Law School Outline - Fall 2003 Corporations- Gregory

CASES FOR CORPORATIONS FORMATION YATES v. BRIDGE TRADING CO. – CHOICE OF LAW BRENNAN v. RUFFNER – MULTIPLE CLIENT PROBLEMS OPDYKE v. KENT LIQUOR MART – MULTIPLE CLIENT PROBLEMS WARTZMAN v. HIGHTOWER PRODUCTIONS – SECURITIES LAW CONSIDERATIONS DEFECTIVE INCORPORATION SIVERS v. R&F CAPITAL – DEFECTIVE INCORPORATION: Prior to incorporation liability EQUIPTO DIVISION v. YARMOUTH – DEFECTIVE INCORPORATION: Dissolved corporation liability COOPERS & LYBRAND v. FOX – DEFECTIVE INCORPORATION: Promoter liability AMERICAN VENDING SERVICES v. MORSE – DEFECTIVE INCORPORATION: Implying a corporation ILLINOIS CONTROLS v. LANGHAM – DEFECTIVE INCORPORATION: Pre-incorporation agreement PIERCING THE CORPORATE VEIL SEA-LAND SERVICES, INC. v. PEPPER SOURCE FRIGIDAIRE SALES CORP v. UNION PROPERTIES In Re SILICONE GEL BREAST IMPLANTS PRODUCTS LIABILITY LITIGATION WALKOVSZKY v. CARLTON KINNEY SHOE CORP. v. POLAN UNITED STATES v. BESTFOODS SPECIAL PROBLEMS OF THE CLOSELY HELD CORPORATION DONAHUE v. RODD ELECTROTYPE CO. – SHAREHOLDERS RIGHTS IN CLOSE CORPORATION/DUTY NIXON v. BLACKWELL – SHAREHOLDERS RIGHTS IN CLOSE CORPORATION RAMOS v. ESTRADA – SHAREHOLDERS RIGHTS IN CLOSE CORPORATION SOMERS v. AAA TEMPORARY SERVICES, CO. – SLIGHT DEVIATIONS FROM THE CORPORATE NORMS LEHRMAN v. COHEN – MULTIPLE CLASSES OF STOCK IN RE RADOM & NEIDORFF – DISSOLUTION AND DEADLOCK OCEANIC EXPLORATION CO. v. GRYNBERG – VOTING TRUST LASH v. LASH FURNITURE CO. – STOCK TRANSFER RESTRICTIONS FRANDSEN v. JENSEN-SUNDQUIST AGENCY LANDSTROM v. SHAVER BOSWORTH v. EHRENREICH RETZER v. RETZER – FAMILY LAW ISSUES CAPITALIZING THE CORPORATION OBRE v. ALBAN TRACTOR CO. – DEBT IN FETT ROOFING AND SHEET METAL CO. – DEBT/EQUITY METROPOLITAN LIFE v. RJR NABISCO INC. – DEBT/EQUITY (Leveraged Buyout) HANEWALD v. BRYAN‟S INC. – THE SHAREHOLDER‟S OBLIGATION TO PAY AND PAR VALUE GOTTFRIED v. GOTTFRIED – SHAREHOLDER‟S OBLIGATION TO PAY GABELLI & CO. v. LIGGETT GROUP, INC. – DIVIDENDS BERWALD v. MISSION DEVELOPMENT CO. – DIVIDENDS CORPORATE GOVERNANCE AND THE ROLES OF OFFICERS, DIRECTORS AND SHAREHOLDERS AUER v. DRESSEL – SHAREHOLDERS versus DIRECTORS CENTAUR PARTNERS IV v. NATIONAL INTERGROUP, INC. DRIVER v. DRIVER ALLEN v. PARK NATIONAL BANK – CUMULATIVE VOTING AMERICAN TELEPHONE & TELEGRAPH COMPANY v. HARRIS CORP. – CORPORATE FORMALITIES STEWART CAPITAL CORP. v. ANDRUS – CORPORATE FORMALITIES and AUTHORITY OF OFFICERS FRADKIN v. ERNST – CORPORATE FORMALITIES and AUTHORITY OF OFFICERS VILLAGE OF BROWN DEER v. CITY OF MILWAUKEE SCHMIDT v. FARM CREDIT SERVICES WHITE v. THATCHER FINANCIAL GROUP, INC. – AUTHORITY OF OFFICERS KANAVOS v. HANCOCK BANK AND TRUST CO. – AUTHORITY OF OFFICERS, Vice-President (Apparent Auth) CONTEL CREDIT CORP. v. CENTRAL CHEVROLET, INC. – AUTHORITY OF OFFICERS, Cert of Sec, Estoppel A.P. SMITH MANUFACTURING CO. v. BARLOW – CHARITABLE DONATIONS (Corp. Social Responsibility) KAHN v. SULLIVAN – CORPORATE SOCIAL RESPONSIBILITY CREDIT LYONNAIS BANK NEDERLAND, NV v. PATHE COMMUNICATIONS CORP. – CORP RESP. MANAGEMENT‟S DUTIES TO THE CORPORATION SHLENSKY v. WRIGLEY – DIRECTOR‟S DUTY OF CARE SMITH v. VAN GORKOM – DIRECTOR‟S DUTY OF CARE FRANCIS v. UNITED JERSEY BANK – DIRECTOR‟S DUTY OF CARE GRAHAM v. ALLIS CHALMERS MANUFACTURING CO. – DIRECTOR‟S DUTY OF CARE MARCIANO v. NAKASH – DUTY OF LOYALTY – General Principles IN re WHEELABRATOR TECHNOLOGIES, INC. Shareholders Litigation – DUTY OF CARE PARENT/SUBSIDIARY DEALINGS SINCLAIR OIL CORP. v. LEVIEN WEINBERGER v. UOP, Inc. THE CORPORATE OPPORTUNITY DOCTRINE BROZ v. CELLULAR INFORMATION SYSTEMS, INC. NORTHEAST HARBOR GOLF CLUB, INC. v. HARRIS COHEN v. AYERS FRAUDULENT TRADING IN SHARES GOODWIN v. AGASSIZ BASIC v. LEVINSON CHIARELLA v. UNITED STATES CARPENTER v. UNITED STATES UNITED STATES v. O‟HAGAN Yates v. Bridge Trading Co., Missouri Court of Appeals (1992) Casebook p. 79 – CHOICE OF LAW FACTS and PP: Yates is appealing bench trial finding that the K arising from a stock purchase agreement void under MO law because the consideration for the stock was a promissory note. Yates arguments: 1. Tendered full payment on the promissory note; 2. The company had converted his shares; 3. MO law should not have been applied because of the internal affairs doctrine barring application of MO law to a corporation organized under the laws of another state; 4. Court should have applied DE law under which Yates would have prevailed because stock issued for promissory note is voidable and not void under DE law; 5. Effect of dissolution and liquidation of the company on the obligation under stock purchase agreement to turn over the disputed shares to appellant. o In 1974, Yates and defendants founded Bridge Holding Company (Holding) under MO law. Holding owned 2 subsidiary companies Bridge Trading Company (Trading) and Bridge Data Company (Data) both organized under DE law with PPB in MO. Yates was president of the 2 subsidiaries under 1986 when he was removed. o Bridge System: The purpose of the triangle was to develop and market a computer system processing for investment companies. o In 1977, Holding sold Trading stock to Loewi &Co, a brokerage firm and although never again owned by Holding, Trading stayed closely affiliated with them because of symbiotic relationship. o In 1978, Noble bought Trading from Loewi. o In 1983, Trading was refinanced through stock purchase agreement of 4/1/83 which stipulated that the stock be purchased for $3.56/share and paid through promissory note payable on demand. The agreement also said that it shall terminate on bankruptcy or dissolution of the company and was executed by all parties. o In 11/83, all parties except for Yates paid the promissory notes. Yates was never paid by Trading unlike the other investors (defendants) and instead was paid through Data. o In 1986, Yates exercised this rights by voting in opposition to a merger between Holding and Trading and blocking its occurrence. (He was listed as having 18,000 shares) o In 1987, Yates again voted against merger. (He again was listed as having 18,000 shares) o In 7/87, Yates tried to sell his shares in Trading to TA Associates for $75/share but defendants would not give him his pledged stock certificates. Later that month, he sent a check to Trading for payment of the promissory note ($90K) and accrued interest. o In 8/87, Trading refused to deliver the stock certificates and returned the check. At this time the shares were valued at $1,35 million. o In 1987, Yates tendered payment without demand being made. The promissory note and pledge agreement did not contain a termination clause. Trial court held: o MO law controlled and promissory note was not valid consideration under MO law. o Stock purchase agreement terminated at Trading‟s filing of articles of dissolution. o Tender of payment for promissory note was ineffective under both state‟s law. ISSUE: 1. What law controls the stock transaction? 2. Does the law validate the stock purchase agreement? 3. What effect does the dissolution have on the stock purchase agreement? HOLDING: Affirmed decision of trial court. RULE: 1. If a choice of law provision makes a K void, then it is not applied because the intent of the parties in entering the agreement was to have a valid agreement. 2. DE law validates the SPA because consideration is not necessary in the sale of stock. 3. Dissolution terminates the agreement because it was provided for in the K and as a result the intent of the parties would best be served by termination of the agreement at dissolution. ANALYSIS: I. Choice of Law o Trading = DE Corp/MO PPB -> Normally DE law would control stock issuance, but the SPA had choice of law provision selecting MO law as governing. o MO law makes the SPA void because a promissory note is not money or property and does not constitute valid consideration for the stock. o DE law treats the stock issuance as voidable with the absence of valid consideration. A. The Internal Affairs Doctrine o Provides that the law of the state of incorporation should be applied to settle disputes affecting the organic structure or internal administration of a corporation. Only recognized in MO o Issuance of stock is considered an internal affair requiring the application of the laws of the state of incorporation. o : IA Doctrine bars application of MO law to the issuance of stock by foreign corporation despite choice of law provision. o Court: Parties were free to choose under stock purchase agreement. o Public policy – “If the corporation‟s sole contact with the state of incorporation is the naked fact of incorporation and all or most of its contacts lie within the forum state, the forum state can intervene in the internal affairs of the corporation so long as the shareholders of the corporation are not subjected to contradictory or inconsistent laws.” o All of the shareholders in the SPA were afforded the same choice of law provision and the company had substantial contacts with the state whose law was selected. o The internal affairs doctrine does not apply here. B. Missouri Law Section o Should be read to apply to only domestic corporations. o The choice of law provision by the parties was Ok to subject a foreign corporation to the laws it would not usually be subject to. C. Restatement Section o MO has adopted Restatement 2nd of the Conflict of Laws which states that where a choice of law provision renders a K void, the choice of law provision will not be applied because it is presumed that the parties enter K that they intend to be valid. o Court: The application of the choice of law provision and allowing this to proceed in MO renders the SPA void; THE DE law SHOULD BE APPLIED BECAUSE MAKING THE SPA VOID WOULD NOT EFFECTUATE THE PRESUMED INTENT OF THE PARTIES TO ENTER A VALID K. II. The Delaware Approach o The issuance of stock without consideration or insufficient consideration does not render the issuance void, but instead voidable. o Up until the dissolution of Trading, Yates could have held stock validly, but after dissolution, he was unable to cure the defect in consideration. IV. The Effect of Dissolution o 6/87: Trading filed articles of dissolution and 7/87 appellant tried to pay for his shares. o : Under DE Law, the corporation had a 3 year winding up period allowing him time to pay and redeem. o Court: The law chosen for the first issue does not have to be the same as other issues under the Restatements. Despite the law chosen, the terms of the SPA state that upon the dissolution the agreement terminates. THE INTENT WAS TO END THE AGREEMENT AT DISSOLUTION. Brennan v. Ruffner, Florida Court of Appeal (1994) Casebook p. 86 – THE PROBLEM OF THE MULTIPLE CLIENT FACTS: In 1976, Brennan (MD) and Martell (MD) hired Ruffner (JD) to incorporate their medical practice as a P.A. for which Ruffner prepared a shareholder‟s agreement. In 1982, Mirmelli (MD) joined the corp and each MD became a 1/3 shareholder in the P.A. so Ruffner was to draw up a new shareholder‟s agreement, which was signed 8 months later including a provision for involuntary termination of any shareholder by a majority vote of the other 2 shareholders. In 1989, Martell and Mirmelli terminated Brennan as shareholder and employee of the corporation who sued them claiming breach of K and fraud in the inducement. This lawsuit was settled. PP: Brennan filed suit against Ruffner for legal malpractice, breach of K, breach of fiduciary duty and breach of K as a thirdparty beneficiary. Despite denying he had representation in the first suit against the MDs he said that Ruffner represented him individually and as the corporation in making the agreement. Ruffner denied having represented him individually. ISSUE: Whether or not a lawyer representing a closely held corporation is also in turn representing the shareholders in an individual capacity? HOLDING: Affirm summary judgment in favor of lawyer because an attorney/client relationship did not exist between the shareholder and the attorney representing the corporation so there is no basis for legal malpractice RULE: A lawyer representing a closely held corporation does not also by that representation represent the shareholders individually unless by agreement or special circumstances. ANALYSIS: Elements of Legal Malpractice Case – o Attorney was employed o Attorney neglected reasonable duty o Negligence of attorney resulted in and was proximate cause of loss to plaintiff There must be privity of contract between lawyer and the client. o No privity here because the lawyer was only representing the corporation. o Brennan said that Ruffner represented him too but he admitted he had no attorney in sworn statement in first case. o Also argues that Ruffner had a duty to him because he was a shareholder of a closely held corporation o COURT: Where an attorney represents a closely held corporation, the attorney is not in privity with and therefore owes no separate duty of diligence and care to an individual shareholder absent special circumstances or an agreement to also represent the individual shareholder. Third Party Beneficiary o There are no facts that show that it was the primary intent of the corporation in hiring Ruffner to draft the shareholder‟s agreement was to directly benefit Brennan. Breach of Fiduciary Duty o The facts do not support the contention that the lawyer had a duty to inform him of conflict of interest. o Ruffner had told the MDs collectively that he represented the corporation in drafting the shareholder agreement. Opdyke v. Kent Liquor Mart, Inc., Delaware Supreme Court (1962) Casebook p. 89 – PROBLEM OF THE MULTIPLE CLIENT FACTS: o In 1959,  and Smith (defendant) were discussing opening a liquor store. They interviewed Richter (owner of a shopping center and defendant) who said there was a place in the shopping center for the store if he could be co-owner of the business to which they agreed. o  and Smith hired Brown (JD) to incorporate the business which was done in 9/59. There were 300 shares of capital stock sold and each man received 100 shares. In the first incorporators and directors meetings, they discussed the possibility of restricting the sales of stock and Brown advised them of the procedures for doing that but nothing came of it. o In 6/60, a liquor license was granted. The company borrowed $20K for goods and working capital with the stockholders and their wives joining in the note. There was also debt to Richter and Meyer (Richter‟s company) for $2600 for construction work. o In 8/60, the store opened and did not prosper. On 10/9/60 and 10/20/60, Richter offered to get out of the venture where finally  gave Richter check for $415 for equity in the corporation. o On 11/19/60, Smith told  he wanted to get out but the result is in dispute. The next day, Smith sold Richter his shares for $415 and Richter‟s promise to relieve Smith of the Promissory Note with a new note being executed among Richter,  and their wives as well as Richter‟s nephew and his wife. o In 2/61, with procedural advice from Brown, Richter transferred his shares to Smith (40) and his nephew (60). o  called Brown later and said that he bought Richter‟s shares and did not assume the debt on the promissory debt. Brown advised that a meeting be held to resolve what was going on. o In 3/61, the meeting was held and discussed Richter‟s stock where Brown stated that he did not represent the individuals but the corporation. They negotiated about the sale, which was in dispute. The final decision was that  would assume the note and get all of Richter‟s shares. was to have under 3/13 to refinance the loan and the debt to Richter and Meyer which was extended. o On 3/24/61,  told Brown that he was going to go through with the deal. On 3/28, Richter and Smith saw Brown and told him  said that the deal was