Corporations Lecture Notes; Kerr

WMC Corporations Fall 2003 Corporations-Kerr Fall 2003 Corporation: an artificial person or legal entity created by or under the authority of the laws of a state. The law treats the corporation itself as a person which can sue and be sued. The corporation survives the death of its investors and the shares can usually be transferred. The best attribute of a corporation is that it protects you from creditors and other liability. Corporation: Management Options Closely Held  Common Law o Directors (voted in yearly) and officers (foot soldiers)  Fiduciary Duties: Due Care (mistakes in judgment) and Loyalty o 2 levels of tax o stockholders o hard to get out of and sell stock o “multiple hats” directors and officers may also be stockholders  Statutory o “S Corp” o stockholders manage directly w/o board of directors or officers o 1 level of tax Publicly Held Incorporate: to protect against unlimited personal liability, continues after death Hypo: Person comes to you and says I want to form a corporation.  First, “There may be better options for you.”  Second, Name reserved with the Sec. of State ($)  Publicly or Closely-held Formation o Articles of Incorporation (5 required + 1 discretionary)  Name  Purpose  Agent for Service of Process w/in State (name/address)  Capitalization  Execution  Release of liability for “due care” but not able to release for “loyalty”  Considered “malpractice” to not mention this option to directors.  Where o $ o advantages & disadvantages of law  DE, tax advantages and law pro-management  CA, laws very pro-plaintiff  Can be done is several states…just expensive. o Closely-held, mom & pop…usually where located Articles of Incorporation: filed with Sec. of State  Must contain five w/ a sixth optional (malpractice if not advised of #6)  Contracting party is on notice of corporate status b/c Articles of Incorporation is a public document.  Amendability: harder to amend but can be done by directors or stockholders (voting?) Name WMC Corporations Fall 2003  Reserve name w/ Sec. of State  DO NOT commence business prior to getting name back from Sec. of State. If it‟s used, you‟re not a corporation but a joint venture which exposes you to unlimited personal liability.  proper if the purpose is not too defraud  not the same or similar to another corporation w/in that state Purpose: General or Specific  amendable  Corporation has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs unless its articles provide otherwise.  General: any lawful purpose o Investor: worried about “general purpose” clauses…too unconstrained o NO UV actions  Specific: Limits purposes that corporation can engage in. “in the business of…” if narrow purpose is desired. Corporation CANNOT expand its purposes unless the articles are AMENDED. o Possible UV actions o If a corporation has a specific purpose clause and a new opportunity comes up, the Articles can be amended by a majority vote.  Capitalization o Shares authorized for each class  If you are going public, take this into consideration when authorizing shares in Articles. Judgment question. If you start small, then decide to go big, will the stockholders agree? They would have to be amended. o Class of stock: are you going to differentiate between stockholders? o Par value: the least amount a corporation can sell its shares for. (Nominal value is good just in case the corporation has trouble…$1.00 is ok)  No par value  Stated value: state value in corporate books and easier to change by BOD‟s  No par No stated value (TX): in the jurisdiction‟s code. Certain % has to go into the corporation‟s “guts” or stated capital. Governed by the policy that nobody is going to loan or due business if this protection isn‟t there.  Agent for Service of Process: MUST include this person‟s address within the state. Usually the corporation‟s attorney.  Execution: Person who signs the Articles (Executor/Promoter) Executor can be a natural citizen (living/breathing person called an incorporator) or a business association that is trying to change into a corporation.  #6 Release of Liability for “due care” Bylaws: internal procedures and not filed with Sec. of State  Strategy: put it in the Articles or the Bylaws?  Delineates what stockholders can and can‟t do.  Amendability: usually stockholders have the sole ability to amend and not managment's There for if you want something UNCHANGED put it in the Articles o Things will always change depending on the players. o Easier to amend things put in the bylaws Other Documents and Activities associated with Incorporating  Minutes: 1st Formation, 2 nd Elect directors 3rd Directors appoint officers (day to day foot soldiers)  Employment K’s:  Pension Plan Documents WMC Corporations Fall 2003  Stockholder Agreements: Stipulates and determines the rights of stockholders. Important in a closely-held corporation b/c there is no separate board of directors, the stock holders are running the corporation.  File the Articles with Sec. of State  Corporate Seal and Stock Certificates  Corporate Bank Account: AVOID commingling corporate and personal monies  Organization Meeting: Elect a BOD, discuss and approve Articles, issue initial shares, etc. COA: Ultra Vires: beyond the scope of the Article‟s purpose SPECIFIC ONLY COA brought by: o Trigger: Specific purpose clause and unauthorized actions by the corporation outside of this specific purpose o CL: at common law if a corporation Ked for activity beyond the authorized corporate powers, then the K was considered VOID. Courts didn‟t like this because it created „unjust results‟ so started to construe specific purpose clauses very broadly or employed estoppel or unjust enrichment or implied ratification by the shareholders to uphold the corporation‟s activities. o Modern: UV doctrine has little effect b/c 1) the inclusion of a general purpose clause by most companies and 2) the abolition of the doctrine by statute. o 711 Kings Highway Corp v. FIM Marine Repair Service (marine shop lease and wanted to engage in movie business, P tried to rescind K to lease building based on D‟s specific purpose clause which excluded the movie business. Rule: No act of a corporation and no transfer of property to or by a corporation otherwise lawful, shall be invalidated by reason of the fact that the corporation was w/o capacity or power to do such act or engage in such transfer except that such law of capacity or power may be asserted (1) in an action brought by a shareholder to enjoin a corporate act, (2) in an action by or in the right of a corporation against an incumbent or former officer or director of the corporation, (3) in an action or special proceeding brought by the Attorney General o Clause 1: used to ENJOIN the activities of a corporation that are UV in nature o Clause 2: used to obtain DAMAGES from the person (power hungry person) responsible for UV activity o Clause 3: used by Attorney General when the corporation is engaged in illegal activity (unless illegal not usually interested) o Who can bring a UV action? 1) Shareholders, 2) “in the name of the corporation” or a shareholder‟s derivative action against the BOD‟s for damages, 3) Attorney General (again, usually only if illegal) o NO UV ACTION W/ GENERAL PURPOSE CLAUSE o P in 711 Kings Highway could not sue b/c he lacked standing…wasn‟t one of the three categories. Plus the K was “executory K‟s” (a contract that sets forth promises that are not yet performed) o Hypo: Corporation has a general purpose clause and enters into a stupid contract, nobody can bring a UV action b/c it‟s not specific. o Stockholder: enjoins the corporation (corp. cannot enjoin itself) o Trigger: self-dealing or improper conduct by directors or officers o Strongest action on “Loyalty” b/c not protected BOD’s FIDUCIARY DUTIES: Since BOD‟s are voted in by shareholders, they have 2:  COA Due Care  COA Loyalty: 24/7 NOT to serve self interests but good of the corporation WMC Corporations Fall 2003 o Hypos: Corporation has general purpose clause…BOD‟s enter into a bad K and took $ under the table…you CAN‟T bring a UV action b/c of the general purpose clause…but you can sue for breach of the duty of due care and loyalty (can get loyalty even if #6 releases liability for breach of due care) o Same Facts: but this time with a specific purpose clause…USE ALL THREE  Corporate Giving of Charitable Contributions o CL: the Articles required that the corporation had power to donate $ o Statutory: Allows every corporation to make donations for the public welfare, scientific, or educational purposes o Kerr’s Rule: corporate give is allowed and promoted unless the Articles have a specific “NO GIFTS” clause that specify that corporate giving is not allowed. Even if there is a specific purpose clause, corporate giving will be w/in the purpose unless specifically prohibited. o Policy: Charitable gifts bolster free enterprise and the general social climate of a where a corporation does business. Furthermore, unless corporations carry an increasing share of the burden to support charities, the business advantages that they enjoy, may be viewed by the public as unacceptable. o Test: Reasonableness standard. Is the contribution reasonable? o How can a charitable contribution benefit the shareholders? Increases goodwill towards the corporation in the local area. This alone does NOT satisfy the duty BOD‟s have to their shareholders.  BOD‟s owe a duty to their shareholders, not community at large  However, when BOD‟s make decisions on behalf of the corporation they CAN take into account non-shareholder concerns. (lots of movement here) o Challenging a Corporate Contribution:  Over the reasonable monetary amount. Look to the income/financial status of the corporation and the effect of the contribution on the shareholders‟ interests  Due care and Loyalty (derivative suit)  Conflict of interest: the $$ is going directly to a person associated with the donating corporation  Donation benefits a Director directly: sue under breach of due care/loyalty Pre-Incorporation Promoter Liability  Trigger: See a K being entered into prior to the Articles being filed with the Sec. of State, then you have a pre-incorporation promoter liability issue.  COA: Parties to a promoter liability suit: 3 rd person trying to hold the promoter liable You v. Promoter‟s name…NOT the name of the corporation  Promoters: person who, acting alone or in conjunction with one or more persons, directly or indirectly, takes initiative in founding or organizing the business or enterprise  Significant fiduciary duty: to other participants in venture. If the investor has dealt directly with the promoter there is little doubt that the promoter is liable for common law fraud in the even of a misrepresentation. Also, look for federal securities issues and use of interstate commerce. Policy: if no liability nobody would invest. Personal liability but people still willing b/c of potentially big profits. o Full Disclosure o Fair Dealing o Good Faith  Owed To: 1) The corporation 2) the creditors 3) Present and future shareholders WMC Corporations Fall 2003  General Rule Promoters are personally liable on the K‟s they make on behalf of a corporation before it‟s formed. Look for: “to be formed”  To Avoid Personal liability: o Use “agent” after your name. Wendy Coats, agent. If you say Wendy Coats, agent for XYZ corp. and this corporation is not in existence, you have committed a fraud. o If you see anything other than “agent” when the promoter signs…argue that it means “agent” o Make it clear by inserting a clause AFFIRMTIVELY that the 3rd party will “look to the corporation” and not the promoter for payment. o If the promoter satisfies the above criteria, the person who has filed suit should go to a court of equity to get partial compensation o Look for co-promoters o “Silent partners” based on a COA of joint and several liability Assert an agency relationship existed between the promoter who signed the K and other co-promoters who did not sign. o General Rule: Promoters are personally liable for the K‟s they make though made on behalf of a corporation to be formed. The well-recognized exception to this rule is if the K‟ing party knows the corporation is not in existence but nevertheless agrees to look solely to the corporation for payment and not the promoter, then the promoter isn‟t liable.  Burden: if released, the Promoter has the burden of establishing his release Prior K’s formed before Incorporation Corporations are not automatically obligated to adopt a K which was formed prior to its existence by one of its promoters. Why? It‟s hard enough for a corporation to survive in the first place, let alone holding them to K‟s entered into on their behalf prior to their existence. Also protects creditors and shareholders.  Binding K?: No, has a choice. Corporation is not bound by K‟s made on its behalf before its organization but it may afterwards. 1) Express 2) Inferred from acts or acquiescence. Is the promoter still liable? Yes. Promoter needs Written Novation releasing her from personal liability.  Normally, BOD‟s vote and agree to adopt the K based on due care and loyalty. This duty also flows to creditors.  