katzowtiz). However, no preemptive
                  right with: 1) compensation to officers; 2) conversion of option
                  rights; and 3) shares authorized within six months of incorporation
             iv. Recapitalization: (Lacos Land Co.)- restructuring in this instance-
                  not in best interests of the corporation (personal reasons)

7. Closely Held Corporations
      a. Characteristics:
               i. Small tightly knit group of participants (30-50 tops)
              ii. Active, often informal participation by non-specialized investors
            iii. Undiversified participants who often use for livelihood
             iv. No ready market to dispose of shares (also cannot rely on the vote
                  for protection—too few)
      b. Protection of Minority Rights
               i. Supermajority requirements- majority (default) but can alter
              ii. Classified Boards (§ 8.06)- staggered elections (staggered three
                  year terms- elect three a year)
            iii. Multiple Class of Shares- different classes- each elect one director
             iv. Voting Agreements (§ 7.31)
                      1. Two or more holder may provide for the manner in which
                          they will vote their shares by signing an agreement (not-
                          self enforcing- also, if pertains to non-shareholder matter
                          (i.e. election of officers- may be invalid- McQuade)
              v. Voting Trusts (§ 7.30)
                      1. Shareholders enter into a written agreement setting out
                          trustee’s obligations, and then holder will transfer shares
                          over to be voted in accordance (agreement will list all
                          shares covered- self-enforcing)- cannot exceed ten years
                      2. Brown v. McLanahan- trustee owes fiduciary duties
                      3. Lehrman v. Cohen- (de facto voting trust?- no-
                          considerable flexibility in shaping structure)
             vi. Irrevocable Proxy
                      1. Common Law- power coupled with an interest (Hunt 23)
                      2. Haft- I could be fired- give me proxies to keep job
                      3. § 7.22(d): Proxy is revocable unless conspicuously states is
                          irrevocable and is coupled with:
                               a. A pledge (lender); a purchaser of credits, a creditor,
                                   an employee, or a party to a voting agreement
            vii. Transfer Limits and Buy/Sell Agreements
                      1. § 6.27 Share Transfer Restrictions
                               a. In unincorporated forms could chose members- now
                                   can here too (impose in the AOI, bylaws, or SA-
                                   does not effect shares issued prior to adoption)
                               b. Valid if authorized and is noted on front or back of
                                   certificate-(Ling—conspicuous (gives notice) and
                                   reasonable (not an undue restraint)
                               c. Valid to: 1) maintain status (S-corp #’s, preserve
                                   exemptions under the law, any other reasonable
                               d. Effect:
                                        i. Obligate offering back to corporation
                                       ii. Obligate someone to buy back the shares

                                      1. Corporation- stock redemption
                                      2. Holders- cross purchase agreement-
                                          buy proportionate amount
                             iii. Require an entity (NYSE?) to approve
              2. Drafting Concerns
                      a. Valuation Experts
                               i. Internal inconsistency- (favor client)
                              ii. Intellectual dishonesty (one side)
                      b. Possible Triggers (death, divorce, bankrupt, fired)
                      c. Valuation Options
                               i. Objective formula (tied to something?)
                              ii. Independent Appraisal (how many?)
                             iii. Agreement by Parties (ehhhh)
c. Closed Corporation Statutes
       i. Special needs of the closed corporations- special sections created
      ii. 17 states adopted- call for special legislative treatment (Donahue)
d. Dispute Resolution in Closed Corporations
       i. Distribution: “means a ready or direct transfer to or for the benefit
          of the shareholders” (§ 1.40)
      ii. Fiduciary Protection (Business Purpose for Retained Dividends)
              1. If majority can point to a business justification- o.k.
              2. Gottfried (if retained in bad faith and there is adequate
                  surplus). Earmarks:
                      a. Intense hostility, exclusion of minority from
                         employment, high salaries to majority, desire to
                         avoid taxes, desire to acquire minority
              3. Dodge v. Ford Motor Company (business justification?)
                      a. Looks to be out of personal motivations
              4. Principles of Corporate Governance (§ 2.01)
                      a. Goal- shareholder gain- but can devote reasonable
                         sums to other goals
     iii. Equal Opportunity
              1. Implied duty (like partnership) for minority holders in
              2. Wilderman (excessive compensation)
                      a. Evidence of what similar make
                      b. IRS determination of reasonableness
                      c. Related to success? Is the increase?
                      d. Salary of other employees
              3. Donahue v. Rodd (unfair redemption)
                      a. In CC- owe the minority “duties of the utmost good
                         faith and loyalty” (breached but not offering same)
              4. Commoli (extends Donahue- duty owed by majority- now
                  by minority)- if buying minority should offer majority same
              5. Wilkes v. Springside Nursing Homes (backed off Donahue)

