Corps - Kerr Spring '09

Corporations Outline – Kerr Spring 09 I. TYPES OF BUSINESS ORGANIZATIONS: A. Sole Proprietorship: 1. Comprised of one person who owns and runs the business 2. Taxation: Only one level of taxation. 3. Liability: Unlimited personal liability B. General Partnership: 1. Two or more people who manage equally (unless management agreement says otherwise) 2. Taxation: Only one level of taxation 3. Liability: Unlimited personal liability C. Limited Partnership: 1. Has at least one general partner and at least one limited partner a. General Partner: Have a voice b. Limited Partner: Passive, generally have no voice, just invest 2. Taxation: Only one level of taxation in general 3. Liability: Unlimited personal liability for general partners and liability up to amount of investment for limited partners D. Joint Venture: 1. Two or more people coming together for a specific business purpose (to make a profit, start a business) 2. Taxation: Only one level of taxation 3. Liability: Unlimited personal liability Corporation: 1. Generally, comprised of a board of directors who set the course, officers who carry out the orders, and stockholders who are the owners 2. Types a. S-Corporation: (1) Taxation: Only one level of taxation b. C-Corporation: (1) Taxation: Two levels of taxation c. Publicly Held Corporation: (1) Shares are traded on the public exchange OR it has more than 10 mil in assets and 500 or more SH in a voting class (2) Always C corporation (3) Taxation: Two levels of taxation d. B- Corporation: (1) ‗for benefit‘ corporation – called the double bottom line. It can be for benefit and for profit at the same time (2) must mention corp will be this kind in the AIC e. Closely Held Corporation: (1) A few stockholders. The stock is NOT publicly traded (2) 4 typical positions: pres, VP, secretary, treasurer. Need at least 2 (pres & secretary) these the 2 that sign the stock certificates (3) Common Law Closely Held Corporation: (a) Non-statutory (b) Has board of directors, SHs DON‘T manage (4) Statutory Closely Held Corporation: E. 1 Corporations Outline – Kerr Spring 09 (a) No board of directors, SHs manage (b) Have to let everyone know in the articles of incorporation that you want to be statutory closely held, so 2 additional provisions must be added: (i) One saying that ―this will be a close corporation‖ (ii) There will be no more than 35-75 SHs (c) In Mom and Pop corporation, Mom and Pop directly manage (5) Can be S or C corporation (a) So taxation depends on what type of corporation they decide to be (b) Common Law Closely Held  Can be S or C (c) Statutory Closely Held  Usually S 3. Liability: Protection from personal liability 4. Formation: Must file Articles of Incorporation Limited Liability Company (LLC): 1. Comprised of memberships. Memberships are sold, not stocks. So you are a member of the company, not a SH 2. Taxation: Only one level of taxation 3. Liability: Limited liability. Members are shielded from liability 4. Formation: Must file Articles of Organization F. II. HOW DO YOU INCORPORATE? A. Reserve a Name 1. Contact Secretary of State‘s Office to determine if name is available 2. If available, you reserve the name for 60 days so that you can get the documents together B. Draw up the Articles of Incorporation- 5 mandatory provisions: 1. Name a. Name should be distinguishable from other names 2. Purpose Clause (says the scope of what business is set up to do) a. General Purpose: Business may engage in any lawful business activity (1) If general purpose clause, likely can‘t sue under an Ultra Vires coa. b. Specific Purpose: Delineates the specific activities of the business. (1) Corp can‘t expand purpose unless amend Articles. (2) Corp gets into trouble if they try to expand line of business past the specific activities they said they‘d stick to in the AIC (3) BUT Corp can still donate to charity. **If you want to amend the purpose clause:**  Common Law Closely-held: BOD must first approve the change then must get SH approval  Statutory Closely-held: only need to get Shareholder approval 3. Name of Agent for service of process & their address a. Usually an attorney 4. Capitalization Provision – (tells SH what their rights are and includes the following info) a. How many classes? (1) State whether there will be differentiation b/w SHs 2 Corporations Outline – Kerr Spring 09 (2) If want to treat all SH alike, only have one class b. How many shares are authorized for each class? (1) Can‘t sell over authorized amount or else deal is void (2) States # of shares the corp is allowed to sell c. What is the par value? (1) Par Value = Minimum amount that the corporation must sell the stock for. (2) If articles say ―no par stated value‖ then the board will decide later on the amount 5. Execution (Signature) a. Can be signed by person or business association C. Bylaws (optional)     Internal operating rules of the corporation / manual of procedures States How many meetings, how to elect, who can be directors Not public document, so don‘t have to file w/ secretary, therefore it‘s easier to amend (don‘t need BOD to amend 1st) ONLY SHs can amend bylaws III. ULTRA VIRES (Beyond the Power/Purpose of the Corporation) A. Red Flag: The corporation has acted beyond the scope of what it is allowed to do and the SHs are not happy about it B. Issue: Did the corporation act outside scope of what was agreed to in AIC? C. RULE: acts beyond what was agreed to in the AIC are held to be ultra vires and are D. unenforceable by the corp. Analysis: 1. What kind of clause is it? a. specific purpose clause? (1) Yes  continue w/ analysis (2) No  you probably don‘t have an ultra vires action, so try due care or loyalty b. OR general purpose clause? (1) Yes  NO ultra vires action, unless corp is expanding into a banking business, then it would be UV action (2) By having a general purpose clause, corporation allowed to conduct business for all lawful purposes. (3) So no suit for ultra vires unless the action is illegal. 2. Is a proper person suing? a. (those who CAN sue for UV)  (1) SHs can sue to enjoin (stop) a corporate act… like can enjoin the K if it‘s not yet fully ex‘d (2) Action by the Corporation against BODs for money damages  ex: if K is already ex‘d, SH can sue execs or or whomever signed the contract (3) Attorney General can sue if there‘s been an illegal act 3. Way to avoid this COA  use a general purpose clause b/cuz gives corp right to expand into other kinds of biz w/out having to amen Corporate Giving of Charitable Contributions 1. CL: the Articles required that the corporation had power to donate $ E. 3 Corporations Outline – Kerr Spring 09 2. Statutory: Allows every corporation to make donations for the public welfare, scientific, or educational purposes 3. Kerr’s Rule: corporate give is allowed and promoted unless the Articles have a specific ―NO GIFTS‖ clause that specify that corporate giving is not allowed. Even if there is a specific purpose clause, corporate giving will be w/in the purpose unless specifically prohibited. Policy: Charitable gifts bolster free enterprise and the general social climate of a where a corporation does business. Furthermore, unless corporations carry an increasing share of the burden to support charities, the business advantages that they enjoy, may be viewed by the public as unacceptable. Test: Reasonableness standard. Is the contribution reasonable? How can a charitable contribution benefit the shareholders? Increases goodwill towards the corporation in the local area. This alone does NOT satisfy the duty BOD‘s have to their shareholders. a. BOD‘s owe a duty to their shareholders, not community at large b. However, when BOD‘s make decisions on behalf of the corporation they CAN take into account non-shareholder concerns. (lots of movement here) Challenging a Corporate Contribution: a. Over the reasonable monetary amount. Look to the income/financial status of the corporation and the effect of the contribution on the shareholders‘ interests b. Due care and Loyalty (derivative suit) c. Conflict of interest: the $$ is going directly to a person associated with the donating corporation d. Donation benefits a Director directly: sue under breach of due care/loyalty 4. 5. 6. 7.  Strategy: If Corporation has no $$, try Pre-incorporation, then Defective Incorporation, then Piercing the Corporate Veil IV. PRE-INCORPORATION- - PROMOTOR LIABILITY A. Red Flag: Someone has entered into a K before the the time corp is officially acknowledged B. C. as a corp, so there is a pre-incorporation K entered into Issue: Can the promoter be held personally liable? Rule: Promoters are presumptively liable unless promoter signed in agency capacity AND third party is looking to corporation once it‘s formed for payment (and not the promoter). 1. Subr: promoter is released from liability only once BOD Adopts the K AND a novation is executed by promoter, corp, and 3 rd party (??) a. Novation (1) Adoption of the K by the corporation does NOT automatically release the promoter from liability- promoter needs a novation (2) Novation = Written agreement b/w parties (corp, third party who made K w/ corp, and promoter) releasing promoter from liability b. Rationale: don‘t automatically release promoter from liability b/cuz success rate of corps in 1st yr is so low, want to make sure someone is liable to 3 rd party who entered into deal Analysis: 1. Has promoter taken the appropriate steps to avoid personal liability? a. Signed in agency capacity? AND made sure other party is looking at the corporation for payment and not him/her personally? D. 4 Corporations Outline – Kerr Spring 09 (1) If yes to both  NO promoter liability (P can try to recover in ct of equity) (2) If no to both  promoter is personally liable (along w/ any copromoters, even if they didn‘t sign K) 2. (even if promoter is liable…)Is the corporation liable? a. Did they adopt the K or receive money? (1) Yes  YES liability (a) Adoption can be implied! (2) No  NO liability 3. Is promoter released from liability? a. Was novation agreement made? – needs to be signed by (1) promoter (2) corp (3) 3rd party Promoter: Person(s) who founds or organizes the corporation. Activities include: 1. Obtaining property through purchase or lease; 2. Arranging for the necessary capital; 3. Gathering all the correct paperwork, filing, and paying fees; 4. Entering into Ks for equipment and employment Promoter can be held personally liable 1. Promoters owe each other a fiduciary duty so they can be jointly and severally liable 2. If one promoter signs a K, they can all be liable 3. Full Disclosure Requirement: Promoters must tell individuals information that could affect their decision to enter into the corp Avoiding Personal Liability: 1. Sign in an agency capacity (ie: ―Rachael, agent‖) AND 2. Get stipulation from the third party saying they will look to the corporation for payment in the future and not to you (unlikely to get) a. If there‘s a personal check from the promoter, it indicates that third party is looking to the promoter 3. Or Include statement saying, ―I‘m not liable‖ (unlikely to get this) Corporation Liability: 1. Corporation is NOT automatically liable, they need to affirm the contract (ADOPTION) or receive money E. F. G. H. V. DEFECTIVE INCORPORATION A. Red Flag: There was an attempt to file articles (incorporate), but there was a mistake (like B. C. D. error in actual document such as zip code missing or doc didn‘t get to receiver) and now someone is suing the officers, directors, and active SHs trying to hold them personally liable b/c they want to get paid. (Use for Tort or Contract disputes) Arises when a company conducts business before it validly incorporated. Issue: Was there a problem with the articles? RULE: 1. If MBCA  defective incorporation if doing business as corp before the stamp date. Active SH will be personally liable a. Look to whether a stockholder has conducted himself or herself in a way that elevates him or her from passive to active (actions beyond common voting, liquidation, and dividend rights) 2. If Non-MBCA  if defective, both active and passive SH are liable. SH can assert 2 defenses though (De Facto and De Jure) Analysis: 1. Was there an effort to form a corporation? 