Two ways: a corporation can adopt a pre-existing K entered into by one of its promoters prior to incorporating: o Express Adoption: Certified resolution signed by the Secretary. If you are a third party who entered into a K prior to incorporation you want to make sure that the corporation has agreed to your K you need to ask for “a certified resolution signed by the Secretary” Absent this document, look for factors indicating implied adoption o Implied Adoption: Adoption based on acquiescence o COA Quantum Meruit: The last way to get paid if you are a third party. (Equity: implied contract that the defendant would pay the plaintiff as much as deserved for services or materials provided) o Does a corporation’s act of adopting a K release the promoter from liability? NO o COA Novation: brought by promoter. Required to verify that as a promoter you are RELEASED from liability (get novation and certified resolution signed by the secretary)  Exception: birth process requiring an attorney‟s services. Corp. is estopped from relying on rule to avoid paying attorney b/c services not authorized by corp.  ALWAYS LOOK FOR COPROMOTERS WMC Corporations Fall 2003 TIMELINE: Defective Incorporation and Piercing the Corporate Veil only apply to K‟s signed after the articles are sent to the Sec. of State. You can‟t use defective incorporation or piercing if the Articles haven‟t been sent out b/c there was no incorporation to call defective. Even if your attorney “forgot”…b/c he‟s your agent. For these situations, use promoter liability above. In defective incorporation and piercing the corporate veil actions the Plaintiffs will ALWAYS be creditors or victims of a tort. Always START w/ Defective Incorporation. If you start with piercing the corporate veil, you are conceding the corporation‟s existence. Defective Incorporation (in law): (Use for Tort or Contract disputes) Arises when a company conducts business before it validly incorporated. The 3 rd party who contracted with the corporation cannot hold the promoter liable for pre-incorporation liability, so next course of action is to try and find a technical defect with the incorporation to that it really isn‟t a corporation which equals that there are NO shareholders, so they are individually liable. Utilize this to hold shareholders personally liable unless they can argue one of the defective incorporation theories to establish a corporation.  Persons acquire personal liability when they assume to act as a corporation when they have no statutory authority to do so.  Stockholders beware: If Corporation not formed, then there really aren‟t stockholders just individuals. Only party around are the individuals.  COA: 3 rd party v. shareholder‟s names  Is there Defective Corporation? Depends on the jurisdiction.  Questions to Ask: o Jurisdiction? o Did incorporation take place? o When was business conducted? o Defective incorporation, you will ALWAYS see an attempt to file the Articles with the Sec. of State and then they come back with a defect cited. If there is NO ATTEMPT TO FILE…they you have promoter liability. o Defective incorporation is different than promoter liability b/c in defective incorporation you are suing the individual “alleged” shareholders o Once the Articles go “up in the air” promoters become stockholders. With defective incorporation, only look to ACTIVE stockholders. Did the stockholders do something to elevate their status from passive to active?  MBCA: date stamp “conclusive presumption that stamp is valid”  Problems: Leaving 1-5 of the requireds out, not signing,  Dejure: If there are problems with the Articles, but the Sec. of States stamps them anyway…you‟re safe “can‟t touch this” Conducting business after the date of incorporation means the corporation is de jure.  Bright Line Rule: before the “stamp” the shareholders are liable and not the corporation  “too defective” If corporation conducts business before the stamp, the corporation is said to be “too defective” and in a MBCA jurisdiction the promoter, directors, officers, and active stockholders are all personally liable. Active v. Passive Stockholders: Active Stockholders, Those who assume to act on behalf of the corporation. Stockholders have three rights unless the Articles say otherwise: voting, dividends, and liquidation. Any activity beyond these three can change you from a passive SH to an active SH, which can expose you to personal liability. Note: Statutory closely-held corporations = all shareholders are Active. It‟s possible to have a statutory closely-held corporation with passive SH‟s but you must have an agreement which stipulates this. Only Active SH’s are liable in MBCA jurisdictions  Non-MBCA: DEFENSES shareholders can argue…CORP EXISTS!! WMC Corporations Fall 2003  In Non-MBCA jurisdictions the Sec. of State‟s stamp means nothing to the analysis. Active and Passive shareholders are liable in a Non-MBCA jurisdiction. o 1. De Jure: as of the date of K or injury the corp. was in substantial compliance w/ all mandatory conditions precedents (Articles w/ 5 provisions + Sec. of State filed and fee paid prior to business being conducted…putting them in the mail isn‟t good enough). Defense: argue that error/typo in Articles. Materiality of mistake decided on a case by case basis. “We are still in substantial compliance.” Effect: “can‟t touch this” not even the Sec. of State. If you‟re a shareholder and this didn‟t work, to avoid liability net argue defacto. o 2. Defacto Corp: use if Articles are missing one of the five provisions or if they forgot to sign them. Requires: 1) valid incorporation statute 2) good faith attempt to comply, and 3) Actual use of corporate privilege. (letter head, contracts, signatures) Effect: The Sec. of State may still have a COA against the directors and active shareholders but any action by 3rd parties is barred. o 3. Estoppel as Last Resort: Holding out corp. form, reliance on corp. by Plaintiff (not relying on an individual…no personal guarantees by promoter or corporate agent ).  Did the 3rd party deal with the corporation in such a way as to “admit” its existence as a corporate body?  A 3rd party‟s examination of an association‟s financial statements doesn‟t equal estoppel (gauging financial health)  Effect: It denies a particular third party (the one who relied) from challenging the corporate status. However, it doesn‟t estop other third parties or the State from bringing an action. You must prove estoppel again and again in every case. o If stockholders can’t show a corporation exists on De Jure, Defacto, or Estoppel then Stockholders are liable. Second, Piercing the Corporation Veil (in equity = judicial discretion)  Q: should shareholders be held personally liable for corp. obligations? Policy that incorporation acquires the privilege of limited/no personal liability and so requires that they act as corporations. “w/ privilege comes responsibility”  ALL piercing cases are in “equity” so even if you prove all the elements you still must show: Equitable/Fair/Necessary to pierce the corporate veil.  Always do 2nd. If you start here, you admit the corporations‟ existence.  When suing…name individual stockholders. (You v. Wendy Coats, Dan Coats)  First ground for PCV: fraud but hard to prove o There must be a misrepresentation at the beginning of the business relationship between the creditor and the corporation and you must show intent to deceive. o Example: Pre-existing debt. Individuals try and shield themselves against pre-existing debt by incorporating. In this case they never “intended” to operate as a corporation…it‟s a sham. o Piercing via Fraud: least popular and most difficult to prove Q #1: Contract and creditor? Or Tort and injury? Q #2: Select Ground Q #3: Equity or fairness. Who are you getting to? Q #4: Strategy: how many piercings do you need? Q #5: Location: DE friendly to corporations but CA is plaintiff friendly  Contract cases: A 3rd party may pierce the corporate veil in a K action by showing BOTH : (you don‟t have to prove fraud) o Lack of adequate capitalization: Corporation needs “reasonable capital” WMC Corporations Fall 2003  Initial Capital: Was there adequate initial capital considering the type of business the corporation was conducting, reasonable expenses for the corporation, and foreseeable risks by the corporation?  Continuing Capital: Need not only have adequate initial capital, but it must have adequate continuing capitalization. Is the corporation paying its bills? (paying salaries, stock being bought back, inability to pay dividends, is there siphoning off of profits for personal use?) o Lack of adherence to corporate formalities: Is the corporation the mere AlterEgo/instrumentality for an individual to conduct business for himself? Courts consider: shares are never formally issued, dividends not being declared (check Articles, mandatory?) shareholder meetings/directors meetings are not being held, suspect officer structure (one individual in the all the positions), absence of corporate records, bank accounts, minutes, use of corporate property for personal reasons and siphoning off of funds by the dominant shareholder.  One factor alone is not sufficient  In K’s you must prove BOTH  Tort cases: Easier: Lack of observation of formalities OR lack of adequate capitalization. Cts tend to allow personal injury claim over contracting. Mostly b/c contracting is a long term continuous interaction (should have been aware of the situation) where personal injury is usually isolated w/ no longer term relationship. Additionally, w/ tort you usually have personal injury.  PCV unlikely in common law closely-held b/c stockholders are passive unless stockholders wearing multiple hats…if wearing multiple hats be clear and sure in what capacity the person is acting.  When substantial ownership of all the stock of a corp. is w/ a single individual and is combined with other factors clearly disregarding the corporate fiction PCV is appropriate on the grounds of fundamental equity and fairness. Alter Ego Theory: (1) Parent and Subsidiary acting as a single economic entity (2) overall element of injustice and unfairness present  use same checklist of lack of observance of formalities Effect of Piercing in Non-MBCA jurisdiction: EVERY stockholder regardless of Active/Passive is affected in a piercing COA.  Protect Yourself: get an indemnification provision in your subscription agreement (“If a piercing COA occurs, you will indemnify me.” Only applies to closely-held corporations.  “Enterprise Piercing Theory”: Separate companies are treated all as one, separate companies are owned by the same person. If you‟re hurt by one, put them all on a skewer…in your complaint think of “WHERE THE MONEY CAN GO” and act accordingly.  Horizontal Piercing: multiple independent corporations held by the same shareholder or parent company. o Parent/Subsidiary: the subsidiary must not be independent. Requires  Complete control of the subsidiary by the parent, the control must violate the duty, the violation must proximately cause the harm.  No inherent wrong for a parent and subsidiary to share the same BOD‟s but if share the same books/accounts, they are acting as ONE.  Majority of jurisdictions require the same showing of factors as in K actions.  Lack of adequate capital by the parent, there could be an additional piercing. Corporate Structures WMC Corporations Fall 2003 Limited Liability Company (the Mona Lisa): LLC is a single business entity which provides limited liability protection fro the partners as well as providing all the owners of the business with federal partnership taxation. This differs from general or limited partnerships which offer partnership taxation, but also makes at least one general partner bear personal liability for the debts and obligations of the business.  Levels of Taxation: Corporations usually have two levels…taxes on profits going into the corporation and taxed on profits going out of the corporation (dividends). o Problem: when you sell stock to raise capital, this opens you to SEC regulation. People solved this with the LLC  LLC’s Provide: o Veil against personal liability for it members o Avoid double taxation (one level) o All members are “active” so memberships sold not security (stocks/bonds/ventures). No passive members who would need protection from the SEC.  COA’s: management has duties and responsibilities to its members: 1) Duty of due care and 2) Loyalty  Formation: Articles of Organization filed with the State…pay a fee. Limited Partnerships: 2 kinds of partner in limited partnership:  General Partner: Runs the company. Benefits: gets a bigger cut, takes first. Drawbacks: Unlimited liability and management responsibilities. If you don‟t want unlimited liability as a general partner…incorporate yourself. You become as “separate entity” which runs the LP.  