                             a. Employment- need discretion to manage this area-
                                same duty not owed
      e. Deadlock
              i. Symptom of fundamental disagreement among parties that
                 paralyses the corporation’s business (Gearing—4 person board, 2,
                 1, and 1- allows election to continue without quorum)
             ii. Judicial Solutions: (In re Radom-applies for dissolution) (§ 14.30)
                     1. Will not do this- (if doing well- health of business)
                     2. Reluctant to use power unless “irreparable harm is
                         threatened, fraud, cannot elect a board, waste” (Comment
                         to 14.30- urges caution in using)
            iii. Planning For:
                     1. Mediation- neutral party to work it out
                     2. Arbitration- agree to have a binding decision
                     3. Deadlock-breaker as a director- (Lehrman)
                     4. Voluntary Dissolution (§ 14.01)
                     5. Statutory Buyout (§ 14.34)
      f. Oppression
              i. Dissolving the Corporation (remedy for deadlock and oppression)
                     1. § 14.01- by incorporators
                     2. § 14.02- by directors/holders (voluntary)- recommend to
                         the holders- approval of a majority of holders at which a
                         quorum is present
                     3. § 14.20- Administratively
                     4. § 14.30- Judicially (above- the last resort)
             ii. Oppression Standard: (moving target)
                     1. First ABA guidebook- duty of fair dealing (vague)
                     2. “Burdensome, harsh, wrongful conduct, a lack of probity,
                         and of fair dealing (a visible departure)
            iii. Relief:
                     1. Dissolution- last option
                     2. New option- § 14.34- statutory buyout- corporation may
                         elect or holder may elect to buy at FMV (file with court-
                         then parties reach an agreement- or let court determine)
                     3. Abreu- (appointment of a provisional director)- only
                         function- break ties (Illinois provision)
8. Shareholder Voting (proxy voting- covered below)
      a. Closed Corporation- voting not adequate protection
      b. Voting Types
              i. Straight- one share, one vote
             ii. Non-Voting Share- no voting rights
            iii. Contingent Voting- usually non-voting, but if not paid- voting
            iv. Weighted Voting- (§ 6.01)- able to say this share has 10 votes
             v. Cumulative Voting (§ 7.28- “opt in”- needs to be in AOI and have
                 to give notice that going to use)

                       1. Designed to give minority protection- 3 directors- 100
                           shares= 300 votes
                       2. Strategy: Number of Shares Needed= [S/(1 +D)] +1 where
                           S= total number of voting shares and D= number of
                           directors to be elected (can lead to mischief- Stancil)
      c. Vote Buying
                i. NY- voting agreement supported by consideration- not per se
                   invalid- but if object is fraud- (then illegal)
               ii. DE- Hewlett v. HP (management cannot buy or sell, holders can)
9. Distributions (§ 6.40)
      a. A BOD may authorize, unless:
                i. Corporation would not be able to pay off its debts in the normal
                   course of business (“Equity Insolvency”)
               ii. Corporations total assets would be less than sum of liabilities and
                   preferential rights owed on dissolution (“Bankruptcy Insolvency”)
      b. May base on: accounting principles that are reasonable under
          circumstances (GAAP not required, can revalue assets)
10. Management and Control
      a. Requirements for a BOD (§ 8.01)
                i. Unless provided in § 7.32- must have a BOD
               ii. All corporate powers are exercised through, or through committees
                   (subject to § 7.32) (Committees- § 8.25)
      b. Meeting Requirements
                i. Shall hold annual meeting (§ 7.01)
               ii. Shall hold special meeting; if: at the call of BOD, or holders over
                   10% (articles can raise to 25%) (§ 7.02)
              iii. Action without meeting: (§ 7.04)
                       1. MBCA- all holders
                       2. Iowa- 90%
                       3. DE- majority
      c. Relationship between BOD and Holders (McQuade v. Stoneham)
                i. SAgreement provided right to be producer invalid- holders
                   exercise power through board- board picks officers- infringement)
               ii. Matter of Auer v. Dressel—shareholders have right to put BOD on
                   notice (but do not get to choose officers)
      d. Directors:
                i. Vote per capita
               ii. Agency theory (all power to holders- who select agents)
              iii. Concession theory (power derived from the state- trustee)
              iv. Platonic Guardian (aristocracy created by statute)
               v. Sui Generis (fiduciary- unique- not trustee)
      e. Cases: (common law before § 7.32 (below))
                i. Clark v. Dodge- (SA stay on board- if give idea and I will vote to
                   ensure), this is ok- no outside harm
               ii. Long Park (all power to one holder- court cannot allow an entire