5 Corporations Outline – Kerr Spring 09 a. Yes  keep going b. No  NOT have defective incorporation; try promoter liability 2. What Jurisdiction are you in? a. MBCA (CA) (1) When were the AIC stamped? Not a valid corporation until the you E. get stamp date by secretary of state on your articles – they stamp AIC when they receive them and that date is date of incorp. (before getting these, YES personal liability) (a) If stamp is before the K was signed corporation is in legal existence (not defective) (b) If stamp date is after K was signed  defective incorporation (2) (If defective), are SHs personally liable? (a) If Active  personal liability if K before stamp (b) If Passive  no personal liability (c) Active v. Passive Stockholders: Active Stockholders, Those who assume to act on behalf of the corporation. Stockholders have three rights unless the Articles say otherwise: voting, dividends, and liquidation. Any activity beyond these three can change you from a passive SH to an active SH, which can expose you to personal liability. Note: Statutory closely-held corporations = all shareholders are Active. It‘s possible to have a statutory closely-held corporation with passive SH‘s but you must have an agreement which stipulates this. Only Active SH’s are liable in MBCA jurisdictions b. Non-MBCA (ie: common law): DEFENSES shareholders can argue…CORP EXISTS!! In Non-MBCA jurisdictions the Sec. of State‘s stamp means nothing to the analysis. Active and Passive shareholders are liable in a Non-MBCA jurisdiction. (1) De Jure (a) as of the date of K or injury the corp. was in substantial compliance w/ all mandatory conditions precedents (i) Must have all 5 requirements in Articles (ii) Articles must have been filed, fee paid, and received by secretary of state before the date of the tort or K (iii) SH is arguing that even though there was an error in the AIC, they have still substantially complied  Effect of De Jure: NO action by 3rd party OR Secretary of State allowed against directors, officers, and active investors. (2) De Facto (a) Good faith attempt to comply w/ statutory requirements AND (b) Use of corporate privilege (acted like a corp ie: used letter head, contracts, signatures)  Effects of De Facto: The Sec. of State may still have a COA against the directors and active shareholders but any action by 3rd parties is barred. Do this after trying promoter liability 6 Corporations Outline – Kerr Spring 09 F. The corporation is NOT the ∆, the SHs are b/c they have the $$ 1. So it‘s P (3rd party who entered into K) vs. D (the SH) – why are the SH trying to G. prove a corporation in fact did exist? b/cuz they want to protect themselves from personal liablity If can‘t win on this, try piercing corporate veil VI. PIERCING THE CORPORATE VEIL (Imposing Individual Liability) A. Red Flag: There is a valid corporation, but 3rd parties still want to hold the individuals behind B. C. the corporation or a parent corporation liable for debts owed to them. (typically comes up w/ closely held corps) Issue: Should the SH be held personally liable for a corporate obligation? Analysis: 1. Who has the money? a. Follow the person who has the most money b. If individual SHs have $$, two actions you can take: Defective Incorporation & Piercing the Corporate Veil 2. What kind of action do you have? a. R: If action in Contract, may pierce by showing: (1) Lack of observance of corporate formalities AND (a) Where corporation is merely being used as an ―alter ego‖ of the individual(s) (b) Factors include: (i) No SH, officers, or indep directors (ii) Shares never formally issued (iii)No shareholder meetings (iv) Use of corp property for personal use (v) Signing w/ personal, not corp, name (vi) Bank accounts – need 2 separate ones to be valid (vii) Non functioning officers/directors – like X is supposedly director but just operates as a puppet (2) Lack of adequate initial and continuing capital(didn‘t have     enough money to start w/ and don‘t have enough money to continue the biz) (a) Initial capitalization- ct looks at following: (i) Type of business that the corporation is conducting (ii) Reasonable expenses for the corp, and (iii)Foreseeable risks of the corporation (b) Continuing capitalization- factors include: (i) Is stock being bought back? (ii) Are salaries being paid out? (iii)Siphoning of profits for personal use? If yes, likely lack of continuing funds (iv) Is there an inability to pay dividends? Judge has final say 3rd party no longer has to prove fraud Ct more likely to allow piercing subsidiary to get parent Action in equity 7 Corporations Outline – Kerr Spring 09 b. If action in Tort, may pierce by showing: (1) Lack of observance of corporate formalities OR (2) Lack of adequate initial and continuing capital  Judge more likely to allow this, so easier to pierce under tort D. Various Piercing Situations: 1. Parent- Subsidiary: The third party has some relationship w/ the subsidiary. Parent company must own a majority of the subsidiary‘s stock. Third party wants to hold parent corp liable for subsidiary‘s debts. Judge most apt to allow piercing of the corporate veil. 2. Brother-Sister (―Enterprise Liability‖): There is a horizontal incorporation and the third party wants all the corporations to be lumped together for liability purposes 3. Personal Liability: Where third party seeks to hold individuals behind the corporation liable for the corporate debts. Judge least likely to allow piercing of corporate veil in this situation. a. Officers and directors are liable under this scenario, as is all SHs (whether active or passive). 4. Instances when corp veil should be pierced  fraudulent representation by corp‘s directors, undercapitalization, no corp records, corp is being used to conduct personal business 5. Effect of Piercing in Non-MBCA jurisdiction: EVERY stockholder regardless of Active/Passive is affected in a piercing COA. Protect Yourself: get an indemnification provision in your subscription agreement (―If a piercing COA occurs, you will indemnify me.‖ Only applies to closely-held corporations. Used to prevent fraud or achieve equity E. VII. CAPITILIZATION A. Types of Capitalization 1. Equity Capitalization: An ―equity holder‖ is someone who buys shares of a corporation. Capital exchanged by other investors for ownership interest a. Authorized Shares (also called “Float”): This is the maximum number of shares that a corporation is allowed to sell (based on the articles of incorporation) b. If want to sell more than the authorized shares, must amend the articles of incorporation (BOD propose, officers draft, SH vote) 2. Debt Capitalization: Money borrowed by 3rd parties (now creditors) a. Creditors can get voting rights, but they must negotiate for these in K and in articles of incorporation must allow for it too B. Common terms 1. Debt: Money that at some point must be repaid and interest paid periodically 2. Equity: Financial contributions by the original entrepreneurs in the firm, capital exchanged by other investors for ownership interest, retained earnings of the enterprise 3. Capital: financing that firms use to fund their business activities. Can be obtained by such sources as  borrowing $ from friends, banks, owners of the firm give money, outside investors give money 4. Par Value: dollar value assigned to shares of stock, which after being assigned, represents the minimum amount for which each share may be sold. Only relates to original issuance of shares C. Financing a Company (raising capital) 1. Friends & Family (―dumb money‖) 8 Corporations Outline – Kerr Spring 09 2. Angel Investors: Sophisticated investors, found by looking at other companies‘ investors and seeing if they want to invest in ur company 3. Venture Capital: Firm that gets investors together D. Classes of SHs 1. Common SH: Class w/ fundamental rights (voting, dividend, liquidation) UNLESS Articles say otherwise 2. Preferred SH: Class w/ usually preferential but limited rights. Only gets these rights if explicit in the articles. Typically they have a dividend or liquidation preference but not the right to vote If there is a preference  the amount must be in the articles  One class CAN‘T substantially harm another class Shareholder Rights (3 primary rights) 1. Voting Rights a. Automatic right unless expressly stated otherwise in Articles b. Voting Shift: A SH may be given a voting shift right in the Articles, stating that if there is no dividend declared over a certain period of time then preferred SHs will have right to vote for directors 2. Dividend Rights a. Dividends = Payment of money out of earnings b. Automatic right unless expressly stated otherwise in Articles c. SHs have right to dividends, but BODs have discretion to declare when dividends will be paid out and how much d. Mandatory Dividends: A common SH may protect his right o dividends by asking for mandatory dividends. This means that dividends must be paid out. However, if the corporation does not have enough to legally declare a dividend, then the corporation is excused. Must be expressly stated in Articles. e. Cumulative Dividend Rights: Whether or not a dividend is declared, your dividend will be carried over into the next year. This says no other dividend may be paid unless the cumulative dividend is paid. This must be expressly stated in the Articles. f. Preferred stock: Many times preferred SHs will not be given right to vote and their incentive to buy is to get preference on declarations of dividends before any of the common SHs. There must be an express declaration giving ―dividend preference‖ in the articles (1) Amount of Preference: The amount of preference will be in the Articles and will be usually a percentage of the par value (ie: 5% of par value $10) g. If an adequate corporate surplus is available, directors may not withhold declaration of dividends in bad faith h. If don‘t get dividends  can make a motion to compel dividends (see below) 3. Liquidation Rights a. SHs have an inherent liquidation right, where they have a right to anything left over after all debts are paid. b. Automatic right unless expressly stated otherwise in Articles c. Liquidation Preference: Explicitly stating in articles that one class gets liquidations rights before the other Additional Rights d. Any additional rights must be expressly stated in the Articles e. Redemption Rights: This is where the corporation buys back stock from the SH. A SH may negotiate to get its own redemption right, which is the right E. 9 Corporations Outline – Kerr Spring 09 to sell stock back to the corporation (SH would want this right if corp was going under) f. Conversion Rights: Preferred shares may be made convertible at the option of the holder into common shares at a fixed ration specified in the articles. (preferred SH does this if common stock is appreciating or if wants power to vote) g. Preemptive Rights: These are rights that allow existing SHs to purchase additional shares of issued stock before outsiders Motion to Compel Dividends 1. Red Flag: SHs are not getting dividends 2. General Rule: (Closely Held Corp) Dividends are up to the discretion of the BOD unless they are mandatory or bad faith. (Publicly Held corp) Majority doesn‘t have to declare dividends if they have an adequate business purpose. 