Limited Partner: Passive investor, you DO NOT run the company. In return, your liability is limited. Joint-Venture  2+ people who come together for a single purpose and it dissolves when purpose ends  Not saved from liability but can protect if you incorporate individually  Is it possible to incorporate either individually or as a group prior to forming a joint-venture? Yes  Promoter & JV‟s can and (should) incorporate Capitalization  Common terms o Debt: Money that at some point must be repaid and interest paid periodically o Equity Capital: Financial contributions by the original entrepreneurs in the firm, capital exchanged by other investors for ownership interest, retained earnings of the enterprise o Common Shares: Class with fundamental rights: voting, dividend, liquidation unless the Articles say otherwise. o If there is only one class of stock…they must have voting rights. Stock must always include at least one right. Regulated: paternalistic, dumb $ Want a little equity and not very much risk: Be a stockholder and a creditor. o Preferred Shares: Class with usually preferential but limited rights…but has all three fundamental rights unless the Articles state otherwise. Preferential treatment requires preferential language. (usually no voting)  Creditors are Always first even before preferred stock. If you want to take before common stock…you need preferential language in the Articles.  General Rules of Shareholder Rights: always included in the Articles. Three basic are voting, dividend, liquidation. Any right besides these 3 basic rights must be expressly stated in the Articles. o ALL classes are treated equally unless the Articles say otherwise. WMC Corporations Fall 2003 o Voting: Basic right. To be taken away, there must be express language in the Articles. Voting shift: “If there are not dividends declared in two years, the PSH‟s will be given the power to vote.” Voting shift but be express in Articles. o Dividend: Basic right, but dividends are at the discretion of the BOD‟s to declare when paid and how much.  Cumulative Dividend Preference: Whether or not a dividend is declared, your dividend will be carried over to the next year. This dividend in arrears and no other dividend may be paid out until the cumulative one is paid. Must be express in the Articles.  Mandatory Dividend Preference: SH may protect his right by getting a mandatory dividend in the Articles. However, if the corporation does not have enough to legally declare a dividend, they are excused from this requirement.  Example: If you don‟t trust the BOD‟s and don‟t want to be at their mercy for dividends, insert a mandatory dividend clause o Liquidation: Inherent liquidation rights to SH‟s, but if a SH was a liquidation preference this must be express in the Articles. Creditors take first, so the “preference” refers to other SH’s.  Liquidation preference: A preferred SH‟s right once the corporation is liquidated, to receive a specified contribution before the common SH‟s.  If you weren‟t present when the Articles were created and you aren‟t happy with your rights, tell the BOD‟s to amend the Articles. They can create NEW classes. Amending Requires: 1) BOD‟s approval and 2) Shareholder approval o Series: A smaller classification of shares w/in a class of stock. Common for large, publicly traded corporations. The different series can have different rights. o Problems: If management doesn‟t like you, they may try to “dilute” your control by selling more shares. Prevent by including a Preemptive Clause  Additional Rights Available: Must be expressly stated in Articles, never inferred o Redemption: Corporation has the right to repurchase stock from SH‟s. A SH may negotiate to get his own redemption right to sell the stock back to the corporation (in the case that the corporation is going under). The question is at whose option? If the SH has enough money to lend the corporation, he may negotiate a redemption right. If not specified, the option is the corporations.  Example: 100,000 shares authorized par value is $100 preferred stock with a redemption at shareholder’s option  Ask P. Kerr: even if the redemption right is at the shareholder‟s preference, is this similar to dividends in that if the company can‟t afford to buy it back..are they excused  Maj and Minority not treated the same: on a repurchase not going to treat Maj and Min the same. Maj. Paid more wanted more control and so gets recognition. Maj and Min may get different amounts on repurchase. o Convertibility: The right to convert preferred stock into common stock. If the common stock is appreciating, then it‟s advantageous to convert. Also if the PSH wants to vote, she will convert. o Indemnification: Protection of SH in the event that the veil is pierced. o Preemptive: Allows existing SH‟s to purchase additional new issuances at the offering price, prior to any outsider Consideration WMC Corporations Fall 2003  COA: Adequate Legal Consideration: The question to ask is, “Has adequate legal consideration been paid?”  COA brought by Shareholders and/or creditors v. BOD’s  Trigger: STOCK BEING SOLD  Policy: protect creditors who rely on capital in extending credit, since it attempts to insure there is “something real” which can be levied against and sold. Protects other investors from dilution of their interests.  Hypo: Par Value $1 and offering price $5. You pay $5 and another pays $2. Since par value has been met, your option is to sue BOD’s for breach of fiduciary duty of due care and loyalty.  Par Value: The face value minimum sales price of the stock. The stock cannot be legally sold for an amount below par. Only way to do this is to amend Articles.  Stated Value: No par value, but stated value which acts as minimum price the stock can be legally sold for. This value is NOT in the Articles, but in the financial books. Easier to change then if in the Articles. (Articles don‟t have to state a par value, but it must be stated somewhere in the corporate books)  2 Tests and BOTH must be passed: o Qualitative Test: Was the PROPER type of consideration given?  Cash: You can give money down, and a note, note must be secured.  Par value is normally nominal, meaning that the stock can‟t be sold below this dollar value. Par value preserves a certain amount of money in the “guts” or stated capital in case the corporation goes under to protect creditors. For this reason dividends can never be declared out of “stated capital”  Services Rendered: Services must be rendered FULLY prior to receiving stock. A promoter who performs pre-incorporation services MAY NOT claim shares in exchange for those services (b/c services not rendered to the corporation)..can get options.  Property/Equipment: real/tangible property. Inventions are ok provided that they are patented..not “patentable” and the patent is issued in the corporation‟s name. For good measure, make sure it works.  Throwing some extra shares in for free: FAILURE o Quantitative Test: Was enough consideration given? Other stockholders and creditors should be indignant if less than 100% is given.  Test: Consideration must be = or > the number of shares purchased times the par value/stated value.  Kerr’s Example: Offer 10, 000 shares par value $1 to D. D is going to pay cash (qualitative test passed). D should give at least $10,000.  What if capital is give plus cash for the stock? Corporation must have the capital assessed to determine its value.  Mistake of Value (services or property)..too much stock given!  Good Faith Jurisdiction: If BOD‟s valued the services or property in good faith, then the quantitative test is passed. Bigger the gap between the assessed and the actual value, the more difficult it is to establish good faith.  True Value Jurisdiction: Good faith means nothing even if off by 1 cent. The qualitative test is failed  Passed BOTH tests then Adequate Legal Consideration has been given. If failed one then name the stock. o Bonus Stock: Qualitative test failed. Since you‟re not giving anything, it‟s bonus. Zero given so cancel all stock. o Discount Stock: Quantitative test failed. Not enough CASH given. WMC Corporations Fall 2003 o Watered Stock: Quantitative test failed. Not enough SERVICES/PROPERTY.  Exceptions to Quantitative Test: o Financial Hardship: the corporation is going down the tubes. o Reissued Treasury Stock: stock that was once issued and bought back. When a corporation redeems and repurchases, it‟s trying to streamline.  Remedies: Name first then remedy. o Cancellation of Stock: Cancel the number of shares above which consideration is lack quantitatively. If it failed the qualitative test, then cancel ALL shares. Use the “big cancel” stamp. o Force Payment: SH forced to pay the extra amount to make up for the inadequate amount given…if that fails. “big cancel stamp” o COA against BOD’s for Damages: If the true value or good faith test was failed by the BOD‟s, they pay damages. SEC Act of 1933: requires the registration of all securities being placed in the hands of the public for the first time. Federal securities laws apply to closely held corporations, publicly traded corps, and LLC. Full compliance with the Act requires: BIG DISCLOSURE  #1 A prospectus that is distributed to potential investors  #1 Additional info to be submitted to the SEC and publicly available  Exception: exempts transactions no involving public offering from the registration requirement applies only when ALL the offerees have ACCESS to the same kind of information that would not be available if registration were required. (SEC v. Ralston Purina)  If the company wants to sell stock, it must file a registration statement or fall w/in an exception. Registration = Disclosure  If company lies to employees? o COA Section 5 violation: before you offer to sell, let alone sell a security, you must register with the SEC or rely on an exception.  Want to invest?  Have you registered with the SEC or will you be relying on an exemption? Investment K’s  COA Section 5 violation: any scheme that sells interests may be classified as a security (requiring registration w/ SEC and disclosure) if it satisfies the following requirements of an investment K. (SEC v. Howey)  Trigger: Corporation selling anything other than stock.  Elements of an Investment K: o Investment of legal consideration o Expectation of profits o Common Enterprise: 2+ investors with similar terms (same for everyone) o Investors must rely primarily on managerial efforts of others. Passive  State laws: most states define investment K‟s as “anytime you put capital at risk” so if you can‟t get the scheme as an investment K under federal laws, you should sue under state rules.  Beauty Club case: Beauty adviser..not an investment K b/c selling make-up for profit, but Distributor  Options if wronged by an investment scheme (Smith v. Gross…earthworms) o CL: Fraud (10b5): intend to misrepresent and misrepresentation is that either 1) the corporation was registered or 2) there was an exemption. Go for fraud and get treble damages (3x). o Section 5 violation (sue or allege). Find a security!!!! WMC Corporations Fall 2003 o Defense: investors are ACTIVE, so not relying on other’s efforts.  Example o Howey, citrus grove. Weather moved in and killed the fruit. Can‟t sue b/c of bad weather, but wanted to get money back. Sued under Section 5 violation. Howey didn‟t register and didn‟t have valid exemption. Had the investors been given proper disclosure they would have been aware of the risk factors. Weather would have been a disclosure item. o Want to sell an investment and AVOID being held an investment K  Control: give up some control over daily operations (McDonald‟s & carrot stick example). As an investor, you‟ll argue that you were totally dependent on the franchiser for profits, but franchisers do the above to protect themselves from these COA‟s. Give others decision making power so that they are relying on the efforts of themselves.  Franchise: has some decision making flexibility. But preserving quality and profitability not an excuse to get away from SEC. Must be able to make decisions to avoid investment K.  Hypo: You want to buy a McDonald‟s but don‟t have enough money? Form a limited partnership, which involves general partners (who run the business) and limited partners (passive investors). Possible issues from this hypo...formation of limited partnership = a security, the franchise itself could be argued to be a security.  Remedy: if you win and successfully argue that it‟s an investment K, then you get rescission of the K and you get your money back. Preemptive Rights: A SH‟s right to purchase newly issued stock—before the shares are offered to the public—in a proportionate amount to the SH‟s current holdings to prevent dilution of the SH‟s ownership.  Red Flag: Look for a corporation issuing more stock (authorized amount) for a corp. to issue new stock, the authorized amount in the Articles cannot be exceeded. This amount is usually set very high to avoid having to Amend the Articles in the event that the corp. “maxes out” and wants to issue more…Amending issue (BOD then Stockholders)  How are SH’s rights affected by dilution? Voting (lower % of votes relative to other SH‟s) Dividend (more pigs at the trough) Liquidation (more people standing in line to collect)  Preemptive rights are usually only given in closely held corps, Why? If you‟re a closely held corp, you have not choice but to sell your stock back to the corp. b/c there is no market for your shares. (creates duties). No preemptive rights in publicly held corporations b/c each time it wanted to sell new stock, existing SH‟s would have to be contacted…too many people so too problematic. No mention of preemptive rights in the Articles = No Rights  COA Exercising Preemptive Rights: Elements (Stokes v. Continental Trust) o 1. Must be in Articles (no inherent) o Purchaser must pay ISSUING PRICE or FMV for the new shares…no just par value. No discount for current SH‟s. SH‟s must give up the additional issuance price over what they originally paid to exercise the preemptive right in the first place.  