              iii. Galler (protection for family after death)- a further recognition of
                   the special status of closed corporations- not outside harm- so a
                   protective clause is acceptable
       f. Shareholder Agreements: (§ 7.32):
                i. Agreement is effective even if inconsistent with MBCA:
                       1. Eliminates the BOD;
                       2. Governs the authorization or making of distributions;
                       3. Establishes directors;
                       4. Governs the exercise of voting powers;
                       5. Established the terms for transfer of property or for
                       6. Transfers to one person all or part of BOD authority;
                       7. Requires dissolution at request of x holders
                       8. Catchall (allow if not contrary to public purpose)
               ii. Authorization:
                       1. Set forth in AOI or bylaws and approved by all holders
                       2. Written agreement signed by all
                       3. Amendment- all holders
              iii. Procedures:
                       1. Noted conspicuously on front or back
                       2. Failure does not effect validity (but purchaser can rescind-
                           90 days of discovery, two years from issue)
                       3. If publicly listed- no longer applies
11. Controlling Share Transactions
       a. Control Premium: the additional value, above the financial value of a
           passive corporate investment, that comes with control
       b. No-Sharing Rule:
                i. General Rule: can sell at whatever price they want (in publicly
                   held, a tender offer may be open to all holders)
               ii. ALI § 5.16: Sale of Controlling Interests
                       1. A controlling holder has the same right, including the right
                           to sell at a price that is not proportionately available to
                           other holders, unless:
                               a. Does not disclose
                               b. Apparent from circumstances that purchaser is
                                    likely to violate duty of fair dealing (does not
                                    impose a duty of investigation- but should)
       c. Exceptions:
                i. Sale of Office
                       1. Directors and officers are strictly forbidden from selling
                           offices for personal gain. Offices are not a possession but
                           are held in a fiduciary sense
                       2. In seriatim resignations- are prohibited if:
                               a. Did not acquire “working control” and could not
                                    elect own slate; or

                                b. Sales price exceeds the premium the block alone is
                                    worth, suggesting sale of office
               ii. Usurpation of Corporate Activities (cannot convert an offer to the
                   corporation into one for the holder alone (if want to merge- cannot
                   suggest an alternative route)
              iii. Sale to Looters
                       1. DeBaun v. First Western- cannot sell if suspicion of looting
                       2. Key: when circumstances are suspicious and the seller fails
                            to investigate, can become liable for the losses
                       3. Danger signals: Price is too high; Buyer cannot afford;
                            Buyer dishonest or hurried; and overall reputation
       d. Perlman v. Feldman
                i. Sale of office (bad), sale to looter (trying to capitalize on low
                   steel), took corporate opportunity (wanted to merge- but did this)
               ii. Court- support for broad equal opportunity doctrine- later rejected
12. Public Corporations
       a. Structure and Theoretical Model
                i. Holders (electorate- vote, little power), BOD (legislative branch-
                   supervise- all decisions flow), Officers (bureaucracy- day to day)
               ii. Model—holders elect managers and as becomes larger- manage
                   through the board (have authority under § 8.01)
       b. Governing Law
                i. State Law (MBCA or equivalent)
               ii. Federal (2 Major Statutes)
                       1. Securities Act of 1933
                                a. If issues a single security- has to comply with these
                                b. Deals with registration act (governs public issuance)
                                c. Multitude of Exceptions
                       2. Securities Exchange Act of 1934
                                a. Regulates the secondary markets
                                b. Jurisdictional reach—interstate commerce
13. Public Regulation and Disclosure
       a. Process:
                i. Officers control the proxy machinery—shareholders are farflung—
                   board members end up controlling the corporation
               ii. Can use corporate assets (in reasonable amounts and for reasonable
                   purposes) to solicit proxies
              iii. Last Century- problems with board independence (moving toward
                   independent boards)
       b. Proxies: § 7.22 (evidence of authority and the authority)
                i. May vote in person or by proxy
               ii. May appoint someone to vote
              iii. Effective when signed and revocable
       c. Reporting Requirements (§ 12 of the Exchange Act (34))
                i. A class of over 500 holders and 10 million in assets

