CORPORATIONS NOTES

CORPORATIONS Midterm – Counts if it helps you, 20%, 1 essay. Class 2: 258-275 How to incorporate What Type of Corporation? (1) (2) Joint Venture (aka GP) two or more people coming together for a specific business purpose. Where? If Closely held – in state where operations are. If Public: Delaware (Because laws are friendly to businesses and management). California is very pro-stockholder. Can also incorporate in multiple states if doing business in many states. Documents Required to Charter: (1) Articles of Incorporation – five mandatory items: Must be filed with Secretary of State. (A) Name of Corporation (B) Purpose Clause – General or Specific Purpose Clause. Can limit what the C-corp is allowed to do. (C) Agent for Service of Process, often attorney. (D) Capitalization – one or more classes of stock and enumerated rights and powers. Can include anti-dilution clauses and pre-emptive rights. How many shares in each class? More than 500,000 shares in articles means a little extra fee at Secretary of State. (E) Execution by incorporator. individual or another business association. Other possibilities: (F) Duration – Unlimited unless specifically limited. (G) Limitations on Liability – Thou shall not sue the board of directors for due care. Two criteria: (1) Due Care (make informed decisions) (2) Fiduciary duty to shareholders, i.e. no conflicts of interest. Directors still liable for lack of due care or fiduciary duty to the stockholders. (2) Bylaws (A) Not a public Document (B) Determine how corporation is run (C )Normally stockholders can amend without board approval. (D) Mandatory Provisions: Stages of changing an Article of Incorporation Filing (A) Class 3: 275-284 Ultra Vires: Latin for "beyond powers," in the law of corporations, referring to acts of a corporation and/or its officers outside the powers and/or authority allowed a corporation by law. Really only used if there is (1) a specific purpose clause or (2) charitable donations by corporation Public documents give constructive notice. Amending the Articles of Incorporation: (1) Directors decide, then take to shareholders (2) Shareholder‟s vote In general stock holder‟s cannot manage directly, with several exceptions. Can become active by: Being a member of the board of Directors. How to Incorporate Being a Promoter Class 4: What Happens if you make a mistake forming a corporation Actions Against Shareholders: Directors have: Duty of Due Care and Duty of Loyalty Ultra Vires Actions 2 Types of Closely Held Corps: (1) Non Statutory Closely Held Corps A few stockholders and stock is not publicly traded (less than 70 or 80). Common stock holders have no voting rights. Board of Dir. And Officers (2) Statutory Closely Held Corps No more than 35 stockholders Stock is not publicly traded Stockholders manage the corp. Provision in Articles of Incorporation (Optional Provision #6): “This is a Close Corporation” Promoters & Premature Commencement: Sign on behalf of company before company formed (premature commencement, which is sometimes necessary): Promoter Definition: A person who gets a corporation going by entering into K’s prior to articles becoming effective. General Rule: (A)Co-Promoters (partners in a JV prior to effective date of incorporation) are jointly and severally liable under partnership law. (B)Jointly and Severally liable with subsequently formed corp unless: Can Get away from liability by: (1) Not putting name on the K. TIP: sign NAME, AGENT. (2) Put in K that the 3rd party is not looking to me to pay up, rather is looking to the corp once it is formed. “Party B shall look to corp for fulfillment of all liabilities and not promoter, and shall sign a novation agreement to this effect.” Promoter Pre-Incorporation Contract Liability: Previous to the valid date of articles of incorporation. Is corporation automatically liable for promoter’s contracts: NO. The public policy is to avoid fraud. **Corporation must adopt through Director’s or Stockholder’s if closely held, the K’s entered into by Promoters. If corp. adopts K, promoter still on K. Promoter needs to get a Novation with all three parties signing the document. Defective Incorporation: (Robertson Case P. 297) Generally: If you have a valid corporation stockholders are protected from personal liability. There is a cause of action for defective incorporation (used when someone enters into a K on behalf of corp. that is not effective). Two Jurisdictional views: (1) MBCA: not valid incorporation until the stamp date of the certificate of incorporation. Stockholders, officers and directors personally liable prior to stamp date. (2) NON MBCA: Three defenses for defective incorporation: No brightline Test: 3 defenses in order of preference: (1) Du Jurey: substantial compliance with all substantial conditions precedent. i.e. all mandatory provisions in articles, filed and received by sec. of state, all fees paid. Must be in substantial compliance, i.e. if there is a typo and it is material not in substantial compliance. If proved then no one can challenge corporate form (2) De Facto: two reqs: (a) Good faith attempt to comply (b) Corporation was acting like a corporation. K signed under corporate name. Good against all third parties, but not against sec. of state. (3) Estoppel: Frontier Case. 3rd Party should have known that: (a) There is a holding out of the corporate form (b) The third party relied on the corporate form. Only works against a single third party. (3) Distinction between active and passive stockholders. Passive should not solicit investors or make management decisions. You vote and take dividends and that’s it. Piercing the Corporate Veil – P.315 When filing a cause of action, try to do this. Consider Jurisdiction: MBCA or NON-MBCA Consider Stamp Date on Articles of Incorporation Consider who the active stockholders are Non-MBCA Jurisdiction: Stockholders will argue: Du-Juri: Was there substantial compliance by date of act or omission from which claim occurs. De Facto – See if they always sign as corporate officer. Estoppel MBCA jurisdiction: Sometimes Secretary of State stamps and certifies articles of incorporation that are wrong. This is still conclusive evidence of a corporation. Disregard of the Corporate Entity: A Parent Company = Owns at least 50% of another company. Subsidiary – owned at least 50% by another company. When trying to pierce the corporate veil, follow the money. Reasons the corporate veil may be pierced: When injustices and inequitable consequences are indicated if not pierced. Fraud – they are not really acting like a corporation, i.e. using the corp. like a private piggy bank. Undercapitalization Both initial and continuing, test: (1) Type of business (2) Foreseeable Risk (3) Reasonable Expenses Failure to observe corporate formalities Lack of stockholder meetings No Corporate Books Election of directors once a year Use or corporate property for non corporate purposes is evidence of corporate alter