Freeze Out: Katzowitz v. Sidler, 2/3 directors formed an alliance to oust Katzowitz (3rd director). The other directors know Katzowitz couldn‟t afford to buy additional shares. They were hoping he would have to sell, and couldn‟t afford to buy new shares. (freeze out)  Katzowitz Rule: Even if you have a preemptive right, that still doesn‟t offer you full protection. Other options: COA: Minority v. Majority SH’s o Breach of duty of due care o Breach of duty of loyalty o Breach of duty of due care on the part of the director (for selling stock for less that what it’s worth, devaluing the corporation) WMC Corporations Fall 2003  Rule: When the issuing price on new stock is proven to be markedly below book value in a close corporation and when the remaining SH‟s and directors benefit from the issuance, a case for judicial relief has been established.  Rule: In a closely held corporation there is a fiduciary duty owed to minority SH‟s by majority SH‟s o Katzowitz‟s only claim in this case was a breach of fiduciary duty of loyalty by arguing a bad faith issuance. The issuing price was so low that it wasn‟t in the best interest of the company.  Note: Preemptive rights will NOT attach when the additional issuance is given for in exchange for property or services rendered. o Strategy: if you want someone out, and preemptive rights are in the Articles, verify the new issuance is for property/services rendered  Freeze Out #2: Refusal to Declare Dividends: Plan is to make minority SH‟s give up and redeem their shares. Dividends  General Rule: Dividends are up to the discretion of the BOD. Majority doesn‟t have to declare dividends if they have an adequate business purpose.  COA: Declaration of Dividends (motion to compel) Minority SH’s must show either 1. Bad Faith/Intense Hostility (1 or both) (CH) or 2. Lack of Business Purpose (public) by the majority. COA: SH’s v. BOD  Bad Faith/Intense Hostility Elements: Gottfried Factors (CH) o History of Hostility (very difficult to prove bad faith)  Bad Faith Test: is the policy of the BOD dictated by their personal interests rather than the corporate welfare? o Exclusion from Corp. employment o Excessive salaries/bonuses for BOD: unreasonable is demonstrated by comparing similarly situated executives.  Wilderman Rule: In the absence of a specific authorization by the BOD‟s a corporate executive may receive only compensation that is reasonably commensurate with her functions and duties  Wilderman: never had EVEN number on the BOD o Existence of a desire by the BOD to acquire the minority stock for cheap o Successful Showing? If yes, then money put back into the corporation.  Lack of Business Purpose (public) o Very difficult to prove b/c there are many business purposes that can justify not paying dividends (R&D, goodwill, reinvesting, $/capital surplus back in) Good will is a legitimate purpose BUT BOD have a duty to SH’s 1 st and the general public 2 nd.  Stockholder Protection: Negotiate a mandatory dividend clause in the Articles, or a voting shift o Voting Shift: After 2 years of non-declaration of dividends, the non-voting SH‟s acquire the right to vote…usually only vote on BOD. You need to negotiate a voting shift while the Articles are being drawn up. Exception: this will not come in to play if the corporation CANNOT afford to pay  Remember: existence of adequate corporation surplus isn‟t sufficient to invoke the COA to compel dividends…need bad faith.  Final Option: If you can‟t prove bad faith, ask for Dissolution of the corp via voting rights o Voluntary Dissolution: majority vote of SH‟s o Involuntary: court ordered o Drawbacks: once corp is gone it‟s gone WMC Corporations Fall 2003 Legality of Distributions: 3 kinds: Dividend, Redemption, Repurchase  Red Flag: a Dividend, Redemption, or Repurchase declared…is the distribution legal?  Stated Capital: # of shares X par value (or stated value) = stated capital “guts” o Purpose: reserved for creditors  Paid in Surplus: Amount paid over par value (or stated valued) = paid in surplus. The surplus gained by the sale, exchanged, or issuance of capital stock at a price above par value. “capital surplus” o Ex: 10K shares par value $1, offered at $2, there is a surplus. Stated Capital 10K and Paid in Surplus: 10K  Earned Surplus: Retained Earnings A corporation‟s accumulated income after dividends have been paid…profits  Tests for Legality of Distribution: Proper Source & Solvency (pass both)  Dividend Rule: Dividends can‟t be paid out of stated capital “guts”  Proper Source Test: The Account? paid in surplus, earned surplus  Solvency Test: Have Enough? Must pass both o Balance Sheet Test: assets greater than liabilities o Cash Flow Test: must be able to pay debts when they come due  Look for these facts: corp is paying dividends but defaulting on paying rent or other bills. This corp does not pass solvency test b/c can‟t pass cash flow.  Redemption Rule: 1st are there redemption rights in the Articles? Yes, then Legal?  Proper Source Test: paid in surplus, earned surplus, or STATED CAPITAL but only to reduce arrearages  Solvency Test: Have Enough? Must pass both o Balance Sheet Test: assets greater than liabilities o Cash Flow Test: must be able to pay debts when they come due  Look for these facts: corp is redeeming stock but defaulting on paying rent or other bills. This corp does not pass solvency test b/c can‟t pass cash flow.  KEY: Defaulting on bills and rent. (Think…defective, piercing cv, and legality of dividends)  Mandatory or Discretionary: look in the Articles and at whose option? o Sinking Fund: if mandatory in the Articles require there to be a “sinking fund” whereby there is specific money available when you want to jump ship  Repurchase Rule: Discretionary event. “May I please sell my stock back?” SH needs money  Proper Source Test: paid in surplus, earned capital  Solvency Test: Have Enough? Must pass both o Balance Sheet Test: assets greater than liabilities o Cash Flow Test: must be able to pay debts when they come due  Look for these facts: corp is redeeming stock but defaulting on paying rent or other bills. This corp does not pass solvency test b/c can‟t pass  “BJR no second guessing” in my notes but don‟t understand???  REMEDIES: check to see if there is a release from “due care” in the Articles? o Will this release get a BOD out of the following? o $ HAS NOT been paid out then cancellation of dividends. Other SH‟s are able to cancel the dividends. o $ HAS been paid out then:  BOD‟s liable for damages b/c they declared dividends when they shouldn‟t have.  SH culpability: SH‟s who knew of the illegality are liable for damages  Insolvency: if the corp. is insolvent, then the receivers may be liable for damages. WMC Corporations Fall 2003 Management: Managerial functions- setting salaries, declaring dividends, appointing offices. Remember in a CLCHC: directors and officers and passive shareholders unless wearing multiple hats…SH‟s can‟t manage in a CLCHC. SH‟s can‟t vote on ordinary matters.  CLCHC: McQuade v. Stoneham, San Fran. Giants. The corp. is managed by the BOD not the SH‟s (passive). SH‟s can‟t vote on ordinary matters, but can get this power but amending the Articles. However, the BOD must support the amendment.  SH‟s can vote ONLY on extraordinary/fundamental matters: o Electing directors  SH agreements: can SH‟s agree who they are going to elect as directors? YES o Removing directors o Mergers and consolidations o Dissolution o Amending Articles and Bylaws o Cannot engage in ordinary matters of management  Order of Voting in CLCHC o 1st BOD votes on fundamental matters b/c they have expertise o 2nd SH‟s vote  Removing Directors o SH can remove directors either for cause or w/o cause  Cause: Breach of Fiduciary Duty: Loyalty and Due Care  Auer v. Dressler, Settled law that SH who are empowered to elect directors have inherent power to remove for cause. This requires:  Service of specific charges  Adequate notice  Full opportunity of defending against the accusations  Amending Articles or Bylaws: o 1st BOD then 2 nd SH‟s o Rule: SH‟s can vote to amend the Articles/Bylaws provided there is no substantial harm to other classes o Red Flag: Whenever you see on class of SH‟s doing something to another class, ask is there substantial harm being done to the other class? If YES, can’t be done. o In Stoneham, the voting agreement stipulated that SH‟s could engage in ordinary matters, since this was a CLCHC, the agreement was non-binding.  Analysis: SH’s are voting on ordinary matters? o Is this a CLCHC or SCHC?  Statutory: “this is a closely held corp and there are no more than 35 stockholders” YOU MUST HAVE THIS LANGUAGE IN THE ARTICLES o What Role are they in when entering into the transaction? o Hat they‟re wearing? If a SH, what they can do depends on CLCHC or SCHC. o Analyze from the director‟s point of view: Timing is key. Did the SH‟s declare dividends before they voted themselves in as directors? If so the declaration will be null and void. o Dividend and salary agreements made as a stockholder are void.  Red Flag: SH’s voting. Can they vote on this matter?  SCHC: SH‟s manage and can vote on ALL matters. SH‟s not obligated to manage but they have the option. If they choose not to manage, they you must have a BOD. Generally there are no public investors and its SH are active in the conduct of business. (mom and pop). The SH are are the BOD and officers. SCHC: Must be in the Articles “this is a closely held corp and there are no more than 35 stockholders and the SH will manage the corporation”  WMC Corporations Fall 2003 o This is to protect creditors and gives notice of management structure  You can chance from a CLCHC to a SCHC by amending the articles o There is NO DEFACTO SCHC  Key: Before the SH’s start managing, the Articles must reflect this or all the transactions of the SH’s are void.  If the SCHC has a BOD, then the SH‟s can only vote on extraordinary matters. The analysis will be the same under CLCHC. o Dividend and salary agreements here are OK b/c SH have the power to vote. Stockholder Action: 2 ways SH‟s take action: 1) Shareholder meeting and 2) by written consent. To vote on matters SH usually have a SH meeting.  Formal Meeting has 4 requirements: If one is missing, the meeting is invalid and any action taken at the meeting is non-binding and void. COA: Is the SH meeting valid or void? o Notice: 10/60 rule: SH must have notice of the meeting no less that 10 and no more than 60 days prior to the meeting.  Waiver: notice can be waived o Record Date: Only SH‟s who are record owners as of the record date, may vote at the meeting. The record owners are kept by the secretary in the corporate ledger. o Salgo v. Matthews: Not all SH‟s can vote at a meeting. Only those SH‟s with voting rights that are record owners on the record date can vote at the SH meeting, unless the beneficial owner gets a proxy to vote from the record owner  Proxy: for a new owner, who acquired the stock after the record date, they must get a proxy signed by the record owner.  Must Contain: both the seller‟s name and purchaser‟s name. The old owner should sign the proxy but the new owner should fill out the vote.  Proxies are Irrevocable:  When legal consideration is given in exchange for the proxy  Proxies are Revocable:  Attending the meeting will revoke the proxy as long as the vote has not been taken  Death/incapacity prior to the vote being taken  Subsequent proxies revoke prior proxies if it reaches the Secretary before the vote. o Quorum: The number of members who must be present in a deliberative body before business may be transacted. A majority of the outstanding voting shares (not SH heads) must be present in person or by proxy. o Inspector of the election establishes quorum o Only way to avoid quorum limitations is to amend bylaws or articles BUT:  Rights of minority SH can‟t be injured. Rule: Majority SH’s owe a fiduciary duty to minority SH’s  Super Majority: (2/3 or higher) To protect yourself against a take over, prior to a potential takeover, amend the Articles to require a super-majority approval requirement. o Valid Vote: Usually a majority of the voting shares present or by proxy.  