              ii. If so have to provide information on a quarterly and annual basis
             iii. Can terminate if under 300 holders, or less than 500 and 10 million
                  for last three fiscal years (12(g))
             iv. Regulation SK merges requirements of 33 and 34 Acts
              v. Sarbanes Oxley- raises this cost
       d. Required Proxy Information
               i. 1934 Statute- 14(a)
                      1. “No solicitation can be made. . . with a statement at which
                           the time it was made is false or misleading to any material
              ii. Formal Requirements: (SEC regulations)
                      1. Specify the disclosure that must accompany (or precede)
                           every proxy solicitation
                               a. Must accompany or precede with proxy statement
                                   with information (14a-3)
                      2. Specify the form of the proxy card (14a-4)
                      3. Require the preliminary filing of the proxy statement with
                           SEC staff
                               a. Before sending out proxy statement (above), must
                                   give SEC preliminary copies (14a-6)
                      4. Prohibit false or misleading proxy statements 14a-9
       e. Cases: (actions under 14a-9)
               i. J.J. Case v. Borak (can a holder bring suit for not including
                  information?) Court allows a private right of action: Elements:
                      1. Company subject to reporting (500 and 10)
                      2. Misrepresentation or omission;
                      3. Has to be material (Mills and Northway)
                      4. Have to have a causal link (can bring direct or der)
              ii. Miller v. Electro-Auto-Lite (omission of material information)
                      1. Material: embodies the determination that the defect was
                           of such a character that it might have been considered
                      2. Northway- adds- that it must have actually been considered
                           important enough that could effect vote (have enough clout
                           to step up and effect action)
             iii. VA Bankshares (owned 85% and misled- ok- foregone conclusion)
14. Shareholder Proposals (14a-8)
       a. Policy: proxy machinery favors management- SEC rules look to promote
          holder involvement (field day for crackpots?)
       b. Procedures:
               i. 1 percent or 2000 worth of stock for a year
              ii. In form of resolution, timely (generally- 120 days before meeting)
                  (less than 500 words)
             iii. If proper, must be included to holders
             iv. If exclude, must file reasons with SEC (they will decide whether to
                  issue a no-action letter)

          c. Proper Proposals: (3 large groups)
                  i. Proposals Inconsistent with Centralized Management
                         1. Not a proper subject (recommendations- if thus phrased
                             will be ok- Auer)
                         2. Not significantly related to operations (more than 5%)
                         3. Ordinary business operations (Cracker Barrel- allowed
                             proposals concerning employment)
                         4. Relates to dividend amount (not specific amount)
                 ii. Proposals that Interfere with Proxy Solicitation
                         1. Relates to election to office
                         2. Conflicts with management proposal (if allow this- holders
                             could vote on every management action)
                         3. Duplicative (included with management’s package)
                         4. Recidivist (has failed in past)
                iii. Proposals that are Illegal
                         1. Violation of law, personal grievances, beyond power, moot
          d. Rauchman v. Mobil Corp.
                  i. Infers private right of action for 14a-9 (since there is one for 8)
                 ii. Most shareholder proposals are phrased as recommendations- will
                     be allowed
          e. Current Efforts:
                  i. More holders attempting to change by-laws, SEC staff required
                     included (Exxon)
                 ii. 10.20 appears to allow (this is where action is moving- backdoor
                iii. Never underestimate power of institutional investors

