CAS ES FOR CORPORATIONS
YATES v. B RIDGE TRADING CO. – CHOICE OF LAW
BRENNAN v. RUFFN ER – MULTIPLE CLIENT PROBLEMS
OPDYKE v. KENT LIQUOR MART – M ULTIPLE CLIENT PROBLEM S
WARTZMAN v. HIGHTOWER PRODUCTIONS – SECURITIES LAW CONSIDERATIONS
SIVERS v. R&F CAPITAL – DEFECTIVE INCORPORATION: Prior to incorporation liability
EQUIPTO DIVIS ION v. YARMOUTH – DEFECTIVE INCORPORATION: Dissolved corporation liability
COOPERS & LYBRAND v. FOX – DEFECTIVE INCORPORATION: Pro moter liability
AMERICAN VENDING S ERVICES v. MORS E – DEFECTIVE INCORPORATION: Imply ing a corporation
ILLINOIS CONTROLS v. LANGHAM – DEFECTIVE INCORPORATION: Pre-incorporation agreement
PIERCING THE CORPORATE VEIL
SEA-LAND S ERVICES , INC. v. PEPPER SOURCE
FRIGIDAIRE SALES CORP v. UNION PROPERTIES
In Re SILICONE GEL BREAS T IMPLANTS PRODUCTS LIAB ILITY LITIGATION
WALKOVS ZKY v. CARLTON
KINNEY S HOE CORP. v. POLAN
UNITED S TATES v. B ES TFOODS
SPECIAL PROB LEMS OF THE CLOS ELY HELD CORPORATION
DONAHUE v. RODD EL ECTROTYPE CO. – SHAREHOLDERS RIGHTS IN CLOSE CORPORATION/DUTY
NIXON v. B LACKWELL – SHA REHOLDERS RIGHTS IN CLOSE CORPORATION
RAMOS v. ES TRADA – SHA REHOLDERS RIGHTS IN CLOSE CORPORATION
SOMERS v. AAA TEMPORARY S ERVICES, CO . – SLIGHT DEVIATIONS FROM THE CORPORATE NORMS
LEHRMAN v. COHEN – MULTIPLE CLASSES OF STOCK
IN RE RADOM & NEIDORFF – DISSOLUTION AND DEADLOCK
OCEANIC EXPLORATION CO. v. GRYNB ERG – VOTING TRUST
LASH v. LASH FURNITURE CO. – STOCK TRANSFER RESTRICTIONS
FRANDS EN v. J ENS EN-S UNDQUIS T AGENCY
LANDSTROM v. S HAVER
BOSWORTH v. EHR ENREICH
RETZER v. RETZ ER – FAMILY LAW ISSUES
CAPITALIZING THE CORPORATION
OBRE v. ALB AN TRACTOR CO. – DEBT
IN FETT ROOFING AND SHEET METAL CO. – DEBT/ EQUITY
METROPOLITAN LIFE v. RJR NAB ISCO INC. – DEBT/ EQUITY (Leveraged Buyout)
HANEWALD v. BRYAN‟S INC. – THE SHAREHOLDER‟S OBLIGATION TO PA Y A ND PA R VA LUE
GOTTFRIED v. GOTTFRIED – SHA REHOLDER‟S OBLIGATION TO PA Y
GAB ELLI & CO. v. LIGGETT GROUP, INC. – DIVIDENDS
B ERWALD v. MISSION DEV ELOPMENT CO. – DIVIDENDS
CORPORATE GOVERNANCE AND THE ROLES OF OFFICERS, DIRECTORS AND S HAREHOLDERS
AUER v. DRESS EL – SHAREHOLDERS versus DIRECTORS
CENTAUR PARTNERS IV v. NATIONAL INTERGROUP, INC.
DRIVER v. DRIVER
ALLEN v. PARK NATIONAL B ANK – CUM ULATIVE VOTING
AMERICAN TEL EPHONE & TEL EGRAPH COMPANY v. HARRIS CORP. – CORPORATE FORMALITIES
STEWART CAPITAL CORP. v. ANDRUS – CORPORATE FORMALITIES and AUTHORITY OF OFFICERS
FRADKIN v. ERNST – CORPORATE FORMA LITIES and AUTHORITY OF OFFICERS
VILLAGE OF BROWN DEER v. CITY OF MILWAUKEE
SCHMIDT v. FARM CREDIT S ERVICES
WHITE v. THATCHER FINANCIAL GROUP, INC. – AUTHORITY OF OFFICERS
KANAVOS v. HANCOCK B ANK AND TRUS T CO. – AUTHORITY OF OFFICERS, Vice-President (Apparent Auth)
CONTEL CREDIT CORP. v. CENTRAL CHEVROLET, INC. – A UTHORITY OF OFFICERS, Cert of Sec, Estoppel
A.P. S MITH MANUFACTURING CO. v. B ARLOW – CHARITA BLE DONATIONS (Corp. Social Responsibility)
KAHN v. S ULLIVAN – CORPORATE SOCIA L RESPONSIBILITY
CREDIT LYONNAIS B ANK NED ERLAND, NV v. PATHE COMMUNICATIONS CORP. – CORP RESP.