ego. Non Statutory: Same Directors and Officers and offices between a parent and subsidiary company. Really same business. Same books is also terrible. Same bank account terrible Absence of corporate records Payment of the corp of individual obligations, or Use of the corporation to promote fraud, injustice or illegalities Personal guarantee by officers or stockholders of loans is contractual and cannot impose tort liability. Minimization of risk strategies: Setup several corporations with segregated assets Plaintiff‟s lawyers will argue that all companies are the same for practical purposes. Skewer together and BBQ, oh yeah! Known as Enterprise Liability Theory. Really horizontal piercing Plaintiff‟s lawyers will also try and pierce vertically to get at personal owners. Capitalization – aka managing investors 5 Areas: (1) Rights of Classes 3 Basic Rights (unless articles say differently): (1) Right to vote (2) right to dividends (3) right to assets upon liquidation Issuance of Shares: Common Stock Preferred Stock Usually takes dividends first. Check articles to see if there is a dividend preference. Usually put in percentage terms. Sometimes has a guaranteed dividend, needs to be in the bylaws. Perhaps a liquidation preference However, if nothing stated different, then same rights as common stock. Rights to ask for: Cumulative Dividend Preference. If funds available, then dividend mandatory. If funds not available, then right snowballs and rolls over, becoming cumulative. Redemption Rights Corp can buy stock thru repurchase or redemption Redemption is may be at corporation or stockholder’s prerogative. Legal Consideration for Stock Cause of action for invalid consideration. Stockholder A could sue Stockholder B to pay up. Creditors could sue to try and recoup some money. Remedies: Stock purchased for not enough cancelled. Or Have person pay up. Qualitative Test: Whatever is given must equal # of shares times Par Value. Cash Not enough cash means “discount stock” Property Real or Personal Not enough means “watered stock” Services Rendered (must be rendered) Same as Property A Promissory Note Many jurisdictions, except AZ require it to be secured. This is why stock options / warrants are used as consideration for new officers of the company. Giving stock doesn’t pass legal consideration, it would be a gift. Quantitative Test: “Enough” must be paid. This is Par Value If don’t meet might be Discount, Watered (not paid enough), or Bonus stock. Section 5 of the 1933 Act says if you are going to sell stock you had better disclose: (1) Register (2) Find Exemption Two Jurisdictions dealing with this: (1) Good Faith Jurisdiction. Meeting Quantitative test is good enough. (2) True Value (cuts no slack, can’t be a penny off). Subscription Agreements Conditions Precedent & Capital Calls Employees Give options or warrants so that there is adequate legal consideration of “Services Rendered” for the stock when it vests. (2) Adequate consideration for stock (3) Investment K’s Regulated by SEC, under section 5, unless can find an exemption. Section 10(b)(5) deals with Fraud. Puts, Calls, Futures, Profit Participations (does the GoDigital K qualify?), franchises (if not carefull). Elements of An Investment Contract: (1) Must show money or legal consideration invested (2) Two or more investors that are similarly situated. (3) Expectation of profit (4) Investors are passive (relying on the efforts of others). How do you make a franchise not an investment contract? Make investor‟s active, by giving franchisee input on certain things. Pyramid Scheme‟s Test: Conditions for an investment K, and test: (1) an investment of money, in (2) a common enterprise with profits to come solely from the efforts of others. (4) Redemptions and Repurchases (5) Pre-Emptive Rights Parent Companies: Own at least 50% of a subsidiary corporation. Can have a second level piercing from subsidiary to parent to Directors. Limited Partnerships General Partners manage Often times a corporation. Limited Partners Invest. Passive by definition, with few exceptions. No mention of units in the SEC code. Units are thereby considered an investment contract. Pre-Emptive Rights, Dilution and Recapitalization P.443 Stokes Case Pre-emptive rights no longer statutorily built in. Must be negotiated for. Dilution: The ability of the company to make mandatory assessments must be in the articles, under it‟s own separate provision or under the capitalization provision. Katsowitz Case P.454: Freeze out by dilution. However, it may violate director‟s fiduciary duty of loyalty to stockholders unless there is a bona fide reason. Must prove bad faith. Gottfried Case: Cause of action for lack of dividend payouts. Must Prove Bad Faith: Factors: Intense hostility of controlling faction against minority. High Salary or bonuses to officers. Fact that Majority group may be subject to high taxes if dividend paid. Note: If you are a stockholder and you want a dividend, ask for cumulative dividend preference before common stock, or a mandatory dividend. Also work in a “voting shift.” If a non-voting class is being denied dividends for a certain period of time, then that class gets the right to vote. Must be in articles. In a public company, board can refuse to declare a dividend if there is a business purpose. There a several jurisdictions that have opened up the possibility that Director‟s may have fiduciary duties to their community constituents. Stock Rights – Put in articles of incorporation. Dividends Mandatory Pre-Determined Amount Cumulative Redemptions (usually a corps right) When redemption called, it is mandatory. Always ask if a repurchase or a redemption, because it sets up different rights. Conversions (between common and preferred or debt and stock). Dilution Purchase Pre-Emption Additional issuance of stock Causes of Action: Lack of Adequate Consideration Pertains to initial distribution, see previous tests. Are pre-incorporation services adequate legal consideration: No, because services where rendered to a joint venture because the biz was not incorporated. Two kinds of stock (on exam): Par Value No Par Stated Value Stock: “No Par, Stated Value” Preferable because directors can state the value later on in the corporate records. Number of shares issued must still meet sum divided by par value. If not a cash transaction, property or services rendered must be valued by the board. Two Jurisdictional tests (see above): Good Faith Fair Value If fail these tests will have discount or watered stock. Who are we going to sue? Stockholder. All stock will be cancelled only if qualitative test failed. Suing on Pre-Emptive Right Can sue on only if express. Bad Faith and breach of fiduciary duty (and the duty of loyalty). Unregistered Profit Participation (aka Investment) Contracts: Four Prongs under Sec. 5. of 1933 SEC act. 1. Consideration needs to be paid 2. Group of people in common enterprise 3. Profit Participation Rights 4. Investors relying on