   1. Duty of Care
         a. Generally
                 i. Addresses attentiveness and prudence of the director in performing
                    the decision-making and supervisory role (have to have a decision)
                ii. Role of Courts?:
                        1. Litwin v. Allen (if judgment is so improvident to be
                            irrational- are they making their own BJudg?)
                        2. Shlensky v. Wrigley (have to allege fraud, illegality, or
                            conflict of interest- tough standard)
         b. Standard of Conduct: § 8.30
                 i. Each member of the board when acting shall act:
                        1. In Good Faith;
                        2. In a manner which the director reasonably believes to be in
                            the best interests of the corporation
                ii. When making decisions, each BM shall use the care that a person
                    in similar circumstances would reasonably believe appropriate

     iii. Director who does not have knowledge can rely on competent
          officers or employees of the corporation or another committee
          whom the board has formally or informally delegated power
     iv. Director who does not have knowledge is entitled to rely on
          information, reports, statements (including financial statements by
          members of the corporation or retained by)
      v. 8.31(a)(2)(iii)- shall be disinterested and independent
c. Business Judgment Rule
       i. Definition: judicial deference- there is a rebuttable presumption
          that the director is performing functions honestly with good
          intentions, and is informed and taking rational action (both
          insulates and shields from personal liability)
      ii. Common Law: (a decision)
              1. In Good Faith
                       a. Honest, no conflicts of interest, and not condoning
                            illegal activity
                       b. Interested activity- would shift to duty of loyalty
                            analysis (disinterested and independent)
              2. In the Honest Belief that the Action was in the Best
                  Interests of the Corporation
                       a. Substance of the decision- embodies idea of
                            “waste” (decision-making)
              3. On an Informed Basis
                       a. Procedural aspects- twin duties- monitoring and
                       b. Must be informed in making decisions
                       c. Must monitor management
     iii. ALI § 4.01(c): A director who makes a business judgment in good
          faith fulfills the standard of care if the director:
              1. Is not interested in the subject of the business judgment;
              2. Is informed to the subject of the business judgment to the
                  extent that the director. . . reasonably believes to be
                  appropriate under the circumstances;
              3. Rationally believes the business judgment is in the best
                  interests of the corporation
     iv. MBCA § 8.31: Standards of Liability (“not trying to codify the
          business judgment rule [which] continues to be developed by the
              1. Action not in good faith;
              2. A decision that the director did not reasonably believe was
                  in the best interests of the corporation or to which was not
                  adequately informed to the extent reasonably appropriate;
                       a. Some decisions (i.e. selling the business—are so
                            important that require more consideration)
                       b. Court faults board for not probing out information
                            readily at hand (Van Gorkom)

                 3. Conduct resulting from a lack of independence or interest;
                 4. Receipt of Improper Benefit
d.   Not in Good Faith
          i. Fraud- A director who acts fraudulently may be liable and any
             action tainted by the fraud may be undone
         ii. Conflict- If director is personally interested, BJR does not attach
                 1. Duty of Loyalty Analysis applies
        iii. Illegality
e.   Irrational Board Action
          i. Comment to § 4.01 of ALI- irrational beyond the realm of reason
         ii. Board inaction?- (only if conscious decision)
f.   Gross Negligence
          i. Decision-making (Smith v. Van Gorkom)
                 1. Not an informed decision- failed to undertake proper
         ii. Inside v. Outside Directors
                 1. Inside- employed- better access to information
                 2. Outside- not- want majority to be outside- independence
                 3. Treatment-shall discharge a would a person in a like
                      position (so a distinction can be drawn)
        iii. Oversight Failure (General Oversight and Monitoring)
                 1. § 8.32(a)(2)(iv) (codification of Graham and Caremark): A
                      sustained failure to devote attention to ongoing oversight of
                      the business and affairs of the corporation, or devote timely
                      attention, when particular facts and circumstances
                      materialize that would alert a reasonably attentive director
                 2. Sustained Failure
                          a. Francis v. United States Bank (failed to monitor)
                 3. Suspicion
                          a. Graham v. Allis Chambers
                                   i. BJR shields directors who fail to detect
                                  ii. “no duty to create a corporate duty of
                                      espionage to ferret out acts that they would
                                      have no reason to suspect”
                          b. In re Caremark
                                   i. Suggests may have duty to install corporate
                                      monitoring system
                                  ii. An attempt in good faith to assure that a
                                      corporation information and reporting
                                      system is adequate, exists, and that failure to
                                      do so under some circumstances may, in
                                      theory, render a director liable for losses
                          c. Sentencing Guidelines
                                   i. If board can eliminate 95% of liability-
                                      board had duty to do so
g.   Remedies- BOD can be held jointly and severally liable