off because Richter and Smith had proposed a sale of the corporation to Behan for $30K, which  wouldn‟t agree to. Brown told them to make a different offer to Behan but also that he might be interested if not for himself but another client in purchasing the company. o In the end, Brown apparently bought Richter‟s interest and told  himself that he had 3 options. Eventually,  agreed to become partners with Brown but expressed his enmity for Richter and the fact that he though he was going to buy the stock from him. o  eventually sought the advice of another attorney and the stock and Brown‟s note were put in escrow. PP:  sued and lost in trial court. His first claim was that he actually bought Richter‟s stock in 10/60 because of the acceptance of his check by Richter and the endorsement. This was decided in favor of Richter and was affirmed by this court. The second claim was that he was entitled to a money judgment representing extra compensation for working in the store for which he was paid $50/week. The court did not decide this question. The third contention was that Brown breached a fiduciary duty by using confidential information to further an adverse interest. The trial court found in favor of Brown. ISSUE: Whether or not an attorney who purchases stock in the corporation he represents breaches a fiduciary duty to one of the stockholders? HOLDING: Reversed the decision of the trial court on the breach of fiduciary duty. RULE: An attorney may not use information gained through his role as counselor in obtaining an interest in property without explicit consent of the party‟s whom he was responsible for counseling. ANALYSIS: Brown‟s argument His fiduciary duty was only to the corporation and not to the stockholders. He advised at the onset of the argument that he represented the corporation only and therefore was free to buy the stock. Trial Court: o The original employment of Brown was limited to the organization of the corporation and obtaining the liquor license. o The issuance of shares was not within the scope of Brown‟s employment. Court: o Corporation has a separate existence from the individual stockholders. o We must determine what the relationship was between Brown and the three shareholders. o Brown was the attorney for all three men at the beginning and he told them at the beginning of problems that he couldn‟t represent one of them against the others. o By advising in the settlement, he was acting as a legal adviser. o WHEN BROWN BOUGHT THE STOCK, HE ACQUIRED AN INTEREST IN THE SUBJECT MATTER OF THE DISPUTE BETWEEN THE CLIENTS, WHICH WAS NECESSARILY ADVERSE TO THE INTEREST OF ONE OF THEM. o He acquired the knowledge of the sale of the stock while acting as counselor. o The only way he could have relieved himself of the obligation was to get explicit consent of the  after a full explanation of his legal rights and position. o o Wartzman v. Hightower Productions, Ltd., Maryland Court of Special Appeals (1983) Casebook p. 99 – SECURITIES LAW CONSIDERATIONS FACTS: o Hightower tried to break the flagpole sitting record. Adler, Billitz and Quinn formed the company, Hightower Productions, in 1974 as a promotional venture. They were going to have someone ride in special flagpole seat from 4/1/75 through the New Years where he would descend in Times Square. o In 11/74, the principals approached an attorney (Kaminkow) of the Wartzman firm to incorporate the venture. He referred them to Wartzman as he was trial attorney. o They met with Wartzman and told him they needed to sell stock to the public to make $250K for financing. JD prepared and filed articles of incorporation and the company came into existence on 11/6/74. The articles authorized 1 million shares at $.10/share for $100K total. o They put $20K in the bank and found a Woody Hightower. PR events occurred and corporate backers were sought. o Company raised $43,000 by selling stock. The company was low on funds so 2 weeks before ascension, they met where JD told them that no further stock could be sold because the corporation was structured wrong and that they needed a securities attorney to fix it. (JD learned this through casual conversation with a friend). o JD failed to prepare offering memorandum and assure that the corporation has made the required disclosures to investors in accordance with MD Securities Act. JD advised that the securities attorney would be about $10K$15K and the work would take between 6-8 weeks, during which time no more stock could be sold. o Shareholders decided to scrap the project at this point. PP: Hightower filed suit alleging breach of K and negligence for the law firm‟s failure to create a corporation authorized to raise the necessary capital. The trial court only submitted the claim of the corporation against the law firm (the individual shareholders suits were dismissed). Jury verdict was $170K in favor of Hightower. The law firm appealed. JD arguments were: 1) Jury verdict amount was speculative; 2) Lack of nexus/causation between the failure to perform and the loss claimed – The result will be unjust where a person performing a collateral service for a new venture will be held liable as full guarantor for all costs incurred by the enterprise upon failure to fully perform the collateral service. ISSUE: Whether or not an attorney is liable for a failed business venture when he fails to set up the securities properly and the company can no longer sell stock for operating capital? HOLDING: Yes, an attorney may be held liable and they may be liable for the speculative damages of the company. ANALYSIS: Reliance Interest – o If it can be shown that full performance would have resulted in a net loss, the plaintiff cannot escape the consequences of a bad bargain by falling back on his reliance interest. o Here, JD should have known or knew that the success of the venture rested upon the ability of Hightower to sell stock and secure advertising as the adventure accelerated. It was not collateral to the issue – it was what the company depended upon. Duty to Mitigate – o The offer to set them up with securities lawyer is not mitigating device that Hightower was obliged to accept. o Doctrine of Avoidable Consequences Sivers v. R&F Capital Corp., Oregon Court of Appeals (1993) Casebook p. 104 – DEFECTIVE INCORPORATION FACTS and PP: Both are businessmen.  is a shareholder and director of R&F.  and  entered into commercial leasing agreement involving warehouse space in Oregon. Lease was signed by  and the  as chairman of R&F. Lease signed on 1/12 to begin on 1/17. R&F was incorporated on 2/9/90. R&F failed to pay rent so  sued.  claimed the  was personally liable under the law.  moved for directed verdict but was denied so he appeals here. ISSUE: Whether or not HOLDING: Reversed trial court RULE: In order for a person to be held personally liable when acting as a corporate agent with faulty incorporation, the person must have ACTUAL knowledge of the defect in incorporation at the time of acting – acting in bad faith. ANALYSIS: The code provides that a person purporting to act as or on behalf of a corporation knowing there was no incorporation is jointly and severally liable for liabilities. “Knowledge” is key. Legislative intent – to protect those who honestly thought they were incorporated (articles had been filed). The test is one of actual knowledge and it is the ‟s burden to show the defendant had such knowledge. : The facts show that he knew. Court: Disagree ( hired a leasing agent to negotiate the lease and never dealt with the  personally so he even thought he was only dealing with the corporation and he didn‟t inquire about the corporations status then. Defendant testimony: No specific experience in incorporating because attorneys handled that. All parties believed the company was incorporated at the time the lease was signed (saw the articles in 12/89). He shouldn‟t have much reason to lie. The evidence does not rise to the level of actual knowledge on behalf of the defendant and that is required by the statute (did not state “constructive knowledge”) – : Jury could disbelieve the defendant about his knowledge and that was their prerogative but the court states that there had to be some evidence that the defendant had actual knowledge about the lack of incorporation. Plaintiff gave no evidence to the contrary so the directed verdict should have been granted. Equipto Division v. Yarmouth, Washington Supreme Court (1998) Casebook p. 107 – EFFECT OF DISSOLUTION ON LIABILITY FACTS and PP: o Yarmouth continued to conduct business after J&R was dissolved in August. o The COA has interpreted the activities to those necessary to wind up business and that the actions were ultra vires and the corporation did not have the capacity to form the K that gave rise to the debt. o The COA brought in common law principle stating – “The persons who purports to contract in the name of a principal may be liable if he knew or should have known about the principals‟ lack of capacity and the other party does not know. Yarmouth should have been aware and court found them personally liable. ISSUE: What is the corporate officer‟s liability for conducting business as usual after the corporation has been dissolved? Whether statutory law resolves the legal question in this case precluding application of common law principles. HOLDING: Reversed RULE: ANALYSIS: The Code: o All persons purporting the act as or on behalf of the corporation, knowing there was no incorporation under this title, are jointly and severally liable for liabilities created while so acting except for any liability to any person who also knew that there was no incorporation. o Acting before the incorporation is one thing – Usually a promoter‟s liability for pre-incorporation contracts. o The  urges application of the statute to his situation (where one acts after dissolution). o The statute imposes liability on only those who act knowing there was no incorporation. The new statute was intended to address the equitable concern for protecting those who act with good faith and to otherwise abolish the common law principles of de facto corporations and corporation by estoppel. NOTES: Coopers & Lybrand v. Fox, Colorado Court of Appeals (1988) Casebook p. 115 – DEFECTIVE INCORPORATION FACTS: Fox met with , a national accounting firm, in 11/81for a tax opinion and other accounting help. He told  that he was acting on behalf of a corporation he was forming.  accepted the engagement knowing that the corporation was not in existence. Fox‟s corporation was incorporated on 12/4/81 and was billed by  for $10K +. The bill was not paid and  sued Fox individually for breach of K on a promoter liability theory. PP:  appeals trial court judgment in favor of the  in that the court erred in ruling that Fox, promoter, could not be held liable on a pre-incorporation contract in the absence of an agreement that he would be so liable and that  had failed to sustain the burden of proof. ISSUE: Whether or not a promoter is liable for the debts incurred in setting up the corporation when there is no proof of express agreement otherwise. HOLDING: Reversed. RULE: GENERAL RULE: Promoters are generally personally liable for the contracts they make, though made on behalf of a corporation to be formed. EXCEPTION: If contracting party knows the corporation is not in existence but nevertheless agrees to look solely to the corporation and not to the promoter for payment then the promoter has no personal liability. ANALYSIS: Evidence: o Fox at trial said that  either expressly or impliedly agreed to look solely to the corporation for payment. o Of course,  said that its client was Fox and not the corporation. Findings at Trial Court level: o No agreement that would obligate Fox without written findings of fact. o Court entered judgment on Fox‟s behalf. This Court: o Fox was not acting as an agent because there was nothing to act as an agent of. o Fox was a promoter: one who, alone or with others, undertakes to form a corporation and procure for it the rights, instrumentalities and capital to enable it to conduct business. o GENERAL RULE: Promoters are generally personally liable for the contracts they make, though made on behalf of a corporation to be formed. - EXCEPTION: If contracting party knows the corporation is not in existence but nevertheless agrees to look solely to the corporation and not to the promoter for payment then the promoter has no personal liability. - There was no agreement here. So Fox is liable. o Trial Court also ruled that the burden to prove there was no agreement was on . o This court said that the proponent of an alleged agreement has the burden of proving the agreement existed so it would be Fox‟s job. NOTES: 1. Question 2. Question American Vending Services, Inc. v. Morse, Utah Court of Appeals (1994) Casebook p. 117 – DEFECTIVE INCORPORATION FACTS and PP: - The Morse family built a car wash in 1984 and ran it for 11 months. Then they entered into K with Durbano and Garn (attorneys) acting as officers of AVSI to buy the car wash. - The JDs claim that they represented to the Morses that the corporation (AVSI) would buy and run the car wash. - They contracted on 7/10/95 when JDs had not filed Articles of Incorporation for AVSI although he had reserved the name. - JDs claimed that their Articles had been returned twice because of the name but they were continually trying to get it filed before the sale. - Articles were filed on 8/19/95 and the explanation for not filing was that he was too busy moving offices. - Morses tried to go after JD personally but the trial court decided that JD was making bona fide effort to incorporate and dismissed the personal charges. - AVSI operated the car wash for 3 years, had money problems and failed to make any payments to Morse on the balance owing under the sales K. The JDs claimed that Morse provided fraudulent projected income figures (both false and padded). Morse says that the numbers were verified and that the real reason for the failure was the inexperience of the JDs in running a car wash. - AVSI eventually allowed the bank to foreclose on the car wash. - AVSI alleges that Morse supplied it with incorrect and false income projections and that it should be able to rescind the K under a) fraudulent misrepresentation, b) negligent misrepresentation, c) material breach of K, or d) mutual mistake. The trial court found the evidence on those claims insufficient to allow rescission of the K. - Important findings of fact by the court: 1) Morses knew that the JDs intended to form a corporation; 2) JDs attempts to file was bona fide attempt to organize the corporation; 3) Morses admitted the corporations existence in their initial answer; 4) Morses intended to K with AVSI and not the JDs individually; 5) AVSI‟s evidence was insufficient to allow rescission. - Important Conclusions of Law by the trial court: 1) AVSI was a de facto corporation when it bought the car wash; 2) AVSI was corporation by estoppel when it bought the car wash; 3) Morses are estopped from denying the existence of the corporation; 4) AVSI failed to establish elements for its claims. - Trial Court damages: Morses - $76.8K plus costs, interest and reasonable attorney‟s fees. This was a hollow victory because AVSI has no assets from which it can satisfy the judgment so they appeal. PP: o o s appeal the trial court‟s ruling in their favor?? They asserted that there was error in the trial court‟s legal conclusions regarding de factor corporations and corporations by estoppel as well as the court‟s decisions regarding attorney fees. s AVSI appeals the trial court‟s ruling against it asserting that the trial court erred in finding that there was insufficient evidence to support the claims of fraudulent and negligent