managerial efforts of others. Possible Investment Contracts: Club Membership (get around by being non-transferable, because then can‟t sell and realize a profit). CA Securities “Blue Sky” Laws Much broader in definitions of investment contracts than Federal. “Any Capital put at risk” may be enough for an investment contract. If an investment contract, must be registered or find an exemption. Lack of Dividend Payment Depends on type of corporation If Publicly held: Lack of business purpose If closely held, must prove bad faith Godfried Case. Showing of intense hostility towards stockholders not getting the dividends. Distribution of corporate funds: Three ways, (1) Dividends (2) Redemptions “Mandatory” May pay out dividends if company wants to get rid of a class of shareholders Must be notice in Articles. (3) Repurchase – “The may I situation” CAUSE OF ACTION TESTS: The cause of action for all three is “was that distribution legal?” See legality chart handout. Two tests, both must be met: (1) Proper Source – 4 proper sources, 1. Paid in surplus (aka capital surplus) If stock sold for more than par value then we have paid in surplus. By law par value amount has to go into stated capital (stated capital is a reserve that must be kept to stay out of insolvency, never used for dividends and only for redemption in extreme circumstances)). The premium of the sale price over par is surplus and can be paid back in dividends. Can only use stated capital for redemption if there are cumulative dividend preferences owed and the company is sliding towards bankruptcy, can use stated capital to pay off dividends owing so they can attract new capital. 2. Earned Surplus (aka retained earnings). Making money and keeping it in corporation. 3. (2) Solvency Assets > Liabilities Must be able to pay debts as they come due. If Can’t sue on dividends per section above: Sue Directors or people who received dividends Statutory Closely Held Corporation: Defined in statute. Possibility that stockholders can manage directly. Stock not closely held Common Law Closely Held Corporation Up to about 80 stockholders Managed By Board of Directors and Officers. Certificate of Determination Found in capitalization provision “rights privileges and preferences or a class of stock listed in another doc other than articles” Lends flexibility Poison Pill: anti-takeover provision. Problems assigned 14-17. Angel Companies: Tech Coast Angels, Cal Coast Angels, Kieretsu MANAGEMENT: The Role of Officers, Managers and Stockholders Common Law Closely Held Corporation: Run by BOD and Officers (elected by BOD) Stockholders can vote on items that are: (1) Extraordinary Board of Directors Amend Articles and Bylaws Mergers (A+B=A) Consolidations: (A+B=C) Dissolution and Liquidation Stockholder agreements as to ordinary matters in a common law closely held corp are void. Directors Vote on items that are: (2) Ordinary Dividends Contracts Statutory Closely Held Corporations: Operate like a partnership – i.e. stockholder managed. State in Articles, this is a Close Corporation Easier to pierce the corporate veil. Hybrid Corporations Stockholders can directly manage on some issues and Directors manage on others. Set forth in contract in bylaws or separate agreement. Limited Liability Company Membership Interests may not be regulated by the SEC because not “stock” unless it is an investment contract. LLC‟s can be managed by partnerships. The Members manage. They should manage equally to avoid the security‟s laws (avoid #4 under investment contract laws). If not managed equally, either must register with SEC or find an exemption. Tax: taxed like a partnership. Many Members Allowed. Stockholder Meetings Always ask “Is the meeting valid?” If not decisions invalid. 4 Requirements (1) Notice (not less than 10 nor more than 60 days) (2) Quorum – Directors Meeting: Count heads. Stockholder meeting, count shares: Majority of outstanding voting shares present in person or proxie (written consent). (3) Record Date: only owners as of record date on company‟s books can vote. However, can get a proxie from the seller. (4) The matters to be voted on are proper” (a) Extraordinary (if close corp). (b) If Everything is managed by members / stockholders, then anything (c) If one item wrong, then a majority of jurisdictions invalidate that one item. Stockholders can vote by written consent (i.e. without holding a physical meeting). Electing directors requires unanimous written consent. Anything else is majority vote. There should be either 1 or 3 inspectors to count and certify votes. Types of Voting: Cumulative Voting (CA allows corps to elect this, unless more than 100 stockholders, then mandatory). Must give notice to secretary or election inspectors. Give minority the possibility to get at least one person on the board. Delaware. The people with the highest number of votes get on the board? 100/(x+1)+1 = % needed for minority stockholder to vote in at least one person. Mandatory cumulative Voting Jurisdictions: If there is mandatory cum. Voting in juris, there shall not be one director per class of stock. CA is mandatory. Discretionary Cumulative Voting Jurisdictions: Delaware. Corp. can decide if this right is vested in shareholders. If the right is vested in shareholders, corp cannot destroy that right. Stockholders can also vote to remove a director. If removal without cause, there is a safety mechanism. The board must go to just the minority stockholders, and they can cumulate their votes against removal. Straight Voting: Majority shareholder has all control because will be able to vote everyone in to Board. Each Director gets to be voted on by each stockholder with all that holder‟s votes. Anti-Take over: Get rid of cumulative voting. Notice must always be given on matters to be voted on. Three types of boards of directors: Straight Boards Everyone elected each year. Classified Boards Classes of stockholders get to each elect a certain number of Directors periodically (can be staggered). Staggered Boards Only a portion comes up for election each year. Aggregating Minority Shareholders Pooling Agreements Loose confederation – can go off of script, tough to enforce. One Question of validity: must vote on proper matters (not extraordinary). Ringling Bros. Case – court tries to enforce. Enforcement: Cross Irrevocable Proxies – each party gives each other a proxy for consideration. Voting Trust Trustee aggregates and votes as a record owner, real owner as beneficial owner. Voting trustees may also collect dividends as the record owner – so should specify dividends paid to beneficiary owner. Must be written and filed with corporation (therefore open for review and inspection). (2) Separation of Title: The voting trustee has legal title and the original stockholder‟s are beneficiaries. Trustee must have the stock certificates issued in the voting trustee‟s name (must be legal owner of record). (3) Length of time not to exceed 10 years (4) Matters voted on must be fore a proper purpose. If one requirement not met, then the validity of the voting trust is void. Trustee‟s are fiduciaries. Voting trustee‟s can be liable for breaches of such fiduciary duties. Even thought they have the power to amend the articles they cannot do anything that would substantially harm the stockholders. 