Some corp. require a super-majority on some matters  This requirement must be specified in the Articles  Written Consent: issues circulated through the mail and you sign off on the action. o Valid by majority vote o No quorum necessary o Exception: if the written consent is to vote in directors, they the vote must be unanimous WMC Corporations Fall 2003 o Strategy: If you‟re up for election as a director and don‟t know if you have enough votes, you would rather have SH vote in a SH meeting than by written consent. Voting to Elect Board of Directors  SH‟s vote to elect the BOD by one of two types: Straight or Cumulative. o Straight: each outstanding share is permitted to cast a vote for each position available on the BOD. Insures majority SH control of the BOD. o Cumulative: each SH is entitled to vote consisting of her voting shares multiplied by the number of BOD. Insures that the minority owners can vote in at least one director. Bond with SH‟s to vote as a block. o (100/x+1) + 1 = % what it takes to elect a director o Some jurisdictions mandate cumulative voting to protect minority SH o Impair Cumulative Voting Rights:  Decrease the # of directors on the BOD which may take away the possibility of the minority securing a seat of the BOD  Strategy: Majority amends the Articles to reduce the BOD size (but we assume that cumulative voting rights were in the Articles to protect minority).  Can they really do this? NO, because creates substantial harm to minority shareholders. Remember, Majority SH‟s owe a fiduciary duty of due care and loyalty to the minority b/c majority has power and with that comes responsibility.  Rule on Removal: Directors elected through cumulative voting may only be removed w/o cause by cumulative voting. Ensures that a director elected by the minority will be able to stay on as long as he satisfies the minority interest. If it too 26% to get the director in then it takes 26% to keep him in. Types of Board of Directors o Straight: All directors are elected each year at the same time  Easier to take over o Staggered: Only a certain number of directors are elected each year  Protects boards against takeovers b/c it takes awhile to get a majority o Classified: certain classes can elect a certain amount of directors for their own classes o Can be classified and staggered or classified and straight o Note: If there is a staggered or classified board, where cumulative voting is taking place, you must have more than one director coming up for election each year. If there is only one director being voted in, cum voting is nullified. (math=51%)  GET IN THE ARTICLES not BYLAWS b/c majority can change this. Board of Director Action: Can either be through a BOD meeting or through unanimous written consent. COA: is the BOD meeting valid?  Meeting  Notice: reasonable, 24-48 hours is considered reasonable.  Quorum: majority of the originally authorized number of BOD‟s (9 directors, need 5 for quorum) Counting heads. o Exception: If vacancies so can‟t make quorum, then BOD may fill posts, but that is the only thing they may do. BOD vacancies can be filled by BOD or SH depending on what the Articles say. Question: can they fill all the vacancies or do they just fill to quorum?  Valid Vote: a majority of the those present once quorum has been established.  If one is missing then director’s action is void.  Unanimous Written Consent: BOD can also take action but must be 1) written and 2) unanimous  Teleconferencing: Analysis: must satisfy the same three requirements for a BOD meeting.  ALWAYS: BOD has a fiduciary duty to ALL shareholders. WMC Corporations Fall 2003 Voting Agreements “strength in numbers”  Red Flag: Is it enforceable?  Two Kinds: Pooling Agreement and Voting Trust  Pooling Agreement: SH decide to pool their votes together. K‟l agreement among SH‟s relating to the voting of their shares. (Ringling Bros. Case) Requires: o Proper Purpose: Can the SH‟s vote on these matters?  1st question…CLCHC or SCHC?  CLCHC  Agreement must be ONLY for extraordinary matters, otherwise agreement is invalid  SCHC  SH can vote on ALL matters. Unfettered voting: except can‟t substantially harm other SH classes or the corporation. o Oral or Written: oral allows for SH flexibility. You can change a pooling agreement after you walk into a meeting. Opposite for voting trusts…the trustee has marching orders. o Enforcement: easiest way, appoint an arbitrator.  Voting Trust: Transfer of title by SH of shares in a corp. to a trustee who is authorized to vote the shares on their behalf. (a track relay…handing off)  Red Flag: SH’s handing off baton to a trustee  Four Requirements: o Legal ownership bestowed on trustee: trustee MUST be Record Owner. The former record owner must transfer the stock to the trustee. Secretary cancels the old certificate and issues a new one in the trustee‟s name. Separation of legal title.  Trustee cannot automatically vote, she must be the record owner on the record date. o Agreement in writing: Insures distributions go to the beneficial owner. Verify there is a provision stipulating dividends go the beneficial owner, otherwise trustee gets them as the record owner. o 10 year limit: irrevocable through out the time period o Only vote on Proper Matters: same analysis as pooling agreement. CLCHC or SCHC? Can a SH vote on this matter? Other Voting Information o Trustee has a fiduciary duty of LOYALTY/GOOD FAITH to the beneficial SH’s in the trust  Must vote in accordance with the SH‟s preference  Brown v. McLanahan: under corp. voting trust, “A trustee may not exercise powers granted in a way that is detrimental to the actual owner of the voting shares, nor may a trustee for different classes favor one class at the expense of another”  Red Flag: look to see if trustee’s vote benefits SH’s or themselves o Voting Trust: written and open for inspection at corp. headquarters b/c it o Void: if any of the four requirements are missing every matter voted on void o Not Enforced: if a voting trust causes substantial harm to other SH‟s it will not be enforced Stock Transfer Restrictions: allows corps to preserve control of the corp or to comply with the code provisions or federal securities laws  Most states require restrictions to be in the Articles b/c public document  Events which trigger a transfer: o Sale of stock o Death of SH o Bankruptcy WMC Corporations Fall 2003 o Divorce o Insanity  Requirements for stock transfer RESTRICTION to be valid: o Conspicuous in Form: Written on the face of the stock certificate. They should stick out (different font, bold, large) o Conspicuous in Content: It must detail specifically the triggering event  Exception: actual notice will overcome these two requirements o Reasonable: depends on relevant code. Usually restrictions dealing with death, incapacity, transfer by sale, divorce, bankruptcy are considered reasonable. o Red Flag: See a restriction. Ask, is it legal and valid?  Scenario: someone showing up at the meeting who is not an original SH. (guardian, creditor, widow)  Analysis: If the restriction fails either test, than it is invalid and the transfer is GOOD. However, if the restriction is valid, then the transfer is VOID.  Who is suing? o Corp. v. transferor o Corp. v. transferee to get the stock back Director Activity: Can the director bind the corp. when he/she is action on their own?  without calling a formal director‟s meeting? o Telephonic conference is like they are “in the room” together  without action through a unanimous written consent?  Mickshaw Exception: CLCHC or SCHC Q: Is the director’s action valid? Red Flag: You see a long director enter into a K and then the corp. pulls back: Question is: Do they have authority to bind the corp?  Mickshaw Exception: under certain circumstances the action of one director will bind the corporation. REQUIRES BOTH 1&2 o 1: After the fact, the remaining directors acquiesced to the action with FULL KNOWLEDGE  WO: director who only gave partial information  Implied acquiescence is OK. o 2: The action cannot harm the stockholders, creditors, or the corp.  some jurisdictions allow for non-shareholder constituents: community o If you don‟t have both, then the action taken by the director is invalid. Process: If you can’t find Director authority…look for Officer authority…if no here…go to SH. Officer Activity: What happens when a corporate officer enters into a K and there is doubt as to whether the K is binding? Q: Do they have the power? If no, and they are acting outside of their authority…they are liable. Officers: minimum 4 positions w/ minimum 2 people  Must always have: President and Secretary as separate people  Pres. VP Treasurer Secretary o Link: if all four positions are not filled in a CHC then this is a “lack of adherence to corporate formalities” and looking for PCV COA.  Normally, if the 3rd party the corp is dealing with enters in a K with the corp and has resolutions signed, stamped, dated by the secretary, then the corp is bound EXCEPT if the 3 rd party had knowledge the secretary was crazy. WMC Corporations Fall 2003 Red Flag: You see a corp. officer enter a K/transaction and then the corp. pulls back, the question is DO THEY HAVE THE AUTHORITY TO ENTER THE K?  COA: Is the officer action valid?  Authority to Bind: o Express: Resolutions passed by BOD‟s and certified by Secretary will not be questioned. Certified board resolution!!!  Other sources: Articles, Bylaws, and Statutes  Any officer can be given “express” authority  Must be given properly: meeting or vote valid? o Implied: Absent express authority…ONLY President has implied to enter into day-to-day K‟s: hiring, firing, ordering inventory, loans  VP: can‟t get implied authority ONLY IF the president is so INCAPACITATED that he/she can‟t do ANYTHING.  Sec: can get it if BOTH Pres/VP are incapacitated  Treas: can get if ALL 3 are totally incapacitated  Can’t bind the corp in EXTRAORDINARY K’s  Examples: loans may be too big, too long, too taxing Note: Be sure SH‟s act as they are supposed to.  Director/Officer: authority to bind?  Can they bind as a stockholder? o CLCHC: No b/c SH‟s are passive…not managing o SCHC: possibly PUBLICALLY HELD CORPORATIONS BIG GOAL: protect integrity of the market!!! Stock traded on national exchanged OR corp. with more than 10 million assets and over 500 SH’s in a single class. Proxy Solicitation: Purpose of 14(a) is to prevent management or others from obtaining authorization for corporate action by means of “deceptive or inadequate disclosure” in their proxies. The purpose of proxy protections in ensuring that SH‟s have adequate knowledge about the financial conditions of the corp and the major questions of policy, which are decided at SH‟s meetings.  The Purpose of 14(a) Is Disclosure to SH’s. o INACTIVE BY ITSELF…must get paired up!!! o  Section 14(a): It shall be unlawful for any person, by use of mails or by any means or instrumentality of interstate commerce…to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to Section 12 of this title  WO: whenever there is a vote in a publicly held corp…check to see if 14(a) applies to the vote. 14(a) contains rules and regulations that prohibit certain conduct arising in the solicitation of votes in publicly held corp. If there is a solicitation, there must be a filing with the SEC. o Mostly dealing with mergers. o Est. private COA for people victimized by false/misleading proxies used during a merger. 14(a) Elements COA: MUST HAVE ALL THREE  Solicitation: occurs when there is a request for a vote or proxy or even when there is a plan for solicitation  WMC Corporations Fall 2003 o Proxy: written authorization by one person to another so that the second person can act for the first, such as, that given by a SH to someone else to represent him and vote his shares at a SH meeting. o Anything: that will end up as a solicitation will be viewed as a solicitation. Any communication to a SH as part of a continuous plan intended to end with solicitation of the SH‟s right to vote is considered a “proxy solicitation” o Solicitation…kicks in Disclosure requirement  Use of Interstate Commerce: IC required. Mail or trading of the stock. (internet)  Publicly Held Corp: o Advantages of “going public”: big money investment for corp from general public, increased liquidity. Disadvantages: DISCLOSURE o Own stock in publicly held corp: get annual report that must have been filed with the SEC. Proxy card included.  If you get your annual report and you think you’ve been lied to, your COA is under 14(a) o Note: BOD COULD let you vote on an ordinary matter. This allows the minority SH to have a voice. Directors do this to keep the minority SH‟s happy so they don‟t vote them out. Thought Process: 14(a) COA…then go to 14(a)(9) 14(a)(9) COA: SH’s v. BOD, and other SH’s responsible for sending out inaccurate proxies.  14(a)(9): Prohibits false or misleading statements or material omissions (of fact) made in connection with a proxy solicitation (including a plan)  Elements: o First: establish 14(a) first o Standing: Both the SEC and individuals  Essentially deputized every person in US to regulate corp. solicitations o You must find a false/misleading statement or omission:  Count as many false/misleading statements or omissions as possible  Each one is a “separate count” = more damages o Material: Substantial likelihood that a reasonable person would find the facts important  Oral Statements: of reasons, opinions or beliefs are considered “material facts” under 14(a)(9) purposes  Both written/oral statements can be used to get management or SH‟s for false/misleading statements/omissions  Opinions: need to know that these are not true or based on known facts which aren‟t true. o Mental Element: Simple Negligence  Low standard b/c of the Grand Canyon between SH and management as far as availability of information is concerned.  