misrepresentation, breach of K and mutual mistake. ISSUES: Whether the trial court erroneously concluded that AVSI was a de facto corporation? Whether the trial court erred by concluding as a matter of law that AVSI was a corporation by estoppel, thereby precluding the Morses from denying its corporate existence? Did the Morse‟s commit fraud in representing the profitability of the car wash? Decided that this was not the case at trial HOLDING: Reverse in part and affirm in part. RULE: - In some courts, de facto corporations do not exist under the BCA, but others still recognize them because the only place in the code where it abolishes them is the comment after the section. ANALYSIS: De Facto Corporations in Utah: - Corporations at common law can be de jure, de facto or by estoppel. - De Jure Corporation: one which has been created as the result of compliance with all of the constitutional or statutory requirements of a particular government entity. - De Facto Corporation: one which has been created by a bona fide attempt to create a corporation even though the efforts at incorporation can be shown to be irregular, informal or even defective. - Corporation by estoppel: one where the parties thereto are estopped from denying the existence of the corporation, basically – the parties by their agreements or conduct estop themselves from denying the existence of the corporation. - Business Corporation Act governs corporations in Utah o A corporation‟s existence begins when the state issues the certificate of incorporation. o All persons who assume to act as a corporation without authority to do so shall be jointly and severally liable for all debts and liabilities incurred or arising as a result thereof. - Common Law de facto corporations: Created to protect individuals from personal liability when they were conducting legitimate corporate business prior to corporate formalities. Corporation was held liable if several factors were present: 1) Valid law existed under which such a corporation could be lawfully organized; 2) An attempt had been made to organize thereunder; 3) the defective corporation was an actual user of the corporate franchise; 4) (sometimes) good faith in claiming to be and in doing business as a corporation. - Criticized highly which led to MBCA (Model Business Corporation Act) which codified uniformity. o A de facto corporation does not exist under the Model Act. - De Jure incorporation is too simple to have to allow de facto corporations. - UTAH‟s ADOPTION OF THE BCA EXTINGUISHED THE DE FACTO CORPORATIONS DOCTRINE. - The corporate existence was not yet begun. Corporation by Estoppel in Utah - AVSI: Morses are estopped from arguing that it was not a corporation because Morses knew that JDs intended to have AVSI purchase and run the car wash. - Is the Corporation by estoppel doctrine still good in Utah? Illinois Controls, Inc. v. Langham, Ohio Supreme Court (1994) Casebook p. 128 FACTS:  invented the cross-slope monitor which is used in highway construction for grading and began to market through Langham Engineering, an un-incorporated business.  was formed to market and manufacture the CSM because although he sold 100 of the devices for John Deere machines he wanted to get them into Caterpillar machines as well. Finding of Facts: - Parties were aware that certain marketing strategies had to be employed requiring about $225,000 over 2 year period. Only 60-80K of this money was committed. - Balderson prior to the PIA told him that he would invest $250K in IL controls to assure amply supply of CSM for CAT but only 20K was committed. - No attempts were made to address the importance of proper training of sales force, proper installation, demonstrations and consignment sales. - Balderson‟s actions were more than neglect as he sacrificed the exclusive relationship between IL Controls with CAT for CAT competitors through Dymax. - Failure to employ reasonable efforts to market the CSM destroyed the potential of IL Controls and doomed a $4 million company. PP: Appellee contends that the reference in the PIA to the marketing capabilities of Clark Balderson and BI created no marketing obligation. The COA agreed with Appellee but the Supreme Court does not. ISSUE: What obligations are created by a pre-incorporation agreement (PIA)? Whether those obligations are breached when…? Who is liable when obligations under pre-incorporation agreement are breached? HOLDING: The agreement leaves little doubt that marketing was one of the covenants to which the parties agreed and the obligation was also backed up by the obligation to exert reasonable efforts to market the CSM. A contractual provision which gives a party the exclusive right to market a product on behalf of another imposes upon that party a duty to employ reasonable efforts to generate sales of the product. Illinois Controls and Balderson are jointly and severally liable to appellants for breach of the PIA. (Corporation and Promoter) RULES: - A corporation is liable for the breach of an agreement executed on its behalf by promoters where the corporation expressly adopts it or benefits from it with knowledge of its terms. - Promoters of a corporation who execute a contract on its behalf are personally liable for the breach thererof irrespective of the later adoption of the contract by the corporation unless the contract provides that performance thereunder is solely the responsibility of the corporation. - Where a corporation, with knowledge of the agreement’s terms, benefits from a pre-incorporation agreement executed on its behalf by its promoters, the corporation and the promoters are jointly and severally liable for breach of the agreement unless the agreement provides that performance is solely the responsibility of the corporation or, subsequent to the formation of the corporation, a novation is executed whereby the corporation is substituted for the promoters as a party to the original agreement. ANALYSIS: Parol Evidence in OHIO: - Parol evidence about the nature of a contractual relationship is admissible where the K is ambiguous and the evidence is consistent with the written agreement, which forms the basis of the action between the parties. Promoters - Legal relationship between promoter and corporate enterprise he seeks to advance is the same as agent and principal. Law of agency can help govern this relationship. - - Where an agent purports to act for a principal without the latter‟s knowledge the principal may nevertheless be liable on obligations arising from the transaction if the principal later adopts or ratifies the agreement arising from the transaction if the principal later adopts or ratifies the agreement arising from the transaction or receives benefits form the agreement with knowledge of its terms. This is true even where the principal lacked capacity at the time of the transaction giving rise to the obligation if, after obtaining such capacity, the principal manifests acceptance of the transaction. A corporation may adopt an agreement after its incorporation that was made prior to its incorporation. NOTES: 1. When individuals act prior to the incorporation, the rules governing their conduct and liabilities come from the law of agency. 2. RESTATEMENT 2nd of AGENCY §326: Unless otherwise agreed, a person who, in dealing with another, purports to act as agent for a principal whom both know to be non-existent or wholly incompetent, becomes a party to such a contract. 3. Comment b: ??? Sea-Land Services, Inc. v. Pepper Source, 7th Cir. (1991) Casebook p. 136 FACTS and PP - Sea Land (SL) was shipping peppers for the Pepper Source (PS) when PS stiffed SL on the shipping bill. - SL sued in Federal court for diversity and won in the amount of $86.8K via default judgment. - SL could not find PS as it had been dissolved for failure to pay taxes and PS, even if it had not been dissolved, had no assets. - Now, in 1988, SL sued the owner of PS – Gerald Marchese and the 5 companies he owns. SL sought to pierce PS‟s corporate veil and “reverse pierce” the other corporations so that all of them would be on the hook for the price. - They alleged that these companies were all alter egos of each other and Marchese and were only there to defraud creditors. (PS was reinstated after these allegations under IL law). - SL amended the complaint in 1989 adding another corporation in which Marchese has ½ ownership and stated that it should also be liable. In 12/89, SL moved for SJ and in 6/90 court granted the motion for SJ. ISSUE: Whether or not piercing the corporate veil can occur when the principal in a corporation has additional assets in other corporations but not the one against whom the judgment is sought? HOLDING: Remand to district court to require that SL show evidence and argument that would establish the kind of additional wrong present in other successful piercing cases. Insufficient to show summary judgment. RULE: In order to pierce the corporate veil: 1. There must be unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist shown by the following: Failure to maintain adequate business records or comply with corporate formalities; Commingling of funds or assets; Undercapitalization; One corporation treating the assets of another corporation as its own. 2. Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud and promote injustice where some wrong beyond a creditor‟s inability to collect would result. ANALYSIS: Van Dorn test: - There must be unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist. o Failure to maintain adequate business records or comply with corporate formalities; o Commingling of funds or assets; o Undercapitalization; o One corporation treating the assets of another corporation as its own. - Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud and promote injustice. Court‟s analysis: - The companies are Marchese‟s playthings. None of the companies have ever had a corporate meeting except for the one he owns ½ of. A lot of commingling was going on, no by-law, all out of same office and paying personal expenses out of the accounts. As a result, the first step of the Van Dorn test is met. - Second part of Van Dorn test – The court questions the meaning of promote injustice: Something less than an affirmative showing of fraud; will an unsatisfied judgment satisfy it? If so there is only one prong of the test really. The piercing should occur when injustice is promoted which mean that “some wrong beyond a creditor‟s inability to collect would result.” SL believed an unsatisfied judgment was enough. - What is enough? Used corporate facades to avoid responsibilities to creditors; someone in the corporate system will be unjustly enriched unless liability is shared by all. NOTES: 1. Questions; 2. Questions; 3. Questions; 4. Questions Frigidaire Sales Corp. v. Union Properties, Inc., Washington Supreme Court (1977) Casebook p. 141 FACTS: Frigidaire entered into K with Commercial Investors, a limited partnership, the general partner was Union Properties and the limited partners were Mannon and Baxter (the officers, directors and shareholders of Union). Baxter and Mannon controlled Union. Commercial breached the K with Frigidaire. PP: Frigidaire sued Commerical including Union properties, Mannon and Baxter. Trial court decided that Baxter and Mannon were not generally liable for the obligations because of the their control of Commercial. Court of Appeals affirmed. Frigidaire says that the individuals should incur general liability for the limited partnership‟s obligations under the Uniform Limited Partnership Act provision that removes limited liability of a limited partner who takes part in the control of the business because they exercises day-to-day control and management of the partnership. Baxter and Mannon argue that Union controlled Commercial and not the individuals in their individual capacities. ISSUES: Whether limited partners may incur general liability for the limited partnership‟s obligations simply because they are officers, directors or shareholders of the corporate general partner? HOLDING: Affirmed decision that they are not generally liable for the limited partnership‟s obligations as corporate shareholders, etc. RULE: 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 on third persons who deal with the corporation, the corporation‟s separate entity should be respected. ANALYSIS: Washington Code: - Taking part of the control of the business is not manifested by the following: o Possessing or exercising a power to vote upon matters affecting the basic structure of the partnership  Election, removal or substitution of general partners;  Termination of the partnership;  Amendment of the partnership agreement;  Sale of the assets. - If a corporate general partner is inadequately capitalized, the rights of a creditor are adequately protected under the “piercing the corporate veil” doctrine of corporate law. - 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 on third persons who deal with the corporation, the corporation‟s separate entity should be respected. - No general liability where they kept the affairs separate. NOTES: 1. Limited partnerships 2. Questions 3. Questions In re Silicone Gel Breast Implants Products Liability Litigation, Northern District of Alabama (1995) Casebook p. 144 FACTS: Bristol is the sole shareholder of Medical Engineering Corporation, a major supplier of breast implants but not manufacturer or distributor of them. MEC was incorporated in Wisconsin in 1969 with PPB in Racine. It is a privately held corporation making a variety of medical devices including breast implants. After extensive due diligence review of the gel bleed and other issues, Bristol (DE Corporation) bought the stock in MEC. In 1982, MEC became a DE corporation, wholly owned by Bristol. In 1988, Bristol expanded its business by buying Natural Y Surgical Specialties and Aesthetech Corporation and paid for through Bristol account though charged to MEC. They also performed a due diligence review of the companies. MEC has had three directors consisting of Bristol VP, another Bristol executive and MEC president. The other two board members could not outvote the Bristol executive. Resolutions passed by MEC were instigated by Bristol. Bristol required significant event reports and plans for its review. MEC submitted budgets for approval by Bristol‟s senior management by filling out Bristol forms. Bristol had the authority to modify this budget. Bristol was MEC‟s banker and provided loans to MEC. Additionally, employment policies and wages were applied to MEC by Bristol. Bristol provided various services to MEC including distribution, development, auditing and review functions and public relations. Bristol also had its name and logo in the product as well as in promotional communications. MEC was profitable every year and filed its own taxes but Bristol bought insurance for MEC under its own policy. In 1991, Bristol suspended sale of breast implants by MEC and later that year MEC stopped all of its operations. The sale of MEC‟s urology division before the cessation of activities was approved by Bristol and the proceeds went to Bristol. At this point, MEC‟s only assets are a demand note from Bristol for the amount from the urology sale and indemnity insurance. PP: Bristol asserts that the evidence is insufficient for the ‟s claims to proceed against it, whether through piercing the corporate veil or under theory of direct liability. CHOICE OF LAW: Look to the laws of several states – DE here. HOLDING: Motion for dismissal of claims against Bristol by summary judgment was denied. ANALYSIS: Plaintiff‟s theories: - Corporate Control: piercing the corporate veil to abrogate limited liability and hold Bristol responsible for MEC‟s actions. - Direct liability: Strict