1) Stock Classes with just voting power is Ok 2) Stock with only dividend rights is OK 3) Stock with just liquidation right is OK. 4) At least one class must have voting rights. If you want to transfer stock and you find out it is encumbered by a provision of the bylaws, these restrictions must give adequate notice (by being filed in the articles), it should also be on the front of the stock certificate. Rule:(1) Must be conspicuous as to form (easily readable, probably a different bold type) and content (Lists triggering events). (2) Reasonable events: Pledge, death, mental incapacity, sale, bankruptcy, divorce. If one of these two things are missing the transfer is valid. Exception to test 1: Transferee has actual knowledge that stock is restricted. DIRECTOR MEETING REQUIREMENTS: (1) NOTICE: Director‟s must have notice of a meeting at least 24hrs ahead of time. Can be waived. (2) QUORUM must be present. Quorum is a majority of the originally authorized number of directors, or as set out in articles or bylaws. Not a majority of the remaining directors. (3) VALID VOTE: Is vote a majority of quorum or a majority of those that are present? Answer: Majority of those that are present. (4) Exception to Quorum: when it is impossible to get a quorum because of extraordinary circumstances. Can vote on replacement Director, unless the stockholders have to vote on this. (5) Written consent is another way for director‟s to decide on actions. Anything decided by written consent must be unanimous. Bylaws cannot generally modify this. Conference Calls: Just like having a regular meeting. McShaw Exception: Fact Situation from case: Director goes out and enters into a K without prior board approval. Is that K valid? Yes, if (1) it is a closely held corporation, and (2) all the director‟s after the fact approve with full actual knowledge, and (3) K cannot harm Corp or stockholders. If director is also wearing another hat (officer or stockholder) then… DEADLOCK (not on midterm) Grounds for corporate dissolution by corps. Stockholder deadlock that is causing irreparable harm. Court will look to equity. Statutory closely held corporation – it is much easier to show oppression and ask for involuntary dissolution because managed by stockholders. Grounds for majority to be forced to buy out minority by courts. Get court to appoint appraiser to value corporation and each shares portion. Court may appoint provisional directors. They are an officer of the court and must report to the court. Still owe duties of due care and loyalty to stockholders. Amending Bylaws and Articles are extraordinary matters that stockholders can do. Articles must first be amended by Directors. Amendments cannot substantially harm other stockholders. Always get a Director‟s resolution enabling the officer to do whatever business is being contemplated. Should be certified (sealed and signed and dated by Secretary). Authority of an officer under a false director‟s resolution is still valid and binding – unless either party knows of it‟s falsity. Powers of officers (on test): VP, Pres, Secretary, Treasurer: Usually have express authority from board. Sometimes has implied authority. I.e. if the president is incapacitated, then VP could step in and take on such responsibilities as Pres. Might have – but only ordinary day to day items. No extraordinary items. Fact pattern: Officer enters into K on behalf of Corp. Question: Did that officer have authority? If so, the corp is bound. President has implied authority. It is possible for VP, or treasurer or secretary to have implied authority when president is incapacitated. Express authority can be granted to any officer by board. Granted by certified resolution. Fact Pattern: If an officer enters into an unauthorized K, look to see if officer wears any other hat, i.e. a director. Look to see if consent in director‟s meeting. SAMPLE MIDTERM: Two people who have agreed to form a corp have automatically entered into a JV Promoters are personally liable for K‟s unless (1) sign K‟s as an agent and sign as an agent for the company and (2) the contracting party is expressly to look to corporation for satisfaction of K. There is a presumption against these two things. Contracting party could have actions for (1) defective incorporation (2 juris, MBCA and non) as well as (2) piercing the corporate veil (which concedes the corp exists). For (1): Stamp date. Errors in articles don‟t matter if stamped, because created presumption of ok. (2) De jure, De Facto, etc. Substantial Compliance with all conditions, articles files or sealed as of K date or tort date. Piercing the corporate veil action. TRANSACTIONS IN CONTROLLING SHARES Majority shareholder owes a duty of reasonable investigation and due care to the corporation. A sale of substantially all of the assets of a corporation is up to Stockholder vote. (ADD TO STOCKHOLDER RIGHTS) ANNUAL REPORTS: 10K – Annual Report - Reviewed by SEC then goes out to shareholders. MD & A – Discussion of risks. Hard and Soft information. If there is not disclosure, then liable for breach of duty of due care. Sec. 10(b)(5) False or misleading statements made in connection with the sale of a security. Treble damages available. 10-Q Quarterly 8-K – Unusual Events PROXY REGULATION (14(a) of the 1934 Act) Proxy = Any kind of solicitation of a vote. Applies to anyone who is soliciting, not just directors and officers. Applies to oral and written assertions. Personal liability applies. J.I. Case Co v. Borak. (On the test). P. 747. Sec. 14 of 1934 Act. – Purpose is to prevent management or others from obtaining authorization for corporate action by means of deceptive or inadequate disclosure in proxy solicitation. Private right of action for public to sue? Sec. 15 of 1933 Act. Proxy Solicitation: Anytime someone asks for a vote, they are soliciting a proxy and is under sec. 14(a)(9) of the 1933 Act. Test: (!) Material False and misleading statements are illegal in proxy solicitation. (2)Materiality test: Substantial likelihood a reasonable shareholder would find the fact important. Causation: (3) Essential Link Causation Test: Can only bring 14(a) action if vote needed to pass action. Exception: In real life, CEO‟s read from a script when giving shareholder‟s meeting, so no 14(A)(9) false or misleading statement is made in the solicitation of a vote. Company usually sends proxy to SEC for approval. SEC makes comments to the corporation. Hard and Soft Information: Most fraud occurs in dissemination of soft information (i.e. financial projections, or future opinions or asset appraisals). Sometimes in a merger with a dominant shareholder, the majority shareholder can vote to cash out the minority shareholders so they do not have an interest in the new company. STOCKHOLDER PROPOSALS: P. 781 four grounds when company may not accept to put stockholder proposals on the ballot. Sec. 14(A)(8) – KNOW CAUSE OF ACTION: If stockholder proposal is declined by the directors, then stockholder can bring this action.. Must have standing: own continuously for at least one year a certain amount of company, $2K or 1% of company. Test on Page 778. Company can decline proposal if: (1) If matter relates to an ordinary matter Exception to Ordinary Matters: If proposal relates to public policy it cannot be declined. (3) Any proposal regarding placing directors that does not come from the nominating committee. (4) Redress of a personal claim (5) Improper under state law (6) Illegal (7) Violation of Proxy Rules: material misstatement (8) Not relevant to Companies Business (9) Conflicts with management proposal (10) (11) (12) Already Substantially Implemented Duplication of a proposal. Resubmission Company must be publicly held. Two prong test: $10M or more dollars in assets and 500 or more shareholders in a voting class. OR, traded on a public exchange. Sec. 14(A)(9) – Know cause of action – Elements: (1) False or misleading statement or omission made in connection with a proxy solicitation. (2) Material ; substantial likely hold a reasonable person would find important. (3) Only simple negligence required (unknowing). (4) Causation – “Essential Link Test” whether minority action was needed. Exception: If you don‟t like the price of the stock you are given in a merger, you can walk into a state court and ask for an appraisal. State must have statute supporting 14(a)(9). One requirement: You must have voted against the merger, even if you don’t need to vote (majority owns at least 85%. Catch 22: If you are lied to you won’t know that you are getting a bad deal, so won’t know to vote against. SO, IF LIED TO CAN STILL SUE ON 14(A)(9) Publicly Held Corp definition: Exchanges have trading floors, with specialists, it is an auction. OTC exchanges match electronically (Nasdaq). More than 500 stockholders in a single voting class, or $10M in assets. DUE CARE 11/9 Summary: Stockholder derivative action. Must overcome Business Judgment Rule. Standard: Reasonable Prudent Person in similar circumstances. Duty to be informed. There should be the right consultant advising. Ie. Investment Banker like Hoolihan Lockey. Breach: Liable if there is gross negligence Causation: “But for” the decision losses would not have ensued Losses: Monetary and Goodwill. Defenses: Provision in the Articles. Relied on proper expert in good faith. Voted against it and say “let the minutes reflect I an dissenting on this matter.” I wasn’t there. Abstained and let the record reflect it. Stockholders do have the right to bring a derivative lawsuit. Compensation lawsuits are under Due Care Action comes up when there is business judgment is questioned (and there are losses). A reasonable prudent person standard applies. Not a “reasonable director” Requires gross negligence (willful). The business judgment Rule (know for test): Evidentiary Presumption that presumes that the Board of Director‟s are making their decisions with due care, good faith, and loyalty. State rule. Also causes of action for breach of good faith and loyalty or special action for injunctive relief for breach of due care. Defense 1: “The stockholder‟s accepted it” is not a defense if the stockholder‟s were not fully informed (including how a valuation was arrived at). Defense 2: Expert valuation. Only an investment banker can really be considered a valuation expert. Defense 3: Market Fixed the Price: Here the pritzker offer was made on a weekend so the market could not price the offer. There may be a duty to non-shareholder constituents. Van Gorkam Case P. 824, A reasonable prudent person standard applies. Not a “reasonable director” gross negligence (willful). Directors must be fully informed and able to do their due diligence. Requires Means unanimous written consent is not really an option. “Leveraged Buyout” – Use company‟s assets as collateral to get a loan to buyout a public company. Then make the business lean and mean by selling off the excess assets and then take public in a few years (again). Michael Milken would throw a party of people who wanted to take over companies and people who wanted to buy junk bonds. “Cash Out Merger” – Director‟s agree then take to stockholder‟s a proposal to have the minority shareholder‟s forcibly bought out and the majority voluntarily sell out to a third party company. Here, Proxy solicitation was made and due care was not exercised and so a section 14(a)(9) action is appropriate. Caused an exit from Delaware. PRACTICAL NOTE: You can now put a provision in articles that the board of director‟s shall not be liable for breach of due care for damages. 49 OF 50 States have this provision now. Does not protect against breach of good faith and loyalty. GOOD FAITH Caremark P.836 Suggests that Directors should set up a system by which they receive information from the ordinary activities of the company so they can be fully informed. Probably more of a duty on inside directors (also officers). Arising from Sarbanes Oxley. i.e. Duty to monitor and make sure that internal reporting / control procedures are adequate. There is a coming together of Fed and State law here. Biz. Judgment Rule is an additional layer of defense in state courts. Ovitz Eisner case: No math being done on Ovitz compensation package may be bad faith. LOYALTY – A fiduciary duty Summary: Identify the scenario Four Standard Ones: (1) Self Dealing Businesses Judgment Rule does not apply because it only applies to Board Decisions as a whole. Conflicting Compensation is here. Transaction voidable unless director can prove: (1) (2)- Impartial Stockholder Approval (3)… (2) Corporate Opportunity Director or Directors that are taking a business opportunity that is in the line of business of the corp they work for. Look for someone bringing the opportunity to the director. Is it within the current business of the corp or future expected business plan. If so, cannot take. Burden on director to show not in line. Remedy is a ‘constructive trust’ which takes the property from the Director. If Director knew was a corp opportunity and took anyways, then can also recover damages. Defenses: (1) Good Faith (best with outside directors) – Only good against damages, not constructive trust. (2) BOD prior approved with impartial vote with full knowledge. There is the temptation to say it is in the future plans of the company if it is a good opportunity. (3) After the fact approval from BOD. (4) Stockholder approval – impartial with full knowledge. Can only rely on if it is something stockholders can vote on (aka extraordinary) (5) Director says corp doesn’t have the money to take advantage of the opportunity. Worst defense. (6) Opportunity is Ultra Vires (equipment, expertise etc) Example: Director bought property in AZ, then corp decides it wants to buy property in AZ. Doesn’t tell BOD it had depreciated. Corp buys It (self dealing, transaction voidable). Then in self dealing again, the BOD buys his land again. Corporate Opportunity action. Corp can get constructive trust and damages. (3) Parent Subsidiary Non Merger Transaction (Sinclair Case) Minority shareholders suing the parent corporation and the board. Initial pleading burden on minority stockholders to show: that the parent received a benefit to the exclusion of and detriment to the minority shareholders of the subsidiary. Then the burden shifts to the parent to show there is intrinsic fairness in this situation. Then the BJR locks on and you can’t go anywhere with this. (4) Parent Subsidiary Merger Transaction. Minority Stockholders of the Sub being hurt. Board has burden to prove: (1) Fair Dealing (2) Fair Price Then BJR locks on There should always be a mergers and negotiations committee. May or may not fall under business judgement rule. This is different than making a poor decision because one didn‟t excercise due care. This is willful malice. Conflict of interest transactions / Self Dealing / Self Interested Transactions. Look for conflicted Director. Ex. Loan from corp to director so the director can buy stock in the company. Ex. Corp buys real estate from the director. How would this be prosecuted? Defense: Three Ways to deal with a conflict of interest: (1) Get majority board approval of transaction. Must be impartial and fully informed of transaction. You as a director can be counted for quorum but the vote cannot be counted. Unanimous Written Consent: Minority – Ok Majority - No (2) Get stockholder impartial approval with full disclosure. May be an ordinary matter that the stockholders can’t vote on. (3) Director proves the transaction is fair (in court). (Not covered by the BJ Rule because not board action) Fair means: Fair to stockholders. New Law: There must be a benefit to the stockholder. Majority Stockholder does not have a fiduciary due care duty, just loyalty because not in a management capacity. Sinclair Case P 938 – Duty of Loyalty Benefit flows to parent company who does not pay subsidiary. There is then a detriment to the stockholders of the subsidiary. “Intrinsically fair” is a term of art here. Minority shareholders of subsidiary may have a cause of action for breach of duty of loyalty in being unfair. BJR locks on after the board proves” intrinsic fairness.” ???? Weinburger Case P 940 Minority stockholders of the subsidiary are the plaintiffs. They must show two things to prove breach of duty of loyalty: (1) Lack of fair dealing (2) Lack of fair price. Board’s defense is to try and show that the deal was “entirely fair,” if they can show this, the business judgment rule will apply as an evidentiary presumption. Common Directors between parent and subsidiary will likely create a conflict of interest. Common director should abstain and independent directors make the decisions. A mergers and negotiations committee of independent directors should be appointed. Proper expert in merger is an investment banker. Should issue a “Fairness Opinion” Signal makes a tender offer to UOP’s stockholders to buy their shares to gain majority control. Then Signal intended to put directors on the board Then Signal intended to get a cash out merger approved. Conflict of interest occurred when they self evaluated the price of the stock and then the board agreed to a lower price (when the board was controlled by Sinclair) because they had not seen the feasibility study. Restates: Basically management didn’t negotiate and tell the stockholders in the proxy what the study said the price should be. (1) (2) (3) False and misleading statements or omissions. THE TREE: BUSINESS JUDGMENT RULE LOYALTY (6 TYPES OF ACTIONS) (1) Self Interest (2) Parent Sub Non Merger (Sinclair) (3) Parent Sub Merger (Weinberg) (4) Compensation (Can also be under Due Care) If board approves and there are losses, then there could be a derivative action for Due Care or Loyalty. 8 years ago SEC mandated public companies disclose executive pay packages. Malone P.851 Board has a duty of honesty, if not then not acting loyal. Board has a duty to act in the best interests of the shareholders No duty to speak. The “no comment” reply. Business Judgment Rule applies Federal and State cause of action. Gall v. Exxon Mobile BOD must make a decision of whether or not to sue itself for bribes made by a subsidiary company. When faced with the decision of whether or not to sue, must appoint a committee and use experts. Then the BOD has a defense that they relied on the right experts in good faith. Zapata Corp. V. Maldonado When director‟s made decision to not pursue a shareholder derivative action it must be made by independent directors. The court may act like the directors and look to see if a shareholder action should not be pursued based on public policy. Brehm v Eisner (Michael Ovitz Case) This is a due care cause of action because it is related to a decision of the board that causes losses. Here board went to compensation committee, who hires an expert in compensation. Won‟t win under due care because hired the best expert. May win under loyalty because there might be conflicts of interest (because the board members were all buddies of Eisner). May win under good faith. The Board Acts Through Committees: If NY stock exchange company, majority of board must be independent; all directors on the following committee must be independent: The Audit Committee SOX may require independence Corporate Governance / Nominating Committee. Makes sure best practices are followed in the corp. Monitors Directors and makes sure a good slate is up for election. Compensation Committee Biggest in terms of filing an action against right now Director and Executive Compensation Should determine exactly what officers are making with perks, bonus, stock options etc. Litigation Committee Merger Committee Elements of a Due Care cause of action. Standard of Care Breach Causation Losses If the decision has to do with litigation then look to see if „demand excused‟ or „ demand required‟ Elements of a Loyalty cause of action Same as above but no losses required. Bringing a stockholder derivative cause of action: (1) Determine if: Demand Required (if Board Truly Independent) Must bring to board first They must appoint a special litigation decision If board members are independent. Definition of Independent: Not financially beholden Possibly not friends Judge will look to ethical and commercially right thing to do when determining of a litigation committee’s move to dismiss is ok. Demand Excused (If Board not independent). Take to court first. (2) Post a Bond (3) Must have owned stock from the time the cause of action arose. Business Judgment Rule (Evidentiary Presumption) Due Care Derivative Action Business Judgement ? DEFENSES Right Experts Didn‟t vote (abstained), or voted against … INSIDER TRADING 10(b)(5) Self Trader (must be an insider to be nailed) Must be an insider Personal Benefit (financial or non) Tipper Must be an insider (directors, officers, controlling stockholders), or constructive insider, I,e, someone in a position of trust and confidentiality. Information must be material: There must be a substantial likelihood a reasonable person would find the information important. Tippee Derivative liability Tippee‟s Tipper must be an insider Tippee‟s Tipper… Tippee knows or should have known this is inside information, AND Tipper was breaching a fiduciary duty in passing on that information. Scientur – Willful intent to trade on information you believe is inside Reckless Disregard is also a possibility. Tippee trades and there is a financial benefit. Defenses There was adequate disclosure and adequate time to react. (10 minutes these days). Publicly held corps have black out rules now. I.e. earning press releases or 8K events. U.S. V. Chestman Rule 10(b)(5) Action Is there liability for someone way down in the chain of passing of insider information? Misappropriation Theory One who misappropriates nonpublic information in breach of a fiduciary duty and trades on that information to his own advantage violated § 10(b)(5). Tippee / Trader must know of the misappropriation. Fiduciary Relationship between Broker and Client. Only negligence must be proven. (“Shingle Theory”). No fiduciary relationship comes from familial relationships. Fiduciary Duty Relationships Broker Attorney or Accountant / Client (does not work if it is a company that the client is going to do a deal with). Doctor / Patient Priest Trustee Analysis: (1) Look for one of the traditional 3 categories, if can‟t get them there, go to: (2) Misappropriation analysis (3) Must be actual purchaser or Seller Basic Inc V. Levinson Preliminary Merger Negotiations. Elements of a 10(b)(5) Action Presumption of reliance by members of the plaintiff on defendants public statements. Actual purchaser or Seller Actual reliance Preliminary Merger Negotiations are only material if there are 2 things: (1) Price As a plaintiff reliance is proved if they say they relied on the price. (2)Structure What is the duty: Not to lie, i.e. no comment is ok. **New Test: The probability of this happening and the magnitude of the scenario. Unless Short Form Merger, magnitude will always be material. Side Note: Short Form Merger (85% of more of company owned by majority shareholder) 14(a)(9) Action Remedies: Monetary Damages and Loss of Goodwill 10(b)(5) SUMMARY: Insider Trading Look for false and misleading statements or omissions. Look for 10(b)(5) in a Merger Elements: (1) Proper plaintiffs are actual purchasers or actual sellers or SEC (2) Proper defendants are names with their self trader, tipper or tippee status delineated. (3) Tipper or Tippee must (1) be either a constructive (on test) or traditional insider and (2) there must be a benefit (always there). Constructive insider is person in position of trust or confidence. (4) Tippee liability: Tippee‟s Tipper must be insider and meet elements above as well as (3) have breached a fiduciary duty. (5) Put down what each Defendant‟s duty is. (6) Was the information material under 14(a)(9) that there is a substantial likelihood people would find material. (All info on test will be hard). (7) Was there reliance? Put down that there is a presumption of reliance. (8) Causation: There is a presumption that the tipee has used the inside information. (9) Scientur: Intel had this reform passed on Congress. Willful intent required, not just reckless disregard. Can you prove it circumstantially? Remedies: Treble Damages, Right of Rescission If cannot prove 10(b)(5) then go after Misappropriation. On test, but not for Tippee or remote Tippee liability. In Re Enron Corp, Derivative Action Proving Scientur: Can Collateral parties be liable and can circumstantial evidence prove Scientur?: Length of relationship How active in the corporation Were they professionals authoring or making statements on their own Under Sarbanes Oxley, an outside party that comes into Privity of information can be liable. SEC wants whistle blowing in exchange for immunity. This can be in conflict with the client attorney privilege. Yes Collateral Partners can be liable. Yes Circumstantial Evidence can prove Scientur. There is a cause of action for Client Abandonment. 16(b) CAUSE OF ACTION (Not on test) known as “Short Swing Profits” Insiders who purchase and trade in a 6 month period, in a publicly held corp, have strict liability (automatic conclusive presumption). “You have traded on insider information” The remedy however is any gains go back to the company. Applies to non publicly held corps too. Cannot sue constructive insiders. Mental standard is TAKEOVERS P. 1179 What is a tender offer? A solicitation to buy shares made directly to stockholders. Two types: 1. Friendly – Go to board first. Called a “bear hug” 2. Hostile – straight to stockholders Read CTS Corp Case on P. 1176 and determine the constitutionality of Control Share Acquisition Laws. In the 1970‟s anti-takeover statutes were passed in 47 states to stop hostile leveraged buyouts. State concerned about two tiered tender offer. Offers usually made for 51% of the company. Many people won‟t tender because they want long term value, but if they tender is successful and a cash out merger is initiated the now minority stockholders could get next to nothing. Struck Down as unconstitutional - NO: Control share acquisition laws that provide that there are no voting rights on newly acquired shares unless everything is disclosed as to the offerors plans. Also provided that the company has as long as they wanted to consider the fairness of the offer. Courts do allow: Tender offers for target corp, corp runs to court and asks for protection by control share acquisition statute. Other Defenses (“Porcupine provisions”): Take out cumulative voting from the bylaws. Put in a requirement for a supermajority vote in the articles. “Scorched Earth” not appropriate ever. Shareholder Rights Plans (aka, “Poison Pills”). (Goes under loyalty) The board should state in minutes that they are concerned about a “bust up” merger occurring. There is an automatic presumption that the target board is going to be conflicted. BJR can lock on at the end of the line. Moran Test: (1) There is a presumption that the board is acting for themselves (in loyalty conflict), (2) Therefore the board has to do something to overcome that presumption when a defensive tactic is entered into, (3) Therefore the BOD must show: (a) They had reasonable grounds for believing a threat to corporate policy and effectiveness existed. (b) This can be satisfied by showing good faith and reasonable investigation. (c) Must be actual threat, not just perceived. The end must be a „bust up merger‟ aka a gutting of the corporation. (d) Defensive