2. Director Protection
      a. BJR: §§ 8.30 and 8.31
      b. Corporate Shield
               i. DE § 102(b)(7): No personal liability for breach of duty, but
                  remains liable for:
                      1. Breaches of duty of loyalty;
                      2. Acts or Omissions not in Good Faith;
                               a. Effect—in DE, if facts can be alleged that the BJR
                                  would not have been available- then go to trial
                                  before determining in good faith (Emerald))
                      3. Approval of illegal distributions;
                      4. Obtaining a personal benefit
              ii. MBCA § 202(b)(4): No liability for money damages except:
                      1. Financial benefits received when not entitled to;
                      2. Intentional infliction of harm on corporation or holders;
                      3. Approving illegal distributions;
                      4. Intentional commission of a crime
      c. Indemnification (Subchapter E) (when money allocated=crucial)
               i. The corporations promise to reimburse the director for litigation
                  expenses and personal liability if the director is sued;
              ii. Depends on whether found not guilty (mandatory) or in good faith
      d. Insurance (Subchapter E- § 8.57) (D+O insurance to cover liability)
3. Shareholder Derivative Actions
      a. Standing (§ 7.41) A shareholder may not commence action unless:
               i. Was holder at time of the act or omission or became a holder
                  through transfer of law from one who was;
              ii. Fairly and adequately represents the interests of the corporation in
                  enforcing the right of the corporation
      b. Demand (§ 7.42) Cannot bring until:
               i. A written demand is made on the corporation;
              ii. Ninety days have expired since the date of the demand unless the
                  holder has been notified that the demand has been rejected or
                  unless irreparable harm would result
      c. Dismissal (§ 7.44)
               i. A derivative proceeding shall be dismissed if determined in good
                  faith after conducting a reasonable inquiry that its maintenance is
                  not in the best interests of the corporation
              ii. Determination may be made by:
                      1. A majority of independent directors (if a quorum)
                      2. A majority vote of a committee consisting of two or more
                           independent directors (appointed by majority vote of
                           independent directors)
             iii. None of the following shall alone cause to not be independent:
                      1. Nomination or election by director by defendants
                      2. Naming the director as a defendant

                      3. Approval of the act or benefit challenged if resulted in no
                          personal benefit
             iv. If derivative suit is still brought, must allege:
                      1. Majority not independent;
                      2. Requirement(a) (good faith/reasonable inquiry) not met
              v. If majority not independent when decision was made, corporation
                  has the burden of showing that (a) met, if majority independent (b)
                  has burden
             vi. Court may appoint independent panel to make the determination
      d. Shareholder Litigation Committees
               i. Generally
                      1. Suit is against corporation- who speaks on behalf?
              ii. Gall v. Exxon (Per Se bar- if demand refused by SLC- ball game- if
                  disinterested and investigation was in good faith)
            iii. Einhorn v. Cullea
                      1. 7.44 provides (the shall not be founds)- this adds factors
                      2. Test: whether a reasonable person in the position of a
                          member of a SLC can base his or her judgment on the
                          merits rather than extraneous considerations
                      3. Court adds these additional factors:
                              a. Status as defendant
                              b. Participation in decision
                              c. Past or present dealings with (i.e. employment)
                              d. Past or present personal, family or social
                                       i. In re Oracle (social connections- and
                                           donations to Stanford- enough to make not
                                           independent- court raising bar?)
                              e. Past or present economic relations with
                              f. Role of corporate counsel
                                       i. If retain independent counsel- more likely
                                           SLC will be independent
                                      ii. Need to empower and make autonomous
                                     iii. Is this using the BJR as a sword and a shield
                                           to kill of derivative suits?
             iv. Iowa Approach (Miller v. Register & Tribune Syndicate, Inc.)
                      1. Concerned with structural bias- a board is unable to
                          delegate the power to bind to a SLC if the board itself is not
                      2. Mandates appointment of an independent panel to make
                          decision whether to go forward (also requires a
              v. Closed Corporations
                      1. Barth- allows a closed corporation to bring direct action
4. Duty of Loyalty
      a. Generally