CA: corporate accountability o Causation: Essential Link Test The false/misleading statement must have led to a majority vote approval. Not simple “but-for”  Was your vote needed to pass the action?  WO: majority v. super majority (look to Articles)  One Excepton:  Did the false/misleading statement/omission cause the Pl. to waive their state remedy? If so, then you have a COA. (Lied to so voted for merger and waived “appraisal” remedy) WMC Corporations Fall 2003  If you‟re a minority SH and you‟re lied to by majority SH, you can‟t prove essential link test. Your 14(a)(9) COA is dead b/c you can‟t prove causation (your vote wasn‟t needed) o Sue under breach of fiduciary duty of loyalty  However, you must have voted against the merger. Remedy here is “re-evaluation” of stock.  Remedies of 14(a)(9) violation: DAMAGES #1 Reason in Fed. Ct. w/ SEC laws o Enjoin: stop further solicitations w/ defective information o Rescind: “take back” any action taken on the basis of proxies acquired through defective information  Ex: If the proxy solicitation resulted in a director being voted in, the SH‟s can remove the director with the 14(a)(9) and a call for a new vote. o Merger Situations: Damages are ordered rather than an injunction.  Too hard to undue b/c time will go by as this goes through court system o Appraisal Remedy: court reevaluates the stock price  1. vote against the merger  2. bring this in state court Shareholder Proposals 14(a)(8): Allows individual SH to place proposals in proxy statements. SH will present management with a proposal before the annual meeting and request that management inserts the proposal in the proxy materials so s/he can avoid the cost of contacting everyone by t hemselves. Management doesn‟t have to include the SH proposal; THEY CAN REFUSE. But the SH can go to the SEC and COMPEL management to include the proposal but on if they have:  Standing  No grounds on which management can rely for exclusion  SH Proposal: SH recommendation or requirement that company and/or its BOD take action which they intend to present at a SH meeting. Red Flag: 14(a)(8) SH giving the BOD a proposal and the BOD ignores it.  Proposal accepted then there is no 14(a)(8) action o Could be “Due Care” or 14(a)(9) issue! o WO: SH proposal included and also includes false and misleading statements…then 14(a)(9) issue Standing: At the time the SH‟s submit the proposal  Must be record/beneficial owner of either 1% or $2000.00 of the company‟s voting stock AND must have owned this amount of stock for at least one year prior to the meeting. o 5% usually need to examine corporate records: usually of SH‟s info Grounds for Exclusion by Management: Four Types  Ultra Vires: Management may refuse to include the proposal b/c it is beyond the powers or purpose of the corp. to effectuate. o SH would first have to amend the Articles o Under MBCA, a SH proposal to amend Articles should be excludable on the grounds that it is not a proper subject for SH action in the absence of initial consideration and favorable recommendation by BOD.  Management Functions: can be excluded if it deals with matters relating to company‟s ordinary business operations o Ordinary matters dealing with social policy issues MAY NOT be excluded.  Mircosoft proxy statement/proposal covered in class used words like “social” and “policy” to make sure it got in.  HIV/AIDS: social policy that corp. can‟t hire/fire based on status WMC Corporations Fall 2003   Relates to Election of Directors: 14(a)(8) COA may NOT be sued to propose a new slate of directors. The BOD nomination committee is in a better position to pick the slate b/c they have information that the SH doesn‟t. Counter to Management Proposal: SH proposal is contrary to that of management, then the BOD may exclude it. o Ex: BOD say we urge you to vote on this merger and SH urges to vote against. Required? NO, but Watch Out!  The BOD doesn‟t have to exclude the SH proposal simply b/c it fits into one of the 4 categories.  BUT: if they could have excluded and they don‟t and something goes bad (losses occur) they can be sued for breach of due car. o If they accept and it was a “bad choice” no 14(a)(8)..but breach of duty of due care. BOD BEST FRIEND: THE BUSINESS JUDGMENT RULE (BJR)  Presumes when the BOD makes a decision, they acted with (1) Due Care (2) Loyalty & Good Faith and within their (3) Authority  BJR: Decisions by the board are usually protected by the BJR which acts like a “comforter”  Rationale: o Judges are not businessmen and they don‟t like to second guess o Every decision by the BOD involves some risk for a corp to grow o Without BJR, BOD would be sued constantly  Three Ways to Overcome and PIERCE the BJR  Note: Directors/Officers get protection from liability by purchasing D&O liability insurance Red Flag: Whenever the Board makes a decision, check to see if the BJR applies? o Prove BOD acted with:  Lack of Due Care  Breach of Fiduciary Duty of Loyalty  Actions outside the scope of Director Authority (easiest one) #1 Breach of Due Care: STATE CAUSE OF ACTION  Duties: THESE CARRY OVER TO OTHER THINGS…KEEP IN MIND o Duty to be informed of material facts reasonably ascertainable o Duty to monitor information process so you’ll be informed o Duty to Disclose material facts at event o Duty not to lie about material things  Annual meetings  Proxy solicitations  Voting situations  Prospectus Two Types: Litigation and Non-Litigation Who’s Suing: SH and/or creditors are suing the BOD‟s as a whole! Red Flag: The BOD makes a decision and losses accrue/occur. Must have a decision with losses OR look for a non-decision. The BOD didn‟t do anything the corp suffered losses. Note: BOD can be liable for any kind of inaction they engage in.  BOD’s has a duty to be informed and to verify information flows through the corp so that officers have the necessary information to make informed decision.  Prima Facie Case for Breach of Due Care: non-litigation o Plaintiff must overcome presumption of BJR WMC Corporations Fall 2003 o Standard of Care:  Reasonable prudent person in similar circumstances AND  Duty to be fully informed Includes: o Adequate Deliberations: thoroughly examine relevant documents. o Seek Independent Experts: independent evaluations especially needed in merger situations. o Fairness Opinion: o Duty to ask questions o Breach: Gross Negligence  Rationale: if breach was just simple negligence, otherwise qualified persons wouldn‟t want to be on BOD for fear of constantly being sued b/c simple negligence standard is too low.  Examples: Declaring dividends w/o checking the accountants first (also illegal dividend issue), Approving a cash out merger w/o requesting any substantiating data to verify there was an accurate valuation of the stock.  Van Gorkom: could argue 14(a)(9) violation too b/c when SH‟s voted yes on the merger you could argue there was a false/misleading statement or omission made in connection with a proxy solicitation…the omission in this case was that the corp implied there was an adequate investigation/valuation of the buyout price made by the BOD.  Water Case: BOD not grossly negligent for relying on a psychic who had a 90% accuracy rate in the past, but this time was wrong. o Causation: But for test…but for the decision, losses would not have occurred. o Losses: Monetary or good will equal losses.  Examples: decrease in the stock value, loss of dividends not being paid out as a result of the lack of due care, good will  Remedy: breach of due care by the BOD…prospective damages even punitive  Defenses: BOD can utilize in response of breach of due care COA o Statutory Protection: Local statute allows the BOD to limit their liability in due care COA by placing a provision in the Articles o “The BOD will NOT be liable for damages in a due care COA” o Note: This does NOT protect BOD from liability from breaches of loyalty or injunctive relief. o Good Faith Reliance on Proper Experts: Fairness Opinion  Not only do they have to be an expert, but must be a proper opinion  An engineer is an expert, but if he says “I feel it in my bones that there‟s oil here” w/o doing scientific study, this is NOT good faith reliance even though he‟s an expert o Individual Director Voted Against/Abstained/Absent from the Action  Bad Defenses that WON’T WORK: o BOD has the necessary experience to make the right decision o Market will set the right price (efficient market capital hypothesis) Doesn‟t work when full information isn‟t going in to the market (Sponge) o SH approved the action. Approval is valid only if the SH‟s are fully informed o SH‟s should be “happy” Breach of Due Care: Litigation: Kerr said we won’t need to know process  WMC Corporations Fall 2003  Stockholder Derivative Suits: SH brings a lawsuit on behalf of the corp. Why do we need SH derivative suits? B/c many times the action will be against the directors themselves, directors would never bring an action against them. o Direct Suits: As opposed to derivative suits. In direct suits, the $ goes straight to the SH (COA to compel dividends). o Derivative Suits: brought on behalf of the corp. o Decisions to Litigate: The BOD decides whether or not to bring a derivative suite on behalf of the corp. A derivative suit is appropriate when the corp in general has been harmed. Derivative suits cannot be based on personal grievances. Analysis for decisions to litigate or not to litigate by a BOD: o Proper Procedures MUST Be Followed:  Make a DEMAND: on the BOD to sue is required.  Burden: SH to prove the BOD weren‟t fully informed o Q: independent litigation committee in existence?  If no litigation committee, this is AUTOMATIC GROSS NEGLIGENCE and SH wins. o 99%: are demand required o BJR: locks on immediately in these situations  Exceptions: Demand Futile  Demand would be futile b/c BOD is not impartial.  SH goes straight to court and MUST DO following THREE: o 1) Prove: Contemporaneous Ownership  SH owned at time action arose  Record owner (in majority jurisdiction)  # of shares (jurisdiction usually silent) 1 enough o 2) Post a Bond o 3) Plead Particularized Facts: P‟s must show that at least a majority of directors are personally interested in the underlying transaction  Who can you name in the complaint? Can‟t name w/o showing that they‟re conflicted. To be conflicted, must have direct pecuniary gain. How do you show that? No paper trail, no mea culpa, no discovery at this stage? In DE it‟s very difficult to bring this b/c you have to allege particularized facts. Board of Director’s Reaction: MOTION TO DISMISS  If Plaintiff is SUCCESSFUL, burden shifts to BOD  Now Court Applies Zapata Two Prong Test: o 1) Litigation Committee Must Prove  1. They made their decision independently, with good faith, and acted with full knowledge. BOD burden to prove this. o 2) Court applies its own judgment that the motion to dismiss filed by the BOD shall be granted/denied. It looks at:  Consumer, ethical, economic considerations, public relations, employee relations, legal judgments.  Rationale: second step is b/c courts feel BOD lost their privilege to decide the question for themselves b/c they didn‟t act independently in the first place.  Issue: Fiduciary Duty of Loyalty owed only to SH.  Consider other constituencies only as it benefits SH. WMC Corporations Fall 2003  Example: Ford Pinto…less expensive to pay wrongful death claims and not fix the design of the car. BINGO: if BOD passes both 1 and 2, then BJR attaches to the BOD. COA: Five different kinds of Breach of Duty of Loyalty: (don‟t call it general one) 1) Interested Director Transaction 2) Management Compensation 3) Parent-Sub Non-Merger Transaction 4) Parent-Sub Merger Transaction 5) Usurpation of Corporate Opportunity Interested Director Transaction  COA: Self Dealing  In an Interested Director Transaction, a director may be liable for breach of loyalty if they enter a transaction on behalf of the corp for his/her own personal benefit.  Red Flag: You see a director on BOTH sides of the transaction (loans/buying or selling property)  BJR doesn’t apply yet…Director has the BURDEN of proof here. No BOD action, just individual director/directors. CL this was per se, VOID, but a majority of jurisdictions will allow the transaction but it is VOIDABLE unless the interested director can prove: o Disinterested Approval by BOD: BOD approved the conflicted transaction with FULL DISCLOSURE.  Only disinterested BOD members may vote  The “interested” vote/s can‟t count towards approval but can count towards quorum  Want formal meeting b/c written consent must be unanimous  Cross over: BOD meeting valid? Full Disclosure required, even if with a valid vote. If the BOD approved the transaction and losses occurred, breach of due care COA. Watch out: Corporate Opportunity issues…BOD votes no, but then takes the opportunity for the corporation alone. o Disinterested Approval by SH’s: Transaction is valid if there is approval by a MAJORITY of DISINTERESTED SH. There must be full disclosure by the conflicted director.  