products liability, negligence, negligent failure to warn, negligence per se for noncompliance with FDA regulations, misrepresentation, fraud and participation. A. Corporate Control Claims - Where single shareholder holds corporation, potential for abuse of corporate form is greatest. - When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice. - WHETHER VEIL-PIERCING MAY EVER BE RESOLVED IN SUMMARY JUDGMENT? o Fact intensive process but if the facts could only result in one conclusion - All jurisdictions have some requirement of showing substantial domination. - Factors in showing substantial domination: 1) Common directors or officers; 2) Common business departments; 3) Consolidated financial statements and tax returns; 4) Parent finances the subsidiary; 5) Parent caused the incorporation of the subsidiary; 6) Gross inadequacy of capital; 7) Parent pays salaries and other expenses of subsidiary; 8) Subsidiaries business comes only from parent; 9) Parent uses subsidiaries property as its own; 10) daily operations are not separate; 11) Subsidiary does not observe basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings. - Many of the factors have been proven here. - DE courts do not require showing of fraud, injustice or inequity if subsidiary is found to be mere instrumentality or alter ego of its sole stockholder. - Many jurisdictions that require that showing in a contract case do not require it in a tort situation. - Because the evidence available at a trial could support a finding that the corporate veil should be pierced, Bristol is not entitled to dismissal through summary judgment. B. Direct Liability Claims - Bristol held itself out as supporting the product because its name was on the product packaging and inserts. - Additionally, Bristol issued press releases stating that the implants were safe. It has potential responsibility under tort law. NOTES: 1. Shareholder of corporation whose veil is sought to be pierced is another corporation here. 2. Contract vs. Tort cases 3. Unitary test vs. the two part test Walkovszky v. Carlton, Court of Appeals of New York (1966) Casebook p. 150 FACTS and PP: Complaint alleges that  was severely injured 4 years ago in NYC when he was run down by a taxicab owned by the defendant Seon Cab Corporation and negligently operated by Marchese. Carlton is claimed to be the stockholder of 10 corporations, including Seon, each has only 2 cabs registered in its name and implied that only the minimum insurance is carried by each individual cab ($10K). The plaintiff alleges that the corporations are operated as a single entity, unit and enterprise with regard to financing, supplies, repairs, employees and garaging and therefore all names as defendants. Plaintiff also alleges that he is entitled to bring suit against the stockholders because the multiple corporate structure constitutes an unlawful attempt to defraud members of the general public who might be injured by the cabs. Defendant Carlton alleges that the complaint fails to state a cause of action upon which relief can be granted and the trial court upheld that motion. The appellate court reversed. HOLDING: No piercing of the corporate veil here. ANALYSIS: - Law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability but the courts will disregard the corporate form (pierce the corporate veil) whenever necessary to prevent fraud or achieve equity. - 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 corporate form may not be totally disregarded merely because the assets of the corporation are insufficient to assure him the recovery sought. If insurance coverage mandated by legislature is inadequate for protection of the public, the remedy is with the legislature and not the courts. - The plaintiff has to prove that Carlton and his associates were actually doing business in their individual capacities, shuttling their personal funds in and out of the corporations without regard to formality and to suit their immediate convenience. - This case is only to be found under respondeat superior. DISSENT: The companies were undercapitalized. How long are the courts going to allow the abuse of the system? Kinney Shoe Corp. v. Polan, 4th Cir (1991) Casebook p. 156 FACTS and PP: In 1984, Polan formed Industrial and Polan Industries, Inc. to re-establish an industrial manufacturing business. Polan Industries was incorporated under West Virginia law in 11/84 and for Industrial in 12/84. Certificates of incorporation were issued but no organizational meetings were held and no officers were elected. In 11/84, Polan started negotiating with Kinney about the sublease of a building that Kinney had leasehold interest in. Kinney was legally obligated to make payments to the owner (Cabell County Commission) through 1/1/93 when it had the right to purchase the building. Sublease began in 12/84 even though the parties signed the written lease on 4/5/85. On 4/15/85, Industrial subleased part of the building to Polan Industries for 50% of the rental amount due to Kinney. Polan signed both subleases. Industrial had no assets, income or bank account, no stock certificates, only income was from the sublease to Polan, Polan personally paid for the sublease for Industrial. After the first rental payment, no more payments were made. Kinney filed suit for unpaid rent and obtained a judgment in the amount of $166,400 on 6/1/87. Polan Industries had filed for bankruptcy so Kinney couldn‟t obtain possession for 6 months. Kinney then filed suit against Polan individually to collect the amount due. The district court held that Kinney had assumed the risk of the undercapitalization and was not entitled to pierce. ISSUE: Whether Kinney can pierce the corporate veil and hold Polan personally liable? HOLDING: Reversed – Kinney was entitled to pierce the corporate veil. ANALYSIS: Two-Pronged Test in West Virginia - Is the unity of interest and ownership such that the separate personalities of the corporation and the individual shareholder no longer exist? - Would an equitable result occur if the acts were treated as those of the corporation alone? Factors in making determination - Commingling of funds of corporation with shareholder - Diversion for personal use of funds - Failure to maintain corporate formalities - Individual shareholder says he‟s personally liable - Failure to maintain adequate corporate records - Identical equitable ownership in two entities - Same parties owning - Undercapitalization - Absence of separately held corporate assets - Use of corporation as mere shell or conduit to operate a single venture or some particular aspect of the business of an individual or another corporation - Sole ownership of stock by one individual - Use of same location - Employment of same people - Concealment or misrepresentation of the identity of the ownership, management or financial interests of the corporation - Disregard of legal formalities and failure to maintain proper arm‟s length relationships among related entities - OTHERS listed on p. 157-8 This case - Undercapitalization - No corporate formalities Third Prong - When a party enters in a contract with the corporation and an investigation would disclose that the corporation is grossly undercapitalized, based upon the nature and the magnitude of the corporate - undertaking, such party will be deemed to have assumed the risk of the gross undercapitalization and will not be permitted to pierce the corporate veil. District court applied this prong and said that Kinney assumed the risk and the piercing does not apply. This court stated that the third prong is permissive and not compulsory. NOTES: 1. How much more than mere undercapitalization should be required? 2. Question 3. Is it an abuse of corporate form of doing business for an affluent individual to split up her business operations among different corporations so as to limit her monetary exposure to a modest amount or is this one of the legitimate advantages which limited liability is supposed to provide? 4. Question 5. Question United States v. Bestfoods, USSC (1998) Casebook p. 160 – PIERCING THE CORPORATE VEIL FACTS: CERCLA – 1980: In response to serious environmental and health risks due to industrial pollution; grants the President broad power to command government agencies and private parties to clean up hazardous waste sites; US can use government monies (superfund) to pay for the clean up and then sue the owners and operators of the violating companies; “person” means corporations and other business entities. In 1957, Ott Chemical (Ott I) began making chemicals in MI where it polluted the soil and ground water. In 1965, CPC International (CPC) made a company to buy Ott I‟s assets with CPC stock. The new company was Ott II. Ott II continued the pollution. CPC kept the same officers of Ott II as in Ott I, but also gave those people positions at CPC and they performed duties for both. In 1972, CPC sold Ott II to Stsory chemical that operated Ott II until bankruptcy in 1977. In 1977, The Michigan Department of Natural Resources (MDNR) found land full of pollution and tried to sell the land to someone who had an established clean-up plan. So, MDNR got Aerojet to buy the land. Aerojet created Cordova CA to buy the land. Cordova CA created Cordova MI to exist on the site to manufacture chemicals. In 1981, the EPA mandated clean up of the site, which cost in the tens of millions of dollars. PP: US sued for the costs of cleaning up industrial waste generated by a chemical plant under the CERCLA (Comprehensive Environmental Response, Compensation, and Liability Act of 1980). US named 5 defendants to the suit: CPC, Aerojet, Cordova CA, Cordova MI and Arnold Ott. The parties and the MDNR filed a bunch of contribution claims, counter claims and cross claims that were consolidated into three phases: liability, remedy and insurance coverage. Liability has been decided in bench trial which focused on the issue: Whether CPC and Aerojet, as parents of Ott II and Cordova, had “owned and operated” under the code. The district court found them both liable because of the following test: 1) exertion of power over its subsidiary by actively participating in and exercising control over the subsidiary‟s business during period of disposal of hazardous waste; 2) parent‟s mere oversight of subsidiary‟s business in a manner appropriate and consistent with investment. COA reversed in part reversed in part stating that a parent can only be held liable where it abuses the corporate form in such a way that will warrant piercing the corporate veil and disregarding the separate corporate entities. COA decided that neither CPC nor Aerojet abused the corporate form in that way since there were separate personalities and parents did not use the subsidiaries to perpetrate fraud or subvert justice. ISSUE: Whether a parent corporation that actively participated in, and exercised control over, the operations of a subsidiary may, without more, be held liable as an operator of a polluting facility owned or operated by the subsidiary? HOLDING: Vacate and remand with instructions – Re-evaluate. RULE: A parent corporation cannot be held liable unless the corporate veil may be pierced so a corporate parent that actively participated in and exercised control over the operations of the facility itself may be held directly liable in its own right as an operator of the facility. ANALYSIS: ISSUE OF LIABILITY - Parent corporation should not be liable for the actions of its subsidiaries. - Parent corporation is not automatically liable under CERCLA as owner/operator just because its subsidiary is subject to liability. - The conduct must show that the corporate form was misused to accomplish certain wrongful purposes. - Only when the corporate veil may be pierced may the parent corporation be held liable for the wrongdoing of its subsidiary. ISSUE OF OWNERSHIP/OPERATOR - Defining actions sufficient to constitute direct parental operation. - Someone who directs the workings of, manages, or conducts the affairs of a facility that have to do with the leakage or disposal of hazardous waste or decisions about compliance with environmental regulations. Donahue v. Rodd Electrotype Co., Supreme Court of Massachusetts (1975) Casebook p. 173 – SHAREHOLDERS RIGHTS IN CLOSE CORPORATION FACTS: In 1935,  Rodd began with Royal which had the Rodd Electrotype as a wholly owned subsidiary. Rodd moved up quickly and by 1946 he was general manager and treasurer. In 1936, ‟s husband was hired by the company and became plant superintendent by 1946 and corporate VP by 1955. He never participated in management of the business. Royal offered shares of the common stock of Rodd to both Rodd and Donahue and Rodd bought 200 shares and Donahue (with Rodd‟s encouragement) bought 50. Kelley had the remaining 25 shares. The parent company held 725 of 1000 shares. In 6/55, the subsidiary bought the rest of the shares from the parent for $135,000 and additionally purchased Kelley‟s shares. Rodd mortgaged his home to obtain some of the necessary funds. These purchases left Rodd with majority control. Shortly before the buy-out, Rodd became president of the company and in 6/60, the company was renamed Rodd Electrotype. Rodd‟s sons began to take spots on the BOD and another son replaced Donahue as superintendent of the plant. In 1965, Charles Rodd (son) took over as president and GM. From 1959-67, Rodd distributed his shares among his family members. In 1970, Rodd resigned due to poor health and the Rodd sons who were in power agreed to buy shares from their father for $36,000. (45 shares at $800/share) Donahue still owned 50 shares but then later divestments to the family left them all with 51 shares by 3/71. It was not until 3/30/71 that Donahue learned that the corporation had purchased Rodd‟s shares and he questioned it. The trial judge found that the Donahue‟s did not ratify the purchase of the shares. After this, Donahue offered his shares for sale at the same deal given to Rodd but the corporation refused to buy them. PP: Donahue is a minority stockholder in REC and is suing its board of directors, the controlling stockholder and the corporation for rescission of their purchase of the controlling shareholder‟s shares and repayment from Rodd the purchase price of the shares ($36,000) because the defendants forced the corporation to purchase the shares in violation of a fiduciary duty to her. She contends that the defendants were diverting assets for the benefit of the Rodd family. She wanted an injunction and restitution of misappropriated funds. The trial court dismissed the case and the COA affirmed the dismissal. ISSUE: Whether or not shareholders in a close corporation are required to offer each stockholder an equal opportunity to sell their shares? What duty of care is owed to minority shareholders in a close corporation? HOLDING: Reversed the decision to dismiss plaintiff‟s claim but the holding is limited to closely held corporations RULE: If a stockholder whose shares were purchased was a majority stockholder, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares at an identical price to the corporation. When it is a close corporation, the purchase is subject to the utmost good faith and loyalty to other stockholders. ANALYSIS:  Argument: Unlawful distribution of corporate assets to controlling stockholders which constituted a breach of fiduciary duty owed by the Rodds because they failed to give her an equal opportunity to sell her shares to the corporation.  Argument: Stock purchase was within the powers of the corporation and met requirements of goods faith and fairness and that there is no right to equal opportunity in corporate stock purchases. - Close corporation looks like partnership – Ownership is limited to the original parties or transferees of their stock to whom the stockholders have agreed, in which ownership and management are in the same hands, and in which owners are dependent on one another for success of the enterprise. - The relationship among stockholders must be one of trust, confidence and absolute loyalty. - The minority shareholders are vulnerable to oppressive devices (freeze-outs) o Refuse to declare dividends - - - - o Drain off earnings of corporation in form of salaries or leases o Deprive minority shareholders of offices and employment o Sales of assets at an inadequate price to majority shareholders Minority can sue based on director‟s fiduciary obligation to the corporation. The judiciary has been reluctant to interfere. This can trap minority shareholder with shares he can‟t get rid of. These schemes are designed to get minority shareholders to sell at a loss to the corporation. Because of the fundamental resemblance of close corporation to partnership, the trust and confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in the close corporations, WE HOLD THAT STOCKHOLDERS IN THE CLOSE CORPORATION OWE ONE ANOTHER SUBSTANTIALLY THE SAME FIDUCIARY DUTY IN THE OPERATION OF THE ENTERPRISE THAT PARTNERS OWN TO ONE ANOTHER WHICH IS UTMOST GOOD FAITH AND LOYALTY. In a corporation, the directors are held to good faith and inherent fairness standard of conduct but the paramount duty is to the corporation. In MASS, a corporation has the power to purchase its own shares but must do so in good faith and without prejudice to creditors and stockholders. When it is a close corporation, the purchase is subject to the utmost good faith and loyalty to other stockholders. If a stockholder whose shares were purchased was a majority stockholder, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares at an identical price to the corporation. o Gives a market for the minority shares; o Access to corporate assts for personal use. Relief given to the minority shareholder: 1) remission of the original sale; 2) allowance of a new sale of the minority stock. Nixon v. Blackwell, Supreme Court of Delaware (1993) Casebook p. 182 – FACTS: PP: Trial court held that defendant directors of a closely held corporation breached their fiduciary duties to the plaintiffs by maintaining a discriminatory policy that unfairly favors employee stockholders over plaintiffs. They found that the directors allowed employees to provide liquidity in selling their stock while there was no comparable deal for minority shareholders. ISSUE: Whether or not the directors of a close corporation must offer the same deal for minority shareholders as majority shareholders? HOLDING: Reverse and remand Ramos v. Estrada, California Court of Appeals (1992) Casebook p. 188 FACTS: PP: ISSUE: HOLDING: RULE: ANALYSIS: Somers v. AAA Temporary Services, Inc., Illinois Court of Appeals (1972) Casebook p. 195 – DEVIATIONS FROM THE CORPORATE NORM FACTS: - AAA was an IL corporation that provided temps. It had 2 shareholders with 25 shares apiece (Raimer and Kay). Raimer was the president and Kay was the secretary and treasurer. - The number of directors was to be determined at the first shareholder‟s meeting. At the first meeting held in May of 1967, they decided on 3 (Kay, Raimer and Somers). Additionally, the by-laws were adopted allowing for the schedule of shareholder and BOD meetings annually (second Monday of each year). - No meeting was held in 1968 but in 1969 at the meeting Kay and Raimer signed waiver of notice of annual shareholders meeting which also was held to amend the number of shareholders from 3 to 2. They elected themselves the sole directors. - Somers says that the meetings for 1969 were ever held and that the actions were not discussed until the end of January. Additionally, he states if they were held, the resolutions were unlawful and not within the power and authority of the shareholders. PP: Director whose position was terminated sued the close corporation for the termination of his position in order to declare the amendment of the corporate by-laws invalid. Trial court held that the resolution was invalid and that he should be reinstated. The corporation appeals. ISSUE: Whether the 2 sole shareholders of a close corporation may validly agree that the by-laws of the corporation be amended to reduce the number of directors and thereupon elect themselves the sole directors? Whether the shareholders have the power to amend the by-laws where such power has not been reserved to the shareholders by the Articles of Incorporation? HOLDING: Affirmed decision of trial court. RULE: - The BCA may not be disregarded in the case of a close corporation but slight deviations from the corporate norms may be permitted. Action by a shareholder that is in direct contravention of the statute cannot be allowed. - Where a plaintiff asserts a valid cause of action, the motive in bringing the action is immaterial. ANALYSIS: - IL BCA provides that number of directors can be changed by amendment to by-laws and that the power to amend is vested in the BOD, unless reserved to the shareholders by articles of incorporation. - Here, the power to amend was not reserved to the shareholders by the Articles so it would rest with the directors. So the amendment was not in compliance and null. -  Argument: Close corporations should be allowed to act in such a way under Galler. - Galler v. Galler: There is no reason for preventing those in control of a close corporation to reach any agreement concerning the management of the corporation, which is agreeable to all despite violating the BCA. o Limited to close corporations where no apparent fraud or injury would be worked upon the public, minority interests or creditors but not violating statutory language. - The BCA may not be disregarded in the case of a close corporation but slight deviations from the corporate norms may be permitted. - Action by a shareholder that is in direct contravention of the statute cannot be allowed. -  Raimer Argument: Plaintiff brought suit in order to conspire and oust Raimer. - Where a plaintiff asserts a valid cause of action, the motive in bringing the action is immaterial. NOTES: 1. Comment 2. Question 3. Question Lehrman v. Cohen, Delaware Supreme Court (1966) Casebook p. 198 FACTS: - Giant Foods (Giant), a DE corporation, founded by Cohen and ‟s father. Each owned equal amounts of the voting stock (AC – Cohen/AL – Lehrman). The two classes of stock have cumulative voting rights and each is entitled to elect 2 members of the BOD (4 members total). There was a dispute among the Lehrman children at the death of the father but in an arrangement,  was allowed to acquire the outstanding AL stock giving him voting power equal to Cohen family. Additionally, Giant was to repurchase a certain amount of stock from Lehrmans and the Cohens. An essential part of the agreement was the creation of an additional seat on the board to obviate the risk of deadlock in the company. - On 12/31/49, Giant‟s incorporation certificate was amended to create a third class of voting stock (AD) entitled to elect the fifth director. The share was empowered with the same rights but not allowed to get any dividends or assets and it could be repurchased by the corporation at any time for par value ($10). - AD was issued to Danzansky who was the corporate attorney for Giant. In 4/50, Danzansky voted his share to elect himself the 5th director and served as such until 1964. No deadlock arrived before this point. - In 12/59, 200,000 shares of non-voting common stock were sold for $3 million in a public issue stating that AD stock is only to prevent deadlock in AC and AL stock votes. - Until 10/1/64, Cohen was president. On that date, a resolution was adopted at Giant‟s stockholders‟ meeting giving Danzansky a 15 year executive employment K at $67.6K and options for 25K of non-voting stock. AC and AD voted in favor and AL voted against. He was elected President by 3-2. On 12/11/64, he resigned as director and voted his share to elect West as the 5th Director. The new board ratified Danzansky‟s election and his K was approved in January with certain modifications. PP: Lehrman sued on 12/11 alleging: the AD stock‟s creation, issuance and voting resulted in an arrangement that was illegal under the law; the election of Danzansky as president and the employment contract violated the 1959 deadlock arrangement which constituted a breach of K and breach of fiduciary duty. The defendants‟ motion for summary judgment was granted. ISSUE: - Applicability of the DE Voting Trust Statute - Legality of the stock having voting power but not dividend or liquidation rights - Alleged unlawful delegation of directorial duties and powers. HOLDING: Affirmed RULE: ANALYSIS: Class AD stock arrangement is a voting trust and it is illegal because it is not limited to a 10 year period as required by Voting Trust Statute. - Criteria of voting trust: 1) The voting rights of the stock are separated from other attributes of ownership; 2) the voting rights granted are intended to be irrevocable for a definite period of time; 3) the principal purpose of the grant of voting rights is to acquire voting control of the corporation. - : Argues that this is the situation. - Court: The stock arrangement was a capitalization of Giant and although it diluted the voting power of AC and AL stock, it did not divest and separate the voting rights which remain vested in the other classes of stockholders. - This is not a trust or a pooling agreement. Class AD stock is illegal because the creation of a class of stock having voting rights only, and lacking any substantial participating proprietary interest in the corporation, violates the public policy of the state as declared in §218. - Court: The public policy that the law has disfavored is the separation of vote from stock not from ownership of stock. - Court: Nothing in the statute says that all stock must have both voting rights and proprietary interest. - Under §151(a), non-voting stock is authorized so public policy does not condemn the separation of voting rights form beneficial stock ownership. - Stock is legal under §151(a). If the AD stock arrangement is allowed to stand, the VTS will become a dead letter because it will be possible to evade and circumvent its purpose simply by issuing a class of non-participating voting stock. - Court: Assumes divestiture of voting rights; the main purpose of VTS is to avoid secret, uncontrolled combinations of stockholders formed to acquire voting control of the corporation to the possible detriment of nonparticipating shareholders; the legislature should be responsible for fixing this. NOTES: 1. ?? 2. Question In re Radom & Nierdorff, NY COA (1954) Casebook p. 204 – DISSOLUTION AND DEADLOCK FACTS and PP: - Business of printing music founded by R and N. - N died and left it to his wife who did not get along with her brother R. - They have been the sole equal stockholders of this company. - R sues for dissolution under §103 of BCA where holders of ½ of the stock entitled to vote at an election of directors may present a verified petition for dissolution of the corporation as prescribed in this article. - Trial court said that there was a basic and irreconcilable conflict between the stockholders requiring dissolution. - Appellate court reversed and ordered dissolution HOLDING (Majority): Order denying dissolution is upheld ANALYSIS: - The dismissal was within the discretion of the appellate court. - “Even when majority stockholders file a petition because of internal corporate conflicts, the order is granted only when the competing interests „are so discordant as to prevent efficient management‟ and the „object of its corporate existence cannot be attained‟” o FACTUAL QUESTION - IN ORDER TO DETERMINE DISSOLUTION, YOU MUST EVALUATE WHETHER JUDICIALLY IMPOSED DEATH WILL BE BENEFICIAL TO THE STOCKHOLDERS OR MEMBERS AND NOT INJURIOUS TO THE PUBLIC DISSENT: - R should be entitled to a hearing to present his proof because he has alleged more than enough. - The deadlock of which petitioner complains is between the stockholders, not the directors, and when the stockholders are deadlocked, section 103 calls for dissolution, not arbitration. - There is no need for corporate insolvency to dissolve. - Just requires a hearing. - HOLDING: No basis in the statute or elsewhere for requiring that irreparable injury must occur before resort may be had to remedy designed to avert it. NOTES: 1. Question 2. Question 3. Question 4. Question 5. Question 6. Question 7. Question Oceanic Exploration Co. v. Grynberg, Delaware Supreme Court (1981) Casebook p. 211 – VOTING TRUSTS FACTS: Hanewald v. Bryan‟s Inc., North Dakota Supreme Court (1988) Casebook p. 277 – SHAREHOLDER‟S OBLIGATION TO PAY AND PAR VALUE FACTS: - On 7/19/84, Keith and Joan Bryan incorporated as Bryans to be a retail-clothing store. The corporation‟s officers were Keith (pres), George (VP) and Joan (Sec-Tres). The corporation was authorized to issue 100 shares of common stock at $1000 par value. Keith got 50 shares and Joan got 50 shares while no money was paid for the shares in labor, services or money. - On 8/30/84, Hanewald sold his store to Bryans, Inc. for $60K and leased the building for $600/month for 5 years. Bryans paid $55K via loan from bank and $5K via promissory note due 8/30/85. - The store only lasted 4 months with operating loss of $4840 and closed in 12/84. The inventory was sent to other Bryans stores and a Notice of Rescission was sent to Hanewald to attempt to avoid the lease. - In 8/1/86, Bryans, Inc. was involuntarily dissolved because of failure to file with SOS. Bryan never paid the $5K promissory note but paid the rest of the creditors. The $55K loan was paid and a $10K loan from Keith and Joan was paid which was intended to be used for operating costs and expenses supposedly. PP: Hanewald sued for breach of lease and promissory note seeking to hold Bryans personally liable. Bryans counterclaimed alleging that Hanewald fraudulently misrepresented the business‟s profitability in negotiating the sale. At bench trial, Hanewald got judgment against Bryans for $38.6K but refused to hold defendant‟s personally liable because the $10K loan from Keith Bryan was enough and lack of bad faith to prevent piercing. ISSUE: Whether or not the Bryans should be held personally liable for the judgment against the corporation? HOLDING: Agreed with Hanewald that Bryan should be held personally liable because of their failure to pay for shares issued to them. RULE: A SHAREHOLDER IS LIABLE TO CORPORATE CREDITORS TO THE EXTENT HIS STOCK HAS NOT BEEN PAID FOR. ANALYSIS: - Statute: Only obligation of the shareholder is the obligation to pay to the corporation the full consideration for which such shares were issued or to be issued. It is a pre-requisite for limited liability. - Consideration for shares: anything but future services, promissory notes - Failure to pay for the shares makes them personally liable under the code. - A SHAREHOLDER IS LIABLE TO CORPORATE CREDITORS TO THE EXTENT HIS STOCK HAS NOT BEEN PAID FOR. - Reasons: violates rights of existing stockholders who do not consent to gratuitous issuance; fraud upon subsequent shareholders. - Loan was a debt and not an asset and not considered a capital contribution. Gottfried v. Gottfried, New York Court of Appeals (1947) Casebook p. 286 FACTS: - Defendants: The corporation, the directors and Hanscom Baking (subsidiary). - Plaintiffs: Minority stockholders of the corporation (closely held family corporation). - Gottfried was wholesale bakery products company and Hanscom was retail. Both operate separately. - At end of 1946, outstanding capitalization of Gottfried consisted of 4500 shares of „A‟ stock without value and 20,862 shares of common stock without par value. The „A‟ stock was entitled to $8/share dividends before common stock was paid. There was also preferred stock. - s owned 38% of each class of stock and the defendants owned 62%. - From 1931-1945, no dividends had been paid to common stock holders but regularly to preferred and sometimes to „A‟ stock. - This action was to compel the declaration of dividends upon the common stock in a fair and adequate amount. The plaintiffs claim that the BOD is breaching fiduciary duty to stockholders and corporation. Supposedly there is animosity between BOD and minority stockholders. Additionally, s say that BOD are trying to force the minority out. HOLDING: Dismissed complaint. RULE: In order to show that fiduciary duty was breached because dividends were not paid, you must show surplus existed and dividends were appropriate but not paid due to bad faith. ANALYSIS: - If adequate corporate surplus is available, dividends may not be withheld in bad faith but the mere existence of surplus is not enough to compel a dividend. - Evidence of bad faith: hostility against the minority; exclusion of minority from employment; high salaries, bonuses, loans made to officers in control; high taxes if dividends are paid; desire to obtain minority stock as cheaply as possible. - TEST OF BAD FAITH: WHETHER THE POLICY OF THE DIRECTORS IS DICTATED BY THEIR PERSONAL INTERESTS RATHER THAN THE CORPORATE WELFARE? - Plaintiffs have failed to prove that the surplus is unnecessarily large, or that the defendants recognized the propriety of paying dividends but refused to do so for personal reasons. Gabelli & Co. v. Liggett Group, Inc., Delaware Supreme Court (1982) Casebook p. 290 – FACTS: - Defendants: Liggett and GM Sub moved to dismiss because the complaint fails to state a claim upon which relief can be granted. - Gabelli owned 800 shared of 8.4 million of Liggett before merger in 1980. Gabelli brought class action against Liggett prior to the merger. - Liggett, DE corp, makes cigarettes and GM Sub, DE corp, is subsidiary of Grant Met an English Corp. GM sub was formed in 3/80 to buy Liggett for Grand Met by way of tender offer. Initially, they offered $50/share but then $69/share to counter Standard Brands. Liggett‟s board approved the latter offer as fair and recommended it to the shareholders. 85% of the shareholders approved the offer and tendered their shares to GM Sub in spring of 1980. - Grand Met then proposed plan of merger where Liggett would be merged into either Grand Met or wholly-owned subsidiary where the minority shareholders would be cashed out at $69/share. The merger date was set for 8/80. - A dividend was not declared as it usually was in late July and minority shareholders brought suit. They were cashed out by the merger in 8/80. - The complaint did not ask for injunction against the merger or adequacy of price of cashout. - Complaint alleges: Grand Met breached fiduciary duty by eliminating the dividend for Liggett until after the merger. - Defendants contend that the dividend is within the discretion of the BOD and cannot be interfered with absent showing of oppressive or fraudulent abuse of discretion which has not been shown. HOLDING: Dismissed complaint (possible amendment) without prejudice ISSUE: Whether a minority stockholder of a subsidiary corporation, faced with being cashed out by a merger orchestrated by the majority stockholder, may compel payment of a dividend where he alleges breach of fiduciary duty by the parent corporation? ANALYSIS: - BOD has been giving wide latitude in making decision of declaring a dividend enjoying a presumption of sound business judgment not disturbed by a court in the absence of a disabling factor. - Statute gives power to BOD as well. - Plaintiff must allege facts that would overcome the protection of the business judgment rule so that transaction might be tested against the intrinsic fairness tetst. - WHETHER THERE ARE ALLEGATIONS IN THE COMPLAINT WHICH WOULD PERMIT THE TRANSACTION TO BE TESTED AGAINST THE INTRINSIC FAIRNESS TEST? - Factors must be shown: 1) Control and domination of the transaction by the parent corporation; 2) selfdealing/self-interest. Berwald v. Mission Development Co., Delaware Court of Appeals (1962) Casebook p. 296 FACTS and PP: - : Owned 248 shares of  corporation and sued to compel liquidation and distribution of assets to shareholders. -  answered and filed motion for summary judgment which was granted and plaintiffs appeal. -  is a holding company which owned a block of 7 million shares of Tidewater Oil Company a large integrated oil company which is controlled through Mission and Getty Oil Company. Mission was formed in 1948 to invest in the stock only. - From 1948-1951, Mission acquired more shares and by 1960 had almost 7 million shares. In 1954, Tidewater stopped paying cash dividends so that it could expand and modernize. ISSUE: Whether or not there was a conflict of interest between majority shareholder of corporation that was formed to hold and acquire shares of another corporation such that the arresting of issuance of dividends would be a breach of fiduciary duty to the minority shareholders? HOLDING: Judgment affirmed ANALYSIS: - There is an inherent conflict of interest because of the tax purposes - The plaintiff has a duty to show evidence of genuine issue of fact - Plaintiff is seeking to wind up the corporation when it was doing what it was lawfully organized to do. - The courts usually side with the majority where there is some plausible reason to do so. Auer (president of R. Hoe & Co.) v. Dressel, New York Court of Appeals (1954) Casebook p. 303 FACTS: - By-Laws state: it shall be the duty of the President to call a special meeting whenever requested in writing to do so, by stockholders owning a majority of the capital stock entitled to vote at such meeting. - On 10/16/53, petitioners submitted to president written request for meeting of class A stockholders signed by more than 55% of the class A stockholders. The president did not call the meeting and after waiting a week, the petitioners instituted this action. - Class A stockholders sued under article 78 of Civil Practice Act for mandamus to compel the president of R. Hoe & Co. to comply with duty under the by-laws. - The  answer denied that he had knowledge sufficient enough to form a belief only. ISSUE: Whether the President has discretion as to when to call a meeting when majority of stockholders request one be held? HOLDING: Allow the special stockholder meetings ANALYSIS: - Purposes of the special stockholder meeting: a) vote on resolution reinstating Auer as president; b) voting on amendment to by-laws or charter about directors; c) voting about director charges; d) voting about other amendment to by-laws. - The stockholders should be allowed to amend their own by-laws to guarantee a right. If there is a problem then the director illegally removed can have his day in court. - Where by-law of corporation provided that it shall be duty of president to call special meeting whenever requested by stockholders owning majority of capital stock, and written requests, signed in names of holders of record of slightly more than 55 per cent of preferred stock, were submitted to president requesting special meeting, and president failed to call meeting, and, after waiting a week, stockholders brought proceedings to compel president to comply with duty to call election, and president denied that he had information sufficient for belief as to adequacy of number of signatures on written requests, Special Term properly disposed of the matters summarily by entering order requiring president to call special meeting. DISSENT: - The meeting was unauthorized as it was. - Corporation code: “The business of a corporation shall be managed by its board of directors.” - This meeting would impair the rights of the common shareholders in participating in filling vacancies upon the BOD and could not be legally adopted at this meeting demanded by petitioners from which the common stockholders would be excluded. - Additionally, the BOD has the power to run the corporation and not the shareholders. Driver v. Driver, Supreme Court of Wisconsin (1984) Casebook p. 317 – CORPORATE GOVERNANCE FACTS: - Prior to 7/82, James was President of UTC and sole director. The shares of UTC were owned by James, the respondents (all members of his family), another member of the family and 2 employees as follows: 2250, 2000 each of the next and 675 each employee. - In 2/82, Connie Driver called special meeting of shareholders to amend the bylaws to increase the numbers of directors and revoke the BOD‟s power to amend the bylaws. James countered with another special meeting to have no change in BOD for 5 years without majority of shareholders approval. There was a meeting but no amendment passed. - On 4/1/82, James amended the bylaws without notice to the other shareholders. The amendments involved making the only member of the BOD the president of the corporation; allowing him alone to call meetings and that he has to be present for the meetings; and that he has to be in the voting party in amendments. - On 7/6/82, Connie called a special meeting with notices sent to each shareholder and James came but left before any voting occurred. The remaining shareholders voted on 5 person board and elected James and others to be members of the board. - James did not attend the first new board meeting. He was removed as president and the amendments he made were repealed. Connie was elected president. Robert was VP and Connie was also Sec/Treasurer. PP: James sued alleging that the meeting on 7/9 was called invalidly because he had not participated in the call. He wanted a temporary injunction against respondents and to change things back to status quo. Respondents countered stating that the meeting was proper and wanted a temporary injunction against appellant. Trial court said that respondents got summary judgment because of the statute that said that “a director, (James), had a fiduciary duty to the other shareholders and could not use his position to entrench himself and perpetuate his own control. James Driver appeals because summary judgment was awarded against him. The trial court held that he raised no relevant factual issues, that his attempted amendments to the bylaws of UTC were invalid because they were contrary to statute and that the respondents adding themselves to the BOD and removing him as president were valid. ISSUE: HOLDING: Affirmed Summary judgment ANALYSIS: James argument – There is a factual issue as to his timely notice of the July 9 meeting. Court – There was no evidence that he was not served in time. James argument – The call of the meeting was invalid under ¶ 3 of the bylaws because he did not join in the call. Court – That paragraph conflicts with the statute because it eliminates the shareholders‟ right to call special meetings. James argument – The joining in only applies to special meetings called on short notice. Ten days notice is sufficient and he need not join in the calling of those meetings so he is not actually denying their rights. Court – This is not what ¶ 3 says and no further methods were contemplated and appellant even said that the meetings couldn‟t be called without his joining in. James argument – The amendment to the bylaws was invalid because he did not vote for it. Court – Each shareholder is entitled to one vote unless the voting rights are enlarged or limited by articles of incorporation. James argument – The veto power is legitimate necessary to protect his minority interest. Court – Every shareholder holds a minority interest. Allen v. Park National Bank, US COA (7th Cir. 1997) Casebook p. 320 – CUMULATIVE VOTING FACTS: PP: Allen filed suit against Bank and then Takiff became intervenor who counterclaimed against Allen. Allen said that bank violated provisions of National Bank Act in adjourning shareholder‟s meeting where BOD was to be elected and seating a board dominated by Takiff. He wanted an injunction commanding the bank to seat a board in accordance with the ballots he cast at the meeting. Takiff‟s counter alleged that Allen was entitled to no relief because he had cast votes for directors in such a way to violate an agreement between the two men. Takiff wanted an injunction commanding Allen to comply with the agreement. At the bench trial, the judge agreed with Takiff‟s interpretation and ordered Allen to cast votes in future elections for directors in accordance with that interpretation. American Telephone & Telegraph Co. v. Harris Corp., Delaware Superior Court (1993) Casebook p. 326 FACTS and PP: Harris moved for partial summary judgment on ATT suing for unpaid and allegedly due royalties pursuant to a license agreement from and after 7/1/83.  argument: ATT is barred by SOL from recovering any royalties allegedly due before 1/3/89 (3 years before the action was filed).  argument: ATT is only barred from 1/3/86 because NY statute should apply which is 6 year SOL. ISSUE: Whether the SOL was a good defense? Whether NY or DE law applies and also whether the license agreement was a sealed instrument under NY law? HOLDING: Because the license agreement is not actually a “sealed” instrument, the DE borrowing statute requires the lesser of the statute of limitations so they would get the 3 year DE limitations period. RULE: In order to create a “sealed instrument”, more than the presence of the word seal and a corporate seal is necessary. ANALYSIS: 1. THE LICENSE AGREEMENT - The SOL depends on whether or not it is considered an instrument under seal. - Factually, it was signed by both parties, “seal” appears below the signature block of each, corporate seal is on each. -  Argument: SJ should be denied because there is a material fact issue as to whether the parties intended to create a sealed instrument o Affidavits from ATT stating that the reason they entered into agreements like that was for them to be sealed instruments. o Affidavits from Harris stating that they used seals to show that the signatures were authenticated and not sealed documents. -  Argument: Under Delaware‟s borrowing statute, the Court must apply DE 3 year statute of limitations applicable to claims for breach of contract not under seal. -  argument: Under Delaware‟s borrowing statute, the Court must apply NY 6 year statute of limitations governing sealed instruments. - Where a cause of action arises outside the state, DE‟s borrowing statute mandates that the shorter period of limitations will control. o So if it is sealed as ATT contends, NY‟s 6 year is shorter than DE‟s 20 year common law SOL. o So if it is not sealed as Harris contends, DE‟s 3 year is shorter than NY‟s 6 year SOL. - CHOICE OF LAW o Agreement states NY law will govern. - Factual support for : no intent to make it sealed in the language of the document (signed, sealed, delivered; hands and seals); far below the signature block. - Factual support for : contains all of the indicia making it sealed (attesting witnesses, seal, impressions). - It is not legally impossible to having an instrument under seal but the instrument here is not under seal. - UNDER NY LAW, the presence of the word seal and a corporate seal on the agreement alone will not suffice to make the document a sealed instrument. It must also contain an express acknowledgment of the presence of the seal or there must be other proof that the parties intended to make the document a sealed instrument. - UNDER DE LAW, a sealed instrument must also contain language in the body of the contract, a recital affixing the seal, and extrinsic evidence showing the parties‟ intent to conclude a sealed contract. - Adoption of the act of the printer…MORTGAGES require less proof in requiring less proof than