3. Analysis: Closely held or publicly held company? a. Closely-Held R: minority SH must prove bad faith / intense hostility (1) Subr: Factors to prove intense hostility/bad faith: (a) History of Hostility (very difficult to prove bad faith) (i) Bad Faith Test: is the policy of the BOD dictated by their personal interests rather than the corporate welfare? (b) Exclusion from Corp. employment (c) Excessive salaries/bonuses for BOD: unreasonable is demonstrated by comparing similarly situated executives. (i) Wilderman Rule: In the absence of a specific authorization by the BOD‘s a corporate executive may receive only compensation that is reasonably commensurate with her functions and duties (d) Existence of a desire by the BOD to acquire the minority stock for cheap b. Publicly-Held  Minority SH must prove lack of business purpose (1) Very difficult to prove b/c there are many business purposes that can justify not paying dividends (R&D, goodwill, reinvesting, $/capital surplus back in) Good will is a legitimate purpose BUT BOD have a duty to SH’s 1st and the general public 2nd. 4. P (SH) v. D (BOD) 5. Strategy  Negotiate a mandatory dividend clause in the Articles 6. Remedy: dividends are paid F. H. Lack of Adequate Consideration 1. Red Flag: The corporation is selling the stock to a SH but SH isn‘t paying enough 2. 3. 4. 5. 6. or not giving the right amount of consideration. 4 types of consideration can give: (1) cash (2) services rendered (3) stock (including stock options) (4) property (real or intellectual) –however services rendered to the corp prior to its incorporation do NOT count as consideration P ______ v. D _________ ? Issue: has there been adequate consideration paid for the stock? Rule: There is legal consideration only when BOTH the Qualitative and Quantitative tests are met. Analysis for Legal Consideration: Both Tests must be met 10 Corporations Outline – Kerr Spring 09 a. Are both qualitative and quantitative tests met? (1) Qualitative Test: Was the proper type of consideration given? 3 ways to pay a company properly and get stock: (a) Cash payment (money) (b) Property (i) Tangible property (real or personal) (ii) Intangible/Intellectual Property (ie: patented invention) (iii)Promissory note (must be secured) (c) Services Rendered (i) Services must be FULLY rendered prior to receiving the stock (ii) Future services NOT exchangeable (iii)Pre-incorporation services NOT exchangeable (2) Quantitative Test: Was enough consideration given? (a) Rule: Consideration must be = to or > than no. of shares X par value (b) CANNOT sell below par/stated value (minimum stock can sell for) – look at Par Value of stock not the sales price! (i) Changing Par Value: Need to amend Articles (ii) Kerr‘s Example: Offer 10, 000 shares par value $1 to D. D is going to pay cash (qualitative test passed). D should give at least $10,000. (c) Exceptions: (i) Financial hardship: The corp is going under (ii) Reissued ―treasury stock‖: Stock that has already been issued and the corp has bought back; when corp is repurchasing and redeeming, they are trying to streamline things (If Quantitative test failed..meaning the rt amt of consideration wasn‘t given) ask  which jurisdiction are we in? (1) Good Faith: (a) If the BODs valued the services or property in good faith, and made a mistake in figuring out how much it was worth then the quantitative test is passed. (b) The bigger the gap btwn the assessed and actual value, the more difficult to establish good faith. (2) True Value: (a) Quantitative test failed even if true value and stock issued is off by one cent. (b) If true is value is off  name that stock, either Discount or Watered. If both tests satisfied  there is adequate consideration If both tests NOT satisfied  what type of stock is it?  Bonus Stock: Qualitative test failed. Zero given, so cancel all stock  Discount Stock: Quantitative test failed. Not enough CASH given. Stock only valid to the amount paid. b. c. d. 11 Corporations Outline – Kerr Spring 09 Watered Stock: Quantitative test failed. Not enough PROPERTY or SERVICES given. Stock only valid to the amount that the Services or Property is worth.  BODs will be held liable for the mistake. 7. Remedies: (what corp can do to punish SH that didn‘t pay enough for their shares) a. Cancellation of Stock: If bonus stock  corp cancel all stock. If stock was sold to 3rd party, then stock won‘t be canceled. b. Force payment: SH may be forced to pay the extra amount to make up for the inadequate consideration. c. Damages from BODs: If the true value or good faith test failed by BODs  they pay damages. Section 5 violation 1. Red Flag: Corp is selling interest in the entity. 2. Concept: A security is a stock, bond, debenture, mutual funds, investment contract or note that has to be registered by SEC. If an interest is classified as a security, it will fall w/in federal and state securities regulations, which offer many more remedies, and a greater potential for recovery. SEC Act of 1933: requires the registration of all securities being placed in the hands of the public for the first time. Federal securities laws apply to closely held corporations, publicly traded corps, and LLC. Full compliance with the Act requires: BIG DISCLOSURE 3. RULE: Before you can offer or sell a security  you must register with the SEC or rely on an exception. 4. Exception: exempts transactions not involving public offering from the registration requirement applies only when ALL the offerees have ACCESS to the same kind of information that would not be available if registration were required. (SEC v. Ralston Purina) 5. If the company wants to sell stock, it must file a registration statement or fall w/in an exception. Registration = Disclosure . Examples  a. Public Offering: Stock must be registered w/ securities authorities before a public offering can take place b. Private Offering: Most closely held corps will file for private offering exemption b/c stock is offered to insiders who are close to the corporate managers and who are fully informed.  I. J. Investment Contract (as a Section 5 violation) 1. Red Flag: Corporation is selling something other than a stock. Investment Ks are forms of security (way of raising money for a business) 2. R: an investment contract exists when: a. Investment of money or legal consideration b. Investment is in a Common Enterprise (2 or more investors are involved) (1) Where the same terms of the investment applies to them equally c. Investing for a profit d. Investors relying solely on the managerial efforts of others (therefore are passive investors) (1) This is where the issue usually comes up. If the investor does anything, then they are NOT passive and therefore there is NO investment K. If it‘s an investment K  it‘s a security so either need to REGISTER or have an EXEMPTION (or else it‘s a violation of section 5) Analysis: a. Is this an investment contract? (go thru 4 elements of rule) 3. 4. 12 Corporations Outline – Kerr Spring 09 b. (if yes)… was it registered OR is there an exemption? (1) If yes  it‘s fine, no coa (2) If no  it‘s a section 5 violation 5. Remedy: , if you win and successfully argue that it‘s an investment K, then you get rescission of the K and you get your money back. 6. P (3rd party who invests in corp) v. D (person saying that X should invest, he‘s the one selling the investment contract) 7. Options if wronged by an investment scheme (Smith v. Gross…earthworms)  CL: Fraud (10b5): intend to misrepresent and misrepresentation is that either 1) the corporation was registered or 2) there was an exemption. Go for fraud and get treble damages (3x). OR Section 5 violation (sue or allege). Find a security!!!! 8. Defense: investors are ACTIVE, so not relying on other‘s efforts. 9. Examples a. Howey, citrus grove. Weather moved in and killed the fruit. Can‘t sue b/c of bad weather, but wanted to get money back. Sued under Section 5 violation. Howey didn‘t register and didn‘t have valid exemption. Had the investors been given proper disclosure they would have been aware of the risk factors. Weather would have been a disclosure item. 10. Strategy  Want to sell an investment and AVOID being held an investment K a. Control: give up some control over daily operations (McDonald‘s & carrot stick example). As an investor, you‘ll argue that you were totally dependent on the franchiser for profits, but franchisers do the above to protect themselves from these COA‘s. Give others decision making power so that they are relying on the efforts of themselves. b. Franchise: has some decision making flexibility. But preserving quality and profitability not an excuse to get away from SEC. Must be able to make decisions to avoid investment K. (1) Hypo: You want to buy a McDonald‘s but don‘t have enough money? Form a limited partnership, which involves general partners (who run the business) and limited partners (passive investors). Possible issues from this hypo...formation of limited partnership = a security, the franchise itself could be argued to be a security Action to Exercise Pre-emptive Rights 1. Red Flag: Corporation is issuing new stock 2. Issue: How do the SHs purchase the newly issued stock before the shares are offered to the public? 3. Rule: pre-emptive right Allows existing SH‘s to purchase additional new issuances at the offering price, prior to any outsider and must be expressly stated in articles 4. Analysis: a. Is there preemptive rights clause in Articles? (must be to have this right) b. Purchase of new issuance must be made at fair market value, not at par value of the stock. c. For preemptive rights to attach, purchase of new stock must be made in cash (not exchange for property or services) 5. Purpose is to allow existing SHs to preserve their interest. By issuing more stock, the existing SHs interest may be diluted (meaning that their voting, dividend, and liquidations rights may be diluted) 6. Strategy  if doesn‘t mention pre-emptive rights in the AIC, do warran buffet exception… have the corp make you your own class that does have pre-emptive right OR if you do have pre-emptive right but BOD knows you can‘t afford to exercise that rt and buy stock sue for breach of fiduciary duty of loyalty K. 13 Corporations Outline – Kerr Spring 09 L. Legality of Distributions (Dividends, Redemptions, & Repurchases) 1. Dividends a. Red Flag: The corporation is making a payout b. Rule: distribution is legal if proper surplus & meets both solvency tests c. Analysis: (1) Proper source? There has to be a proper source of money for the distributions (either of these two): (a) Paid In Surplus  Selling stock for more than par value, so there‘s a capital surplus OR (i) If stock‘s purchase price is more than par value you automatically have paid-in-surplus (b) Earned Surplus  Corporation is retaining earnings $$ (so they CAN pay surplus) (2) Solvent? (must pass 2 tests) (a) Balance Sheet Test  Assets must be greater than liabilities AND (b) Cash Flow Test Corp must be able to pay bills as they become due d. Even if corp does have surplus, if liabilities are more than assets then corp‘s not solvent and doesn‘t have to declare dividends Redemptions: SHs must return stock to the corp (must be expressly in Articles) – means corp pays SH for their stocks a. Rule: for redemption to be legal (1) must state it in articles (2) proper source (3) solvent b. If stocks are illegally redeemed who is liable? BOD c. Analysis: (1) expressly in articles? (2) Proper source? There has to be a proper source of money for the distributions (either of these two): (a) Paid In Surplus  Selling stock for more than par value, so there‘s a capital surplus (b) Earned Surplus  Corporation is retaining $$ (3) Solvent? Must be solvent (must pass 2 tests) (a) Balance Sheet Test  Assets must be greater than liabilities (b) Cash Flow Test Corp must be able to pay bills as they become due Repurchases: SH‘s option to sell back his shares. Don‘t need to be in articles b/c Discretionary a. RULE: repurchase is legal if proper source & solvent b. Analysis: Is it legal? (1) Proper source? There has to be a proper source of money for the distributions (either of these two): (a) Paid In Surplus  Selling stock for more than par value, so there‘s a capital surplus (b) Earned Surplus  Corporation is retaining $$ (2) Solvent? Must be solvent (must pass 2 tests) (a) Balance Sheet Test  Assets must be greater than liabilities 2. 3. 14 Corporations Outline – Kerr Spring 09 (b) Cash Flow Test Corp must be able to pay bills as they become due II. MANAGEMENT (Role of SHs & Directors) G. The PLAYERS! 1. BOD (board of directors) a. R: BOD owe SH 2 duties, (1) fiduciary duty of loyalty and (2) duty to operate with due care (1) T4 SH can sue saying there was a breach of loyalty or breach of due care (see above COA) b. Directors think of the policies 2. SH (shareholders) 3. Officers – either Pres, VP, Treasurer, Secretary. They are in the trenches and execute the policies Amending Articles or Bylaws: 1. 1st BOD then 2nd SH‘s 2. Rule: SH‘s can vote to amend the Articles/Bylaws provided there is no substantial harm to other classes 3. Red Flag: Whenever you see on class of SH‘s doing something to another class, ask is there substantial harm being done to the other class? If YES, can‘t be done. 4. In Stoneham, the voting agreement stipulated that SH‘s could engage in ordinary matters, since this was a CLCHC, the agreement was non-binding. Types of Matters – ORDINARY vs. EXTRAORDINARY 1. Ordinary Matters (ie: Management of the corporation, things the BOD usually decides): a. Appointing officers, b. Officer‘s Salaries c. Declaring dividends d. Ks e. Hiring/ firing of employees 2. Extraordinary Matters: Fundamental changes in the corporation a. Appointment of Directors b. Removal of Directors c. Filling Vacancies d. Amending Articles (1) Common Law Closely Held  BODs first, then SHs (2) Statutory Closely Held  SH approval e. Amending Bylaws (1) SHs can vote to amend bylaws w/o BODs approval, provided there is no substantial harm to other classes f. Mergers (1) 2 corps come together where one dies and one remains (2) Procedure: (a) First the BODs of both companies need to approve (b) Second the SHs of both companies need to approve (i) Short form merger- NO SH approval needed (c) Third check if proper procedures were followed (ie: SH meetings, formal Director meetings, etc.) g. Acquisitions H. I. 15 Corporations Outline – Kerr Spring 09 h. Consolidations (1) Both corporations die and another one emerges i. Dissolutions J. Valid Vote by SH? 1. Red Flag: SH‘s voting. Can they vote on this matter? 2. Analysis: SCHC, CLCHC, PHC? 3. RULES: a. Publicly Held Corporations  BODs and officers decide on ordinary matters. SHs vote on extraordinary matters ONLY b. Common Law Closely Held Corporations  BODs and officers decided ordinary matters. SHs vote on extraordinary matters ONLY c. Statutory Closely Held Corp: SH‘s manage and can vote on ALL matters. (1) SH‘s not obligated to manage but they have the option. If they choose not to manage, they you must have a BOD. Generally there are no public investors and its SH are active in the conduct of business. (mom and pop). The SH are are the BOD and officers. Must be in the Articles “this is a closely held corp and there are no more than 35 stockholders and the SH will manage the corporation”. This is to protect creditors and gives notice of management structure. You can change from a CLCHC to a SCHC by amending the articles.Key: Before the SH‘s start managing, the Articles must reflect this or all the transactions of the SH‘s are void. If the SCHC has a BOD, then the SH‘s can only vote on extraordinary matters. 4. Can creditors have voting rights? Yes, if rights are expressed in the articles Valid removal of director? 1. RULE: SH can remove directors either for cause or w/o cause a. Exception: can‘t remove directors w/out cause if he was voted in by cumulative voting, have to let minority SH cumulate their votes again to see if they want to keep that director in 2. Analysis: a. For Cause (1) Red Flag: Egregious conduct Ie: Embezzlement, Director‘s self service b. W/o Cause (1) Red Flag: There‘s cumulative voting, minority finally gets someone on the board in valid fashion then majority SH kicks them off w/o cause (2) Analysis: Corp will ask minority SHs if they still want person on the board so will vote again for retention. If the percentage was the same as when first voted in  person is kept. Valid Stockholder Action? 2 ways SH‘s take action: 1) Shareholder meeting and 2) by written consent. To vote on matters SH usually have a SH meeting. 1. SHAREHOLDER MEETING: a. Red Flag: There is a formal meeting. There are 2 types of meetings annual and special  (1) Annual: Most states require a corporation to hold an annual meeting at which the SHs vote on the BODs and address any other relevant issues (2) Special Meetings: A special meeting is usually called to discuss very important matters that cannot be held over until the annual meeting. The notice for these meetings must state the particular K. L. 16 Corporations Outline – Kerr Spring 09 issues to be discussed. Management must call a special meeting when the necessary number of voting shares back such a request and the purpose is not improper. b. Issue: Is the meeting valid? c. Analysis: 4 requirements for a valid stockholder meeting (1) Notice (a) Has to be w/in a reasonable time frame of not less than 10 nor more than 60 days prior to the meeting (b) Notice can be waived (2) Record Date (a) Has to be not less than 10 nor more than 60 days prior to the meeting to determine the record date (b) Only SHs who are record owners as of the record date may vote at the meeting, unless beneficial owner gets a proxy to vote from the record owner (must be signed by owner and stamped by Secretary§) (c) Ex: If record date is 9/1 and you bought before that you‘re fine. If you bought after then need proxy to vote (3) Quorum (a) A majority of the outstanding voting shares (not SHs) must be present either in person or by proxy. (b) Inspector of election determines if quorum established (4) Proper Vote (a) Usually a majority of the voting shares present or proxy (b) Supermajority: 2/3 or higher. Requirement must be specified in the articles d. If one of the 4 requirements NOT met  Invalid meeting so anything that happened in the meeting is INVALID e. If voting in person  ballot f. If not voting in person ie, sending in vote  proxy (1) Voting by proxy is revocable in 2 situations: (1) you sent proxy in and then decide to come to mtg in person, but must give notice of your presence b4 vote is taken to the secretary or inspector of election OR (2) death or incapacity – send in proxy and then before meeting you die, must also give notice, if no notice your vote will not be revoked and will still count g. Record owner as of record day is the ONLY one who can vote 2. WRITTEN CONSENT - issues circulated through the mail and you sign off on the action a. SHs are able to vote informally w/ use of written consent forms b. Valid by majority vote. No quorum necessary c. Exception: if the written consent is to vote in directors, they the vote must be unanimous d. Strategy: If you‘re up for election as a director and don‘t know if you have enough votes, you would rather have SH vote in a SH meeting than by written consent Voting to Elect Board Of Directors Valid? 2 types of voting 1. Straight - each outstanding share is permitted to cast a vote for each position available on the BOD. Insures majority SH control of the BOD. M. 17 Corporations Outline – Kerr Spring 09 2. Cumulative - each SH is entitled to vote consisting of her voting shares multiplied by the number of BOD. Insures that the minority owners can vote in at least one director. Bond with SH‘s to vote as a block a. Red Flag: SH challenging the vote, saying he didn‘t have chance to cumulate shares b. Analysis: what jx, mandatory or discretionary? (1) If mandatory – if SH was denied vote, a revote must happen (2) If discretionary and corp has said that SH can cumulate, and they were denied vote – a revote must happen c. (100/x+1) + 1 = % what it takes to elect a director d. Ex: A has 18 shares, B has 82 shares. There are 5 directors running. So A has 90 votes (18x5) and B has 410 votes (82x5) e. Some jurisdictions require cumulative voting (1) CA has mandatory cumulative voting (2) Delaware is discretionary f. Effect of cumulative voting is that it increases minority participation on the BODs g. If there‘s cumulative voting, corporation can’t try to destroy it h. 3 ways to destroy cumulative voting rights: (1) Divide board into classes so only one comes up for election each year (2) Reduce board down to 1 (3) Removal of directors by majority SHs i. Removing a Director: If a director was elected through cumulative voting, then he can only be removed w/o cause by cumulative voting Types of Board of Directors 1. Straight: All directors are elected each year at the same time a. Strategy  easiest type of board to do a hostile takeover of 2. Staggered: Only a certain number of directors are elected each year so there is overlap in leadership 3. Classified: Certain classes can elect a certain amount of directors for their own class a. Number of directors are assigned to each class so the class can only vote for that many b. Can have classified and staggered or Can have classified and straight c. Note: If there is a staggered or classified board, where cumulative voting is taking place, you must have more than one director coming up for election each year. If there is only one director being voted in, cum voting is nullified. (math=51%)… classified or staggard destroys cumulative voting Voting Agreements valid? 1. Red Flag: People coming together before meeting to put votes together and decide how to vote 2. Strategy: minority SH doesn‘t have enough stock by themselves to vote in a director so they form a voting agreement w/ someone else 3. Issue: Is the voting agreement valid? (either pooling or voting trust) 4. Pooling Agreement a. Concept: SH decide to pool their votes together. K‘l agreement among SH‘s relating to the voting of their shares. It can be oral or written. oral allows for SH flexibility. You can change a pooling agreement after you walk into a meeting. Opposite for voting trusts…the trustee has marching orders. N. O. 18 Corporations Outline – Kerr Spring 09 b. Rule: agreement must be based on a matter that SH can properly be voting on in the first place c. Analysis: (1) Proper matter? Can the SH‘s vote on these matters? (2) CLCHC or SCHC? (a) CLCHC - Agreement must be ONLY for extraordinary matters, otherwise agreement is invalid (b) SCHC - SH can vote on ALL matters. Unfettered voting: except can‘t substantially harm other SH classes or the corporation. d. Enforcement: easiest way, appoint an arbitrator. 5. Voting Trust (1) Red Flag: Shareholder is parting w/ their shares and giving it to a trustee— if you see a trustee, go to this (2) Issue: Is it a valid voting trust (legal)? (3) Analysis: 4 requirements for a valid legal trust: (a) Legal ownership bestowed on trustee: trustee MUST be Record Owner. The former record owner must transfer the stock to the trustee. Secretary cancels the old certificate and issues a new one in the trustee‘s name. Separation of legal title. (b) Trust can‘t be longer than 10 yrs (c) Voting trust has to be written and open for inspection (so when you buy stock in company, you know what you are getting) (d) Voting trustee has to vote on a proper matter (must be kind of matters stockholders can vote on) (i) Statutory closely held or common law? (ii) If statutory closely held, are SH managing directly or is there a Board and officers? (4) So the record owner is the new trustee and you are now a beneficiary; So any distributions of dividends goes to trustee (5) No votes allowed on dividends in statutory closely held (6) Trustee has fiduciary duty of loyalty/ good faith to beneficial SH in the voting trust (7) Benefits over pooling agreement: legally enforceable, once beneficial SH have signed K cant change the way they want the trustee to vote so no flipflopping. Disadvantages: voting trust can minimize power of other SH  If trustee has caused substantial harm  then voting trust agreement will invalidate the voting trust Methods of Voting 1. Ballot: In person 2. Proxy: Not in person 3. Can come in w/ proxy in a meeting a. Usually come in w/ proxy b/c proxy is signed by someone else- the record owner 4. Send in proxy, then day of meeting you can attend a. What makes the proxy revocable? (1) If you attend and the vote hasn‘t been taken yet  secretary or inspector of election needs to know you‘re there (2) If SH becomes incapacitated, what will revoke that proxy? (a) NOTICE: if no notice of incapacity, then proxy will be counted P. 19 Corporations Outline – Kerr Spring 09 Q. Invalid Transfer – Stock Transfer Restrictions 1. Red Flag: Problem b/w who had the shares and who has it now, fight b/w SH and there‘s a restriction. Corporation is suing the transferee. Issue: Are the restrictions valid? Is the transfer legal? 2. Rule: for share restriction to be valid a. It must be conspicuous as to form and content AND b. Restriction must be reasonable (1) Exception: restriction does not have to be conspicuous when transferee has actual knowledge of the restriction (if this is the case, restriction is valid) (2) Subr: triggering events that are considered reasonable include: (a) Death of SH (b) Sale of stock (c) Incapacity (d) Bankruptcy (e) Divorce (f) Pledge (pledging securities as collateral) 3. Analysis: 2 Tests: a. Restrictions must be Conspicuous as to form and content (1) Form: Restrictions should be on front of certificate (2) Content: On back should say what restrictions are (3) Print has to be large enough to be readable to a reasonable person. (4) Most problems come up b/c of this test b. Triggering events (restrictions) which haults transfer of shares is reasonable (1) Ie: Death, incapacity, sale, gift, divorce, bankruptcy  If one of those not met  restriction is invalid  transfer is valid  If YES to both then restriction is valid, so can‘t transfer and corp can get those shares back from transferee  Who is suing?  Corp (P) vs Transferor (D)  Corp (P) vs Transferee (D) to get the stock back Actions by Directors valid? 1. ways or methods directors can bind the company  a. Formal Meeting b. Telephonic Board Meetings c. Unanimous Written Consent d. Mickshaw Exception 2. Formal Meeting a. Red Flag: Directors had a formal meeting b. Issue: Was there a valid meeting? c. RULE: 3 requirements for a valid directors meeting: (1) Notice (a) Has to be btwn 24 to 48 hours, unless waived (2) Quorum (a) Majority of the number of originally authorized directors as stated in articles or bylaws (b) It‘s the majority of the originally authorized directors, it doesn‘t matter if people got out of director position after bylaws were made R. 20 Corporations Outline – Kerr Spring 09 (c) Exception: don‘t have to observe the quorum rule when S. there‘s no possible way to get quorum like if director has died or resigned. However, only thing they can do is fill vacancies, can‘t decide on other matters. If want to decide other matters must 1st adjourn and re-meet w/other directors (3) Valid Vote (a) Majority of those that are present (once you meet quorum but NOT majority of quorum) (b) Ex: If have 11 directors, majority would be 6. But 8 directors show up so majority for that meeting is 5.  If one of the requirements missing  invalid meeting  anything decided in the meeting will be ignored as if it didn‘t happen 3. Telephonic Board Meetings– directors can‘t meet in person so they ―meet‖ over the phone a. Requirements: (1) Notice (a) Has to be btwn 24 to 48 hours (b) Can be waived (2) Quorum (a) Majority of the number of originally authorized directors as stated in articles or bylaws (b) It‘s the majority of the originally authorized directors, it doesn‘t matter if people got out of director position after bylaws were made (c) What if there are so many vacancies that there is no quorum? (i) BODs can decide who can fill those vacancies (3) Valid Vote (a) Majority of those that are present (once you meet quorum but NOT majority of quorum) (b) Ex: If have 11 directors, majority would be 6. But 8 directors show up so majority for that meeting is 5.  If one of the requirements missing  invalid meeting  anything decided in the meeting will be ignored as if it didn‘t happen 4. Written Consent a. Must be unanimous! Piece of paper is circulated around directors and all must sign b. If not unanimous  invalid  anything decided will be ignored 5. Mickshaw Exception a. Red Flag: Director goes out and contracts with a 3rd party and tries to bind the corporation to this agreement b. RULE: for director to bind corp in this way (1) director must disclose to board all info regarding K and (2) all other directors must acquiesce c. The action CANNOT harm SHs, creditors, or the corp.  Strategy: If you‘re a director and want a certain action passed but don‘t know how others will vote, what will you do?  Will want a formal meeting or telephonic board meeting b/c that way you don‘t need unanimous consent Valid Actions by Officers ? 1. Red Flag: Officers getting into transactions, entering K 21 Corporations Outline – Kerr Spring 09 2. Issue: Do they have authority to do that? 3. Analysis: a. If the record director and officer is the same, see if they have authority b. 2 Types of Authority: (1) Express Authority: In Bylaws or Articles (a) Certified Resolution by the Board (board gives authority to officer) (i) Signed resolution saying that X has the authority to enter into the K (ii) Secretary has to sign this (iii)Usually has a corporate seal (which has a date) (iv) If BOD argues they didn‘t give authority, just have to show this to prove them wrong (v) This will be a conclusive presumption EXCEPT where party you‘re contracting with has notice that the board didn‘t vote on the certified resolution (vi) Strategy  as officer, best thing to do is ask for express board resolutions stating that you have express authority to do X (2) Implied Authority c. President (1) Could have express authority through certified resolution given to them by the board (2) If president doesn‘t have expressed authority, he has implied authority to do ORDINARY things (ie:h/firing…he can enter into Ks that deal w/ ordinary day to day matters) (3) How about getting loans? It depends on: (a) Short Term vs Long Term (b) Interest (4) But if pres fires the most important employee, that might be extraordinary and not allowed d. Vice President (1) Could have express authority through certified resolution given to them by the board (2) NO implied authority unless president incapacitated (3) How incapacitated? Depends on the facts e. Secretary (1) Could have express authority through certified resolution given to them by the board (2) NO implied authority unless Pres & VP incapacitated (3) Normally has role of f. Treasurer (1) Could have express authority through certified resolution given to them by the board (2) NO implied authority unless above three incapacitated Want to go after $$, so if corp doesn‘t have $$  try DEFECTIVE INCORPORATION and PIERCING THE CORPORATE VEIL 4. 22 Corporations Outline – Kerr Spring 09 5. If have small company and all are directors and officers. Want to know what capacity they are acting in. If don‘t know  talk about all three. Start at Director, then authority as Officer, then authority as SH. MIDTERM PUBLICLY HELD COMPANIES  Key Terms / Concepts: o Sarbanes Oxley Act (SOX): says that corp must have financial controls inside the company that will ensure information gets to the board. Requirements  internal controls, independent officers, majority of board members are independent (meaning they don‘t have financial ties to the corp), independent committees for Auditing, Compensation, and Corporate Governance o ISS: organization that represents SH and rate companies based on the corporate governance measures they take. If the corp is great for SH, it gets a high rating. Pension funds and other large investors look at what rating the ISS gives a corp an then decides whether or not to invest in it. ISS prefers corp to have straight board, straight voting, and controls on compensation o Fraud: fraud generally occurs with the C-level execs, so under the SOX act now both the CEO and CFO must sign off on financial statements saying they‘re accurate o Different from closely held corps b/cuz  1) SEC disclosure requirement and 2) if SH is unhappy w/ what‘s going on, can sell his shares on the open market  Strategy: Start by saying that Federal COA are more important because are more remedies. Federal COA include: o § 5: Must register or find exception if buying or selling stock o 10b-5: Insider Trading o 14(a)(9): False or Misleading Statements or Omissions dealing w/ proxy solicitation o 14(a)(8): Stockholder Proposal there III. PROXY SOLICITATION G. 14(a)(9) Action: 1. concept: proxy solicitation is asking other SH to vote on certain proposals 2. Red Flag: publicly held corporation and there‘s a false or misleading statement or omission made by either board or another SH in connection w/ the solicitation of votes (proxy solicitation)… so can be w/in a SH proposal that people will be voting on. Find as many false/misleading stmts or omissions as possible – look for SH in audience saying something. a. Corporation or other SHs can be soliciting b. Can be oral in the meeting or in the materials themselves c. Ex: CEO says that earnings from corp were 18mil for the year. after vote takes place we find out that was wrong, earnings were only 16mil. Rule: Materially false or misleading statements or omissions in connection with a proxy solicitation is prohibited Who can bring the claim? a. Individuals who have standing b. SEC P _______ v. D __________ Analysis: (elements P must prove) a. Publicly Held corporation? 3. 4. 5. 6. 23 Corporations Outline – Kerr Spring 09 (1) Shares are traded over a national exchange (NYSE or AMEX), not regional OR (2) Corporation has $10 million in assets + 500 or more in SH‘s in a voting class b. There was a Solicitation (request for a vote or proxy)? c. False or Misleading statement OR Omission d. Which was Material (1) Material = There is substantial likelihood that a reasonable SH would consider it important in deciding how to vote. e. As a result of Simple Negligence on part of person who made statement or omission (1) Simple negligence – person just made a mistake f. Causation- ―Essential Link Test‖ (1) Have to show that vote was needed to pass the action (2) If vote not necessary to pass item/action  no causation unless the false and misleading statement or omission caused the P to waive their remedy 7. Remedy: a. Damages 14(a)(8) Action: Stockholder Proposal 1. Red Flag: Stockholders approach management b4 mtg and want proposal put in materials that they are sending out to SH. BOD will have to make decision as to whether to include proposal or exclude it. If Proposal is rejected, SH brings this COA and goes to SEC to compel management to include the proposal OR they can always file the proposal using their own money and send out their own materials 2. Rule: Management must include in its solicitation materials proposals made by SHs if they are made on proper subjects 3. Strategy  if management decides to let in the proposal but then something bad happens, SH should bring a breach of due care COA 4. Analysis: a. Does SH have standing to bring proposal? (1) At the time proposal is submitted, proponent shall be a record or beneficial owner of either 1% or $2,000 of company‘s voting stock AND must have owned this amount for at least one year prior to the meeting and they must continue to hold those securities through the date of the meeting b. Can BODs exclude? (4 situations where they can exclude proposal) (1) the proposal is beyond purpose or power of corp (proposal is asking corp to do something that corp has no power to do) (2) proposal Relates to Ordinary Matters: SHs can‘t vote on ordinary matters, so BODs can exclude (a) exception: if ordinary matter relates to some kind of social policy it cannot be excluded! (b) Hypo: proposal saying corp shouldn‘t cut down timber in area where spotted owl lived. If proposal only said that corp shouldn‘t cut down timber period that would be an ordinary matter, however putting the spotted owl thing in gives it a social policy concern. So if you want proposal to get in frame it in way that sounds like social policy. (c) ‗say on pay‘ (ie: exec compensation) is normally an ordinary matter and can be excluded. However ‗say on pay‘ as it relates to the economy could be perhaps a social H. 24 Corporations Outline – Kerr Spring 09 policy exception. But in reality, corp will deal with SH who are institutional investors and so make it a non binding advisory one. (3) proposal Relates to an Election/ Qualification/ Removal/ Number of Directors (a) rationale: board knows who would be best qualified as a director, more so then the SH (4) proposal is Counter to Proposal Being Brought By Manager: If a SH proposal is contrary/ opposite to that of the management then the Board may exclude it (a) ex: company says we‘d like you to vote for this merger, and there‘s a SH that comes w/ a proposal that says they‘d like SH to vote against the merger c. Even if they can exclude, should they? (1) Strategy  even if board can exclude the proposal, doing so will piss off big investors, so instead can allow proposal in but make it advisory / non binding Most SH proposals will come from institutional investors (CALPERS, TIAA CREF, CALSTERS) Examples of SH proposals: a. to cap compensation (ex: get rid of death benefits) b. make compensation more performance related c. proposals that are aimed at making corp disclose it‘s carbon footprint (and what it‘s doing to address environmental issues for ex: greening and sustainability proposals) d. proposals to make corporation more accountable (1) way to make board more accountable  (a) make the board straight (b) make there be cumulative voting. (c) each director that gets voted in must be voted by Majority. 5. 6. FIDUCIARY DUTY OF DIRECTORS BUSINESS JUDGMENT RULE (BJR): **NOTE**: Never can pierce the corporate veil of a publicly held company. Start ANALYSIS of due care, loyalty, good faith, and authority with the BJR.  BJR: a board‘s decisions are protected by the BJR, meaning there is a heavy presumption that the Board acted w/ due care, good faith, loyalty, and within its authority  Rule protects decisions made by the board, NOT decisions of individual directors acting alone. SH has the burden to overcome this rule  To overcome business judgment rule, SH must show either: o Lack of due care, o Breach of fiduciary duty or loyalty, o Breach of Good Faith, or o Action outside the scope of director authority I. BREACH of DUE CARE – LAST THING TO ARGUE!!  Strategy: Do this last. Explain that this is difficult to prove b/c many states allow clause in articles preventing due care actions & BJR is a high burden Board Decision 25 Corporations Outline – Kerr Spring 09 1. Red Flag: Board has made a decision AND there was a loss a. Directors didn‘t get highest price they could for stock on behalf of SHs b. In a Merger transaction, there was no fairness opinion from an investment banker 2. Issue: Whether BOD has exercised due care in making their decision 3. SH (P) v. ___________ 4. Analysis: a. Does the Business Judgment Rule apply? (1) SH must overcome presumption of BJR to win b. Does the SH meet the elements of a Due Care action? (1) Standard: Director must do what a reasonable prudent person would do in similar circumstances  (sub duty): Duty to be fully informed. Means that when directors are making a decision they should (1) look at all relevant documents, (2) deliberate (asking advice/questions etc.) seek right experts, prepare documents that are important in making decisions (2) Breach: There must be Gross Negligence (a) Have to overcome business judgment rule (b) Ex: BODs declares dividends but doesn‘t check financials first (3) Causation: but for that decision those losses would not have occurred (a) Unless there are intervening factors (ie: act of G-d) (b) Counter – board will argue things other than their decision caused the loss (4) Damage/Loss: Could be loss of $ or loss of good will (like someone refuses to do business w/ the company due to the board‘s decision) Defenses BOD can raise (aka counter arguments) 1. Statutory Provision: provision in AIC says BOD is protected from this COA 2. Good Faith Reliance on Proper Expert: For mergers  must have been an investment banker 3. Individual Director did NOT Approve the Action: If director abstained from voting or voted against or was absent, then can avoid liability 4. Stockholder Approval: Have to show SHs made unanimous, fully informed decision (SH approved, so can‘t then sue for breach of duty) a. Counter argument by SH is that they relied on stmts from BOD and there were omissions, so SH can come back and sue under COA 14(a)(9). Board Decisions AND Takeovers / Tender Offers 1. Board of Aggressor decides to make a tender offer a. Red Flag: Bidding Corporation bids to takeover another entity (1) Rule: If the BOD of a bidding corporation decides to takeover another entity, they owe a fiduciary Duty of Due Care to its stockholders of their corporation to act in their interest (a) Types of Offensive Takeover Strategies: (i) Buy up to 4.9% of target company‘s shares, followed w/ a bear hug (ii) Buy up to 4.9% followed w/ a hostile tender offer, followed by a merger (iii)Buy shares up to control acquisition percentages (iv) Buy shares or make tender offer for shares w/o triggering poison pill (to trigger poison pill, you need to acquire 20% or tender offer for 30%) (v) Wage Proxy Contest where someone acquires 20% and if have cumulative voting, that would B. C. 26 Corporations Outline – Kerr Spring 09 allow that person to get at least one person on the board (2) Analysis: (a) BJR attaches upfront: A BOD‘s decision to takeover 2. another corporation is protected by the BJR if the board was fully informed before making its decision Board of Target says YES (wants to be taken over) a. Red Flag: BODs allowed takeover to occur there was losses b. Analysis: BJR attaches upfront: A BOD‘s decision to takeover another corporation is protected by the BJR if the board was fully informed before making its decision Board of Target says NO, but does NOT DEFEND a. RF: BODs refuses takeover but does nothing to stop the takeover & losses occurred b. Analysis: BJR attaches upfront: A BOD‘s decision to takeover another corporation is protected by the BJR if the board was fully informed before making its decision  Strategy: Harder to get Due Care action b/c most states have provision in articles not allowing due care analysis and have BJR presumption (which is hard to overcome). Management Compensation under Breach of Due Care A. Red Flag: Directors are not deciding own compensation B. Issue: Was there a mismanagement of compensation? C. Analysis: 1. Is there a compensation committee? a. Corporation should create a compensation committee composed of outside directors to avoid problems 2. What kind of corporation is it? a. Publicly Held (1) Along w/ standard, breach, causation and loss Must show waste (compensation amounted to waste t4 it was gross negligence) (a) Waste = financial crippling b. Closely Held (1) Must show compensation was unreasonable (a) That amounts to gross negligence (b) Don‘t need to show financial crippling (2) Easier burden to prove ** Note**:  If directors are deciding salaries of officers but not of themselves  apply the due care analysis if the director‘s decision led to losses for the corporation  If directors are deciding their own compensation  might have interested director / self dealing scenario 3. II. Breach of LOYALTY: first determine which COA you have A. When making a business decision, the directors owe a duty of loyalty to the corporation, shareholders, and creditors. Breach duty of loyalty by director acting in OWN interest, instead of in the interest of the SH. Self Dealing/ Interested Director 27 Corporations Outline – Kerr Spring 09 1. Red Flag: Director enters into a transaction with own corporation. Director is on 2. 3. 4. 5. BOTH sides of the transaction (being loaned money & loaning money to corp) a. Two companies coming together and there‘s common directors Issue: Is the transaction void or voidable? Who is Suing? a. SHs or b. That particular director Who is Responsible? Individual directors, not board as a whole a. So BJR does NOT apply b. BJR protects the board, not individual directors Analysis: a. Common Law: If there‘s a conflict of interest, the transaction is automatically void b. Modern Rule: The transaction is voidable UNLESS the interested director can prove one of these three: (if he proves then the transaction is OK) (1) Impartial board Approval w/ full information: BOD approved the conflicted transaction w/ FULL DISCLOSURE or (a) Only disinterested BODs may vote (b) The ―interested‖ vote/s can‘t count towards approval but can count towards quorum (c) Burden on director to show this (2) Impartial SH Approval w/ full information: SHs approved the conflicted transaction w/ FULL DISCLOSURE or (a) Here, director is also a SH (b) Approved by a majority of disinterested SHs (c) If the conflicted director owns a majority of the stock, there can be NO SH approval (3) Transaction is Fair: director must show that the transaction was intrinsically fair. (a) Must be fair to SHs, creditors, and corporation Strategy  if there was impartial board approval, SH can still challenge the transaction by bringing COA for ‗invalid director decision‘ 6. Management Compensation under Self Dealing 7. Red Flag: Directors are deciding their own compensation as officers 8. Issue: Was there a mismanagement of compensation? 9. Analysis: a. Is there a compensation committee? (1) Corporation should create a compensation committee composed of outside directors to avoid problems b. What kind of corporation is it? (1) Publicly Held (a) R: SH Must show that compensation amounted to waste (b) Subr: majority SH can‘t give away or waste corporate property/assets over the objection of the minority SH. (c) Ex of ‗waste‘  Bonus payments that have no relation to the value of the services rendered (d) Subr: to be considered ‗waste‘ a transaction must be so one-sided that no business person or ordinary, sound 28 Corporations Outline – Kerr Spring 09 judgment could conclude that the corporation has received adequate consideration. (e) Board‘s decision regarding compensation is inherently as matter of business judgment and if the corp gets substantial consideration (ie: they get a lot out of the executive, and need to pay him a lot to keep him) and there‘s good faith judgment that transaction is worthwhile, then its NOT waste. Closely Held (a) Must show compensation was unreasonable (i) That amounts to gross negligence (ii) Don‘t need to show financial crippling (b) Easier burden to prove (2) ** Note**:  If directors are deciding salaries of officers but not of themselves apply the due care analysis if the director‘s decision led to losses for the corporation  If directors are deciding their own compensation  might have interested director scenario Parent-Subsidiary Non Merger 10. Red Flag: Parent and Subsidiary is NOT merging but the Parent is playing around w/ assets, draining money, etc of the subsidiary, parent treating subsidiary unfairly by ‗self dealing‘. There is a disproportionate transfer of assets in favor of the parent. 11. Minority SHs of the Subsidiary (P) v. Parent directors and company 12. R: parent corp is self dealing if parent receives a benefit to the exclusion of / detriment to the minority SH of the subsidiary 13. Analysis: a. Initial Pleading Burden: Minority SHs must prove that (1) Parent received a benefit (2) At the exclusion of and detriment to minority SHs of the subsidiary (3) Burden then shifts to Parent BODs to show fairness b. Intrinsic Fairness Test (DEFENSE): Parent BODs must show that (1) Minority SHs of subsidiary and subsidiary received a benefit and no harm to creditors (2) Once parent shows some kind of benefit  BJR comes in, so you can‘t use this COA anymore (3) If no benefit  damages are in order (money) Parent-Subsidiary Merger 14. Red Flag: Parent and Subsidiary are merging, Parent will own at least 51% of subsidiary‘s shares. Usually there are directors who sit on both the parent and the sub‘s board. a. To have Merger need: (1) BODs approval of BOTH companies AND (a) Interested directors may be counted towards quorum but vote NOT counted for approval of merger (2) SH approval of BOTH companies (a) Merger is an extraordinary matter, so need SH approval (b) Interested SHs may count towards quorum but NOT counted for approval of merger (3) Have to check that correct procedures were followed 29 Corporations Outline – Kerr Spring 09 (ie: SH meetings, formal Director meeting, etc.) Minority SHs of Subsidiary (P) v. Parent directors and company Analysis: a. Initial Pleading Burden: Minority SHs must prove: (1) Lack of Fair Price AND (a) There was NO negotiations over the price being paid to the minority SHs for their stock which majority is cashing out (b) NO investment banker opinion report provided (2) Lack of Fair Dealing (a) NO full disclosure of material facts (b) NO negotiation Committee was made up of impartial/outside directors and experts (3) (DEFENSE) Burden then shifts to Parent BODs to show ENTIRE fairness (a) transaction is fair to minority SH of sub and no harm to creditors 15. 16. **NOTE**: Other COAs that stem from this COA  14(a)(9): Both corporations SHs must have approved the merger so there lacked full disclosure to both corporations  Due Care: Subsidiary minority SHs against their own BODs for not negotiating w/ parent BODs over price they would have been paid for their stock  Self dealing: if there are common directors can have self dealing/interested directors  10b-5: Insider Trading Usurpation of Corporate Opportunity 17. Red Flag: A director is being offered some kind of business opportunity by someone (it can be subtle, so be careful!) 18. Corporation (P) v. That Particular Director (D) 19. Analysis: a. R: Director has burden of showing that this opportunity is NOT w/in the corporation‘s line of business b. Line of Business Test (1) Was the opportunity fully disclosed to the Board? (2) Was the opportunity w/in Current Line of Business OR w/in Future Expectations of the corporation? (3) How did the director learn of the opportunity? c. If NOT w/in line of business  Director will win d. If IS w/in line of business  Go to Defenses 20. Defenses for Director: a. Disclosure ???? (1) Director told corporation before or after making the deal and got full approval b. Ultra Vires (1) Corporation has a specific purpose clause so can‘t do this particular deal c. Corporation Unable To Take Advantage of the Opportunity (1) Opportunity is presented to the corporation first but they can‘t take it / can‘t afford to take it d. Corporation Refuses the Opportunity 30 Corporations Outline – Kerr Spring 09 (1) Corporation was offered the opportunity but refused it e. Illegal for Corporation to Take the Deal 21. Remedies: (things board can seek to recover) a. Constructive Trust (1) Brings back what was taken from the corporation (2) If property was sold, then money goes back to corp b. Bad Faith Damages (1) Was there Bad Faith? (a) Where director knew it was corp opportunity (can‘t sue for damages if they didn‘t know it was a corp opp) (b) Strategy  since start of SOX laws, both ―inside‖ and ―outside‖ directors are held to same standards of having knowledge so both will likely know that opportunity is a corporate opp. (2) Profits made by fiduciary may be recovered by the corporation (Takeovers / Tender Offers) Decision To Defend 1. Red Flag: Takeover offered and BOD of Target corp adopts defensive mechanism(s) 2. concept: If the Board of a target corporation adopts defensive mechanisms, it owes a fiduciary duty of loyalty to its stockholders to act in their interest. 3. RULE: When BOD implements an anti-takeover measure, there arises a presumption that the BOD is acting in its own self interest. Therefore, to be protected by the BJR, the BOD must show that: (MORAN TEST) a. There was reasonable grounds for believing there was an actual or perceived threat to corporate policy or effectiveness AND (1) Board must do a good faith investigation (2) Threats (a) Bust Up Merger: Where acquiring entity is just concerned about breaking up target and selling off assets.-Perceived (b) Two Tier Coercive Tender Offer: Acquiring entity tells SHs that if they don‘t tender, they won‘t get anything good at the end---Perceived Threat (c) Tender Offer: This is an Actual Treat (d) Poison Pill: Perceived Threat b. That the defensive measure taken was reasonable in relation to the threat posed (1) The more defensive measures taken, the less likely the court will find it reasonable b/c it‘s harder for any entity to take over, even if it might be good for the corporation c. If both tests passed BJR locks in d. If one or both tests fail  ct can force corp to take down the defensive mechanism OR award damages B. Types of Defensive Mechanisms: 1. Shark Repellent (Control Share Acquisition Statute): Meant to counter threat of coercive two tier tender offer which would make the second set of shareholders unprotected and would get junk. So pay first SHs for tender offer then have to pay second SHs for their voting rights a. RF: if a certain % of stock is acquired by someone, then voting rights are no longer attached to those shares 31 Corporations Outline – Kerr Spring 09 b. This is a way for SH to protect themselves b/cuz forces the offeror to 2. disclose up front what his plans are, and gives them power at the negotiation table Poison Pill: preferred stock that goes out to existing SH of the target corp. they give SH superior rights to the rights tender offeror is acquiring, also since puts more stock out there, dilutes what tender offeror bought. New preferred stock allows SH to buy more of the target stock at a discount rate (flip in provision) OR allows SH to buy shares of the company once tender offeror buys it at a discount (flip out provision) a. Triggering event  someone acquires 15% of stock b. Poison pills may be ―neutralized‖ or ―disarmed‖ by the BODs if they approve the transaction c. Usually considered reasonable, but if bundled up w/ something else then might be unreasonable (1) Ok to use if there‘s an actual threat (2) Look at facts if a perceived threat, if it is then it might be unreasonable d. Rationale: forces tender offeror to negotiate and treat SH fairly Porcupine: Anything in bylaws or articles designed to make unwanted takeover attempts impossible or impractical w/o consent of target‘s management a. Often reasonable but could be unrx b. Types: (1) Supermajority provisions (could be on SH or Director level)requiring a vote of 100% to reach super maj is NOT rx, however, requiring 85 or 90% can be (2) Staggard Board – rx (except cant have 1 member coming up for election ea yr b/cuz destroys cumulative voting) (3) Getting rid of Cumulative Voting – rx in only a discretionary jx (4) Anti-green mail provision Golden Parachutes: Change of control provision in compensation package which says that payment will be given to the management when another company takes control a. Meant to keep management w/ the new entity & make it expensive for new entity to start over b. May or may not be rx (have to see how much money is being paid out) Tin Parachute: Type of Golden Parachute but offered to all employees, not just high executives. Makes it so that every employee has to paid off if there‘s a change of control. Very expensive so NOT reasonable Pacman Defense: Target makes a tender offer to the acquirer (ie: Counter Tender Offer). May or may not be rx (have to see how much target is giving on the premium) White Knight: target approaches another entity or individual and asks them to rescue the corp. they either merge or issue add‘l stock to WK and then after treat passes the WK sells back the stocks. Normally Rx but have to look at terms of the deal Termination Fee: Making it too expensive to get our of the merger. Usually NOT reasonable, but look at facts Self Tender Offer: Target makes tender offer for its own shares. This is a repurchase so issue comes up of it‘s a legal repurchase (proper source?). This may be expensive, due care issue. May or may not be rx, have to look at terms. Crown Jewel: Target sells its most prized assets. NOT reasonable unless offeror has reputation for gutting corps. 3. 4. 5. 6. 7. 8. 9. 10. 32 Corporations Outline – Kerr Spring 09 a. Strategy  to make crown jewel a rx tactic, pair it with White Knight. Sell 11. best assets to WK, then he can sell it back after the threat passes Scorched Earth: gutting your corp / selling all assets so that there‘s nothing left for offeror. NOT reasonable Duty to Auction 1. Red Flag: Two companies entering into merger negotiations and there‘s bidding for the price of stock. 2. Issue: Is a duty to auction triggered? 3. Rule: BOD has to open up tender offer bidding to the market and cannot shut-out 4. 5. 6. any companies willing to make bids; it must be fair to all bidders, can‘t favor one company Analysis: a. Duty to Auction arises where: (1) The corporation puts itself on the auction block (2) The corporation enters into a transaction that will break it up, so that the corporation will no longer be there (3) There is a transaction that will cause a sale of control (a) Where there‘s a merger of a publicly held corporation w/ widely dispersed stock ownership (where no one has a majority) AND a closely held corporation (a sovereign entity where the majority is owned by one person)  Duty to Auction (the PHC would be merged into the other corp that‘s really owned by 1 person) (b) Where there‘s a merger of TWO publicly held corporations and both have ownership widely dispersed  NO Duty to Auction b. Duty Requirements: (1) Put all defensive mechanisms down (can‘t use any) (2) BOD must seek best offer (3) BOD must abide by fair bidding process If BODs tried these three and proved they did them  BJR locks on REMEDY: if not all 3 satisfied, P can get ct to compel board to do all 3 or get damages II. Not w/in AUTHORITY A. concept: board needs to act w/in their authority B. Ultra Vires: BJR clamps on this, SH has burden to prove that board is acting outside their C. authority. Improper Decision Procedures: 1. Red Flag: Directors are having a meeting 2. Issue: Did they act w/in their authority? 3. Analysis: SHs have burden of showing directors didn‘t act w/in their authority a. Was it a matter for the BODs (ordinary matters)? b. Action by directors (formal meeting, written consent, etc.) III. Breach of GOOD FAITH 33 Corporations Outline – Kerr Spring 09 A. Red Flag: Board didn‘t consider all necessary information, or was dishonest, or didn‘t have good lines of communication in place B. Issue: Did the Board act w/ Good Faith? C. RULE: board has a Duty to monitor and supervise, make sure controls are in place to get the information up to the board of directors, and to be Honest D. Analysis: 1. Board has burden to show they acted in good faith a. Acting in good faith means they are not doing anything intentionally wrong, they ARE making decisions with the best interest of SH in mind, and the BOD doesn‘t have any personal stake 2. If they show this  BJR locks in (it locks in here LAST) 3. If they don‘t show this  Violation In Delaware they have tried to count duty of Good Faith as w/in the Duty of Due Care. That way, less liability for the corp esp since have provision in AIC that protects board from breach of Due Care suits. Board has burden to show they were honest or had best practices, only if they show that does the BJR lock on SH (P) v. the entire board (D) Breach of duty to be honest 1. RF: board is lying about something 2. Analysis: is board being intentionally dis-honest? 3. Strategy  if hard to show that board‘s actionts were intionally dishonest, SH can sue under Federal law 14(a)(9) for false/misleading stmts and in that case have an easier standard to meet (simple negligence). Breach of duty to have best practice 1. RF: Board didn‘t have good lines of communication in place 2. Analysis: were there practices in place to ensure info got up to the board? 3. R: directors must make sure there are best practices in place at the corp to monitor (supervise), have controls in place to get info up to board, and at present day, have ERMs (enterprise risk management policies). Good Faith and Takeovers / Tender Offers 1. Red Flag: Takeover offered but Board does nothing at all, there was no adequate information in place or no control in place to get information from top level management (ie: CEO, CFO) to BODs 2. Rule: Dereliction of Duty: Where there is a friendly or hostile tender offer, target BODs supposed to respond to SHs, telling them that tender offer is either good or bad. Board has a duty to do something, so if they aren‘t doing anything then they are not acting w/in their duty. 3. Analysis: a. Board has burden to show that they did act in good faith b. If they show this  BJR locks in c. If they don‘t show this (respond to SHs)  Violation of 14(d)(1) and lack of Good Faith (1) Form 14(d)(1): Board can express their opinion on the hostile tender offer. The usual response is that the Board says the offer does not serve the interest of the SHs. However, SHs would want their board to negotiate for more money **NOTE**: Look at this as bad or worse than Loyalty Breach E. F. G. H. I. J. IV. INSIDER TRADING – 10b5 34 Corporations Outline – Kerr Spring 09  Traditional Insider: Executive Officers, Directors, and Majority SHs or Controlling SHs  Constructive Insider: Person who the corporation shares information with for a specific purpose because of their position of confidence or trust. Attorneys, Bankers for the Company, Accountants, Consultants  ―Pivot‖: If you are a tippee and an insider, as soon as you pivot around and tell someone else, you become a tipper. And if you trade on the tip, you become a self-dealer  Personal Benefit: Can be financial or non-financial (ie: Self Esteem) A. Red Flag: People passing on or trading based on inside information B. Rule: 10b-5: anyone in possession of material inside information must either disclose or C. abstain from trading or tipping 1. Inside information is non public information P (SEC if civil or admin case / or ACTUAL purchaser or seller of stock) v. D (self trader, tipper, or tippee) (1) Self Trader: Gets info himself then uses it to trade (a) Traditional or Constructive insider (b) Person has to personally benefit (either financially or non financial like friendship) (2) Tipper: Passes non-public info to another person (a) Traditional or Constructive insider (b) Person has to personally benefit (3) Tippee: Receives non-public info and trades on it (a) Tippee‘s Tipper has to be an insider (b) Tippee‘s Tipper has to personally benefit (c) Tippee knew or should have known that tipper was breaching his fiduciary duty by tipping (i) Harder to prove if Tipper is a constructive insider b/c hard to know your fiduciary duty when you‘re a constructive insider  Derivative Liability: Based on someone else‘s liability when transfers to Tippee  Could be multiple roles, the more roles they have the more you can go against them  Pre existing SH does NOT have a COA under 10b5 Analysis: First see if traditional works, if not then try other misappropriations 1. Traditional Approach a. Who is the ∆, is he/she a proper ∆? (self trader, tipper, tippee) b. Duty: Duty to Disclose to general public or general media and give them time to react (15 minutes) OR Duty to Refrain from trading or tipping c. Materiality: Substantial likelihood that a reasonable person would find the fact important to making an investment decision d. Scienter or Reckless Disregard (1) Knowledge and intent to do the act which is prohibited (2) High standard to show e. Causation (1) Use NOT Possession (a) Have to prove use of that inside information f. Reliance: presumed that P relied on the integrity of the market g. Defense (1) Adequate Disclosure AND Market had time to react (15 minutes) (2) Abstain from trading (3) D can say P didn‘t prove all elements h. Remedies: D. 35 Corporations Outline – Kerr Spring 09 Damages (SEC can get treble if win) Injunctions Freezing assets Cease and desist 2. Misappropriation Approach: P must prove these elements  a. Fiduciary Relationship btwn the two people? (1) Fiduciary Relationship = 2 people are in a position of trust/confidence with each other w/ regards to business information (a) Traditional types: atty/client, dr/patient, accountant/client, employer/employee. (b) Non traditional ones: friendship (c) No automatic fiduciary relationship btwn family, so have to find it somewhere in facts b. breach? (1) Breach = Taking this info and trading for themselves or tipping (2) Hypo: Psychiatrist and patient. Fiduciary relationship is from the psychiatrist to client. Psychiatrist tells patient some information and patient trades on it. Does that fall w/in misappropriations? No, b/c the patient looks to the psychiatrist for the confidence, not vice versa. If the client told psychiatrist, then that‘s 10b-5 issue. (3) Strategy  will be an initial tippee who breaches. This is the person who initially has the info tipped to them (4) Non-public information (a) Inside information was not available to the public c. Materiality d. Scienter or Reckless Disregard 3. Defenses: disclose information a. Disclosure must either be wide dissemination, or to person you owe a fiduciary duty to (1) Hypo: If psychiatrist tells client, ―too bad I‘m going to trade.‖ That‘s a defense 4. Remedies a. Injunction b. Freezing of Assets  Difficult to prove 10b-5 action, so usually they are charged w/ mail fraud, wire fraud, or raqueteering, which are easier to prove  Occurs often in Mergers  **NOTE**: If there‘s a merger and there‘s misleading information at the meeting, that‘s 14(a)(9) and 10b-5 issue (1) (2) (3) (4) V. TAKEOVERS/ TENDER OFFERS A. Red Flag: Takeover = An attempt by a bidder to acquire control of a subject company though acquisition of some or all of its outstanding shares. Most commonly, takeover bids are made directly to shareholders of the target as a cash tender offer or as an exchange offer of the bidding corporation‘s stock Tender Offer: Acquiring company making offer to majority SHs in target w/o going to BODs2 Types 1. Friendly Tender Offer: Acquiring company makes offer for 51% or stocks (or if have position in the target company they make an offer for whatever will bring them to majority). If it‘s a friendly tender offer, target won‘t use defensive mechanism B. 36 Corporations Outline – Kerr Spring 09 2. Hostile Tender Offer = Made directly to target shareholders w/o management approval to purchase their shares. Board then has to respond to SHs by filing out 14(d)(1) form where tell SHs if offer is good or not a. Issue: Is the acquiring entities BODs making a good decision going after this entity? (1) Analysis: If no  Lack of Due Care b. Issue: What is the target company‘s response? (1) Analysis: (a) No response but no defense  Due Care (b) Don‘t do anything  Good Faith (c) Say yes  Due Care (d) Takes defensive mechanisms  Loyalty 3. Tender Offer  Actual Threat 4. No announcement of tender offer  Likely Perceived Threat Form 14(d)(1): Board can express their opinion on the hostile tender offer. The usual response is that the Board says the offer does not serve the interest of the SHs. However, SHs would want their board to negotiate for more money Cash Tender Offer = Tender offer made directly to SH‘s of the target corporation as a ―cash tender offer‖ or as an exchange offer of the bidding corporation‘s stock. Cash-Out Merger = Someone or an entity has acquired 51% of the stock and they say that they want their company to merge w/ the acquired company. The SH‘s of the acquired corporation are out, and are given cash for their shares Bear Hug = A takeover attempt that consists of a proposal made to the directors. The proposal may be for a merger or for a cash tender or exchange offer not opposed by management. Although the approach may be friendly, there is a valid or explicit threat that if the target chooses not to negotiate, an unfriendly offer may result 1. If bear hug accepted  followed by friendly tender offer and/or merger Williams Act: Any person or entity who acquires 5% or more of a corporation‘s stock has to file a discloser statement w/ the SEC w/in 10 days of the acquisition. Meant as protection so that target, acquiring company, and target SHs are treated equally. C. D. E. F. G.  Strategy:  2 Major Ways to Attack a Corporation: o Announce Hostile Tender Offer o Proxy Contest (acquiring entity would have to be SH to wage this, so they suggest their own slate of candidates)  **NOTE**: Never have an even number of directors on BODs  **NOTE**: If it could help the target, then BODs shouldn‘t use defenses CORPORATE SOCIAL RESPONSABILITIES 1. concept: every PHC must look at risks associated w/ their corporate footprint. BOD must do an internal assessment regarding these risks. 2. S&P will give PHC lower credit rating if they don‘t do risk assessment 3. Having CSR‘s in place can add value to the corp and their stock 37 Corporations Outline – Kerr Spring 09 Business Judgment Rule Due Care Loyalty w/in Authority Good Faith Compensation SelfDealing Parent/Sub Merger Parent/Sub Non-Merger Corporate Opportunity Decision to Defend Duty to Auction Ultra Vires Formalities Compensation DIVIDENDS: Proper Source: Paid-in surplus Earned surplus Re-evaluation surplus Reduction surplus Must be Solvent: Balance sheet test Assets > Liabilities AND Cash Flow Test – must be able to pay debts as they become due Proper Source: Paid-in surplus Earned surplus Stated capital but ONLY to reduce arrearages Must be Solvent: Balance sheet test Assets > Liabilities AND Cash Flow Test – must be able to pay debts as they become due Proper Source: Paid-in surplus Earned surplus Must be Solvent: Balance sheet test Assets > Liabilities AND Cash Flow Test – must be able to pay debts as they become due 38