Corporations Outline (DOC)

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					CORPORATIONS PROF. QUINN FALL 2009 Agency .................................................................................................................................................... 3 PRINCIPLES OF AGENCY ................................................................................................................................................... 3 Creation of Agency Relationship ............................................................................................................................... 3 Termination ................................................................................................................................................................... 5 LIABILITY OF PRINCIPAL TO THIRD PARTIES IN CONTRACT ..................................................................................... 7 Actual Authority ............................................................................................................................................................ 7 Apparent Authority ...................................................................................................................................................... 8 Undisclosed Principals ...............................................................................................................................................10 Ratification ...................................................................................................................................................................11 Agency by Estoppel ....................................................................................................................................................12 Notice, Notification, and Knowledge .....................................................................................................................13 Contracts and Other Transactions with Third Parties .........................................................................................14 LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT .............................................................................................15 Liability of Agent and Principal ................................................................................................................................15 Tort Liability and Apparent Agency ........................................................................................................................17 Employees and Scope of Employment...................................................................................................................17 iIntentional Torts ........................................................................................................................................................19 Statutory Claims ..........................................................................................................................................................21 Liability for Torts of Independent Contractor ......................................................................................................21 FIDUCIARY DUTIES IN AGENCY RELATIONSHIP ........................................................................................................22 Duties and Obligations of Agent to Principal .......................................................................................................22 Duties and Obligations of Principal to Agent .......................................................................................................25 Partnership .............................................................................................................................................25 PRINCIPLES OF PARTNERSHIP ........................................................................................................................................25 Nature of a Partnership .............................................................................................................................................25 Partners v. Wage Earners ..........................................................................................................................................27 Partners v. Lenders .....................................................................................................................................................27 Partners v. Contract ....................................................................................................................................................28 Partnership by Estoppel ............................................................................................................................................28 RELATIONS OF PARTNERS TO EACH OTHER AND TO THE PARTNERSHIP ............................................................29 Partner‟s Rights and Duties.......................................................................................................................................29 Opting Out of Fiduciary Duties ...............................................................................................................................30 Grabbing and Leaving................................................................................................................................................31 Expulsion .....................................................................................................................................................................31 The Sharing of Losses ................................................................................................................................................32 PARTNERSHIP PROPERTY ................................................................................................................................................32 Partnership Property ..................................................................................................................................................32 RIGHTS OF PARTNERS IN MANAGEMENT ....................................................................................................................34 Binding the Partnership .............................................................................................................................................34 PARTNERSHIP DISSOLUTION ..........................................................................................................................................36 Dissolving the Partnership ........................................................................................................................................36 Dissociation .................................................................................................................................................................39 LIMITED PARTNERSHIPS .................................................................................................................................................41 Principles of Limited Partnership ............................................................................................................................41 The Corporation .....................................................................................................................................42 THE CORPORATE ENTITY...............................................................................................................................................42 Principles of Corporate Law .....................................................................................................................................42 Liability During Incorporation Process ..................................................................................................................43 Corporate Formation .................................................................................................................................................44 Corporate Powers and the Ultra Vires Doctrine...................................................................................................44 CORPORATE LIMITED LIABILITY...................................................................................................................................45 Principles of Limited Liability ..................................................................................................................................45

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Enterprise Liability Doctrine ....................................................................................................................................46 Piercing the Corporate Veil .......................................................................................................................................46 Parent-Subsidiary Piercing Doctrine .......................................................................................................................48 Corporation as Sole General Partner in Limited Partnerships ...........................................................................48 SHAREHOLDER LITIGATION ..........................................................................................................................................49 Principles of Shareholder Litigation ........................................................................................................................49 Nature of Shareholder Derivative Litigation .........................................................................................................49 The Demand Requirement........................................................................................................................................50 Special Litigation Committees ..................................................................................................................................51 Insurance ......................................................................................................................................................................53 THE ROLE AND PURPOSE OF THE CORPORATION.....................................................................................................54 Principles of Corporate Law .....................................................................................................................................54 Duties of Officers, Directors, and Other Insiders ..................................................................................55 THE OBLIGATIONS OF CONTROL .................................................................................................................................55 The Corporate Fiduciary Duty .................................................................................................................................55 Duty of Care ................................................................................................................................................................55 Business Judgment Rule (BJR) .................................................................................................................................56 Overcoming the Business Judgment Presumption ...............................................................................................57 Remedies for Breaching Duty of Care ....................................................................................................................59 SELF-DEALING TRANSACTIONS ....................................................................................................................................60 Duty of Loyalty ...........................................................................................................................................................60 Entire Fairness Standard............................................................................................................................................60 Shareholder Ratification ............................................................................................................................................61 Statutory Safe Harbors ...............................................................................................................................................62 Corporate Opportunity Doctrine.............................................................................................................................63 Fiduciary Duties of Controlling Shareholders .......................................................................................................65 Remedies for Self-Dealing.........................................................................................................................................66 THE OBLIGATION OF GOOD FAITH .............................................................................................................................66 Principles of the Duty of Good Faith .....................................................................................................................66 Compensation..............................................................................................................................................................67 Oversight ......................................................................................................................................................................68 DISCLOSURE AND FAIRNESS ..........................................................................................................................................69 Delaware‟s Duty of Disclosure .................................................................................................................................69 Delaware‟s Duty of Honesty .....................................................................................................................................70 Federal Disclosure Requirements ............................................................................................................................71 SECURITIES FRAUD ..........................................................................................................................................................71 Principles of Rule 10b-5 ............................................................................................................................................71 Fraud Elements of Private Rule 10b-5 Actions.....................................................................................................72 INSIDE INFORMATION .....................................................................................................................................................76 Principles of Insider Trading ....................................................................................................................................76 State Law on Insider Trading ...................................................................................................................................77 Classic Insider Trading Rules – Application of Rule 10b-5 ................................................................................78 Misappropriation Theory (Outside) Trading Rules – Application of Rule 10b-5 ...........................................82 Remedies for Insider Trading ...................................................................................................................................83 Problems of Corporate Control ..............................................................................................................84 MANAGEMENT AND CONTROL .....................................................................................................................................84 The Board of Directors .............................................................................................................................................84 Internal Fundamental Changes ................................................................................................................................85 SHAREHOLDER RIGHTS ...................................................................................................................................................86 Shareholders‟ Governance Role ...............................................................................................................................86 Shareholders‟ Inspection Rights ...............................................................................................................................86 Mechanics of Shareholders‟ Meetings .....................................................................................................................89 Election of Directors..................................................................................................................................................91 SHAREHOLDER PROPOSALS............................................................................................................................................92 Access to Other Shareholders ..................................................................................................................................92 Shareholder Proposals under SEC Rule 14a-8 ......................................................................................................93

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Mergers, Acquisitions, and Takeovers ...................................................................................................97 MERGERS AND ACQUISITIONS .......................................................................................................................................97 Statutory Mergers ........................................................................................................................................................97 Sale of Assets ...............................................................................................................................................................98 The De Facto Merger Doctrine ...............................................................................................................................99 Squeeze-Out Mergers .............................................................................................................................................. 100 DELAWARE SHAREHOLDERS‟ APPRAISAL RIGHTS .................................................................................................. 103 Appraisal Rights ....................................................................................................................................................... 103 Appraisal Proceedings ............................................................................................................................................. 103 Exclusivity of Appraisal .......................................................................................................................................... 104 TAKEOVERS .................................................................................................................................................................... 105 Development of Corporate Law ........................................................................................................................... 105 Corporate Defensive Measures ............................................................................................................................. 106 Enhanced Scrutiny Standard .................................................................................................................................. 108 Revlon Duties ........................................................................................................................................................... 111 State Antitakeover Statutes .................................................................................................................................... 115

Agency A. PRINCIPLES OF AGENCY i. Creation of Agency Relationship  Agency is the label the law applies to a relationship in which: (i) by mutual consent (formal/informal, express/implied) (ii) one person or entity (“agent”) (iii) undertakes to act on behalf of another person or entity (“principal”), (iv) subject to the principal‟s control.  Legal concept applies regardless of whether the parties had the concept in mind and regardless of whether the parties contemplated the consequences.  Parties‟ self-selected labels are never dispositive.  R.3d § 1.01 – Agency Defined  The fiduciary relationship that arises when one person (a “principal”) manifests assent to another person (an “agent”) that the agent shall act on the principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise consents so to act.  Characteristics of Agency Relationship  Manifestation of Consent.  Necessarily involves two steps: manifestation by the principal and consent by the agent – assent or intention through written or spoken words or conduct.  Manifestation by or attributable to the principal must somehow reach the agent, otherwise the agent has nothing to which to consent.  Principal may initially be unaware of the agent‟s consent and agency relationship.  Control.  Since the whole purpose of the agency relationship is that the agent shall carry out the will of the principal, agency cannot exist unless the “acting for” party consents to be subject to the will of the “acted for” party.  At minimum, principal must have right to control the goal of the relationship.  Consensual but Not Necessarily Contractual.  While either acting as an agent or promising to do so creates an agency relation, neither the promise to act gratuitously nor an act in response to the principal's request for gratuitous service creates an enforceable contract.  Capacity to Act as Principal.  An individual has capacity to act as principal in a relationship of agency as defined in R.3d § 1.01 if, at the time the agent takes action, the individual would have capacity if

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acting in person. If performance of an act is not delegable, its performance by an agent does not constitute performance by the principal. R.3d § 3.04.  Capacity to Act as Agent.  Any person may ordinarily be empowered to act so as to affect the legal relations of another. The actor's capacity governs the extent to which, by so acting, the actor becomes subject to duties and liabilities to the person whose legal relations are affected or to third parties. R.3d § 3.05.  Elements of Control  Control as an Element of “Employee” Status.  Whether the principal has the right to control the physical performance of the agent‟s task determines whether the agent is a “servant” or “employee.”  Control as a Consequence.  Even though the agent have consented to give the principal only limited control, once the agency relationship comes into existence, the principal has the power – but not necessarily the right – to control every detail of the agent‟s performance.  Control as a Substitute Method for Establishing Agency Status.  When a creditor exercises extensive control over the operations of its debtor, that control can by itself establish an agency relationship. The law treats the debtor as the agent and the creditor as the principal.  Terminology  Disclosed Principal.  A principal is disclosed if, when an agent and a third party interact, the third party has notice that the agent is acting for a principal and has notice of the principal's identity.  Undisclosed Principal.  A principal is undisclosed if, when an agent and a third party interact, the third party has no notice that the agent is acting for a principal.  Unidentified Principal.  A principal is unidentified if, when an agent and a third party interact, the third party has notice that the agent is acting for a principal but does not have notice of the principal's identity.  Gratuitous Agent.  A gratuitous agent acts without a right to compensation.  Subagent.  A subagent is a person appointed by an agent to perform functions that the agent has consented to perform on behalf of the agent's principal and for whose conduct the appointing agent is responsible to the principal. The relationship between an appointing agent and a subagent is one of agency, created as stated in R.3d § 1.01.  Agent v. Supplier  One who contracts to acquire property from a third person and convey it to another is the agent of the other only if it is agreed that he is to act primarily for the benefit of the other and not for himself. R.2d § 14K.  Factors indicating that the one who is to acquire the property and transfer it to the other is selling to, and not acting as agent for, the other are:  (i) That he is to receive a fixed price for the property, irrespective of the price paid by him – this is the most important; (ii) that he acts in his own name and receives the title to the property which he thereafter is to transfer; (iii) that he has an independent business in buying and selling similar property.
Gorton v. Doty Facts: Plaintiffs, father and son, brought suit against defendant owner for injuries sustained in an automobile accident. Son's coach was the driver of the owner's car. Son and father's theory of recovery against the owner was based upon the alleged negligence of the coach, acting as the special agent of the owner. Owner argued that no agency relationship existed, because she loaned her car to the coach. Holding: Court found relationship of principal and agent existed between the coach and the owner.

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Reasoning: Defendant volunteered the use of her car for the purpose of furnishing additional transportation. Appellant, of course, could have driven the car herself, but instead of doing that, she designated the coach and, in doing so, made it a condition precedent that the coach should drive her car. That the defendant thereby at least consented that the coach should act for her and in her behalf, in driving her car to and from the football game, is clear from her act in volunteering the use of her car upon the express condition that he should drive it, and, further, that the coach consented to so act for appellant is equally clear by his act in driving the car. It is not essential to the existence of authority that there be a contract between principal and agent or that the agent promise to act as such nor is it essential to the relationship of principal and agent that they, or either, receive compensation. Dissent: Budge, J., dissenting wrote that agency means more than mere passive permission. It involves request, instruction or command. A. Gay Jenson Farms Co. v. Cargill, Inc. Facts: Plaintiffs, brought an action against Cargill and Warren Grain & Seed Co. to recover losses sustained when Warren defaulted on contracts made with the farmers for the sale of grain. Cargill financed Warren‟s grain elevator operation and purchased the majority of Warren's grain. At issue was whether Cargill, by its course of dealing with Warren, became liable as a principal on contracts made by Warren with the farmers. Holding: The court found that an agency relationship was established. Reasoning: First, a creditor who assumes control of his debtor's business may become liable as principal for the acts of the debtor in connection with the business. A creditor becomes a principal when he assumes de facto control over the conduct of his debtor, whatever the terms of the formal contract with his debtor may be. Here, Cargill was an active participant in Warren‟s operations rather than simply a financier. Cargill and Warren had a paternalist relationship, with Cargill making the key economic decisions and keeping Warren in existence. Second, under the modern view adopted by the court, since the farmers did not indicate to Cargill that Warren had settled their accounts with them, Cargill, as principal, was not discharged from liability to the farmers by making a settlement payment to Warren.  A creditor who assumes control of his debtor's business may become liable as principal for the acts of the debtor in connection with the business. A security holder who merely exercises a veto power over the business acts of his debtor by preventing purchases or sales above a specified amount does not thereby become a principal.  However, if he takes over the management of the debtor's business either in person or through an agent, and directs what contracts may or may not be made, he becomes a principal, liable as a principal for the obligations incurred thereafter in the normal course of business by the debtor who has now become his general agent.

ii. Termination  Ending the Agency Relationship  Through Express Will of Agent/Principal.  In true agency relationship both the principal and the agent have the power to end the relationship at any time by communicating to the other that the relationship is over.  Principal‟s exercise of this power is called a revocation.  Agent‟s exercise of this power is called a renunciation.  Manifestations are judged by an objective standard.  Through the Expiration of a Specified Term.  Relationship automatically terminates at the end of the specified period unless the parties agree to an extension or renewal.  Agreement can be inferred from the parties‟ conduct.  Through Accomplishment of Agency‟s Purpose.  If the manifestations that create an agency indicate a specific objective, achieving that objective terminates the agency.  Without further manifestations from the principal, the agent has no basis for believe that either its authority or its agency continues.  Principal‟s acceptance or acknowledgement of agent‟s efforts after achieving objective may manifest consent for the agency to continue or resume.  By the Occurrence of an Event or Condition.  Once the event or condition occurs (or does not occur) the agent can no longer reasonably believe itself authorized to act on the principal‟s behalf.  By Destruction of or End of Principal‟s Legal Interest in Property.

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 If the agent‟s role is predicated on some particular property and the property is no longer practically or legally available to the agent, the agency ends.  By the Death, Bankruptcy, or Mental Incapacity of the Agent/Principal.  Under traditional common law rules, any of these events terminates the agency.  By the Expiration of a Reasonable Time.  Where the original manifestations set no specific term, the agency relationship expires automatically after a reasonable time has passed. A reasonable time depends on:  The manifestation of the parties when the agency is created  The extent and nature of the communications between the parties after the agency is created – including communications by a part that it wishes to end the agency or that it believes the agency has ended.  The particular objective of the agency.  Past dealings, if any, between the principal and agent.  The custom, if any, if the locality with regard to agency relationships of the same or similar type.  Power Versus Right in Termination  The Role of Contract.  Contractual terms can, inter alia, set a specific duration for the agency, during which neither party may rightfully end the relationship without cause; provide for the agency to continue indefinitely until ended by a party giving notice; define “cause” sufficiently to allow a party to end agency; or provide for agency to continue so long as the agent meets certain performance requirements.  A contract leaves intact the parties‟ power to end the agency relationship – if an agent renounces or a principal revokes in breach of contract, the other party make seek contract damages but cannot avoid the destruction of the agency.  Implied Terms.  Most agents have right to renounce at will and most serve at the will of the principal.  Courts will likely find an implied, contractual limit on termination when:  The agency relationship is outside the employment context;  The limitation is asserted against the principal; and either  (i) The principal‟s manifestations are the source of the implication or (ii) the agent has reasonably incurred costs in undertaking the agency and needs time to recoup those costs.  Non-Contract Limitations on the Right to Terminate  The Gratuitous Agent.  If a gratuitous agent (i) makes a promise or engages in other conduct that causes the principal to refrain from making different arrangements, and (ii) the gratuitous agent had reason to know that the principal would so rely, then:  If alternative arrangements are still possible, the agent has a duty to end the agency only after giving notice so the principal can make alternative arrangements, and  If alternative arrangements are not possible, the agent has a duty to continue to perform the agency as promised.  The Principal.  Even if a principal has the right to terminate the agency at will, the principal may not exercise that right in bad faith – i.e., when the principal tries to snatch some benefit away from the agent.  Effects of Termination  Agent‟s Obligation to Cease Acting for Principal.  Once agent knows or has reason to know that the agency relationship has ended, the now former agent has a duty to not act for the principal. If the former agent violates this duty and binds the former principal the former agent will be liable for damages.  Principal‟s Duty to Indemnify Agent.

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 The termination of the agency relationship does not eliminate any right of indemnity that the agent may have on account of events that occurred before the termination.  Agent‟s Right to Compete with Principal.  Once the agency relationship has ended, so does the absolute barrier to competition.  The right to compete, however, has three limitations:  Prohibition Against Using Former Principal‟s Confidential Information.  Agent‟s duty not to disclose or exploit the principal‟s confidential information continues after the agency relationship ends.  Duty to “Get Out Clean.”  While an agent may properly contemplate post-termination competition with the principal, the agent cannot disregard its current loyalty obligations to further its post-termination plans. This duty has two aspects: (i) the agent has a duty to not begin actual competition while still and agent and (ii) the agent may not actively deceive the principal as to the agent‟s reasons for terminating the agency relationship.  Noncompetition Obligations Imposed by Contract.  The restraints must be reasonable with respect to the scope of activities foreclosed, the geographic area foreclosed, and the duration of foreclosure. B. LIABILITY OF PRINCIPAL TO THIRD PARTIES IN CONTRACT i. Actual Authority  R.3d § 2.01 – Actual Authority  An agent acts with actual authority when, at the time of taking action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principal's manifestations to the agent, that the principal wishes the agent so to act.
 When agent acts with actual authority, the agent's power to affect the principal's legal relations with third parties is coextensive with the agent's right to do so, which actual authority creates.

 R.3d § 2.02 – Scope of Actual Authority  An agent has actual authority to take action designated or implied in the principal's manifestations to the agent and acts necessary or incidental to achieving the principal's objectives, as the agent reasonably understands the principal's manifestations and objectives when the agent determines how to act.  An agent's interpretation of the principal's manifestations is reasonable if it reflects any meaning known by the agent to be ascribed by the principal and, in the absence of any meaning known to the agent, as a reasonable person in the agent's position would interpret the manifestations in light of the context, including circumstances of which the agent has notice and the agent's fiduciary duty to the principal.  An agent's understanding of the principal's objectives is reasonable if it accords with the principal's manifestations and the inferences that a reasonable person in the agent's position would draw from the circumstances creating the agency.
 R.3d § 34, cmt. a provides a non-exhaustive list of factors including the situation of the parties and the business in which they are engaged, the general usages in the trade, nature of the subject matter, formality or informality.

 R.3d § 3.01 – Creation of Actual Authority  Actual authority, as defined in R.3d § 2.01, is created by a principal's manifestation to an agent that, as reasonably understood by the agent, expresses the principal's assent that the agent take action on the principal's behalf.
 Although it is commonly said that a principal grants or confers actual authority, the principal's initial manifestation to the agent may often be modified or supplemented by subsequent

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manifestations from the principal and by other developments that the agent should reasonably consider in determining what the principal wishes to be done.  A principal's manifestations may reach the agent directly or indirectly.  Except in rare circumstances, a latter manifestation trumps an earlier one.

 Implied Authority – A Subset of Actual Authority  Implied authority is often used to mean actual authority either (i) to do what is necessary, usual, and proper to accomplish or perform an agent's express responsibilities or (ii) to act in a manner in which an agent believes the principal wishes the agent to act based on the agent's reasonable interpretation of the principal's manifestation in light of the principal's objectives and other facts known to the agent.  These meanings are not mutually exclusive – Both fall within definition of actual authority.  Sometimes the implication is based on custom or past dealing – other times the principal‟s objectives and other facts known to the agent cause him to infer that a particular act is authorized. R.3d § 2.01, cmt. b.  Termination of Actual Authority  The death of an individual agent terminates the agent's actual authority. R.3d § 3.07(1).  The death of an individual principal terminates the agent's actual authority. Termination is effective only when the agent has notice of the principal's death. Termination is also effective as against a third party with whom the agent deals when the third party has notice of the principal's death. R.3d § 3.07(2).  An individual principal's loss of capacity to do an act terminates the agent's actual authority to do the act. Termination is effective only when the agent has notice that the principal's loss of capacity is permanent or that the principal has been adjudicated to lack capacity. Termination is also effective as against a third party with whom the agent deals when the third party has notice that the principal's loss of capacity is permanent or that the principal has been adjudicated to lack capacity. R.3d § 3.08(1).
Mill Street Church of Christ v. Hogan Facts: Mill Street Church hired Bill Hogan to paint its building, and during previous jobs, it allowed the Bill Hogan to employ his brother Same Hogan to assist him. Sam Hogan was injured on the first day at work. Sam Hogan filed a claim for workers compensation but the board held that he was not an employee of the Church. The Church argued that Bill Hogan did not possess authority to as an agent to hire his brother Sam Hogan. Holding: The court held that Bill Hogan had implied authority to hire his brother and that his brother was validly within the Church‟s employment at the time he was injured. Reasoning: In examining whether implied authority exists, it is important to focus upon the agent's understanding of his authority. It must be determined whether the agent reasonably believes because of present or past conduct of the principal that the principal wishes him to act in a certain way or to have certain authority. The nature of the task or job may be another factor to consider. Implied authority may be necessary in order to implement the express authority. The existence of prior similar practices is one of the most important factors. Specific conduct by the principal in the past permitting the agent to exercise similar powers is crucial.  A principal will be bound to a third person by the act of the agent within his implied authority even if the third person was unaware that the agent's authority was only implied.

ii. Apparent Authority  R.3d § 2.03 – Apparent Authority  Apparent authority is the power held by an agent or other actor to affect a principal's legal relations with third parties when a third party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal's manifestations.
 This definition does not presuppose the present or prior existence of an agency relationship, and thus applies to actors who appear to be agents but are not, as well as to agents who act beyond the scope of their actual authority. R.3d § 2.03, cmt. a.

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 An agent who appears to a third party to be authorized, but who lacks actual authority, would breach the agent's duty to the principal by acting in excess of actual authority. The principal has a claim against the agent for any loss incurred. R.3d § 2.03, cmt. a.

 R.3d § 3.03 – Creation of Apparent Authority  Apparent authority is created by a person's manifestation that another has authority to act with legal consequences for the person who makes the manifestation, when a third party reasonably believes the actor to be authorized and belief is traceable to the manifestation.
 Apparent authority is present only when a third party's belief is traceable to manifestations of the principal. The fact that one party performs a service that facilitates the other's business does not constitute such a manifestation. R.3d § 3.03, cmt. b.

 Third Party‟s Reasonable Belief  Apparent authority is based on a third party's understanding of signals of all sorts concerning the actor with whom the third party interacts.  When the third party knows the actor is an agent and knows the identity of the principal, the presence of apparent authority turns on the tie between these signals and the principal in the mind of the reasonable third party.  If a third party knows that the actor in question is an agent and knows the identity of the principal, the third party should assess what is observed of the agent in light of the agent's position as a fiduciary with a duty to use authority on behalf of the principal.  The third party observes the agent in a particular context, one that may be defined in part by interactions, dealings, or relationships between the principal and the agent that the third party has observed in the past, by an organization, by an industry and its customs; by a type of transaction that is conventionally done in a particular way; or, if in new context, by reasonable expectations based on analogous situations and other relevant circumstances.  Duty of Inquiry.  The reasonable interpretation requirement imposes a duty of inquiry on the thirdparty claimant – particularly where the manifestation itself might be ambiguous or where the apparent agent‟s conduct is discordant.  Methods of Manifestation  Intermediaries.  A manifestation that reaches the third party through intermediaries can still give rise to apparent authority.  Authority by Position.  An agent is sometimes placed in a position in an industry or setting in which holders of the position customarily have authority of a specific scope. Absent notice to third parties to the contrary, placing an agent in such a position constitutes a manifestation that the principal assents to be bound by actions by the agent that fall within that scope. R.3d § 1.03, cmt. b.  Acquiescence.  Inaction.  Only applicable if: (i) someone (including apparent agent) must assert that apparent agent has actual authority; (ii) apparent principal must be aware of those assertions and fail to do anything to contradict them; (iii) third-party claimant must reasonably believe that the apparent agent is authorized; (iv) third-party claimant must be aware of (a) the assertions themselves, (b) the apparent principal‟s knowledge of the assertions and (c) the apparent principal‟s failure to contradict the assertions; and (v) third party‟s reasonable belief that the apparent agent is authorized must be traceable to the apparent principal‟s failure to contradict the assertions.

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 R.3d § 3.11 – Termination of Apparent Authority  Termination of actual authority does not by itself end any apparent authority held by agent. Apparent authority ends when it is no longer reasonable for the third party with whom an agent deals to believe that the agent continues to act with actual authority.
 It is reasonable for third parties to assume that an agent‟s actual authority is a continuing and ongoing condition. Therefore, a person‟s apparent authority can continue after the person‟s actual authority has ended. R.3d § 3.11, cmt. c. Three-Seventy Leasing Corp. v. Ampex Corporation Facts: Buyer brought an action against defendant seller for breach of a contract to sell computer core memories. Holding: The court concluded that a salesman had apparent authority to accept buyer's offer on behalf of defendant and that a letter could reasonably be interpreted to be an acceptance. Reasoning: An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would lead a reasonably prudent person to suppose that the agent had the authority he purports to exercise. Absent knowledge on the part of third parties to the contrary, an agent has the apparent authority to do those things, which are usual and proper to the conduct of the business, which he is employed to conduct.

iii. Undisclosed Principals  R.3d § 2.06 – Liability Of Undisclosed Principal  (1) An undisclosed principal is subject to liability to a third party who is justifiably induced to make a detrimental change in position by an agent acting on principal's behalf and without actual authority if principal, having notice of the agent's conduct and that it might induce others to change their positions, did not take reasonable steps to notify them of the facts.  (2) An undisclosed principal may not rely on instructions given an agent that qualify or reduce the agent's authority to less than the authority a third party would reasonably believe the agent to have under the same circumstances if the principal had been disclosed.
 Under subsection (1), a principal is subject to liability to a third party who is justifiably induced to make a detrimental change in position by the conduct of an agent acting without actual authority when the principal has notice of the agent's conduct and its likely impact on third parties and fails to take reasonable steps to inform them of the facts. The underlying principle is consistent with the estoppel doctrine stated in R.3d § 2.05.  Under subsection (2), a principal is subject to liability to a third party when the third party would have no reason to inquire into the scope of the agent's authority if the third party knew the agent acted on behalf of a principal. The principal may not rely on qualifications or reductions to the agent's authority when the doctrine of apparent authority would make the qualification or restriction ineffective as to an agent acting on behalf of a disclosed or an unidentified principal. In such cases, the principal has chosen to place the agent in a position in which it is reasonable for third parties to believe that the agent has authority consistent with the position. Watteau v. Fenwick Facts: Humble, a manager of a bar, made arrangements for the purchase of cigars, Bovril and other articles in the name of the bar that he worked at. His employment agreement specifically prohibited him from buying such goods unless previously approved by the bar‟s owners. Holding: The court held that an undisclosed principal (the bar owners) is liable for acts of an agent, done on his account, if usual or necessary in such transactions, although forbidden by the principal. Reasoning: The court reasons that to hold otherwise, in “every case of an undisclosed principal, or at least in every case where the fact of there being a principal was undisclosed, the secret limitation of authority would prevail and defeat the action of the person dealing with the agent and then discovering that he was an agent and had a principal.”  The R.2d referred to this concept as an “inherent agency power.”  The R.3d expressly rejected the concept in favor of a rule directly targeted at such cases.

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iv. Ratification  R.3d § 4.01 – Ratification Defined  Ratification is the affirmance of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority.  A person ratifies an act by (a) manifesting assent that the act shall affect the person's legal relations, or (b) conduct that justifies a reasonable assumption that the person so consents.  (3) Ratification does not occur unless (a) the act is ratifiable, (b) the person ratifying has capacity, (c) the ratification is timely, (d) the ratification encompasses the act in its entirety.
 A purported principal can also affirm through inaction – that is, by failing to repudiate the act “under such circumstances that, according to the ordinary experience and habits of men, one would naturally be expected to speak if he did not consent.” R.2d § 94, cmt. a.  A person may ratify an act through conduct by receiving or retaining benefits it generates if the person has knowledge of material facts and no independent claim to the benefit. If principal retains a benefit, and additionally, manifests dissent to the agent's act, the third party has a choice – third party may elect to treat the principal's retention of the benefit as a ratification or may rescind the transaction. R.3d § 4.01, cmt. g.

 Nature and Effect of Ratification  The act of ratification consists of an externally observable manifestation of assent to be bound by the prior act of another person. When the prior act did not otherwise affect the legal relations of the ratifier, ratification provides the basis on which the ratifier's legal relations are affected by the act.  The set of effects that ratification creates are the consequences of actual authority.  A principal's ratification confirms or validates an agent's right to have acted as the agent did. That is, an agent's action may have been effective to bind the principal to the third party, and the third party to the principal, because the agent acted with apparent authority.  If the principal ratifies the agent's act, it is thereafter not necessary to establish that the agent acted with apparent authority.  Moreover, by replicating the effects of actual authority, the principal's ratification eliminates claims the principal would otherwise have against the agent for acting without actual authority.  Actions by the Principal that Constitute Ratification  Ratification requires an objectively or externally observable indication that a person consents that another's prior act shall affect the person's legal relations.  To constitute ratification, the consent need not be communicated to the third party or the agent because the focal point of ratification is an observable indication that the principal has exercised choice and has consented.  R.3d § 4.04 – Capacity to Ratify  A person may ratify an act if (a) the person existed at the time of the act, and (b) the person had capacity at the time of ratifying the act.
 Capacity to ratify requires that the would-be ratifier have capacity to act as a principal in a relationship of agency, which under R.3d § 3.04 requires capacity, as to delegable acts and transactions, to have legal relations affected by the act if done in person. The agent's capacity neither augments nor diminishes that of the principal. R.3d § 4.04, cmt. b.

 R.3d § 4.06 – Knowledge Requisite To Ratification  A person is not bound by a ratification made without knowledge of material facts involved in the original act when the person was unaware of such lack of knowledge.
 Ratification concerns actions that have already taken place, of which the person is aware, not actions or events that may occur in the future. R.3d § 4.06, cmt. b.

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 The burden of establishing that a ratification was made with knowledge is on the party attempting to establish that ratification occurred. R.3d § 4.06, cmt. b.  Not all facts are material for purposes of this doctrine – the point of materiality in this context is the relevance of the fact to the principal's consent to have legal relations affected by the agent's act. R.3d § 4.06, cmt. c.  Principal may choose to ratify the action of an agent or other actor without knowing material facts. A fact finder may conclude that a principal has [assumed the risk of ignorance and ratified] when the principal is shown to have had knowledge of facts that would have led a reasonable person to investigate further, but the principal ratified without further investigation. R.3d § 4.06, cmt. d.

 R.3d § 4.07 – No Partial Ratification  A ratification is not effective unless it encompasses the entirety of an act, contract, or other single transaction.
 A person may not, by ratifying an act, obtain its economic benefits without bearing the legal consequences that accompany the act.

 R.3d § 4.08 – Estoppel To Deny Ratification  If a person makes a manifestation that the person has ratified another's act and the manifestation, as reasonably understood by a third party, induces the third party to make a detrimental change in position, the person may be estopped to deny the ratification.
Botticello v. Stefanovicz Facts: A husband and wife, each held an undivided one-half interest in a farm. Husband executed a lease with an option to purchase with the lessee. After taking possession and making improvements to the land, the lessee exercised the option to buy. The owners refused to honor the agreement and in the lessee's subsequent suit for specific performance, the trial court compelled the owners to convey the land to the lessee. Holding: The court ruled that trial court's finding were wholly insufficient to support its conclusion that the husband acted as the wife's authorized agent in the discussions concerning the sale and in the execution of the contract. Moreover, the court ruled, there was no evidence that the wife ratified the underlying contract. Thus, the court ruled, the wife was not bound by the agreement and she could not be forced to convey her interest. Reasoning: "Ratification" is defined as the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account. Ratification requires acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material circumstances. Before the receipt of benefits may constitute ratification, the other requisites for ratification must first be present. Thus if the original transaction was not purported to be done on account of the principal, the fact that the principal receives its proceeds does not make him a party to it.

v. Agency by Estoppel  R.3d § 2.05 – Estoppel To Deny Existence Of Agency Relationship  A person who has not made a manifestation that an actor has authority as an agent and who is not otherwise liable as a party to a transaction purportedly done by the actor on that person's account is subject to liability to a third party who justifiably is induced to make a detrimental change in position because the transaction is believed to be on the person's account, if:  (i) the person intentionally or carelessly caused such belief, or  (ii) having notice of such belief and that it might induce others to change their positions, the person did not take reasonable steps to notify them of the facts.
 The doctrine is applicable when the person against whom estoppel is asserted has made no manifestation that an actor has authority as an agent but is responsible for the third party's belief that an actor is an agent and the third party has justifiably been induced by that belief to undergo a detrimental change in position. R.3d § 2.05, cmt. c.  Most often the person estopped will be responsible for the third party's erroneous belief as the consequence of a failure to use reasonable care, either to prevent circumstances that foreseeably led to the belief, or to correct the belief once on notice of it. R.3d § 2.05, cmt. c.

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Hoddeson v. Koos Bros. Facts: Plaintiff purchaser bought furniture from defendant company, but failed to get a receipt for the cash payment she made for the items. After the assured date of delivery elapsed, she contacted defendant as to the whereabouts of her furniture. Defendant's records failed to disclose any such sale to plaintiff nor any payment made by her, and plaintiff was unable to identify the clerk who assisted her from defendant's salesmen. Defendant contended that the person who served plaintiff was an imposter deceitfully impersonating a salesman of defendant without its knowledge. Plaintiff brought suit to recover the amount paid by her for the furniture, and obtained a judgment against defendant in reimbursement for her cash expenditure. Defendant appealed contending that a reversal of the judgment was necessary as there was a deficit of evidence to support conclusion that a relationship of master and servant existed between defendant and man who served and received money from plaintiff. Holding: The court reversed on other grounds but concluded that plaintiff should be entitled to reconstruct her complaint as to the evidence to prove agency. Reasoning: Where a proprietor of a place of business by his dereliction of duty enables one who is not his agent conspicuously to act as such and ostensibly to transact the proprietor's business with a patron in the establishment, the appearances being of such a character as to lead a person of ordinary prudence and circumspection to believe that the impostor was in truth the proprietor's agent, in such circumstances the law will not permit the proprietor defensively to avail himself of the impostor's lack of authority and thus escape liability for the consequential loss thereby sustained by the customer.

vi. Notice, Notification, and Knowledge  R.3d § 5.02 – Notification Given by or to an Agent  A notification given to an agent is effective as notice to the principal if the agent has actual or apparent authority to receive the notification, unless the person who gives the notification knows or has reason to know that the agent is acting adversely to the principal.  A notification given by an agent is effective as notification given by the principal if the agent has actual or apparent authority to give the notification, unless the person who receives the notification knows or has reason to know that the agent is acting adversely to the principal.
 An agent is not charged with notice of facts that a principal knows or has reason to know.  Notifications received by a principal are not effective as notice to the principal's agents.

 R.3d § 5.03 – Imputation of Notice of Fact to Principal  For purposes of determining a principal's legal relations with a third party, notice of a fact that an agent knows or has reason to know is imputed to the principal if knowledge of the fact is material to the agent's duties to the principal, unless the agent (a) acts adversely to the principal or (b) is subject to a duty to another not to disclose the fact to the principal.
 If an agent knows a fact or has reason to know it, notice of the fact is imputed to the principal if the fact is material to the agent's duties unless the agent is subject to a duty not to disclose the fact to the principal or unless the agent acts with an adverse interest. R.3d § 5.03, cmt. e.  An agent brings the totality of relevant information that the agent then knows to the relationship with a particular principal. R.3d § 5.03, cmt. e.  Notice of facts that a principal knows or has reason to know is not imputed downward to an agent. A principal does not owe a duty of disclosure to an agent that is a full counterpart of the duty owed by an agent to relay material facts. R.3d § 5.03, cmt. g.

 Information Communicated by Agent to Others  If an agent acting with actual or apparent authority (i) gives notice or a third party, or (ii) makes a state or promise to a third party, or (iii) makes a misrepresentation to a third party, the information conveyed has the same legal effect under contract law as if the principal had conveyed the information directly.

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vii. Contracts and Other Transactions with Third Parties  R.3d § 6.01 – Agent for Disclosed Principal  When an agent acting with actual or apparent authority makes a contract on behalf of a disclosed principal, (i) the principal and the third party are parties to the contract; and (ii) the agent is not a party to the contract unless the agent and third party agree otherwise.
 An agent acts on behalf of a disclosed principal when third party with whom agent deals has notice that agent acts for principal and has notice of principal's identity. R.3d § 6.01, cmt. b.

 R.3d § 6.02 – Agent for Unidentified Principal  When an agent acting with actual or apparent authority makes a contract on behalf of an unidentified principal, (i) the principal and the third party are parties to the contract; and (ii) the agent is a party to the contract unless the agent and the third party agree otherwise.
 A principal is unidentified when the third person has notice that the agent acts on behalf of a principal but does not have notice of the principal's identity. R.3d § 6.02, cmt. b.

 R.3d § 6.03 – Agent for Undisclosed Principal  When an agent acting with actual authority makes a contract on behalf of an undisclosed principal, (i) unless excluded by the contract, the principal is a party to the contract; (ii) the agent and the third party are parties to the contract; and (ii) the principal, if a party to the contract, and the third party have the same rights, liabilities, and defenses against each other as if the principal made the contract personally.
 When an agent acts on behalf of an undisclosed principal, the third party does not manifest assent to an exchange with the principal and the principal does not make a manifestation of assent to the third party. The third party's manifestation of assent is made to the agent to whom the third party expects to render performance and from whom the third party expects to receive performance. R.3d § 6.03, cmt. b.  If an agent acts without actual authority in making a contract on behalf of an undisclosed principal, the principal may be subject to liability. R.3d § 6.03, cmt. c.  A principal in such a case may acquire rights against the third party by ratifying the agent's conduct. An agent does not act with apparent authority with regard to an undisclosed principal because the principal has made no manifestation requisite for apparent authority.  If an agent purports to act on behalf of an undisclosed principal but lacks actual or apparent authority to bind the principal, the agent is subject to liability on the agent's implied warranty of authority. R.3d § 6.10.

 R.3d § 6.04 – Principal Does Not Exist Or Lacks Capacity  Unless the third party agrees otherwise, a person who makes a contract with a third party purportedly as an agent on behalf of a principal becomes a party to the contract if the purported agent knows or has reason to know that the purported principal does not exist or lacks capacity to be a party to a contract.
 Applicable when a person purports to make a contract with a third party on behalf of an entity that does not exist. If that person and the third party manifest assent that the contract shall bind the third party, the person who purports to act on behalf of the entity is personally liable on the contract. R.3d § 6.04, cmt. b.  If a person purporting to act as an agent does not know or have reason to know that the purported principal does not exist or lacks capacity, either the purported agent or the third party may be able to avoid the contract by showing that both were mistaken about a basic assumption on which the contract was made that has a material effect on the exchange of performances. R.2d (Contracts) § 153. Atlantic Salmon A/S v. Curran

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Facts: Curran dealt with two exporters as a representative of a seafood exchange company. Curran used the designation "treasurer" on his checks and gave the exporters business cards that identified him as the marketing director of the seafood exchange company. At all relevant times, no such company existed. At trial, Curran purchaser alleged that he was acting as an agent of another company when he incurred the debt that the exporters sought to recover from him individually. That other company had filed a certificate with the city that it was doing business in the name of the seafood exchange company. Trial court found in favor of Curran. Holding: On appeal, the court reversed. The court held that it was not sufficient that the exporters might have had the means, through a search of the records of the city clerk, to determine the identity of the purchaser's principal. Actual knowledge was the test. It was Curran‟s duty, if he wanted to avoid personal liability, to disclose his agency. Curran‟s use of trade names or fictitious names was not a sufficient identification of the alleged principal so as to protect him from personal liability. Reasoning: The duty rests upon the agent, if he would avoid personal liability, to disclose his agency, and not upon others to discover it. It is not, therefore, enough that the other party has the means of ascertaining the name of the principal; the agent must either bring to him actual knowledge or, what is the same thing, that which to a reasonable man is equivalent to knowledge or the agent will be bound. There is no hardship to the agent in this rule, as he always has it in his power to relieve himself from personal liability by fully disclosing his principal and contracting only in the latter's name. If he does not do this, it may well be presumed that he intended to make himself personally responsible.

C. LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT i. Liability of Agent and Principal  R.3d § 7.01 – Agent’s Liability to Third Parties  An agent is subject to liability to a third party harmed by the agent's tortious conduct.  Unless an applicable statute provides otherwise, an actor remains subject to liability although the actor acts as an agent or an employee, with actual or apparent authority, or within the scope of employment.
 An agent whose conduct is tortious is subject to liability. This is so whether or not the agent acted with actual authority, with apparent authority, or within the scope of employment.  If an agent's tortious conduct breaches a duty that the agent owes to the principal, the agent is subject to liability to the principal for harm caused by the breach. R.3d § 7.01, cmt. a.

 R.3d § 7.03 – Principal’s Liability  A principal is subject to direct liability to a third party harmed by an agent's conduct when:  The agent acts with actual authority or the principal ratifies the agent's conduct and (a) the agent's conduct is tortious, or (b) the agent's conduct, if that of the principal, would subject the principal to tort liability; or  The principal is negligent in selecting, supervising, or otherwise controlling agent; or  The principal delegates performance of a duty to use care to protect other persons or their property to an agent who fails to perform the duty.  A principal is subject to vicarious liability to a third party harmed by an agent's conduct when (a) the agent is an employee who commits a tort while acting within the scope of employment; or (b) the agent commits a tort when acting with apparent authority in dealing with a third party on or purportedly on behalf of the principal.
Humble Oil & Refining Co. v. Martin Facts: Martin brought suit for himself and his two minor children against the Humble Oil for injuries resulting from an automobile, belonging to the Loves and which Mrs. Love had left, unattended, upon the driveway of the Humble filling station, rolling unoccupied, from said station out into the street, across same and onto the premises of Martin where it struck Mr. Martin and his two children. Holding: The court held that Humble Oil was liable as a principal. Reasoning: The relationship established between an oil company, which maintained a filling station for the distribution of its own products, and the manager of such station, is that of master and servant, when said manager operates the station under a "Commission Agency Agreement" and makes regular reports to said company, which not only direct him in the management of the station but shares in its receipts and disbursements, even though it exercises no control over the employees, who look to the manager of the station as their director.

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Hoover v. Sun Oil Company Facts: Car owners sought damages as a result of a fire that started at the rear of their car while being filled with gasoline at the oil company's service station. The complaint alleged that the fire was caused by the negligence of the operator's employee. The oil company argued that the operator was an independent contractor and therefore the employee's negligence could not be attributed to the oil company. Car owners argued that oil company could be liable because the operator acted as its agent. Holding: The court granted the oil company's motion for summary judgment, holding the operator was an independent contractor under the undisputed facts. Reasoning: The lease contract and dealer's agreement failed to establish any relationship other than landlord-tenant and independent contractor. There was nothing in the individuals' conduct that was inconsistent with that relationship. While the oil company and the operator had a mutual interest in the sale of the oil company's products and the success of the operator's business, the oil company had no control over the day-to-day operation of the service station. Hence it could not be liable for the allegedly negligent acts of the operator's employee.  Whether the operator of a service station is an independent contractor of the oil company that owns the service station varies according to the contracts involved and the conduct and evidence of control under those contracts. The test to be applied is that of whether the oil company retains the right to control the details of the day-to-day operation of the service station; control or influence over results alone is viewed as insufficient. Murphy v. Holiday Inns, Inc. Facts: Plaintiff had fallen on the premises of a Holiday Inn franchise and filed an action alleging negligent maintenance. Holiday Inn filed for summary judgment on the grounds that it had no relationship with regard to the operator of the premises other than a license agreement. Holding: The court held that facts determinative of the question of actual agency were those contained in the license agreement. The court held that summary judgment was proper since the license agreement gave defendant no control or right to control the methods or details of doing the work and, therefore no principal-agent or master-servant relationship was created. Reasoning: In determining whether a contract establishes an agency relationship, the critical test is the nature and extent of the control agreed upon. The fact that an agreement is a franchise contract does not insulate the contracting parties from an agency relationship. If a franchise contract so regulates the activities of the franchisee as to vest the franchisor with control within the definition of agency, the agency relationship arises even though the parties expressly deny it. Vandemark v. McDonald‟s Corp. Facts: McDonald‟s custodian, who worked when the restaurant was closed, was attacked while taking a break outside the restaurant. The custodian argued that the franchiser voluntarily assumed a duty to ensure that a management company would follow the franchiser's security measures designed to protect employees by adopting a quality, service, and cleanliness playbook published by the franchiser. Holding: The court found no error, noting that, inter alia, the franchiser did not assume a duty to ensure that the management company would follow the franchiser's security measures and that the custodian failed to submit evidence that the franchiser knew, or should have known, that the restaurant was "shrouded by darkness" during the nighttime hours. The custodian also argued that the trial court erred in failing to find the existence of an agency relationship between the franchiser and the management company. The court disagreed, noting that the relevant documents expressly provided that there was no such agency relationship. Wendy Hong Wu v. Dunkin‟ Donuts, Inc. Facts: Two teenagers entered a store and brutally attacked and raped plaintiff employee of Dunkin‟ Donuts franchise. Plaintiffs alleged, among other things, that the attack resulted from the vicarious and direct negligence of Dunkin‟ Donuts. Holding: The court found Dunkin‟ Donuts did not exert actual control over the security measures employed by the franchisee, so they had no legal duty to plaintiff through vicarious liability. The court found the record was barren of evidence demonstrating plaintiff's reliance on defendant's recommendations regarding security were what she relied on in accepting the job. Moreover, plaintiffs provided no evidence for their assertion defendant "required" the franchisee to install a working alarm system and, in fact, the undisputed evidence showed defendant merely recommended the franchiser take stronger security measures. With no duty, plaintiff's negligence claims failed. Reasoning: The franchisor typically is found to be vicariously liable only in situations where it exercised considerable control over the franchisee and the specific instrumentality at issue in a given case. Most courts have found that retaining a right to enforce standards or to terminate an agreement for failure to

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meet standards is not sufficient control. A right to reenter premises and inspect also generally does not give rise to a legal duty.

ii. Tort Liability and Apparent Agency  R.3d § 7.08 – Agent Acts with Apparent Authority  A principal is subject to vicarious liability for a tort committed by an agent in dealing or communicating with a third party on or purportedly on behalf of the principal when actions taken by the agent with apparent authority constitute the tort or enable the agent to conceal its commission.
 A contractual term that purports to exempt or exculpate a party to the contract from tort liability for harm that the party intentionally or recklessly causes is unenforceable on grounds of public policy. R.3d § 7.08, cmt. c. Miller v. McDonald‟s Corp. Facts: Customer sought damages for injuries she suffered while eating a sandwich purchased at a McDonald‟s franchise. Under a detailed license agreement, the franchisee was required to operate the restaurant in a manner consistent with the corporation's system and was considered an independent contractor. The customer claimed that she relied on the corporation's reputation because the restaurant was similar in appearance to other restaurants of the corporation that she had patronized and there was no indication that any entity other than the corporation was involved. McDonald‟s filed for summary judgment on the grounds that it did not own or operate the restaurant. Holding: The court reversed the grant of summary judgment because there was enough evidence to permit a jury to find that the corporation was vicariously liable for the franchisee's alleged negligence. There was sufficient evidence to raise an issue of actual agency because the corporation had the right to exercise control over the franchisee's daily operations. There was sufficient evidence to raise an issue of apparent agency because the corporation's requirements were imposed to maintain an image of uniformity. The level of the customer's reliance on the corporation's reputation was also not unreasonable as a matter of law. Reasoning: If, in practical effect, the franchise agreement goes beyond the stage of setting standards, and allocates to the franchisor the right to exercise control over the daily operations of the franchise, an agency relationship exists.

iii. Employees and Scope of Employment  R.3d § 7.03 – Employee Acting Within Scope Of Employment  An employer is subject to vicarious liability for a tort committed by its employee acting within the scope of employment.  An employee acts within the scope of employment when performing work assigned by employer or engaging in a course of conduct subject to employer's control. An employee's act is not within the scope of employment when it occurs within an independent course of conduct not intended by the employee to serve any purpose of the employer.  For purposes of this section, (a) an employee is an agent whose principal controls or has the right to control the manner and means of the agent's performance of work, and (b) the fact that work is performed gratuitously does not relieve a principal of liability.
 Although an employer's ability to exercise control is an important element in justifying respondeat superior, the range of an employer's effective control is not the limit that respondeat superior imposes on the circumstances under which an employer is subject to liability. R.3d § 7.03, cmt. b.  An independent course of conduct represents a departure from, not an escalation of, conduct involved in performing assigned work or other conduct that an employer permits or controls.

 Respondeat Superior  Respondeat superior subjects an employer to vicarious liability for employee torts committed within the scope of employment, distinct from whether the employer is subject to direct liability.

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 An employer's ability to exercise control over its employees' work-related conduct enables the employer to take measures to reduce the incidence of tortious conduct.  It may be difficult, after the fact of an employee's tortious conduct, to identify an instance of negligence on the part of the employer. This may be so even when, before the fact of the employee's tortious conduct, steps were available to the employer that, if taken, would have prevented the tort.  In contrast, when an employee's tortious conduct is outside the range of activity that an employer may control, subjecting the employer to liability would not provide incentives for the employer to take measures to reduce the incidence of such tortious conduct.  Moreover, for an employer to insure against a risk of liability, whether from thirdparty sources or its own assets, the risk must be at least to some degree ascertainable and quantifiable.  Servant v. Independent Contractor  A master-servant relationship exists where the servant has agreed (a) to work on behalf of the master and (b) to be subject to the master‟s control or right to control the “physical conduct” of the servant – that is, the manner in which the job is performed, as opposed to the result alone. R.2d §§ 1, 2.  An agent-type independent contractor is one who has agreed to act on behalf of another, the principal, but not subject to the principal‟s control over how the result in accomplished.  A non-agent independent contractor is one who operates independently and simply enters into arm‟s length transactions with others.  The right to terminate is not by itself dispositive. It carries weight only to the extent that is creates the practical ability to control the agent‟s performance.  The Nomenclature Question  Numerous factual indicia are relevant to whether an agent is an employee.  These include:  (i) Extent of control that agent and principal have agreed the principal may exercise over details of the work; (ii) whether agent is engaged in a distinct occupation or business; (iii) whether type of work done by agent is customarily done under principal‟s discretion or without supervision; (iv) skill required in the agent‟s occupation; (v) whether agent or principal supplies the tools and other instrumentalities required for the work and the place in which to perform it; (vi) length of time during which the agent is engaged by the principal; (vii) whether agent is paid by the job or by the time worked; (viii) whether agent‟s work is part of the principal‟s regular business; (ix) whether the principal and agent believe that they are creating an employment relationship; (x) whether or not the principal is a business.  R.2d § 229 – Kind Of Conduct Within Scope Of Employment  To be within the scope of the employment, conduct must be of the same general nature as that authorized, or incidental to the conduct authorized.  In determining whether or not the conduct, although not authorized, is nevertheless so similar to or incidental to the conduct authorized as to be within the scope of employment, the following matters of fact are to be considered:  (a) Whether or not the act is one commonly done by such servants; (b) the time, place and purpose of the act; (c) the previous relations between the master and the servant;(d) the extent to which the business of the master is apportioned between different servants; (e) whether or not the act is outside the enterprise of the master or, if within the enterprise, has not been entrusted to any servant; (f) whether or not the master has reason to expect that such an act will be done; (g) the similarity in quality of the act done to the act authorized; (h) whether or not the instrumentality by which the harm is done has been furnished by the master to the servant; (i) the extent of departure from the normal method of accomplishing an authorized result; and (j) whether or not the act is seriously criminal.

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 Conduct in the Performance of Work and Scope of Employment  An employee's conduct is within the scope of employment when it constitutes performance of work assigned to the employee by the employer. The fact that the employee performs the work carelessly does not take the employee's conduct outside the scope of employment, nor does the fact that the employee otherwise makes a mistake in performing the work. Likewise, conduct is not outside the scope of employment merely because an employee disregards the employer's instructions. R.3d § 7.07, cmt. c.  Other Conduct within Employer‟s Control  Purely personal acts that an employee undertakes during the work period – such as personal hygiene, smoking, and eating – may be within the scope of employment because they are incidental to the employee's performance of assigned work. However, a tortious act committed in connection with purely personal conduct is not within the scope of employment if the employee is motivated solely by purposes other than the employer's.  If an employer exercises control over an employee's personal acts while the employee is off the employer's premises and not otherwise engaged in work, the employee's conduct remains within the scope of employment because it is subject to the employer's control.  However, an employee's conduct is not within the scope of employment, although the employee is physically present on the employer's premises, when the employee's actions are far removed in purpose from work assigned by the employer.  In some circumstances, even multitasking at an employee's assigned work station may remove the employee's conduct from the scope of employment because it may provide an employee with an occasion to commit a tort motivated solely by the employee's own purposes. R.3d § 7.07, cmt. d.  Peregrinations  In general, travel required to perform work, such as travel from an employer's office to a job site or from one job site to another, is within the scope of an employee's employment while traveling to and from work is not. R.3d § 7.07, cmt. e.  However, an employer may place an employee's travel to and from work within the scope of employment by providing the employee with a vehicle and asserting control over how the employee uses the vehicle so that the employee may more readily respond to the needs of the employer's enterprise. An employee's travel to and from work may also be within the scope of employment if the employee does more than simply travel to and from work, for example by stopping for the employer's benefit to accomplish a task assigned by the employer.  An employee's travel during the workday that is not within the scope of employment has long been termed a “frolic” of the employee's own.  De minimis departures from assigned routes are not “frolics.” A “frolic” may also consist of activity on an employer's premises and within working hours. The conventional meaning of the term “detour” is a deviation from travel on an assigned route that is still within the scope of employment.  A “mere incidental deviation from the performance of assigned work” remains within the scope of employment. R.3d § 7.07, ill. 14.  Frolics end when an employee reenters employment, that is, when the employee is once again performing assigned work and taking actions incidental to it.  When a frolic consists of a physical journey away from the workplace or a material departure from an assigned route of travel, an employee reenters employment when the employee has taken action consistent with once again resuming work. iv. Intentional Torts  Intentional Torts  In determining whether an employee's tortious conduct is within the scope of employment, the nature of the tort is relevant, as is whether the conduct also constitutes a

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criminal act. An employee's intentionally criminal conduct may indicate a departure from conduct within the scope of employment, not a simple escalation.  The nature and magnitude of the conduct are relevant to determining the employee's intention at the time.  Intentional torts and other intentional wrongdoing may be within the scope of employment. R.3d § 7.07, cmt. c.  R.2d § 228 – General Statement  Conduct of a servant is within the scope of employment if, but only if: (a) it is of the kind he is employed to perform; (b) it occurs substantially within the authorized time and space limits; (c) it is actuated, at least in part, by a purpose to serve the master, and (d) if force is intentionally used by the servant against another, the use of force is not unexpectable by the master.  R.2d § 228 – Criminal or Tortious Acts  An act may be within the scope of employment although consciously criminal or tortious.  The fact that the servant intends a crime, especially if the crime is of some magnitude, is considered in determining whether or not the act is within the employment, since the master is not responsible for acts which are clearly inappropriate to or unforeseeable in the accomplishment of the authorized result.  The master can reasonably anticipate that servants may commit minor crimes in prosecution of business, but serious crimes are not only unexpectable but in general are in nature different from what servants in a lawful occupation are expected to do.  The Purpose Test  Under the R.2d approach, and the majority of cases, the pivotal inquiry is whether (i) the employee (ii) in engaging in the conduct that constituted the intentional tort (iii) was motivated at least in part by a desire to serve the employer. R.2d § 228(1)(c).  The R.3d approach uses a different formulation – whether the tortious act occurs within an independent course of conduct not intended by the employee to serve any purpose of the employer. R.3d § 7.07(2).  The Incidental/Foreseeable Test  A few recent cases focus on whether “the conduct constituting the intentional tort should fairly have been foreseen from the nature of the employment and the duties relating to it,” or “whether the risk of such conduct was one that may be fairly regarded as typical of or broadly incidental to the enterprise undertaken by the employer.”  The R.3d criticizes the incidental/foreseeable approach noting, “the possibility that the work may lead to or somehow provide the occasion for intentional misconduct that is distinct from an employee‟s actions in performing assigned work…is indeed always „foreseeable‟ given human frailty, but its occurrence is not a risk that an employer can effectively control.”
Ira S. Bushey & Sons, Inc. v. United States Facts: Plaintiff was an owner of a drydock in which the Coast Guard was docking a ship. A ship crewmember was drunk and opened tank valves, which caused the ship to fall and destroy parts of the drydock. Government appealed claiming it was not liable where the crewmember's acts were not within the scope of his employment. Holding: The Court held that the government was properly held liable for damages caused to the drydock where it was reasonably foreseeable that a crewmember might cause some damage, whether negligently or intentionally. It was held immaterial that the employee's specific acts were not foreseen. Reasoning: What is reasonably foreseeable in this context of respondeat superior is quite a different thing from the foreseeably unreasonable risk of harm that spells negligence. The foresight that should impel the prudent man to take precautions is not the same measure as that by which he should perceive the harm likely to flow from his long-run activity in spite of all reasonable precautions on his own part. An employer should be held to expect risks, to the public also, which arise out of and in the course of' his employment of labor. Manning v. Grimsley

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Facts: Spectator brought an action sounding in battery and negligence against Grimsley and the Baltimore Orioles after he was hit with a ball near the bullpen. Evidence suggested that the pitcher was expert, looked at the spectators several times immediately following heckling, and that the ball traveled at a right angle from the direction in which he had been pitching. The Orioles argued that Mass. law required a plaintiff seeking to recover damages “from an employer for injuries resulting from an employee‟s assault…must show that the employee‟s assault was in response to the plaintiff‟s conduct which was presently interfering with the employee‟s ability to perform his duties successfully. This interference may be in the form of an affirmative attempt to prevent an employee from carrying out his assignments.” Holding: The court rejected the argument and remanded. Reasoning: Jury could have found that the heckling interfered with pitcher's ability to perform his job.

v. Statutory Claims
Arguello v. Conoco, Inc. Facts: Minority consumers alleged Conoco violated state and federal statutes barring racial discrimination by refusing to serve minorities, and subjecting them to derogatory remarks. In three separate incidents (two of them at franchisee-owned stores), the minority consumers were subjected to discrimination. Conoco successfully argued before the district court that it was not liable for incidents at franchise stores, and the store clerk was not a supervisory employee. Consumers appealed. Holding: The Fifth Circuit affirmed the district court's finding that no agency relationship existed between Conoco and its franchised stores, but reversed the district court's determination that Conoco's store clerk acted outside the scope of her employment as a matter of law. Reasoning: Agency is a fiduciary relation that results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. At the core of agency is a "fiduciary relation" arising from the consent by one person to another that the other shall act on his behalf and subject to his control. Equally central to the master-servant relation is the master's control over or right to control the physical activities of the servant. In a public accommodation case, the supervisory status of the discriminating employee is much less relevant than it is in an employment discrimination case. Under general agency principles, a master is subject to liability for the torts of his servants while acting in the scope of their employment. Some of the factors used when considering whether an employee's acts are within the scope of employment are: (a) the time, place and purpose of the act; (b) its similarity to acts which the servant is authorized to perform; (c) whether the act is commonly performed by servants; (d) the extent of departure from normal methods; and (e) whether the master would reasonably expect such act would be performed.  The fact that an employee engages in intentional tortious conduct does not require a finding that the employee was outside the scope of his employment.  Therefore, it follows that the duty not to discriminate is not a non-delegable duty.

vi. Liability for Torts of Independent Contractor  R.3d § 7.05 – Principal's Negligence in Conducting Activity through Agent  A principal who conducts an activity through an agent is subject to liability for harm to a third party caused by the agent's conduct if the harm was caused by the principal's negligence in selecting, training, retaining, supervising, or otherwise controlling the agent.
 A foreseeable risk of harm may be created when one person conducts an activity through another person. For example, the actor chosen for a task may lack competence to perform it without endangering others. A task may require using an instrumentality that is dangerous to others unless the user has appropriate skill or supervision. R.3d § 7.05, cmt. b.  Some tasks require performance in settings that pose a foreseeable risk of criminal or other intentional misconduct against third parties or their property unless the actor is chosen with due care in reference to that risk. R.3d § 7.05, cmt. b.  When a principal conducts an activity through another person, the nature of the task to be performed and the conduct required for performance are relevant to whether the principal acted negligently, either in selecting the actor or in instructing, supervising, or otherwise controlling the actor. R.3d § 7.05, cmt. d. Majestic Realty Associates, Inc. v. Toti Contracting Co. Facts: Majestic filed suit against defendants, parking authority and demolition contractor, after it‟s building was damaged during demolition of an adjacent building by Toti demolition contractor. Trial court dismissed the action against defendant parking authority on the grounds that defendant demolition

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contractor was an independent contractor for whose negligence defendant parking authority could not be held responsible. Holding: The court remanded the action for determination on parking authority‟s liability. Reasoning: The court found that the supervisory interest of defendant parking authority related to the result accomplished, not to the means by which it was accomplished. The court determined that defendant parking authority, as landowner, retained liability for the work of defendant demolition contractor because the work done was inherently dangerous.  Liability will be imposed where (a) the landowner retains control of the manner and means of the doing of the work which is the subject of the contract; (b) where he engages an incompetent contractor; or (c) where the activity contracted for constitutes a nuisance per se.

D. FIDUCIARY DUTIES IN AGENCY RELATIONSHIP i. Duties and Obligations of Agent to Principal  R.3d § 8.01 – General Fiduciary Principle  An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship.
 The general fiduciary principle complements and facilitates an agent's compliance with duties of performance that the agent owes to the principal. R.3d § 8.01, cmt. b.  An agent has a duty to the principal to use care in acting on the principal's behalf.  An agent has a duty to use reasonable efforts to provide material information to principal.

 R.3d § 8.02 – Material Benefit Arising Out of Position  An agent has a duty not to acquire a material benefit from a third party in connection with transactions conducted or other actions taken on behalf of the principal or otherwise through the agent's use of the agent's position. R.3d § 8.02.
 A principal may consent to conduct by an agent that would otherwise constitute a breach of the duty stated in this duty. R.3d § 8.02, cmt. a.  Many material benefits are explicit, direct, and pecuniary in nature. However, an agent may breach the agent's duty to the principal by acquiring a material benefit more indirectly if the benefit is acquired through the agent's use of position or in connection with a transaction conducted on behalf of the principal. Reading v. Regem Facts: Reading was a sergeant in the Royal Army Medical Corps in Egypt. Wearing his uniform, he would escort a truck will of unidentified boxes through civilian checkpoints. Over several weeks, he had been paid several thousands pounds. The Crown discovered his activities and seized the money. Holding: The court held that the Crown was correct in seizing the bribes. Reasoning: Where the wearing of the King‟s uniform and plaintiff‟s position as a soldier is the sole cause of his getting the money and getting it dishonestly, that is an advantage which he is not allowed to keep.

 R.3d § 8.03 – Acting As Or On Behalf Of An Adverse Party  An agent has a duty not to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship.
 As a fiduciary, an agent has a duty to the principal to act loyally in the principal's interest in all matters in connection with the agency relationship. R.3d § 8.03, cmt. b.  When an agent deals with the principal on the agent's own account, the agent's own interests are irreconcilably in tension with the principal's interests because the interest of each is furthered by action – negotiating a higher or a lower price, for example – that is incompatible with the interests of the other.  If an agent acts on behalf of the principal in a transaction with the agent, the agent's duty to act loyally in the principal's interest conflicts with the agent's self-interest.  N.B. Even if the agent's divided loyalty does not result in demonstrable harm to the principal, the agent has still breached the agent's duty of undivided loyalty.

 R.3d § 8.04 – Competition

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 Throughout duration of an agency relationship, an agent has a duty to refrain from competing with the principal and from taking action on behalf of or otherwise assisting the principal's competitors. During that time, an agent may take action, not otherwise wrongful, to prepare for competition following termination of the agency relationship.
 Action by an agent that competes with the principal's business or assists a competitor of the principal, when connected to the agency relationship, contravenes the general fiduciary principle because it is contrary to the principal's interests, although the agent does not use the principal's property or confidential information. R.3d § 8.04, cmt. b. General Automotive Manufacturing Co. v. Singer Facts: Plaintiff employer hired defendant employee as general manager of its business and affairs and defendant accepted employment pursuant to a written contract. Plaintiff brought suit against defendant for breach of contract. Trial court found that defendant had breached his contract of employment with plaintiff because his sideline business was in direct competition with plaintiff. Defendant appealed. Holding: The court affirmed. Reasoning: The court held that by failing to disclose all the facts relating to certain orders and by receiving secret profits from the orders, defendant violated his fiduciary duty to act solely for the benefit of plaintiff. Therefore, defendant was liable for the amount of profits he earned in his sideline business. The court held that defendant's operations were in competition with plaintiff, and that he had received undisclosed personal profits.  Under a fiduciary duty to an employer, an employee is bound to the exercise of the utmost good faith and loyalty so that he does not act adversely to the interests of the employer by serving or acquiring any private interest of his own. The employee is also bound to act for the furtherance and advancement of the interest of the employer.

 R.3d § 8.05 – Use of Principal's Property; Use of Confidential Information  An agent has a duty: (i) not to use property of the principal for the agent's own purposes or those of a third party; and (ii) not to use or communicate confidential information of the principal for the agent's own purposes or those of a third party.
 Duty of nondisclosure and nonuse applies to any information the agent acquires or develops during the course of the agency relationship. R.3d § 8.05, cmt. b.  Duty applies even if the confidential information does not relate to the subject matter of the agency. Confidential information includes any information that is not generally known and that either carries an economic benefit for the principal, or could, if disclosed, otherwise damage or embarrass the principal.  Duty to respect confidential information continues after the agency ends. Town & Country House & Home Service, Inc. v. Newbery Facts: Plaintiff sought injunctive and other relief after former employees formed a competing house cleaning service using many of plaintiff's methods and persuaded several of plaintiff's customers to switch companies. Holding: The court affirmed and stated that plaintiff was entitled to injunctive relief because their customer list was a trade secret, plaintiff had expended great amounts of time and energy to develop it, and the contents of the list were not easily discernable from any other source. Reasoning: The information became known to defendants only because of their employment by plaintiff. Therefore plaintiff was entitled to enjoin defendants from further solicitation of its customers and to receive damages corresponding to the profits defendants made by reasons of the customers they enticed away from plaintiff. Plaintiff was not, however, entitled to enjoin defendants from operating a competing business.  Even where a solicitor of business does not operate fraudulently under the banner of his former employer, he still may not solicit the latter's customers who are not openly engaged in business in advertised locations or whose availability as patrons cannot readily be ascertained but whose trade and patronage have been secured by years of business effort and advertising, and the expenditure of time and money, constituting a part of the good-will of a business which enterprise and foresight have built up.

 R.3d § 8.06 – Principal’s Consent  Conduct by an agent that would otherwise constitute a breach of duty does not constitute a breach of duty if the principal consents to the conduct, provided that:

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 In obtaining the principal's consent, the agent (i) acts in good faith, (ii) discloses all material facts that the agent knows, has reason to know, or should know would reasonably affect the principal's judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know them, and (iii) otherwise deals fairly with the principal; and  The principal's consent concerns either a specific act or transaction, or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship.  An agent who acts for more than one principal in a transaction between or among them has a duty (a) to deal in good faith with each principal, (b) to disclose to each principal (i) the fact that the agent acts for the other principal or principals, and (ii) all other facts that the agent knows, has reason to know, or should know would reasonably affect the principal's judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know them, and (c) otherwise to deal fairly with each principal.  R.3d § 8.07 – Duties Created by Contract  An agent has a duty to act in accordance with the express and implied terms of any contract between the agent and the principal.
 A contract may create duties of performance on the part of an agent through its express and implied terms. The terms of an agreement between a principal and an agent may incorporate, either expressly or impliedly, the custom or usage of a particular trade. R.3d § 8.07, cmt. b.

 R.3d § 8.08 – Duties of Care, Competence, and Diligence  Subject to any agreement with the principal, an agent has a duty to the principal to act with the care, competence, and diligence normally exercised by agents in similar circumstances. Special skills or knowledge possessed by an agent are circumstances to be taken into account in determining whether the agent acted with due care and diligence. If an agent claims to possess special skills or knowledge, the agent has a duty to the principal to act with the care, competence, and diligence normally exercised by agents with such skills or knowledge.
 A principal and an agent may establish benchmarks or other measures for the effort and skill to be expected from the agent. R.3d § 8.08, cmt. b.  A contract may also, in appropriate circumstances, raise or lower the standard of performance to be expected of an agent or specify the remedies or mechanisms of dispute resolution available to the principal. Regardless of their content, contractually shaped or contractually created duties are grounded in the mutual assent of agent and principal.

 R.3d § 8.0 – Duty to Act Only Within Scope of Actual Authority and to Comply With Principal's Lawful Instructions  An agent has a duty to take action only within the scope of the agent's actual authority.  An agent has a duty to comply with all lawful instructions received from the principal and persons designated by the principal concerning the agent's actions on behalf of the principal.
 Although an agent may have the power to act beyond the scope of actual authority, an agent does not have the right to do so. To the contrary, the agent has duty to act only as authorized.  Agent‟s duty to obey instructions is consistent with agent‟s duty to act within authority.  Duty to obey instructions exists even if the principal has contracted away the right to instruct. The agent may have a claim for breach of contract, but is nonetheless obliged to either obey the principal‟s instructions or resign. R.3d § 8.09, cmt. b.

 R.3d § 8.10 – Duty of Good Conduct  An agent has a duty, within the scope of the agency relationship, to act reasonably and to refrain from conduct that is likely to damage the principal's enterprise.

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 This aspect of the duty of loyalty “may extend to conduct that, although it is beyond the scope of activity encompassed by the agency relationship itself, is nonetheless closely connected to the principal or the principal‟s enterprise and is likely to bring the principal or the principal‟s enterprise into disrepute.” R.3d § 8.10, cmt. b.

 R.3d § 8.11 – Duty to Provide Information  An agent has a duty to use reasonable effort to provide the principal with facts that the agent knows, has reason to know, or should know when (i) subject to any manifestation by the principal, the agent knows or has reason to know that the principal would wish to have the facts or the facts are material to the agent's duties to the principal; and (ii) the facts can be provided to the principal without violating a superior duty owed by the agent to another person.
 An agent owes the principal a duty to provide information to the principal that the agent knows or has reason to know the principal would wish to have. An agent also owes the principal a duty, subject to any manifestation by the principal, to provide information to the principal that is material to the agent's duties to the principal. R.3d § 8.11, cmt. b.  The principal may direct that information be furnished to another agent or another person designated by the principal. The agent's duty is satisfied if the agent uses reasonable effort to provide the information, acting reasonably and consistently with any directions furnished by the principal.

ii. Duties and Obligations of Principal to Agent  R.3d § 8.13 – Duty Created by Contract  A principal has a duty to act in accordance with the express and implied terms of any contract between the principal and the agent.
 When the relationship between a principal and an agent is one of employment, as an employer the principal owes duties to the employee, distinct from any contract between them, that are defined by statutes, by administrative regulations, and by common-law doctrines specifically applicable to employment relations. R.3d § 8.13, cmt. b.

 R.3d § 8.14 – Duty Created by Contract  A principal has a duty to indemnify an agent (i) in accordance with the terms of any contract between them; and (ii) unless otherwise agreed, (a) when the agent makes a payment (i) within the scope of the agent's actual authority, or (ii) that is beneficial to the principal, unless the agent acts officiously in making the payment; or (b) when the agent suffers a loss that fairly should be borne by the principal in light of their relationship.
 An agent's right to be indemnified by a principal is distinct from any right of the

agent to receive compensation for the agent's services.

Partnership A. PRINCIPLES OF PARTNERSHIP i. Nature of a Partnership  Creature of Common Law and Statute  A general partnership arises when two or more persons manifest their intentions to associate as co-owners in a business for profit, whether or not the persons intend to form a partnership.  Their manifestations – whether by word or conduct – create what is essentially a contract between or among them.  The provisions of the RUPA expressly rely on judge-made law to fill statutory gaps.

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 RUPA § 201 – Partnership as Entity  A partnership is an entity distinct from its partners.
 The aggregate theory traditionally applied by the common law courts does not regard the partnership as an organization with a separate legal personality. The aggregate approach views the partnership as nothing more than a conduit for a collection of individuals. Each partner is seen as owning an undivided share of partnership assets and as conducting a pro rata share of partnership business.  The entity theory treats the partnership as a distinct entity interposed between partners and partnership assets. The partner's interest is viewed as a separate bundle of rights and liabilities associated with the partner's participation in the organization, analogous to the interest of a corporate shareholder in shares of stock.

 RUPA § 202 – Formation of Partnership  Except as otherwise provided, the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership.  An association formed under a statute other than this [Act], a predecessor statute, or a comparable statute of another jurisdiction is not a partnership under this [Act].  In determining whether a partnership is formed, the following rules apply:  Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property, or part ownership does not by itself establish a partnership, even if the coowners share profits made by the use of the property.  The sharing of gross returns does not by itself establish a partnership, even if the persons sharing them have a joint or common right or interest in property from which the returns are derived.  A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment: (i) of a debt by installments or otherwise; (ii) for services as an independent contractor or of wages or other compensation to an employee; (iii) of rent; (iv) of an annuity or other retirement or health benefit to a beneficiary, representative, or designee of a deceased or retired partner; (v) of interest or other charge on a loan, even if the amount of payment varies with the profits of the business, including a direct or indirect present or future ownership of the collateral, or rights to income, proceeds, or increase in value derived from the collateral; or (vi) for the sale of the goodwill of a business or other property by installments or otherwise.
 The intent of the parties to be classified as partners or to avoid partnership classification is not determinative. Rather, the question is whether or not the partners have intended to enter into a relationship, however it is denominated, the essence of which is partnership.  It should be assumed that relationships that are classified as “joint ventures” will be treated as partnerships unless there is a reason why they should be classified as something else. In general, the term “joint venture” is used to describe what is, in essence, a partnership for a limited time or purpose.

 RUPA § 103 – Effect of Partnership Agreement; Nonwaivable Provisions  Except as otherwise provided below, relations among the partners and between the partners and the partnership are governed by the partnership agreement. To the extent the partnership agreement does not otherwise provide, this [Act] governs relations among the partners and between the partners and the partnership.  The partnership agreement may not:  Vary the rights and duties under § 105 except to eliminate the duty to provide copies of statements to all of the partners;  Unreasonably restrict the right of access to books and records under § 403(b);  Eliminate the duty of loyalty under §§ 404(b) or 603(b)(3), but: (i) the partnership agreement may identify specific types or categories of activities that do not violate the

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duty of loyalty, if not manifestly unreasonable; or (ii) all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty; Unreasonably reduce the duty of care under § 404(c) or 603(b)(3); Eliminate the obligation of good faith and fair dealing under § 404(d), but the partnership agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable; Vary the power to dissociate as a partner under § 602(a), except to require the notice under § 601(1) to be in writing; Vary the right of a court to expel a partner in the events specified in § 601(5); Vary the requirement to wind up the partnership business in cases specified in §§ 801(4), (5), or (6); Vary the law applicable to a limited liability partnership under § 106(b); or Restrict rights of third parties under this [Act].

      

ii. Partners v. Wage Earners  Determining Partner from an Employee  Courts tend to emphasize five factors in resolving disputes of the characterization of the business relationship: (i) control, (ii) agreements to share losses, (iii) contributions of property to the business, (iv) extent to which profit share constitutes recipients only remuneration from the business, and (v) the parties‟ own characterization of the relationship.
“Partner” Participates in all important decisions Has expressly agreed to share losses Contributed property to the business All payout via profit share Called a partner

    

“Wage Earner” Obeys instructions; has no important discretion Has never agreed to share losses; when losses occur, payout does not change Merely works in the business Profit share is only bonus Called an employee

Fenwick v. Unemployment Compensation Commission Facts: Employer entered into an agreement with a receptionist after receptionist demanded more money. Receptionist was to receive 20 percent of the profits at the end of the year. Employer retained all control of the business and its management. UCC found that receptionist was an employee and the state challenged the ruling. Holding: The court affirmed the decision of the UCC, holding that a partnership did not exist between the employer and the receptionist Reasoning: The sharing of profits by the employer and his receptionist alone did not give rise to a partnership. The court noted that the employer retained all control and management of the business, that there was no obligation to share in losses and the employer contributed all of the capital, and that upon dissolution the receptionist would receive no compensation.  The elements considered include the (i) intention of the parties, (ii) the right to share profits, (iii) the obligation to share losses, (iv) ownership and control of partnership property, (v) community of power, (vi) language of any agreements, and (vii) the parties‟ conduct with respect to third parties.

iii. Partners v. Lenders
Martin v. Peyton Facts: Martin claimed that defendants became partners in a firm doing business as bankers and brokers. Because Martin claimed an actual partnership, the claim depended on the interpretation of certain instruments. One of the firm's partners got a loan from defendants for the firm to use as collateral for bank advances. Defendants refused to become partners in the firm but reached an agreement with one of the firm's partners expressed in three documents. The general purpose was for defendants to loan the firm liquid securities for use in the business. To insure defendants against losses, the firm was to turn over its own more speculative securities, which could not be used as collateral for bank loans. In

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compensation for the loan, defendants were to receive a percent of the firm's profits and an option to join the firm. Holding: Court found that the documents did not associate defendants with the firm so that they and it together carried on as co-owners of a business for profit. Defendants' measures taken as precautions to safeguard the loan were ordinary caution and did not imply an association in the business. Reasoning: An arrangement for sharing profits is to be considered and given its due weight in connection with all the rest. It is not decisive. It may be merely the method adopted to pay a debt or wages, as interest on a loan or for other reasons.

iv. Partners v. Contract
Southex Exhibitions, Inc v. Rhode Island Builders Association, Inc. Facts: The association contracted with the exhibitor to produce home shows. The contract was assigned to the assignee. The association became dissatisfied and hired another exhibitor to do its home shows. The assignee argued that the contract showed a partnership was formed as it provided for (a) a 55-45 percent sharing of profits; (b) mutual control over designated business operations; and (c) the respective contributions of valuable property to the partnership by the partners. Holding: The appellate court agreed with the district court that no partnership was formed. Reasoning: The court noted that (i) the assignee had entered into contracts and conducted business with third parties in its own name, (ii) the venture was never given a name, (iii) there were no partnership tax returns filed, (iv) there was no jointly owned property, (v) the term "partners" appeared only once in the contract, (vi) the contract was not labeled as a partnership agreement, was devoid of the provisions usually found in a partnership agreement, and contained other provisions inconsistent with an intent to form a partnership.

v. Partnership by Estoppel  RUPA § 308 – Liability of Purported Partner  If a person, by words or conduct, purports to be a partner, or consents to being represented by another as a partner, in a partnership or with one or more persons not partners, the purported partner is liable to a person to whom the representation is made, if that person, relying on the representation, enters into a transaction with the actual or purported partnership.  If the representation, either by the purported partner or by a person with the purported partner's consent, is made in a public manner, the purported partner is liable to a person who relies upon the purported partnership even if the purported partner is not aware of being held out as a partner to the claimant.  If partnership liability results, the purported partner is liable with respect to that liability as if the purported partner were a partner. If no partnership liability results, the purported partner is liable with respect to that liability jointly and severally with any other person consenting to the representation.  If a person is thus represented to be a partner in an existing partnership, or with one or more persons not partners, the purported partner is an agent of persons consenting to the representation to bind them to the same extent and in the same manner as if the purported partner were a partner, with respect to persons who enter into transactions in reliance upon the representation. If all of the partners of the existing partnership consent to the representation, a partnership act or obligation results. If fewer than all of the partners of the existing partnership consent to the representation, the person acting and the partners consenting to the representation are jointly and severally liable.
Young v. Jones Facts: Plaintiffs were investors from Texas who deposited a large sum of money into a S. Carolina bank for transfer to an investment opportunity. Price Waterhouse Bahamas issued an unqualified audit letter regarding the investment. Based on the audit letter, the plaintiffs deposited the money. Plaintiffs further alleged that PW-Bahamas and Price Waterhouse were operating as partners by estoppel. Holding: The court rejected the argument. Reasoning: The plaintiffs failed to demonstrate that they specifically relied on the alleged partnership relationship between PW-Bahamas and Price Waterhouse.

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B. RELATIONS OF PARTNERS TO EACH OTHER AND TO THE PARTNERSHIP i. Partner‟s Rights and Duties  RUPA § 401 – Partner's Rights and Duties  Each partner is deemed to have an account that is: (i) credited with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, the partner contributes to the partnership and the partner's share of the partnership profits; and (ii) charged with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, distributed by the partnership to the partner and the partner's share of the partnership losses.  Each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partner's share of the profits.  A partnership shall reimburse a partner for payments made and indemnify a partner for liabilities incurred by the partner in the ordinary course of the business of the partnership or for the preservation of its business or property.  A partnership shall reimburse a partner for an advance to the partnership beyond the amount of capital the partner agreed to contribute.  A payment or advance made by a partner which gives rise to a partnership obligation or constitutes a loan to the partnership which accrues interest from the date of the payment or advance.  Each partner has equal rights in the management and conduct of the partnership business.  A partner may use or possess partnership property only on behalf of the partnership.  A partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership.  A person may become a partner only with the consent of all of the partners.  A difference arising as to a matter in the ordinary course of business of a partnership may be decided by a majority of the partners. An act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all of the partners.  RUPA § 403 – Partner's Rights and Duties With Respect to Information  A partnership shall keep its books and records, if any, at its chief executive office.  A partnership shall [must] provide partners and their agents and attorneys access to its books and records. It shall provide former partners and their agents and attorneys access to books and records pertaining to the period during which they were partners. The right of access provides the opportunity to inspect and copy books and records during ordinary business hours. A partnership may impose a reasonable charge, covering the costs of labor and material, for copies of documents furnished.  Each partner and the partnership shall furnish to a partner, and to the legal representative of a deceased partner or partner under legal disability: (i) without demand, any information concerning the partnership's business and affairs reasonably required for the proper exercise of the partner's rights and duties under the partnership agreement or this [Act]; and (ii) on demand, any other information concerning the partnership's business and affairs, except to the extent the demand or the information demanded is unreasonable or otherwise improper under the circumstances.  RUPA § 404 – Standards of Partner's Conduct  The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth below.  A partner's duty of loyalty to the partnership and the other partners is limited to the following: (i) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business

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or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity; (ii) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and (iii) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. A partner shall discharge the duties to the partnership and the other partners under this [Act] or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing.  A partner does not violate a duty or obligation under this [Act] or under the partnership agreement merely because the partner's conduct furthers the partner's own interest. A partner may lend money to and transact other business with the partnership, and as to each loan or transaction the rights and obligations of the partner are the same as those of a person who is not a partner, subject to other applicable law. Section applies to a person winding up the partnership business as the personal or legal representative of the last surviving partner as if the person were a partner.

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Meinhard v. Salmon Facts: A joint venture existed in which two partners pooled their money in order to lease a building for shops and offices. Defendant Salmon was more business savvy and, in an effort to increase his wealth, he entered into an agreement prior to the termination of the partnership with another businessperson to purchase surrounding property as a leasehold estate. The specifics of this transaction were not disclosed to plaintiff Meinhard, and he subsequently sued for breach of the joint venture agreement when he discovered the transaction. Litigation ensued and Meinhard received a substantial judgment for breach of contract. Salmon appealed. Holding: The Court of Appeals affirmed the judgment, holding that Salmon would not have been in the rewarding leasehold position if it were not for the joint venture. Accordingly, after lessening stock distribution, the court reaffirmed the lower tribunal's finding on behalf of the Meinhard. Reasoning: Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty. Many forms of conduct permissible in a workaday world for those acting at arm's length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior. A co-adventurer has the duty to concede and reveal any chance to compete and any chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency. One partner may not appropriate to his own use a renewal of a lease, though its term is to begin at the expiration of the partnership. Dissent: Andrews, J., dissenting wrote that it seems to me that the venture so inaugurated had in view a limited object and was to end at a limited time. There was no intent to expand it into a far greater undertaking lasting for many years. The design was to exploit a particular lease. Doubtless in it Mr. Meinhard had an equitable interest, but in it alone. This interest terminated when the joint adventure terminated. There was no intent that for the benefit of both any advantage should be taken of the chance of renewal – that the adventure should be continued beyond that date. Mr. Salmon has done all he promised to do in return for Mr. Meinhard's undertaking when he distributed profits.

ii. Opting Out of Fiduciary Duties
Perretta v. Prometheus Development Company, Inc. Facts: Plaintiffs, two limited partners suing as representatives of the class of limited partners, brought an action for breach of fiduciary duty against defendants, the general partner and its sole officer. Plaintiffs alleged that defendants breached their fiduciary duty of loyalty under Cal. Corp. Code § 16404(b) by imposing a self-dealing merger, on unfair terms, without a valid ratification by disinterested limited partners. Holding: The court held that plaintiffs' claim for a violation of the duty of loyalty was not extinguished by a valid ratification of the merger under Cal. Corp. Code § 16103(b)(3)(B). The district court erroneously based its determination of what constituted a "majority vote" on the rules in the proxy statement. The court held that only the partnership agreement could vary the unanimous ratification requirement of § 16103(b)(3)(B) and that it would be "manifestly unreasonable" for a partnership agreement to include votes cast by an interested general partner in a ratification vote. Construing the

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agreement as requiring a vote of the majority of the outstanding limited partner units owned by unaffiliated partners, the court found no valid ratification. Reasoning: Under California law, the general partner of a limited partnership has the same fiduciary duties as a partner in any other partnership. The fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care. A partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his copartner for his share of the prospective business opportunity. However, not all self-interested transactions violate the duty of loyalty. A partner does not violate a duty or obligation under the Uniform Partnership Act of 1994 or under the partnership agreement merely because the partner's conduct furthers the partner's own interest. Cal. Corp. Code § 16404(e). The question is not whether the interested partner is benefitted, but whether the partnership or the other partners are harmed. Partnership is a fiduciary relationship, and partners may not take advantages for themselves at the expense of the partnership. There is an obvious and essential unfairness in one partner's attempted exploitation of a partnership opportunity for his own personal benefit and to the resulting detriment of his copartners. Thus, a partner who seeks a business advantage over another partner bears the burden of showing complete good faith and fairness to the other. One way a self-interested partner may meet this burden is to have disinterested partners ratify its actions.  The California Court of Appeals has held that there is no breach of a fiduciary duty if there has been a full and complete disclosure, if the partner who deals with partnership property first discloses all of the facts surrounding the transaction to the other partners and secures their approval and consent.  A partnership agreement provision that allows an interested partner to count its votes in a ratification vote would be "manifestly unreasonable" within the meaning of Cal. Corp. Code § 16103(b)(3)(B).  "Majority Vote," in turn, is defined as "the vote of Limited Partners who are entitled to vote, consent or act and are holders of record of a majority of the outstanding Units."

iii. Grabbing and Leaving
Meehan v. Shaughnessy Facts: Plaintiff former law partners left defendant law firm to start their own firm. Plaintiffs initiated action against defendant to recover amounts owed to them under the partnership agreement with defendant. Defendant contended that plaintiffs violated the agreement when they left the firm. The trial court granted judgment in favor of plaintiffs, and defendant sought review. Holding: The Supreme Judicial Court held that plaintiffs owed defendant a fiduciary duty of the utmost good faith and loyalty and that they must have refrained from acting for purely private gain. The court held that the trial court erred in deciding that plaintiffs acted properly in acquiring consent to remove clients and cases from defendant. The court held that plaintiffs failed to establish their burden of proving no causal connection between their breach of duty and defendant's loss of clients. Reasoning: Where a partnership agreement provides that the partnership is to continue indefinitely, and the partnership is therefore "at will," a partner has the right to dissolve the partnership, and the dissolution occurs without violation of the agreement between the partners. Partners owe each other a fiduciary duty of "the utmost good faith and loyalty." As a fiduciary, a partner must consider his or her partners' welfare, and refrain from acting for purely private gain. Partners thus may not act out of avarice, expediency, or self-interest in derogation of their duty of loyalty. Fiduciaries may plan to compete with the entity to which they owe allegiance, provided that in the course of such arrangements they do not otherwise act in violation of their fiduciary duties. A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner.  Shifting the burden of proof may be justified on policy grounds because it encourages a defendant both to preserve information concerning the circumstances of the plaintiff's injury and to use best efforts to fulfill any duty he or she may owe the plaintiff. Once it is established that a partner or corporate manager has engaged in self-dealing, or has acquired a corporate or partnership opportunity, the trial courts require the fiduciary to prove that his or her actions were intrinsically fair, and did not result in harm to the corporation or partnership.

iv. Expulsion
Lawlis v. Knightlinger & Gray Facts: Plaintiff, former partner, was expelled from defendant, law partnership, due to alcoholism. He filed an action for wrongful expulsion, alleging that defendant breached the partnership agreement, breached a fiduciary duty to him, committed constructive fraud against him, and breached an oral contract to restore him to partnership status if he quit drinking. The trial court entered summary judgment in favor of defendant. Holding: On appeal, the court affirmed the judgment dismissing plaintiff's action, holding that plaintiff had no claim for damages for wrongful expulsion under Ind. Code § 23-4-1-18(a)(2) because he remained

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a senior partner until he was expelled by vote of the partners in accordance with the partnership agreement. The court further held that plaintiff had no claim for breach of fiduciary duty because the facts showed the firm had no "predatory purpose" in expelling him, that there was no constructive fraud because the facts showed defendant acted in good faith, and that defendant violated no oral agreement to restore plaintiff to partner status because he was never downgraded from that status and he would have waived any claim for damages by his own acquiescence. Reasoning: The lifeblood of any partnership contains two essential ingredients, cash flow and profit, and the prime generators of that lifeblood are "good will" and a favorable reputation. The term "good will" generally is defined as the probability that old customers of the firm will resort to the old place of business where it is well-established, well known, and enjoys the fixed and favorable consideration of its customers. An equally important business adjunct of a partnership engaged in the practice of law is a favorable reputation for ability and competence in the practice of that profession. A favorable reputation not only is involved in the retention of old clients, it is an essential ingredient in the acquisition of new ones. Any condition which has the potential to adversely affect the good will or favorable reputation of a law partnership is one which potentially involves the partnership's economic survival. Where the remaining partners in a firm deem it necessary to expel a partner under a no cause expulsion clause in a partnership agreement freely negotiated and entered into, the expelling partners act in "good faith" regardless of motivation if that act does not cause a wrongful withholding of money or property legally due the expelled partner at the time he is expelled. Used in this context, "good faith" means a state of mind indicating honesty and lawfulness of purpose: belief in one's legal title or right: belief that one's conduct is not unconscionable: absence of fraud, deceit, collusion, or gross negligence.  Where one has full knowledge of an alleged fraud in the inducement yet acts in a manner that shows an intent to confirm the contract, he waives any claim for damages relating to such alleged misrepresentation.

v. The Sharing of Losses
Kovacik v. Reed Facts: Defendant labor partner appealed from a judgment of the Superior Court, which ruled plaintiff financial partner was to recover from the labor partner one half of the losses of the venture. Holding: The court concluded that inasmuch as the parties agreed that the financial partner was to supply the money and the labor partner the actual work required to carry on the venture, the labor partner was correct in his contention that the trial court erred in holding him liable for one half the monetary losses. The financial partner lost only some $ 8,680 - or somewhat less than the $ 10,000 that he originally proposed and agreed to invest. The court concluded that the evidence to support the essential findings and conclusions had to be found in the settled statement, or the judgment must fall. It followed that the conclusion of law upon which the judgment in favor of the financial partner for recovery from the labor partner of one half the monetary losses was untenable, and that the judgment should be reversed. Reasoning: It is the general rule that in the absence of an agreement to the contrary the law presumes that partners and joint adventurers intended to participate equally in the profits and losses of the common enterprise, irrespective of any inequality in the amounts each contributed to the capital employed in the venture, with the losses being shared by them in the same proportions as they share the profits. However, in the cases in which the above stated general rule has been applied, each of the parties had contributed capital consisting of either money or land or other tangible property, or else was to receive compensation for services rendered to the common undertaking which was to be paid before computation of the profits or losses. Where, however, one partner or joint adventurer contributes the money capital as against the other's skill and labor, neither party is liable to the other for contribution for any loss sustained. Thus, upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services. Where one party contributes money and the other contributes services, then in the event of a loss each would lose his own capital - the one his money and the other his labor. Another view would be that in such a situation the parties have, by their agreement to share equally in profits, agreed that the values of their contributions - the money on the one hand and the labor on the other - were likewise equal; it would follow that upon the loss, as here, of both money and labor, the parties have shared equally in the losses.

C. PARTNERSHIP PROPERTY i. Partnership Property  RUPA § 203 – Partnership Property

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 Property acquired by a partnership is property of the partnership and not of the partners individually.
 Partners are not conceived of as co-owners of partnership property. The partnership entity owns partnership property. Even property that is contributed by partners becomes property of the entity rather than property of a co-tenancy of the contributing partners.

 Partnership Property Between and Among Partners  No Right to Partition.  There is no right to partition as there is in the case of tenants in common.  Any right of a partner to liquidate the partnership and its assets is governed by RUPA articles 6, 7 and 8.  No Right to Withdraw Property or to In-Kind Distribution.  A partner who contributes property to a partnership loses his separate interest in it – even if there is no documentation of a transfer of title to the partnership. If it has become partnership property, the contributing partner has no right to get it back – in the absence of an agreement to the contrary. The contributing partner has no right to reclaim the property even if the partner agrees to substitute other property. Nor does the contributing partner have the right to receive a distribution of the property, either in a current distribution or in a liquidating distribution.  No Right to Use for Personal Purposes.  Another consequence of property becoming partnership property is that the individual partner, even the partner who has contributed the property, has no right to use it for personal purposes. Thus, unless otherwise agreed, partners must pay for any personal use of partnership property.  Contrary Agreements Are Enforceable.  All RUPA's rules governing the property rights among partners can be varied by agreement. The partners may agree, for example, that the partner who contributes a particular piece of partnership property has a right to a return of that particular piece of property upon dissolution or upon any other event.  So, too, a partnership agreement can provide that a partner may use partnership property without compensation. Because there is no requirement that the partnership agreement be in writing, there is no requirement that any special property arrangement be in writing.  RUPA § 204 – When Property Is Partnership Property  Property is partnership property if acquired in the name of: (i) the partnership; or (ii) one or more partners with an indication in the instrument transferring title to the property of the person's capacity as a partner or of the existence of a partnership but without an indication of the name of the partnership.  Property is acquired in the name of the partnership by a transfer to: (i) the partnership in its name; or (ii) one or more partners in their capacity as partners in the partnership, if the name of the partnership is indicated in the instrument transferring title to the property.  Property is presumed to be partnership property if purchased with partnership assets, even if not acquired in the name of the partnership or of one or more partners with an indication in the instrument transferring title to the property of the person's capacity as a partner or of the existence of a partnership.  Property acquired in the name of one or more of the partners, without an indication in the instrument transferring title to the property of the person's capacity as a partner or of the existence of a partnership and without use of partnership assets, is presumed to be separate property, even if used for partnership purposes.
 Ultimately, it is the intention of the partners that controls whether property belongs to the partnership or to one or more of the partners in their individual capacities, at least as among the partners themselves.  A partner may contribute merely the use of property to a partnership, either on an

exclusive or on a nonexclusive basis, either free of charge or for a fee

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Putnam v. Shoaf Facts: After the previous partner conveyed her partnership interest to the succeeding partners, it was discovered that the partnership's bookkeeper had embezzled funds. The partnership brought an action against the bookkeeper and the banks that honored any forged checks. Subsequently, the administrator, on behalf of the deceased previous partner, brought an action to recover one half of the amounts that the banks were ordered to pay into the court as a result of the partnership's forgery action. Trial court denied recovery to the administrator, and the administrator sought review. Holding: On appeal, the court affirmed. The court held that the evidence of the previous partner's quitclaim deed showed that the intent of the previous partner was to convey the interest that she owned, which was her share of the profits and surplus. The court held that the asset that the partnership possessed in its claim against the banks was a partnership asset and not the personal assets of the individual partners. Therefore, the court ruled that this matter was not about mutual mistake but one of mutual ignorance for which the administrator was not entitled to recover. Reasoning: The right in "specific partnership property" is the partnership tenancy possessory right of equal use or possession by partners for partnership purposes. This possessory right is incident to the partnership and the possessory right does not exist absent the partnership. The possessory right is not the partner's "interest " in the assets of the partnership. The real interest of a partner, as opposed to that incidental possessory right before discussed, is the partner's interest in the partnership which is defined as his share of the profits and surplus and the same is personal property. Therefore, a co-partner owns no personal specific interest in any specific property or asset of the partnership. The partnership owns the property or the asset. The partner's interest is an undivided interest, as a co-tenant in all partnership property. That interest is the partner's pro rata share of the net value or deficit of the partnership. For this reason a conveyance of partnership property held in the name of the partnership is made in the name of the partnership and not as a conveyance of the individual interests of the partners.

D. RIGHTS OF PARTNERS IN MANAGEMENT i. Binding the Partnership  RUPA § 301 – Partner as Agent of Partnership  Each partner is an agent of the partnership for the purpose of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.  An act of a partner which is not apparently for carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership only if the act was authorized by the other partners.  RUPA § 305 – Partnership Liable for Partner's Actionable Conduct  A partnership is liable for loss or injury caused to a person, or for a penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership or with authority of the partnership.  If, in the course of the partnership's business or while acting with authority of the partnership, a partner receives or causes the partnership to receive money or property of a person not a partner, and the money or property is misapplied by a partner, the partnership is liable for the loss.
National Biscuit Company v. Stroud Facts: Two individuals had entered into a partnership to sell groceries. The non-assenting partner advised National Biscuit that he was no longer responsible for any additional bread sold by the company to the partnership. After that, the assenting partner requested additional deliveries of bread from the company and the company provided the bread. Holding: The court found that the assenting partner's purchases of bread from the company as a going concern bound the partnership and the non-assenting partner. The court consider the N.C. Gen. Stats. and found that activities within the scope of the business of the partnership could not be limited except

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by the expressed will of a majority decision on the disputed question and that half of the members were not a majority. Reasoning: When A and B are general partners to do some given business; the partnership is, by operation of law, a power to each to bind the partnership in any manner legitimate to the business. If one partner go to a third person to buy an article on time for the partnership, the other partner cannot prevent it by writing to the third person not to sell to him on time; or, if one party attempt to buy for cash, the other has no right to require that it shall be on time. And what is true in regard to buying is true in regard to selling. What either partner does with a third person is binding on the partnership. It is otherwise where the partnership is not general, but is upon special terms, as that purchases and sales must be with and for cash. There the power to each is special, in regard to all dealings with third persons at least who have notice of the terms. N.C. Gen. Stat. § 59-39 reads that every partner is an agent of the partnership for the purpose of its business, and the act of every partner, including the execution in the partnership name of any instrument, for apparently carrying on in the usual way the business of the partnership of which he is a member binds the partnership, unless the partner so acting has in fact no authority to act for the partnership in the particular matter, and the person with whom he is dealing has knowledge of the fact that he has no such authority. N.C. Gen. Stat. § 59-39(4) states that no act of a partner in contravention of a restriction on authority shall bind the partnership to persons having knowledge of the restriction.  Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners.  In cases of an even division of the partners as to whether or not an act within the scope of the business should be done, of which disagreement a third person has knowledge, it seems that logically no restriction can be placed upon the power to act. The partnership being a going concern, activities within the scope of the business should not be limited, save by the expressed will of the majority deciding a disputed question; half of the members are not a majority. Summers v. Dooley Facts: Despite defendant's repeated objections to plaintiff's request to hire a third man to work for the partnership, plaintiff hired a new employee, paid him $ 11,000 out of his own pocket, and sought reimbursement from defendant. The trial court granted him only partial relief on his claims for reimbursement of costs he incurred by employing the third man. Holding: On appeal, the court affirmed the trial court's decision to award plaintiff only partial relief in the amount of one half of $ 966.72. The court held that, because the parties' partnership agreement did not specify otherwise, the business differences between the parties should have been resolved by a by a majority of the partners pursuant to Idaho Code § 53-318(8). The court determined that plaintiff was not entitled to full reimbursement of the expenses he incurred when unilaterally hiring a new employee over defendant's objections because it would have been manifestly unjust to permit recovery of an expense that was incurred individually and not for the benefit of the partnership but rather for the benefit of plaintiff.  The party seeking to upset the status quo bears the burden. Day v. Sidley & Austin Facts: The attorney lost authority as chairman of a branch office of the law firm when he was made cochairman as the result of a merger with another firm. He alleged that the executive committee of the law firm had represented that no one would be "worse off" as a result of the merger. The attorney contended on appeal that the partnership resided at the forum under D.C. Code Ann. § 13-421 by virtue of its business activity, that he had a contractual right to maintain his authority, and that the misrepresentations were actionable. District court entered summary judgment in favor of the partners in the attorney‟s action against the partners and their law firm for breach of contract and misrepresentation. Holding: The court affirmed the judgment. The court stated that the law governing service on partnerships, that the partnership entity was never to be served and service was to be made on all partners, had not been changed by the enactment of § 13-421, and concluded that removal was proper. The court sustained the trial court's finding that no foundation for the breach-of-contract claim was shown. The court noted that a sine qua non of any recovery for misrepresentation was a showing of pecuniary loss proximately caused by reliance on the misrepresentation, and concluded that no compensable harm to the attorney from the conduct complained of had been indicated. Reasoning: Where a written agreement purportedly represents the parties' complete expression of their relationship, neither is at liberty to modify any of its terms by parol evidence. This wholesome principle safeguards the integrity of partnership agreements no less than others. In any determination of the relations of partners inter se, the primary reference is to the terms of the partnership agreement.

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E. PARTNERSHIP DISSOLUTION i. Dissolving the Partnership  RUPA § 801 – Events Causing Dissolution and Winding Up of Partnership Business  A partnership is dissolved, and its business must be wound up, only upon the occurrence of any of the following events:  In a partnership at will, the partnership's having notice from a partner, other than a partner who is dissociated under § 601(2) to (10), of that partner's express will to withdraw as a partner, or on a later date specified by the partner;  In a partnership for a definite term or particular undertaking:  (i) within 90 days after a partner's dissociation by death or otherwise under § 601(6) through (10) or wrongful dissociation under § 602(b), the express will of at least half the remaining partners to winding up the partnership business, for which purpose a partner's rightful dissociation under § 602(b)(2)(i) is an expression of that partner's will to wind up the partnership business;  (ii) the express will of all of the partners to wind up the partnership business; or  (iii) the expiration of the term or the completion of the undertaking;  An event agreed to in the partnership agreement resulting in the winding up of the partnership business;  An event that makes it unlawful for all or substantially all of the business of the partnership to be continued, but a cure of illegality within 90 days after notice to the partnership of the event is effective retroactively to the date of the event for purposes of this section;  On application by a partner, a judicial determination that: (i) the economic purpose of the partnership is likely to be unreasonably frustrated; (ii) another partner has engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with that partner; or (iii) it is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement; or  On application by a transferee of a partner's transferable interest, a judicial determination that it is equitable to wind up the partnership business: (i) after the expiration of the term or completion of the undertaking, if the partnership was for a definite term or particular undertaking at the time of the transfer or entry of the charging order that gave rise to the transfer; or (ii) at any time, if the partnership was a partnership at will at the time of the transfer or entry of the charging order that gave rise to the transfer.  RUPA § 802 – Partnership Continues After Dissolution  Subject to the subsection below, a partnership continues after dissolution only for the purpose of winding up its business. The partnership is terminated when the winding up of its business is completed.  At any time after the dissolution of a partnership and before the winding up of its business is completed, all of the partners, including any dissociating partner other than a wrongfully dissociating partner, may waive the right to have the partnership's business wound up and the partnership terminated.
 The provisions makes explicit the right of the remaining partners to continue the business after an event of dissolution if all of the partners, including the dissociating partner or partners, waive the right to have the business wound up and the partnership terminated. Only those “dissociating” partners whose dissociation was the immediate cause of the dissolution must waive the right to have the business wound up.

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 RUPA § 804 – Partner's Power to Bind Partnership After Dissolution  Except as otherwise may be provided in a statement of dissolution, a partnership is bound by a partner's act after dissolution that: (i) is appropriate for winding up the partnership business; or (ii) would have bound the partnership under § 301 before dissolution, if the other party to the transaction did not have notice of the dissolution.
 Even if the partnership is not bound under § 804, the faithless partner who purports to act for the partnership after dissolution may be liable individually to an innocent third party under the law of agency. Owen v. Cohen Facts: Cohen and Owen entered into an agreement to run a bowling alley. Subsequently, the relationship between the two became strained. Owen brought suit against Cohen for the dissolution of the partnership and for the sale of the partnership assets in connection with the settlement of partnership affairs. The trial court found for Owen, stating that the partnership was a partnership at-will and that the relationship of the parties was so strained that Owen was entitled to dissolution under Cal. Civ. Code § 2425(1). Cohen sought review, arguing that the evidence showed only petty discord between the parties. Holding: The court affirmed, holding that dissolution was proper where there were quarrels or disagreements of such a nature and to such an extent that all confidence and cooperation between the parties had been destroyed. Thus, Owen made out a cause for judicial dissolution of the partnership under Cal. Civ. Code § 2426, as Cohen was guilty of such conduct that affected prejudicially the carrying on of the business. Cohen, because of his commission of provocative acts, was in no position to insist on continuation. Reasoning: Courts of equity may order the dissolution of a partnership where there are quarrels and disagreements of such a nature and to such extent that all confidence and cooperation between the parties has been destroyed or where one of the parties by his misbehavior materially hinders a proper conduct of the partnership business. Cal. Civ. Code § 2426 states that on application by or for a partner the court shall decree a dissolution whenever: a partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business; a partner willfully or persistently commits a breach of the partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him; or other circumstances render a dissolution equitable. Collins v. Lewis Facts: The financial partner that owned 50 percent of partnership sought a receivership of the partnership business, a judicial dissolution of the partnership, and foreclosure of a mortgage upon remaining partner‟s interest in the partnership assets. The partnership was established for the construction and operation of a cafeteria. The cafeteria exceeded all reasonable estimates of startup costs. The financial partner contended the trial court erred in refusing to dissolve the partnership. The financial partner also asserted the trial court erred in refusing to foreclose his lien upon the managerial partner's interest in the partnership. The financial partner argued that whenever partners were in hopeless disagreement concerning a partnership, which had no reasonable expectation of profit, the legal right to dissolution existed. Holding: The court determined the financial partner had not performed his partner duties. The court concluded the managerial partner met his obligation therefore the trial court properly denied foreclosure of the mortgage. The court determined the financial partner was not entitled to dissolution of the partnership. Thus, the court affirmed. Reasoning: We agree with appellants' premise that there is no such thing as an indissoluble partnership only in the sense that there always exists the power, as opposed to the right, of dissolution. But legal right to dissolution rests in equity, as does the right to relief from the provisions of any legal contract. A court of equity, doubtless, will not assist the partner breaking his contract to procure a dissolution of the partnership, because, upon familiar principles, a partner who has not fully and fairly performed the partnership agreement on his part has no standing in a court of equity to enforce any rights under the agreement. Page v. Page Facts: Two partners entered into an oral partnership agreement. The supplying partner owned a corporation that supplied the linen and machinery necessary for the business. When the partnership suffered losses for eight years, the supplying partner wanted to terminate the partnership, despite a slight improvement in the next two years. At issue was whether the partners had provided that the partnership would stay in business until the business paid itself out. Under Cal. Corp. Code § 15031(1)(b), a

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partnership was dissolved by express will of any partner when no definite term or particular undertaking was specified. Holding: The court found that there was no partnership for a term. The remaining partner failed to prove any facts from which an agreement to continue the partnership for a term could have been implied. There was no bad faith by the supplying partner, and there was no showing that the improved profit situation was more than temporary. Reasoning: The Uniform Partnership Act provides that a partnership may be dissolved by the express will of any partner when no definite term or particular undertaking is specified. When a partner advances a sum of money to a partnership with the understanding that the amount contributed was to be a loan to the partnership and was to be repaid as soon as feasible from the prospective profits of the business, the partnership is for the term reasonably required to repay the loan. Some cases hold that partners may impliedly agree to continue in business until a certain sum of money is earned, or one or more partners recoup their investments, or until certain debts are paid, or until certain property could be disposed of on favorable terms. In each of these cases, however, the implied agreement finds support in the evidence. No more than a common hope that the partnership earnings would pay for all the necessary expenses does not establish even by implication a definite term or particular undertaking as required by Cal. Corp. Code § 15031(1)(b). All partnerships are ordinarily entered into with the hope that they will be profitable, but that alone does not make them all partnerships for a term and obligate the partners to continue in the partnerships until all of the losses over a period of many years have been recovered. Even though the Uniform Partnership Act provides that a partnership at will may be dissolved by the express will of any partner, Cal. Corp. Code § 15031(1)(b), that power, like any other power held by a fiduciary, must be exercised in good faith.  Partners are trustees for each other, and in all proceedings connected with the conduct of the partnership every partner is bound to act in the highest good faith to his copartner and may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation, concealment, threat or adverse pressure of any kind.  A partner at will is not bound to remain in a partnership, regardless of whether the business is profitable or unprofitable. A partner may not, however, by use of adverse pressure "freeze out" a copartner and appropriate the business to his own use. A partner may not dissolve a partnership to gain the benefits of the business for himself, unless he fully compensates his copartner for his share of the prospective business opportunity. In this regard his fiduciary duties are at least as great as those of a shareholder of a corporation. Prentiss v. Sheffel Facts: Plaintiffs brought an action seeking dissolution of the parties' partnership on the grounds that defendant had been derelict in his partnership duties, and that he had failed to contribute the balance of his proportionate share of the operating losses incurred by the partnership property. Defendant counterclaimed seeking a winding up of the partnership and the appointment of a receiver, contending that his rights as a partner were violated in that he had been wrongfully excluded from the partnership. The receiver and the trial court proceeded with the liquidation and sale of the partnership property, and plaintiffs were the high bidders. The trial court confirmed the sale of the partnership property to plaintiffs, and defendant appealed. Holding: The court affirmed, concluding that plaintiffs were allowed to purchase the partnership and exclude defendant where there was no indication that such exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith. The court held that defendant failed to demonstrate how he was injured by the participation of the plaintiffs in the judicial sale. Reasoning: While the trial court did find that the defendant was excluded from the management of the partnership, there was no indication that such exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith rather than being merely the result of the inability of the partners to harmoniously function in a partnership relationship. The method of conducting and the confirmation of a judicial sale lie within the sound discretion of the court ordering the sale. Pac-Saver Corporation v. Vasso Corporation Facts: Corporation was the owner of a trademark and patents for the design and marketing of concrete paving machines. The corporation formed a partnership with an attorney for the manufacture and sale of the machines. The corporation sought to terminate the partnership and filed an action for a court-ordered dissolution, return of its patents and trademark, and an accounting. Holding: The court held (i) that the partnership agreement contemplated a permanent partnership, terminable only upon mutual approval; (ii) that the corporation's unilateral termination violated the agreement; (iii) upon the corporation's notice terminating the partnership, the attorney was entitled to continue the business pursuant to Ill. Rev. Stat. ch. 106 1/2, para. 38(2)(b); (iv) that the trial court did not err in refusing to return the patents and trademark to the corporation or assigning a good-will value; (v) that the amount of the liquidated damages was not unreasonable and was a legitimate matter bargained

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for between the parties; and (vi) that the liquidated damages payout formula was enforceable and the doctrine of equitable setoff did not apply. Reasoning: When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows: (a) Each partner who has not caused dissolution wrongfully shall have, the right, as against each partner who has caused the dissolution wrongfully, to damages for breach of the agreement; (b) The partners who have not caused the dissolution wrongfully, if they all desire to continue the business in the same name, either by themselves or jointly with others, may do so, during the agreed term for the partnership and for that purpose may possess the partnership property, provided they secure the payment by bond approved by the court, or pay to any partner who has caused the dissolution wrongfully, the value of his interest in the partnership at the dissolution, less any damages recoverable, and in like manner indemnify him against all present or future partnership liabilities; (c) A partner who has caused the dissolution wrongfully shall have: If the business is continued the right as against his copartners and all claiming through them in respect of their interests in the partnership, to have the value of his interest in the partnership, less any damages caused to his co-partners by the dissolution, ascertained and paid to him in cash, or the payment secured by bond approved by the court and to be released from all existing liabilities of the partnership; but in ascertaining the value of the partner's interest the value of the good will of the business shall not be considered." Ill. Rev. Stat. 1983, ch. 106 1/2, par. 38(2).

ii. Dissociation  RUPA § 601 – Events Causing Partner's Dissociation  A partner is dissociated from a partnership upon the occurrence of any of the following events:  The partnership's having notice of the partner's express will to withdraw as a partner or on a later date specified by the partner;  An event agreed to in the partnership agreement as causing the partner's dissociation;  The partner's expulsion pursuant to the partnership agreement;  The partner's expulsion by the unanimous vote of the other partners if: (i) it is unlawful to carry on the partnership business with that partner; (ii) there has been a transfer of all or substantially all of that partner's transferable interest in the partnership, other than a transfer for security purposes, or a court order charging the partner's interest, which has not been foreclosed; (iii) within 90 days after the partnership notifies a corporate partner that it will be expelled because it has filed a certificate of dissolution or the equivalent, its charter has been revoked, or its right to conduct business has been suspended by the jurisdiction of its incorporation, there is no revocation of the certificate of dissolution or no reinstatement of its charter or its right to conduct business; or (iv) a partnership that is a partner has been dissolved and its business is being wound up;  On application by the partnership or another partner, the partner's expulsion by judicial determination because: (i) the partner engaged in wrongful conduct that adversely and materially affected the partnership business; (ii) the partner willfully or persistently committed a material breach of the partnership agreement or of a duty owed to the partnership or the other partners under § 404; or (iii) the partner engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with the partner;  The partner's: (i) becoming a debtor in bankruptcy; (ii) executing an assignment for the benefit of creditors; (iii) seeking, consenting to, or acquiescing in the appointment of a trustee, receiver, or liquidator of that partner or of all or substantially all of that partner's property; or (iv) failing, within 90 days after the appointment, to have vacated or stayed the appointment of a trustee, receiver, or liquidator of the partner or of all or substantially all of the partner's property obtained without the partner's consent or acquiescence, or failing within 90 days after the expiration of a stay to have the appointment vacated;  In the case of a partner who is an individual: (i) the partner's death; (ii) the appointment of a guardian or general conservator for the partner; or (iii) a judicial determination that the partner has otherwise become incapable of performing the partner's duties under the partnership agreement; (8) in the case of a partner that is a trust or is acting as a partner by virtue of being a trustee of a trust, distribution of the

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trust's entire transferable interest in the partnership, but not merely by reason of the substitution of a successor trustee;  In the case of a partner that is an estate or is acting as a partner by virtue of being a personal representative of an estate, distribution of the estate's entire transferable interest in the partnership, but not merely by reason of the substitution of a successor personal representative; or  Termination of a partner who is not an individual, partnership, corporation, trust, or estate.  RUPA § 603 – Effect of Partner's Dissociation  If a partner's dissociation results in a dissolution and winding up of the partnership business, [Article] 8 applies; otherwise, [Article] 7 applies.  Upon a partner's dissociation: (i) the partner's right to participate in the management and conduct of the partnership business terminates, except as otherwise provided in § 803; (ii) the partner's duty of loyalty under § 404(b)(3) terminates; and (iii) the partner's duty of loyalty under § 404(b)(1) and (2) and duty of care under § 404(c) continue only with regard to matters arising and events occurring before the partner's dissociation, unless the partner participates in winding up the partnership's business pursuant to § 803.  RUPA § 701 – Purchase of Dissociated Partner's Interest  (a) If a partner is dissociated from a partnership without resulting in a dissolution and winding up of the partnership business under § 801, the partnership shall cause the dissociated partner's interest in the partnership to be purchased for a buyout price determined pursuant to subsection (b).  (b) The buyout price of a dissociated partner's interest is the amount that would have been distributable to the dissociating partner under § 807(b) if, on the date of dissociation, the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner and the partnership were wound up as of that date. Interest must be paid from the date of dissociation to the date of payment.  (c) Damages for wrongful dissociation under § 602(b), and all other amounts owing, whether or not presently due, from the dissociated partner to the partnership, must be offset against the buyout price. Interest must be paid from the date the amount owed becomes due to the date of payment.  (d) A partnership shall indemnify a dissociated partner whose interest is being purchased against all partnership liabilities, whether incurred before or after the dissociation, except liabilities incurred by an act of the dissociated partner under § 702.  (e) If no agreement for the purchase of a dissociated partner's interest is reached within 120 days after a written demand for payment, the partnership shall pay, or cause to be paid, in cash to the dissociated partner the amount the partnership estimates to be the buyout price and accrued interest, reduced by any offsets and accrued interest under subsection (c).  (f) If a deferred payment is authorized under subsection (h), the partnership may tender a written offer to pay the amount it estimates to be the buyout price and accrued interest, reduced by any offsets under subsection (c), stating the time of payment, the amount and type of security for payment, and the other terms and conditions of the obligation.  (g) The payment or tender required by subsection (e) or (f) must be accompanied by the following: (1) a statement of partnership assets and liabilities as of the date of dissociation; (2) the latest available partnership balance sheet and income statement, if any; (3) an explanation of how the estimated amount of the payment was calculated; and (4) written notice that the payment is in full satisfaction of the obligation to purchase unless, within 120 days after the written notice, the dissociated partner commences an action to determine the buyout price, any offsets under subsection (c), or other terms of the obligation to purchase.  (h) A partner who wrongfully dissociates before the expiration of a definite term or the completion of a particular undertaking is not entitled to payment of any portion of the buyout price until the expiration of the term or completion of the undertaking, unless the

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partner establishes to the satisfaction of the court that earlier payment will not cause undue hardship to the business of the partnership. A deferred payment must be adequately secured and bear interest.  (i) A dissociated partner may maintain an action against the partnership, pursuant to § 405(b)(2)(ii), to determine the buyout price of that partner's interest, any offsets under subsection (c), or other terms of the obligation to purchase. The action must be commenced within 120 days after the partnership has tendered payment or an offer to pay or within one year after written demand for payment if no payment or offer to pay is tendered. The court shall determine the buyout price of the dissociated partner's interest, any offset due under subsection (c), and accrued interest, and enter judgment for any additional payment or refund. If deferred payment is authorized under subsection (h), the court shall also determine the security for payment and other terms of the obligation to purchase. The court may assess reasonable attorney's fees and the fees and expenses of appraisers or other experts for a party to the action, in amounts the court finds equitable, against a party that the court finds acted arbitrarily, vexatiously, or not in good faith. The finding may be based on the partnership's failure to tender payment or an offer to pay or to comply with subsection (g). F. LIMITED PARTNERSHIPS i. Principles of Limited Partnership  RUPA § 303 – Statement of Partnership Authority  A partnership may file a statement of partnership authority, which: (1) must include: (i) the name of the partnership; (ii) the street address of its chief executive office and of one office in this State, if there is one; (iii) the names and mailing addresses of all of the partners or of an agent appointed and maintained by the partnership for the purpose of subsection (b); and (iv) the names of the partners authorized to execute an instrument transferring real property held in the name of the partnership; and (2) may state the authority, or limitations on the authority, of some or all of the partners to enter into other transactions on behalf of the partnership and any other matter.  If a statement of partnership authority names an agent, the agent shall maintain a list of the names and mailing addresses of all of the partners and make it available to any person on request for good cause shown.  If a filed statement of partnership authority is executed pursuant to § 105(c) and states the name of the partnership but does not contain all of the other information required by subsection (a), the statement nevertheless operates with respect to a person not a partner as provided in subsections (d) and (e).  Except as otherwise provided in subsection (g), a filed statement of partnership authority supplements the authority of a partner to enter into transactions on behalf of the partnership as follows:  (1) Except for transfers of real property, a grant of authority contained in a filed statement of partnership authority is conclusive in favor of a person who gives value without knowledge to the contrary, so long as and to the extent that a limitation on that authority is not then contained in another filed statement. A filed cancellation of a limitation on authority revives the previous grant of authority.  (2) A grant of authority to transfer real property held in the name of the partnership contained in a certified copy of a filed statement of partnership authority recorded in the office for recording transfers of that real property is conclusive in favor of a person who gives value without knowledge to the contrary, so long as and to the extent that a certified copy of a filed statement containing a limitation on that authority is not then of record in the office for recording transfers of that real property. The recording in the office for recording transfers of that real property of a certified copy of a filed cancellation of a limitation on authority revives the previous grant of authority.  A person not a partner is deemed to know of a limitation on the authority of a partner to transfer real property held in the name of the partnership if a certified copy of the filed

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statement containing the limitation on authority is of record in the office for recording transfers of that real property.  Except as otherwise provided in subsections above and §§ 704 and 805, a person not a partner is not deemed to know of a limitation on the authority of a partner merely because the limitation is contained in a filed statement.  Unless earlier canceled, a filed statement of partnership authority is canceled by operation of law five years after the date on which the statement, or the most recent amendment, was filed with the [Secretary of State].
Holzman v. De Escamilla Facts: Appellants challenged a judgment of the Superior Court, which decreed they were general partners in a limited partnership, and as such were liable as general partners to the creditors of the partnership. Holding: The court held that evidence clearly established that appellants took part in the control of the business of the partnership and thus became liable as general partners. Reasoning: That the limited partners took "part in the control of the business" and thus became liable as general partners, as provided by Civ. Code, § 2483, was sufficiently supported by evidence that they had absolute power to withdraw all the partnership funds without the knowledge or consent of the general partner while he could withdraw no money without the signature of one of them; and that the limited partners dictated the management policies of the business, even against the will of the general partner, later requiring him to resign and selecting his successor.

The Corporation A. THE CORPORATE ENTITY i. Principles of Corporate Law  Corporation‟s existence and attributes arise from state-enabling statutes, which give business participants significant freedom to choose their own customized relationships.  Corporation as an investment vehicle for the pooling of capital and labor.  Capital comes from the shareholders and creditors.  Human capital comes from the executives and employees.  Characteristics of the Corporation.  Entity Status.  A corporation is a legal entity created under the authority of the legislature.  Limited Liability.  As a legal entity, a corporation is responsible for its own debts. A corporation‟s shareholders normally are not responsible for its debts. Their liability is limited to the amount of their investment.  Free Transferability of Interests.  Ownership interests in a corporation are represented by shares, which are freely transferable.  Centralized Management and Control.  Management and control are centralized in a board of directors and in officers acting under the board‟s authority. Shareholders elect the board but cannot control its activities. Shareholders have no power to either participate in management or to determine questions within the scope of the corporation‟s business. Shareholders have no authority to act on the corporation‟s behalf.  Duration.  A corporation is capable of perpetual duration.  Taxation.  Firm-Taxation Model → a business is taxable on its income.  Flow-Through Model → all firm‟s income/expenses taxable directly to shareholders.  No double-taxation problem.  As a general rule, corporations are taxed under the firm-taxation model unless they elect to assume the status of a Subchapter S Corporation.

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 Theories of the Firm  Contract Theory. The corporation as a web of contracts between its constituents.  We have to assume arms-length bargaining, and a reluctance to fill in gaps.  Agency relationships are implied only to the extent necessary to fulfill the corporations express goals.  Fiduciary Theory. Older view, based on the idea that the corporation is like a trust, with strong obligations toward its shareholders.  Places strong obligations on corporate management toward its shareholders.  Default rules put the burden on management to justify its actions.  Government Theory. Looks at the corporation as something like a government, with an elected leadership.  Leadership decisions are treated like legislative or executive actions, with residuary power remaining in the shareholders. ii. Liability During Incorporation Process  Promoters and Incorporators  A promoter is one who participates in the formation of a corporation. The promoter usually arranges compliance with the legal requirements to form a corporation, secures initial capitalization, and enters into necessary contracts on behalf of the corporation before it is formed.  Prior to formation, the promoters are regarded as a joint venturer (similar to partners) and for that reason owes a fiduciary duty of full disclosure and fair dealing as to all matters pertaining to the corporation.  Absent a contrary intent, a promoter can be held personally liable on pre-incorporation contract. R.3d § 6.04  The De Facto Corporation Doctrine  Requires (i) some colorable, good faith attempt to incorporate and (ii) actual use of the corporate form, such as carrying on business as a corporation or contracting in the corporate name.  Only state can challenge the existence of a de facto corporation.  As to outsiders, a de facto corporation has all attributes of a de jure corporation.  Corporation by Estoppel Doctrine  Arises when parties have dealt with each other on the assumption a corporation existed, even though there has been no colorable attempt to incorporate.  Outsiders who rely on representations or appearances that a corporation exists and act accordingly are estopped from denying corporate existence or limited liability.  “It is settled…that as a rule, one who contracts with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced.”
Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. Facts: Buyer contracted with the Camcraft for the purchase and sale of a supply ship, which the Camcraft was to construct. The contract indicated that the buyer was an existing Texas corporation, when in fact it had yet to be organized under the laws of any state. Subsequently Camcraft was informed that the buyer had been incorporated under the laws of the Cayman Islands. Still later, probably because of appreciation in the price the vessel might fetch, Camcraft balked at delivering it to the buyer. Camcraft claimed that there was no cause of action since the buyer lacked corporate existence at the time of contracting. Holding: The court held that the trial court committed legal error in holding that the buyer's lack of legal status at the time of contracting was an impediment to its maintenance of this action. Reasoning: The court said that absent some prejudice to its substantial rights, the Camcraft was estopped to escape performance by raising the issue of the buyer's prior lack of de jure status. The court

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noted that both parties relied on the contract, and that the contract was fully enforceable against the buyer, notwithstanding that it was only a de facto corporation when it entered into the contract.  If a party has no other objection to oppose to the enforcement of the contract than that the obligee is incompetent to sue, for reasons anterior to his contract, or last acknowledgement, he should not be permitted to escape liability. The case would be different where the incompetency is the result of something happening subsequent to the contract, or last acknowledgement of existence and capacity. It is a familiar principle that one cannot be permitted to play fast and loose, so as to take advantage of his own unfair vacillations.

iii. Corporate Formation  Most corporate statutes prescribe the information that must/may be contained in corporation‟s original charter documents.  Public companies tend to have short and concise articles of incorporation (i.e., eBay) while privately held companies (i.e., Google) are much more detailed.  Articles of Incorporation  Del. § 102(a) sets forth the information that the articles of incorporation must contain.  State the corporation‟s complete name and include reference to its corporate status (i.e., the magic words) such as corporation, incorporated, or Inc. Del. § 102(a)(1).  State the corporation‟s registered office for service or process and for sending official notices. The articles must also name a registered agent at that office on whom process can be served. Del. § 102(a)(2).  Nature of business or purposes to be conducted or promoted. Del. §§ 101(b), 102(a)(3).  Specify the securities or shares the corporation will have authority to issue. Articles must describe the various classes of authorized shares, number of shares of each class, par value (if any) and the privileges, rights, limitations and preferences of each class. Del. §§ 102(a)(4), 151(a).  Name and mailing address of the incorporator or incorporators. Del. § 102(2)(5).  If power of the incorporator terminates on filing certificate of incorporation, names and addresses of the initial directors is required. Del. § 102(a)(6). Similarly, board of directors need only be comprised of “one or more natural persons.” Del. § 141(b).  Del. § 102(b) sets forth information that may be included in articles of incorporation.  Such clauses often include voting provisions, membership requirements, management provisions, and indemnification provisions.  Filing Process and Organizational Meeting  The corporate existence commences upon the date of filing. Del. § 106.  Once the corporation is created, the first item of business at the organizational meeting is to elect directors (unless already named in articles), approve bylaws, elect officers, designate a bank for corporate funds, authorize the issuance of shares, and setting the consideration for the shares. Del. § 108.  Bylaws typically describe in greater detail the functions of each corporate office, how shareholders‟ and directors‟ meetings are called and conducted, the formalities of shareholder voting, qualifications of directors, functions of board committees, and procedures for and limits on issuing and transferring shares.  State law does not require the bylaws be filed but they must be consistent with the articles and not contain anything inconsistent with the law. Del. § 109(b). iv. Corporate Powers and the Ultra Vires Doctrine  In nineteenth century, state legislatures chartered corporations with narrow purposes and with limited powers → state sponsored capitalism for need public projects.  Formed to run capital-intensive businesses such as canals, railroads and banks.  Development of interstate transportation created a need for larger business structures.  Chartering became a busy but lucrative business for state legislators.

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 State legislators soon enacted general enabling statutes that authorized a variety of corporate purposes and powers.  New Jersey passed one of the first enabling statutes because of its proximity to New York.  With passage of new anti-trust laws in New Jersey, corporations left en masse and reincorporated in Delaware.  Ultra Vires Transactions  Transactions that are beyond the purposes and powers of the corporation.  Tort Actions.  Under modern law, ultra vires is no defense to tort liability.  Criminal Actions.  Ultra vires is no defense to criminal liability.  Contract Actions (Common Law).  Where there has been no performance on either side, defense of ultra vires could be raised by either party.  Where contract was fully performed, neither party could rescind on the ground that the contract was ultra vires.  Where contract was partially performed, the majority view held that the nonperforming party was estopped to assert a defense of ultra vires - minority view held that the party could assert the defense.  Modern Statutes.  Most states now have statutes that curtail the doctrine of ultra vires – neither the corporation nor the third party can assert ultra vires as a defense.  Corporation can still sue officers and directors for damages caused when they exceeded their authority.  Erosion of Ultra Vires Doctrine  Courts recognized the commercial uncertainty created by the ultra vires doctrine and modified it in three respects: (i) courts permitted ultra vires defense only if the contract was still executory; (ii) courts interpreted charter provisions flexibly to authorize transactions reasonably incidental to the business; and (iii) most courts held that the ultra vires defense could be barred by unanimous shareholder approval, unless a creditor would be injured by doing so.  Corporate Powers under Modern Statutes  Modern statutes dispense with the need for setting out a long list of corporate purposes, by providing that a corporation can engage in any lawful business.  Modern statutes set out a long list of powers conferred on every corporation, whether or not these powers are stated in the certificate of incorporation.  Under the Delaware General Corporation Laws, corporation is granted following express powers: to have perpetual existence; to sue and be sued; to have a corporate seal; to acquire, hold, and dispose of personal and real property; to appoint officers; to adopt and amend bylaws; to conduct business inside and outside the state; to establish pension and other incentive and compensation plans; to acquire, hold, vote and dispose of securities in other corporations; to make contracts of guaranty and suretyship; to participate with others in any corporation, partnership, or other association of any kind that it would have power to conduct by itself, whether or not such participation involves sharing or delegating control with others; to make donations for the public welfare or for charitable, scientific, or educational purposes, and in time of war or other national emergency, in aid thereof. B. CORPORATE LIMITED LIABILITY i. Principles of Limited Liability  Corporation separates business assets from the personal assets of corporate participants.  Participants‟ liability for corporate obligations is limited to individual amount invested.

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 Limited liability is the default rule; it applies absent an agreement otherwise.  Rationale for Limited Liability.  Capital Formation.  Corporation, by limiting losses to the amount invested, allows investors to finance a business without risking their other assets.  Reduces the need for investors to investigate and monitor whether the business will expose them to personal liability. It encourages investors to choose to invest in desirable, though risky, enterprises.  Management Risk Taking.  Without the promise of limited liability, shareholders might discourage and managers might be reluctant to undertake high-risk projects, even when highly profitable.  Investment Diversification.  Limited liability allows investors to invest in many businesses without exposing other assets to unlimited liability with each new investment.  Diversification spreads out investment risk, further reducing the need for investors to investigate and monitor business in which they invest → reduces cost of investing.  Allocation of Risk.  To reflect the risk of limited liability, voluntary creditors often increase the cost of credit to incorporated businesses or demand contractual stipulations to bolster the business‟ creditworthiness.  Involuntary creditors have no means to protect themselves – critics argue that insiders, shielded by limited liability, do not internalize the costs of accidents or excessive risk taking. ii. Enterprise Liability Doctrine  Can pierce the corporate veil to disregard multiple corporations of the same business under common ownership and pool together business assets to satisfy the liabilities of any part of the enterprise.  Assets of individual owners or managers are not exposed.  Can also be used when a business is split into a number of “brother-sister” corporations, each owned by the same investors, so that the assets of each “affiliate” corporation are isolated from the risk of the others.
Walkovszky v. Carlton Facts: Plaintiff alleged that he was injured when a taxicab struck him. Defendant was stockholder of ten corporations, each of which had two cabs registered in its name and carried the minimum automobile insurance required by law. Although independent of one another, the corporations were alleged to have operated as a single enterprise. Plaintiff contended that he was entitled to hold defendant personally liable for his damages because the multiple corporate structure constituted an unlawful attempt to defraud members of the public. Holding: The court held that whenever anyone used control of a corporation to further his own rather than the corporation's business, he would be liable for the corporation's acts under the principle of respondeat superior. However, the decision was reversed because plaintiff 's complaint failed to allege that defendant was doing business in his individual capacity. Reasoning: It is one thing to assert that a corporation is a fragment of a larger corporate combine, which actually conducts the business. It is quite another to claim that the corporation is a "dummy" for its individual stockholders who are in reality carrying on the business in their personal capacities for purely personal rather than corporate ends. Either circumstance would justify treating the corporation as an agent and piercing the corporate veil to reach the principal but a different result would follow in each case. In the first, only a larger corporate entity would be held financially responsible, while, in the other, the stockholder would be personally liable. Either the stockholder is conducting the business in his individual capacity or he is not. If he is, he will be liable; if he is not, then, it does not matter - insofar as his personal liability is concerned - that the enterprise is actually being carried on by a larger "enterprise entity."

iii. Piercing the Corporate Veil

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 The piercing doctrine, an exception to limited liability, seeks to protect outsiders who deal with the corporation. When a court pierces the corporate veil, it places creditor expectations ahead of insiders‟ interest in limited liability.  No reported case of piercing has ever involved shareholders of a publically traded corp.  According to Cardozo, “whenever anyone uses control of the corporation to further his own rather than the corporation‟s business, he will be liable for the corporation‟s acts „upon the principle of respondeat superior applicable even where the agent is a natural person.”  The Sea-Land Test for Piercing the Corporate Veil  A corporate entity will be disregarded and the veil of limited liability pierced when two requirements are met: (i) there must be such unity of interest and ownership that the separate personalities of the corporation and the individual or other corporation no longer exist; and (ii) circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.  As for determining whether a corporation is so controlled by another to justify disregarding their separate identities, the focus is on four factors: (i) the failure to maintain adequate corporate records or to comply with corporate formalities, (ii) the commingling of funds or assets, (ii) undercapitalization, and (iv) one corporation treating the assets of another corporation as its own.
Sea-Land Services, Inc. v. Pepper Source Facts: Sea-Land brought suit against Pepper Source to collect on an outstanding freight bill for $87,000. PS disappeared and had actually been dissolved for failure to pay its annual franchise tax. SL then brought suit against the owner of PS and his five other corporations claiming that they were all functioning as the alter egos of the owner and thus should be liable for the debt owed by PS. SL alleged the owner intentionally shifted assets and liability among his corporations. Holding: Court held that although the shared unity of interest and ownership part of the test was met, SL failed to show that honoring the corporate separate existences would sanction a fraud or promote injustice. Reasoning: SL failed to produce evidence similar to the wrongs found in other cases where the court properly pierced the corporate veil to avoid promoting injustice. On remand, the court noted that the SL could try to show the owner used corporate facades to avoid responsibility to creditors or one corporation would be enriched unless liability was shared by all. Alleging that an unsatisfied judgment would be enough to promote injustice is insufficient.  Although an intent to defraud creditors would surely play a part if established, the Illinois test to determine whether a corporate entity should be disregarded does not require proof of such intent. Once the first element of the test is established, either the sanctioning of a fraud, intentional wrongdoing, or the promotion of injustice, will satisfy the second element.  The promote injustice feature of the veil-piercing inquiry has been interpreted and summarized as some element of unfairness, something akin to fraud or deception or the existence of a compelling public interest must be present in order to disregard the corporate fiction.  The courts that properly have pierced corporate veils to avoid promoting injustice have found that, unless they did so, some wrong beyond a creditor's inability to collect would result: the common sense rules of adverse possession would be undermined; former partners would be permitted to skirt the legal rules concerning monetary obligations; a party would be unjustly enriched; a parent corporation that caused a sub's liabilities and its inability to pay for them would escape those liabilities; or an intentional scheme to squirrel assets into a liability-free corporation while heaping liabilities upon an asset-free corporation would be successful. Roman Catholic Archbishop of S.F. v. Sheffield Facts: In an action for damages against the Roman Catholic Archbishop of San Francisco, based on the refusal by a monk belonging to a Catholic order in Switzerland to ship Sheffield a St. Bernard dog in breach of an alleged sales agreement, the Archbishop moved for summary judgment, alleging, inter alia, by declaration, that the Archbishop had no business dealings or relationship with the religious order in Switzerland. Counter-affidavits filed on behalf of Sheffield alleged, inter alia, that the Roman Catholic Church was a single entity controlled, spiritually and temporally, by the Pope in Rome, that both the Archbishop and the religious order in Switzerland were controlled by the Pope, and that if plaintiff could not sue the Archbishop he would have to discontinue the action since suing in Switzerland or Italy would be prohibitive.

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Holding: The court held there was no evidence to support application of the "alter ego" doctrine, because there was no showing that petitioner controlled and dominated the organization with whom real party in interest contracted. There was also no showing that failure to pierce corporate veil would lead to inequity. Reasoning: The terminology "alter ego" or "piercing the corporate veil" refers to situations where there has been an abuse of corporate privilege, because of which the equitable owner of a corporation will be held liable for the actions of the corporation. The requirements for applying the "alter ego" principle are thus stated: It must be made to appear that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of such person and corporation has ceased, and adherence to the fiction of the separate existence of the corporation would sanction a fraud or promote injustice. Among the factors to be considered are commingling of funds and other assets of the two entities, the holding out by one entity that it is liable for the debts of the other, identical equitable ownership in the two entities, use of the same offices and employees, and use of one as a mere shell or conduit for affairs of the other.

iv. Parent-Subsidiary Piercing Doctrine  In such contexts, courts have often required a showing that the parent dominated the subsidiary so that they acted as a “single economic entity,” and recognizing corporate separateness would be unfair or unjust. Radaszewski v. Telecom Corp.  Quinn says you must always follow corporate formalities to avoid a unity of interest.
In re Silicone Gel Breast Implants Products Liability Litigation Facts: Bristol Myers Squibb Co. filed a motion for summary judgment in plaintiff victims' multidistrict silicone gel breast implant products liability litigation. It asserted that the evidence was inadequate for plaintiffs to support any of their claims against it, whether based on piercing the corporate veil or on a theory of direct liability. Holding: The court held that under the corporate control theory, there was ample evidence from which a jury could find that Bristol‟s subsidiary, the manufacturer of the breast implants, was Bristol's alter ego. Reasoning: The court noted that the evidence presented demonstrated that Bristol controlled the subsidiary‟s board of directors, annual budgets, financial arrangements, employment policies, regulatory compliance, manufacturing quality control, and public relations. Moreover, Bristol failed to provide insurance to cover the subsidiary‟s potential exposure and had permitted the use of its name of the subsidiary‟s ads and packaging.  Totality of circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of a parent corporation. Among the factors to be considered are whether: (i) the parent and the subsidiary have common directors or officers; (ii) the parent and the subsidiary have common business departments; (iii) the parent and the subsidiary file consolidated financial statements and tax returns; (iv) the parent finances the subsidiary; (v) the parent caused the incorporation of the subsidiary; (vi) the subsidiary operates with grossly inadequate capital; (vii) the parent pays the salaries and other expenses of the subsidiary; (viii) the subsidiary receives no business except that given to it by the parent; (ix) the parent uses the subsidiary's property as its own; (x) the daily operations of the two corporations are not kept separate; and (xi) the subsidiary does not observe basic corporate formalities, such as keeping separate books/records and holding shareholder/board meetings.

v. Corporation as Sole General Partner in Limited Partnerships  Beginning in the late 1960s, tax lawyers developed a variation on the limited partnership → a corporation as the sole general partner.  Under this form, no individual, acting as both a director of the corporation and a member of the partnership, was liable for the debts of the partnership.
Frigidaire Sales Corporation v. Union Properties, Inc. Facts: Frigidaire sued when the limited partnership breached its contract. Noting that the limited partners were also the officers, directors, and shareholders of the corporate general partner, Frigidaire sought to impose general liability upon the limited partners, claiming that they exercised the day-to-day control of the partnership through the general partner and were therefore liable under a Washington statute. Holding: The court ruled that the limited partners did not incur general liability for the partnership's liabilities under the statute simply because they controlled the corporate general partner. Reasoning: The record showed that the limited partners did not form the general partner for the sole purpose of operating the partnership, but to create several business opportunities. Thus, their control of the general partner was not merely for the benefit of the partnership. Also, although the limited partners signed the contract, the contractor knew they were agents and it was dealing with a limited partnership with a corporate general partner.

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 When the shareholders of a corporation, who are also the corporation's officers and directors,

conscientiously keep the affairs of the corporation separate from their personal affairs, and no fraud or manifest injustice is perpetrated upon third persons who deal with the corporation, the corporation's separate entity should be respected.  If a corporate general partner is inadequately capitalized, the rights of a creditor are adequately protected under the "piercing-the-corporate-veil" doctrine of corporation law.

C. SHAREHOLDER LITIGATION i. Principles of Shareholder Litigation  Courts actions brought by shareholders are in two flavors: (i) a direct action on the shareholder‟s own behalf (or on behalf of a class of shareholders to which he belongs) for injury to his interest as a shareholder; or (ii) a derivative suit filed on behalf of the corporation for injury done to the corporation for which it has failed to exercise its rights.  Direct suits are those in which shareholders seek to enforce rights arising from their share ownership, as opposed to rights of the corporation. Direct suits generally vindicate individual shareholders‟ structural, financial, liquidity and voting rights.  Direct suits include actions to (i) enjoin ultra vires actions, (ii) compel payment of dividends declared but not distributed, (iii) compel inspection of shareholders‟ lists, or corporate books and records, (iv) require the holding of a shareholders‟ meeting, whether the board has violated statutory or fiduciary duties, (v) challenge fraud on shareholders in connection with their voting, sale or purchase of securities, (vi) challenge the sale of the corporation in a merger where directors violated their duties to become informed or structure a fair transaction, (vii) challenge corporate restrictions on share transferability, (viii) compel dissolution of the corporation, and (ix) challenge the denial or dilution of voting rights.  Many requirements that apply to derivative suits do not apply to direct class actions.  Class action plaintiff need not make demand on the board before bringing suit.
Eisenberg v. Flying Tiger Line, Inc. Facts: Eisenberg brought suit against Flying Tiger to enjoin the effectuation of a plan of reorganization and merger. He alleged that a series of corporate maneuvers were intended to dilute his voting rights. Corporation argued that suit was derivative in nature and thus required posting of security for litigation. Holding: Court determined that because Eisenberg claimed the reorganization deprived him and other minority shareholders of any voice in affairs of corporation, injury suffered was personal and not derivative. Reasoning: If the gravamen of the complaint is injury to the corporation, the suit is derivative, but if the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation, the suit is individual in nature and may take the form of a representative class action. Security for costs cannot be required where a plaintiff does not challenge acts of the management on behalf of the corporation but challenges the right of the present management to exclude him and other stockholders from proper participation in the affairs of the corporation and claims that the defendants are interfering with his rights and privileges as a stockholder.  Where a shareholder sues on behalf of himself and all others similarly situated to enjoin a proposed merger or consolidation, he is not enforcing a derivative right; he is, by an appropriate type of class suit, enforcing a right common to all the shareholders, which runs against the corporation.

ii. Nature of Shareholder Derivative Litigation  If management has abridged a duty owed to the corporation, and the corporation fails to enforce its cause of action, a shareholder may bring suit on behalf of the corporation.  Derivative litigation is the principal means by which shareholders enforce fiduciary duties.  In theory, the shareholder (i) sues the corporation in equity (ii) to bring an action to enforce corporate rights. The corporation, as an indispensable party, is made a nominal defendant.  All recovery is to the corporation.  SH-π shares in the recovery only indirectly, to the extent that her shares increase in value because of the corporate recovery.  SH-π also benefits indirectly by the deterrent value of an award or when equitable relief forbids or undoes harmful behavior.

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 Since in derivative suit the shareholder plaintiff sues on behalf of the corporation, the corporation becomes bound by any judgment or settlement → res judicata.  To discourage strike suits, a few states have statutes that required the plaintiff to post a bond or other security to indemnify the corporation against certain of its litigation expenses in the event the plaintiff loses the suit.  Prerequisites to Bringing a Shareholder Derivative Suit  To bring a shareholder derivative suit, a shareholder plaintiff must:  Have “clean hands.”  Be able to “adequately represent” all shareholders.  Be a shareholder of record or a beneficial equitable owner of stock.  Delaware requires plaintiff be a record (not merely beneficial) owner. Del. § 327.  MBCA excludes option holders and convertible debt holders. MBCA § 7.40(2).  Have been a shareholder when the wrong occurred.  Referred to as the contemporaneous ownership requirement. MBCA § 7.41(1).  Delaware courts recognize a narrow exception when plaintiff ceases to be a shareholder after fraudulent or illegal merger. Lewis v. Anderson.  Continue to be a shareholder when the suit is brought and then through the trial.  Referred to as the continuing interest requirement. MBCA § 7.41(1).  Exhausted all available remedies within the corporate structure → demand on board.  Distorted Incentives in Derivative Litigation  Incentives of derivative suit parties may produce results at odds with corporate interests.  Plaintiff may be indifferent to the outcome of the litigation since any recovery will be to the corporation.  Plaintiff‟s attorney, whose fees are usually contingent on a settlement or court award, may be indifferent to the substantive outcome so long as there are attorney fees.  Contrary to the prevailing American rule that each litigant bears his own expenses, the universal rule is derivative litigation is that the corporation pays the successful plaintiff‟s litigation expenses, including attorney fees.  Individual defendants usually will prefer settlement rather than trial. Settlement increases the chances that their expenses and amount paid in settlement will be indemnified by the corporation or covered by insurance.  Corporation‟s board will often be influenced by the interests of individual defendants. iii. The Demand Requirement  A stockholder filing a derivative suit must allege either that the board rejected his pre-suit demand that the board assert the corporation‟s claim OR allege with particularity why the stockholder was justified in not having made the effort to obtain board action.  Designed to create a balanced environment which will (i) deter costly baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms and (ii) permit suit by a stockholder who is able to articulate particularized facts showing that a reasonable doubt exists.  Basis for claiming excusal would normally be that (i) the majority of the board has a material financial or familial interest; (ii) a majority of the board is incapable of acting independently for some other reason such as domination or control; OR (iii) the underlying transaction is not the product of a valid exercise of business judgment.  Particularized showing of either is sufficient to establish demand futility.

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 N.B. By making demand on the board, you waive your right to claim demand futility.  If demand is made and rejected, the board rejecting the demand is entitled to the presumption of the business judgment rule unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is not entitled to the benefit of the presumption.  Only option at that point is to argue for wrongful dismissal of the demand.  That board‟s rejection was not made in good faith after reasonable investigation.
Grimes v. Donald Facts: Stockholder claimed that the board unlawfully abdicated its statutory duty to manage the corporation's affairs by entering into an employment agreement which provided for the payment of a large sum of money to the CEO, in the event of a constructive termination, and that the board breached its fiduciary duties by failing to exercise due care and committing waste. Holding: The court held that (i) the stockholder's abdication claim was a direct claim where it alleged an injury which was separate and distinct from the injury suffered by other shareholders; (ii) the stockholder's abdication claim failed as a matter of law where, in light of the corporation's financial size, the payment provided for in the employment agreement would not have constituted a de facto abdication; (iii) where the stockholder had demanded that the board take action on his abdication claim, the stockholder was not entitled to assert that demand was excused with respect to his remaining claims; and (iv) the stockholder did not have a remedy for the board's alleged wrongful refusal of his demand to take action on his abdication claim where he failed to plead with particularity why the board's refusal to act was wrongful. Reasoning: If a claim belongs to the corporation, it is the corporation, acting through its board of directors, which must make the decision whether or not to assert the claim. The derivative action impinges on the managerial freedom of directors. The demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of the corporation. A stockholder filing a derivative suit must allege either that the board rejected his pre-suit demand that the board assert the corporation's claim or allege with particularity why the stockholder was justified in not having made effort to obtain board action.  Although Delaware law does not require demand in every case, because Delaware does have the mechanism of demand excusal, it is important that the demand process be meaningful. Therefore, a stockholder who makes a demand is entitled to know promptly what action the board of directors has taken in response to the demand. A stockholder who makes a serious demand and receives only a peremptory refusal has the right to use the tools at hand to obtain the relevant corporate records, such as reports or minutes, reflecting the corporate action and related information in order to determine whether or not there is a basis to assert that demand was wrongfully refused. In no event may a corporation assume a position of neutrality and take no position in response to the demand. If a demand is made, the stockholder has spent one – but only one – arrow in the quiver. The spent arrow is the right to claim that demand is excused. The stockholder does not, by making demand, waive the right to claim that demand has been wrongfully refused.  Where a stockholder has shown that there is reason to doubt that a board of directors acted independently or with due care in responding to a stockholder's demand that it take action, the stockholder then has the right to bring a derivative action with the same standing which the stockholder would have had, ex ante, if demand had been excused as futile.

iv. Special Litigation Committees  Boards of directors responded to increase in derivative litigation during the 1970s by appointing a special litigation committee (SLC) of disinterested and often recently appointed directors to decide whether the suit should go forward.  Under Del. § 141(c), boards of directors may certain delegate powers to a committee.  Commentators doubted the trustworthiness of the SLC creation suggesting that committee members face unspoken pressure to dismiss charges against fellow directors – the so-called structural bias.  Business Judgment Review of SLC Recommendation  Initially courts held that an SLC‟s recommendation to dismiss litigation was like any other corporate business decision, despite the self-interested taint of the board that had appointed the committee.

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 Unless the plaintiff could show the committee‟s members were themselves interested or had not acted on an informed basis, the committee‟s recommendations were entitled to full judicial deference under the business judgment doctrine.  SLCs could recommend dismissing the suit on various grounds such as (i) suit would undermine employee morale and waste corporate time, (ii) expenses would exceed any possible gain, (iii) suit would create bad publicity, (iv) claim lacks merit, (v) corporation might be required to indemnify defendant, and so on.
Auerbach v. Bennett Facts: A specially appointed committee of disinterested directors – acting on behalf of defendant, a board of directors of a corporation – made a decision to terminate a shareholders' derivative action. Plaintiff shareholders filed suit to challenge the decision, and defendant filed for summary judgment and to dismiss. Holding: The court found that the decision of defendant's committee was beyond judicial inquiry under the business judgment doctrine. The court acknowledged that it could inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee. Reasoning: Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to the directors' and officers' honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient. Absent evidence of bad faith or fraud the courts must and properly should respect the determinations of corporate directors and officers.

 Heightened Scrutiny in Demand-Excused Cases  In Delaware, when demand on the board is excused as futile, the courts listen to the SLC but with suspicion. The courts established a two-part inquiry into whether an SLC‟s recommendation to dismiss would be respected.  (i) Procedural Inquiry. The defendants must carry the burden of showing the committee member‟s independence from the defendants, their good faith, reasonable investigation, and the legal and factual bases for the committee‟s conclusion.  If there is a genuine issue of material fact as to any of these counts, the derivative litigation proceeds.  (ii) Substantive Inquiry. Even if the SLC‟s recommendation passes the first procedural inquiry, the trial judge must apply his own “independent business judgment” as to whether the suit should be dismissed.  Far more intrusive inquiry than even the fairness test that is applicable to selfdealing transactions.  Recognizes that judges are particularly adept to evaluate the merits of litigation and that judicial incentives to further the interests of the corporation are perhaps stronger than those of the SLC.  Quinn says courts prefer direct actions to acquire the corporate books and records so that such evidence may be used in a subsequent derivative suit.
Zapata Corp. v. Maldonado Facts: Stockholder brought derivative actions in state and federal court, alleging that the corporation's officers and directors had breached their fiduciary duty. The stockholder did not first demand that the board members bring the action, alleging that such a demand would have been futile as all of the directors were defendants. After replacement of some board members, the new board created an investigation committee. The committee determined that each action against the corporation should be dismissed. Holding: On an interlocutory appeal, the court remanded, holding that a court should inquire into the independence and good faith of an independent committee and the bases supporting its conclusions. The chancery court was then directed to determine, applying its own independent business judgment, whether the motion should be granted. Reasoning: The final substantive judgment whether a particular lawsuit should be maintained requires a balance of many factors -- ethical, commercial, promotional, public relations, employee relations, fiscal as well as legal. However, such factors are not beyond the judicial reach of the Court of Chancery, which regularly and competently deals with fiduciary relationships, disposition of trust property, approval of settlements and scores of similar problems.

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 The court should apply a two-step test to the motion an independent committee files to dismiss a derivative

suit. First, the court should inquire into the independence and good faith of the committee and the bases supporting its conclusions. Limited discovery may be ordered to facilitate such inquiries. The corporation should have the burden of proving independence, good faith and a reasonable investigation, rather than presuming independence, good faith and reasonableness. If the court determines either that the committee is not independent or has not shown reasonable bases for its conclusions, or, if the court is not satisfied for other reasons relating to the process, including but not limited to the good faith of the committee, the court shall deny the corporation's motion. If, however, the court is satisfied that the committee was independent and showed reasonable bases for good faith findings and recommendations, the court may proceed, in its discretion, to the next step. The second step provides the essential key in striking the balance between legitimate corporate claims as expressed in a derivative stockholder suit and a corporation's best interests as expressed by an independent investigating committee. The court should determine, applying its own independent business judgment, whether the motion should be granted.

In re Oracle Corp. Derivative Litigation Facts: In plaintiff shareholders' derivative action against putative defendant corporation and alleging defendant directors engaged in insider trading while in possession of material, non-public information, the special litigation committee of the corporation moved to dismiss the action. Nevertheless, the chancery court's dispositive issue was whether or not the two-member SLC was independent. Holding: The court held that the SLC did not meet its burden to prove it, or either of the members, was independent. The chancery court's independence test was whether the individual SLC member was incapable of making a decision with only the best interests of the corporation in mind, or, as a corollary, without considering any way in which his decision would impact him. Reasoning: The ties that the SLC members and directors had to one university, as alumni, tenured faculty professors, very major contributors, and speakers were too vivid to be ignored. At bottom, the question of independence turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. That is, the Delaware Supreme Court cases ultimately focus on impartiality and objectivity. This formulation is wholly consistent with the teaching of Aronson, which defines independence as meaning that a director's decision is based on the corporate merits of the subject before the board rather than extraneous considerations or influences. A director may be compromised if he is beholden to an interested person. Beholden in this sense does not mean just owing in the financial sense, it can also flow out of personal or other relationships to the interested  It is not possible to anticipate, or explicitly provide for, all circumstances that might signal potential conflicts of interest, or that might bear on the materiality of a director's relationship to a listed company. Accordingly, it is best that boards making independence determinations broadly consider all relevant facts and circumstances. In particular, when assessing the materiality of a director's relationship with the company, the board should consider the issue not merely from the standpoint of the director, but also from that of persons or organizations with which the director has an affiliation. Material relationships can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others. In Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart Holding: A variety of motivations, including friendship, may influence the demand futility inquiry. But, to render a director unable to consider demand, a relationship must be of a bias-producing nature. Allegations of mere personal friendship or a mere outside business relationship, standing alone, are insufficient to raise a reasonable doubt about a director‟s independence.  In order to show lack of independence, the complaint of a stockholder-plaintiff must create a reasonable doubt that a director is not so “beholden” to an interested director (in this case Stewart) that his or her “discretion would be sterilized.”

v. Insurance  Corporate statutes permit the corporate to purchase insurance for itself to fund its own indemnification obligations and for directors or corporate officers to fill the gaps in corporate indemnification, principally when a director is liable to the corporation in a derivative suit.  Directors and Officers (D & O) Insurance  Premium payments for such policies constitute additional executive compensation and are authorized either as such or by specific statute. Del § 145(g).  Statute authorizes the purchase of insurance even if it covers expenses and liabilities the corporation could not indemnify.

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 Theory is that the director himself could have bought insurance and it should not make any difference that the corporation compensates him by paying premiums.  D & O policies typically cover any liabilities or defense costs arising from the executive‟s position with the corporation.  Typically exclude coverage for  Improper personal benefits (such as self-dealing);  Actions in bad faith (including dishonesty);  Illegal compensation;  Libel or slander;  Knowing violations of the law;  Bodily injury/property damage;  Pollution; and  Other willful misconduct.  Many policies also exclude coverage for fines, penalties, and punitive damages. D. THE ROLE AND PURPOSE OF THE CORPORATION i. Principles of Corporate Law  A for-profit corporation‟s primary purpose is to make money for its constituents.  Courts generally accept the premise that corporations have implicit powers to make charitable gifts that in the long run may arguably benefit the corporation.  Gifts cannot be for unreasonable amounts and must be for a proper purpose.  Excessive or unreasonable gifts may be attacked as corporate waste.  In general, if the gift is tax deductible, corporate law treats it as a reasonable exercise of corporate powers. I.R.C. § 170(b)(2) (deduction for corporate giving limited to 10% of the corporation‟s taxable income).  Del. § 122(9) – Specific Powers  Every corporation created under this chapter shall have power to make donations for the public welfare or for charitable, scientific or educational purposes, and in time of war or other national emergency in aid thereof.
Dodge v. Ford Motor Co. Facts: Ford decided to exercise his discretion and hold back part of the company's capital earnings for reinvestment, thereby denying certain expected dividend payments to the Dodge brothers as shareholders. The Dodge brothers contended that the reason Ford was holding back dividends, partially to reinvest in the company and bring down the ultimate cost of buying a car, was semi-humanitarian and was not authorized by the company's charter. Holding: The court held that the accumulation of so large a surplus established that there was an arbitrary refusal to distribute funds to stockholders as dividends and ordered that such dividends, plus interest, should be paid by Ford. Reasoning: Courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud, or breach of good faith which they are bound to exercise towards stockholders.  A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the non-distribution of profits among stockholders in order to devote them to other purposes.

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Duties of Officers, Directors, and Other Insiders A. THE OBLIGATIONS OF CONTROL i. The Corporate Fiduciary Duty  At heart of corporate law lie duties of trust and confidence – fiduciary duties – owed by those who control and operate the corporation‟s governance machinery to the body of constituents known as the corporation.  Directors, officers, and controlling shareholders are obligated to act in the corporation‟s best interests, principally for the benefit of shareholders – the owners of the corporation‟s residual financial rights.  Theories of Corporate Fiduciary Duty  Management Discretion.  The efficiency of specialized management suggests that managers should have broad discretion. Giving shareholders (and courts) significant oversight would undermine this premise of the corporate form.  Management Accountability.  Entrusting management to non-owners suggests a need for substantial accountability. Although shareholder voting constrains management abuse, voting is episodic. Without supplemental limits, management discretion would ultimately cause investors to lose confidence in the corporate form.  Fiduciary rules aim to minimize “agency costs.” ii. Duty of Care  The board of directors manages and oversees the corporation‟s business and affairs.  Judicial review of board decision-making and oversight is governed by the duty of care, which is in turn confined by the business judgment rule.  Addresses the attentiveness and prudence of directors performing duties.  Courts will even tolerate decisions that in hindsight were awful if the board exercised due care.  Delaware Common Law Standard  A party challenging a business decision must show that the directors failed to act (i) in good faith, (ii) in the honest belief that the action taken was in the best interest of the company, or (iii) on an informed basis. Aronson v. Lewis.  Duty of care allegations are almost always going to fail unless the plaintiff can show that the board of directors was uninformed.  Facets of Duty of Care  Good Faith.  A subset of the duty of loyalty.  The “good faith” standard requires that directors (i) be honest, (ii) not have a conflict of interest, and (iii) not approve (or condone) wrongful or illegal activity.  Fraudulent or self-dealing transactions are subject to scrutiny under the director‟s duty of loyalty.  Conscious disregard of corporate duties and intentional violations of positive law violate the director‟s duty of good faith.  Reasonable Belief.  Standard involves the substance of director decision-making.  A board decision must be related to furthering the corporation‟s interests.  Embodies the corporate waste standard, under which board action is invalid if it lacks any rational business purpose.  Reasonable Care.

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 “Informed basis” and “ordinary care” standards relate to the process of board decisionmaking and oversight.  Directors must be informed in making decisions and must monitor and supervise corporate activities.  Directors must have at least minimal levels of skill and expertise.  Recognizes that risk-taking decisions are central to the director‟s role.
Shlensky v. Wrigley Facts: Stockholder filed a stockholders' derivative suit against the directors for negligence and mismanagement. Stockholder sought damages and he prayed for an order that required the corporate directors to install lights at the baseball field owned by the corporation, and requested that they schedule night baseball games. Lower court held that stockholder's amended complaint did not state cause of action. Holding: The court affirmed, maintaining that courts should not interfere in a corporation's management unless fraud or a breach of faith existed. The decision at issue was one properly before the corporation's directors, and the motives alleged in the amended complaint showed no fraud, illegality, or conflict of interest in their making of that decision. The allegations in the stockholder's amended complaint were mere conclusions, which were insufficient to except the directors from the business judgment rule. Reasoning: In a purely business corporation the authority of the directors in the conduct of the business of the corporation must be regarded as absolute when they act within the law, and the court is without authority to substitute its judgment for that of the directors. Directors are elected for their business capabilities and judgment and the courts cannot require them to forego their judgment because of the decisions of directors of other companies. Courts may not decide these questions in the absence of a clear showing of dereliction of duty on the part of the specific directors and mere failure to "follow the crowd" is not such a dereliction.

iii. Business Judgment Rule (BJR)  A rebuttable presumption that directors in performing their functions are honest and well meaning, and that the directors‟ decisions are informed and rationally undertaken.  Presumes directors do not breach their duty of care.  Offshoot of the BJR is the reliance corollary, enabling directors to rely on information and advice from other directors (including committees of the board), competent officers and employees, and outside experts.  Del § 141(e) – Reliance on Information Provided  A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.  Operation of the Business Judgment Rule  Shields directors from personal liability and insulates board decisions from judicial review.  Has two important aspects:  Describes the substantive standard of review to which director and board action should be submitted.  Creates a procedural burden of proof that requires the plaintiff to rebut the presumption that the directors acted in good faith, in the best interests of the corporation, and with adequate information.  Rationale of the Business Judgment Rule  Encourages Risk-Taking.  Shareholders expect the board to take business risks – the old adage “nothing ventured, nothing gained” is why shareholders invest.  Without the BJR, directors might be overly cautious in their business decisions.

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 Avoids Judicial Meddling.  Judges are not business experts.  Corporate statutes reflect the notion that corporate management is entrusted to the board of directors.  Encourages Director Service.  Encourages qualified persons to serve as directors and take business risks without fear of being judged in hindsight. iv. Overcoming the Business Judgment Presumption  A plaintiff can overcome the business judgment presumption by proving either (i) fraud, bad faith, illegality, or a conflict of interest, (ii) the lack of a rational business purpose, (iii) failure to become informed in decision-making, or (iv) failure to oversee the corporation‟s activities.  Once a plaintiff overcomes the business judgment presumption, the burden shifts to the board to demonstrate the entire fairness of the transaction, i.e., the transaction is assumed to be unfair until proven otherwise.  Waste Claims  Under the rational purpose test, board decisions that even in hindsight seem patently unwise or imprudent are protected from review and the directors shielded from liability so long as the business judgment was not “improvident beyond explanation.”  Only if the shareholder shows that “the consideration received by the corporation was so inadequate that no person of ordinary sound business judgment would deem it worth the consideration the corporation paid” will the BJR be overcome.  Extremely low threshold to overcome.
Kamin v. American Express Company Facts: Plaintiffs filed a derivative action against defendants arising from defendants' decision to issue a dividend arising out of the acquisition of DLJ shares (for a loss). Plaintiffs alleged that the board should have written the acquisition of the shares as a loss on their tax reports to offset against taxable capital gains. The board declined. Holding: The court held that it would not interfere with decisions of directors of a corporation unless there had been some sort of fraud, dishonest practices, or other grounds that allowed for equitable interference – questions of policy and business management were better left to the judgment of corporate management. Reasoning: The question of whether or not a dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the board of directors. Courts will not interfere with such discretion unless it be first made to appear that the directors have acted or are about to act in bad faith and for a dishonest purpose. It is for the directors to say, acting in good faith of course, when and to what extent dividends shall be declared. The statute confers upon the directors this power, and the minority stockholders are not in a position to question this right, so long as the directors are acting in good faith.  Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to the board‟s honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient.

 Gross Negligence  To claim the business judgment presumption in a decision-making context, directors must make reasonable efforts to inform themselves in making the decision.  The focus is on procedure, and the courts assume diligent board deliberations ensure rational board action.
Smith v. Van Gorkom Facts: Plaintiff shareholders brought an action seeking rescission of a cash-out merger of Trans-Union into another, or in the alternative, damages against defendant directors. Evidence demonstrated a litany of errors by the board of directors to be informed, including failing to inquire into one director‟s role in merger, failing to review merger documents, failing to seeking outside investment council, etc…

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Holding: The court agreed, finding that defendant directors based their decision on one person's representations, which did not constitute a report on which they could reasonably rely under Del. § 141(e), and that they did not seek documentation of either the merger terms or the adequacy of the proposed price per share. The court also found defendant directors were grossly negligent in permitting the agreement to be amended in a way they had not authorized. Finally, the court found that the stockholders' vote did not ratify the action, because the stockholders weren't aware of the lack of valuation information, and because defendant directors' statements were misleading. Reasoning: The determination of whether a business judgment is an informed one turns on whether the directors have informed themselves prior to making a business decision of all material information reasonably available to them. There is no protection for directors who have made an unintelligent or unadvised judgment  In context of a proposed merger of domestic corporations, a director has a duty under Del. § 251(b), along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. Certainly in the merger context, a director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement. Only an agreement of merger satisfying the requirements of Del. § 251(b) may be submitted to the shareholders under Del. § 251(c).

 The Lessons of Trans-Union  Delaware Reassertion.  Delaware Supreme Court was giving teeth to its fiduciary laws.  Its emphasis on board processes also put a premium on good lawyering.  Fast Shuffles.  Delaware courts have readily faulted directors who approve transactions in which managers extract bribes from the acquirer as a condition of the transaction.  End-Period Events.  Mergers and other “end-period” decisions should be subject to more stringent review than typical operational decisions.  Inattention to Mismanagement/Management Abuse  Particularly in public corporations, directors are expected to monitor management, to whom is delegated the day-to-day business operations.  Duty to monitor requires directors to inquire into managers‟ competence and loyalty.  Courts have been reluctant to hold directors liable for inattention to mismanagement.  Courts have been less reluctant when a director fails to supervise management embezzlement and deceit.  Liability often turns on whether the director knew or had reason to know of the management abuse.  Proximate cause is important in oversight cases.
Barnes v. Andrews Facts: A director, whose only attention to the affairs of the company consisted of talks with the president – who was also a friend – was sued after business failed because of the president‟s poor business judgments. Holding: Judge Hand concluded the passive director, though he had technically breached his duty of care, could not be liable because nothing indicated that he could have prevented the business failure. Reasoning: Judge Hand pointed out that it would be impossible to know if the director could have saved the business. Even if the inquiry were possible, the business judgment rule teaches the courts that judges should not conduct such inquiry. Francis v. United Jersey Bank Facts: Plaintiff estates brought suit against widow and director of corporation alleging negligence in failing to prevent other of the corporation's directors [two sons] from misappropriating trust funds from the corporation. Widow argued that she was not liable for directors' conversion of trust funds because she was not aware of it. Holding: Court held that the directors did have a duty to exercise ordinary care in managing the corporation. Court noted that ordinary care included becoming familiar with corporate business, staying informed about activities, becoming familiar with corporate financial status, and objecting to or taking means to prevent illegal activity when it was discovered. Court then found that the directors had breached their duty by failing to do those things, and that such negligence proximately caused plaintiffs harm.

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Reasoning: Corporate directors owe that degree of care that a businessman of ordinary prudence would exercise in the management of his own affairs. The nature and extent of reasonable care depends upon the type of corporation, its size, and its financial resources. As a general rule, a director should acquire at least a rudimentary understanding of the business of the corporation. Accordingly, a director should become familiar with the fundamentals of the business in which the corporation is engaged.  Because corporate directors are bound to exercise ordinary care, they cannot set up as a defense lack of the knowledge needed to exercise the requisite degree of care. If one feels that he has not had sufficient business experience to qualify him to perform the duties of a director, he should either acquire the knowledge by inquiry, or refuse to act.  In general, the relationship of a corporate director to the corporation and its stockholders is that of a fiduciary. Shareholders have a right to expect that directors will exercise reasonable supervision and control over the policies and practices of a corporation. The institutional integrity of a corporation depends upon the proper discharge by directors of those duties.

v. Remedies for Breaching Duty of Care  Personal Liability of Directors  If board action violates the duty of care, courts have held that each director who voted for the action, acquiesced in it, or failed to object to it becomes jointly and severally liable for all damage that the decision proximately caused the corporation.  Some statutes allow a director who has not voted for the action to register his dissent or abstention by delivering written notice at or immediately after the meeting. MBCA § 8.24(d).  When directors disregard management abuse, courts readily find proximate cause.  In Delaware, the court refused to make proximate cause an element of the plaintiff‟s case and shifted the burden to the careless defendants to prove the challenged transaction‟s “entire fairness.” Cede & Co. v. Technicolor, (Cede II).  Under this approach, lack of proximate cause becomes an affirmative defense.  Statutory Elimination of Duty of Care  During the 1980s insurance premiums for D & O insurance increased dramatically and there was a general fear that individual would decline to serve for fear of liability exposure.  Delaware enacted an exculpation statute that authorizes charter amendments shielding directors from personal liability for breaching their duty of care – a raincoat protecting directors from liability.  Can be included articles of newly formed corporation or added by amendment.  N.B. Statute does not affect the granting of equitable relief.  Del. § 102(b)(7) – Limitations of Liability in Certificates of Incorporation  A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) for any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.  Effect of Exculpation  In Emerald Partners v. Berlin (Emerald I), the Delaware court concluded that an exculpation provision is “in the nature of an affirmative defense,” requiring directors to establish each of its elements, including good faith in a parent-subsidiary merger.  In a second appeal of the same case, Emerald II, the court decided that when claims of care violations are mixed with claims of disloyalty and lack of good faith, the question of exculpation arises only after a finding that the transaction was not entirely fair. Only then can the trial court decide whether the unfairness arose from exculpated care claims or from non-exculpated loyalty or bad faith claims.  When a plaintiff adequately pleads conduct that falls within the statutory exceptions, directors charged with both care and loyalty/good-faith violations must go through a

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full trial on both claims before interposing their affirmative exculpation defense – which once presented presumably wipes clean any damages based only on care violations.

B. SELF-DEALING TRANSACTIONS

i. Duty of Loyalty  Corporate law‟s suspicion of director self-dealing grows out of two assumptions: (i) human nature tell us the director will advance his own interests in the transaction to the detriment of the corporation and (ii) group dynamics lead the other directors to identify with their interested colleague even if they do no themselves have an interest in the transaction.  Nineteenth-century courts flatly prohibited self-dealing by directors.  Self-dealing was either void or voidable at the request of the corporation, regardless if the transaction was fair or not.  No Business Judgment Presumption  The conflicts that permeate a self-dealing transaction rebut the business judgment presumption that directors act in good faith.  Once a plaintiff demonstrates the existence of a director‟s conflicting interest in a corporate transaction, the burden generally shifts to the party seeking to prove the transactions validity – entire fairness. Lewis v. S.L. & E. ii. Entire Fairness Standard  When an actual conflict of interest of the directors approving a transaction is found, Delaware courts apply the most exacting standard, “entire fairness” review, which requires a judicial determination of whether a transaction is entirely fair to stockholders.  In assessing entire fairness the court must consider the process itself that the board followed, the quality of the result it achieved and the quality of the disclosures made to the shareholders to allow them to exercise such choice as the circumstances could provide.  The absence of certain elements of fair dealing does not preclude directors from establishing that a challenged transaction was otherwise fair, in terms of price and process, to stockholders.  Substantive Fairness  A substantive fairness test examines whether the director‟s interests won out over the corporation‟s interest and will accept the fairness of self-dealing if the court concludes that the transaction was in the corporation‟s best interest. It has two aspects:  Objective Test. The self-dealing transaction must replicate an arm‟s-length market transaction by falling into a range of reasonableness (i.e., examining price).  Value to Corporation. The transaction must be of particular value to the corporation, as judged by the corporation‟s needs and scope of its business.  “Under the entire fairness standard of judicial review, the defendant directors must establish to the court's satisfaction that the transaction was the product of both fair dealing and fair price.” Cede & Co. v. Technicolor, Inc.  Procedural Fairness  A procedural fairness test inquires into the process of board approval, showing varying levels of deference if the transaction is approved by informed, disinterested and independent directors.  Courts focus on three procedural elements: (i) disclosure to the board, (ii) the composition of the board (or committee) that approved the transaction, and (iii) the role of the interested director in the transaction‟s initiation, negotiation and approval.  Board (or Committee) Composition  Some courts have upheld self-dealing transactions approved by disinterested directors, applying a less exacting standard of fairness that approximates business judgment review.

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 Upholding “independent business judgment” of disinterested directors who initiated and negotiated purchases from company‟s controlling family. Puma v. Marriott.  Other courts have held there is a presumption of fairness – and have shifted the burden of proving unfairness to the plaintiff – if the self-dealing is approved by a majority of disinterested directors. Cooke v. Ollie.  A director is “disinterested” if he has no direct financial interest in the transaction, or indirect financial interest through close family ties or business relationships, that would affect his judgment.  A director is “independent” if he is neither beholden to nor dominated by an interested director.
Bayer v. Beran Facts: Shareholders alleged a breach of the fiduciary duty of loyalty by the directors in connection with a program of radio advertising featuring the wife of the president of the company. Holding: The court concluded there was no breach of fiduciary duty on the part of the directors because the evidence failed to show that the program was designed for a purpose other than one benefiting the corporation. Moreover, the court held the directors acted in the free exercise of their honest business judgment, and their conduct in the transactions challenged did not constitute negligence, waste, or improvidence. Reasoning: The business judgment rule yields to the rule of undivided loyalty. The dealings of a director with the corporation for which he is the fiduciary are viewed with jealousy by the courts. Such personal transactions of directors with their corporations, such transactions as may tend to produce a conflict between self-interest and fiduciary obligation, are, when challenged, examined with the most scrupulous care, and if there is any evidence of improvidence or oppression, any indication of unfairness or undue advantage, the transactions are voided.  By the early twentieth century, courts hesitated to let firms void their contracts so easily. If a disinterested majority of directors had ratified a contract and if the complaining party could not prove it unfair, the courts generally held the contract valid.  N.B. Bayer takes the rule one step further → because the contract is fair, it is valid even though disinterested directors have not formally ratified it.

iii. Shareholder Ratification  Courts show substantial deference to self-dealing transactions approved or ratified by a majority of informed, disinterested shareholders.  Majority Ratification  Where a majority of the shares are cast by informed shareholders who neither have an interest in the transaction nor are dominated by those who do, most courts do not require that a defendant show “fairness.”  Courts review the transaction under the business judgment rule and shift the burden to the plaintiff to show the transaction constituted waste – that no person of ordinary sound business judgment would say the consideration was fair. Aronoff v. Albanese.  In Delaware, where self-dealing is by a non-controlling shareholder, approval by informed, disinterested shareholders of a transaction with the non-controlling shareholder not only extinguishes any claim the board acted without due care, but also leads disloyalty claims to be viewed under the business judgment rule. In re Wheelabrator Tech. Litigation.  Disinterested shareholder ratification of transactions with controlling shareholders, however, is less cleansing and only shifts the burden to show unfairness to the challenger. Kahn v. Lynch Communication Systems.  In self-dealing transactions with approval by a majority of shareholders interested in the transaction, courts have been more suspicious and leave the burden with the defendants to show the “intrinsic fairness” of the transaction.  Unanimous Ratification  If self-dealing is ratified unanimously by all of the shareholders or by a sole shareholder, courts agree that it cannot be set aside even under a waste standard so long as there is no injury to creditors.

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 Effective ratification depends on full disclosure to shareholders of the director‟s conflicting interest.
Flieger v. Lawrence Facts: Defendant officer (the president of the corporation), in his individual capacity, acquired certain antimony properties under a lease option, which he offered to transfer to the corporation. The board of directors agreed that the corporation's legal and financial position would not permit acquisition and development of the properties. Thus, defendant officer transferred the properties to a newly formed corporation, a majority of whose stock was owned by the individual defendants, granting the corporation an option to purchase. After the corporation exercised the option, the shareholder filed the derivative action. Holding: The court held that the burden was upon defendants to demonstrate the intrinsic fairness of the transaction. The court held that defendant officers did not wrongfully usurp an opportunity belonging to the corporation and that defendants, officers and newly formed corporation, did not wrongfully profit by causing the corporation to exercise an option to purchase that opportunity. The court held that the shareholder had shown no detrimental use of the corporation's assets. Reasoning: When individual corporate officers stand on both sides of a transaction in implementing and fixing the terms of an option agreement, the burden is upon them to demonstrate its intrinsic fairness. Shareholder ratification of an "interested transaction" (a transaction between a director or officer of the corporation and the corporation), although less than unanimous, shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets. In re Wheelabrator Technologies, Inc. Shareholders Litigation Facts: The plaintiff class alleged a breach of fiduciary obligation to disclose to the class material information as to the merger that would have significant effect upon shareholders' vote, and alleging that the directors breached the duties of loyalty and due care. Holding: The court held that: (i) the class failed to adduce evidence sufficient to defeat summary judgment on the duty of disclosure claim, as proxy statements in a vote to approve the merger were consistent with relevant facts; (ii) the fully-informed shareholder vote approving the merger operated to extinguish the class' duty of care claims, but not its duty of loyalty claim; and (iii) the business judgment standard of review, with the class having the burden of proof, rather than the entire fairness standard, applied to the class' claim against the directors that alleged their recommendation of the merger violated the duty of loyalty. Reasoning: Del. § 144(a)(2) provides that an interested transaction is not voidable if it is approved in good faith by a majority of disinterested stockholders. Approval by fully informed, disinterested shareholders pursuant to Del. § 144(a)(2) invokes the business judgment rule and limits judicial review to issues of gift or waste with the burden of proof upon the party attacking the transaction. The result is the same in interested transaction cases not decided under Del. § 144. Where there is independent shareholder ratification of interested director actions, the objecting stockholder has the burden of showing that no person of ordinary sound business judgment would say that the consideration received for the options is a fair exchange for the options granted. In a parent-subsidiary merger, the standard of review is ordinarily entire fairness, with the directors having the burden of proving that the merger is entirely fair. However, where the merger is conditioned upon approval by a majority of the minority stockholder vote, and such approval is granted, the standard of review remains entire fairness, but the burden of demonstrating that the merger is unfair shifts to the plaintiff. That burden-shifting effect of ratification is held applicable in cases involving mergers with a de facto controlling stockholder, and in a case involving a transaction other than a merger.

iv. Statutory Safe Harbors  As fiduciary standards have become more process-oriented, courts have interpreted “interested director” statutes as creating a safe harbor.  Obtaining proper board or shareholder approval under a statute‟s standard creates a presumption of validity under the business judgment rule.  Delaware‟s Statutory Safe-Harbors  At first, Delaware courts treated disinterested director approval as merely shifting the burden to the plaintiff to prove the transaction was not entirely fair. Cinerama, Inc. v. Technicolor, Inc.

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 Delaware courts now suggest that the statute creates a safe harbor for self-dealing transactions, if approved by fully informed, disinterested, and independent directors or by fully informed, disinterested shareholders → permitting invocation of the BJR.  Delaware courts have now made clear that Del. § 144 creates a safe harbor and that director self-dealing that satisfies the conditions of the statute receives business judgment deference. Benihana of Tokyo, Inc. v. Benihana, Inc.  Effectively, the Delaware courts have concluded that properly informed and qualified directors are superior at determining the value of a self-dealing transaction to the corporation than a reviewing judge.  Del. § 144 – Interested Directors; Quorum  (a) No contract or transaction between a corporation and one or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which one or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director's or officer's votes are counted for such purpose, if:  (1) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or  (2) The material facts as to the director's or officer's relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or  (3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the shareholders.  (b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction.  Del. § 141(b) – Quorum  Unless the certificate of incorporation provides otherwise, the bylaws may provide that a number less than a majority shall constitute a quorum which in no case shall be less than 1/3 of the total number of directors
Benihana of Tokyo, Inc. v. Benihana, Inc. Facts: Due to financial problems and a change of corporate control, three of the members of the subsidiary's board of directors considered the issuance of convertible stock and its sale to defendant potential buyer BFC. Ultimately, the entire board approved resolutions ratifying the execution of a stock purchase agreement with the buyer and authorizing the stock issuance. Thereafter, the BOT filed an action against all but one of the subsidiary's directors, alleging breaches of fiduciary duties – one individual was director for subsidiary and buyer. Holding: The court held that the record clearly established that the board possessed all of the material information when it approved the transaction. The court noted that notwithstanding the one individual‟s role, the transaction was fair to the corporation. Reasoning: Del. § 144(a)(1) provides a safe harbor for interested transactions if the material facts as to a director's relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors, and the board in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors. After approval by disinterested directors, courts review an interested transaction under the business judgment rule, which is a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.

v. Corporate Opportunity Doctrine

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 Delaware Corporate Opportunity Test  “If there is presented to a corporate officer or director a business opportunity (i) which the corporation is financially able to undertake, (ii) is, from its nature, in the line of the corporation‟s business and is of practical advantage to it, (iii) is one in which the corporation has an interest or a reasonable expectancy, and (iv) by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of the corporation, the law will not permit him to seize the opportunity for himself.” Guth v. Loft, Inc.  Corporate Rejection  Delaware‟s corporate statute permits a corporation to “renounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in…specified business opportunities or specified classes or categories of business opportunities” presented to the corporation. Del. § 122(17).  The corporation‟s rejection of a specific opportunity, however, may itself be a selfdealing transaction because of the possible conflict between the manager‟s/director‟s and the corporation‟s interests.  Some courts subject corporate rejection, like the approval of a self-dealing transaction, to fairness review and require rejection by informed, disinterested directors or shareholders. Texlon Corp v. Meyerson (stating that board‟s informed, considered refusal of corporate opportunity creates safe harbor for interested director).  Remedies for Usurping a Corporate Opportunity  A director who usurps a corporate opportunity without consent must share the fruits of the opportunity as though the corporation had originally taken it.  Remedies include: (i) liability for profits realized by the usurping manager/director, (ii) liability for lost profits and damages suffered by the corporation, and (iii) imposition of a constructive trust on the new business or subject matter of the opportunity.  Because an outside third party is on the other side of the opportunity, rescission is not available unless the third party had notice of the insider‟s wrongdoing.
Broz v. Cellular Information Systems, Inc. Facts: While Broz was a corporate director at CIS, he purchased a cellular telephone service license for the benefit of his own corporation. The new owners of CIS brought an action against Broz that sought equitable relief on the grounds that the purchase constituted a usurpation of a corporate opportunity that allegedly belonged to CIS. Holding: On appeal, the court held that the lower court erred as a matter of law when it held that appellant corporate director had a duty to formally present the purchase opportunity to appellee's board. The court also held that the trial court erred in its application of the corporate opportunity doctrine under the facts of the case, where appellee had no interest or financial ability to acquire the opportunity. The court held that appellant corporate director was not required to consider the contingent and uncertain plans of a third party that sought to acquire appellee in reaching his determination of how to proceed. Reasoning: While presentation of a purported corporate opportunity to the board of directors and the board's refusal thereof may serve as a shield to liability, there is no per se rule requiring presentation to the board prior to acceptance of the opportunity. A director or officer may take a corporate opportunity if: (1) the opportunity is presented to the director or officer in his individual and not his corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. In re eBay Shareholders Litigation Facts: Shareholders of eBay, Inc. filed consolidated derivative actions against certain eBay directors and officers for usurping corporate opportunities. Plaintiffs alleged that Goldman Sachs engaged in “spinning,” a practice that involves allocating shares of lucrative initial public offerings of stock to favored clients. In effect, the plaintiff shareholders allege that Goldman Sachs bribed certain eBay insiders, using the currency of highly profitable investment opportunities – opportunities that should have been offered to, or provided for the benefit of, eBay rather than the favored insiders.

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Holding: The court held that the defendant directors were not free to accept this consideration from Goldman Sachs when they were doing significant business with eBay and that arguably intended the consideration as an inducement to maintaining the business relationship in the future. Reasoning: The complaint gives rise to a reasonable inference that the insider directors accepted a commission or gratuity that rightfully belonged to eBay but that was improperly diverted to them. Even if this conduct does not run afoul of the corporate opportunity doctrine, it may still constitute a breach of the fiduciary duty of loyalty.

vi. Fiduciary Duties of Controlling Shareholders  Courts generally impose fiduciary duties on controlling shareholders that generally parallel those of directors.  Directors are generally elected by majority vote, and any shareholder who can assemble a voting majority wields effective control of the board – directors as agents of shareholder.  Controlling shareholders have fiduciary duties to minority shareholders; they cannot use their control to benefit themselves to the detriment of the minority.  In controlling shareholders‟ dealings in the ordinary course of business, “their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the shareholder[s] not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein [minority shareholders].”  Dealings with Wholly Owned Subsidiaries  When a subsidiary is wholly owned and there are no minority shareholders, the parent has virtually unfettered discretion to do with the subsidiary corporation as it pleases.  Duties exist only to corporate creditors, and to a limited extent, future minority shareholders, i.e., liability of parent for siphoning off corporate funds at the expense of creditors.  Dealings with Partially Owned Subsidiaries.  Such dealings create risks of control abuse in areas including dividend policies, share transactions, intra-company transactions (parent-subsidiary) and the usurpation of corporate opportunities.  Ordinary Business Dealings  Parent-subsidiary dealings in the ordinary course of business are subject to fairness review only if the minority shows the parent has preferred itself at the minority‟s expense.  The initial burden is on the minority shareholders to show the dealings were not those that might be expected in an arm‟s-length relationship, rather than on the parent to show that they were.  If shown, court presumes parent dominates the subsidiary‟s board and shifts the burden to the parent to prove the transaction was entirely fair to the subsidiary.
Sinclair Oil Corp. v. Levien Facts: Plaintiff, minority stockholder of a subsidiary corporation, brought a derivative action against the parent corporation for an accounting of excessive dividends and a breach of contract between two subsidiaries. Holding: The court reversed the order as to dividends because the dividends were paid fairly to all stockholders, and it affirmed the order as to breach of contract because the intrinsic fairness standard applies to dealings between subsidiaries. Reasoning: The standard of intrinsic fairness involves both a high degree of fairness and a shift in the burden of proof. Under this standard, the burden is on the parent company to prove, subject to careful judicial scrutiny, that its transactions with the subsidiary were objectively fair. The court reasoned that the parent‟s non-enforcement of contracts for sale of oil products to other affiliates preferred the affiliates to the subsidiary‟s detriment. The parent failed to show that the non-enforcement was “fair” to the subsidiary.  When the situation involves a parent and a subsidiary, with the parent controlling the transaction and fixing the terms, the test of intrinsic fairness, with its shifting of the burden of proof, is applied.  The rule applies when the parent has received a benefit to the exclusion and at the expense of the subsidiary. A parent owes a fiduciary duty to its subsidiary when there are parent-subsidiary dealings,

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but this alone will not evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self-dealing, when a parent is on both sides of a transaction with its subsidiary. Self-dealing occurs when the parent, by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary. Zahn v. Transamerica Corporation Facts: Plaintiff was a holder of Class A shares in the corporation. The Class B shares held voting control but the Class A shares were entitled to twice as much in liquidation as Class B shares, and could be redeemed by the corporation at any time for a $60 per share. The controlling shareholder then had the corporation redeem all of the minority‟s Class A shares and then liquidate the corporation‟s assets, which had recently tripled in value. Controlling shareholder moved to dismiss the action and the trial court granted the motion. Holding: The appeals court reversed because defendant, as the board of directors of the company and as controlling stockholder, had a fiduciary duty to minority Class A stockholders that was violated if the allegations of plaintiff were true. The act of redeeming the Class Act stock was consummated at the direction of defendant, for its own profit, not for protection of minority stockholders' interests. Reasoning: One in control of a majority of the stock and of the board of directors of a corporation occupies a fiduciary relation towards the minority stockholders, and is charged with the duty of exercising a high degree of good faith, care, and diligence for the protection of such minority interests. Every act in its own interest to the detriment of the holders of minority stock becomes a breach of duty and of trust, and entitles to plenary relief from a court of equity.

vii. Remedies for Self-Dealing  Remedies for improper parent-subsidiary dealings are same as those for director self-dealing.  Rescission is the general remedy unless it is inadequate – such as when a parent usurps the subsidiary‟s corporate opportunities – or when rescission is no longer possible.  When a controlling shareholder transacts in the corporation‟s stock to the detriment of the minority, courts permit minority shareholders to sue directly and seek either equal treatment in the transaction or a recovery based on what the minority would have received absent breach. C. THE OBLIGATION OF GOOD FAITH i. Principles of the Duty of Good Faith  “The good faith required of a corporate fiduciary includes not simply the duties of care and loyalty, but all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.” In re The Walt Disney Co. Deriv. Litigation.  “Intentional dereliction of duty, a conscious disregard for one‟s responsibilities… deliberate indifference and inaction in the face of a known duty to act…are clearly disloyal to the corporation. It is the epitome of faithless conduct”  “A failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the duty of care.”  The duty of good faith is a subset of the duty of loyalty and, as such, it is a duty that cannot be exculpated under Del. § 102(b)(7).  Intentional Dereliction of Duty Non-Exculpable  According to the court in Walt Disney Co. Deriv. Litig., it must be for two reasons:  First, the universe of misconduct is not limited to either disloyalty in the classic sense or gross negligence. A vehicle is needed to address such intermediate violations doctrinally, and that doctrinal vehicle is the duty to act in good faith.  Second, the legislature has also recognized this intermediate category of fiduciary misconduct, which ranks between conduct involving subjective bad faith and gross negligence. Del § 102(b)(7)(ii) expressly denied money damage exculpation for “acts

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or omissions not in good faith or which involve intentional misconduct or a knowing violation of law. ii. Compensation  Disinterested Approval Avoids Fairness Review  Executive compensation is not subject to fairness review so long as informed, disinterested, independent directors approved the compensation.  Courts have held that “ back scratching” – where officer-directors tacitly agree to approve each other‟s compensation, which each interested executive steps out of the meeting as his compensation is approved – does not satisfy the requirement of disinterested approval.  Recent cases have concluded that shareholder ratification cleanses the transaction and shifts the burden to the shareholder challenger to show waste. Lewis v. Vogelstein.  The Prevailing Standard - Waste  If executive compensation is approved by disinterested and independent directors, courts invoke the presumptions of the business judgment rule.  Challenger must show that the board was grossly uninformed or that the compensation was a waste of corporate assets – that is, the compensation had no relation to the value of the services promised and was really a gift. Beard v. Elster.
In re The Walt Disney Co. Derivative Litigation Facts: Shareholders brought derivative actions on behalf of Walt Disney against Disney‟s former president, Ovitz, and the directors who served at the time. Shareholders claimed that a decision to approve the president's employment agreement and a decision to terminate him on a non-fault basis resulted from various breaches of fiduciary duty by the president and the corporate directors. Chancery Court found that the director defendants did not breach their fiduciary duties or commit waste. Shareholders appealed. Holding: The Delaware Supreme Court affirmed. No reasonably prudent fiduciary in the president's position would have unilaterally called a board meeting to force the corporation's chief executive officer to reconsider his termination and the terms thereof, with that reconsideration for the benefit of shareholders and potentially to the president's detriment. The decisions to approve the president's employment agreement, to hire him as president, and then to terminate him on a no-fault basis were protected business judgments, made without any violations of fiduciary duty. Having so concluded, it was unnecessary to reach the shareholders' contention that the directors were required to prove that the payment of severance was entirely fair. Because the shareholders failed to show that the approval of the no-fault termination terms of the employment agreement was not a rational business decision, their corporate waste claim failed. Reasoning: Del. § 102(b)(7) authorizes Delaware corporations, by a provision in the certificate of incorporation, to exculpate their directors from monetary damage liability for a breach of the duty of care. That exculpatory provision affords significant protection to directors of Delaware corporations. The statute carves out several exceptions, however, including most relevantly, for acts or omissions not in good faith. Thus, a corporation can exculpate its directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith. To adopt a definition of bad faith that would cause a violation of the duty of care automatically to become an act or omission "not in good faith," would eviscerate the protections accorded to directors by the General Assembly's adoption of Del. § 102(b)(7).  The concept of intentional dereliction of duty, a conscious disregard for one's responsibilities, is an appropriate (although not the only) standard for determining whether corporate fiduciaries have acted in good faith.  Grossly negligent conduct, without more, does not and cannot constitute a breach of the corporate fiduciary duty to act in good faith. The conduct that is the subject of due care may overlap with the conduct that comes within the rubric of good faith in a psychological sense, but from a legal standpoint those duties are and must remain quite distinct.  To adopt a definition that conflates the duty of care with the duty to act in good faith by making a violation of the former an automatic violation of the latter would nullify those legislative protections and defeat the legislature‟s intent. There is no basis in policy, precedent, or common sense that would justify dismantling the distinction between gross negligence and bad faith.

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iii. Oversight  At the very least, a director must have a rudimentary understanding of the firm‟s business and how it works, keep informed about the firm‟s activities, engage in a general monitoring of corporate affairs, attend board meetings regularly, and routinely review financial statements.  The Graham Standard (Graham v. Allis-Chalmers Manufacturing Co.)  Delaware Supreme Court held that “absent cause for suspicion there is no duty upon the directors to install and operate a corporate system of espionage to ferret out wrongdoing which they have no reason to suspect exists.”  Board may rely in good faith on reports of subordinates and experts. Del. § 141(e).  The BJR will shield a director who may depend upon the presumption of regularity, absent knowledge or notice to the contrary.  The Caremark Standard (Caremark Int‟l Inc. Deriv. Litig.)  Delaware Supreme Court held that “generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation…only a sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.”  Two consequences:  (i) There is no independent duty of good faith.  (ii) Duty of loyalty violations may involve actions other than financial or other cognizable fiduciary conflicts of interest.
Stone v. Ritter Facts: Bank and corporation paid fines and civil penalties for the bank's failure to file Suspicious Activity Reports in violation of the Bank Secrecy Act, in relation to a money-laundering scheme. Shareholders alleged that the directors failed to implement any statutorily required monitoring, reporting, or information controls that would have enabled them to learn of the problems. Chancery Court dismissed the suit and shareholders appealed. Holding: Court found that the chancery court applied the correct standard. A necessary condition for director oversight liability was a sustained or systematic failure of the board of directors to exercise oversight. A consultant's report reflected that the directors not only discharged their oversight responsibility to establish an information and reporting system but also proved that the system was designed to permit the directors to periodically monitor the bank's compliance with regulations. Although there were ultimately failures by employees to report deficiencies, there was no basis for an oversight claim seeking to hold the directors personally liable for such failures by the employees. In the absence of red flags, good faith in the context of oversight must be measured by the directors' actions to assure a reasonable information and reporting system exists and not by second-guessing after the occurrence of employee conduct that results in an unintended adverse outcome. Reasoning: The phraseology used in Caremark describing the lack of good faith as a necessary condition to liability is deliberate. The purpose of that formulation is to communicate that a failure to act in good faith is not conduct that results, ipso facto, in the direct imposition of fiduciary liability. The failure to act in good faith may result in liability because the requirement to act in good faith is a subsidiary element, i.e., a condition, of the fundamental duty of loyalty. It follows that because a showing of bad faith conduct is essential to establish director oversight liability, the fiduciary duty violated by that conduct is the duty of loyalty.  The view of a failure to act in good faith results in two additional doctrinal consequences. First, although good faith may be described colloquially as part of a triad of fiduciary duties that includes the duties of care and loyalty, the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty. Only the latter two duties, where violated, may directly result in liability, whereas a failure to act in good faith may do so, but indirectly. The second doctrinal consequence is that the fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. A director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation's best interest.

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 Caremark articulates the necessary conditions predicate for director oversight liability: (a) the

directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations. Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.

D. DISCLOSURE AND FAIRNESS i. Delaware‟s Duty of Disclosure  When Seeking Shareholder Action  When seeking stockholder action, directors and controlling shareholders owe a fiduciary obligation to disclose all material facts known to them. Cede & Co. v. Technicolor, Inc.  This duty of disclosure is derived from the primary duties of care and loyalty.  The failure of the board to disclose all material facts when it seeks shareholder approval may constitute either a breach of the duty of care or the duty of loyalty.  It will be a breach of the duty of loyalty only when the failure to disclose occurs in a transaction that would otherwise be subject to an entire fairness standard of review because of duty of loyalty violations. In a transaction where duty of loyalty issues are implicated, the duty to disclose is an element of the fair dealing prong of the entire fairness standard.  In a transaction that is not subject to an entire fairness analysis, failure to disclose is a breach of the board's duty of care.  In order for a breach of the duty of disclosure to occur, the alleged omission or misrepresentation must be material.  When determining whether an omission or misrepresentation is material, Delaware courts decide whether the information would be material from the perspective of a reasonable stockholder. Kahn v. Lynch Communications Sys.  What Must Be Disclosed?  Directors and controlling stockholders must fully disclose all the material facts they know and supplement previously disclosed information if the board thereafter learns of new material facts after the prior disclosure. Arnold v. Soc'y for Sav. Bancorp.  The board, however, is not required to disclose every material fact to stockholders in all situations. Facts that are generally known to shareholders need not be specifically disclosed.  A board may withhold material information that could mislead a shareholder. When withholding information on this basis, directors are required to carefully balance the benefits that would be gained from disclosure against the harm it could cause.  Directors also have no obligation to speculate about the future or engage in selfflagellation. Furthermore, disclosure of highly sensitive information may be conditioned upon the shareholders agreeing to a reasonable confidentiality agreement.  In reviewing nondisclosure claims, the courts place more emphasis on what the shareholders know than on the form in which they receive the information.  The directors are not required to make the best or optimal disclosure, but are required to inform shareholders fully and fairly of all material facts pertaining to the transaction. In In re Santa Fe Pacific Corp. Shareholder Litigation, the Delaware Supreme Court held that disclosure that sufficiently apprises shareholders of all pertinent issues, without making material misstatements, satisfies the duty of disclosure even though the directors failed to disclose all available information.  The duty of disclosure requires not only that directors disclose all material facts within their possession, but also requires that shareholders or directors who ratify board action be fully informed of all material facts regarding the transaction.

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 Effective shareholder ratification requires the full disclosure of all material facts that the board knows or should have known.

 General Disclosures About the Corporation‟s Business – Split Courts  “Directors owe a duty to honestly disclose all material facts when they undertake to give out statements about the business to stockholders.” Kahn v. Roberts citing Kelly v. Bell.  “When a board is not seeking shareholder action there is no duty to inform the market accurately of material developments.” Raskin v Birmingham Steel.
Jones v. Harris Associates L.P. Facts: Plaintiffs, who owned shares in several mutual funds, contended that the fees were too high and thus violated § 36(b) of the Investment Company Act of 1940. The Act requires at least 40% of a mutual fund‟s trustees to be disinterested in the adviser…obliges the fund to reveal the financial links between its trustees and the adviser… Compensation for the adviser is controlled by a majority of the disinterested trustees. § 36(b) provides that the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services. Holding: Court found that defendant charged a lower percentage of assets to other clients, but this did not imply that it must be charging too much to the funds. The instant court reasoned that different clients called for different commitments of time. Reasoning: Section 36(b) does not say that fees must be "reasonable" in relation to a judicially created standard. It says instead that the adviser has a fiduciary duty. That is a familiar word; to use it is to summon up the law of trusts. And the rule in trust law is straightforward: A trustee owes an obligation of candor in negotiation, and honesty in performance, but may negotiate in his own interest and accept what the settlor or governance institution agrees to pay. When the trust instrument is silent about compensation, the trustee may petition a court for an award, and then the court will ask what is "reasonable"; but when the settlor or the persons charged with the trust's administration make a decision, it is conclusive. It is possible to imagine compensation so unusual that a court will infer that deceit must have occurred, or that the persons responsible for decision have abdicated, but no court would inquire whether a salary normal among similar institutions is excessive.  In the context of § 36(b), the test is essentially whether the fee schedule represents a charge within the range of what would have been negotiated at arm's-length in the light of all of the surrounding circumstances. To be guilty of a violation of § 36(b), the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's-length bargaining.

ii. Delaware‟s Duty of Honesty  The Duty of Honesty  Delaware Supreme Court held that corporate directors have a state-based fiduciary duty not to knowingly disseminate false information to shareholders. Malone v. Brincat.  Duty is triggered whether the communication involves a request for shareholder action, compliance with federal disclosure requirement, or a voluntary press release, and can be enforced by shareholders claiming individual losses or in a derivative action on behalf of the corporation.  Court created no general duty to disclose information, but simply held that whenever directors communicate they must be honest.  Honest communications ensures that shareholders can exercise their voting and transfer rights, as well as their fiduciary rights to discipline management indolence or disloyalty.  A State Fiduciary Duty and Federal Securities Law  Under the Securities Litigation Uniform Standards Act of 1998 (SLUSA), any class action alleging fraud in publicly traded securities must be brought in a federal court under federal law; state claims are preempted.  Delaware Supreme Court decided that SLUSA, passed after Malone v. Brincat had commenced, did not apply. But as to future cases, the court pointed out that the federal legislation would not prevent “duty of honesty” litigation in state court.

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SLUSA excludes from its coverage derivative suits or state-based claims of fiduciary disclosure obligations – the so-called “Delaware carve-out.”

iii. Federal Disclosure Requirements  SEC Registration  Companies must register with the SEC under the Exchange Act in two circumstances.  Exchange “Listed” Companies.  Companies whose debt or equity securities are listed on a stock exchange must register with the exchange, with copies to the SEC. Exchange Act § 12(a).  OTC Companies.  Companies whose equity securities are publicly traded on the over-the-counter markets. A company must register if it has a class of equity securities held of record by more than 500 shareholders and has total assets exceeding $10 million.  Periodic Disclosure  Registered companies become “reporting companies” and must file annual, quarterly, and special reports with the SEC.  Annual Report.  Reporting companies must file annually, within 60 to 90 days of the close of their fiscal year, an extensive disclosure document that contains much the same information as a Securities Act registration statement when a company goes public. Form 10-K.  Quarterly Report.  Reporting companies must file quarterly, within 35-45 days of the close of each company‟s first three fiscal quarters, a report that consists mostly of updated financial information. Form 10-Q.  Special Report.  Reporting companies must file a special report on specified, material developments. Form 8-K.  Significantly expanded by the SEC to post-Enron concerns, Form 8-K has moved closer to a continuous disclosure system. E. SECURITIES FRAUD i. Principles of Rule 10b-5  The Regulation  Section 10(b) of the Securities and Exchange Act of 1934 makes it unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange:  To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered…any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.  The Rule  Section 10(b) is not self-executing – it did not prohibit any conduct until the SEC adopted rules implementing it.  It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange:  (a) To employ any device, scheme, or artifice to defraud,

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 (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or  (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.  SEC Enforcement  Rule 10b-5 is a potent tool in SEC enforcement. Section 21 of the Exchange Act gives the SEC broad enforcement powers to sue in federal court to enjoin violations of its rules, including Rule 10b-5.  Using this authority, the SEC has sought injunctions and other equitable remedies.  The SEC can also recommend that the US DoJ institute a 10b-5 criminal action.  Application of Rule  The best known use of the rule has been in insider trading cases, typically those in which an officer, director, or other person who has a fiduciary relationship with a corporation buys or sells the company's securities when in the possession of material, nonpublic information. But the rule is also used in at least five other situations:  When a corporation issues misleading information to the public, or keeps silent when it has a duty to disclose;  When an insider selectively discloses material, nonpublic information to another party, who then trades securities based on the information (generally called “tipping”);  When a person mismanages a corporation in ways that are connected with the purchase or sale of securities;  When a securities firm or another person manipulates the market for a security traded in the over-the-counter market; and  When a securities firm or securities professional engages in certain other forms of conduct connected with the purchase or sale of securities. ii. Fraud Elements of Private Rule 10b-5 Actions  Supreme Court has looked to the statutory language of § 10(b) and insisted that Congress meant “fraud” when it said “any manipulative or deceptive device or contrivance.”  Plaintiff has the burden of showing:  Materiality.  Scienter.  Reliance.  Causation.  In connection with the purchase or sale.  Material Deception  Materiality.  “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote…what the standard [contemplates] is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the „total mix‟ of information made available.” TSC Industries Inc. v. Northway, Inc.  Duty to Speak.  Courts have imposed a duty to speak when defendants have a relationship of trust and confidence with the plaintiff. Chiarella v. United States.  A duty to speak also arises when a closely held corporation deals with its shareholderemployees. Jordan v. Duff & Phelps, Inc.

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 Silence is also actionable in connection with corporate activities in a limited number of circumstances: (i) when the company itself is trading its own securities, (ii) when the company fails to correct misinformation it begot and that is actively circulating in the market, or (iii) when the company knows that insiders are trading based on information not available to the public.  Duty to Update.  Most federal circuits have held that there is a duty to update when forward-looking statements still “alive” in the market have become inaccurate. But there is no duty to update periodic SEC filings, which speak only as of the date when made.  Corporate Mismanagement.  Mismanagement by corporate officials can violate Rule 10b-5 if the mismanagement involves fraudulent securities actions that can be said to injure the corporation.  Supreme Court has held that Rule 10-b5 only regulates deception, not unfair corporate transactions or breaches of fiduciary duties. Santa Fe Indus. Inc., v. Green.  “Corporations are creatures of state law, and investors commit their funds to corporate directors on the understanding that, except where federal law expressly requires certain responsibilities of directors with respect to stockholders, state law will govern the internal affairs of the corporation.”  Scienter  A plaintiff in a 10b-5 action must plead and prove the defendant‟s Scienter, a “mental state embracing intent to deceive, manipulate or defraud.”  Scienter means the defendant was aware of the true state of affairs and appreciated the propensity of his misstatement or omission to mislead.  Appeals Circuits have uniformly concluded that recklessness is sufficient to establish Scienter under Rule 10b-5, when misrepresentations were so obvious that the defendant must have been aware of them. Greebel v. FTP Software, Inc.  Allegations of fraud must be pleaded “with particularity.” Fed. R. Civ. P. 9(b).  A complaint alleging securities fraud must state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.  Supreme Court has interpreted “strong inference” to mean, “more than merely plausible or reasonable – it must be cogent and at least as compelling as any opposing inference of non-fraudulent intent. Tellabs Inc. v. Makor Issues & Rights Ltd.  Reliance  Reliance, an element of traditional common law deceit, is also elements of a private 10b-5 action – though not an SEC enforcement action.  Non Disclosure. When the defendant fails in a duty to speak – whether in a face-to-face transaction or an anonymous trading market – courts disperse with proof of reliance if the undisclosed facts were material.  Omitted Information. In cases of half-truths – omitted information that makes a statement misleading – courts are divided on whether reliance must be shown. The PSLRA, however, makes reasonable reliance an explicit condition for “knowing” securities violations and thus joint and several liability, whether the claim is based on a misrepresentation or an omission.  Fraud on the Market  In cases of false or misleading representations on a public trading market – so-called fraud on the market – courts have created a rebuttable presumption of reliance.  Theory is that those who trade on public trading markets rely on the integrity of the stock‟s market price. In an open and developed stock market, the efficient capital market hypothesis posits that market prices reflect all publically available information about a company‟s stock. On the assumption that material misinformation artificially distorts the market price, courts infer that investors have relied on the misinformation. Theory assumes that if the truth had been disclosed, investors would not have traded at the prevailing non-disclosure price.

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 A defendant can rebut the presumption of reliance and avoid the fraud on the market theory by showing either: (i) the trading market was not efficient, such as by showing that the challenged misrepresentation did not in fact affect the stock‟s price or (ii) the particular plaintiff would have traded regardless of the misrepresentation.  Causation  Causation, an element of traditional common law deceit, is also elements of a private 10b5 action – though not an SEC enforcement action.  Courts have required that 10b-5 plaintiffs show two kinds of causation to recover.  Transaction Causation.  Plaintiff must show “but for” the defendant‟s fraud, the plaintiff would not have entered the transaction or would have entered under different terms – a restated reliance requirement.  Loss Causation.  Plaintiff must show that the fraud produced the claimed losses to the plaintiff – a foreseeability or a proximate cause requirement.  Supreme Court has held that plaintiff cannot simply allege losses caused by an artificially inflated price due to fraud on the market, but must allege and rove actual economic loss proximately causes by the alleged misrepresentations.  In Connection with Purchase or Sale  The Birnbaum Doctrine.  Supreme Court held that only actual purchasers or sellers (offers not covered) may recover damages in a private 10b-5 action. This standing requirement avoids speculation about whether and how much a plaintiff might have traded. Blue Chip Stamps v. Manor Drug Stores.  Purchasers of stock options also have standing. Deutschman v. Beneficial Corp.  Damages  Exchange Act imposes only two limitations on damages.  Section 28 states that the plaintiff‟s recovery cannot exceed actual damages, implying that the goal of liability is compensation and effectively precluding punitive damages.  Section 21D(e), added by the PSLRA, caps damages according to a formula meant to disregard post-transaction volatility unrelated to any misinformation.  Damage Formulas.  Rescission. Allows the defrauded plaintiff to cancel the transaction. If plaintiff sold, he gets his stock back; if he bought, he returns the stock and the seller refunds the purchase price. Rescission is suited only to face-to-face transactions where the parties can be identified.  Rescissionary (disgorgement) Damages. If rescission is not possible because the stock has been resold, rescissionary damages replicate a cancellation of the transaction.  Cover (conversion) Damages. Cover damages, like those in a tort conversion action, assume the plaintiff mitigates his losses by selling or reinvesting. They are the difference between the price at which the plaintiff transacted and the price at which the plaintiff could have transacted once the fraud was revealed.  Out-of-Pocket Damages. Most common measure of damages in 10b-5 cases. Plaintiff recovers the difference between the purchase price and the true “value” of the stock at the time of purchase. Measure does not take into account any post-transaction price changes.  Contract Damages. Compensate the plaintiff for the loss of the benefit of the bargain. They are the difference between the value received and the value promised.  Damages Cap.  When recovery is based on the market price of the stock – as with out-of-pocket and cover damages – the PSLRA imposes a damages cap. Concerned that a “crash price” might substantially overcompensate plaintiffs‟ losses for a company with a highly

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volatile stock, Congress required that courts consider a longer 90-day window for determining the market price.  Under § 21D(e), damages are capped at the difference between the transacted price and the average of the daily prices during the 90-day period after corrective disclosure.
Basic Inc. v. Levinson Facts: Representatives of Combustion had meetings and telephone conversations with the officers of Basic, concerning the possibility of a merger. In 1977 and 1978, during the pendency of these discussions, Basic made three public statements, the first of which denied that Basic was engaged in merger "negotiations," and the later two of which said, in effect, that Basic knew of no company developments that would explain the abnormally high trading activity and price fluctuations in the company's stock. Later in 1978, however, Basic, on three succeeding days, (i) asked for a suspension of trading in its stock, (ii) endorsed an offer by Combustion for Basic‟s stock, and (iii) publicly announced the approval of the offer. Former Basic shareholders who had sold their stock, after the first public denial and before the trading suspension, filed against Basic and its directors a class action which alleged that Basic and its directors had issued three false or misleading public statements in violation of 10(b) and Rule 10b-5. Holding: Supreme Court held that that under 10(b) and Rule 10b-5, in the context of preliminary corporate merger discussions, (a) information which would otherwise be considered significant to the trading decisions of a reasonable investor is not excluded from the definition of materiality merely because an agreement-in-principle as to price and structure has not yet been reached between the wouldbe merger partners, (b) information does not become material merely by virtue of a public statement denying the information, and (c) instead, the materiality of a fact will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of company activity, so that whether merger discussions in any particular case are material depends on the facts; (3) in a private civil action under 10(b) and Rule 10b-5, it is appropriate to apply a presumption – supported by fraud-on-the-market theory – of reliance by the plaintiff investors on allegedly material misrepresentations made by the defendants; and (4) such a presumption of reliance is rebuttable. Reasoning: Whether merger discussions in any particular case are material therefore depends on the facts. Generally, in order to assess the probability that the event will occur, a fact finder will need to look to indicia of interest in the transaction at the highest corporate levels. Without attempting to catalog all such possible factors, by way of example board resolutions, instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest. To assess the magnitude of the transaction to the issuer of the securities allegedly manipulated, a fact finder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.  In a private civil action under the antifraud provisions of 10(b) of the Exchange and Rule 10b-5 it is appropriate to apply a presumption – supported by fraud-on-the-market theory – of reliance by the plaintiff investors on allegedly material misrepresentations made by the defendants, because (1) although reliance – which provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury – is an element of a Rule 10b-5 cause of action, there is more than one way to demonstrate the causal connection; (2) the modern securities markets, involving millions of shares changing hands daily, differ from the face-to-face transactions contemplated by early fraud cases, and an understanding of Rule 10b-5's reliance requirement must encompass those differences; (3) requiring a plaintiff to show a speculative state of facts – how the plaintiff would have acted if admitted material information had been disclosed or if the misrepresentation had not been made – would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market; (5) such a presumption of reliance is consistent with, and, by facilitating Rule 10b-5 litigation, supports the congressional policy embodied in the Act – a policy, based on the premise that securities markets are affected by information, of facilitating an investor's reliance on the integrity of those markets; and (6) the presumption is also supported by common sense and probability, for an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. West v. Prudential Securities, Inc Facts: Plaintiffs investors sued defendant Prudential Securities alleging a securities-fraud action and sought a class certification under the fraud-on-the-market doctrine. Investors alleged that their stockbroker who worked for the company told the investors that a certain bank was going to be acquired at a big premium. This statement was a lie. Investors traded on this information, which they thought was confidential. In their lawsuit, the investors sought class certification for everyone who bought the bank's stock during the months when the stockbroker was making his false statements.

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Holding: The Seventh Circuit held that the fraud-on-the-market doctrine did not apply because the information was not made available to the public. The investors failed to identify any causal link between the non-public information and securities prices. Thus the record did not support the extension of the fraud-on-the-market doctrine to the alleged non-public statements. Reasoning: The theme of Basic and other fraud-on-the-market decisions is that public information reaches professional investors, whose evaluations of that information and trades quickly influence securities prices. But the defendant did not release information to the public, and his clients thought that they were receiving and acting on non-public information; its value (if any) lay precisely in the fact that other traders did not know the news. In an efficient market, how could one ignorant outsider's lie cause a long-term rise in price? Professional investors would notice the inexplicable rise and either investigate for themselves (discovering the truth) or sell short immediately, driving the price back down. In an efficient market, a lie told by someone with nothing to back up the statement (no professional would have thought the defendant a person "in the know") will self-destruct long before eight months have passed. Deutschman v. Beneficial Corp. Facts: Plaintiff stock purchaser brought suit against defendants, corporation, chairman and chief executive officer, and chief financial officer based on violations of the Exchange Act. District court held that the purchaser of a call option lacked standing to sue under the Exchange Act and was not an appropriate class representative for purchasers of defendants' stock. Stockholder appealed. Holding: The court held that plaintiff's complaint appeared to satisfy every requirement of a § 10(b) of the Exchange Act damage action which dealt with affirmative misrepresentations which affected the market price of a security. The court was not willing to construe § 10(b) as inapplicable to option contracts on the basis of speculation about the relationship between option contracts, market liquidity, and capital formation. The court held that plaintiff had standing as a purchaser of an option contract to seek damages under § 10(b) for the affirmative misrepresentation defendants allegedly made. Reasoning: Because the market value of an option contract is responsive to changes in the market price of the underlying stock, holders of option contracts are susceptible to deceptive practices. Insiders or others who do not trade in either market can injure option holders by misstating material facts to the public, thereby causing a distortion in the market price of the underlying security, and in the necessarily related market price of the option contract.

F.

INSIDE INFORMATION i. Principles of Insider Trading  Theories for Regulating Insider Trading.  Fairness.  Insider trading is unfair to those who trade without access to the same information available to insiders and others in the know – a fairness rationale.  Legislative history of the Exchange Act is replete with congressional concern about abuses in trading by insiders.  Fairness notion, however, has not been generally accepted by state corporate law.  Market Integrity.  Both insider and outsider trading undermine the integrity of stock trading markets, making investors leery of putting their money into a market in which they can be exploited.  Many professional participants in the securities markets already trade on superior information; the efficient capital market hypothesis posits that stock prices will reflect informed trading.  Cost of Capital.  Insider trading leads investors to discount the stock prices of companies (individually or generally) when insider trading is permitted, thus making it more expensive for companies to raise capital.  Property Rights.  Both insider and outsider trading exploit confidential information of great value to its holder. Those who trade on such information reap profits without paying for it and undermine incentives to engage in commercial activities that depend on confidentiality.

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 Policing Insider Trading  Stock exchanges have elaborate, much-used surveillance systems to alert officials if trading in a company‟s stock moves outside of preset ranges. When unusual trading patterns show up or trading occurs before major corporate announcements, exchange officials can ask brokerage firms to turn over records of who traded at any given time.  Exchanges conduct computer cross-checks to spot “clusters” of trading – such as from a particular city or a particular brokerage firm.  An Automated Search and Match system, with data on thousands of companies and executives on such things as social affiliations and even college ties, assists the exchanges in their examination. ii. State Law on Insider Trading  Fraud or Deceit – Limited Tort Liability  The traditional law of deceit applies when:  Insider affirmatively misrepresents a material fact or omits a material fact that makes his statement misleading → there a duty to speak only in a relationship of trust and confidence.  Insider knows the statement is false or misleading or, under evolving notions, recklessly disregards its truthfulness.  Other party actually and justifiably relies on the statement  Other party is harmed as a result.  Absent a duty to speak, the insider can avoid tort liability by remaining silent.  State Fiduciary Rules – Special Facts Doctrine  Imposes a duty on insiders not to trade with corporate shareholders in face-to-face transactions while in the possession of highly material, nonpublic corporate information.  Neither affirmative misrepresentations nor actual reliance need be established.  The special facts doctrine is limited:  Insider (an officer/director) purchased from an existing shareholder – sales by insiders to non-shareholder investors in the case of “bad news” are not covered.  Insider was in privity with the selling shareholder – there must be a face-to-face transaction or something approximating it, i.e., such as an insider using an agent to hide the insider‟s identity.  Insider knew of highly material corporate information.  Secrecy was critically important to the sale – it must be clear that the shareholder would not have traded had he known the information.  State Fiduciary Rules – Strict (Kansas) Rule  Minority rule.  Directors who have information by virtue of their position with the company hold it in trust for shareholders. As a result, directors have a duty to disclose all material information to shareholders before trading with them.  State Fiduciary Rules – No Duty to Disclose  Majority rule.  Insiders have a fiduciary duty to the corporation, not to individual shareholders.  State Fiduciary Rules – The New York Approach  In an attempt to overcome gaps in the common law, the Court of Appeals held more than 30 years ago that insider trading creates liability to the corporation, which liability can be enforced in a derivative suit. Diamond v. Oreamuno.  To the objection that a corporation has not been harmed, the Court had two responses:  (i) It held that no harm need be shown. As between insiders and the corporation – just as when an agent receives confidential information on behalf of his principal –

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the corporation has “a higher claim to the proceeds derived from the exploitation of the information.”  (ii) The court inferred that the insider trading might have damaged the corporation‟s reputation and thus the marketability of its stock – though this need not be proven.  Court of Appeals approach has not fared well outside of New York.
Goodwin v. Agassiz Facts: Mining company stockholder filed suit for losses suffered in selling stock shares to the defendants who were directors of the corporation, alleging that defendants' purchase of stocks without first disclosing to him the existence and positive results of the geological survey created a breach of their fiduciary duties. Holding: Court held that no fiduciary relationship was created between them in regards to the stock sale and there existed no circumstances requiring the court to set aside the transfer of stock. Court held that silence on the part of the director buyer usually does not amount to a breach of duty and that here, although defendants knew the survey results, the report was not conclusive, and thus defendants were not obligated to inform the shareholders of survey results. Reasoning: The fact that a defendant is a director of a corporation does not create a fiduciary relation between him and a stockholder in the matter of the sale of his stock. Where a director personally seeks a stockholder for the purpose of buying his shares without making disclosure of material facts within his peculiar knowledge and not within reach of the stockholder, the transaction will be closely scrutinized and relief may be granted in appropriate instances. The applicable legal principles are almost always the fundamental ethical rules of right and wrong.  An honest director would be in a difficult situation if he could neither buy nor sell on the stock exchange shares of stock in his corporation without first seeking out the other actual ultimate party to the transaction and disclosing to him everything which a court or jury might later find that he then knew affecting the real or speculative value of such shares. Business of that nature is a matter to be governed by practical rules.  Fiduciary obligations of directors ought not to be made so onerous that men of experience and ability will be deterred from accepting such office. Law in its sanctions is not coextensive with morality. It cannot undertake to put all parties to every contract on an equality as to knowledge, experience, skill and shrewdness. It cannot undertake to relieve against hard bargains made between competent parties without fraud. On the other hand, directors cannot rightly be allowed to indulge with impunity in practices that do violence to prevailing standards of upright businessmen.

iii. Classic Insider Trading Rules – Application of Rule 10b-5  Federal Duty to “Abstain or Disclose”  Early federal courts held that anyone “in possession of material inside information” must either abstain from trading or disclose to the investing public. SEC v. Texas Gulf Sulphur.  The SEC based this disclose-or-abstain rule on two factors:  (i) “[T]he existence of a relationship giving access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone”; and  (ii) “[T]he inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing.”  Thus, the SEC's theory of liability took one of two basic forms:  Equality of access to information – The SEC contended that those persons, such as insiders, who acquired nonpublic information as a result of privileged positions that gave them special access to material nonpublic information, should not be allowed to profit from such information.  Equality of information – Under this broader theory, a defendant could be liable for insider trading if he or she traded on the basis of information which he or she knew or had reason to know was nonpublic, regardless of the source of that information or how it was acquired.  Federal Duty of Confidentiality  Supreme Court provided a framework for the duty to abstain or disclose in the 1980s.  Reading Rule 10b-5 as an antifraud rule, the Court has held that any person in the possession of material, nonpublic information has a duty to disclose the information, or

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abstain from trading, if the person obtains the information in a relationship of trust and confidence – a fiduciary relationship.  Court anchors federal regulation of classic insider trading on a presumed fiduciary duty of corporate insiders to the corporation‟s shareholders – even though state corporate law has largely refused to infer such a duty in impersonal trading markets.  Satisfying the Disclosure Duty  As a practical matter, the abstain-or-disclose duty is really a prohibition against trading, since any disclosure must be effective in eliminating any informational advantage to the person who has material, nonpublic information – thus eliminating any incentive to trade.  Chiarella v. United States  One who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so, and the duty to disclose arises when one party has information that the other party is entitled to know because of a fiduciary or similar relation of trust and confidence between them.  Court rejected both the equality of information theory and the equality of access theory used in the lower federal courts.  Court's rather quotable admonition that “Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud.”  Court took pains to note that Rule 10b-5 “liability” is “premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction.”  Dirks v. Securities and Exchange Commission  The duty to disclose can only arise from a fiduciary relationship between the parties and not merely from unfair access to information.  Court held that the duty to disclose can only arise from a fiduciary relationship between the parties and not merely from unfair access to information.  Court introduced the concept of constructive insiders in the footnote 14, which set out the following rule:  “Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders . . . [when] they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes.”  Tippee Liability (from Dirks v. Securities and Exchange Commission)  A duty to disclose arises from the relationship between parties and not merely from one's ability to acquire information because of his position in the market.  Unlike insiders who have independent fiduciary duties to both the corporation and its shareholders, the typical tippee has no such relationships. There must be a breach of the insider's fiduciary duty before the tippee inherits the duty to disclose or abstain.  A tippee, however, is not always free to trade on inside information.  His duty to disclose or abstain is derivative from that of the insider's duty. Tippees must assume an insider's duty to the shareholders not because they receive inside information, but rather because it has been made available to them improperly.  Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.  In determining whether a tippee is under an obligation to disclose or abstain, it is necessary to determine whether the insider's "tip" constituted a breach of the insider's fiduciary duty. Whether disclosure is a breach of duty depends in large part on the personal benefit the insider receives as a result of the disclosure. Absent an improper

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purpose, there is no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.  Sub-tippees tipped by a tippee assume a duty not to trade, if they know (or should know) the information came from a breach of duty.  Strangers‟ Liability  A stranger with no relationship (of trust or reciprocity) to the source of the material, nonpublic information – whether from an insider or an outsider – has no 10b-5 duty to abstain or disclose, i.e., strangers who overhear nonpublic information.  SEC v. Switzer (holding that eavesdropper was not liable for trading after overhearing the chief-executive officer tell his wife that the company might be liquidated).  SEC Regulation FD  In 2000, the Commission concluded that selective disclosure to analysts undermined public confidence in the integrity of the stock markets.  Regulation FD provides:  If someone acting on behalf of a public corporation discloses material nonpublic information to securities market professionals or “holders of the issuer‟s securities who may well trade on the basis of the information,” the issue must also disclose that information to the public.  Where the disclosure is intentional, the issuer must simultaneously disclosure the information in a manner designed to convey broad non-exclusionary distribution to the general public (i.e., corporate website).  Where the disclosure is unintentional, as where a corporate officer “let something slip,” the issuer must make a public disclosure “promptly” after a senior officer learns of the disclosure.  The “equal access” rules of Regulation FD have some exclusions (Rule 100(b)):  Disclosure occurring in the normal course of business, such as to professional advisors (attorneys, investment bankers or accountants), business partners in contract negotiations, or credit-rating agencies.  Disclosure to media or government officials, such as by responding to newspaper inquiries or complying with regulatory investigations.  Disclosures made in securities offerings registered under the Securities Act, such as to analysts and institutional investors in going-public road shows.  Disclosure by foreign private issuers (which, if they meet the jurisdictional requirements, remain subject to the securities antifraud provisions).
Securities and Exchange Commission v. Texas Gulf Sulphur Co. Facts: Defendant employees of defendant mining company discovered large deposit of ores. Some defendants purchased stock in the company. The company released an ambiguous statement about drilling, and then released a detailed statement a few days later, after which the price of the company's stock increased substantially. District court found some employees guilty of violating securities laws, but dismissed claims as to others and the company. Holding: The Second Circuit found many defendants violated the law because the fact that the company forbade disclosure did not justify insider trading, and such information constituted material facts as it might have affected the price of the stock. Good faith was no defense, as the law only required negligent conduct. The company's ambiguous statement may have violated the law because its makers did not have to make related security transaction, only a misleading statement that might have made reasonable investors rely on it. Reasoning: An insider's duty to disclose information or his duty to abstain from dealing in his company's securities arises only in those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security if the extraordinary situation is disclosed. The effective protection of the public from insider exploitation of advance notice of material information requires that the time that an insider places an order, rather than the time of its ultimate execution, be determinative for 10b-5 purposes. Otherwise, insiders would be able to "beat the news," by requesting in advance that their orders be executed immediately after the dissemination of a major news release but before outsiders could act on the release.  Before insiders may act upon material information, such information must have been effectively disclosed in a manner sufficient to insure its availability to the investing public. Particularly here, where a formal announcement to the entire financial news media had been promised in a prior

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official release known to the media, all insider activity must await dissemination of the promised official announcement.  The reading of a news release is merely the first step in the process of dissemination required for compliance with the regulatory objective of providing all investors with an equal opportunity to make informed investment judgments. Assuming that the contents of the official release could instantaneously be acted upon, at the minimum [the insider] should have waited until the news could reasonably have been expected to appear over the media of widest circulation, the Dow Jones broad tape, rather than hastening to insure an advantage to himself. Chiarella v. United States Facts: Chiarella, a worker at a financial printer, deciphered the identity of five public companies that were to be takeover targets from confidential financial documents entrusted to his employer for printing. As a result, Chiarella entered into 17 pre-announcement stock transactions, and made a profit of approximately $30,000. Chiarella did not induce any trades, did not make any affirmative statements, false or otherwise, and did not have any contact with target companies' shareholders. Chiarella was convicted for violating § 10(b) and Rule 10b-5. Holding: Supreme Court overturned his conviction. Reasoning: The obligation to disclose or abstain derives from an affirmative duty to disclose material information, which has been traditionally imposed on corporate "insiders," particularly officers, directors, or controlling stockholders. Insiders must disclose material facts which are known to them by virtue of their position but which are not known to persons with whom they deal and which, if known, would affect their investment judgment. One who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so.  Silence in connection with the purchase or sale of securities may operate as a fraud actionable under § 10(b) of the Exchange Act despite the absence of statutory language or legislative history specifically addressing the legality of nondisclosure. But such liability is premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction. Application of a duty to disclose prior to trading guarantees that corporate insiders, who have an obligation to place the shareholder's welfare before their own, will not benefit personally through fraudulent use of material, nonpublic information. Dirks v. Securities and Exchange Commission Facts: Dirks was a registered broker-dealer who learned from a former employee of an insurance corporation that the corporation's success was in part due to fraud. Dirks was able to corroborate these allegations, but was unable to convince either the SEC to investigate the fraud or the Wall Street Journal to publish a story about it. Dirks then informed his clients of his information about the fraud and their sales of Equity Funding stock caused the stock price to fall precipitously. After a hearing concerning Dirk‟s role in the exposure of the fraud, the SEC found that he had aided and abetted violations of the antifraud provisions of the federal securities laws, including § 10(b) of Exchange Act and Rule 10b-5, by repeating the allegations of fraud to members of the investment community who later sold their stock in the insurance company. Holding: Court held that held that Dirks did not violate the antifraud provisions of the federal securities laws, since Dirks had no pre-existing fiduciary duty to the corporation's shareholders, took no action inducing the shareholders to repose trust in him, and did not misappropriate or illegally obtain the information, and the insiders did not violate their fiduciary duty to the shareholders by providing the information so as to create a derivative fiduciary duty on the part of Dirks, the insiders having received no monetary or personal benefit for revealing the information, only being motivated by a desire to expose fraud. Reasoning: Thus the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.  A duty to disclose under § 10(b) before trading securities of material nonpublic information does not arise from the mere possession of nonpublic information, but rather arises from the existence of a fiduciary relationship.  When a corporate outsider becomes a fiduciary of the corporation's shareholders by entering into a special confidential relationship with the enterprise and by being given access to information solely for corporate purposes, and then breaches his fiduciary relationship, he may be treated more properly as an insider providing the nonpublic information rather than as the outsider who receives the information and trades securities on inside information.  Not only are insiders of a corporation forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain, and the transactions of those who knowingly participate with the fiduciary in such a breach are as forbidden as transactions on behalf of the trustee himself, the tippee's duty to disclose the

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information before trading securities or to refrain from trading the securities being derivative from that of the insider's duty.

iv. Misappropriation Theory (Outside) Trading Rules – Application of Rule 10b-5  The theory holds that a person commits fraud “in connection with” a securities transaction, and thereby violates § 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.  Under this theory, a fiduciary‟s undisclosed, self-serving use of a principal‟s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information.  In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company‟s stock, the misappropriation theory premises liability on a fiduciary-turned-security trader‟s deception of those who entrusted him with access to confidential information.  To satisfy the requirement that there be no deception, there need be only disclosure, where full disclosure forecloses a fiduciary's liability under the misappropriation theory, because, if the fiduciary discloses to the source of confidential information that the fiduciary plans to trade on the information, then there is no deceptive device.  Doctrinal Rifts in 10b-5 Jurisprudence  O‟Hagan suggests that there can be no 10b-5 insider trading liability if there is no breach of trust or confidence → seemingly allowing individuals who gain access to material, nonpublic information by other wrongful means to avoid 10b-5 sanctions.  Fiduciary who discloses his trading intentions or receives permission to trade from the source would seemingly also escape 10b-5 liability since there would be no breach.  O‟Hagan also left largely unanswered the question of who has duties of trust or confidence and when a duty of confidentiality attaches.  United States v. Chestman  The Second Circuit held, “the misappropriation theory considers not only whether there exists a fiduciary relationship but also whether there exists a similar relationship of trust and confidence. As the term „similar‟ implies, a relationship of trust and confidence must share the essential characteristics of a fiduciary association. Entrusting confidential information to another does not, without more, create the necessary relationship and its correlative duty to maintain the confidence. A similar relationship of trust and confidence, therefore, must be the functional equivalent of a fiduciary relationship.”  In the absence of participation in confidential business discussions, a familial relationship standing alone will not create a fiduciary relationship.  SEC Rule 10b5-2(b)  In 2000, the SEC addressed the Chestman problem by adopting Rule 10b5-2, which provides a non-exclusive list of three situations in which a person has a duty of trust or confidence for the purposes of the misappropriation theory. Such a duty exists:  Whenever someone agrees to maintain information in confidence.  Between two people who have a pattern or practice of sharing confidences such that the recipient of the information knows or reasonably should know that the speaker expects the recipient to maintain the information‟s confidentiality.  When someone receives or obtains material nonpublic information from a spouse, parent, child, or sibling.  Rule 14e-3  The SEC has used the misappropriation theory to adopt rules prohibiting trading based on material, nonpublic information about unannounced tender offers. Rule 14e-3.  The rule prohibits, during the course of a tender offer, trading by anybody (other than the bidder) who has material, nonpublic information about the offer that he knows (or has reason to know) was obtained from either the bidder or the target.

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 There is no need under Rule 14e-3 to prove that a tipper breached a fiduciary duty for personal benefit.
United States v. O‟Hagan Facts: When a law firm began representing a client regarding the client's confidential tender offer for a company's common stock, a firm partner, who did no work on the offer, purchased company stock and stock options that the partner sold at a profit of more than $ 4.3 million after the client publicly announced the tender offer and the stock price per share rose substantially. The partner, who was charged with defrauding the firm and the client by using for the partner's trading purposes material nonpublic information regarding the tender offer, was convicted on numerous counts including § 10(b) and Rule 10b-5. Holding: Court held that the law firm partner may properly be made the subject of a criminal charge for breaching a duty owed to the firm and its client by trading on the basis of nonpublic information regarding the client's planned tender offer for a company's common stock, under the misappropriation theory of securities fraud because misappropriation, as so defined, is consistent with the Supreme Court's precedent and satisfies § 10(b)'s requirement of deceptive conduct in connection with a securities transaction, as (1) the partner did not disclose all pertinent facts; (2) a fiduciary's fraud is consummated when, without disclosure to the principal, the fiduciary uses the information to purchase or sell securities, even though the entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information; (3) § 10(b)'s language does not require deception of an identifiable purchaser or seller; (4) the misappropriation theory is well-tuned to the Exchange Act's animating purpose of insuring honest securities markets and thereby promoting investor confidence; and (5) Congress has provided two sturdy safeguards regarding scienter in the Exchange Act, which provides, with respect to Rule 10b-5, that (a) a criminal violation of the rule must be willful, and (b) a defendant may not be imprisoned for violating the rule without knowledge of the rule. Reasoning: A fiduciary that pretends loyalty to the principal while secretly converting the principal's information for personal gain, dupes or defrauds the principal. A company's confidential information qualifies as property to which the company has a right of exclusive use. The undisclosed misappropriation of such information, in violation of a fiduciary duty, constitutes fraud akin to embezzlement--the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another.  When the person misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information – the partner's securities trading does not escape Exchange Act sanction if the partner was associated with, and gained nonpublic information from, the bidder, rather than the target.

v. Remedies for Insider Trading  Civil Liability to Contemporaneous Traders  The Insider Trading and Securities Fraud Enforcement Act of 1988 limits recovery to traders (shareholders or investors) whose trades were contemporaneous with the insider‟s.  Recovery is based on the disgorgement of the insider‟s actual profits realized or losses avoided, reduced by any disgorgement obtained by the SEC under its broad authority to seek injunctive relief.  Civil Recovery by “Defrauded” Source of Confidential Information  A defrauded company may recover if it suffered trading losses or was forced to pay a higher price in a transaction because the insiders‟ trading artificially raised the stock price.  Although some have proposed corporate recovery on behalf of shareholders, courts have insisted on a corporate injury for there to be a corporate recovery.  SEC Enforcement Actions  Commission can bring a judicial enforcement action seeking a court order that enjoins the inside trader or tippee from further insider trading and that compels the disgorgement of any trading profits.  Civil Penalties.  Commission can seek a judicially imposed civil penalty against those who violated Rule 10b-5 or Rule 14e-3 of up to three times (treble) the profits realized (or losses avoided) by their insider trading.  Watchdog Penalties.

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 Commission can seek civil penalties against employers and others who “control” insider traders and tippers. Controlling persons are subject to additional penalties of up to $1 million or three times the insider‟s profits – whichever is greater.  Bounty Rewards.  Commission can pay bounties to anyone who provides information leading to civil penalties. The bounty can be up to 10 percent of the civil penalty collected.  Criminal Sanctions  To punish those who engage in “willful” insider trading, the Commission can (and often does) refer cases to the US DoJ for criminal prosecution.  Congress has twice increased criminal penalties for violations of Exchange Act and Rules.  In the ITSFEA, the maximum criminal fines increased from $100,000 to $1,000,000 ($2,500,000 for non-individuals) and jail sentences from five years to ten years.  In the Sarbanes-Oxley Act, the maximum fines were again increased to $5,000,000 ($25,000,000 for non-individuals) and jail sentences to twenty years. Problems of Corporate Control A. MANAGEMENT AND CONTROL i. The Board of Directors  Board Corporate Powers  The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. Del. § 141(a).  A majority of the total number of directors shall constitute a quorum for the transaction of business unless the certificate or bylaws require a greater number.  Unless certificate provides otherwise, the bylaws may provide that a number less than a majority shall constitute a quorum, which in no case shall be less than 1/3 of the total number of directors. Del. § 141(b).  The vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of a greater number.  Director Resignation  Each director shall hold office until such director's successor is elected and qualified or until such director's earlier resignation or removal. Del. § 141(b).  Any director may resign at any time upon notice given in writing or by electronic transmission to the corporation.  A resignation is effective when the resignation is delivered unless the resignation specifies a later effective date or an effective date determined upon happening of an event(s).  A resignation which is conditioned upon the director failing to receive a specified vote for reelection as a director may provide that it is irrevocable.  Delegation of Power  Board of directors may designate one or more committees, each committee to consist of one or more of the directors of the corporation. Del. § 141(c)(2).  Any such committee, to extent provided in the resolution of the board of directors, or in the bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation.  No such committee shall have the power or authority in reference to: (i) approving or adopting, or recommending to the stockholders, any action or matter (other than the election or removal of directors) expressly required by the Delaware statute to be

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submitted to stockholders for approval or (ii) adopting, amending or repealing any bylaw of the corporation. Del. § 141(c)(2).  Unless otherwise provided in the certificate of incorporation, the bylaws or the resolution of the board of directors designating the committee, a committee may create one or more subcommittees, each subcommittee to consist of one or more members of the committee, and delegate to a subcommittee any or all of the powers and authority of the committee.  Classified Board  The directors of any corporation organized under this chapter may, by the certificate of incorporation or by an initial bylaw, or by a bylaw adopted by a vote of the stockholders, be divided into 1, 2 or 3 classes. Del. § 141(d).  The term of office of those of the first class to expire at the first annual meeting held after such classification becomes effective; of the second class 1 year thereafter; of the third class 2 years thereafter; and at each annual election held after such classification becomes effective, directors shall be chosen for a full term, as the case may be, to succeed those whose terms expire.  Good Faith Reliance  A member of the board of directors, or a member of any committee designated by the board, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to corporation by any of corporation's officers or employees, or committees of board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation. Del. § 141(e).  Appointment/Removal of Officers and Agents  Every corporation created under the Delaware statute shall have power to:  Appoint such officers and agents as the business of the corporation requires and to pay or otherwise provide for them suitable compensation. Del. § 122(5).  The board has a very low threshold standard to overcome → the business judgment rule. ii. Internal Fundamental Changes  Charter Amendments  Power to Amend Charter.  Corporate statute permits amendment of the certificate of incorporation so long as the new provision, amendment, or deletion could have been part of the certificate as originally adopted. Del. § 242(a).  Mechanics of Approving Charter Amendments.  Delaware requires the board to propose any amendment to the certificate – shareholders cannot initiate the amendment. Del. §242(b)(1).  Shareholder approval by a majority of all outstanding shares is required.  Dissolution  Process of Approval.  Dissolution, like a charter amendment, is subject to majority rule.  Voluntary dissolution is subject to only two levels of protection: (i) approval by the board and (ii) approval by shareholders. Del. § 275.  Winding Up.  Corporate law protects creditors in dissolution – the corporation must pay all known claims. Delaware further provides that unknown claims (such as contingent tort claims) may be brought against the dissolved corporation for a period of three years after the dissolution. Del. § 278.

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B. SHAREHOLDER RIGHTS i. Shareholders‟ Governance Role  It is said, metaphorically, that shareholders “own” the corporation, but they are not given much power under the traditional corporate model. Shareholders cannot:  Act on the ordinary business and affairs of the corporation.  Bind the corporation contractually.  Select and remove officers – even for cause.  Fix employees‟ compensation.  Have the corporation pay dividends.  Compel or overturn particular board decisions, unless the board failed to comply with the corporate statute or the corporation‟s charter documents or unless the directors breached their fiduciary duties.  Approval of Board-Initiated Transactions  Fundamental Corporate Changes.  Shareholders must vote on fundamental corporate changes initiated by board of directors, including amendments to articles of incorporation (Del. § 242(b)(1)), mergers with other corporations (Del. § 251(a)), sales of substantially all of corporate assets not in regular course of business (Del. § 271(a)), and voluntary dissolutions (Del. § 275(a)).  Delaware statute does not create appraisal rights in the case of charter amendments. Del. § 262(a).  Conflicting Interest Transactions.  Shareholders can vote on transactions with the corporation in which directors have a conflict of interest. Del. § 144(a)(2).  Shareholders can also vote to approve the indemnification of directors, officers, or others against whom claims have been brought because of their relationship to the corporation. Del. § 145(a).  Shareholder-Initiated Changes  Shareholders can initiate on their own changes in corporate governance and structure.  Amendment of Bylaws.  Shareholders have the power to adopt, amend, and repeal bylaws. Del. § 109.  Even if the board shares the power to amend the bylaws (if in the articles), the board‟s power is coterminous with the shareholders – board power does not divest or limit the power of shareholders. Del. § 109(a).  Nonbinding Recommendations.  Shareholders can make nonbinding, precatory recommendations about governance structures and the management of the corporation, including matters entrusted exclusively to the board of directors. ii. Shareholders‟ Inspection Rights  Informational Rights  Inspection of Corporate Books and Records.  Corporate statutes codify shareholders‟ common law rights to inspect corporate books and records. Del. § 220. Most statutes extend inspection rights to beneficial owners, not just record shareholders. Del. § 220(a)(2).  Delaware‟s statute makes shareholder lists available as of right 10 days before a shareholders‟ meeting. Del. § 219(a).  Books and records (a broad category under Delaware law) and a shareholders‟ list more than 10 days before a shareholders‟ meeting are available for inspection upon a showing of a “proper purpose.” Del. § 220(b).  Proper Purpose for Inspection.

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 Courts have found a proper purpose if the shareholder‟s request for records relates to the shareholder‟s interest in his investment – such as to investigate corporate wrongdoing, to bring a shareholder lawsuit, or to initiate a takeover or proxy contest. But management need not provide records to a shareholder planning to give them to competitors or seeking to advance a political agenda unrelated to his investment.  Right to Inspect as a Tool for Shareholder Litigation.  Shareholders have tools at hand to develop necessary facts for pleading purposes in shareholder derivative suits. Brehm v. Eisner.  Inspection is all the more important since discovery is not available in defending a motion to dismiss on the grounds of demand futility in Delaware derivative litigation or failure to allege particular facts creating a strong inference of Scienter in a federal securities fraud class action.  In Delaware, a requesting shareholder must identify specific, already-existing documents and show how they are “essential” to the articulated purpose for those documents. Saito v. McKesson HBOC, Inc.  A shareholder seeking to investigate corporate wrongdoing must present evidence establishing a “credible basis” of possible wrongdoing; a mere suspicion is not enough. Seinfeld v. Verizon Communications, Inc.  Shareholder Lists  CEDE List.  A CEDE list identifies the brokerage firms and other record owners who bought shares in a street name for their customers and who have placed those shares in the custody of depository firms such as Depository Trust Co. – these shares are reflected in the corporation‟s records only under the names of the nominees used by such depository firms. Depository Trust Co. uses “Cede & Co.” as the name of the nominee for shares it holds for brokerage firms and such lists, regardless of the nominee names adopted by other depository firms, are known as CEDE lists.  NOBO List.  A NOBO (non-objecting beneficial owners) list contains the names of those owning beneficial interests in shares of a corporation who have given consent to the disclosure of their identities.  The SEC requires brokers and other record holders of stock in street name to compile a NOBO list at a corporation‟s request.  Enforcement of Shareholder Rights  Shareholders can enforce their voting powers and informational rights in direct actions against the corporation or directors.  In some situations, state corporate statutes specify expedited judicial review and summary orders.  Expedited review of shareholder application for inspection of board records, accounting information, and shareholder lists. Del. § 220(c).  Summary order for failure to hold annual or special meeting. Del. § 211(c).
Crane Co. v. Anaconda Facts: Crane had publicly announced offer to exchange up to 100 million dollars in subordinated debentures for as many as 5 million shares of Anaconda. Anaconda sent letters to shareholders asserting that the exchange offer was not in the best interests of the company. Crane sought to inspect the list of the company's stockholder and send them information regarding the proposed offer. At the time, Crane owned 11% of Anaconda and included in its request an affidavit stating that the inspection was “not desired for a purpose that is in the interest of a business or object other than the business of Anaconda.” After the company refused, the purchasers filed an action against the company seeking compliance with the Bus. Corp. Law. Appellate Division concluded that the purpose was proper being one of general interest to Anaconda‟s shareholders by virtue of their common interest in the corporation as shareholders. Holding: The Court of Appeals affirmed. Court stated that the issue was whether a qualified stockholder may inspect the corporation's stock register to ascertain the identity of fellow stockholders for the

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avowed purpose of informing them directly of its exchange offer and soliciting tenders of stock. Court held that the questioned should be answered in the affirmative. Reasoning: A shareholder desiring to discuss relevant aspects of a tender offer should be granted access to the shareholder list unless it is sought for a purpose inimical to the corporation or its stockholders – and the manner of communication selected should be within the judgment of the shareholder.  Although everything affecting the shareholders will not affect the corporation, the converse is not true. Whenever the corporation faces a situation having potential substantial effect on its well-being or value, the shareholders qua shareholders are necessarily affected and the business of the corporation is involved within the purview of N.Y. Bus. Corp. Law § 1315. This statute should be liberally construed in favor of the stockholder whose welfare as a stockholder or the corporation's welfare may be affected. A "proper purpose" of the demand should be determined in the light of the shareholders' interest.  The dispositive inquiry is whether the recalcitrant corporation can prove that inspection of corporate records is sought for a purpose, which is contrary to the best interests of the corporation or its stockholders. State ex rel. Pillsbury v. Honeywell, Inc. Facts: Petitioner was opposed to Honeywell‟s participation in Vietnam War effort and eventually bought one share of Honeywell‟s stock for purpose of voicing his concerns to Honeywell's shareholders. Petitioner sought shareholder ledgers in order to find the identity of shareholders so he could speak to them about Honeywell's participation in the war. Trial court denied petitioner's writ of mandamus to compel Honeywell to produce its shareholder ledgers and all corporate records. Holding: Court affirmed and held respondent's purpose was improper to obtain an inspection of respondent's records. Law required petitioner to have proper purpose in seeking inspection of corporate records. Mere desire to communicate with other shareholders was not proper because it gave an almost absolute right to compel inspection. Furthermore, petitioner's status as a stockholder was shaky. He had only one definitive share, purchased for the purpose of the present suit. Reasoning: A stockholder who bought shares in a corporation for the sole purpose of bringing a suit to compel production of corporate books and records, who is motivated by preexisting social and political beliefs, and who has no concern for the economic well-being of the corporation, does not have a proper purpose germane to his interest as a shareholder and, therefore, cannot compel production of a corporation's shareholder lists or business records.  Because the power to inspect may be the power to destroy, it is important that only those with a bona fide interest in the corporation enjoy that power.  Where it is shown that such stockholding is only colorable, or solely for the purpose of maintaining proceedings of this kind, [the court] fails to see how the petitioner can be said to be a person interested, entitled as of right to inspect. Sadler v. NCR Corporation Facts: Plaintiffs, New York residents, sued under New York law to compel NCR, which did business in New York, to provide a list of record stockholders and to compile and produce a list of non-objecting beneficial owners. NCR's state of incorporation, Maryland, did not allow plaintiffs to obtain the lists. AT&T had been trying to begin a tender offer to NCR‟s shareholders and/or have the board redeem the corporation‟s poison pill. AT&T used the Sadlers, who had been stockholders of NCR for longer than six months to pursue the action against NCR. Holding: The Second Circuit held that N.Y. Bus. Corp. Law § 1315 authorized production of the shareholder and NOBO lists; plaintiffs were qualified persons under the statute to obtain the lists, even though they named another as their agent for purposes of inspecting the records; and that N.Y. Bus. Corp. Law § 1315 compelled defendant to compile and produce a NOBO list when the plaintiffs requested one. Reasoning: States have traditionally exercised authority to require disclosure of stockholder lists of foreign corporations doing business within their borders. Moreover, such authority will not normally create the sort of irreconcilable conflict that would arise if a state purported to regulate voting rights or other aspects of the internal affairs of a foreign corporation that admit only of one uniform system, or plan of regulation. Access to stockholder lists is a recognized exception to the internal affairs doctrine as a matter of corporate law and conflicts of law, and it should take a substantial threat of conflict adversely affecting interstate commerce before a court invalidates a state's assertion of this traditional authority.  We do not find either distinction compelling. Since compilation of a NOBO list is a relatively simple mechanical task, the fact that compilation takes longer than for a CEDE list is an insubstantial basis for distinction. As to both sets of information, the underlying data exist in discrete records readily available to be compiled into an aggregate list. Nor are the functions of the lists significantly dissimilar. Both facilitate direct communication with stockholders, in the case of a NOBO list, at

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least with those beneficial owners who have indicated no objection to disclosure of their names and addresses.  We think New York would apply § 1315 to permit a qualifying shareholder to require the compilation and production of such a list.  Denying opponents an opportunity to contact the NOBOs is inconsistent with the statute's objective of seeking "to the extent possible, to place shareholders on an equal footing with management in obtaining access to shareholders. Bohrer v. International Banknote Co.

 Aftermath of Sadler v. NCR Corporation.  Subsequent to decision in Sadler, New York law was amended to provide that, in response to shareholder requests for information, “the corporation shall not be required to obtain information about beneficial owners not in its possession.” Bus. Corp. Law § 1315(a). iii. Mechanics of Shareholders‟ Meetings  Annual and Special Meetings  There are two types of shareholders‟ meetings – annual meetings at which directors are elected and other regular business is conducted (Del. § 211(b)), and special meetings called in unusual circumstances where shareholder action is required.  Usually the bylaws specify the timing and location of the annual meeting. Del. § 211(c) (permitting board to hold meeting by “remote communication” without physical location).  All corporate statutes require an annual meeting, and Delaware permits shareholders to apply to a court to compel a meeting if one is not held within 30 days after designated date or thirteen months after annual meeting. Del. § 211(c).  Delaware statute provides that a special meeting can be called only by the board of directors or a person authorized in the certificate or the bylaws. Del. § 211(d).  Notice  Record Date.  Amended Del. § 213(a) permits a board of directors to fix two separate record dates for a single stockholder meeting: a “notice” record date to determine the stockholders entitled to notice of the meeting and a later “voting” record date to determine the stockholders who are entitled to vote at the meeting.  By enabling a corporation to fix a voting record date closer in time to the stockholder meeting, the corporation can attempt to decrease the likelihood of a disparity between the stockholders entitled to vote at the meeting (i.e., the holders on the voting record date) and the persons who actually hold stock as of the meeting date.  Contents of Notice.  Whenever stockholders are required or permitted to take any action at a meeting, a written notice of the meeting shall be given which shall state the place, if any, date and hour of the meeting, the means of remote communications, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such meeting, the record date for determining the stockholders entitled to vote at the meeting, if such date is different from the record date for determining stockholders entitled to notice of the meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called. Del. § 222(a).  Timing of Notice.  Unless otherwise provided, the written notice of any meeting shall be given not less than 10 nor more than 60 days before the date of the meeting to each stockholder entitled to vote at such meeting as of the record date for determining the stockholders entitled to notice of the meeting. Del. § 222(b).  Defective Notice.  Whenever notice is required to be given under any provision of this chapter or the certificate of incorporation or bylaws, a written waiver, signed by the person entitled to notice, or a waiver by electronic transmission by the person entitled to notice, whether before or after the time stated therein, shall be deemed equivalent to notice.

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Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Del. § 229.  If notice is defective and the defect is not waived by all affected shareholders, the meeting is invalid and any action taken at the meeting is null and void.  Quorum  For action at a shareholders‟ meeting to be valid, there must be a quorum. Statutes typically set the quorum as a majority of shares entitled to vote. Del. § 216(a).  Certificate of incorporation or bylaws of any corporation authorized to issue stock may specify the number of shares and/or the amount of other securities having voting power, the holders of which shall be present or represented by proxy at any meeting in order to constitute a quorum for, and the votes that shall be necessary for, the transaction of any business.  But in no event shall a quorum consist of less than one-third of the shares entitled to vote at the meeting  Appearance in Person or by Proxy  Shareholders can appear at a shareholders‟ meeting, for purposes of a quorum and to cast their votes, either in person or by proxy. Del. § 212.  If voting by proxy, state statutes require that the proxy appointment be in writing and signed, including by electronic transmission. Del. § 212(b).  No such proxy shall be voted or acted upon after 3 years from its date, unless the proxy provides for a longer period.  Voting at Shareholders‟ Meetings  Who Votes.  Each share is generally entitled to one vote unless provided otherwise. Del. § 212(a).  Delaware also permits bondholders to have voting rights. Del. § 221.  Corporate statutes prohibit a majority-owned subsidiary from voting the shares of the parent corporation. Del. § 160(c).  This circular voting arrangement, if permissible, would enable a corporation‟s board to dilute the voting rights of the corporation‟s shareholders by placing the corporation‟s voting shares in the subsidiary, which would vote them as directed by the corporation‟s board.  Majority Vote.  Shareholder approval of board-initiated transactions – such as mergers, sale of assets, or dissolution – requires the favorable vote of an absolute majority of the outstanding share entitled to vote. Del. §§ 242(b), 251(c), 271(a), and 275(b).  Abstentions and no-shows effectively count as votes against the proposal.  Unless specified otherwise, shareholder approval requires only a majority of shares represented at a meeting at which a quorum is present – a simple majority. Del. § 216(a).  Action by Consent  Unless otherwise provided in the certificate of incorporation, any action required or which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Del. § 228.  Prompt notice of the taking of corporate action without a meeting by less than unanimous written consent shall be given to those stockholders or members who have not consented in writing and who, if the action had been taken at a meeting,

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would have been entitled to notice of the meeting if the record date for notice of such meeting had been the date that written consents signed by a sufficient number of holders or members to take the action were delivered to corporation. Del. § 228(e).  N.B. Most public corporations withdraw the availability of action by written consent. iv. Election of Directors  Qualifications and Number of Directors  Directors need not be shareholders, residents of the state of incorporation, or have any other special qualifications. Del. § 141(b).  Statutes only require that directors be individuals who meet the qualifications, if any, prescribed in the certificate or bylaws.  The number of directors on the board is specified in certificate or by laws. Del. § 141(b).  Delaware requires that the board consist of one or more members, each of whom shall be a natural person. Del. § 141(b).  Frequently the certificate specifies a variable range, with the actual number of directors fixed in the bylaws. The range can be changed only with shareholder approval, but the number of directors within the range can be set by the board.  Voting Methods  Generally all directors face election at each annual shareholders‟ meeting. Del. § 211(b).  The general method for electing directors is by straight (plurality) voting – the top vote getters for the open seats are elected. Del. § 216(b).  Example: Certificate of AB Corp. authorizes five directors and there are two shareholders – A
owns 51 shares and B owns shares. Under straight voting, A and B would each cast their votes five times for five different candidates. Each of A‟s five candidates would receive 51 votes; each of B‟s five candidates would receive 49 notes. A‟s slate of candidates would be elected.

 Cumulative voting is permissive and applies if adopted in the certificate. Del. § 214.  Example: Suppose A has 70 shares and B has 30 shares. Under cumulative voting in an election of five directors, A would have a total of 350 (70 x 5) votes to distribute among his candidates; B would have a total of 150 (30 x 5). If B votes intelligently, cumulative voting assures him at least one director. If B casts all his 150 votes for his candidate, A cannot prevent the candidate‟s election.

NS 

ND  TS x  y TD1

 Where: NS = number of shares needed to elect desired number of directors. ND = number of directors that shareholder desires to elect  TS = total number of shares authorized to vote TD = total number of directors to be elected X/ = A positive fraction (or 1). Y  The (ND x TS)/(TD + 1) represents the equilibrium point where there would be a voting tie. To break the tie, a shareholder needs only a fraction more – hence the formula‟s requirement that something be added.  Unless the corporation recognizes fractional voting, the needed shares must be pushed up to the next whole number, either by rounding up or adding one.  Removal of Directors  Built on the republican notion that legislators may remain in office during good behavior, the common law allowed shareholders to remove directors only for cause – such as fraud, criminal activity, gross mismanagement, or self-dealing.  Today, any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors. Del. § 141(k).

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 Due Process for Removal.  When a director is to be removed (whether for cause or without), shareholders must be given specific notice that removal will be considered at a meeting.  Directors to be removed for cause have due process rights to be informed of the reasons for removal and to answer the charges. Campbell v. Loew‟s, Inc.  Removal Under Cumulative Voting.  To prevent the majority from circumventing minority representation under cumulative voting, the statute specifies that a director elected under cumulative voting cannot be removed without cause if any minority faction, with enough shares to have elected him by cumulative voting, votes against his removal. Del. § 141(k)(2).  Delaware courts have treated removal for cause, however, as an absolute prerogative of the majority stockholders. Campbell v. Loew‟s, Inc.  Filing Vacancies  A board of directors may fill a directorship when a vacancy arises or a director position is newly created, but even in those events, the board-appointed directors will serve at most until the next election of the class for which the director was appointed. Del. § 223(a)(1).  Some statutes limit the board‟s authority to fill vacancies, particularly when directors are removed or new directorships created, on the theory that the board cannot usurp the shareholders‟ power to elect directors.  Delaware courts have held that shareholders have the inherent right between annual meetings to fill newly created directorships. Campbell v. Loew‟s, Inc. C. SHAREHOLDER PROPOSALS i. Access to Other Shareholders  In public corporation where shareholder voting happens by proxy, shareholder initiatives face large obstacles. Shareholders who identify value-producing ideas are generally unwilling or unable to commit the financial resources for mass mailings to other shareholders – their relatively small investment rarely justifies it.  SEC proxy rules attempt to overcome these impediments in two ways: (i) management can be compelled to help shareholders communicate with fellow shareholders – at shareholder expense; or (ii) in limited circumstances, management must include “proper” shareholder proposals in the company‟s proxy mailings to shareholders – at corporate expense.  “Common Carrier” Obligation under Rule 14a-7  Rule 14a-7 requires management to mail, either separately or together with the corporation‟s proxy materials, any shareholder‟s soliciting materials if the shareholder agrees to pay the corporation‟s reasonable expenses.  There is no limit on the length of the materials, nor does the rule allow management to refuse if it objects to their contents.  Management can avoid the “common carrier” obligation by providing a list of shareholders, including intermediaries. This significantly expands the shareholder‟s rights under state law to obtain a list of shareholders for a “proper purpose.”  As a practical matter, management is often reluctant to provide the shareholders‟ list because it can be used for personal solicitations or beyond a shareholder proxy solicitation – such as in a takeover contest.  Amended Del. § 112 – Access to Proxy Solicitation Materials  Expressly permits a corporation to adopt a „proxy access‟ bylaw – that is, a bylaw that would require the corporation to include stockholder nominees for director in the corporation‟s proxy solicitation materials (including its proxy card) if the corporation solicits proxies with respect to an election of directors.  Also specifies that a proxy access bylaw may impose procedures or conditions that must be satisfied before the corporation is required to include a stockholder nominee on the corporation‟s proxy solicitation materials, including conditions:

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 to require a nominating stockholder to own (beneficially or of record) a minimum amount of stock or hold such stock for a specified duration;  to require a nominating stockholder to submit specified information concerning the stockholder and his or her nominee (including information on stock ownership and the ownership of options or other rights related to the corporation‟s stock);  to limit the number or proportion of directors nominated by a stockholder based on how many nominees such stockholder is presenting for election or based on whether the stockholder has previously sought to include a nominee on the corporation‟s proxy solicitation materials;  to deny proxy access to a stockholder if the stockholder (or one or more its affiliates, associates or nominees for director) recently acquired, or publicly pro- poses to acquire, a specified percentage of voting power of the corporation‟s stock within a specified time before the election of directors; and  to require a nominating stockholder to undertake to indemnify the corporation for any loss arising as a result of false or misleading information submitted by that stockholder in connection with a nomination.  Also provides that an access bylaw can include any other „„lawful condition‟‟ as a prerequisite to obtaining proxy access.  Del. § 112 is an enabling provision, i.e., a corporation can require proxy access through a bylaw adopted by its stockholders or by the board of directors (if the certificate of incorporation authorizes the board of directors to amend the bylaws).  Statute does not require proxy access, however, and therefore the decision whether, and how much, proxy access to allow for a given corporation would be left to the stockholders and board of the corporation.  Amended Del. § 113 – Proxy Expense Reimbursement  Section permits a corporation to adopt a bylaw that would provide for the reimbursement by the corporation of the expenses a stockholder incurs in soliciting proxies in connection with an election of directors. Similar to Del. § 112, Del. § 113 permits the drafters of a reimbursement bylaw to condition reimbursement on any „„lawful condition‟‟ and also expressly authorizes certain types of conditions for reimbursement, including:  conditioning eligibility for reimbursement on the number or proportion of persons nominated by a stockholder seeking reimbursement or on whether that stockholder previously sought reimbursement for similar expenses;  limitations on the amount of reimbursement, which could be based on the proportion of votes cast in favor of the stockholder‟s nominees or on the amount spent by the corporation in its proxy solicitation; and  limitations concerning director elections by cumulative voting  Del. § 113 contains one mandatory provision: a reimbursement bylaw will not apply to a director election if any record date for that election precedes the adoption of the bylaw.  Thus, for example, a stockholder seeking to elect directors to the board will not be able to couple its solicitation for director nominees with a new bylaw proposal that would require the corporation to reimburse the stockholder for the election contest that occurred in the same solicitation that resulted in the adoption of the reimbursement bylaw. Rather, the reimbursement bylaw will apply only prospectively, for director elections that occur after the reimbursement bylaw is adopted.  Del. § 113 is an enabling provision that permits, but does not require, a corporation to adopt a bylaw providing for proxy expense reimbursement. ii. Shareholder Proposals under SEC Rule 14a-8  Rule 14a-8 Procedures  Any shareholder who has owned (beneficially or of record) 1 percent or $2,000 worth of a public company‟s shares for at least one year may submit a proposal. Rule 14a-8(b)(1).  Shareholders must submit their proposals in a timely fashion.

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 For an annual meeting, this will generally be at least 120 calendar days before the date proxy materials were sent for the last year‟s meeting. Rule 14a-8(e). Proposal, along with a supporting statement, can be up to 500 words. Rule 14a-8(d). Management‟s proxy card must give shareholders a chance to vote for or against the proposal. Rule 14a-8(a). If the proposal is proper, management must include it in the company‟s proxy mailing to shareholders. If management decides to exclude a submitted proposal, it must give the submitting shareholder a chance to correct any deficiencies. Rule 14a-8(f).  If proposal is proper and included in proxy materials, management can recommend that shareholders vote against it and give its reasons. Rule 14a-8(m).  If management fails to include a proposal that is not excludable, the proponent can seek an SEC determination that the proxy rules are being violated. Rule 14a-8(k).  Alternatively, the proponent can bring a private action in federal court to compel inclusion or enjoy management‟s proxy solicitation.  Shareholders who prevail in court may recover their attorneys‟ fees on the theory that “the litigation conferred a substantial benefit” on the body of shareholders. If management intends to exclude the proposal, management must file its reason (and a copy of the proposal) with the SEC for review. Rule 14a-8(j).  The SEC staff issues a “no-action” letter if it agrees with management, which simply states that the staff will not recommend that the Commission bring an enforcement proceeding against the company if the proposal is excluded.  Staff will usually also recommend to shareholder how to amend the proposal. Management can exclude a proposal if it fits any of categories specified in Rule 14a-8(i).

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 Proposals Inconsistent with Centralized Management  Improper Under State Law.  If the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company's organization. Rule 14a-8(i)(1).  Depending on the subject matter, some proposals are not considered proper under state law if they would be binding on the company if approved by shareholders.  Most proposals that are cast as recommendations or requests that the board of directors take specified action are proper under state law.  Not Significantly Related.  If the proposal relates to operations which account for less than 5 percent of the company's total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earning sand gross sales for its most recent fiscal year, and is not otherwise significantly related to the company's business. Rule 14a-8(i)(5).  Lovenheim Court held that 5% objective measure okay, but if it is a measure that relates to significant social or ethical considerations, then the operative language – “otherwise significantly related” – is not limited to economic significance.  Management Functions.  Management can exclude proposals that relate to the company‟s ordinary business operations. Rule 14a-8(i)(7).  The SEC has previously accepted proposals dealing with such things as construction of nuclear power plant and employment discrimination on the theory that they do not relate to ordinary business because of their economic, safety, and social impact.  Related to Dividend Amount.  Management can exclude proposals that relate to the specific amount of dividends. Rule 14a-8(i)(13).  Recognizes fundamental feature of US corporate law that the board of directors has discretion to declare dividends, without shareholder initiate or approval.

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 Proposals that Interfere with Management‟s Proxy Solicitation  Related to Nomination or Election to Office.  If the proposal relates to a nomination or an election for membership on the company's board of directors or analogous governing body or a procedure for such nomination or election. Rule 14a-8(i)(8).  Exclusion prevents dissidents from “clogging” the company‟s proxy statement with their own candidates or views on management‟s nominees, as well as preventing shareholders from adopting procedures to nominate their own candidates to the board.  Conflicts with Management Proposal.  If the proposal “directly conflicts” with one of the company's own proposals to be submitted to shareholders at the same meeting. Rule 14a-8(i)(9).  A company's submission to the Commission under this section should specify the points of conflict with the company's proposal.  Otherwise, the rule would create an open forum in which every shareholder could offer a proposal to undermine any management initiative subject to a shareholder vote.  Duplicative.  If the proposal substantially duplicates another proposal previously submitted to the company by another proponent that will be included in the company's proxy materials for the same meeting. Rule 14a-8(i)(11).  Resubmission/Recidivist.  If the proposal deals with substantially the same subject matter as another proposal or proposals that has or have been previously included in the company's proxy materials within the preceding 5 calendar years, a company may exclude it from its proxy materials for any meeting held within 3 calendar years of the last time it was included if the proposal received (Rule 14a-8(i)(11)):  Less than 3% of the vote if proposed once within the preceding 5 calendar years;  Less than 6% of the vote on its last submission to shareholders if proposed twice previously within the preceding 5 calendar years; or  Less than 10% of the vote on its last submission to shareholders if proposed three times or more previously within the preceding 5 calendar years.  Proposed SEC Rule 14a-11  The SEC is proposing under certain circumstances, require companies to include in their proxy materials security holder nominees for election as director. These proposed rules are intended to enhance shareholder‟s ability to participate meaningfully in the proxy process for the nomination and election of directors.  The proposed rules would not provide security holders with the right to nominate directors where it is prohibited by state law.  Instead, the proposed rules are intended to create a mechanism for nominees of longterm security holders, or groups of long-term security holders, with significant holdings to be included in company proxy materials where there are indications that security holders need such access to further an effective proxy process.  This mechanism would apply in those instances where evidence suggests that the company has been unresponsive to security holder concerns as they relate to the proxy process. The proposed rules would enable security holders to engage in limited solicitations to form nominating security holder groups and engage in solicitations in support of their nominees without disseminating a proxy statement.  Proposals that are Illegal, Deceptive, or Confused  Violation of Law.  If the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject. Rule 14a-8(i)(2).

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 If the proposal or supporting statement is contrary to any of the Commission's proxy rules, including Rule 14a-9, which prohibits materially false or misleading statements in proxy soliciting materials. Rule 14a-8(i)(3).  Personal Grievance/Special Interest.  If the proposal relates to the redress of a personal claim or grievance against the company or any other person, or if it is designed to result in a benefit [submitter], or to further a personal interest, which is not shared by the other shareholders at large. Rule 14a-8(i)(4).  Absence of Power/Authority.  If company would lack power or authority to implement proposal. Rule 14a-8(i)(6).  Substantially Implemented.  If company has already substantially implemented the proposal. Rule 14a-8(i)(10).
Lovenheim v. Iroquois Brands, Ltd. Facts: Lovenheim sought to bar Iroquois from excluding from the proxy materials being sent to all shareholders information concerning a proposed resolution relating to the procedure used to force-feed geese for production of pate de foie gras in France, imported by Iroquois. Iroquois relies on an exception to the general requirement of Rule 14a-8(c)(5) – proposal being not significantly related. Holding: Court found that Rule 14a-8(c)(5) did not contain an economic significance test and therefore the social significance of the Lovenheim‟s proposal excluded it from the exception. The court further found that the public and the plaintiff's interests would be irreparably harmed without the relief sought, while ordering the relief would not unduly prejudice the defendant. Reasoning: The Commission stated in 1976 that it did "not believe that subparagraph (c)(5) should be hinged solely on the economic relativity of a proposal." Thus the Commission required inclusion "in many situations in which the related business comprised less than one percent" of the company's revenues, profits or assets "where the proposal has raised policy questions important enough to be considered 'significantly related ' to the issuer's business." The 1983 revision adopted the five percent test of economic significance in an effort to create a more objective standard. Nevertheless, in adopting this standard, the Commission stated that proposals will be includable notwithstanding their "failure to reach the specified economic thresholds if a significant relationship to the issuer's business is demonstrated on the face of the resolution or supporting statement." Thus it seems clear based on the history of the rule that "the meaning of 'significantly related' is not limited to economic significance." AFSCME v. AIG, Inc. Facts: Shareholder, a public service employee union, held numerous shares of the corporation's stock through its pension plan. It submitted a proposal for inclusion in a proxy statement that would amend the corporation's bylaws to require the corporation to publish the names of shareholder-nominated candidates for director positions together with any candidates nominated by the board of directors. The corporation excluded the proposal from the proxy statement on the basis of Rule 14a-8(i)(8), and the shareholder filed suit. District court found that the proposal was properly excluded from the proxy statement because it related to an election. Holding: The Second Circuit reversed, noting that the language of the rule was ambiguous and that the SEC had ascribed two different interpretations to this rule – one interpretation when the rule was published and the other interpretation about 16 years later. However, as the SEC did not offer sufficient reasons for its changed interpretation of the rule, the court held that the controlling interpretation was the one that was made when the regulation was implemented. Reasoning: The 1976 Statement clearly reflects the view that the election exclusion is limited to shareholder proposals used to oppose solicitations dealing with an identified board seat in an upcoming election and rejects the somewhat broader interpretation that the election exclusion applies to shareholder proposals that would institute procedures making such election contests more likely. The SEC suggested as much when, four months after its 1976 Statement, it explained that the scope of the election exclusion does not cover shareholder proposals dealing with matters such as cumulative voting and general director requirements, both of which have the potential to increase the likelihood of election contests.

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Mergers, Acquisitions, and Takeovers A. MERGERS AND ACQUISITIONS i. Statutory Mergers  In a statutory merger, the acquiring corporation absorbs the target corporation, the target corporation disappears, and the acquiring corporation becomes the surviving corporation.  A consolidation, a close relative of the statutory merger, is of diminishing importance in corporate practice. In a consolidation, two or more existing corporations combine into a new corporation and the existing corporations disappear.  The same rules that apply to mergers also apply to consolidations.  Effect of Merger  In a merger the surviving corporation absorbs the target corporation when the required certificate of merger is filed at the appropriate state office. Del. § 251(c).  By operation of law, the surviving corporation becomes the owner of all the target corporation‟s assets, becomes subject to all its liabilities, and is substituted in all pending litigation.  Statute allows consideration to the target corporation‟s shareholders to be paid in the form of securities of the acquiring corporation (or any corporation), cash, property, or a combination. Del. § 251(b).  Statutory Protections in Merger  A statutory merger carries three layers of protection: (i) board initiation and approval – implicating the board‟s fiduciary duties; (ii) shareholder approval in some situations (creating disclosure rights under state fiduciary rules and federal securities law); and (iii) appraisal remedies in certain mergers.  Board Adoption.  The board of each constituent corporation must initiate the merger by adopting a plan of merger – a document outlining, inter alia, the terms and conditions of the merger (including how shareholders will vote on it) and the consideration that the shareholders of the target corporation will receive. Del. § 251(b).  Merger plan may also amend the articles of the acquiring surviving corporation.  Fiduciary Duties.  In approving a merger, the directors are bound by their fiduciary duties of care and loyalty. If the merger is with a controlling shareholder or otherwise involves a conflict of interest, the merger is subject to review as a self-dealing transaction.  Disclosure Duties.  Issuance of stock in a merger is a “sale” under Rule 145 of the Securities Act. Shareholders who receive publically traded shares for stock are entitled to prospectus disclosure and receive antifraud protections of federal securities law.  Shareholder Approval.  After board adoption, the plan of merger must be submitted to the shareholders of each corporation for their separate approval. Del. § 251(c).  Second layer of protection is supplemented by federal proxy rules for voting in a public corporation and a “duty of disclosure” under state fiduciary laws.  Requires favorable vote by a majority of all outstanding shares. Del. § 251(c).  Delaware does not require class voting. Approval by a majority of outstanding voting shares is sufficient, even if nonvoting shares or separate voting classes might have rejected the merger. Del. § 251(c).  Statutory Protections in Acquiring Corporation‟s Shareholders  Shareholders of the acquiring corporation do not have voting rights unless the corporation does not survive in the merger, its certificate of incorporation is changed, or its shareholders end up holding a different number of shares after the merger. Del. § 251(f).

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 Shareholders can vote if the acquiring corporation issues new shares in the merger with voting power equal to 20% or more of the voting shares that existed prior to the merger. Del. § 251(f).  Alternative Combinations  Forward Triangular Merger.  In a forward triangular merger, the target corporation ("Target") merges into a subsidiary ("Sub") of the acquiring corporation ("Acquiring") with the former Target shareholders receiving the merger consideration in exchange for their Target stock.  Reverse Triangular Merger.  In a reverse triangular merger, a subsidiary ("Sub") of the acquiring corporation ("Acquiring") merges into the target corporation ("Target"). Acquiring's Sub stock is converted into Target stock and the former Target shareholders receive the merger consideration in exchange for their Target stock. This form of acquisition is often desirable for regulatory or contractual reasons when it is important that no transfer of Target assets take place. ii. Sale of Assets  Statutory Protections in Sale of Assets  Most statutes treat the sale of all or substantially all of the corporate assets – not in the usual or regular course of business – as a fundamental change.  For shareholders of the selling corporation, most of the same protections apply to a sale of assets as apply to a merger: board approval and shareholder approval.  Delaware does not grant appraisal rights in context of a sale of assets. Del. § 271(a).  Conditions Triggering Protections  Sale of Assets.  Not all dispositions of assets trigger shareholder voting.  The authorization or consent of stockholders to the mortgage or pledge of a corporation's property and assets shall not be necessary, except to the extent that the certificate of incorporation otherwise provides. Del. § 272.  “Substantially All” Assets.  When a corporation sells less than all of its assets outside the ordinary course of business, the approval of both the board and the shareholders are required only if “substantially all” the assets were sold. Del. § 271.  Delaware Chancery court has adopted a disjunctive qualitative-quantitative test.  Under the test, shareholder approval is required is the sale involves assets that are either quantitatively vital to the company‟s operations or qualitatively substantial to its existence and purpose. Gimbel v. Signal Companies.
Gimbel v. Signal Companies Facts: Plaintiff, a Signal stockholder, brought an action against Signal seeking injunctive relief to prevent the consummation of the pending sale of all of the outstanding capital stock of Signal's oil company subsidiary. Plaintiff contended that the meeting of Signal's board of director's in which the sale was decided was not properly noticed and that the agreed upon price was recklessly inadequate. Signal was trying to sell its energy subsidiary – which accounted for 41% of total net worth, 26% of balance sheet assets, and 15% of the earnings of the conglomerate parent Holding: The court found that the sale of the oil company stock did not constitute the sale of all or substantially all of Signal's assets – even though the subsidiary had once been the bedrock of Signal‟s business – and therefore, plaintiff's argument that sale violated Del. § 271(a), had no reasonable probability of success on the merits. Reasoning: If the sale is of assets quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects the existence and purpose of the corporation, then it is beyond the power of the Board of Directors.

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Katz v. Bregman Facts: Plaintiff, a shareholder of defendant Plant Industries brought action seeking entry of an order preliminarily enjoining the proposed sale of Plant‟s assets. Plant was trying to sell a subsidiary that accounted for 45% of total net sales and 51% of Plant‟s assets. Holding: Court held at common law that a sale or all or substantially all of the assets of a corporation required unanimous vote of stockholders. Court concluded proposed sale of defendant corporation's assets, which constituted over 51 percent of total assets and which generated approximately 45 percent of defendant corporation's 1980 net sales, would constitute a sale of substantially all of defendant corporation's assets. Thus, court issued an injunction to prevent consummation of sale at least until it had been approved by a majority of the outstanding stockholders of defendant corporation entitled to vote at a meeting duly called on at least twenty days' notice. Reasoning: In the case at bar, I am first of all satisfied that historically the principal business of Plant Industries, Inc. has not been to buy and sell industrial facilities but rather to manufacture steel drums for use in bulk shipping as well as for the storage of petroleum products, chemicals, food, paint, adhesives and cleaning agents, a business which has been profitably performed by National of Quebec. Furthermore, the proposal, after the sale of National, to embark on the manufacture of plastic drums represents a radical departure from Plant's historically successful line of business, namely steel drums. I therefore conclude that the proposed sale of Plant's Canadian operations, which constitute over 51% of Plant's total assets and in which are generated approximately 45% of Plant's 1980 net sales, would, if consummated, constitute a sale of substantially all of Plant's assets. By way of contrast, the proposed sale of Signal Oil in Gimbel v. Signal Companies, Inc., represented only about 26% of the total assets of Signal Companies, Inc. And while Signal Oil represented 41% of Signal Companies, Inc. total net worth, it generated only about 15% of Signal Companies, Inc. revenue and earnings.

iii. The De Facto Merger Doctrine  A judicially created doctrine, a handful of courts have interpreted the statutory merger provisions to give shareholders in functionally equivalent asset sales the same protections available in a statutory merger.  If the asset sale has the effect of a merger, shareholders receive merger-type voting and appraisal rights.  Most courts have rejected the de facto merger doctrine and have refused to imply merger-type protection for shareholders when the statute does not provide it.  In many states where the courts have implemented the de facto merger analysis, the state legislature has later abolished the doctrine by statute. 15 Pa. CSA § 1904.  The Equal Dignity Rule  Delaware courts accept that management can structure a combination under any technique it chooses. To maximize flexibility, form trumps substance.  Each combination method, including particular protections, has its own legal significance.  Successor Liability Doctrine  In an asset acquisition, none of the outstanding claims or liabilities is transferred to the surviving party unless the parties agree.  Sale of assets significantly more advantageous than a merger for buyer-successor.  Courts have fashioned a successor liability doctrine that imposes liability on the purchasing corporation (or another successor down the chain) when the claims were unknown or contingent at the time the assets were sold.  Delaware, while rejecting the de facto merger doctrine for shareholders, has accepted the possibility of successor liability on behalf of tort victims. Heilbrunn v. Sun Chemical Corp.
Farris v. Glen Alden Corporation Facts: Plaintiff, a shareholder of Glen Allen, filed a complaint against Glen Allen seeking to prevent the execution of a reorganization agreement between Glen Allen and List Industries Corp. The basis of plaintiff's complaint was that the reorganization agreement was actually a merger between Glen Allen and List and that proper notice was not given to the Glen Allen shareholders of their right to dissent and claim fair value for their shares. Glen Allen contended that the agreement was a purchase of corporate assets of which shareholders had no right of dissent or appraisal. Holding: The court determined that the nature of the agreement proposed a merger because it fundamentally changed the character of Glen Allen and the interest of the plaintiff as a shareholder

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therein. Since plaintiff would be forced to give up his stock in one company and accept that of another, he should have been notified. Reasoning: To determine properly the nature of a corporate transaction, the court must refer not only to all the provisions of the agreement, but also to the consequences of the transaction and to the purposes of the provisions of the corporation law said to be applicable. When a corporation combines with another so as to lose its essential nature and alter the original fundamental relationships of the shareholders among themselves and to the corporation, a shareholder who does not wish to continue his membership therein may treat his membership in the original corporation as terminated and have the value of his shares paid to him.  If a combination outlined in a "reorganization" agreement so fundamentally changes the corporate character of the company at issue, and interest of plaintiff as a shareholder therein, that to refuse him the rights and remedies of a dissenting shareholder would in reality force him to give up his stock in one corporation and against his will accept shares in another, the combination is a merger within meaning of § 908A of the corporation law. Hariton v. Arco Electronics, Inc. Facts: Plaintiff, an Arco shareholder, sued Arco to enjoin consummation of a plan to sell Arco's assets under Del. § 271, dissolve pursuant to Del. § 275, and distribute the purchasing corporation's stock to shareholders. Plaintiff contended that the sale of assets and dissolution statutes could not be legally combined, and that the plan constituted a de facto merger without affording shareholders rights provided in the merger statute. Holding: Court affirmed, holding combination of the sale of assets and dissolution statutes was legal. Although Arco's actions did accomplish a de facto merger, the sale of assets and merger statutes were independent and the validity of actions taken pursuant to one statute did not depend on the other. Reasoning: The general theory of the Delaware Corporation Law is that action taken pursuant to the authority of the various sections of that law constitute acts of independent legal significance and their validity is not dependent on other sections of the act.

iv. Squeeze-Out Mergers  Short-Form Mergers (Subsidiary → Parent)  When a parent corporation owns 90% or more of a subsidiary, the subsidiary may be merged into the parent without the approval by shareholders of either corporation. Only approval of the parent‟s board of directors is required. Del. § 253.  Principal purpose is to reconstitute the subsidiary‟s ownership by involuntarily eliminating the equity interest of the minority shareholders.  Rationale for streamlined, short-form procedure is that approval by the subsidiary‟s board and its shareholders is preordained, and the parent‟s shareholders will not be materially affected since parent already holds at least 90% interest in the subsidiary.  Subsidiary‟s minority shareholders are protected at two levels:  The fiduciary rules applicable to the parent as controlling shareholder in a squeeze-out transaction.  Appraisal remedies automatically granted by statute. Del. § 253(d).  Squeeze-out mergers are subject to judicial review under an “entire fairness” test that requires fair dealing and fair price.  “Entire Fairness” Test in Squeeze-Out Merger Context  The concept of fairness has two basic aspects: fair dealing and fair price.  The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.  The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.  However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness. Still, in a non-fraudulent transaction courts recognize that price may be the preponderant consideration outweighing other features of the merger

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 Shifting Burdens in Squeeze-Out Merger Context  A plaintiff in a suit challenging a cash-out merger must allege specific acts of fraud, misrepresentation, or other items of misconduct to demonstrate the unfairness of the merger terms to the minority.  Although the ultimate burden of proof is on majority shareholder to show by a preponderance of evidence that transaction is fair, it is first the burden of the plaintiff attacking the merger to demonstrate some basis for invoking the fairness obligation.  Where corporate action has been approved by an informed vote of a majority of the minority shareholders, the burden entirely shifts to the plaintiff to show that the transaction was unfair to the minority.  No Business Purpose Test in Delaware  The Delaware courts no longer employ a business purpose test for determining if a merger was for the sole purpose of eliminating a minority on a cash-out basis.  In view of the fairness test applicable parent-subsidiary mergers, the expanded appraisal remedy available to shareholders, and the broad discretion of the Chancery Court to fashion such relief as the facts of a given case may dictate, the courts do not believe that any additional meaningful protection is afforded minority shareholders by the business purpose requirement.  The De Facto Non-Merger  In Rauch, the plaintiff urged adoption of, and the court rejected, what might be called a “de facto non-merger” doctrine. The transaction took the form of a merger but the plaintiff argued that it was in substance a sale of assets followed by a redemption.  If the sale-of-assets route had been followed, then, in the absence of any change in the redemption price of the preferred shares, those shares would have been entitled to $100 per share, plus any previously unpaid dividends, before the common shares received anything.  Under Del. § 242(b)(2), however, the redemption price could have been altered by a majority vote of the preferred shares. A sale-of-assets transaction might have been made conditioned on a prior vote of the preferred shares, approving amendment of the certificate of incorporation to lower the liquidation preference to $40 per share.
Weinberger v. UOP, Inc. Facts: Plaintiff, a former shareholder of UOP, brought an action that challenged the elimination of UOP‟s minority shareholders by cash-out merger between UOP and its majority owner, Signal. The Chancery Court held that the terms of the merger were fair to plaintiff and the other minority shareholders of UOP. Plaintiff appealed. Holding: On appeal, the court held that the record did not establish that the transaction satisfied any reasonable concept of fair dealing, as the matter of disclosure to the UOP's directors was wholly flawed by conflicts of interest raised in feasibility study, and the minority shareholders were denied critical information; thus, the vote of the minority shareholders was not an informed one. Reasoning: When directors of a Delaware corporation are on both sides of transaction, they are required to demonstrate utmost good faith and most scrupulous inherent fairness of bargain. The requirement of fairness is unflinching in its demand that where one stands on both sides of transaction, he has burden of establishing its entire fairness, sufficient to pass test of careful scrutiny by courts. There is no dilution of this obligation where one holds dual or multiple directorships, as in a parent-subsidiary context. Thus, individuals who act in a dual capacity as directors of two corporations, one of whom is parent and the other subsidiary, owe the same duty of good management to both corporations, and in the absence of an independent negotiating structure, or the directors' total abstention from any participation in the matter, this duty is to be exercised in light of what is best for both companies.  Part of fair dealing is the obvious duty of candor. One possessing superior knowledge may not mislead any stockholder by use of corporate information to which the latter is not privy. Delaware imposes this duty even upon persons who are not corporate officers or directors, but who nonetheless are privy to matters of interest or significance to their company.

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Coggins v. New England Patriots Football Club, Inc. Facts: Plaintiff, an owner of 10 shares of the “Old Patriots,” representing minority shareholders brought a class action on behalf of himself and certain other stockholders of the “Old Patriots,” following a freeze-out merger by the majority stockholder. The freeze-out was designed for the majority shareholder's own personal benefit to eliminate the interests of the minority stockholders and did not further the interests of the corporation. Holding: Applying the business purpose test, the court held that the merger was a violation of fiduciary duty to minority stockholders, and therefore impermissible. Although rescission is the normal remedy, the court determined it would be inequitable and remanded for a determination of the present value of the nonvoting stock, as though the merger was rescinded. Those plaintiffs who did not turn in their shares and did not perfect their appraisal rights were entitled to receive damages in the amount their stock would be currently worth, plus interest at the statutory rate. Reasoning: The so-called business-purpose test holds that controlling stockholders violate their fiduciary duties when they cause a merger to be made for the sole purpose of eliminating a minority on a cash-out basis. In freeze-out situations, a judge should examine with closest scrutiny the motives and the behavior of the controlling stockholder. A showing of compliance with statutory procedures is an insufficient substitute for the inquiry of the courts when a minority stockholder claims that the corporate action will be or is illegal or fraudulent as to him. A director of a corporation violates his fiduciary duty when he uses the corporation for his or his family's personal benefit in a manner detrimental to the corporation. Because the danger of abuse of fiduciary duty is especially great in a freeze-out merger, the court must be satisfied that the freeze-out was for the advancement of a legitimate corporate purpose. If satisfied that elimination of public ownership is in furtherance of a business purpose, the court should then proceed to determine if the transaction was fair by examining the totality of the circumstances.  A defendant bears the burden of proving that a merger was for a legitimate business purpose, and, that, considering the totality of the circumstances, it was fair to the minority. Rabkin v. Philip A. Hunt Chemical Corporation Facts: Minority stockholders sought to enjoin the proposed merger of the majority stockholder corporation, Olin Corp., with the minority stockholder corporation, Hunt Chemical. Minority stockholders challenged the proposed merger on the grounds that the price offered was grossly inadequate because the majority shareholders unfairly manipulated the timing of the merger to avoid a one-year commitment regarding the purchase of the additional shares. Additionally, minority stockholders contended that specific language in the majority stockholders' schedule 13D, which they filed when they first purchased the stock, constituted a price commitment by which they failed to abide contrary to their fiduciary obligations. Majority stockholders and Olin Corp. argued the minority stockholders' claims were primarily directed to the issue of fair value; therefore appraisal was the only available remedy. Holding: The court held that the facts alleged by the minority stockholders regarding the majority shareholders' avoidance of the one-year commitment supported a claim of unfair dealing that was sufficient to defeat the motion to dismiss. Reasoning: Plaintiffs, who assert a conscious intent by the majority shareholder of a corporation, to deprive the minority shareholders of the same bargain that the majority shareholder made with the corporation's former majority shareholder, where but for the majority shareholder's allegedly unfair manipulation, the charges of bad faith go beyond issues of mere inadequacy of price, and state a cause of action. While a plaintiff's monetary remedy ordinarily should be confined to the more liberalized appraisal proceeding, the court does not intend any limitation on the historic powers of the Chancellor to grant such other relief as the facts of a particular case may dictate. The appraisal remedy the court approves may not be adequate in certain cases, particularly where fraud, misrepresentation, self-dealing, deliberate waste of corporate assets, or gross and palpable overreaching are involved.  Fair dealing is defined as embracing the questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.
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While a plaintiff's mere allegation of unfair dealing, without more, cannot survive a motion to dismiss, averments containing specific acts of fraud, misrepresentation, or other items of misconduct must be carefully examined under the notion of fair dealing.