other cases because they are traditionally sealed instruments. Intent Stewart Captial Corp. v. Andrus, Southern District Court of NY (1979) Casebook p. 332 FACTS and PP: - This is a suit for a declaratory judgment and injunction against the Secretary of Interior by the highest bidder of an off-shore oil and gas lease which was awarded to the lower bidders because of a presumed defect of the higher bid submitted. - Stewart submitted a bid for $213K with his enclosed check of 1/5 of the amount of the bid signed by the company‟s assistant secretary ($42.6K) as required by the noticed. The bid was signed by the Stewart‟s president. - The bid was rejected on 3/29/70 and awarded to bidders Murphy and Ocean. It was rejected because of a technical deficiency, namely the signature of the president on the bid was not attested to by the secretary. ISSUE: Whether or not there was sufficient attestation as to the authority of the president of the corporation to make the bid? HOLDING: The plaintiff was the highest bidder and should have been granted. High bidder on offshore oil and gas lease which showed that it submitted a legal bid was entitled to injunctive relief precluding lower bidders to whom leases were awarded asserting the rights under those leases and requiring the Secretary of the Interior to execute a lease in favor of the high bidder. RULE: Absent explicit statutory provision to the contrary, attestation of a corporate document is a mere formality of bearing witness to, or affirming the genuineness of, the execution of the document. ANALYSIS: - The ‟s documents completely satisfied the requirements of statute but the memorandum to the  concluded that the bid was deficient and legally unacceptable. - Secretary of Stewart submitted several certificates to the documents that accompanied the bid and the certified check which she signed for the required deposit to be made by the corporation. - The effect of attestation upon the authority of a corporate officer to make an offer which binds the corporation depends upon state law and as  is incorporated in DE, the law of that state is controlling in this controversy. - The presence or absence of attestation has no effect whatsoever on the validity of plaintiff‟s bid as a binding offer. - The determination that the bid was legally insufficient and deficient was erroneous. There was sufficient attestation. Fradkin v. Ernst, Northern District Court of Ohio (1983) Casebook p. 336 FACTS: Challenge to the 1983 stock option plan for the senior executives of Mohawk Rubber Company which was approved by directors on 1/4/83 and presented and allegedly approved by the stockholders at the annual meeting. Shareholder brought derivative action against board of directors seeking declaration that stock option plan had not been approved at shareholder's meeting and that proxy solicitation statement had been materially false and misleading. Mohawk is Ohio corporation with PPB in Ohio. It manufactures tires sold in replacement market for tires. It has experienced recent substantial financial success. Stock is traded on NYSE – as of 1983, over 2 million shares of common stock were divided among 2600 shareholders. During 1982, the prices for shares ranged from $15 ¼ to $25 1/8. But during 1983, the shares sold for about $32/share. Because of Mohawk‟s success and relatively small portion of stock controlled by management, the investment community has viewed Mohawk as an ideal takeover candidate. ‟s Fawcett and Ernst are the principal executives of Mowhawk. They developed stock option plan because they had been with Mowhawk for so long and owned very little stock. Since 1978, F & E‟s compensation has also included a stock option plan both earned profits upon cancellation of stock appreciation rights (SAR‟s). In 1982, there was an additional grant of stock options to F & E. (SARs are a recent development that serve as a substitute for the grant and exercise of stock option rights. SARs allow a single payment by the corporation of the amount of appreciation on the stock to the grantee with no purchase or sale of the stock yet the grantee receives the value of the appreciation of the stock). In 1983, the BOD decided that the compensation available to them was inadequate so Ernst was directed to give this subject further consideration. The terms of that plan were option and SARs with options on 200K shares of stock. (9.25% of Mohawk‟s outstanding shares). The value of the options was tied to the market price of the shares on the day of the grant and the increased market price in 1983 diminished the value of options to Fawcett and Ernst. Under the terms of the Plan, any options would be invalidated if the Plan failed to receive approval by the holders of the majority of the common stock present or represented and entitled to vote at 1983 stockholder‟s meeting which was designed to qualify the Plan for exemption to the short swing profit rules of the Securities Exchange Act. On 12/17/82, some large shareholders of Mohawk filed amended schedule indicating intent to seek out other investors who might be interested in acquiring Mohawk. On 1/4/83, 16 days prior to the BOD meeting where the Plan was to be presented, Ernst called the directors individually to obtain approval for the Plan. He sent no written notice and Plan was not before them in written form prior to the telephone call. Each director orally approved the plan as it was presented to him (in parts) but the Plan presented to the shareholders was not in final form after 1/4/83 phone calls. Three of the directors agreed to be on an “Option Committee”. Minutes of the BOD meeting and option committee meeting were prepared outlining events of January 4, 1983 as if they had taken place in formal meetings (the minutes were basically fudged). Option agreements were prepared and signed by Fawcett, Ernst and members of the Option Committee at 1/20/83 BOD meeting (It was not discussed at same meeting). On 3/7/83, a notice and proxy statement was sent to shareholders for annual meeting to be on 4/12/83 indicating that the two principal items were proposal to re-elect directors and proposal to adopt the Plan. In a letter with the proxy, Fawcett and Ernst urged the shareholders to give prompt attention to the proxy and indicated that the BOD unanimously recommended a vote for the plan. On 3/17/83, Independence met with F & E to discuss the Plan and proxy statement and their efforts to get a seat on the BOD. Independence told F & E that the statement was misleading because it didn‟t fully disclose the benefits. (Independence was a majority stockholder). Independence send amendment to schedule stating that it wouldn‟t intend to support the adoption of the Plan because it was excessive and not in the best interest of the corporation. On 5/19/83, the BOD signed document designed to cure failure of not holding formal BOD meeting.  filed the complaint on 3/25/83 asking to enjoin the vote on the plan at the shareholder‟s meeting which was denied but enjoining implementation of the Plan until a trial on the merits. An amended complaint was filed on 4/18/83 raising derivative and class action claims which are the subject of the law suit. Count I alleges violations - - - - - - PP: - of Securities Exchange Act, Count II alleges common law corporate waste, and Counts III and IV allege that the Plan was not approved according to terms of the Plan or code of regulations.  says that a proxy statement issued to shareholders describing the Plan prior to the annual meeting violated federal securities laws.  also says that the Plan constitutes corporate waste and was not approved by the requisite number of shareholders at the annual meeting. - HOLDING: - After denying motion to dismiss and granting class certification, the District Court, held that: (1) stock option plan had not gotten the required majority vote at shareholder's meeting, and (2) proxy solicitation statement was materially misleading in a number of respects. The representations to the shareholders were materially false and misleading because they stated that the BOD had taken formal action and given deliberate consideration to the Plan so as a result, they violated rules. The shareholders did not approve plan and that the proxy statement was materially false and misleading with respect to the actions of the board of directors and the option committee. ANALYSIS: I. Approval of the Plan - Court must consider whether the Plan was approved by the shareholder‟s vote at the annual meeting. - Court decided that the shareholders did not approve the Plan. II. Violations of the Exchange Act - Proxy Rules o “An omitted fact is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote” o Mixed question of law and fact – “reasonable shareholder” from the given set of facts. - The facts in this case o The Misstatement: “The BOD, at its meeting of January 4, 1983, adopted, and directed to be submitted to the shareholders of the Company for their approval, the 1983 Non-Qualified Stock Option Plan.” o : That disclosure is materially false or misleading o : Disclosure, although not precise Shlensky v. Wrigley, Illinois Court of Appeals (1968) Casebook p. 387 – DIRECTOR‟S DUTY OF CARE TO CORPORATION FACTS and PP: -  appeals dismissal of their amended complaint in stockholder derivative action against directors for negligence and mismanagement seeking damages and order forcing s to install lights in Wrigley field and schedule night games. -  is minority stockholder of Chicago National League Ball Club (defendant corporation) which is a DE corporation with PPB in Chicago and it operates the Cubs and Wrigley Field, its concessions, TV and radio broadcasts of the games. Along with the corporation,  also sued directors of the Cubs and Wrigley is president of the corporation. -  says that night games have been scheduled by most every other team in the league in order to maximize revenue and income. During 1961-65, Cubs operated at a loss because of inadequate attendance at the home games according to the  and  therefore concludes that if they continue to refuse to install lights at the field they will continue to lose attendance.  alleges that the funding for the lights could be obtained by financing and it would be easily recaptured. He says that Wrigley won‟t allow it because he thinks that baseball is a daytime sport and that play at night would deteriorate the surrounding neighborhood. The directors supposedly acquiesced to the policy of Wrigley though the concern was not good faith motive for the corporation. -  alleges that directors are acting contrary and wholly unrelated to the business interest of the corporation. Arbitrary and capricious acts constitute mismanagement and waste of corporate assets. Additionally,  alleges that the directors have been negligent in failing to exercise reasonable care and prudence in the management of the corporate affairs. ISSUE: Whether the complaint states a cause of action when it does not allege fraud, illegality or conflict of interest in mismanagement suit? RULE/HOLDING: Affirmed dismissal of complaint ANALYSIS: -  Argument – Courts should not step in absent a showing of fraud, illegality or conflict of interest. -  Argument – That list is not exhaustive. - Precedent o Wheeler v. Pullman: The majority shareholders must be permitted to control the business of the corporation in their discretion, when not in violation of its charter or some public law or corruptly and fraudulently subversive of the rights and interests of the corporation or of a shareholder. o Davis v. Louisville Gas: The judgment of the directors of a corporation enjoys the benefit of a presumption that it was formed in good faith and was designed to promote the best interest of the corporation they serve – unless shown to be tainted with fraud. -  Argument – Dodge v. Ford Motor Co stated that there must be fraud or breach of good faith in order to justify courts entering into the internal affairs of corporations. - Court – It is not satisfied that the motives assigned to Wrigley and the other directors are contrary to the best interest of the corporation and the stockholders. The decision is best left to the directors without any showing of fraud, illegality or conflict of interest. - Court – No actual damage to the corporation -  Argument – Failure to follow the example of other major league clubs in scheduling night games constitutes negligence. - Court – Nope – There must be a clear showing of dereliction of duty on the part of the directors. Smith v. Van Gorkom, Delaware Court of Chancery (1984) Casebook p. 392 – Director‟s duty of care FACTS: Francis v. United Jersey Bank, Supreme Court of New Jersey (1981) Casebook p. 412 – Director‟s Duty of Care FACTS: - Parties: The s are trustees in bankruptcy of Pritchard & Baird Intermediaries Corp. a reinsurance broker. Overcash () is daughter of Pritchard and executrix of her estate. Pritchard was the largest single shareholder and she died after suit and before trial. - The litigation focuses on payments made by Pritchard to her 2 sons who were officers, directors and shareholders. PP: Trial court found Pritchard liable for negligence in losses caused by the sons. The appellate court affirmed. ISSUE: Whether a corporate director is personally liable in negligence for the failure to prevent the misappropriation of trust funds by other directors who were also officers and shareholders of the corporation? RULE/HOLDING: Affirmed decision of trial and appellate courts ANALYSIS: 1. Was Mrs. Pritchard negligence in not noticing and trying to prevent the misappropriation of funds held by the corporation in an implied trust? - LLL 2. Whether her negligence was the proximate cause of the plaintiff‟s losses? - LLLL Graham v. Allis-Chalmers Manufacturing Co., Delaware Trial Court (1963) Casebook p. 426 – DIRECTOR‟S DUTY OF CARE FACTS and PP: -  (derivative action) against directors and four non-director employees because of guilty pleas based on indictments charging violations of Federal anti-trust laws. They want to recover damages, which Allis-Chalmers is claimed to have suffered due to the violations. - Allis-Chalmers makes electrical equipment with lots of employees. BOD meets once a month and has 4 officers on it. The charges that were made against the defendants were that they conspired with other manufacturers and their employees to fix prices and use rig bids to private electric utilities and governmental agencies in violation of antitrust laws of the US. - There was no evidence from the Federal Government against the Defendant Directors in this case. ISSUE: Whether or not a corporation‟s directors can be held liable for the action of the employees? RULE/HOLDING: Affirmed holding of lower court = the individual director defendants are not liable as a matter of law merely because, unknown to them, some employees of Allis-Chalmers violated the anti-trust laws subjecting the corporation to loss. ANALYSIS:  Argument – The Defendants had actual knowledge of the anti-trust conduct upon which the indictments were based or in the alternative knowledge of the facts which should have put them on notice of such conduct. - Court: No evidence of actual knowledge during hearing or depositions. - Failed to establish actual knowledge of imputed knowledge on the part of the BOD  New Argument – The Defendants are liable as a matter of law because they failed to take action designed to learn of and prevent anti-trust activity on the part of any employees of Allis-Chalmers. - The defendants are liable for losses suffered by their corporation by reason of their gross inattention to the common law duty of actively supervising and managing the corporate affairs. - Rests on idea that the duty of care depends on the circumstances and facts of the particular case. Court: The directors were entitled to rely on the honesty and integrity of their subordinates until something occurs to put them on notice that something is wrong. Marciano v. Nasash – Delaware Court of Chancery (1987) Casebook p. 433 – Duty of Loyalty (General Principles) FACTS and PP: - Defendants appeal validation of claim in liquidation of Gasoline Ltd. (corporation placed in custodial status pursuant to DE business law because of deadlock among the BOD). - 50% of Gasoline is owned by Joe and Nakash and the other 50% by Marciano - Vice Chancellor ruled that §2.5 million in loans made by the Nakashes faction to Gasoline were valid and enforceable debts of the corporation despite their origin in self-dealing transactions. - This company was formed as a joint venture to market designer jeans (Guess jeans). Nakash owned Jordache and decided to go in on this with the Marcianos. - Prior to 3/86, Gasoline secured the necessary financing from Israel Discount Bank in NY at 1% above prime secured by Gasoline‟s accounts receivable and Nakashes‟ personal guarantee. In re Wheelabrator Technologies, Inc. Shareholders Litigation, Delaware Court of Chancery (1995) Casebook p. 438 – MANAGEMENT‟S DUTIES TO THE CORPORATION AND SHAREHOLDER RATIFICATION FACTS and PP: ISSUE: Whether or not shareholder ratification should operate to extinguish a duty of loyalty claim against a director? What are the legal consequences of a fully-informed shareholder approval of a challenged transaction? HOLDING: The court dealt with ‟s MSJ in following way: 1) granted for disclosure claim; 2) granted for duty of care claim; 3) denied as to duty of loyalty claim. ANALYSIS: - Acts of directors can be void or voidable. o Voidable acts are those that are performed in the interest of the corporation but beyond authority and are curable by shareholder approval. o Void acts are those that are ultra vires, fraudulent or involve corporate waste and are not curable by shareholder approval. - Shareholder ratification of voidable director conduct has extinguished claims against the director when: o Director acted in good faith, but exceeded the board‟s de jure authority. o Directors failed to reach an informed business judgment in approving a transaction. - Ratification decisions that involve duty of loyalty claims include: o Interested transactions between a corporation and its directors;  This will not be voidable if it is approved in good faith by a majority of the disinterested shareholders because it invokes the business judgment rule and limits judicial review to issues of gift or waste. o Cases involving a transaction between the corporation and its controlling shareholder.  These involve primarily parent-subsidiary mergers conditioned upon getting majority of the minority stockholder approval.  In parent-subsidiary merger, standard of review is entire fairness and BOD has to prove that the merger was entirely fair.  Where merger is conditioned upon majority of the minority approval, the burden shifts to the plaintiff? - A FULLY-INFORMED SHAREHOLDER VOTE OPERATES TO EXTINGUISH A CLAIM: o Where the BOD takes action that is claimed to exceed the board‟s authority; or o Where the BOD failed to exercise due care to adequately inform itself before committing the corporation to a transaction. - SHAREHOLDER RATIFICATION DOES NOT AUTOMATICALLY EXTINGUISH A CLAIM FOR BREACH OF DIRECTOR‟S DUTY OF LOYALTY. - THE EFFECT OF SHAREHOLDER RATIFICATION IN DUTY OF LOYALTY CASES HAS BEEN: o Change the standard of review to the business judgment rule with burden of proof resting on the plaintiff; o Leave entire fairness as standard of review but shifting burden of proof to the plaintiff. NOTES: 1. Notes about Marciano and this case. 2. New section in the MBCA Sinclair Oil Corp. v. Levien, Delaware Supreme Court (1971) Casebook p. 442 – PARENT-SUBSIDIARY DEALINGS FACTS and PP: Sinclair is a holding company primarily in the oil business. It owned 97% of Sinven stock. The Plaintiff (Levien) owned 300 of the 120,000 shares of Sinven. Sinven was incorporated in 1922 and has been oil company mainly in Venezuela. Sinclair is responsible for nominating all members of Sinven‟s BOD and the trial court found that the directors were not independent from Sinclair because they were in some way related to Sinclair. The trial court found that and this court determined that: because of Sinclair‟s domination, it is clear that Sinclair owed Sinven a fiduciary duty. -  says that from 1960-66 Sinclair caused Sinven to pay out excessive dividends and causing industrial development to be prevented. - From 1960-66, Sinven paid out $108 million $38 million more than earnings. Sinclair could not prove that these transactions were intrinsically fair to the minority shareholders of Sinven. This action was a derivative action requiring Sinclair to account for damages sustained by its subsidiary Sinven because of dividends, denial of industrial development and breach of contract. Sinclair appeals the requirement. The trial court held that because of the fiduciary duty and control over Sinven, the relationship with Sinven must meet the intrinsic fairness test – where Sinclair had to prove that its transactions with Sinven were objectively fair. ISSUE: 1. Were the dividends self-dealing and therefore subject to the intrinsic fairness test? 2. If not, did they deny Sinven of industrial development and which test should be applied to this? HOLDING: ANALYSIS: -  Argument: The transactions between it and Sinven should be tested by the business judgment rule where the court will not interfere unless there is a showing of gross and palpable overreaching. - Court: Where it is a parent-subsidiary relationship, the business judgment rule is not applied but the intrinsic fairness test is used. The basic situation for the application for the rule is one in which the parent has received a benefit to the exclusion and the expense of the subsidiary. - Precedent: As long as the parent does not receive any benefit, the business judgment rule is properly applied. - A parent owes fiduciary duty to subsidiary in dealings between the two. - Self-dealing occurs when the parent 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. - If a  can meet his burden of proving that a dividend cannot be grounded on any reasonable business objective, then the courts can and will interfere with the board‟s decision to pay the dividend. -  Argument: It is improper to apply the intrinsic fairness standard to dividend payments. - Court: If such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is the proper standard. - ISSUE: Were the dividend payments by Sinven self-dealing by Sinclair? o The minority shareholders of Sinven got a proportionate share of money. o As a result the dividends were not self-dealing. o The business judgment standard should have been applied. - ISSUE: Did Sinclair hinder the industrial development in such a way to be self-dealing? o Carpenter v. United States, USSC (1987) Casebook p. 530 FACTS: - In 1981, Winans was reporter for Wall Street Journal and in 1982 became one of 2 writers of daily column – “Heard on the Street” which discussed stocks with information about them. To do this he interviewed corporate executives. - Because of what was said in this column and its perceived quality and integrity, it had the potential to affect the price of stocks that were examined in it. - Prior to publication, the contents of the columns were the Journal‟s confidential information. Despite that rule, Winans entered into a scheme in 10/83 with Brant and Felis (both with Peabody brokerage firm in NY) to give them advance information about the Heard column. Brant and Felis then allowed Clark (a client of theirs) to buy or sell based on the probable impact of the column on the market. They shared the profits. They made about $690K. - In 11/93, Peabody noticed the correlations and inquiries began. Then SEC got involved and eventually Winans and Carpenter went to SEC and told them the whole scheme. PP: The District Court found that Winans had knowingly breached a duty of confidentiality by misappropriating prepublication information regarding the timing and contents of the Heard column – and although the Journal was not a party to the trading in was nevertheless considered to be in connection with a purchase or sale of securities within the meaning of the statute and the rule. o The scheme‟s sole purpose was to buy and sell securities at a profit based on advance information of the contents of the column. Felis and Winans were convicted of violating 10(b), 10b-5 and additional other federal violations. Carpenter was convicted for aiding and abetting. COA affirmed the trial court holding. ISSUE: HOLDING: ANALYSIS: United States v. O‟Hagan, USSC (1997) Casebook p. 534 – THE SCOPE OF DUTY TO DISCLOSE OR ABSTAIN FROM TRADING FACTS: - O‟Hagan was partner in law firm in Minnesota. - In 1988, Grand Met (an English corporation) retained his firm as counsel to represent them in a potential tender offer for the common stock of Pillsbury Co. (a Minnesota company). - Both GM and law firm made efforts to protect the confidentiality of the tender offer plans. - O‟Hagan did no work on the deal. - In 9/88, the law firm withdrew as counsel and less than 1 month later, GM announced the tender offer publicly. - On 8/18/88, while the firm was still representing GM, O‟Hagan began buying call options for Pillsbury stock which gave him the right to but 100 shares of Pillsbury stock by specified date in September of that year. Additionally he kept on buying options and common stock until the tender offer was announced. - When GM made the offer on 10/4, O‟Hagan made $4.3 million on the stock he bought. PP: SEC began investigating O‟Hagan which led to 57 count indictment alleging that he: o Defrauded his law firm and their client by using non-public information for his own personal gain; o Used the money to cover embezzlement and conversion of trust accounts; o Committed mail fraud, securities fraud, fraudulent trading in connection with tender offer and violated money laundering statutes. At jury trial he was convicted of all counts and sentenced to about 3 ½ years in imprisonment. COA reversed all of the convictions by a divided court holding the following: o Liability under 10b-5 may not be grounded on the misappropriation theory of securities fraud. o Rule 14e-3(a) (which prohibits trading while in possession of material, non-public information relating to a tender offer) exceeds the SEC‟s rulemaking authority because it didn‟t require a breach of fiduciary duty. o The other convictions rested on the violation of the securities laws and therefore could not stand once the other convictions were reversed. - ISSUE: - First issue relates to the misappropriation of material, nonpublic information for securities tradition o Is a person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, guilty of violating 10b-5? - Second issue relates to fraudulent practices in the tender offer setting. o Did the SEC exceed its rulemaking authority by adopting Rule 14e-3(a), which proscribes trading on undisclosed information in the tender offer setting, even in the absence of a duty to disclose. HOLDING: Issue One: A person who trades in securities for personal profit is guilty of violating 10b-5 when they use confidential information misappropriated in breach of fiduciary duty. Issue Two: The SEC did not exceed its authority in rulemaking that trading on undisclosed information in the tender offer setting is prohibited under Rule 14e-3(a). RULE: ANALYSIS: 1. The 10b-5 convictions may be predicated on the misappropriation theory - §10b prohibits using any deceptive devices in connection with the purchase or sale of securities in contravention of rules made by the Commission. - The statute reaches to any deceptive devices used in connection with the purchase or sale of any security. - Rule 10b-5 and hence §10b are violated (under traditional or classical theory of insider trading liability) when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information because it qualifies as a deceptive device under 10b because a relationship of trust and confidence exists between shareholders of corporation and insiders who have obtained the information because of their position inside the corporation. Chiarella - - - - - The classical theory applies to officers, directors and other permanent insiders of a corporation AND to others who temporarily become fiduciaries of a corporation. The “misappropriation” theory, as opposed to the classical theory holds that: “a person commits fraud in connection with a securities transaction and thereby violates 10b-5 when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. o Liability is premised on a fiduciary-turned-trader‟s deception of those who entrusted him with access to confidential information. The two theories, classical and misappropriation complement each other because one deals with the duty to the shareholders and the other with duty to fiduciaries of the shareholders. Elements: o Deception: required that he feigns fidelity to the source of the information. o Connection with purchase or sale of security: fraud is consummated when he uses the information to get the stocks. Theory behind the theory: A misappropriator who trades on the basis of material nonpublic information, in short, gains his advantageous market position through deception; he deceives the source of the information and then harms members of the investing public. o It catches fraudulent means of capitalizing on confidential information through securities transactions. o The theory gels with the purpose of the act: to insure honest securities markets and promote investor confidence. This case: Proper to use misappropriation theory because it met the statutory requirement that there was “deceptive conduct in connection with securities transactions.” Problem with the COA argument: They said there needed to be a breach of duty to parties in a securities transaction or to other market participants. This court said that the statute does not require that. o 2. Fraudulent trading in connection with a tender offer in violation of 14e-3(a): Did the SEC exceed its rulemaking authority in its adoption of 14e-3(a) without requiring a showing that the trading at issue entailed a breach of fiduciary duty? The authority comes from the second section of §14(e) which delegates definitional and prophylactic rulemaking to SEC. The Act was designed to make disclosure rather than court-imposed principles of fairness or artificiality the preferred method of market regulation. 14e-3(a): Disclose and abstain from trading requirement which is violated when one trades on the basis of material non-public information concerning a pending tender offer that he knows or has reason to know has been acquired directly or indirectly from an insider or someone working on their behalf. A duty is created to disclose or abstain from using the information without regard to whether the trader owes a pre-existing fiduciary duty to respect confidentiality. USSC states that SEC may prohibit acts that aren‟t fraudulent under common law if it is reasonably designed to prevent acts and practices that are fraudulent. - - Scalia‟s DISSENT/CONCURRENCE: Dissents to the 10b-5 discussion: Must construe 10b-5 to require the manipulation or deception of a party to a securities transaction. Thomas‟ DISSENT/CONCURRENCE: 1. Misappropriation theory fails to provide a coherent and consistent interpretation of the requirement of use or employment of the deceptive device in connection with the purchase or sale of any security. 2. There was no relevant or underlying fraud against which 14e-3(a) reasonably provides prophylaxis.