       i. Addresses self-dealing (on both sides)
      ii. Role of court? (traditional- per se bar/ now- allow if “fair”)
     iii. Two types: (Conflict of Interest and Corporate Opportunity)
b. Conflict of Interest Transaction
       i. Interest
               1. Iowa Code 490.832- conflict with the corporation in which
                   a director has a direct or indirect interest
               2. Direct: sales/purchases of assets, loans, services
               3. Indirect: close relatives/financial interest
      ii. MBCA (if this step is met, stop- the deal is valid)
               1. What is necessary to insulate? (§ 8.31)
                       a. Material facts were known and the conflict was
                           disclosed and the board or committee approved;
                       b. Material facts known-majority of qualified shares
                       c. Transaction was fair
                                i. Marciano- if meets test- do not
                                    independently evaluate fairness (stop)
               2. Approval by Directors:
                       a. Qualified Director- § 8.62(d)- no conflict and not
                           familial, financial, or employment relationship that
                           would effect judgment
                       b. Quorum rule- majority of qualified (same as Iowa)
               3. Approval by Committee:
                       a. All members qualified and appointed by majority of
                           qualified directors
               4. Required Disclosure: (§ 8.60(4))
                       a. Disclosure by the director of the existence and
                           nature of conflict; of all facts known to him
                           respecting the subject matter that an ordinarily
                           prudent person would reasonably believe material
               5. Fairness: (arm’s length transaction/equal treatment?)
     iii. Iowa
               1. Test:
                       a. Material facts of the transaction and the director’s
                           interest were disclosed or known to the BOD or a
                           committee and approved
                       b. Material facts disclosed or known to holders- and
                       c. Transaction was fair (see below)
               2. Voting:
                       a. Majority of BOD or on committee who have no
                       b. If majority of directors who have no interest- have
               3. Fairness:

                     a. Still have to show fair to corporation (even if above
                        test is met)
                             i. Cookies- reverse of Marciano—still have
                                 this burden
                            ii. If can make showing- BJR applies (fraud or
                     b. Fairness- two components (Sinclar)
                             i. Fair Dealing (disclosure, speed, negotiation)
                            ii. Fair Price
             4. Best Practice: Independent Negotiating Committee
                     a. This would have been independent and would have
                        shifted the burden on plaintiff to prove unfair
                     b. DE Court’s have not been shy about invalidating if
                        not really independent or at arm’s length
                     c. Have allowed freezeout mergers (not totally out
                        here- can buy back in)
                     d. Still not going to judge BJR- majority has right to
c. Corporate Opportunity
       i. Generally:
             1. Duty of corporate managers to put corporate interests ahead
                of their own (subset of duty of loyalty)
             2. Two issues (What is it?; Procedure)
             3. Remedies (Liability for profits realized, lost profits, and
                imposition of a constructive trust)
      ii. Four Common Law Tests (oft-quoted case- Guth)
             1. Expectancy
                     a. Did the corporation have an interest or expectancy
                        to acquire the corporation? (same building?)
             2. Line of Business
                     a. Compare the new business with corporation’s
                        existing operations (problem- decline of ultra vires)
             3. Fairness Test (a malleable standard- Cardozo in Meinhard-
                a nexus?/ hard to advise a client based on)
             4. ALI § 5.05: A director or senior executive:
                     a. Becomes aware in corporate capacity;
                     b. Should know outside party if offering to
                     c. Became aware of it though corporate information,
                        and should know corporation would be interested;
                     d. Knows it closely relates to current business
     iii. Procedure
             1. ALI- not relevant that offering party refused to work with
                corporation- still has to let the corporation know and give
                opportunity to decline (disclosure)
             2. Corporation may voluntarily relinquish, if:

                              a. Manager offered and disclosed;
                              b. BOD or holders rejected or declined
              iv. § 8.70 (proposed): Business Opportunities
                      1. A director taking advantage of business opportunity, ok if:
                              a. BOD disclaims
                              b. Holders disclaim
                      2. The fact that did not follow above process does not create
                          inference that should have first been presented or breached
5. Insider Trading
       a. Generally
                i. Federal law grew up where state law was deficient
               ii. Malone v. Brincat (imposed duty of honesty)
       b. State Law
                i. Common law fiduciary duties (to whom or what do the directors
                   owe a duty of disclosure?)- applies to all business structures
                      1. Majority Rule: expanded special facts rule- to impose a
                          duty to disclose material non-public information in any face
                          to face transaction (Hotchkiss-declaration of dividend)
                      2. Special Factors Rule: disclose or refrain from trading
               ii. RS 2d (Torts) § 525: Fraudulent Misrepresentation (Deceit)
                      1. If fraudulently make a misrepresentation of fact, opinion,
                          intention or law for the purpose of inducing action in
                          reliance, subject to liability
             iii. RS 2d (Torts) § 550: Liability for Fraudulent Concealment
                      1. If by concealment or other action intentionally prevent
                          other from acquiring information subject to liability for loss
                          as though had stated the non-existence
              iv. RS 2d (Torts) § 551: Liability for Nondisclosure
                      1. One who fails to disclose a fact that knows may justifiably
                          induce to act or refrain from acting is subject as though had
                          presented the non-existence, but only if subject to a duty to
                          exercise reasonable care
                      2. If in business transaction, under duty to other until over:
                              a. Matters known that other is entitled to know
                              b. Matters necessary to prevent ambiguous statements
                                  of fact
                              c. Subsequently acquired information that will make
                                  representations untrue;
                              d. Falsity was not made with expectation of action, but
                                  learns that the other is going; and
                              e. Facts basic to a transaction, that if knows going to
                                  enter into under a mistake about them, and the
                                  customs of trade would reasonably expect
               v. Statutory Rights
                      1. RUPA §§ 404-408 (partners right of information, conduct)

              2. ULLCA §§ 408-09 (same)
              3. Uniform Securities Act (2002), IC § 502.402- (registration
                  requirements- duty not to make false statements
c. Federal Law- Section 10(b) of the Securities Act of 1934 and Rule 10b-5
       i. Generally
              1. 10b-5 “the judicial oak that has grown from little more than
                  a judicial acorn” (allowed for inferred COA in Kardon)
              2. Procedural advantages- nationwide service of process,
                  discovery and venue
              3. Statute v. Rule (Rule broader than statute)
      ii. Jurisdiction and Definition of Security
              1. “the purchase or sale of any security”
              2. Hinges on specific jurisdictional nexus- instrumentality of
                  interstate commerce, mails or traded on national security
                  exchange (10b-5 violations- must be brought in fed. court)
     iii. Elements
              1. Standing (purchaser or seller)
                      a. Blue Chips- did not allow non-buyer
              2. Deception
                      a. False or misleading statements that induce other to
                          trade to their detriment
                      b. Central Bank- held this applied to only those who
                          engage- not aiding and abetting
                      c. PLSRA- allows SEC to go after these people
              3. Materiality
                      a. Affirmative misrepresentation- in the face of a duty
                          to disclose that would have been material
              4. Scienter
                      a. Intent to deceive, manipulate, defraud
                      b. Recklessness? (so obvious should have been aware)
              5. Reliance (relied on these facts)
              6. Causation (but for would not have entered in)
              7. “In connection with” the purchase or sale of security-
                  applies to even non-parties
              8. Damages – need actual (Old rule- J/S, PLSRA-
                  proportionate liability


Shared By: