What U S Corporations Offer Secured Investment Contract by sgt19112


What U S Corporations Offer Secured Investment Contract document sample

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									                             CORPORATIONS OUTLINE
                               HONE, SPRING 2005
99 Cents Only Stores
A. This is a family owned company
       1. It is a problem to have primarily family ownership
                 a. Issues with nepotism
                 b. Are those in charge really any good at what they are doing?
                 c. Can there be any good things relating to having family in charge?
       2. They are classified as discount and variety retail
                 a. They have big competitors
                 b. It is small and therefore has a good chance to grow
       3. They have a crappy website
                 a. The devil is in the details
B. Financial Information
       1. Net Income Growth
                 a. If it is in parenthesis, then it is negative
                           i. Their net income growth is negative
       2. It is a bad sign that profits are down and employees are up
       3. There is going to be a financial restatement
                 a. They are evaluating certain issues and the method of accounting for these issues
                           i. Leasehold improvements
                           ii. Depreciation
                 b. They state emphatically they are not going to be affecting their cash assets
                           i. Claim the problem will be non cash
                 c. They took the things that would not be adversely affected but everything else is
                 going be affected
                 d. When the statements come out, they are to be certified by the CFO that they are
                 correct and complete
                           i. This is due to the Sarbanes-Oxley Act
                                    A. Sarbanes-Oxley is not going to affect crooks
                                    B. It will affect people who are not crooks but have not paid a lot
                                    of attention to their internal accounting systems
                 e. 99 Cents is not accurately recording things
                           i. They have known about this problem since Dec.
                                    A. They cannot file the form since they cannot make the proper
                           ii. They cannot get signed off by the outside accountants
       4. Investment banking
                 a. They do not make a lot of money off of us, so therefore their advice is not that
                 b. “Reduce”:
                           i. This is used in place of sell
                           ii. What is the broker telling a client if the instruction is to reduce?

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C. Stock
       1. The stock seems to be doing ok
       2. There is not much information being given
D. Hone’s thoughts
       1. If I was the president I would think that something was wrong and it was someone’s
                a. Who is responsible for the internal controls?
                         i. The Chief Financial Officer
                                 A. It is time to make them resign
E. When a CFO Resigns
       1. Is it due to fraudulent activities on the part of the company?
       2. They are going to argue the restatement of financial information was not due til. Feb.
       so they should not be in trouble
       3. The real issue is now they are going to explain the failure to comply with SOX
                a. Mr. Gold knew that things were not in compliance and their control system
                doesn’t work
       4. Outside accounting firms cannot find every flaw that exists
                a. However maybe they did know and didn’t want the problem to go public
       5. They were without a CFO and had to hire a firm to look for someone
                a. The new CFO is the son-in-law
       6. New person: Jeff Kniffin
                a. Experience
                b. Went to UCLA
                c. Oversees SOX compliance
F. Directors
       1. They had to get rid of some of their directors since they were not that independent
                a. Father and son team, the father was friends with Gold
-Founded when Bill Gates was in college
-They had equity investors and are now multimillionaires
-Microsoft was far behind Apple
        -Their advantage was that thy shared their operating system with otheres
-In a small company the risk is overwhelming
        -It is hard to calculate success
        -Young people tend to have better insight as to what might happen
Martha Stewart
-She was told insiders were selling their stock
-She sold hers
-If the government could have proved she was acting as a tippee, they would have prosecuted her
as such, which they did not do
Dell Computer
-Each division operates as a separate entity and they compete against each other
-The loyalty is for the unit and not the company
-The business judgment rule allows you to do this kind of thing and go out on a limb and try
something new
       -This results in a more flexible economy since it allows you to not be pinned down

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I. Authority
      A. Actual Authority
             1. When is it created?
                     a. When a principal manifests through words, conduct, or otherwise to the
                     agent that the agent may act on the principal’s behalf
                             i. Principalmanifestsagent (who must reasonably believe
                             because of something the principal says that the agent may act on
                             their behalf
             2. What is the consequence of an agent having actual authority?
                     a. Rule: Once an agent has actual authority, that agent has the power to
                     bind the principal
             3. What is the scope of actual authority?
                     a. Rule: An agent has actual authority to take action designated or implied
                     in the principal’s manifestations and acts necessary or incidental to
                     achieving the principal’s objectives, as the agent reasonably understands
                     then when the agent determines how to act
                     b. An agents interpretation of the principal’s manifestations is reasonable
                             i. It reflects any meaning known by the agent to be ascribed by the
                             ii. If no meaning known to the agent, as a RP in the agents position
                             would interpret the manifestations in the context given
                                       A. Including circumstances in which the agent has notice
                                       B. Including the agent’s fiduciary duty to the principal
                     c. An agent’s understanding of the principal’s objectives is reasonable if it
                             i. Accords with the principal’s manifestations
                             ii. And the inferences that a RP in the agent’s position would draw
                             from the circumstances creating the agency
      B. Apparent Authority
             1. Rule: created when a principal makes manifestations which a 3rd party
             reasonably believes indicates that an actor has authority to act on behalf of the
             principal with regard to the principal’s legal relations
                     a. The principal must manifest to the 3rd party that the agent has the
                     authority to act on behalf of the principal
             2. What is the consequence of an agent having apparent authority?
                     a. Rule: once an agent has apparent authority, that agent has the power to
                     bind the principal
             3. What are the policy reasons t allow a party to be bound by apparent authority?
                     a. The critical relationship is between the 3rd party and the principal
                             i. We want to honor good faith negotiations between the3rd party
                             and the agent
                             ii. We want to protect the 3rd party because we want to protect the
                             reasonable expectations of the 3rd party
             4. The issues are what is reasonable for the agent or the 3rd party to expect under
             the facts and circumstances
             5. When the agent has actual or apparent authority, what is the duty of the agent?

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                      a. Rule: there is a fiduciary duty to act in the best interests of the principal
                              i. Must be in good faith
                              ii. Seeking to protect the RP of the principal
                      b. The agent is accountable to the principal for any profits arising out of
                      the transaction
                              i. Breached if the transactions benefits the agent or someone else
                              other than the principal
                      c. The duties of an unpaid agent may be lesser than those of a paid agent
      C. Inherent Authority
             1. Rule: A general agent may sometimes bind an undisclosed principal based on
             inherent authority
                      a. Not a well defined concept
                      b. Two concepts that support inherent authority
                              i. An undisclosed principal
                                      A. Someone the 3rd party does not know exists
                              ii. The concept of general agent
                                      A. A general agent is someone authorized to conduct a
                                      series of transactions involving a continuity of service
                                      B. This person (general agent) has done things regularly for
                                      the principal in the past
                                      C. A general agent can also bind a principal through
                                      apparent or inherent authority
             2. If the principal is disclosed, use actual or apparent authority
      D. How to bind a principal
             1. Rule: a principal may be bound under all three kinds of authority
                      a. Also on the basis of estoppel
                      b. Also on the basis of ratification
                              i. DEF: knowing acceptance of benefits
II. Sole Proprietorships
      A. What is a Sole Proprietorship?
            1. Rule: A SP is a business owned 100% by one individual
            2. This is the most common form of businesses
      B. What is the Tax Status?
            1. Rule: Not treated as an entity for federal or state tax purposes
                     a. The income gain or loss is deducted or added into the owner’s income
            2. Profits are placed in Schedule C of an individual tax return
            3. Ordinary and necessary expenses are deductible
                     a. Capital expenses are not
                             i. However, can write off a certain amount of what otherwise
                             would be capital expenses
      C. What is the Liability of a SP?
            1. Rule: A SP is 100% liable for all of the debts and liabilities of the SP
      D. Why Operate as a SP?
            1. You want to be 100% owner
            2. However, this is not a good idea if there is going to be liability
            3. You form a SP by going out and doing business

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                    a. Nothing needs to be filed with the state
                    b. Must file and information return that tells how much the SP earned
III. Operating as a General Partnership
      A. Definition of a GP
             1. Rule: A GP is an unincorporated association of two or more persons operating
             a business as co-owners
                     a. Elements
                              i. Two or more
                              ii. Persons
                                      A. Statute can either state a person or an individual
                                              I. Individual: human person
                                              II. Person can include a SP, LLP or a corp.
                              iii. Operating a business for profit
                                      A. A business must be operated for profit
                              iv. Must be co-owners issue
                                      A. Who put up the money?
                                      B. Did they share in profits? (presumption of
             2. When is a person considered a partner?
                     a. Rule: It only matters if it meets the elements of a general
                              i. Courts can create a partner by estoppel if you put
                              someone out as a partner and they are really not
             3. What is the liability of a GP?
                     a. Rule: Partners are jointly and severally liable for all
                     liabilities of the partnership
      B. Tax Status of a GP
             1. Rule: The entity does not pay taxes but the individual partners do
             pay taxes
             2. SP, GP and LP do not pay taxes
             3. The income or loss goes on the owner’s taxes under Schedule K
      C. Why Operate as a GP?
             1. Share the liability, loss and expenses
             2. Diverse skills among the partners
             3. Vacation time
      D. Formation of a GP
             1. Rule: a written agreement is not needed to form a GP
                     a. If you meet the definition, you are a partner
                              i. Default in CA: you are a GP
                     b. The state has default rules that they will use if you do not
                     have a written agreement
                              i. What are the benefits of a written agreement?
                                      A. Memorializes what was agreed to
                                      B. Causes the parties to see ambiguities or
                                      problems, which avoids future litigation

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                                     C. May highlight troublesome pts in the future
                                     D. Allocates tax burdens
                                     E. Determines what happens in the case of a
                                     partner leaving or dying
      E. Partnership Accounting
              1. What is the difference between a balance sheet and an income
                     a. Balance Sheets
                             i. A picture of the assets, liabilities and net worth as of a
                             particular day in time
                             ii. What does a balance sheet look like?
                                      A. Assets on the left
                                              I. Cash is listed separately
                                              II. Accounts receivable: the amount that is
                                              owed to you by others that you have yet to
                                              III. Inventory: things you hope to sell
                                              IV. Fixtures: The things in a store that hold
                                              the products
                                      B. Liabilities on the right
                                              I. Short term: liabilities due within one year
                                                       a. A lot of these is a bad sign
                                              II. Long term: due in more than one year
                                              III. Net worth: Allows us to think about both
                                              positive and negative numbers
                                                       a. Equity: ownership or net worth
                     b. Income Statement
                             i. This is a statement of profits and losses
                             ii. Not for a particular day, but instead a particular period
                             of time
                             iii. What does an income statement look like?
                                      A. Used to figure out whether there was a profit or
                                      a loss in a set period
                                      B. Start with sales
                                              I. Subtract costs of sales
                                      C. Sales-cost of sales=gross profit
                                              I. Other expenses to take from gross profit
                                                       a. Advertising
                                                       b. Rental Costs
                                                       c. Depreciation
                                                       d. Salaries
                                                       e. Misc.
                                      D. Gross Profits-Other expenses=Net profit

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             2. Financial Accounting
                      a. There are four assumptions
                              i. The business that is the subject of the financial
                              statements is an entity for accounting purposes
                              ii. All entries have to be in terms of dollars
                              iii. A balance sheet must balance
                                       A. Rule: carry assets at cost or market, whichever
                                       is less
                                               I. Stocks, bonds and securities are always
                                               carried at market
                                               II. Assets are generally carried whichever is
                                               the least out of market or cost
                                               III. If real property appreciates in value, it is
                                               a hidden asset, since it is listed at the
                                               purchase price
                                       B. Balance Sheet Math
                                               I. Assets-Liabilities=Net Worth
                                               II. Assets=Net Worth (equity)+ Liabilities
                                               III. Assets=Liabilities+ Net Worth (equity)
                              iv. Double Entry Book-keeping
                                       A. Every transaction that a business enters must be
                                       recorded at least two ways if the balance sheet is
                                       going to balance
                                               I. Negatives go on in parens
                                               II. Risk/Reward ratio
             3. What are Capital Accounts?
                      a. Rule: Sets forth the partner’s ownership interest in the
                              i. Equals the capital contributed by the partner-the
                              amount of any distributions to the partner+ partner’s
                              share of the profits-partner’s share of the losses
                              ii. A partner’s capital account may be negative from time
                              to time
                      b. What does it look like?
                              i. Partners can carve up their amounts differently if there
                              is a written agreement to do so
                              ii. Drawing for the year: amount of money that the
                              partner takes out of the partnership
      F. Sharing of Profits and Losses
             1. Rule: In the absence of an agreement, the default rule has the
             partners sharing the profits and losses equally
                      a. An agreement overcomes the default rule
             2. If there is an amount that is owed out a partner’s capital account
             that will not be paid by that partner that amount is treated as a loss and
             split under the agreed upon rule or the default rule amongst the

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             3. Sharing the loss equally means taking the loss for each partner and
             deducting this from the partner’s capital account
      G. Management of the Partnership
             1. Rule: The partnership agreement should state who shall manage
             and shall include
                      a. Who manages, who has the power, who can fire and hire
                      b. The clear way to limit authority is to write such limitations
             into the partnership agreement
             2. If the agreement is silent, the general rule is that each partner has
             equal authority in carrying out activities in the course and scope of the
                      a. What is the course and scope of the partnership?
                              i. Some cases say that each partner under the concept of
                              authority may bind the partnership
                              ii. Some cases say that if there is a conflict, then neither
                              can bind the partner
             3. Default rule is simple majority wins
             4. A person can always bind the partnership under the concept of
             apparent authority
             5. Formal Accounting
                      a. Rule: A comprehensive investigation or transactions of the
                      partnership and partners, and an adjudication of their relative
                              i. Ultimate result is some sort of money judgment for or
                              against each partner according to the balance struck
                              ii. Bringing suit for a breach of fiduciary duty
      H. Fiduciary Duties of Partners
             1. Rule: you have a fiduciary duty to your partner (Meinhard v.
                      a. Joint adventurers are like copartners and owe each other a
             high duty of loyalty
                      b. Disclosure/notice was possible on the part of the Δ
                      c. Best way to deal with this stuff
                              i. Put it in writing
                              ii. Tell the person about it when you get the information
             2. If you take money from the partnership and reinvest it, the other
             partners can sue you for the money back
                      a. If you make a profit, the other partners are entitled to some of
                      the money
                      b. If you lose money, the partnership is liable for your losses as
             3. Doctrine of Corporate Opportunities
                      a. If you take an opportunity that belongs to the corporation, the
                      profits are put in a constructive trust for the benefit of the

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      I. Law Firm Partnerships
             1. The Old Days
                      a. Law firms were general partnerships
                      b. Stayed with one firm the whole time
             2. Today
                      a. Due to liability, 20-25% of firms are not GPs
                      b. Partner compensation and tenure is based on the ability to
             attract clients
                      c. Other compensation factors
                              i. Billable hours
                              ii. Economics of Practice
                              iii. Management
             3. Types of Partners
                      a. Traditional Partners
                              i. Equity interest, can vote
                      b. Two-tiered partnerships
                              i. Income Partners
                                       A. Fixed salary and no equity interest
                              ii. Equity Partners
                                       A. Owner and share in risk and reward
             4. Associates face a Problem
                      a. Overpaying associates seemed as though the clients were getting
                      b. Puts lots of pressure on midsized firms
             5. Other Types of Positions
                      a. Of Counsel
                              i. Some contractual relationship with the firm, yearly
                      b. Contract Attorney
                              i. Temp attorney hired for specific projects
IV. Limited Partnerships
      A. Introduction and Structure
              1. Background
                     a. People would examine the risk/reward ratio of being a GP
                     b. If the risk was too great, people would not do it
                     c. If you had a lot of money, you would not want to become a general
                     d. The need grew for a form where the entity does not pay taxes, the
                     income flows through the partners, but the liability is limited
              2. Consists of two kinds of partners
                     a. Limited Partner
                              i. Puts up the money
                              ii. Passive
                              iii. Liability is limited to the amount they have agreed to invest
                              iv. Their risk/reward ratio is a set amount
                                       A. Calculable risk

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                    b. General Partner
                            i. Run the business
                            ii. Provides the skill that is being done at the partnership
                            iii. They do not have to put up any money
                            iv. They get a percentage of the profits
                                     A. The more money that is invested in the LP, the greater
                                     the potential reward for the general partner
                            v. GP will want to try and limit some of his losses
                                     A. Agreement that if money is lost, he is not liable
                                             I. Will work if the GP is someone that has a good
                                             track record
                            vi. Their salary must be paid back before the business can calculate
                            the profits
                            vii. A GP can be involved with more than one partnership, it
                            depends on the agreement
                            viii. The GP can be a corporation
                                     A. Therefore, the corporation is liable and not a person as
                                     the GP
                                     B. The only risk is what has been put into the GP
                                     C. There are tax rules that require a minimum net worth
                                     D. Also subject to piercing the corporate veil
                    c. Today some people can be both limited and general partners in the same
                    firm at the same time
             3. Tax Status
                    a. Rule: like a GP, a LP is not treated as a separate taxable entity
                            i. All of the profits and losses are passed through the partners
                            ii. EXCEPTION: Publicly traded partnership
                                     A. Taxed as entities and the profits and losses do not go
                                     through the owners
      B. Formation Process
             1. Limited Partnership Agreement
                    a. Very long and complicated, spells out allocations of profits and losses,
                    fiduciary duties, obligations
                    b. Stock issues
                    c. Private document not subject to public disclosure
                    d. Involve the conjunction of tax, business, and corporate law
             2. Limited Partnership Certificate
                    a. Filed with the Sec. of State
                    b. Signed by all the partners
                    c. Informs the public that the LP has been formed and what the name is
                    d. This does not provide a lot of information
                    e. Once this is filed, the partnership is up and running
      C. Limited Partners
             1. Admission Upon Formation and Thereafter

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                     a. They are admitted upon formation
                     b. They are generally passive
                     c. They do not partake in the control of the LP
             2. Liability
                     a. Control
                            i. Rule: Limited partners have no liability beyond the amount that
                            they agreed to contribute to the limited partnership
                                     A. Exceptions
                                              I. Cal. Corp. Code §15632
                                                       a. Defines what control is NOT
                                                       b. Is not an exhaustive list
                                                       c. Lists things a LP can do without being
                                                       considered a GP
                                                       d. You can remove and advise, but not tell a
                                                       GP what to do, since that would be control
                                              II. Cal. Corp. Code §15633-improper formation
                                                       a. When a GP may be liable
                                                               i. No LP certificate is filed
                                                                        If someone has a good
                                                                        faith believe that it has been
                                                                        filed and acts accordingly,
                                                                        then they are not liable
                                                               ii. LP is liable to a 3rd party if they
                                                               transact business before the
                                                               certificate is filed and to the GP at
                                                               the time of the transaction
                                     B. If no LP document is filed, then the entity is considered
                                     to be a a GP
                                     C. Also liable if the LP commits a tort
                                     D. Liable if they take control
                     b. Outside of CA
                            i. LP might be liable if their name is used
                     c. Limitations on who can sue
                            i.Those who knew that the LP participated in control and
                            reasonably believed the LP was a GP
                            ii. Failure to file a LP Certificate
                                     A. Those who reasonably believed LP was a GP
                                     B. Transacted business before the certificate was filed
             3. Divisions of Profits and Losses
                     a. Rule:
                            i. Default: based on capital contributions
                            ii. Whatever is in the agreement

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V. Forming a Corporation
      A. Background
             1. Historical
                     a. Would have to go to the King and ask permission to incorporate
                     b. Limitations on durations
                     c. Limitations on what they could do
             2. Today
                     a. There are no limits on the life of a corporation
                     b. There are no limitations on the amount of money or activity
      B. Factors to Consider When Incorporating
             1. Limited Liability for Shareholders
                     a. Rule: The first reason people form corporations is because the
                     shareholders have no personal liability for the debts and obligations of the
                               i. Generally and in the normal course of business individual
                               shareholders will have no liability
             2. Different Tax Treatment than Partnerships or Sole Proprietorships
                     a. Rule: Corporations are taxed as separate entities so when you have
                     incorporated, you have formed a tax paying entity that is separate and
                     distinct from the ownership of the corporation
                     b. In determining what to make the entity, you compare the tax rates for
                     individuals v. corporations
                               i. For individuals it is progressive and the more money you have,
                               the higher the tax bracket
                               ii. For corporations, the tax structure is mildly progressive
                     c. It is generally better to have a lower tax rate
                     d. What is the difference between the average tax rate and the
                     marginal tax rate?
                               i. Marginal Tax Rate
                                        A. This is the percent tax you will pay on each
                                        dollar you have earned from whatever one does in
                                        a day
                                        B. Allows you to consider what will happen to a
                                        set income amount if you add more additional
                                        income to it
                               ii. Average Tax Rate (Effective Tax Rate)
                                        A. This is the tax on income and total taxes for the
                     e. Double Taxation and Corporations
                               i. If income is earned in a partnership, LP or SP there is
                               only one tax paid by the individual owner of the partner
                                        A. If you are a C corporation, first the corporation
                                        pays tax on the income and then when the income
                                        is paid to the shareholder as a dividend, the
                                        dividend is also taxed

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                             ii. The effective tax rate is higher than it would have been
                             had the entity filed as a SP, or LP
                             iii. If you are looking to get a better tax rate, there are
                             advantages to not being a corporation
                             iv. What effect does this have on corporations?
                                       A. It causes corporations to issue debt rather than
                                       pay dividends
                                       B. There are many arguments as to whether it is
                                       good or bad
                     f. Progressive and Regressive Taxes
                             i. Progressive Tax
                                       A. Additional income is taxed at an increasingly
                                       higher marginal rate
                             ii. Regressive Tax
                                       A. Lower amounts of income are taxed at higher
                                       rates than higher amounts of income
                                               I. Alcohol, tobacco and gas and their
                                               disproportionate use by lower economic
                     g. Exceptions to Corporate Taxation
                             i. Subchapter S Corporations
                                       A. arouse from the desire for an entity with the
                                       advantages of a corporation, but no double taxation
                                       B. Profits and losses are passed to the shareholders
                                       C. Every shareholder must agree to elect
                                       Subchapter S status
                                       D. Rules
                                               I. No more than 75 shareholders
                                               II. No limit on the amount of assets
                                               III. Only one class of stock
                                               IV. May have corporate shareholders
                                       E. This only affects IRS tax status
             3. State of Incorporation
                     a. Rule: for corporations the internal rule governing the conduct
                     of corporations are based on the state in which the corporation
                     is incorporated
                     b. Historically, a company is only required to operate internally
                     under the laws of the state of incorporation
                             i. Quasi-California Corporation
                                       A. If you are truly a CA corporation, then the
                                       important provisions of CA’s corporation law will
                                       be applicable to you
                                       B. What is Truly CA corporation?
                                               I. Ownership: more than half the stock is
                                               held by shareholders located in CA

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                                             II. Operations: the property, payroll and
                                             sales are more than 50% under the franchise
                                             tax rules in CA
                                     C. You have to pay franchise taxes in any state
                                     where you are doing business
                    c. Delaware and Incorporation
                            i. Rule: for initially forming a corporation, it is not
                            desirable to incorporate in DE, but instead the state in
                            which you are doing business and your management is
                            ii. Called the certificate of incorporation, not articles
                                     A. If you decide to go public, reincorporate in DE
                            ii. DE is corporation friendly
                                     A. Special courts of Chancery
                                     B. Biased towards management
                                     C. Only place where directors can block a meeting
                                     of the shareholders to throw them out
                            iii. Disadvantages of incorporating in DE
                                     A. You will be forced to litigate in DE
                                     B. Bias towards management, anti-shareholder
            4. Foreign Incorporation
                    a. The rules of where you incorporate governs
                    b. Many places do not afford the same duties to the shareholders that the
                    U.S. has
                    c. You do not need to pay US taxes if you incorporate elsewhere
                    d. Hone thinks this is stupid
                    e. A foreign corporation is any corporation that is not formed in CA
                            i. Domestic means formed in CA
                            ii. Rules
                                     A. Register to do business in CA
                                             I. Includes naming a agent for service of process
                                     B. Filed a Statement of Information
                                     C. If publicly traded must file a Corporate Disclosure
                                     D. Pay applicable franchise tax
            5. Close corporations
                    a. Have a limited (less than 75) number of shareholders
                    b. Large amount of flexibility
                    c. Not really used
      B. How to Incorporate
            1. Contents of the Articles of Incorporation
                    a. Rule: To form a corporation, the corporate entity must submit to be
                    filed with the Secretary of State the articles of incorporation
                    b. Must include (Cal. Corp. Code §202)
                            i. Name of Corporation
                                     A. CA: Name governed by §201

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                                    I. Cannot use bank or trust unless you are
                                    II. May not use a name that is likely to mislead the
                   ii. Registered Agent for Service of Process
                            A. Person in the state of incorporation available to receive
                            service on behalf of the corporation
                   iii. Issuing Shares and Par Value
                            A. The Articles of Incorporation will authorize the Board of
                            Directors to issue a certain number of shares
                                    I. They can be amended by a vote of the
                                    shareholders and directors and refilling with the
                            B. What is a share of stock?
                                    I. Stock is a percent ownership in a company
                                             a. Number of shares are only important as
                                             far as it gives you a percent ownership in the
                                    II. Stock is either issued or outstanding
                                             a. Outstanding means shares that are sold by
                                             the company
                                    III. What matters to the corporation is the number of
                                    outstanding shares
                            C. Practice tip: list a huge number of shares so you do not
                            have to amend the articles of incorporation
                                    I. This is because it is a pain to get it changed
                            D. Par Value
                                    I. You could not sell shares below par value
                                    II. No longer in CA, since the board can change par
                                    III. DE still requires it
                                    IV. Some states allow you to set it at zero
                                    V. Some states allow companies to amend the
                                    articles of incorporation to change the par value of
                   iv. CA RULES
                            A. Statement that
                                    I. The purpose of the corporation is to engage in any
                                    lawful act or activity for which a general
                                    corporation may be organized under the general
                                    corporation law of CA
                            B. If the directors are named in the articles, the directors
                            must sign the articles
                                    I. Practice tip: Do not name the directors in the
                            C. Range Rules

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                                           I. The minimum number in a range cannot be less
                                           than 3 and the maximum cannot exceed the
                                           minimum by more than two times toe minimum
                                           minus one
                   c. DO NOT INCLUDE THE BYLAWS
                          i. These are private documents that are available for the
                          shareholders to see
                   d. Other Corporate Formalities
                          i. The Minute Book
                                   A. Records of the manager and shareholder meetings
                          ii. Corporate Seal
                                   A. Archaic
                                   B. Corporate signature
                                           I. Name, Date and State
                                   C. Required by the government and the bank
                          iii. Stock Transfer Book
                                   A. Book in which corporate records are kept
                          iv. Corporate Bylaws
                                   A. Every corporation must have one
                                   B. This is a private document kept by the company
                                   C. This is usually boilerplate information
                          v. Number of Directors
                                   A. Having an odd number is best
                                   B. The lower the better since it is hard to get a large group
                                   of people to do things
                                   C. Does not need to be fixed, bylaws usually will state a
                                   D. There does not need to be a minimum number
                                           I. However, if you have very few, it is more likely
                                           that the courts will find a reason to pierce the
                                           corporate veil
                                   E. CA rule on number of Directors
                                           I. 1-2-3 Rule
                                           II. If you have one shareholder, you need one
                                           director, from three on, you need a minimum of
                                           three directors
                          vi. Set a Time and Place for the Annual Meeting of Shareholders
                                   A. Today state time and place or other time the board of
                                   directors approves
                                           I. Courts use minor slipups against a corporation in
                                           deciding whether or not to pierce the corporate veil
                                   B. Time for Meetings
                                           I. Make sure that there is total flexibility
                                           II. If you are one shareholder and also a director
                                           you must have a shareholder and director meeting
                                                    a. Circumvent liability

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                               vii. Corporate Tax ID
                                        A. Corporation is an entity and therefore needs its own ID
                               viii. Franchise Taxes
                                        A. CA used to collect this tax
                                        B. Drove businesses out
                                        C. Abolished
              2. Effect of Filing the Articles of Incorporation with the Sec. of State
                       a. When the articles are filed there is a presumption that the corporation is
                       running and is in existence
                       b. Can overcome the presumption by proving the corporation has
              3. Mechanics of Filing the Articles of Incorporation
                       a. Who can act as an incorporator?
                       b. Where to file
                               i. The Articles of Incorporation, original and two copies are filed
                               with the Sec. of State
                               ii. 40 dollar fee
                               iii. Can be mailed or hand delivered
                               iv. Once filed, there is a presumption that the corporation has been
                               formed and exists
                                        A. Can be overcome by showing the corporation has
      C. Obtaining a Corporate Name
              1. Rule: No other corporation in the same state may be registered
              using the same or similar name
                       a.CA: so similar that it would be misleading
              2. Each state has different requirements and procedures
                       a. CA: can reserve a name for up to 60 days
              3. May not call yourself a bank or trust unless you are one
              4. Intellectual Property law
                       a. Even if you have filed and received a corporate name, you
                       might not be able to use it
              5. Practice Note: get three names from the client
              6. Fictitious Business Names
                       a. A corporation must file a fictitous business name statement
                               i. Filed with the county clerk
                               ii. When not using its corporate name for conducting business
                               iii. Must publish this name in any newspaper of general circulation
                                        A. This does not do anything or really provide any notice
                                        since no one reads them
      D. Statement of Information
              1. Purpose
                       a. The corporation must file a Statement of Information
                               i. A statement of a domestic stock corporation must be filed with
                               the Secretary of State every year

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                               ii. Must contain name and address of the CEO, Secretary, CFO and
                               the agent of service of process
                               iii. Must be filed within 90 days of the filing of the incorporation
                               and every year thereafter
                     b. If it is publicly traded, they must also file a Corporate Disclosure Form
                               i. Name of the independent auditor, date of the last audit report,
                               and if the auditor is providing any other services
                               ii. Names directors and officers and the number of shares that these
                               people own, their compensation, any loans that have been made to
                               the members of the board of directors or bankruptcies and frauds
                               by the same
                               iii. Federal securities and banking law violations within the last 10
             2. Failure to File
                     a. First they will receive mailed notice
                     b. Then the corporate privilege is suspended
                               i. Cannot file or defend suits
                     c. The corporate name is also revoked and can be used by another
                               i. Common Cause example
VI. Commencing to Operate as a Corporation after Articles of Inc. are Filed
      A. Power of Incorporator to Appoint Directors and Officers and Adopt Bylaws
              1. Rule: The incorporator has the power to appoint officers, directors, adopt
              bylaws and to do such things that are necessary to perfect the incorporation
                      a. The client decides who the directors will be
                      b. The incorporator signs the articles of incorporation
                      c. The incorporator is the client through the attorney
              2. The incorporator will sign an Action by Unanimous Consent that appoints the
              directors, the officers, and adopts the bylaws
                      a. Then the incorporator will usually resign
                               i. Since this is the attorney
                      b. Action by Unanimous Consent
                               i. This says that the board of directors or a committee of the board
                               or the incorporator may take action by unanimous written consent
                               that is just as effective as if a meeting had been held
                               ii. Attorney writes this out and the directors all sign it
      B. First Action by the Board of Directors
              1. Action by Written Consent, Conference Telephone, other Electronic Means or
              by Holding a Meeting of Directors
                      a. Initial Organizational Meeting
                               i. Must have a quorum
                                        A. This means a simple majority
                               ii. Must elect a chairperson and a secretary and officers of the
                               corporation and set salaries for those positions
                               iii. Secretary must present and read the articles of incorporation,
                               present the minute book, which is then adopted

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                            iv. Approve the bylaws
                                     A. Bylaws are a private document
                                     B. Usually just a repeat of the laws of the corporation
                                            I. Meetings, etc.
                            v. Approve stock certificates and the corporate seal
                            vi. Make stock sale determinations
                                     A. The most important part
                                     B. What kind of stock will be sold
                                     C. What is the amount to be sold
                                     D. Must be voted on by the board
                            vii. Set up a corporate bank account
                            viii. Can all be done through the Written Action of Unanimous
VII. Individual Shareholder (or Promoter) Liability
      A. Promoter Liability
            1. When a Corporation is bound by a Pre-Incorporation Contract
                    a. Issue: Who is a promoter and how is that different than a founder?
                            i. Promoters are sleazy
                            ii. They come to a company with their great ideas
                            iii. They owe a fiduciary duty to the company
                                     A. Prior to formation, they are essentially partners
                                            I. Therefore they owe a fiduciary duty of full
                                            disclosure to each other
                            iv. You should not make any pre-incorporation contracts since it
                            takes about a day to make a corporation
            2. When a Corporation can enforce a Pre-Incorporation Contract
                    a. Rule: If a promoter enters into an agreement with a third party to
                            benefit a planned, unformed corporation, the promoter is
                            personally liable on the agreement
                            i. Liability continues after the corporation is formed
                            ii. Rule: Liability is extinguished if there is novation
                                     A. Agreement to release the promoter from liability
                                            I. Usually must be an express agreement
                    b. However, the promoter can make the contract such that they
                    will no longer be bound when the corporation is formed
                    c. Three theories to enforce the contract
                            i. 3rd party beneficiary
                            ii. Assign to promoter
                                     A. Does not apply for personal service contracts
                            iii. Argue implied novation
                    d. Generally corporations are not liable on a pre-incorporation contract
                    since they did not exist at the time
                            i. If they accept the goods knowing of the contract, then they will
                            be bound
                    e. Reasoning by analogy is problematic

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                              i. If there is no corporation, it can be considered to be a association
                              and all persons involved would be liable
      B. Defective Incorporation
              1. De Jure Incorporations
                      a. A properly created corporation
                      b. The articles of incorporation have been signed by the incorporator
                      c. Has directors, etc.
              2. De Facto Incorporations
                      a. Has all the rights and powers of a de jure corporation, but it is
                      defectively incorporated
                      b. Requirements
                              i. Must have had a valid law to incorporate under
                              ii. There must have been an attempt to organize a corporation
                              pursuant to the law
                                       A. Colorable attempt to comply with the incorporation laws
                              iii. There must be a user of the corporate franchise
                                       A. It must be acting like a corporation
                                       B. Exercise corporate privileges, conduct business in the
                                       corporate name
                              iv. Good faith is required
                      c. Causes of action
                              i. Contract
                              ii. Tort
                              iii. Active associates are held liable as partners
              3. Corporations by Estoppel
                      a. This is another way to have a corporate if a de facto corporation is not
                      b. Rule: Persons who treat an entity as a corporation will be estopped
                      from later claiming that the entity was not a corporation
                              i. Can be applied to either an outsider seeking to avoid liability on
                              a contract
                              ii. Or to a purported corporation seeking to avoid liability
                      c. PP: We want to prevent unjust enrichment
                      d. This doctrine is applied on a case by case basis
                              i. Applied in contracts cases
                              ii. Not applied generally in torts cases
                              iii. Active associates are held liable, as if they were partners
      C. Piercing the Corporate Veil
              1. Factors to Consider
                      a. Rule: The shareholders of corporations are not liable for corporate
                      obligations and debts
                              i. EXCEPTION: It may be pierced when the corporate privilege
                              has been abused to the detriment of 3rd persons
                                       A. Serious Abuse
                                                I. Co-mingling of funds

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                                             a. Two corporations sharing funds, facilities,
                                             b. Easy to see/find
                                    II. Undercapitalization
                                             a. CA TEST: Is the capital trifling
                                             compared to the risk to be undertaken?
                                                      1. Rule: The more capital the better
                                                      2. There is no exact ratio, it just
                                                      needs to pass the smell test
                                                      3. This test applies at the time of
                                             b. A company with lots of insurance is seen
                                             as a good thing
                                                      1. There is a desire to protect 3rd
                                    III. A parent corporation’s inadequate capitalization
                                    of the subsidiary corporation may constitute
                                    constructive fraud
                                             a. Rule: Whether the subsidiary may
                                             reasonably expect to achieve independent
                                             financial stability from its operation
                                    IV. Fraud
                                             a. If there is fraud the corporate veil is
                                    V. Avoidance of existing obligations
                                             a. EXCEPTION: the mere fact that an
                                             individual chooses to adopt the corporate
                                             form of business to avoid personal liability
                                             is not in and of itself a reason to pierce the
                                             corporate veil
                                             b. Contract v. tort
                                             c. Covenants not to compete
                            B. To the detriment of 3rd parties
                                    I. The abuse must be such that 3rd parties are hurt
                   ii. Alter Ego Theory
                            A. The corporate veil will be pierced when no separate
                            entity exists and the corporation is the mere alter ego or
                            instrumentality of its shareholders and injustice would
                                    I. Injustice must be more than the Π not being paid
                                    II. There may be a correlation between the
                                    egregiousness of the actions of the corporate Δ and
                                    the likelihood that the court will find that an
                                    injustice would result
                            B. This is another way to look at piercing problems
                   iii. Failure to follow corporate formalities

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                                       A. Less than 10 shareholders
                                       B. No shareholder meetings
                                       C. No corporate meetings
                             iv. NB: How does this potentially impact the mom and pop
                             v. Piercing usually happens to a company with less than 10
                             shareholders, usually 1-3
                                       A. Concept that low number of shareholders means it
                                       is a sham
                                               I. NOTE: public companies are almost never
             2. Who is Held Liable?
                    a. The corporate officers are held personally liable
                    b. Theories of Liability
                             i. Joint and Several
                                       A. The shareholders are held liable for the entire amount of
                                       the claim
                                       B. Liability for obligations of the corporation is extended to
                                       the shareholders as joint and several liability
                             ii. Property Cases
                                       A. If a corporation has conveyed its assets to a shareholder
                                       in fraud of creditors, the assets can be reached by creditors
                                       when the corporate veil is piereced
                    c. Types of Liability
                             i. Tort
                             ii. Contract
                                       A. This is harder since there was time to investigate the
                                       B. If they can show arm’s length dealing, they have a better
                                       C. However, there tends to be more piercing in contract
             3. Subsidiaries
                    a. Brother Sister Corporations
                             i. Rule: When the same or substantially the same shareholders own
                             two or more corporations in the same line of business sometimes
                             the assets of the corporations will be treated as being held by one
                             ii. The individual shareholders are not held individually liable
                             iii. Possibility of piercing suit
                             iv. argue that they should be treated as the same thing for the
                             purpose of the lawsuit
                             v. Common with cab companies
                    b. Parent-subsidiary
                             i. It is tough to pierce the corporate veil of a well run subsidiary
                                       A. Must have their own books and such

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                            ii. If a parent owns 80% or more of the stock of a subsidiary it
                            must consolidate the earnings, profits, losses, balance sheet and
                            income statement of the subsidiary with the statements of the
                                      A. The best way to do this is to have a cash management
                            iii. A subsidiary is a separate corporation owned wholly or
                            controlled by the parent corporation
                            iv. Fletcher v. Atex: Held that the parent could not be found liable
                    c. Division
                            i. A functional work group of a corporation
             4. The Deep Rock Doctrine
                    a. Issue: When a company goes broke, who gets paid first?
                    b. Rule: Courts have the equitable power to subordinate (change) the
                    order of priority of shareholder debts if the transaction “smells bad”
                            i. This only applies to shareholder debt
                            ii. Issue: Does a person who has an option to buy stock qualify as
                            a shareholder under the doctrine?
                                      A. Rule: Depends on the interpretation of the court
                    c. When a company goes broke, the ownership is wiped out and the
                    creditors get all the rights
                    d. Bankruptcy law looks to the rights of the creditors and the owners
                            i. Priority for paying off companies
                                      A. Secured Debt
                                      B. Unsecured Debt
                                      C. Preferred Stock
                                      D. Common Stock
                    e. How do you avoid making the deal smell bad?
                            i. Offering the deal to others
                            ii. Problem: if it is a good deal, the client is not going to want to
                    f. NB: You do not need to show fraud
VIII. The Ultra Vires Doctrine
      A. Historical Overview
             1. When corporations were first created there were concerns about their size and
             2. When Parliament authorized each corporation, it limited their
                     a. Power
                            i. Areas of concern
                                    A. Serving as partners
                                    B. Guarantees
                                    C. Making charitable contributions
                                    D. Limited life
                                    E. Limited capital

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                       b. Purpose
                               i. For example, they could only sell broadband and it would be
                               illegal to sell computers
                                        A. This would be an illegal contract and therefore
      B. The California Solution
             1. Have a broad powers clause in the articles of incorporation
             2. There is a broad purposes section in the GCL
             3. Rule: Binding contracts trump ultra vires
             4. Issue: How does this problem arise?
                       a. A broad purposes clause prevents it
                       b. Powers clause allows businesses to make charitable contributions
                       c. Have the directors breached their duty of care or loyalty?
                               i. Duty of Care
                                        a. Would a reasonable person do the same thing under the
                                        b. If the donation is a majority of net worth, a reasonable
                                        person would not make it
                       d. Embezzling is ultra vires
             5. What are remedy and who can sue if a corporation enters into a binding ultra
             vires contract?
                       a. Shareholders can sue the directors for violating the articles of
                       b. Must have standing (NB: applies in all states)
                               i. Shareholders
                               ii. Officers can sue directors in the name of the company
                               iii. The AG has standing to sue
                                        A. This is rare since they do not usually have the time or
                                        the inclination
                       c. The officers will be sued for breach of duty of care and duty of loyalty
                       as two separate actions
                       d. The defense is that the officers did not breach duty of care or the duty of
      C. Outside of CA
             1. CA Solution +
                       a. All relevant parties must be joined in the proceedings
                       b. It must be equitable to enforce the ultra vires contract
                               i. CA does not want to have to burden the courts with making this
                               kind of judgment call
      D. Derivative Suit
             1. Brought by the shareholders in the name of the corporation
             2. It is the real Π, but a nominal Δ
             3. The money, payment and remedy go to the corporation

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IX. Types of Equity and Debt Securities
      A. Debt and Equity Securities: How does a corporation secure money to operate other
      than through earnings?
              1. Issue: What is a Security?
                      a. Also an investment contract
                      b. Definition
                              i. An investment
                              ii. In a common enterprise
                              iii. With the expectation of profits
                              iv. Solely from the efforts of others
                      c. If you are selling securities you need a registration or an exemption
                      d. E.g.: Investment contracts
                              i. Investing in a general partnership is not a security
                                       A. It is an investment in a common enterprise with the
                                       expectation of profit, but you are working there so it is not
                                       solely from the efforts of others
                              ii. Investing in a limited partnership is a security
                                       A. It is an investment in a common enterprise with the
                                       expectation of profit solely from the efforts of others
                                       B. You are only putting up the money
                                       C. Therefore, all limited partnerships need registration or
                                       an exemption
              2. Issue: Stocks and Stock Prices
                      a. The price of stock is a reflection of the value of the company
                              i. The value will go up and down depending on the news one hears
                              about a company
                              ii. Unanticipated good and bad news is why insider trading is
                                       A. Those in the know use the information to their
                      b. Valuing a share of stock
                              i. Value the company
                                       A. What would be the price someone would be willing to
                                       pay for the company?
                              ii. Determine the Number of Shares Issued and Outstanding
                                       A. Outstanding shares
                                                I. Shares that have been sold and not repurchased by
                                                the corporation
                                       B. Authorized Shares
                                                I. The number of shares the corporation can issue
                                       C. The ownership of a corporation is in the hands of the
                                       people who own shares
                      c. Calculating the Price per Share
                              i. Value of Corporation/# outstanding shares
                              ii Value/outstanding=Price per share

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                     d. Issue: What makes the price go up or down in a rational market?
                             i. News
                             ii. A buyout offer
                             iii. Tender Offer
                                     A. A 3rd party wants to buy the stock above the market
                                     B. You must offer a premium over market if you want the
                                     C. This is information that not everyone will know, so you
                                     can make money on it
             3. Issue: How do you get money from people?
                     a. Always want to use OPM
                     b. You can get capital from a variety of sources
                             i. Borrowing (debt)
                             ii. Capital contributions from the owners
                             iii. Capital contributions from outside investors (stock)
                             iv. Retaining the earnings rather than distributing them
                                     A. This would be a cash dividend
                     c. Equity is synonymous with ownership
             4. Issue: Debt Financing
                     a. Tax deduction given for interest paid on debt as an ordinary and
                     necessary business expense
                     b. There are NO tax deduction for dividends
                     c. Most bank financing is debt financing
                     d. Debt is borrowing
                             i. The money must be repaid
                             ii. The repayment is done over time
                             iii. The repayment is not contingent on the success of the business
                     e. There is a lower return, but it is a lower risk
                     f. Types of debt
                             i. Secured
                                     A. Highest liquidation preference
                                     B. Secured by an asset
                             ii. Unsecured
                                     A. Second highest liquidation preference
                                     B. Not secured by an asset
                             iii. Registered
                                     A. The owner of the bond or the deventure is registered on
                                     the books of the corp. so you can tell who owns it
                                     B. Similar to a stock certificate and it is registered with the
                             iv. Unregistered
                                     A. Bearer bonds, coupon clippers
                     g. Debt is a fixed claim

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             5. Issue: Equity Financing
                     a. This is giving away a percentage of the corporation to raise money
                     b. There is a higher risk, but also potential higher returns for the lender
                     c. Issue: What is Preferred Stock?
                             i. Elements
                                     A. Liquidation Preferences
                                             I. The amount is usually the purchase price, might
                                             include the set dividend price
                                             II. Rule: The liquidation value will matter if the
                                             company has real assets that can be obtained by the
                                             preferred stockholders in case of a bust
                                     B. Dividend
                                             I. Cumulative
                                                     a. If not paid in any quarter, it accumulates
                                                     and must be paid next term
                                                     b. Most public companies
                                             II. Non-cumulative dividend
                                                     a. If not paid in any quarter/year then it is
                                                     not paid and it does not accumulate
                                             III. Cumulative if earned
                                                     a. If the corporation has enough money to
                                                     pay it, it is paid
                                                     b. VC often take these
                                                              1. Prefer greater voting power
                                     C. Conversion Privilege
                                             I. Allows the holder of the preferred stock to
                                             convert a certain set number of shares to common
                                             stock at their discretion
                                                     a. The common stockholders will want to
                                                     limit this, while the preferred shareholders
                                                     will want more of this
                                             II. Rule: The most important factor of preferred
                                             stock is convertibility
                                                     a. Gives the investor the most opportunity
                                                     for gain and future control over the company
                                             III. They are usually utilized if the stock booms
                                     D. Anti-Dilution Protection
                                             I. Protects in the case of a stock split so that the
                                             conversion rate after the split is equivalent to the
                                             conversion rate after the split
                                     E. Put Right
                                             I. Allows the holder to put the stock back to the
                                             II. This is not very valuable

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                   d. Issue: Plain Vanilla Preferred Stock
                           i. This is preferred stock which only has a liquidation preference
                           and/or dividend
                           ii. Does not have conversions rights
                           iii. VC do not like this kind of stock
                   e. Price of Preferred at the time of Sale
                           i. Issue: How many shares of common will it be converted in to
                           and at what premium over the cheap stock it will be sold at
                                     A. How much money does the company need?
                                     B. At what price will the preferred stock be converted
                                     C. VC want the most converting possible, the founders
                                     want the least
                                             I. The ultimate success depends on whether or not
                                             the company increases in value
                           ii. N.B.: The conversion ratio is fixed at the time the preferred
                           stock is offered
                           iii. The founders try to get the preferred shareholders to buy in at
                           4-6 times what the founders bought in at
                           iv. CA: absent a provision to the contrary in the articles of
                           incorporation, each share has one vote per share, REGARDLESS
                           of kind of stock
                   f. Call Rights
                           i. Rule: A company can tell a preferred shareholder they are
                           calling the stock, i.e. a right to repurchase the stock at a certain
                           ii. Typical call rate is purchase price +accrued and unpaid
                           iii. If the co calls the stock the conversion rates goes with the stock
                           iv. Preferred shareholders have 60-90 days to decide whether to
                           convert to common or to allow their stock to be called
                           v. Generally, the co calls stock when they are sure they do not have
                           to buy it
                                     A. This usually does not happen til about 5-7 years after the
                                     preferred sale
                                     B. Forces the VCs to convert their stock to common
                   g. Note: in order to issue preferred stock, the company must vote to amend
                   the articles of incorporation and file an amendment with the sec. of State’s
                           i. Sec. of State must approve the issuance and amendment of the
                           articles before the stock can be sold
                   h. When the conversion takes place, the common stock that the shares are
                   issued from is the authorized but unissued stock
                   i. Voting Rights and Stock
                           i. Issue: What voting rights attach with stock ownership?
                                     A. CA RULE: Each share of stock gets one vote

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                             ii. Issue: Does preferred carry a voting right?
                                      A. Rule: In public co. preferred stock generally will not
                                      have a voting right
                                              I. In a private co they generally do
                                      B. Preferred shareholders can negotiate for votes
                                      surrounding their share
                     j. Common Stock
                             i. Can sometimes be better than preferred stock
                                      A. Microsoft example
                             ii. Represents the residual value in a company
                                      A. This goes up and down
                             iii. Value determined by calculating the value of the co/number of
                             shares issued
                             iv. Voting rights
                                      A. One share, one vote
      B. Rights to Acquire Stock-Employee Stock Options and Warrants
             1. Stock Options
                     a. Rule: Prior to offering stock to an employee, the board must approve of
                     the stock option plan
                             i. Usually X shares at Y dollars per share for Z years
                     b. There are various regulatory bodies which limit the percent of the co
                     that can be available in options
                             i. CA : Limited to 20%
                     c. What is a stock option plan?
                             i. You put up no money until you elect to exercise your option
                             within the set period
                             ii. 3-7 is the typical vesting period
                                      A. Look to the percentage of the co that the option involves
                             iii. There will also be anti-dilution protection
                     d. Allow the potential employee to speculate on the value of the co
                     e. Problems with stock options
                             i. You need board approval, this is easy to get
                             ii. The option is intended to be an incentive to stay with the
                                      A. If you leave, you do not get the unvested options
                             iii. The employee is going to want the most shares they can get at
                             the lowest price, vesting as soon as possible and lasting the most
                             amount of years
                             iv. Most large companies have non negotiable stock option plans
                     f. Option Under Water
                             i. When the agreed option value under the stock option is far above
                             the current selling price of the stock
                                      A. What companies do now is issue new options to
                     g. When a co goes public
                             i. Do company stock options adversely affect an IPO?

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                                    A. No
                                    B. The number of shares outstanding on a fully diluted
                                           I. This is the number of shares outstanding as if all
                                           the options were exercised
                                           II. Shares outstanding plus options outstanding
             2. Warrants
                    a. Definition:
                            i. Like an option, can be given to banks as an equity kicker in lieu
                            of a lower interest rate
                                     A. Given to shareholders so the co. can raise equity capital
                                     B. They do not vest, instead they are only good for a certain
                                     period of time
                            ii. For every set number of shares a person owns the corporation
                            will offer them X additional shares at $Y
                                     A. Must be acted upon within a year
                            iii. The holder can hold on to it and speculate the share will go up
                            in the next year
                            iv. This is a way to raise money without having to get an
                            v. They can be bought and sold on the public market since they
                            have a value
                    a. Issue: Who can authorize warrants?
                            i. The Board of Directors has the authority
                                     A. By meeting or
                                     B. Unanimous written consent
                            ii. Can be sold or transferred
                                     A. Option market
                                            I. Warrants being bought and sold on speculation
X. Voting and Meetings
      A. Shareholder Meetings
             1. These meetings take place once a year
                    a. Annual Meetings
                           i. Vote on both ordinary and important matters
                           b. Annual Shareholder Meetings
                           i. Issue: Attendance requirements
                                   A. Quorum requirements state the majority of outstanding
                                   shares must be present at the meeting
                                          I. Physical or Proxy presence
                                          II. 50% plus one share
                                   B. Quorum can be changed in the articles of incorporation
                                   C. An abstention will be counted as part of the quorum
                           ii. Issue: What is the required vote for passage of ordinary matters
                           at a shareholder’s meeting?
                                   A. When you do not count abstentions, the vote requires a
                                   majority of the quorum

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                            B. Look to abstentions not as noes, but instead look to how
                            many yeses there are
                   iii. Issue: The rules for voting
                            A. Rule: Depends on the jx
                                    I. Some states require 2/3
                                    II. Other states require 50% plus one vote of the
                                    total voting power of the corporation
                            B. In some states a person may make a special appearance
                            for the sake of voting but will not be counted towards the
                            C. In some cases the owners of preferred stock may have
                            more than one vote
                                    I. If it is not specified, the default is one vote per
                            D. Can limit the number of votes one person can have
                                    I. A person cannot vote more than 10% of the stock
                                    II. This has been upheld by some courts
                            E. Class Voting
                                    I. First a majority of the class of preferred then to a
                                    majority of the rest of the shareholders
                   iv. Issue: Timing and Method of Notice Meetings
                            A. Rule: Notice must not be given more than 60 days prior
                            to the annual meeting and not less than 10 days
                                    I. First class mail is the most common
                                    II. Can also call or talk to the shareholders
                            B. Most states now allow phone or personal notice
                            C. New method: internet notice and delivery of material on
                            the internet
                   v. Issue: Information Needed in the Annual Meeting Notice
                            A. Rule: All that must be included is the date, location and
                            B. CA Rule: All those matters known to the Board at the
                            time the notice is sent must be conveyed
                                    I. Certain matters must be noticed
                                              a. Amendment to the articles
                                              b. Merger
                                              c. Dissolution
                            C. FED RULE: Federal Override Rule
                                    I. For corporations subject to proxy rules: All
                                    matters on which shareholders will vote must be
                                    included in the annual notice
                                    II. The only matters that can be voted on are the
                                    ones which are noticed
                                    III. Applies to NYSE and 12(i) corporations
                            D. Improper Notice
                                    I. Any action taken at the annual meeting is invalid

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                                           II. The corporation may obtain waivers of notice
                                           from those who did not receive proper notice
                                                    a. May be an applicable de minimus rule if
                                                    the number that did not receive proper
                                                    notice was inconsequential
                                                    b. The written waiver can be submitted
                                                    before or after the defective meeting
                                   E. Issue: Who is noticed?
                                           I. Holders of records
                                                    a. Beneficial owners
                                                    b. People entitled to dividends if they have
                                                    them on the record date even if they have
                                                    sold them
                                           II. Sometimes the holder of records is hiding it for
                                           the true owner
                                   F. Record Date
                                           I. This is set by the shareholders
                    b. Special Meetings of the Shareholders
                           i. The topic must be something the shareholders can vote on
                                   A. Ususally removal of a board member
                           ii. Issue: Who can call a special meeting?
                                   A. Rule: a special meeting is any meeting of the
                                   shareholders other than the annual meeting
                                           I. Directors
                                           II. Certain Officers
                                           III. Certain percentage of shareholders (5-10%)
                                   B. DE: the corporation may prohibit shareholders from
                                   calling a special meeting
                                   C. What special rules apply to special meetings?
                                           I. Rule: The only matters that may be voted on at a
                                           special meeting are those that were noticed
                           iii. The purpose of the meeting must be something upon which
                           shareholders have the power to vote
             2. Voting at Meetings
                    a. Rule: There are four methods of voting
                           i. Revocable Proxies
                                   A. The beneficial owner signs an agreement authorizing
                                   agents to vote their shares
                                           I. People are usually sent a proxy in the mail
                                           II. The company pays for proxy mailing
                                           III. The benefical owner is the real owner
                                           IV. The proxy is sent to the street record holder and
                                           then from that to the beneficial record holder
                                           V. NOBO
                                                    a. Non-objecting beneficial owner

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                                             b. Allowing the record holder to tell the
                                             corporation your name
                            B. Rule: When you solicit proxies under federal rules you
                            then have a legal obligation to show up at the meeting and
                            vote the way the proxies have specified
                            C. Revocable vote can be revoked
                                    I. By a more recent proxy vote
                                    II. A person can revoke it by showing up to the
                            D. A proxy is voted on by an agent
                                    I. Rule: The shareholder may specifically direct that
                                    agent how to vote on the proxy
                                    II. Default Rule: If the proxy is simply signed and
                                    returned the agent will vote in favor of what
                                    management has proposed
                                    III. Scope of agent authority
                                             a. The agents only have the authority that is
                                             given to them by the proxy
                                             b. You can check a different box indicating
                                             that this is not your vote
                            E. The length of revocable proxies
                                    I. Rule: State law holds that they last for 11 months
                                    II. FED LAW: public company proxies only last for
                                    11 months
                                    III. Private companies can have them last longer
                   ii. Irrevocable Proxies
                            A. Definition: These are proxies that cannot be revoked by
                            the beneficial owner
                                    I. They are used for control
                            B. Issue: How do you make a proxy irrevocable?
                                    I. Rule: It must be coupled with an interest
                                    II. Must state on its face that it is irrevocable
                            C. CA RULE: Must be stated that it is irrevocable and
                                    I. People who will be employed by the co
                                    II. People who have the right to or have bought
                                             a. Use the record date to determine these
                                                     1. Administrative convenience of
                                                     having a cut-off date
                                    III. People who have received stock as collateral
                                    IV. If you are party to a voting agreement, then you
                                    can have an irrevocable proxy
                   iii. Voting Agreements
                            A. Definition: An agreement amongst a majority of
                            shareholders as to how they will vote their stock

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                                    B. Rule: If they relate to the way in which shareholders
                                    vote for directors, then they are enforceable if they are
                                    reasonable as to duration and nature
                                            I. Sometimes not enforced due to reasons of equity
                                    C. Rule: If they relate to the way the directors will vote on
                                    how to run the corporation, they are not enforceable
                                            I. Analysis will turn on interpretation
                                            II. Barnum and Bailey Circus: Voting agreement
                                            ran the co into the ground and DiFi’s husband
                                            bought it and made more than one circus so it could make
                                    D. Exceptions: If 100% of the shareholders agree and there
                                    is little interference with the discretion of the board of
                            iv. Voting Trusts
                                    A. Definition: A pure creature of statute, will therefore be
                                    void unless it conforms to the particular state’s statute
                                    B. Rule: The beneficial owner of the stock puts it into a
                                    voting trust and a trustee is appointed and it lasts for a
                                    certain set period
                                              I. In most states, it cannot be longer than 10 years
                                    C. Elements
                                              I. The name of the trustee
                                              II. The duration of the voting trust
                                              III. Extensions and agreement regarding
                                              IV. What happens after dissolution of the trust
                                              V. Successor issues
                                              VI. Conflicts of interest
                                              VII. Where distributions are to go
                                              Must follow the same formalities as regular trusts

            3. Issue: Who acts as a referee during voting conflicts?
                    a. Rule: The inspector of elections is the referee
                            i. They make all the decisions regarding the validity of proxies
                            ii. Normally appointed by the board of directors before the voting
                            iii. Some who is perceived to be honest and fair
      B. Meetings of the Directors
            1. There are two kinds of meetings
                    a. Regular meetings do not require notice
                            i. The schedule is set in the morning
                            ii. Notice is sent out as a courtesy
                    b. Special Meetings
                            i. Must give 2-3 days written notice, but do not need to disclose the
                            subject of the meeting
                            ii. If you do not get notice
                                     A. Can waive it by going to the meeting
                                     B. Can sign a waiver of notice after the fact

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                            iii. Meeting is only valid if every single director either comes or
                            waives notice
                            iv. Mailing to their address of record is sufficient
                     c. Meeting Rules
                            i. The President of the Board can call a meeting
                                     A. Some states allow for other directors
                            ii. A board member may never appoint a proxy or representative
                            for a meeting
                            iii. In most states by statute, a Board member may appear via
                            conference call
                            iv. Recall: the board always has the power to act by unanimous
                            written consent
XI. Requirements to Issue Stock
      A. Sufficient Authorized but Unissued Stock
             1. Issue: There must be sufficient, but unissued stock in the corporate coffers to
             issue stock
                     a. If there is not a sufficient amount of unissued stock, then the
                     corporation must amend the articles of incorporation to increase the
                     amount of shares prior to the issue of the same
                     b. The way to avoid this is to authorize millions of shares
                              i. Stock itself is in intangible object
      B. Authorization of the Sale
             1. Issue: The authority to issue stock lies with the board of directors
                     a. Rule: Any sale of stock requires a meeting of the board or action by
                     written consent of the board (which requires 100%)
             2. Officers do not have the authority to issue stock
      C. Federal Requirements to Issue Stock
             1. Registration Statement
                     a. SEC requires full disclosure
                              i. Usually 3 years of historical financial data
                              ii. Must be fair, just and equitable
                              iii. Issue: Does the issue involve an instrumentality of intrastate
                              commerce or the mails?
                              iv. Must be for the sale of securities
                                       A. A security is an investment contract
                                               I. An investment
                                               II. In the common enterprise
                                               III. With an expectation of profit arising solely from
                                               the efforts of others
                     b. Required for
                              i. Issuer
                              ii. Dealer
                              iii. Underwriter
                     c. Writing a statement is no easy task
                              i. The information must all be accurate
                                       A. There is significant liability

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                                   B. The cost is significant
                    d. Example
                            i. Company talks to underwriters
                            ii. Underwriting group will sell the stock-find out how much
                            interest there is
                            iii. Company enters into a quiet period until the IPO
                            iv. Officers of the company then speak to the people w/o making
                            projections as to how it will do in the future
                    e. GP does not count since this is not from the efforts of others
                    f. Real Estate
                            i. Counts if the purchase is connected to the rental phase
                    g. Elements
                            i. Prospectus
                                     A. A document distributed to potential and actual investors
                            ii. Additional information that is also publicly available
             2. Exemptions from Filing Registration Statements
             -Section 5: the stock must be registered or there must be a federal exemption
                    a. Transactions not Involving Issuer, Dealer or Underwriter
                            i. No registration is required unless
                                     A. Issuer
                                             I. This is the corporation itself
                                                      a. If you are a controlling person in a
                                                      corporation and sell stock in that
                                                      corporation, you are considered an issuer
                                     B. Underwriter
                                             I. Like Goldman Sachs
                                             II. Do not necessarily be have to be making money
                                     C. Dealer
                                             I. Like Schwab
                            ii. Individuals buying and selling are exempt
                    b. Private Offerings
                            i. There is an exemption for private offerings
                                     A. Section 4(2) of the Securities Act of 1933
                                             I. Exempts transactions by an issuer not involving
                                             any public offering
                                     B. Requires you to look at every person that is offering
                                     stock, and not just those who by it
                                             I. Exemption must apply to every person to whom it
                                             was offered
                            ii. Ralston Purina
                                     A. Focus on the need of the offerees for the protections
                                     afforded by the Act
                                     B. Offerees have access to the kind of information that
                                     registration affords
                            iii. The burden of proof is on the person seeking the exemption

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                           iv. All offerees must fit within the exemption even if they don’t
                           v. Continental Tobacco
                                    A. Very subjective test
                                    B. This lead to Reg. D
                           vi. There must be access on the part of the offeree to information to
                           make an informed decision that registration offers
                                    A. If not present, even to one person, it is a public offering
                   c. Regulation D
                           i. A solution to the dilemma of the private offering exemption
                                    A. The most widely used exemption
                                    B. Very common in VC offerings
                           ii. Shift away from offerees to purchasers
                           iii. Each purchaser must purchase for own account and not for
                           iv. Rule 504 applies for private companies
                           v. If any unaccredited investor than certain information must be
                           vi. Acknowledges there are two kinds of investors
                                    A. Accredited
                                            I. Companies want more accredited investors
                                                     a. Bank
                                                     b. Organization with total assets 5mil
                                                     c. Director/exec. Officer/ general partern of
                                                     securities being offered/sold or of that issuer
                                                     d. Person whose net worth exceeds 1mil
                                                     e. Individual income 200k in two most years
                                                     and its probably going to stay that way
                                            II. Must fill out a form to determine if they are
                                    B. Unaccredited
                                            I. Usually not wanted since they need disclosure
                                            II. Limited in amount as there is a desire to limit the
                                            amount of revelations which need to be made
                   d. Intrastate Offerings
                           i. Rule 3(a)(11)
                                    A. Exempts “any security part of any issue offered and sold
                                    only to persons resident within a single State…where the
                                    issuer of such security is a person resident and doing
                                    business within, such State”
                                    B. Breakdown
                                            I. Issuer resident
                                            II. Persons resident
                                            III. Issuer doing business within state
                                            IV. Issue comes to rest
                                                     a. Rule 147: safe harbor

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                                                          b. You must hold the stock for 9 mos. before
                                                          you can resell it “has come to rest”
                              ii. This is a hard exemption to fall into
                              ii. CA RULE
                                        A. 80% rule
                                        B. This is absolute insurance that you are doing business in
                                        the state
                              iii. This rule is a very narrow exemption
                              iv. A reasonable belief is not Ok
                                        A. You must know for sure that the person is a resident of
                                        the state
                              v. Historical basis: strength of State’s rights in the 30s
                      e. Regulation A
                              i. This is for people who do not know what they are doing
                                        A. Must file a mini-registration with the SEC
                              ii. Companies want to sell to accredited investors
                              iii. P: Do not represent someone who wants to do Reg. A
                                        A. It is a terrible thing
                              iv. If it is a Reg. A that means other investors have passed it over
      D. State Sky Blue Laws
             1. Issue: Must comply with State Blue Sky Laws
                      a. Blue Sky laws have decreased in importance
                              i. Started in KS to as a reaction to the city slickers
                                        A. You cannot try to sell someone the blue sky
             2. RULE IN CA: Must acquire either a permit or an exemption prior to
             the stock offering (security offering), if the seller fails to do so, the buyer has a
             right to rescind the sale
                      a. Caveat: §25102(f):
                              i. If you meet the exemption, no permit is necessary
                              ii. If you cannot meet the requirements of Reg. D, they
                              probably cannot meet the CA Blue Sky Laws
                              iii. This relates to the number of purchasers
                              iv. Very similar to Reg. D
                              v. Elements
                                        A. Less than 35 people
                                        B. Purchasers have preexisting personal/business
                                        relationships/capacity to protect themselves
                                        C. Purchaser not purchasing for others
                                        D. Not public advertising used
                      b. Goes to the Department of Corporations
                              i. Decides if the sale is fair, just and equitable
             3. If a person qualifies as an accredited investor under federal law, they will likely
             qualify as such understand law
      E. Mustang Ranch
             1. A whorehouse that wanted to go public

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             2. They filed with the SEC
             3. They had to file about all the risk factors involved with the business
             4. The SEC tried to make it take so long so that the ranch would go broke first
XII. The Role of Directors
      A. The Role of the Board of Directors
             1. General Corporations Code §300(a)
                     a. The business and affairs of the corporation shall be managed and all
                     corporate powers shall be exercised by or under the direction of the board
                             i. In big public corporations, a board cannot possibly run the
                             corporation on a day to day basis
                             ii. Instead works in an oversight capacity
                             iii. Officers run the corporation on a day to day basis
                     b. In small or family companies, the board is usually family or full time
                     c. See 99 Cent stores
                     d. The Board can delegate duties provided that the ultimate control is
                     vested in the Board
             2. Traditional Roles of the Shareholders and Directors
                     a. Pre-1990s
                             i. Inside Directors
                             ii. Old Boy Network
                             iii. Less than adequate attention paid to role as director
                             iv. Company run on a day to day basis by the officers
                     b. The board was not very tough on itself
                             i. Situations like GM not making good products, etc.
                     c. Since the 1990’s
                             i. Majority are now outside directors
                                      A. Hiring and firing officers
                                      B. Approving yearly plan
                                      C. Monitoring results against plan
                                      D. Approving long term plan
                                      E. Advice to CEO
      B. Mechanics Relating to Directors
             1. Number of Directors
                     a. See Initial incorporation
                     b. Want to have an odd number
                             i. 3-7 is the best option
                     c. CA: 1-2-3 rule
                     d. DE: 2 minimum
                     e. Other states have a minimum of 3
             2. Election, Appointment and Removal of Directors
                     a. Rule for Appointment: The initial incorporator appoints directors
                             i. Issue: What happens if a director dies or resigns?
                                      A. Rule: The remaining directors may fill in the vacancy
                                      for the remainder of the terms
                             ii. We seek flexibility

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                   b. Rule for Elections
                          i. Directors are elected for 3 year terms in a majority of states
                          ii. Staggered Terms
                                   A. Created by Willie Brown
                                   B. Exists in a majority of states
                                           I. CA : this only applies to public companies
                          iii. Kinds of Voting
                                   A. Straight Voting
                                           I. The majority elects all of the directors
                                           II. Main kind of voting used
                                   B. Cumulative Voting
                                           I. Allows individuals holding a minority of shares to
                                           elect under some circumstances a minority of the
                                           II. Proportional Representation
                                                   a. In practice this does not have a real
                                                   impact on the board
                                           III. This cannot be done in PRIVATE corporations
                                                   a. Default rule is that it has to be asked for,
                                                   and if this happens, then it becomes
                   c. Rule for Removal
                          i. Directors can be removed by a vote of the shareholders at either
                          a regularly scheduled meeting or a special meeting
                                   A. The special meeting must be called for a legitimate
                                   business purpose
                          ii. Exceptions to having the majority of the shareholders
                                   A. The Board can remove someone convicted of a felony
                                   B. Found to be retarded
                          iii. Issue: Why would a director be removed?
                                   A. There is a split of authority
                                           I. DE says must be removed for cause
                                           II. CA allows for removal without cause
                                   B. No matter what, removal is by a shareholder vote
                                   C. Issue: What is cause?
                                           I. Cause is defined as a pure power struggle
                                           II. There will almost always be a finding of cause
                                           since the definition is so broad
                                   D. Courts do not like to get involved with this type of stuff
                          iv. How does removal happen?
                                   A. Rule: Shareholders in all jx EXCEPT DE can call a
                                   special meeting
                                   B. A director can also be forced out by other Shareholders
                                   or Directors
                                           I. Force them to resign or be fired
                                           II. 99 Cent store example

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                                               III. Resigning from the Board allows them to
                                               remain as an officer, they are just no longer on the
                                      C. Any money the corporation spends trying to remove a
                                      director is reimbursable as a corporate expense unless the
                                      removal is simply a power fight
             3. Director’s Meetings
                     a. See Sec X. Voting and Meetings
                     b. The Board also has committees
                             i. Audit Committee
                                      A. Should be made up of outside directors who meet with
                                      the auditors
                                      B. Managers should not be at these meetings to encourage
                                      candor with the outside auditing firms
                             ii. Nominating Committee
                                      A. Should be composed of outside directors as well
                             iii. Compensation Committee
                                      A. There are many weird kinds of compensations schemes
                                      B. Social ethics are calling for a change
      C. Director’s Duty of Care: The Business Judgment Rule
             1. GCL 309(a)
                     a. A director shall perform the duties of a director in good faith and with
                     such care, including reasonable inquiry, as an ordinarily prudent person in
                     a like position would use under similar circumstances
             2. Rule: In addition to the above: Courts will not interfere with the honest
             business judgment of the directors unless there is a showing of fraud, illegality or
             conflict of interest
                     a. Good faith must exist
                             i. If there is no good faith, deference to the board is extinguished
                     b. Issue: What is a conflict of interest?
                             i. Rule: A conflict of interest will also be a breach of loyalty, to
                             have a conflict of interest, you must have personal economic
                             interest contrary to that of the corporation
                     c. The burden of proof is on the Π to show
                             i. Breach of duty of care
                             ii. Damages
                             iii. That damages proximately caused breach of duty of care
                             It is very difficult to prove this
                     b. Derivative Action
                             i. This is brought by the minority shareholders against the
                             ii. The corporation is named as a Δ but they are really the Π
                             because the damages that are awarded go to the corporation
                             iii. You must as the permission of the Board for the suit and they
                             must consent

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                                     A. Recall: this is a suit in equity brought in equity by a
                                     shareholder on behalf of the corporation
                            iv. If you are suing all the directors you do not need to ask for
             3. Reliance
                     a. This is one of the director’s defenses in a lawsuit for violating the duty
                     of care
                             i. GCL 309(b)
                                      A. Can rely on
                                              I. Officers and employees
                                              II. Counsel, independent accountants and experts
                                              III. Committees of board on which director does not
                                      B. So long as director acts in good faith without knowledge
                                      that would cause reliance to be unwarranted
                             ii. Policy Reasons
                                      A. We want directors to seek the advice of experts in
                                      making their decisions
                     b. What is the role of the lawyer in the corporation?
                             i. Rule: It is the duty of the attorney to make sure that the Board
                             has sufficient information to make an informed decision
                                      A. This means that most lawyers will drown them with
                                      B. To also advise a director that is not living up to the
                                      business judgment rule to resign
             4. The Business Judgment Rule
                     a. Elements
                             i. Good Faith
                             ii. No conflict of interest in the subject of the business judgment
                                      A. This means not personally economically interested in
                                      the subject of the business judgment
                                      B. No interest means that you have no economic interest in
                                      the subject matter that is or might be different than that of
                                      the corporation
                             iii. Informed with respect to the subject of the business judgment to
                             the extent the director reasonably believes to be appropriate
                                      A. This means the director must have enough information
                                      so that they reasonably believe they have received
                                      sufficient information
                                      B. Two elements
                                              I. Objective: must be reasonable
                                              II. Subjective: they need to have read the
                             iv. Rationally believes the business judgment is in the best interests
                             of the corporation
                                      A. Relatively easy to satisfy

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                                       B. Conduct that may be imprudent or unreasonable is not
                                        necessarily irrational
                                       C. Not merely a subjective test
                                       D. A decision that fails to satisfy the standard is a decision
                                       that cannot be coherently explained
                                               I. Does not have to be an economic explaination
      D. Director’s Duty of Care: The Domino Effect
             1. Del. General Corporation Law §102(b)(7): Limitations on Liability for
             Monetary Damages
                     a. There shall be no personal liability to the corporation or its shareholders
                     for monetary damages for breach of fiduciary duty as a director, if such a
                     exculpatory provision is included in the Articles/Certificate of
                     incorporation unless certain exception are met
                             i. Any breach of the director’s duty of loyalty to the corporation or
                             its shareholders
                             ii. Acts or omissions not in good faith or which involve intentional
                             misconduct or a knowing violation of law
                             iii. Violations of §174: improper dividends
                             iv. Any transaction from which the director derived a personal
             2. Notes
                     a. Mergers
                             i. Rule: When there is a merger, you need a vote of the
                             shareholders and directors of both the purchasing company and the
                             company to be purchased
                             ii. Cash-out Merger: Sometimes the acquiring corporation does not
                             want the shareholders to have stock anymore, they give them cash
                             for their stock
                                       A. In most states you need 90% of the shareholders to
                                       approve this
                     b. Leveraged Buy-Outs
                             i. Money used to try and buyout the shareholders by leveraging
                             debt, if this fails it is colossal, and will lead to bankruptcy
                     c. Investment Tax Credit
                             i. A credit that you can take against your taxes for capital
                             expenditures you make
                                       A. Credit v. Deduction
                                               I. Credit goes against the taxes you pay
                                               II. Deduction means you calculate your income,
                                               take the deduction form the income to get an
                                               adjusted gross income
                             ii. It is useless to a business if you have no taxes to pay or you
                             have more in credits than you have in income
             3. Smith v. Van Gorkum
                     a. The directors failed to avail themselves in making their decision of all
                     of the information that was reasonably available to them

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                     b. Therefore, they acted without good faith
                     c. This case sent tremors through the business community
                     d. Thought to be an overreaching of the idea of what was necessary
XIII. Duty of Loyalty (Directors and Controlling Persons)
      A. California
             1. §309(A)
                    a. A director shall perform the duties of a director in good faith and with
                    such care, including reasonable inquiry, as an ordinarily prudent person in
                    a like position would use under similar circumstances
                    b. Elements of loyalty
                            i. Good faith of the director trying to benefit the corporation
                            ii. Best interests of the corporation
                            iii. Best interests of the shareholders
                            iv. Note: This does not include employees or community
                    c. Reasonable is based on the director’s belief
             2. §310(a): When a director has a material financial interest in a contract
                    a. When it is between the director’s corporation and the director
                    b. Between the director’s corporation and a corporation, firm or
                    association in which the director has a material financial interest
                            i. Issue: What is a material financial interest?
                                     A. Rule: This is undefined in the statute, ask this question
                                     on an individual basis
                            ii. Issue: What about relatives?
                                     A. Good statutes have included this area
                                     B. May argue about who falls under a relative that will
                            iii. Issue: May the board approve a contract in which a Member of
                            the Board has a material financial interest in that contract?
                                     A. Rule: It may be approved if
                                             I. Material facts as to the transaction
                                             II. And material facts as to the director’s interest
                                             III. Are fully disclosed or known to the board or to a
                                             committee of the board
                                             IV. The Board or committee authorizes or ratifies
                                             the transaction without counting the vote of the
                                             interested shareholder and the transaction is just and
                                             reasonable at the time it was authorized or ratified
                                     B. The burden is on the person attacking the transaction to
                                     show that it was not just and reasonable
                                             I. This is primarily an economic determination
                                             II. Burden shifting is costly
                    c. Rule for Approval by a Shareholder
                            i. Material facts as to the transaction
                            ii. And to the director’s interest
                            iii. Are fully disclosed and known to the shareholders

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                               iv. The shareholders authorize or ratify the transaction in good
                               faith without counting the vote of the interested director
                               v. See above for other issues
                       d. Counseling the Client on the Duty of Loyalty
                               i. Would the client in good faith be able to assert and contend that
                               the deal was just and reasonable?
                                        A. If not, the deal should be avoided
                       e. NB: This is a Two-Sided Analysis
                               i. Must look to how this affects both corporations involved
      B. Outside California
             1. It is a huge mess and there is no real consensus
      C. Compensation
             1. Corporate Law
                       a. Rule: There are 2 General Tests
                               i. Common Law
                                        A. Does the compensation paid shock the conscience?
                               ii. Corporate Law Rule/Heller v. Boylan
                                        A. Does the compensation amount to a waste or spoliation?
                       b. Both of these tests are hard to prove
                               i. Waste is particularly hard as it can be easily justified
                                        A. Can relate to the totality of what has been done
             2. Approach of the IRS
                       a. Rule: Is this an ordinary and necessary business expense? (Revenue and
                       Reconciliation Act)
                               i. This is a higher standard and harder to meet
                               ii. Question: is this similar to other businesses in a like position?
                                        A. If no, then the IRS will investigate
                       b. If anyone in a public company gets over 1mil that amount is not deemed
                       deductible by the corporation as a legitimate payment
                               i. This rule only applies to public corporations
                               ii. Only applies to covered employees
                                        A. CEO and four highest paid officers
                       c. EXCEPTION: Compensation subject to performance goals is not
                               i. Therefore corporations set up committees with outsiders to show
                               that this is the policy
                               ii. The compensation board must certify that the goals were met
             3. Compensation in General
                       a. There are two types: Case and Options
                       b. There is a lot of pressure on compensation committees
                               i. Excessive compensation is due to year end bonuses since they
                               are deducted from the taxable income and the person getting it has
                               to pay the tax so the corporation wants to give them out
             4. The Sunshine Laws
                       a. Companies in their proxy statements must state how much the officers
                       are making

Cassandra Escher                      Page 45 of 55
                     b. A compensation committee that is comprised of two or more outside
                     directors must set performance goals
                     c. SEC: the material terms of how much a director is to be paid must be
                     disclosed to the shareholders and approved in advance by the shareholders
                             i. Also: shareholders must be allowed to put in proposals at
                             shareholder meetings that
                                      A. Cap total compensation at no more than 20x the pay of
                                      average employees
                                      B. Eliminating retirement plans for the Board
                                      C. Prohibiting management bonuses until dividends reach a
                                      certain level
                                      D. Cutting management salaries and stock options until the
                                      co. is profitable
      D. Corporate Opportunities
             1. Issue: when has a director breached the duty of loyalty by virtue of their
             actions with regard to a corporate opportunity?
                     a. Issue: What is a corporate opportunity?
                             i. Rule: If you as an employee learn of an opportunity that belongs
                             in equity to the corporation, you have a duty to turn it over to the
                                      A. Interest/Expectancy Test
                                              I. Existing relationships reasonably anticipated
                             ii. The more obvious it is, the more in trouble you are
                             iii. A full time officer is always on duty, no matter where they
                             learn of the opportunity
                             iv. Other Tests
                                      A. Line of Business Test
                                              I. Rule: Is this opportunity in the line of business of
                                              the particular corporation?
                     b. Prima Facie Case
                             i. An offer is made to an officer, director or employee
                             ii. The offer was intended to go to the corporation
                             iii. Officer, director or employee took advantage and did not offer
                             it to the corporation
                     c. Defenses
                             i. Disclosure
                                      A. Present the opportunity to the company
                                      B. Provide all the material facts
                                      C. If the board rejects it, then you are fine
                             ii. Defenses of non-disclosure because the co. did not have enough
                             money to fund the opportunity
                                      A. This is a weak defense
                     d. Remedies
                             i. Place disputed opportunity in a constructive trust
                                      A. Then the court determines what is fair and just

Cassandra Escher                      Page 46 of 55
                     e. Notes
                            i. CA
                                       A. Attorneys must always assess where the opportunity
                                       came from
                                               I. Especially important in the context of new
      E. Duties to Other Constituencies
             1. There are no duties to preferred Shareholders
                     a. Unless they have convertible shares since that is equity
                             i. Therefore the duty is measured in equity
                             ii. Often there is a provision which nullifies their status as
                             shareholders for this reason
                     b. Scope of relationship is essentially contractual
                     c. Usually not successful in their arguments
             2. Creditors
                     a. There is no fiduciary duty as a general rule
                     b. Scope of duty is a contractual relationship
                     c. When the corporation is insolvent and the shareholders have no viable
                     economic interest, and the corporation is not in bankruptcy, the director’s
                     duty is shifted from the shareholders to the creditors
             3. Others
                     a. Present or retired employees
                     b. Suppliers, customers, local community
                     c. Statutes protect directors from the above
      F. Duties of Controlling Shareholders
             1. Rule: Majority or controlling shareholders have a duty to act fairly to minority
                     a. Majority: 50% or more
                     b. Controlling shareholder: not necessarily a majority shareholder
                             i. Look to the corporation’s situation
             2. Issue: What is the duty of a corporation that controls another?
                     a. Rule: A corporation that controls another has a duty to act fairly
                     b. See Business Judgment Rule
                     c. Other test: inherent/intrinsic fairness
                             i. If there is any possible unfairness to the minority shareholder and
                             the majority does not consider or account for, it will not meet the
                             scrutiny of this test
                             ii. Apply whenever a part corporation enters into a contract with a
                     d. When to apply the tests
                             i. BJR: if the controlling shareholder gets something in direct
                             proportion to its interest
                             ii. IF: if the controlling shareholder/ majority shareholder does not
                             get something in direct proportion to their interest

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      G. Sale of Control
             1. You have a public stock and the stock is doing well
             2. When you buy a lot of stock you must offer a premium
             3. Controlling shareholders can sell their stock for whatever they want
                    a. They can sell for whatever they want
                    b. When you get over 10% you must disclose what you have to the SEC
                            i. This is done so you do not come out of nowhere and suddenly
                            have control
                            ii. The minority view is that it is nothing wrong since its not a
                            problem since the premium for control is an asset that belongs to
                            all the shareholders
                                      A. Hone doesn’t like this
                    c. Exceptions to the general view
                            i. If an offer is made to a controlling shareholder and the
                            controlling shareholder says you don’t need to buy more than my
                            block since you will have control. In this case, he has taken a
                            shareholder’s opportunity and diverted it to himself- is a breach of
                            loyalty to the company by the controlling shareholder
                                      A. Premium has to be shared
                                      B. If the controlling shareholder knows or reasonably
                                      believes that the buyer is going to loot the corporation they
                                      have to share the premium with others
                            ii. CA EXCEPTION
                                      A. Controlling shareholder has a duty to use reasonable
                                      efforts to get the same premium for the other shareholders
                                               I. Anyone that would do this is dumb since what is a
                                               reasonable effort
                                               II. Except in the most extreme situation the
                                               controlling shareholders are stuck
                    d. Who is a controlling shareholder?
                            i. Someone that owns 50% or more of the voting stock
                    e. You cannot share a directorship
                            i. The board can fill vacancies on the board not matter why it is
                            ii. Exception: if you sell a controlling interest in the corporation
                            you can agree that they will get a majority on the board of directors
                                      A. How is this done?
                                               I. Siradum resignations
                    f. Capital International airlines
                            i. It is selling at 10, people want to buy the controlling interest at
                            13, this was not a CA corp.
XIV. Fraud in the Sale of Securities
      A. The Common Law
             1. There was no disclosure
             2. Then a duty developed when there were special facts

Cassandra Escher                     Page 48 of 55
             3. KS Rule: There is always a duty to disclose when there is inside information
      B. Rule 10(b)(5)
             1. Reasons for the Expansive Use
                    a. Federal courts are better than state courts
                    b. Nationwide service of process
                    c. Broad venue
                             i. Where Δ resides or wrong committed
                    d. No privity required
                             i. Compare to common law
                    e. Broad applicability
                             i. Applies to any security
                    f. Jxtional nexus easily established
                             i. Use of any facility of interstate commerce
                    g. Exclusive federal jx
             2. Types of Claims
                    a. Civil and criminal
                    b. Fraud
                    c. Insider trading
             3. Applicability
                    a. Jurisdiction: Any facility of interstate commerce
                    b. Any security
                             i. See security definition: investment in a common enterprise with
                             an expectation for profit arising solely from the efforts of others
                             ii. Might also have an issue with registration issues
                    c. Pleading requirements
                             iii. Must plead with particularity
             4. Elements
                    a. It shall be unlawful for any person, directly or indirectly, by any use of
                    means/instrumentalities of interstate commerce, or of the mails, to
                    defraud, make untrue statements of material facts, omit material fact,
                    engage in any practice/act/course of conduct which would operate a fraud
                    in connection with purchase or sale or a security
                             i. Misrepresentation of Material Fact
                                      A. Material: If there is a substantial likelihood that a
                                      reasonable shareholder would consider it important in
                                      deciding whether to buy or sell
                                      B. Secret discussions of merger material
                                             I. No bright line test
                                             II. Will depend on a balancing of both the indicated
                                             probability the event will occur v. anticipated
                                      C. Fact: Must be something that is true
                             ii. Reliance on the Misstatements
                                      A. Π must have relied and been reasonable in that reliance
                                      B. Exception to reliance
                                             I. No reliance requirements for omissions

Cassandra Escher                     Page 49 of 55
             5. Statute of Limitations
                     a. SCOTUS has made these up
                              i. 1 year from the discovery of the violation
                                       A. Or when it would have been discovered with reasonable
                              ii. But no later than 3 years
             6. Standing
                     a. Buyer-Seller Requirement
                              i. Must be either a buyer or seller of securities or a member of the
                              SEC to have standing to sue
                              ii. Only applies to the Π bringing suit
                              iii. Limited to prevent litigation
                              iv. Blue Chip stamps
                                       A. Only those that bought and sold the stamps could
                                       B. No standing if they “would have”
             7. Scienter Requirements
                     a. Π must show intent to defraud by the Δ
                     b. State of Mind: Ernst v. Ernst
                              i. Negligence is not enough
                     c. CA NEGLIGENCE IS ENOUGH!!!!
      D. Duty
             1. There must be a breach of a duty to sue
             2. Rule: A duty to disclose does not arise from the mere possession of nonpublic
             market information
                     a. There is a duty to refrain from trading on it
                     b. Just knowing about it is not enough
             3. Those who have a duty
                     a. Insiders
                              i. An insider may not trade when in possession of material
                              nonpublic information
                                       A. Officers, directors and employees always have a duty
                              ii. Temporary insiders
                                       A. Accountants, attorneys
             4. Tender Offer
                     a. If there is a public tender offer, anyone who has material inside
                     information regarding the offer cannot trade until after it goes public
                              i. Rule 14e-3
                                       A. Not to disclose that information to anyone
                                       B. Not to trade on the information
                     b. This is an offer to buy a significant amount of stock
             5. Misappropriation Theory
                     a. Def: When a person takes something from someone else
                              i. Duty to
                                       A. Give the information back
                                       B. Not to trade on the basis of that information

Cassandra Escher                     Page 50 of 55
                     b. Rule: Violation of the rule when confidential information has been
                     misappropriated for the purpose of security trading, in breach of a duty
      E. Tippee Liability
             1. Elements for the Tippee
                     a. Know or have reason to know that a tippor disclosed information in a
                     breach of duty
                     b. And the tippor did breach a duty in disclosing the information
                     c. And the tippor received some benefit for the disclosure or in the tender
                     offer context
                     d. If the above are met, any trading on material nonpublic insider
                     information gives rise to liability
             2. Elements for the Tippor
                     a. If they violate a duty by disclosing material nonpublic information or
                     use, disclose or trade on information in a tender offer context
                     b. And it was disclosed for personal, monetary or relationship benefit
      F. Fraud on the Market Theory
             1. A substitute for reliance
                     a. A presumption of reliance arises if a publicly traded co issued a
                     materially misleading statement
                              i. There is a rebuttable presumption that the Π relied on the
                              statement in buying or selling
                                      A. Δ can rebut
                     b. Idea that a lot of people are gaming the markets
             2. This is a powerful tool for class actions
             3. CA has rejected this theory
      G. Aiding and Abetting
             1. The SEC can bring an enforcement action for aiding and abetting
                     a. This is how attorneys and accountants are charged
             2. There is no private right of action
      H. Damages
             1. Punitive
                     a. There are none available
             2. Joint and Several Liability
                     a. There is only full joint and several liability for knowing fraud
             3. Otherwise proportional liability
      I. Defenses
             1. Safe Harbor Provisions
                     a. Projections made by co’s are covered under this
             2. Business chat rooms
                     a. Not enough for reliance
                              i. The pump and dump guy

XV. The Sarbanes-Oxley Act
      A. This was designed to clean up corporations
             1. Hone hates it
             2. Sarbanes Oxley was the response

Cassandra Escher                     Page 51 of 55
                     a. Corporate Disclosure and CEO/CFO certification
                             i. CEO and CFO must certify in quarterly and annual reports that
                             the information is fair
                             ii. Must certify that the reports are accurate and do not contain
                             false information
                             iii. Must disclose all material off balance sheet transactions
                             iv. Must disclose if there is a code of ethics and have a financial
                             expert on the Audit Committee
                             v. Have reported information to auditors, both inside and outside
                     b. Maintenance of Internal Controls for Monitoring
                             i. The annual report must contain and internal control report
                     c. Creation of a new Board to oversee accounting firms that audit public
                             i. Each co must have this board and it must have 5 members
                             ii. Has some bullshit stuff that they require
                     d. Audit committees of corporate boards of directors
                             i. Members must be independent
                             ii. Defines what a financial expert is
                             iii. Must have procedures for whistleblowers
                     e. Executive compensation, loans to executives, disgorgement of incentive
                     based compensation
                             i. If you have to restate your financials, you have to give up
                             incentive based compensation
                     f. Professional Standards for Attorneys
                             i. Standards for attorneys who practice before the SEC
                     g. Whistleblower Provisions
                             i. Cannot harm whistleblowers
                     h. Barring people from serving as officers and directors of public
                             i. Can bar someone from serving if they are unfit
                     i. Securities analysts conflicts of interest
      B. Enron
             1. Difficult to evaluate financial statements
             2. They did not record their special purpose entities
             3. They did not record their liabilities
             4. Enron made people question the American system
XVI. Retirement Plans
      A. Set up a tax deferred savings plan
      B. Buy a house
      C. Evaluate Student Loans
              1. The interest paid is not tax deductible but if you can pay off with equity in a
              home, try to make it tax deductible
      D. Build 3-6 months of income in savings
      E. Evaluate insurance
              1. Think term, not whole

Cassandra Escher                      Page 52 of 55
XVII. Distributions
      A. Dividends and Stock Repurchases
             1. Similar in regard to a corporation’s net worth
             2. When you pay out a cash dividend, you reduce the net worth by the amount of
             the cash dividend
             3. If a corporation repurchases its own stock, it pays out 10k and all it gets out is
             its stock
                      a. Back to unauthorized but unissued stock
             4. 2 and 3 are the modern view
             5. Stock split/dividend is merely more stock and it does not impact the net worth
             6. This is important because it decreases the protection of creditors and the
             liquidation preference (if any) of preferred shareholders
                      a. Therefore cash dividends and stock repurchases should be treated the
                      b. Stock dividends and splits should be treated in a different fashion
                      c. Earnings per share
                              i. Total earnings divided by number of issued/outstanding (does
                              not consider the exercise of warrant and stock options)
                              ii. Diluted earnings per share: look at what is really out there and
                              then calculate it on a diluted basis
                                       A. When the stock is purchased, the ownership is diluted
                                       B. Only count shares and warrants outstanding
                              iii. Warrant v. stock option
                                       A. Both are rights to purchase at a certain time for a certain
             7. The nature of the consideration that can be received in a return for sale of a
             stock by a corporation
                      a. RULE: The corporation can sell stock for any time of consideration
                              i. The decision to sell is solely at the discretion of the directors
                      b. Can sell for dollars or property
                              i. EXCEPTION: Cannot be sold for future services
                                       A. Reason for stock options
                              ii. EXCEPTION: Promissory notes of the purchaser even when
                              secured by the stock itself is not good consideration
                                       A. e.g.: you have a start up and go to bill gates and
                                       convince him it’s a good company, it is bad since we do not
                                       know how the co is going to do and if the stock is
                                       consideration it might not be worth enough
                              iii. CA EXCEPTION TO THE EXCEPTION: Promissory notes
                              are good if they are issued to employee, officer and director
                              pursuant to a plan adopted by the shareholders
                                       A. Even here they cannot consider future employment
                      c. Remember: Issue is about what consideration is not ok
      B. Stock Dividends and Splits
             1. This is merely more stock and does not affect the net worth of the company
                      a. They are excluded from the definition of distributions

Cassandra Escher                      Page 53 of 55
                      b. The solvency tests do not apply to them
      C. Insolvency Tests
             1. No distribution is allowed if either of the tests are not met after the distribution
                      a. Equity Insolvency Test
                               i. The corporation is unable to pay its debts as they mature in the
                               ordinary course of business
                                        A. This requires a value judgment
                      b. Balance Sheet Insolvency test
                               i. The assets of the corporation are less than its liabilities plus the
                               amount needed to meet liquidation preferences
      D. Sources of Payment
             1. CA Asset test: Retained earnings
                      a. If the equity insolvency test is met and the liquidation preference of
                      preferred shareholders is not harmed, a distribution may be paid
                               i. Out of Retained Earnings
                                        A. Earnings the company has made but still has retained
                                        from day one
                               ii. If certain financial ratios are met
             2. Nimble Dividends
                      a. You can pay a dividend in an amount equal to or less than this year’s
                               i. They are always friends to the shareholder
                                        A. Used in DE
             3. There does not have to be an equal right to distributions
                      a. Shares can be divided into classes with varying rights
      F. Improper Dividends
             1. If a director votes for or assents to a distribution that violates any of the above
             rules, then they are liable to the corporation for the amount of the distribution that
             exceeds what could have been properly distributed
             2. A director will be deemed to have assented to the declaration of a distribution if
             they were present at the meeting and failed to dissent
             3. Defenses
                      a. Good faith
                               i. Based on financial statements
                                        A. Prepared according to reasonable accounting practices
                                        B. Or on a fair valuation
                                        C. Another method that is reasonable under the
                               ii. By relying on information from officers, employees, legal
                               counsel, accountants, or a committee of the board of which the
                               director is not a member
             4. A director who is held liable for an unlawful distribution is entitled to a
             contribution from
                      a. Every other director who could be held liable for the distribution
                      b. Each shareholder for the amount she accepted knowing that the
                      distribution was improper

Cassandra Escher                      Page 54 of 55
      G. Forcing Directors to Pay Dividends
             1. Discretion of Board: Fraud, Illegality, bad faith
             2. Ford Case
                       a. He stopped issuing dividends to reduce stock prices to get the Dodge
                       brothers to lose money so that they could not start a competitive business
                       b. The shareholders got a special dividend
                       c. Facts
                               i. Making 100 cars a day
                               ii. Ford wanted to make 1000 a day
                               iii. Ford owned 58% of the stock
                               iv.. Decided to mass produce the Model T in black and reduce the
                       d. Had regular dividends and then gave a special dividend at the end of the
                               i. It was a plan to increase business
                                          A. P: The court probably didn’t believe a word he said,
                                          however he was really powerful and probably had the
                                          courts in his pocket
                                                          I. They did not want to say anything bad
                                                          about him
                                                          II. Found for the middle: a business is for
                                                          profit; therefore the shareholders should get
                                          B. He announced he would start a new company to try and
                                          get the minority shareholders to sell to him
      H. Record Date
             1. If you are a shareholder of record on the record date get dividends
                       a. This applies even if you sell the stock before the payment date
             2. Therefore a lot of attention is paid to the record date
             3. Shares which are now reacquired go back into authorized but unissued
      I. Cumulative v. Non-Cumulative v. Cumulative if Earned
             1. Cumulative dividend, if not paid, accumulates and must be paid later
             2. If it is non cumulative, then it falls by the wayside
                       a. P: Finds this bizarre and is not something he would invest in
                               i. You are at the mercy of the co in whether or not you make any
                       b. The directors must still declare a dividend
             3. Cumulative if earned
                       a. If you have one of these dividend to the extent that the corporation earns
                       the price per share of your stock it accumulates
                               i. If it is 5 dollars per share, the co has to earn 5 dollars per share
                       b. The right to receive the dividend accumulates and it carries over to the
                       next year
                       c. P: hard to evaluate
                       d. Garbage in, garbage out: The assumptions are so squiggly it is hard to

Cassandra Escher                       Page 55 of 55

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