Conflicted stock DOESN’T count towards the vote  WO: if the conflicted director owns a majority of the stock, then there can be no SH approval o Intrinsically Fair: Show in court the transaction was intrinsically fair. Must be fair the SH, creditors, and the corporation. Management Compensation  COA: Self-Dealing  Directors determine officer compensation. Self-dealing problems arise when the officers and directors are the same people. (Note: If directors are deciding their own compensation, this might be an interested director situation also)  Avoiding Self-Dealing Problems: Publicly held corporations create a compensation committee composed of “outside” directors (non-officers). If there is no compensation committee, the directors are deciding their own compensation.  Challenging Compensation: o Publicly Held: Waste/Spoilation standard  Old Waste Standard: The compensation must be trashing the company financially. Hard to prove Waste. WMC Corporations Fall 2003  New Waste Standard: entails an exchange for corporate assets for consideration so disproportionately to be beyond the range @ which any reasonable person might be willing to trade (SH‟s Eisner and Ovitz)  Exception: Good faith by BOD‟s that judgment was worthwhile then considered not wasteful and BJR locks on  It can be that the exchange is so risky that substantial consideration is needed to get the person to take the risk. Again look to good faith.  Serious financial impact (Grasso and NYSE)  So hard b/c SOO much bigger than CHC‟s and bigger compensation expected o Closely Held: Unreasonable standard  Unreasonableness is easier  Factors: industry standards, type of position, location (cost of living)  Compensation COA: will fall under either o Interested Director: directors are also officers o Normal Business Transactions: directors are deciding salaries of officers but not of themselves (Grasso). In this case, not breach of loyalty, so you apply the due care analysis if the director‟s decision lead to losses for the corp.  Standard, Duty, Breach, Loss  Standard: Waste (not gross negligence) Parent-Sub NON-Merger Situation  Typical scenario is MINORITY SH‟s of the subsidiary corp are challenging the action of the parent (to be a parent 50+% of the subsidiary)  Who‟s suing? Minority SH‟s of the subsidiary are suing the BOD of the parent  Remember: The parent as a majority SH owes a fiduciary duty to the minority SH’s (subsidiary). The parent only owes a duty of LOYALTY, not due care. o Sinclair v. Levien, Sinclair (parent) sued by Sinven (subsidiary) for alleged breachs of loyalty in 1) dividends paid out of the subsidiary (this failed), 2) denial of opportunities from the subsidiary (this failed) and 3) causing the subsidiary to breach a contract (success)  Red Flag: Parent-Sub, Non-Merger situation, where parent is “mistreating the sub.” o Treating subsidiary as a treasure chest.  Analysis in this situation: o BJR doesn’t apply at the beginning…hard test to prove…if successful then BJR will attach. o Initial Burden w/ Minority: subsidiary so show parent received a BENEFIT to the exclusion and detriment of the minority SH‟s of the subsidiary.  WO: if the minority receives ANY type of benefit the COA fails.  Check for: different classes of stock o If Minority Successful: burden then shifts to parent corp to show the deal was intrinsically fair to the subsidiary and the minority of the SH‟s of the subsidiary.  Parent argues that there is a long term benefit to the subsidiary  No $ now, but you‟ll get some later…  Good will  Delayed Gratification: parent argues that they had big picture/information the minority SH‟s didn‟t have. “It looks bad now but wait until later.” Benefit to Subsidiary Proven by Parent = BJR lock on  Remedies: If parent fails and BJR doesn‟t apply…Damages (money) Parent-Sub CASH OUT Merger Situation WMC Corporations Fall 2003  Here, attempt to gain 50+% or more of the stock of the subsidiary to gain majority control. After this, a cash out merger takes place.  Who’s suing? The minority SH‟s of the subsidiary are suing the directors of the parent.  Process: A corp makes a CASH tender offer to obtain at least 50+% of the stock of another corp. With ownership of 50% of the stock, the corp becomes a parent and can facilitate a cash-out merger, essentially buying out the remaining minority SH‟s. o Board Approval:  Both BOD’s must vote  The BOD must approve the merger before it goes to the SH‟s (extraordinary matter). A majority of disinterested directors must approve the merger. The interested directors may be counted towards quorum, but cannot vote for approval of the merger. After BOD‟s approve goes to SH‟s.  Bear Hug: B/C SEC laws require that the BOD respond to a “tender offer” on whether it is fair or not…the company wanting to merger wants this process to be friendly and not hostile. (Approaches BOD 1 st) o Shareholder Approval: SH‟s must approve the merger through a vote b/c it‟s an extraordinary matter. The interested SH‟s in this can (parent majority) may NOT vote on the merger, but their votes may count towards quorum.  Not a Short Form Merger: both corporation SH’s must vote  Most likely going to be lied to here in a “cash out” merger  Initial Burden on SH’s: o Breaches of loyalty are disgusting, therefore the SH‟s need not prove gross negligence as in due care COA. o Standard: Simple Negligence: SH‟s must present FACTS showing BOTH:  Lack of Fair Dealing:  Requires TRUE NEGOTIATION  Full Disclosure of material facts  BOD obtained a fairness opinion  Negotiation Committee made up of impartial/outside directors and experts o No Negotiation Committee..SH’s WIN COA  WO: 14(a)(9) false and misleading statements/omission of material facts  Lack of Fair Price:  There must have been negotiations over the price being paid to the minority SH‟s for their stock which the majority is cashing out.  Minority SH‟s can‟t directly manage = victims  If SH’s prove both lack of fair dealing AND price, then the burden shifts to the BOD’s of the parent company  BOD’s to show deal was FAIR o BOD‟s to show that as directors they were serving the corp and not themselves. o Fairness established:  Existence of arms length negotiations  Final price paid for subsidiary SH‟s stock that was cashed out was within the initial fairness report range  Remedy: The minority SH‟s of the subsidiary will attempt to RESCIND the merger, but this is unrealistic (too difficult to unwind). o Appraisal Remedy: difference b/w what they were paid in the merger and the actual value of the stock if there hadn‟t been a breach of loyalty by the parent BOD‟s. WO: COA‟s that stem from this type of fact pattern: Breach of Loyalty challenge brought against the parent BOD‟s by the subsidiary‟s minority SH‟s.  14(a)(9) COA: there are two. WMC Corporations Fall 2003 o Both corporations SH‟s must have approved the merger…via proxy…so there lacked full disclosure to both corporations  Breach of Due Care COA o Subsidiary minority SH‟s against their own BOD‟s for not negotiating with eh parent BOD‟s over the price they would have been paid for their stock. o Look for negotiations  Breach of Due Care COA o Against parent BOD‟s by their own SH‟s for making a decision that caused losses to their SH‟s through the merger.  10(b)(5) can be filed by future minority SH’s of the subsidiary corp against its BOD‟s. Usurpation of Corporate Opportunity  A director takes an opportunity from the corp for their own benefit.  Who‟s suing: SH derivative suit (or creditors) are suing a director individually who took the opportunity  BJR doesn’t apply b/c not action by the BOD’s as a whole  Individual Director has the Burden of proving WAS NOT a corporate opportunity o Not initial burden by SH‟s o Director owe 24/7 fiduciary duty of loyalty: DUTY TO BE INFORMED  Test: Is the opportunity within the current plan of the corp  Line of Business Test: o In a majority of jurisdictions, a director has usurped a corporate opportunity if the acquired asset or business is within the corp.‟s general line of business. Ask if the the opportunity is one in which the corp has an interest or reasonable expectation and by embracing the opportunity, the self-interest of the office or director will be brought into conflict with that of the corp?  1: Was the opportunity fully disclosed to the BOD?  2: Was the opportunity within the CURRENT or FUTURE interests of the corp? Is the opportunity essential to the corp‟s present business?  3: How did the Director learn of the opportunity? Weak factor…b/c the director has the 24/7 duty of loyalty.  ALI APPROACH: A director/officer may not take advantage of a corporate opportunity, unless:  1) they first offer the opportunity to the BOD‟s and make full disclosure regarding the conflict of interest  2) the BOD‟s rejects the opportunity  3)the rejection is fair to the corp, the opportunity is rejected in advance by the disinterested directors in a manner that satisfies the BJR, or the rejection is authorized in advance by disinterested SH‟s and the rejection is NOT a waste of corp‟s assets.  Director Defenses against Usurpation of Corporate Opportunity COA: o “Just for You: person offering the opportunity refuses to deal with the corporation and is only offered to you individually o Disclosure: to the BOD‟s with their FULL APPROVAL  Cross over: Due Care: Did the BOD‟s decision cause losses to the corp? o UV: specific purpose clause and so corp. can‟t do this particular deal  Slam Dunk Defense o Illegal: corp couldn‟t take advantage of the opportunity (anti-trust or tax) o Acquiescence: The BOD‟s knew about the opportunity and did nothing (statutes don‟t tell us how much time must past before this defense is valid) WMC Corporations Fall 2003 o BAD DEFENSES  Corp couldn‟t afford to do the deal: can always get credit  Corp. didn‟t have necessary personnel: can always hire people  I‟m stupid and didn‟t know: directors have a duty to be informed, this defense may limit DAMAGES but not a CT.  Remedies o Constructive Trust: (CT) Takes the property/opportunity from the director and gives it to the corp. If the property/opportunity has been sold in the meantime, the profits from the sale go back to the corp. o Damages: Will be awarded only if you can prove the director acted in BAD FAITH. Did the director know the opportunity was a corp opportunity? Insider Trading: Public and Closely Held Corporations 10(b)(5): Prohibits false or misleading statements or omissions made in connection with the purchase or sale of a security. 10(b)(5) Is a type of “omission” b/c of the failure to disclose the material inside information. Insider Information: Non-public information. Trading on inside information is considered bad b/c it creates an unfair advantage for the trader versus others in the market. SEC wants to preserve integrity of the market. o Traditional Insiders: Directors, Exec. Officers, Majority or controlling SH. o Constructive Insiders: Anyone in a position of TRUST or CONFIDENCE with the corporation  Lawyers, Financial Institutions, Accountants, Engineers, Possibly blue collar employees: like janitors. Chiarella, Legal Printers.  Must have a fiduciary relationship with the corp to be considered a constructive insider!!  NO: family relationship alone  NO: security guards hired to patrol outside and rush in during a fire and find confidential information and trade. But if they found the information outside in the bushes where they patrol, they CI. BIG RULE: ANYONE considered an “insider” either constructive or traditional, has a DUTY TO DISCLOSE or ABSTAIN from trading or tipping on inside information.  Adequate Disclosure Requires: If you‟re going to trade on inside information, there must be adequate disclosure. o Widespread Disclosure: national source/newspaper (AP newswire, NY Times) o Reaction Time: market reaction time after disclosure: 10-15 minutes. o Personal Disclosure: you are trading. Prima Facie Case for 10(b)(5): for either Public or Closely Held  Interstate Commerce: must be some type of IC  Standing: proper plaintiff and proper defendant o SEC: always has standing to sue o Private: Must be the ACTUAL purchaser or seller of stock at issue, or someone who received the stock through a merger. It‟s not good enough if the Plaintiff says they would have bought or sold but for the non-disclosure. o A stockholder voting on a merger transaction is considered an actual purchaser or seller, once the merger goes through (you also have 14(a)(9) COA.   WMC Corporations Fall 2003  Proper Person: TRIAGE, A person who has a duty to disclose the inside information, or refrain from trading. Note: possible for person to fall under more than one category…so put them in ALL that they go under…multiple COA‟s for liability. The more you get the more damages are available. o Self-Trader: an insider who personally benefits. (doesn‟t pass, trades)  Insider: Traditional or constructive  Benefit: either financially/non-financially (reputation, feel good) o Tipper: an insider who “tips” information but doesn‟t necessarily trade on it. There is no requirement that a tipper actually trade.  Insider: traditional or constructive  Benefit: financially/non-financially (reputation, feels good, revenge) o Tippee: A person who receives information from a “tipper” and TRADES ON IT. The “tippee” does not have to be an insider. For a person to be considered a “tippee” the tipper must have INTENTIONALLY given the information to the tippee. No eavesdropper!! He‟s not a tippee and has no liability.  