measure taken must be reasonable to the threat posed. Then the Business Judgment Rule attaches. For Poison pill: In most juris, technically under state law a stockholder approval not required. However ISS have said stockholders should have a say. Three kinds of dividends: Property, cash and stock like dividends. Hostile Offree’s can buy stock in an offeror to make proxy votes to remove board members of the offeror. Question on final: Shark Repellant (anti-takeover statutes are constitutional) Porcupine Provisions: Super majority provisions for director and stockholder vote are normally fine up to 80-85%, but not to 90% or unanimous. Getting rid of cumulative voting: 1st, look to state statute, if in mandatory state, forget about it. Otherwise, ok Golden Parachutes: Very lucrative compensation packages given to certain top executive officers. Make’s sure that management is loyal and takeovers are more expensive. Cannot be so excessive as to be unreasonable. Tin Parachutes: Not reasonable. Covers everyone else in the corporation. Pac-Man Defense: Tender Offeror makes offer for target, and target turns around and makes tender offer for Offeror. Is reasonable. Scorched Earth Defense: No gutting yourselves by selling off all parts of company, never reasonable. Crown Jewel: Asset in corporation that makes it what it is. So board sells it when the tender offer comes. Very rarely reasonable. Exam situation: BOD say tender offer coming, BOD afraid of bust up merger and that Offeror likes them for their crown jewels. There must be good faith reasonable investigation. Stockholders of offeree may sue in a derivative action for money damages for lost profits or equitable relief to get the action taken. Poison pill: Reasonable Self tender offer by target: White Knight: Get another friendly company to make an offer for stock. May buy some and sell back when tender offeror goes away. May or may not be reasonable. If Good Faith investigation And defensive mechanism reasonable Then BOD is safe and there can be no further challenge on those grounds. Attack on basis the meeting was invalid or under due care. If losses occur tender offeror’s shareholders will sue for due care. Tender Offeror may also sue offeree to invalidate defensive mechanisms BOD of Target could say come abord, and not take any defensive action, therefore no presumption of conflict, then if losses occur stockholders sue on due care. “you should have done something” Two scenarios: Defenses to actual tender offer NO resistance, sued for Due care Invite in, losses occur, sued for Due Care Gobbles up Auction. PROCEDURE NOTE: Pick out the loyalty actions first. Self Dealing and Corporate Opportunity. The question given out in class. Determine if publicly held. Proxy solicitation. Do I have a 14(a)(8) or 14(a)(9) cause of action for nondisclosure? 14(a)(9). Is the non-disclosure material? Since merger / sale possible 10(b)(5) cause of action. Board Voted, so a Self Dealing cause of action. Due care not applicable because no losses. Illegal Dividends Cause of Action. Duty to Auction (Under Loyalty) QVC v. Paramount Paramount and Viacom enter into merger agreement. Martin Davis fired Barry Diller previous, and he came back with QVC to buy paramount to mess up the Viacom merger. Paramount Did not shop around Paramount would owe $100M if merger didn‟t go through. Barry Diller goes into court to get the poison pill done away with because a “duty to auction” has been triggered. Was he relevant to triggering the auction? No, it was triggered as soon as Viacom entered into a merger transaction. Revlon case lists the triggering events: (1) Corp itself puts itself on the auction block (2) Transaction entered into that would end up in the ultimate breakup of the company (3) NEED TO KNOW ON TEST: Transaction that will lead to the sale of control. If two companies come together where ownership is widely dispersed there is technically no sale of control so this does not apply. What this means is that you cannot lose control on a merger and not pop the top off. When the duty to auction is triggered: (1) All defensive mechanisms come down (2) Up to management to consider all offers (3) Up to management to get the best price Fact Pattern: Two entities entering into a merger agreement. Is a duty to auction triggered? Yes, if one entity is publicly held and ownership is widely dispersed, and that company is going to be merged into a company primarily controlled by someone else. Definition of control: No cases have defined. Parent / Subsidiary Merger never triggers an auction scenario. Newer cases say that BOD‟s can take into account future value in valuing a bid. Take Over Strategies If acquire more than 5% must disclose to SEC that own more than 5%. Reason must also be disclosed. T. Boone Pickens would buy stock and greenmail. He would threaten board and they would have to buy him out or put up with his proxy wars etc. (On test) If you have Mergers, remember the procedures associated with them. (1) Must have approval by both BOD‟s and stockholder approval from both companies, if a short form merger don‟t need stockholder approval. (No short form on test) A board member selling stock to a looter is a breach of fiduciary duty. Not tested on: LLC’s, LLP’s or GP’s. There is however JV’s with relationship to pre-incorp promoter contracts. P. 587-608 Info on deadlocks and dissolution not on exam. Except Gearing Case if there is ever an exception to quorum, will be on test. No Transactions in controlling shares P. 621-642 Nothing on stockholder derivative lawsuits. Nothing on § 16(b), but yes on 10(b)(5), except not false or misleading statements or omissions. When see on test it will be something else. Scan P. 956 on corporate opportunity, and it will be testable. Publicly Held Companies Insider Trading Mergers and Acquisitions Causes of Action: (1) Premature Commencement: Promoter Liability (2) Defective Incorporation: MBCA: Stamp Date, Non-MBCA: du jury substantial compliance, de facto good faith attempt, estoppel, 3rd party relied on corporate form. (3) Piercing the Corporate Veil: Lack of adequate capitalization, using corp property for personal use, illegal use, alter ego, no corporate formalities, injustices and inequitable consequences if not pierced. (4) Ultra Vires – “Beyond Powers” Specific Purpose, Charity. (4.5) Violation of Fiduciary Duty (loyalty and Due Care) (5) Stock Issuance not Authorized by Articles (Class of stock not in Articles) (6) Inadequate Consideration for Stock. Cash = Bonus, Property = Watered, Services (Good faith, fair value). (7) Invalid Director Meeting (Notice, Quorum, Valid Vote). (8) Invalid Stockholder Meeting (Notice, Quorum, Record Date, Proper Matters). (9) Invalid Encumbrance (Notice, Reasonable) (10) Lack of Dividend Payment (Public – Business Purpose, Close – Bad Faith) (11) Illegal Distribution (Proper Source) (12) Cause of Action: False and Misleading statements or omissions in a proxy solicitation.