Rauch v. RCA Corporation Facts: Plaintiff shareholder filed a class action that challenged the propriety of a merger. Plaintiff claimed that the merger constituted a "liquidation or dissolution or winding up of RCA and a redemption of the [Preferred Stock]," as a result of which holders of the Preferred Stock were entitled to $100 per share in accordance with the redemption provisions of RCA's certificate of incorporation. Holding: On appeal, the court found the merger agreement complied fully with Del. § 251(c). The court rejected plaintiff's contention that the transaction between defendant corporations was essentially a redemption rather than a merger. The court held that defendants were entitled to choose the most

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effective means to achieve the desired reorganization subject only to their duty to deal fairly with the minority interest. The court held that the district court properly dismissed plaintiff's complaint because it was barred by Delaware's doctrine of independent legal significance. Reasoning: Action taken under one section of the Delaware General Corporation Law is legally independent, and its validity is not dependent upon, nor to be tested by the requirements of other unrelated sections under which the same final result might be attained by different means. Del. § 151(b) provides that a corporation may subject its preferred stock to redemption by the corporation at its option or at the option of the holders of such stock or upon the happening of a specified event. Minority stock interests may be eliminated by a merger. And, where a merger of corporations is permitted by law, a shareholder's preferential rights are subject to defeasance. Stockholders are charged with knowledge of this possibility at the time they acquire their shares.

B. DELAWARE SHAREHOLDERS‟ APPRAISAL RIGHTS i. Appraisal Rights  Transactions that Trigger Appraisal Rights  Merger, Consolidation, or Compulsory Share Exchange.  All record shareholders of the acquired corporation (both voting and nonvoting) in a merger or consolidation have appraisal rights. Del. §§ 262(a), (b).  Shareholders of the acquiring corporation have appraisal rights, except when it is a “whale-minnow” merger or the shareholders have a “market out.” Del. §§ 251(g) and 262(a), (b).  Short-Form Merger.  Shareholders squeezed out in a short-form merger have appraisal rights, even though they do not vote. Del. § 262(b).  The shareholders of the parent corporation, which consolidates its control over the partially owned subsidiary, do not have appraisal rights.  Sale of Assets.  Shareholders have no appraisal rights in a sale of assets unless provided in the corporate charter. Del. § 262(c).  Charter Amendment.  Shareholders have no appraisal rights in a charter amendment unless provided in the corporate charter. Del. § 262(c).  Shares Subject to Appraisal  Shares are often held of record by a nominee (such as a securities broker) on behalf of the beneficial owner. To avoid any confusion, the Delaware statute gives appraisal rights only to record shareholders. Del. § 262(a); Cede & Co. v. Technicolor, Inc.  Market Exception in Public Companies  Delaware‟s statute has a market-out exception that excludes appraisal in a stock-for-stock merger if before and after the merger the shares are traded on a national stock market or held by more than 2,000 shareholders of record. Del. § 262(b)(1), (b)(2).  Appraisal rights are available for in a stock-for-cash merger when publically traded shares are acquired wholly or partially for cash. Del. § 262(b)(2).  Theory is that a dissatisfied shareholder in a stock-for-stock merger who prefers cash can simply sell in a public trading market at a price market has determined to be fair. ii. Appraisal Proceedings  Delaware Procedures.  Preserving Right to Appraisal.  Before the shareholder‟s meeting on the fundamental change, the corporation must send shareholders notice of their appraisal rights. The notice must contain sufficient information for the shareholder to make an informed choice on whether to seek appraisal or accept the consideration offered in the transaction. Nagy v. Bistricer.

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 Shareholders who want to dissent must give the corporation written notice of their intent before the meeting.  Shareholders must vote against, or at least not vote for, the proposed change.  Exercising Right to Appraisal.  After the effective date of the fundamental change, the corporation must notify shareholders of their appraisal rights. Within a specified number of days, dissenters must accept the terms of the change or tender their shares to the corporation and demand payment.  Bringing Appraisal Action.  Dissenters must then bring an appraisal action in court and initially bear all their litigation expenses. Dissenters do not receive payment until finally ordered by the court. Dissenter‟s expenses (such as attorney and expert fees) can only be charged against the value of the appraised shares and cannot be recovered from corporation.  Fair Value  Modern courts, following the lead of professional business valuators, look at customary and current valuations concepts and techniques generally employed for similar businesses.  Delaware courts have abandoned the “block method” and called on the appraiser to look to elements of future value, provided they are susceptible proof. Weinberger v. UOP.  Delaware courts can take into account the firm‟s earning potential after a merger, so long as it is not speculative – a limited sharing rule.  A new business strategy implemented after a merger‟s approval but before its effective date, could be used in valuing the dissenters‟ shares. Cede & Co. v. Technicolor, Inc. (Technicolor IV).  In a two-step cash-out merger context, the court has held that value added by the acquiring corporation subsequent to its initial purchase of a controlling block of shares was considered part of going concern value, which dissenting shareholders who sought appraisal were entitled to share. Cede & Co. v. Technicolor, Inc. (Technicolor IV).  Discounts  Most courts have not discounted minority shares for lack of control, on the theory that “fair value” is the value of the “proportionate interest in a going concern.” Tri-Continental Corp. v. Battye.  But when the appraisal is of shares in a conglomerate, where firm value is the sum of its many controlled subsidiaries, the value should reflect the value of selling control in each subsidiary.” Rapid-American Corp. v. Harris. iii. Exclusivity of Appraisal  Price or Process Fairness  A Delaware shareholder may challenge a transaction, even if appraisal is available, if either:  Approval of the transaction was obtained fraudulently;  Fiduciaries breached their duty of fair dealing; or  Transaction did not comply with formal approval requirements. Weinberger v. UOP.  Non-appraisal Remedies  Where rescission would impose a significant burden, particularly where the challenge is resolved long after the transaction closed, some courts have accepted the possibility of rescissory damages – damages based on the value of the shares if the transaction had been originally rescinded – to compensate shareholders for unfair dealing or an inadequate price. Weinberger v. UOP.  Effect of Choice  The Delaware Supreme Court has allowed shareholders in an appraisal proceeding who discover evidence of procedural unfairness to commence simultaneously a fairness challenge. Cede & Co. v. Technicolor, Inc. (Technicolor I).

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C. TAKEOVERS i. Development of Corporate Law  The Corporation‟s Best Interest  The board of directors has the responsibility to oppose takeover attempts that in its best judgment are detrimental to the company or its shareholders. This obligation is based on the directors' fiduciary duty to act in the best interests of the corporation's stockholders, which includes protecting the corporation and its owners from perceived threats originating from third parties or other shareholders.  However, this power is not absolute, and a corporation does not have unbridled discretion to defeat any perceived threat by any means available.  Dominant Motive Judicial Review  Courts accepted defensive actions if the incumbent board could point to a “reasonable investigation” – preferably by outside directors – into a plausible business purpose for the defense – thus showing the absence of an entrenchment motive.  One a business purpose was demonstrated, the challenger bore the difficult burden to prove that the board‟s dominant motive was entrenchment.  Courts readily accepted almost any business justification for defensive tactics.  Board‟s Duties to Other Constituents  Pennsylvania‟s corporate statute permits the board of directors to take in account nonshareholders constituencies in a takeover, as well as other corporate contexts.  “In discharging [their] duties, directors of a business corporation may…consider… the effects of any action upon…shareholders, employees, suppliers, customers, and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.” Pa. BCL § 1715.  Such statutes are meant to insulate a board‟s active defense against unwanted takeover bids.  Delaware does not have such a statute → but the courts have found that protecting other constituents is acceptable only if their interests coincided with maximizing shareholder interests.
Cheff v. Matthes Facts: Plaintiff shareholders filed a derivative suit against Holland Furnace‟s directors, alleging that purchases of company stock with corporate funds were made for the purpose of ensuring the perpetuation of control by the incumbent directors. The trial court agreed with plaintiffs' allegations and found that the directors acted with the improper desire to maintain control. Directors appealed. Holding: In reversing the lower court, the court noted that the evidence indicated that the directors' decisions were based upon direct investigation, receipt of professional advice, and personal observations of the company attempting a takeover. Based upon their information, the board of directors believed, with justification, that there was a reasonable threat to the corporation's continued existence. The court upheld the board‟s defense because board investigated the threat that the acquirer posed to “the corporation in its current form” and because the buyout premium paid to the greenmailer reflected a reasonable price for a control block. Reasoning: If the actions of the board are motivated by a sincere belief that the buying out of a dissident stockholder is necessary to maintain what the board believes to be proper business practices, the board will not be held liable for such decision, even though hindsight indicates the decision not to have been the wisest course. On the other hand, if the board members act solely or primarily because of the desire to perpetuate themselves in office, the use of corporate funds for such purpose is improper.  An inherent danger exists in the purchase of shares with corporate funds to remove a threat to corporate policy when a threat to control is involved. The corporate directors are of necessity confronted with a conflict of interest, and an objective decision is difficult. Hence, in such a circumstance, the burden is on the directors to justify such a purchase as one primarily in the corporate interest.  Corporate directors satisfy their burden of proof by showing that they acted in good faith and after reasonable investigation; they will not be penalized for an honest mistake of judgment if the judgment appeared reasonable at the time the decision was made.

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ii. Corporate Defensive Measures  Paying Greenmail  The term "greenmail" refers to the technique of creating the threat of a corporate takeover by purchasing a significant amount of the company's stock, and then selling the shares back to the company at a premium when its executives, in fear of their jobs, agree to purchase the acquirer's shares. The plan is to acquire a substantial block of stock in the target company, preparatory to making a tender offer for a sufficient amount of the remaining shares to gain control of the target and thus effect a merger, but the greenmailer really expects that the target company will offer to buy the shares at a price in excess of that paid by him or her, as well as in excess of their current market value.  § 5881 of the Internal Revenue Code, enacted in 1987, imposes a penalty tax of 50% on the gain from greenmail, which is defined as gain from the sale of stock that was held for less than two years and sold to the corporation pursuant to an offer that “was not made on the same terms to all shareholders.”  Del. § 160(a) provides that, except where prohibited, every corporation may purchase, redeem, receive, take or otherwise acquire, own and hold, sell, lend, exchange, transfer or otherwise dispose of, pledge, use and otherwise deal in and with its own shares.  Shareholder Rights Plans – “Poison Pills”  Pill is typically adopted by the board of directors without any shareholder action and designed to compel a bidder to negotiate with the board to ensure fair treatment.  Shareholder rights plans involve the issuance of rights or warrants to shareholders that entitle the holder (other than the owner of a specified percentage of the target's voting stock, that is, a hostile bidder who acquires typically 15 percent of the company's stock without board approval) to purchase shares of the target corporation's common or preferred stock at either a designated exercise price or a price set by formula.  Whether designated or set by formula, the exercise price is usually significantly higher than the target's current market price because it is intended to reflect the anticipated long-term value of the stock during the term of the warrant (typically ten years). Because the exercise price is “out of the money,” it is expected that the warrants will not be exercised. The actual “poison” in the “poison pill” however, is typically found in so-called “flip-over” and “flip-in” provisions of shareholder rights plans.  Flip-Over. Flip-over provisions give shareholders the right to buy shares of the entity acquiring the target corporation at a designated price, often half of the bidder's current market price, if the bidder is able to obtain control of the target and complete a merger. The surviving corporation is obligated to honor the rights and sell its shares at the designated cheap price. The intended and almost inevitable effect of such a plan is to dilute the acquirer's equity to a “devastating” level.  Flip-In. Flip-in provisions allow shareholders other than the acquirer to exercise a right to buy stock of the target cheaply when a bidder acquires a designated percentage (usually an amount between 10 and 20 percent) of the outstanding stock of the target or when an acquirer engages in a merger in which the target corporation is the surviving corporation. As with flip-over provisions, flip-in provisions operate on the theory that a bidder will be reluctant to trigger the rights plan due to the consequent dilution of its equity if the rights plan takes effect. In practice, a flip-in provision is virtually always accompanied by a flip-over provision.  Del. § 151(b) provides that “any stock which may be made redeemable under this section may be redeemed for cash, property or rights, including securities of the same or another corporation, at such time or times, price or prices, or rate or rates, and with such adjustments, as shall be stated in the certificate of incorporation or in the resolution or resolutions providing for the issue of such stock adopted by the board of directors pursuant to subsection (a) of this section.”

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 Dead Hand Provisions in “Poison Pills”  “Dead hand” or “Continuing director” provisions in rights plans can frustrate a hostile bidder's attempt to displace a shareholder rights plan by unseating the incumbent board and electing board members that will presumably redeem the rights plan. Such provisions provide that a poison pill can only be redeemed by directors who were in place when the poison pill was adopted (also referred to as “incumbent directors”) or who were elected with the approval of such directors or their approved or designated successors (also referred to as “continuing directors”). This type of provision is intended to prevent a hostile bidder from gaining control over the board of directors by commencing a proxy contest – by replacing board members or expanding the board and filling such newly created vacancies – and having the new directors redeem or remove the poison pill.  The Delaware Supreme Court has found dead hand provisions invalid. Quickturn Design Systems, Inc. v. Shapiro.  “Chewable” Plans  In contrast to dead hand provisions, poison pill plans with “chewable” provisions are poison pills that are automatically redeemed when certain conditions favorable to the shareholders and the corporation are met. These terms are called the “qualifying offer.”  A “qualifying offer” is often defined as an all cash tender offer that (i) is open to all stockholders for a minimum number of days, (ii) is supported by a firm financing commitment from a responsible financial institution, (iii) is accompanied by an opinion of a nationally recognized investment banking firm that the offer price is fair to all stockholders, from a financial point of view, (iv) results in the offeror acquiring a specified percentage of the target's outstanding shares (usually between 50 and 75 percent), and (v) is accompanied by the offeror's commitment to effect a second-step merger transaction at the same price.  TIDE Plans  Another shareholder friendly rights plan is the so-called “TIDE” (three-year, independent director evaluation) plan. A TIDE plan is simply a standard rights plan which contains a provision requiring the company's outside directors to review the plan at a regular intervals (usually every two or three years) to determine whether the plan continues to be in the best interest of the company's shareholders. If appropriate, the independent directors may recommend a modification or amendment to the plan.  Protective Charter and By-Law Provisions – “Shark Repellents”  Staggered Board.  A charter provision calling for longer board terms for directors and staggered board elections in which only a portion of the directors are elected each year make hostile bids more difficult. The theory behind implementing longer board terms as a protective measure is that even a raider acquiring all or a majority of the target's shares will not gain control of the corporation immediately because a majority of the board members must first serve their terms.  Special Meeting.  Charter or by-law provisions that limit shareholders' ability to call a special meeting provide some protection against a hostile bid.  Advance Notice.  By-law provisions requiring shareholders to give advance notice of an intention to elect directors or to submit proposals at a shareholder meeting serve to protect against unexpected hostile bids or attempts to gain control of the target's board.  Meeting by Written Consent.  Charter provisions disallowing a shareholder vote via written consent in lieu of holding a meeting serve to prevent bidders from taking immediate action affecting corporate control and pressuring a board into taking precipitous action.  Supermajority Vote.

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 Charter provisions that require more than a simple majority (i.e., 75% or higher) of the shareholders to approve any merger or acquisition or to amend protective charter or by-law provisions also serve as a protective mechanism. Such provisions are usually accompanied by a provision requiring a supermajority vote to amend the supermajority provision. Fair Price.  Fair price charter provisions can require that a bidder pay all of a target's shareholders the highest cash price the bidder paid for any shares it acquired at any time in a twotier front end loaded merger. Fair price provisions are intended to prevent discriminatory pricing in the second step of a merger that might otherwise be used to pressure the target's shareholders into selling their shares in the first step. These provisions generally do not apply if a supermajority of the target's shareholders or the board approves the merger or the stock acquisition. Limitations on Removal of Directors.  Charter provisions limiting removal of directors “for cause only” may also thwart hostile takeover attempts by making it more difficult for a raider to remove the target's incumbent board. No Cumulative Voting Rights.  Eliminating cumulative voting rights serves to deter hostile takeover attempts by making it more difficult for raiders to gain seats on the target corporation's board. Blank Check Preferred Stock.  Charter provisions allowing the board to issue preferred shares and to determine the rights and preferences of those shares (including the voting rights of those shares) may be used as a protective measure. By issuing such shares into managementfriendly hands, the incumbent board would seek to gain votes in its favor.

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iii. Enhanced Scrutiny Standard  Enhanced Scrutiny Standard  Under this “enhanced scrutiny” standard, when a board undertakes measures in anticipation of, or in response to, a possible takeover attempt, the initial burden of proof with regard to the subject action shifts to the directors.  Applicable as an “enhanced scrutiny” standard (rather than the business judgment rule) in circumstances where there exists the “specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders.”  Represents adoption of intermediate procedural and substantive standards – between intrinsic fairness and rational basis.  Directors may consider when evaluating the threat posed by a takeover bid, the inadequacy of the price offered, nature and timing of the offer, questions of illegality, the impact on "constituencies" other than shareholders, the risk of nonconsummation and the quality of securities being offered in the exchange.  The Unocal Two-Prong Test  Under the test, the board of directors must show that:  (i) the directors had reasonable grounds for believing that a danger to corporate policy and effectiveness existed; and  (ii) the defensive measure adopted was reasonable in relation to the threat posed.  If the board satisfies the two-prong burden, the court will then review the board's decision under the business judgment rule standard with the burden of proof on the challenging party to rebut the rule's presumption of propriety.  The first prong of may be satisfied by “showing good faith and reasonable investigation” by the directors – which is enhanced when a majority of the board consists of outside independent directors.  The second prong requires that directors balance “the nature of the takeover bid and its effect on the corporate enterprise” with that of the defensive tactic undertaken and

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the result of this balance must be that the defensive tactic is “proportionate” to the threat – the so-called “proportionality test.” If the board does not meet both prongs of the Unocal threshold test, it must then prove that its decision was entirely fair to the corporation and its stockholders. When the board adopts multiple defensive measures, the court will scrutinize those measures individually and collectively to determine whether they were a reasonable response to the perceived threats.  The second prong of the enhanced scrutiny test does not focus on whether the board's actions were "necessary" or the best possible options. Rather, the defensive measure need only be "within a range of reasonableness" to satisfy Unocal's proportionality prong. This enhanced scrutiny standard is applicable to both pre-offer and post-offer defensive measures. In either situation, the board of directors must fulfill its fiduciary obligation to act in “the best interests of the corporation and its shareholders.” While Unocal imposes a higher level of scrutiny than that of the traditional business judgment rule, in applying the Unocal standard, courts have remained deferential to business determinations made by directors, particularly where independent directors participate in the decision-making process.

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 Further Refining Unocal‟s Two-Prong Test in Unitrin  In applying the two-prong test, a court must engage in a two-step process: first, the court should determine whether the defensive measure was coercive or preclusive; and second, if the measure was not coercive or preclusive, the court should determine if the measure falls within a “range of reasonableness.”  A defensive measure is “preclusive if it deprives stockholders of the right to receive all tender offers or precludes a bidder from seeking control by fundamentally restricting proxy contests.”  A defensive measure is coercive if it is aimed at forcing upon stockholders a management-sponsored alternative to a hostile offer or if it has “the effect of causing the stockholders to vote in favor of the proposed transaction for some reason other than the merits of the transaction.”  If the defensive measure adopted by the board is preclusive and/or coercive, it is per se unreasonable under Unocal's proportionality prong. In such cases, the burden shifts to the board to establish that the defensive measures were entirely fair to the corporation and its shareholders.  To determine whether a defensive measure is “within the range of reasonableness,” the Delaware Supreme court advised the Chancery Court to consider whether:  (i) the decision was authorized under Delaware law as one that could be made in contexts outside of that of a takeover;  (ii) whether the defensive measure was limited and proportional to the threat; and  (iii) the boards decision took into account that stockholders varying interests and provided the stockholders with the right to cash-out if so desired.  Board‟s Obligation to Redeem an Intact Rights Plan  The board of the target of a hostile takeover attempt can refuse to redeem an intact shareholder rights plan, and offer its shareholders an economic alternative to tendering, which can be provided by, among other things, a restructuring or recapitalization. The economic alternative is intended to allow the target to remain independent while offering shareholders not only a short-term gain via dividends or other distribution of corporate assets, but also a continued equity interest in the target's long-term viability  This issue is typically manifested in one of three circumstances: (i) the target refuses to redeem an intact rights plan, and offers its shareholders an economic alternative to tendering so that it can remain independent; (ii) the target refuses to redeem an intact rights plan, and sells all or a majority of its shares to a favored bidder; (iii) the target refuses to redeem an intact rights plan, and does not offer its shareholders an economic alternative to tendering (the “Just Say No” defense).

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 In refusing to redeem a shareholder rights plan in the face of an unsolicited takeover bid, (i) the board must have “reasonable grounds for believing that a danger to corporate policy and effectiveness [exists]” and (ii) the rights plan must be “reasonable in relation to the threat posed.
Unocal Corporation v. Mesa Petroleum Co. Facts: Chancery Court granted a preliminary injunction to the plaintiffs, Mesa, enjoining an exchange offer of the defendant, Unocal, for its own stock in response to an unwanted tender offer for Unocal‟s stock made by Mesa. The court concluded that a selective exchange offer, excluding Mesa, was legally impermissible. On appeal the issue was whether Unocal‟s board of directors had the power and duty to oppose a takeover threat it reasonably perceived as being harmful to the corporate enterprise, and, if so, whether the action taken was entitled to protection of business judgment rule. Holding: The court held that there was directorial power to oppose plaintiffs' tender offer and to undertake a selective stock exchange made in good faith and upon a reasonable investigation pursuant to a clear duty to protect the corporate enterprise. The court further held that the repurchase plan chosen by defendant was reasonable in relation to the perceived threat and was entitled to be measured by business judgment rule. Reasoning: When corporate board addresses a pending takeover bid it has an obligation to determine whether the offer is in the best interests of the corporation and its shareholders. In that respect a board's duty is no different from any other responsibility it shoulders, and its decisions should be no less entitled to the respect they otherwise would be accorded in the realm of business judgment. There is an enhanced duty, which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred. There is an inherent danger in the purchase of shares with corporate funds to remove a threat to corporate policy when a threat to control is involved. The directors are of necessity confronted with a conflict of interest, and an objective decision is difficult. In the face of this inherent conflict directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person's stock ownership. However, they satisfy that burden by showing good faith and reasonable investigation. Furthermore, such proof is materially enhanced by the approval of a board comprised of a majority of outside independent directors who have acted in accordance with the foregoing standards. If a defensive measure is to come within the ambit of the business judgment rule, it must be reasonable in relation to the threat posed. This entails an analysis by the directors of the nature of the takeover bid and its effect on the corporate enterprise.  A restriction placed upon a selective stock repurchase is that the directors may not have acted solely or primarily out of a desire to perpetuate themselves in office. To this is added the further caveat that inequitable action may not be taken under the guise of law. A defensive measure to thwart or impede a takeover must be motivated by a good faith concern for the welfare of the corporation and its stockholders, which in all circumstances must be free of any fraud or other misconduct.  Unless it is shown by a preponderance of the evidence that corporate directors' decisions were primarily based on perpetuating themselves in office, or some other breach of fiduciary duty such as fraud, overreaching, lack of good faith, or being uninformed, a court will not substitute its judgment for that of the board. Unitrin v. American General Corp. Facts: In response to a hostile bid from AmGen, the board of Unitrin refused to redeem a poison pill and commenced a share repurchase program for up to 10 million shares of its own stock. AmGen filed suit to enjoin Unitrin from repurchasing its own stock. AmGen argued that Unitrin‟s repurchase of approximate 10% of its shares – increasing management‟s holdings to 28% - when combined with a poison pill plan and a supermajority voting provision requiring 75% approval of any merger with any more-than-15-percent shareholder, made a proxy contest untenable. The Chancery Court preliminarily enjoined defendants from making further repurchases on the ground that the repurchase program was a disproportionate response to the threat posed by AmGen‟s inadequate offer. Holding: The court determined that the Chancery Court incorrectly determined that the repurchase program was a disproportionate defensive response and incorrectly applied an erroneous legal standard of "necessity" to the repurchase program as a defensive response. Reasoning: Pursuant to the Unocal proportionality test, the nature of the threat associated with a particular hostile offer sets the parameters for the range of permissible defensive tactics. Accordingly, the purpose of enhanced judicial scrutiny is to determine whether the board acted reasonably in relation to the threat which a particular bid allegedly poses to stockholder interests. A court applying enhanced judicial scrutiny should be deciding whether the directors made a reasonable decision, not a perfect decision. If a board selected one of several reasonable alternatives, a court should not second-guess that choice even though it might have decided otherwise or subsequent events may have cast doubt on the board's determination. Thus, courts will not substitute their business judgment for that of the directors, but will determine if the directors' decision was, on balance, within a range of reasonableness.

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 In assessing a challenge to defensive actions by a target corporation's board of directors in a

A board may reasonably consider the basic stockholder interests at stake, including those of short-term speculators, whose actions may have fueled the coercive aspect of the offer at the expense of the long-term investor.
takeover context, the Court of Chancery should evaluate the board's overall response, including the justification for each contested defensive measure, and the results achieved thereby

Moran v. Household International, Inc. Facts: Directors of Household voted to institute a preferred share purchase rights plan designed to defend the corporation from any future hostile takeover. Household‟s directors adopted the plan after becoming concerned about the corporation's vulnerability in the takeover context. One dissenting director brought suit challenging that the plan was legitimate exercise of directors‟ business judgment. Holding: The court held that the board, in adopting the plan, was properly concerned with the coercive nature of potential front-loaded tender offers and the effect bust-up takeovers could have on company morale. The preferred share purchase rights plan, the court concluded, was a reasonable response to these threats because it established the board‟s preeminent negotiating position. Reasoning: Pre-planning for the contingency of a hostile takeover might reduce the risk that, under the pressure of a takeover bid, management will fail to exercise reasonable judgment. In reviewing a preplanned defensive mechanism it is even more appropriate to apply the business judgment rule.

iv. Revlon Duties  Enhanced Unocal Duties in Sale or Change of Control  Delaware courts adopted an additional standard for board conduct in connection with a sale or contest for corporate control.  If a “sale” or “breakup” of a corporation becomes “inevitable,” the board's duty changes “from the preservation of [the corporation] as a corporate entity to the maximization of the company's value at a sale for the stockholders' benefit.”  The directors' role is changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.  Basis for the Revlon Duties  Such transactions frequently have a negative effect on shareholder voting rights.  The transaction typically results in the sale and loss of the shareholders' control premium.  A control premium recognizes not only the value of a control block of shares, but also compensates the shareholders for their loss of voting power. Once control has shifted in a sale or change of control transaction, the resulting minority stockholders will have no ability to demand another control premium. Therefore, the directors are obliged to "take the maximum advantage of the current opportunity to realize for the stockholders the best value reasonably available."  When the Revlon Duties Are Triggered  Delaware courts have indicated two circumstances may implicate a duty under Revlon to conduct an auction:  (i) when a corporation “initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear breakup of the company;” and  (ii) when in response to a bidder's offer, a corporation “abandons its long-term strategy and seeks an alternative transaction also involving the breakup of the company.”  When Revlon responsibilities attach, the burden is on the board to prove its actions were reasonable. If the board proves that its actions were reasonable, the board then receives the protection of the presumptions of the business judgment rule.  If, however, the board cannot satisfy its Revlon duties, the court will review the transaction under the entire fairness standard.  When the decision of the board is tainted by self-interest, this duty of loyalty breach will rebut the presumption of propriety under the business judgment rule and the court will review the transaction under the entire fairness standard.

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 Further Refining When the Revlon Duties Are Triggered  Delaware courts clarified that the duty to seek “best value” – the Revlon auction duty – arises not only when (i) the company initiates a bidding process or when (ii) its breakup is inevitable, but also when (iii) there will be a change in control.  “There are few events that have a more significant impact on the stockholders than a sale of control or a corporate breakup. Each event represents a fundamental (and perhaps irrevocable) change in the nature of the corporate enterprise from a practical standpoint. It is the significance of each of these events that justifies: (a) focusing on the directors' obligation to seek the best value reasonably available to the stockholders; and (b) requiring a close scrutiny of board action which could be contrary to the stockholders' interests.”  If a corporate board of director's reaction to a hostile tender offer is found to constitute only a defensive response and not an abandonment of the corporation's continued existence, duties under Revlon are not triggered, though duties under Unocal do attach.  Duties will not be applied to corporate transactions simply because they might be construed as putting a corporation either "in play" or "up for sale.  Revlon duties do not apply to a board actively engaged in a merger or sale where control is passed from one fluid aggregation of unaffiliated stockholders to another, thus not concentrating voting power and control in the hands of an individual or single entity.  Maximizing Shareholder Value  When a board approves a transaction that results in a change of corporate control, such that the stockholders are no longer able to participate in a change of control premium, the board is obligated exclusively to reasonably and in good faith maximize the company‟s value by securing the best available price for shareholders  A board that takes action to favor one bidder over another in such a way as to retard an active bidding contest has not acted reasonably and has breached its duty to maximize immediate shareholder value.  The Revlon duty “requires the board to act reasonably, by undertaking a logically sound process to get the best deal that is reasonably attainable,” but “does not…require every board to follow a judicially prescribed checklist of sales activities.”  Deal Protection Mechanisms under Revlon  Lock-up Agreements.  Revlon distinguishes the potentially valid uses of a lockup from those that are impermissible: While those lock-ups which draw bidders into a battle benefit shareholders, similar measures which end an active auction and foreclose further bidding operate to the shareholders detriment.  Even f the lockup is permissible, when it involves "crown jewel" assets careful board scrutiny attends the decision. When the intended effect is to end an active auction, at the very least the independent members of the board must attempt to negotiate alternative bids before granting such a significant concession.  No-Shop Provisions.  The use of a no-shop clause is even more limited than a lockup agreement. Absent a material advantage to the stockholders from the terms or structure of a bid that is contingent on a no-shop clause, a successful bidder imposing such a condition must be prepared to survive the careful scrutiny which that concession demands.
Revlon, Inc. v. MacAndrews & Forbes Holdings Facts: Plaintiff shareholders brought an action against defendant directors due to irregularities of a corporate auction. Essentially, plaintiffs moved for an injunction to bar Forstmann Little from engaging in deals with Revlon in the form of options, the sale of assets, and exclusive dealing provisions. The trial court granted the injunction on the grounds that defendants had breached their duty of care by entering into such transactions, thus ending an active auction for the company. Essentially, the breach occurred because defendants made concessions to the third-party corporation, rather than maximizing the sale price of the company for the stockholders' benefit. Holding: The Delaware Supreme Court affirmed, holding that defendants allowed considerations other than maximizing shareholder profit to affect their judgment.

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Reasoning: When exercising power in an effort to forestall a hostile takeover, the board's actions are strictly held to the fiduciary standards outlined in Unocal. These standards require the directors to determine the best interests of the corporation and its stockholders, and impose an enhanced duty to abjure any action that is motivated by considerations other than a good faith concern for such interests. In a takeover situation, a board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders. However, such concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder. When a board ends an intense bidding contest on an insubstantial basis, and where a significant by-product of that action is to protect the directors against a perceived threat of personal liability for consequences stemming from the adoption of previous defensive measures, the action cannot withstand the enhanced scrutiny that it required of director conduct. Favoritism for a white night, to the total exclusion of a hostile bidder, might be justifiable when the latter's offer adversely affects shareholder interests, but when bidders make relatively similar offers, or dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced duties by playing favorites with the contending factions. Market forces must be allowed to operate freely to bring the target's shareholders the best price available for their equity.  While concern for various corporate constituencies is proper when addressing a takeover threat, that principle is limited by the requirement that there be some rationally related benefit accruing to the stockholders.  Lock-ups and related agreements are permitted under Delaware law where their adoption is untainted by director interest or other breaches of fiduciary duty Mills Acquisition Co. v. MacMillan, Inc. Facts: When Mills sought control of MacMillan, McMillan's board of directors granted an asset option agreement – a lockup agreement – to rival bidder KKR. The rival bidder was the purported high bidder in an auction for control of MacMillan. Mills contended that MacMillan should be enjoined from entering into the lockup agreement. Holding: the court held that the record before the trial court indicated breaches of the duties of loyalty and care by various of defendant's corporate fiduciaries, which adversely affected the general interest of defendant's stockholders, therefore the lockup option could not stand. Additionally, it was not shown that defendant's directors met the standard of intrinsic fairness, the trial court erred in not applying this standard, and the auction was found insupportable under Delaware law. Reasoning: Revlon requires the most scrupulous adherence to ordinary standards of fairness in the interest of promoting the highest values reasonably attainable for the stockholders' benefit. When conducting an auction for the sale of corporate control, this concept of fairness must be viewed solely from the standpoint of advancing general, rather than individual, shareholder interests. When a court reviews a board action, challenged as a breach of duty, it should decline to evaluate the wisdom and merits of a business decision unless sufficient facts are alleged with particularity, or the record otherwise demonstrates, that the decision was not the product of an informed, disinterested, and independent board. Yet, this judicial reluctance to assess the merits of a business decision ends in the face of illicit manipulation of a board's deliberative processes by self-interested corporate fiduciaries. In such a context, the challenged transaction must withstand rigorous judicial scrutiny under the exacting standards of entire fairness. At a minimum, Revlon requires that there be the most scrupulous adherence to ordinary principles of fairness in the sense that stockholder interests are enhanced, rather than diminished, in the conduct of an auction for the sale of corporate control. This is so whether the "sale" takes the form of an active auction, a management buyout, or a "restructuring." Under these special circumstances the duties of the board are "significantly altered." The defensive aspects of Unocal no longer apply. The sole responsibility of the directors in such a sale is for the shareholders' benefit. The board may not allow any impermissible influence, inconsistent with the best interests of the shareholders, to alter the strict fulfillment of these duties. Clearly, this requires the intense scrutiny and participation of the independent directors, whose conduct comports with the standards of independence.  While a board of directors may rely in good faith upon information, opinions, reports or statements presented by corporate officers, employees and experts selected with reasonable care, Del. § 141(e), it may not avoid its active and direct duty of oversight in a matter as significant as the sale of corporate control.  The conduct of a corporate auction is a complex undertaking both in its design and execution. The court does not intend to limit the broad negotiating authority of the directors to achieve the best price available to the stockholders. To properly secure that end may require the board to invoke a panoply of devices, and the giving or receiving of concessions that may benefit one bidder over another. But when that happens, there must be a rational basis for the action such that the interests of the stockholders are manifestly the board's paramount objective.

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 The latitude a board will have in responding to differing bids to buy the corporation will vary

according to the degree of benefit or detriment to the shareholders' general interests that the amount or terms of the bids pose.

Paramount Communications, Inc. v. Time, Inc. Facts: Plaintiff shareholders filed suits against Time seeking a preliminary injunction to halt defendant's tender offer for 51% of Warner in preparation of a merger. Plaintiffs argued that Paramount‟s uninvited all-cash, all-shares, "fully negotiable" offer for Time triggered duties under Unocal, and that Time's board of directors, by not responding to Paramount's offer, breached those duties. As a consequence, plaintiffs argue that in the review of Time board's decision to enter into a revised merger agreement with Warner, Time is not entitled to the benefit and protection of the business judgment rule. Plaintiffs also argued that the original Time-Warner merger agreement resulted in a change of control which effectively put Time up for sale, thereby triggering Revlon duties. Those plaintiffs argue that Time's board breached its Revlon duties by failing, in the face of the change of control, to maximize shareholder value in the immediate term. Holding: The court held that Paramount's tender offer was reasonably perceived by Time's board to pose a threat to Time and that the Time board's "response" to that threat was, under the circumstances, reasonable and proportionate. Applying Unocal, the court rejected the argument that the only corporate threat posed by an all-shares, all-cash tender offer is the possibility of inadequate value. The court also held that Time's board did not by entering into its initial merger agreement with Warner come under a Revlon duty either to auction the company or to maximize short-term shareholder value, notwithstanding the unequal share exchange. Therefore, the Time board's original plan of merger with Warner was subject only to a business judgment rule analysis. Reasoning: Delaware law imposes on a corporate board of directors the duty to manage the business and affairs of the corporation. This broad mandate includes a conferred authority to set a corporate course of action, including time frame, designed to enhance corporate profitability. Thus, the question of long-term versus short-term values is largely irrelevant because directors, generally, are obliged to charter a course for a corporation which is in its best interest without regard to a fixed investment horizon. Absent a limited set of circumstances, a board of directors, while always required to act in an informed manner, is not under any per se duty to maximize shareholder value in the short term, even in the context of a takeover. If a corporate board of director's reaction to a hostile tender offer is found to constitute only a defensive response and not an abandonment of the corporation's continued existence, duties under Revlon are not triggered, though duties under Unocal do attach.  The fiduciary duty to manage a corporate enterprise includes the selection of a time frame for achievement of corporate goals. That duty may not be delegated to the stockholders. Directors are not obliged to abandon a deliberately conceived corporate plan for a short-term shareholder profit unless there is clearly no basis to sustain the corporate strategy.  Precepts underlying the business judgment rule militate against a court's engaging in the process of attempting to appraise and evaluate the relative merits of a long-term versus a short-term investment goal for shareholders. To engage in such an exercise is a distortion of the Unocal process and, in particular, the application of the second part of Unocal's test. Paramount Communications, Inc. v. QVC Network, Inc. Facts: Paramount and Viacom entered into negotiations for Viacom to purchase controlling stock in Paramount. QVC then made an unsolicited tender offer that eventually exceeded the Viacom's final offer by over $ 1 billion. Due to a "no-shop" defensive provision in the agreement between Paramount and Viacom, however, the Paramount's board declined to enter into negotiations with QVC. QVC sought and received a preliminary injunction to prevent use of the "no-shop" and other defensive provisions, including a termination fee and a stock option agreement greatly favoring Viacom. Holding: On appeal, the injunction was affirmed. First, the court applied enhanced scrutiny to the sale of control transaction, rejecting defendants' contention that a "break-up" of the corporation to be sold was required before such scrutiny applied. Second, the target's directors breached their fiduciary duty by failing to adequately consider which tender offer was best for the stockholder; the defensive provisions could not alter this duty. Reasoning: In pursuing the objective of securing the transaction offering the best value reasonably available for the stockholders in the sale of control context, the directors must be especially diligent. The board must be adequately informed in negotiating a sale of control: The need for adequate information is central to the enlightened evaluation of a transaction that a board must make. This requirement is consistent with the general principle that directors have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Moreover, the role of outside, independent directors becomes particularly important because of the magnitude of a sale of control transaction and the possibility, in certain cases, that management may not necessarily be impartial. In determining which sale of control alternative provides the best value for the stockholders, a board of

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directors is not limited to considering only the amount of cash involved, and is not required to ignore totally its view of the future value of a strategic alliance. Instead, the entire situation should be analyzed, and the consideration being offered should be evaluated in a disciplined manner. Where stock or other non-cash consideration is involved, the board should try to quantify its value, if feasible, to achieve an objective comparison of the alternatives. In addition, the board may assess a variety of practical considerations relating to each alternative including: an offer's fairness and feasibility; the proposed or actual financing for the offer, and the consequences of that financing; questions of illegality; the risk of non-consummation; the bidder's identity, prior background and other business venture experiences; and the bidder's business plans for the corporation and their effects on stockholder interests.  The consequences of a sale of control impose special obligations on the directors of a corporation. In particular, they have the obligation of acting reasonably to seek the transaction offering the best value reasonably available to the stockholders. The courts will apply enhanced scrutiny to ensure that the directors have acted reasonably.  It is not required that a corporate "break-up" must be present and inevitable in a sale of control transaction before directors are subject to enhanced judicial scrutiny and are required to pursue a transaction that is calculated to produce the best value reasonably available to the stockholders. When bidders make relatively similar offers, or dissolution of the company becomes inevitable, the directors cannot fulfill their enhanced Unocal duties by playing favorites with the contending factions. Revlon thus does not hold that an inevitable dissolution or "break-up" is necessary.  The Macmillan decision articulates a specific two-part test for analyzing board action where competing bidders are not treated equally: In the face of disparate treatment, the trial court must first examine whether the directors properly perceived that shareholder interests were enhanced. In any event the board's action must be reasonable in relation to the advantage sought to be achieved, or conversely, to the threat which a particular bid allegedly poses to stockholder interests. Before this test is invoked, the plaintiff must show, and the trial court must find, that the directors of the target company treated one or more of the respective bidders on unequal terms.

v. State Antitakeover Statutes  Delaware Statute  In 1988 Delaware passed a moratorium statute applicable to all public corporations incorporated in Delaware Del. § 203.  Under the statute, any person who acquires 15% or more of a Delaware corporation‟s stock – an “interested stockholder” – is disabled for the next three years from effecting any merger or business combination, unless either:  The board of directors approved the combination before the triggering 15% acquisition, or  The interested shareholder crosses the 15% threshold in a transaction (tender offer) in which it acquires at least 85% of the company‟s stock, presumably at a highly favorable price – the 85% excludes shares held by management and management controlled ESOPs; or  The business combination is approved by the board and two-thirds of the shares held by other shareholders.  Evading the Antitakeover Statute  The Delaware statute can be avoided in a number of ways.  The statute specifies the bidder can:  (i) Negotiate a deal with incumbent management;  (ii) Make an attractive tender offer for 85% of the company‟s stock;  (iii) Propose a back-end transaction that will gain two-thirds minority support; or  (iv) Simply wait out the three-year moratorium.  Bidder can also mount a proxy contest for board control and, if successful, have the new board approve the bidder‟s proposed business combination.  The statute is not mandatory, and a corporation can opt out of it in its original certificate or by amendment, subject to a one-year waiting period.

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