Tippee’s Tipper: Insider, either constructive or traditional  Tippee’s Tipper: MUST personally benefit (financially/non-financially) (ax to grind, self-esteem, family relationship enhanced).  Tipper KNOWS or has reason to know: the tipper breached his/her fiduciary duty in tipping (knows they are a traditional insider…slam dunk) Look for the Pivot: When a tippee becomes a tipper…gets the info…pivots… and tips. If you are a tippee and an insider, as soon as you pivot around and tip the inside information, you have become a tipper. If you trade, you‟re a self-dealer.  False or Misleading Statements or Omission: Insider trading is a false or misleading statement or omission because you‟re not disclosing that you‟re trading on inside information. o TO DO: identify the FSMO that has not been disclosed. o TO DO: identify the fact that they had a duty to disclose  Materiality: the inside information must have been material. That is, there must be a substantial likelihood that a reasonable person would find the facts important o Facts…but in Texas Gulf Sulphur we learned that material information can be “speculative”  Reliance: “presumed” There must be proof that P relied on the non-disclosure of the information in trading. If P would have traded anyway, there is NO reliance.  Scienter: The intent to do the prohibited act. o D has to know that what they are doing is wrong o If your‟re a traditional insider…ignorance is not bliss…you should know what adequate dissemination is. o Hard to prove: intent to commit fraud…intent to trade on inside information.  Causation: but for the non-disclosure, damages would not have occurred. o Not just in possession, but used it  Defenses and Remedies to 10(b)(5) o Defenses: Adequate Disclosures  Disclosure through national media  Market needs time to react: 15 minutes  Disclosure at annual SH meeting not good enough o Remedies  Treble damages as punishment from SEC  Private party damages  Injunctions  Recission or Specific Performance WMC Corporations Fall 2003 Misappropriation Theory under 10(b)(5) “outsider trading”: Applies when a person misappropriates information DERIVED from a “fiduciary relationship” then uses that information to trade (buy/sell securities).  Non-public and publicly held corporations.  No insider requirement  Rule: A person commits fraud in connection with a security transaction (buy or sell) when she misappropriates confidential information for securities trading purposes, in BREACH of a “fiduciary duty” owed to the source of the information.  Fiduciary Relationship: “confidential or trust” fiduciary trades on information gained through the fiduciary relationship o Identify WHO holds the duty to be “confidential” Doctor: yes Patient: no o Broker/client, doctor/patient, lawyer/client, psychologist/patient, employer/employee, priest/parishioner o NO: familial relationship, not an “independent” fiduciary relationship o Ex: Doctor asks if he can trade on the information you shared with him. You say “No” and he trades anyway =‟s a BREACH. o Financial Institutions ALWAYS owe a fiduciary duty. Anytime you part with money there is a fiduciary relationship. Prima Facie Case: Misappropriate Theory 10(b)(5)  Someone Misappropriates: information derived from a fiduciary relationships  Scienter or Reckless Disregard: intent to take for self and trade  Defenses: ONLY ONE: DISCLOSURE to the person who you owe the duty to that you are going to trade on the information. You DON‟T have to disclose to the market. Takeovers: A take over is an attempt by a “bidder” to acquire control of a “target” company through the acquisition of some or ALL of it‟s outstanding shares. Takeovers can occur internally through a proxy contest (look for crossover issues) or externally through a tender offer. Ask: What is the duty of the BOD’s? Williams Act 1968: first federal act to require certain procedures in tender offers. 1) Equal footing between corporate raiders and SH‟s by mandating truthful disclosure by the bidder. 2) Requires disclosure because once you‟re out as a SH, you‟re out for good and it‟s in takeovers or cash-out merger situations that a SH is most likely to be lied to. Advantages and Disadvantages of TO’s:  Advantages o Streamline Corporation: Restructure corporate management if entrenched. With new owners, management will either work harder or be ousted. Entrenchment causes stock to be undervalued. o Increases SH wealth: SH‟s get higher price for stock as compared to open market (2030%) o Expands Market Share: TO‟s allow a company to diversify assets.  Disadvantages o Unemployment: In many cases a TO will result in cleaning out corporations, which usually means job losses. o Potential Bust Up: The bidder may have the intention of busting up the corporation and selling off the assets. o Costly: Implementing defensive measures can deplete a corp‟s assets and result in an inefficient use of resources. Takeover Methods: WMC Corporations Fall 2003  Cash Tender Offers/Hostile Takeovers: Most Common. TO are made DIRECTLY to SH‟s of the target corporation as a “cash tender offer” or as an exchange offer of the bidding corporation‟s stock. No need to go to management of the target corporation first. A hostile TO is made directly to SH‟s without management approval and usually for CASH.  Cash-Out Merger: Someone or an entity has acquired 51% of the stock and they say that they want their company to merge with the acquired company. The SH‟s of the acquired corporation are out, and are given cash for their shares. o Defense: run into State court and sue under Control Share Acquisition statute.  Takeover from Soft Underbelly: From inside. Buy stock and then have a proxy contest.  Bear Hug: Approaching the BOD‟s of the target corporation and offer to buy the shares of the target. Takeover Parties:  Tender Offeror: Person or entity make the offer to buy your stock.  Target: The company whose SH‟s are getting an offer for their shares  SH’s of the Target: the person getting the offer Director Responsibility in a Takeover  Bidding Corporation: Duty of Due Care. If a BOD‟s of a bidding corporation decides to takeover another entity, they MUST act knowing that they owe a fiduciary duty of due care to THEIR OWN stockholders. o BJR attaches upfront: A BOD‟s decision to takeover another corporation is covered by the BJR. The board must be fully informed before making its decision. o THE BOD’s owe NO DUTY to the SH’s of the “target” corporation.  Types of Offensive Takeover Strategies Used by the Bidding Corporation o Buys up 4.9% of the corporation‟s stock and follow w/ a “bear hug” Section 13(d) of the Williams Act requires any person or entity who acquires 5% or more a corporation‟s stock to file a disclosure statement with the SEC w/in 10 days of acquisition. o Buy shares or make tender offer up to the control acquisition percentage…Most states have “anti-take over” statutes. (shark repellant statutes) providing protection to target corporations. These statutes state that upon acquisition of a certain percentage of the target‟s shares, the raider is DENIED VOTING RIGHTS from any stock that is purchased UNLESS the existing SH‟s give permission. (varies from 20, 33.3, 50%)  These statutes are VALID CTS Corp v. Dynamics Corp of America o Buy shares or make tender offer without triggering the poison pill. A corp can buy shares or make a tender offer for shares in the target UP TO the triggering level (usually 20-30%) and wage a proxy contest to gain control. Decision to Defend: Is the defense mechanism valid?  Bidding Corporation: owes a fiduciary duty of DUE CARE to THEIR OWN SH‟s. The BJR attaches upfront. They must be fully informed when making their decision to TO another corporation.  Target Corporation: 3 Options 1) Take NO Defensive Action (DUE CARE) or 2) Take Defensive Action (Loyalty) 3) Decides to be Taken Over (Due Care) o Take NO Action: Does Nothing. “just say no” (Due Care) Since the BOD‟s took no defensive tactics, this is covered by Due Care b/c there‟s NO presumption that the BOD‟s is acting out of self-interest (save job)  BJR: applies, In analyzing due care, look for actual or potential losses  Decision NOT to take action: by itself could lead to losses, therefore use a due care COA. (Standard, Breach, Causation, Losses) WMC Corporations Fall 2003  Hypo: Corporation makes a decision to make a tender offer, this falls under due care. This is on the exam.  Who’s Suing: The SH‟s of the tender offeror v. their own board.  Does the tender offeror decision lead to losses? o Target Corporation Decides to be Taken Over: if losses occur  BJR applies at the beginning o Target Corporation Defends: (duty of loyalty) If the board of the target corporation adopts defensive mechanisms, it owes a fiduciary duty of loyalty to its stockholders to act in their interest.  BJR not Automatic Here: When a BOD‟s implement anti-takeover measures, THERE IS A PRESUMPTION THAT THEY ARE ACTING IN THEIR OWN INTERESTS TO SAVE THEIR JOBS  Who’s Suing? SH‟s of the target corporation (lost premium of share price) and the tender offeror are suing the target BOD‟s  Red Flag: A target corporation‟s BOD‟s take defensive step to FIGTH off a TOl The BOD’s of the Target Corporation MUST PROVE 2 Prong Moran Test:  An Actual or perceived threat to corporate policy or effectiveness o There was a reasonable, good faith investigation to see if threat was real o Takeover/acquisition committee (uninterested directors/SH‟s) o If you don‟t see an actual threat, look for a perceived threat (cash liening around at target corporation, or the target corporation has an invention that someone wants to get it) o Patter of past conduct of corporation posing the threat  Defensive mechanism has to be reasonable in relation to the threat posed o Will it work? o Before you determine whether it was reasonable, verify the BOD‟s conducted the good faith investigation to see if the threat was real. DO THIS 2 nd. o Check to see if tactic is “reasonable” o Compare with the threat…very relationship based. BJR: attaches IF corporation has passed both prongs of the test. SH’s cannot challenge the Board’s decision to implement the defensive mechanism. If they FAIL the test…ACTION IS VOID. Remedies: Injunction on the defensive mechanism (it doesn‟t go through) or damages against the target board. If the measure is “unreasonable” strike it. However, even if the measure is reasonable it may be put aside if the Duty to Auction is triggered. Defensive Tactics: Measures used by a target corporation to make itself less attractive to raiders (offerors). These measures CANNOT be for entrenchment purposes. The target’s BOD’s must prove the tactic is used to protect the company from a TO, not to protect the BOD’s jobs.  Poison Pill: (Preferred Share Repurchase Rights Plan): The option to buy more stock at a bargain price is given to current SH‟s of the target corporation. The new shares have superior right to those share purchased by the offeror. o Reasonable: when the offeror buys more that 10-15% of the target corporation. o If the poison pill kicks in at less that 10% it will not be reasonable (most are reasonable. o Make it harder for offeror to gain control of target b/c they have to buy more share in order to gain control. (more expensive) Can be in Articles right out of the box…especially if you think you have a product people are coming after.  Porcupine Provision: A corporation adopts into the Articles and Bylaws that make it more difficult to be taken over. These provisions are ONLY EFFECTIVE if the BOD‟s has proposed to WMC Corporations Fall 2003 amend the Articles, and the SH‟s approved the amendment to include these provision. LOOK FOR THIS ON THE EXAM. Buys you time. o Supermajority voting: allowed at both SH and BOD level. These are generally reasonable up to 75-80%. Anything higher is unreasonable. o Staggered Board: (allows target to buy time) ALWAYS reasonable. o Eliminate Cumulative Voting: Whether it‟s reasonable depends on the jurisdiction. If it‟s mandatory, you can‟t eliminate s a defense mechanism.  Shark Repellant: The target runs into state court seeking protection from anti-takeover statutes. Prevents SH‟s from being coerced into tendering their shares in but up two-tier tender offers. o Offerors can only gain voting rights if the pre-existing SH’s approve it. o Always reasonable.  Self-Tender Offer: RepurchaseThe target redeems some of its outstanding shares from existing SH‟s. The publicly held corporation will privatize, transform into a closely-held corporation to remove stock from the raider. o May be so expensive o Proper Source of $ o May not be reasonable if you gut the corporation o Must pay SH‟s a reasonable price for their SH‟s shares and the redeption is legal (proper source and solvency test)  Selling off the Crowned Jewel: The target sells of its most prized possession. o Unreasonable, unless the corporation is facing certain bust-up merger unless they sell prized asset. 1) Who they are? 2) What they want? Find facts that they‟re selling for purchase of something else…make it ok.  Scorched Earth: Target sells off all of its assets to deter a takeover. The BOD‟s waste the corporation. o NEVER REASONABLE o BOD’s does it they are liable for breach of loyalty.