MANAGEMENT‟S DUTIES TO THE CORPORATION
SHLENS KY v. WRIGL EY – DIRECTOR‟S DUTY OF CA RE
SMITH v. VAN GORKOM – DIRECTOR‟S DUTY OF CA RE
FRANCIS v. UNITED J ERS EY BANK – DIRECTOR‟S DUTY OF CA RE
GRAHAM v. ALLIS CHALMERS MANUFACTURING CO. – DIRECTOR‟S DUTY OF CARE
MARCIANO v. NAKAS H – DUTY OF LOYA LTY – General Principles
IN re WHEELAB RATOR TECHNOLOGIES, INC. Sharehol ders Li tigation – DUTY OF CARE
PARENT/S UBSIDIARY DEALINGS
SINCLAIR OIL CORP. v. LEVIEN
WEINB ERGER v. UOP, Inc.
THE CORPORATE OPPORTUNITY DOCTRINE
BROZ v. CELLULAR INFORMATION S YSTEMS, INC.
NORTHEAS T HARBOR GOLF CLUB , INC. v. HARRIS
COHEN v. AYERS
FRAUDUL ENT TRADING IN S HARES
GOODWIN v. AGASSIZ
BASIC v. LEVINSON
CHIARELLA v. UNIT ED STATES
CARPENTER v. UNITED STATES
UNITED S TATES v. O‟HAGAN
Yates v. Bridge Trading Co., Missouri Court of Appeals (1992) Casebook p. 79 – CHOICE OF LAW
FACTS and PP:
Yates is appealing bench trial finding that the K arising fro m a stock purchase agreement void under MO law because the
consideration for the stock was a pro missory note.
1. Tendered full payment on the promissory note;
2. The company had converted his shares;
3. MO law should not have been applied because of the internal affairs doctrine barring application of M O law to a
corporation organized under the laws of another state;
4. Court should have applied DE law under which Yates would have prevailed because stock issued for pro missory
note is voidable and not void under DE law;
5. Effect of d issolution and liquidation of the company on the obligation under stock purchase agreement to turn over
the disputed shares to appellant.
o In 1974, Yates and defendants founded Bridge Holding Co mpany (Ho lding) under MO law. Ho lding owned 2
subsidiary companies Bridge Trading Co mpany (Trading) and Bridge Data Co mpany (Data) both organized under DE
law with PPB in M O. Yates was president of the 2 subsidiaries under 1986 when he was removed.
o Bridge System: The purpose of the triangle was to develop and market a co mputer system processing for investment
o In 1977, Ho lding sold Trading stock to Loewi &Co, a b rokerage firm and although never again owned by Holding,
Trading stayed closely affiliated with them because of symbiotic relationship.
o In 1978, Noble bought Trading fro m Loewi.
o In 1983, Trad ing was refinanced through stock purchase agreement of 4/ 1/83 which stipulated that the stock be
purchased for $3.56/share and paid through promissory note payable on demand. The agreement also said that it shall
terminate on bankruptcy or dissolution of the company and was executed by all part ies.
o In 11/83, all part ies except for Yates paid the promissory notes. Yates was never paid by Trading u nlike the other
investors (defendants) and instead was paid through Data.
o In 1986, Yates exercised this rights by voting in opposition to a merger between Ho lding and Trading and blocking its
occurrence. (He was listed as having 18,000 shares)
o In 1987, Yates again voted against merger. (He again was listed as having 18,000 shares)
o In 7/87, Yates tried to sell his shares in Trading to TA Associates for $75/share but defendants would not give him his
pledged stock certificates. Later that month, he sent a check to Trading for payment of the pro missory note ($90K) and
o In 8/87, Trad ing refused to deliver the stock certificates and returned the check. At this time the shares were valued at
o In 1987, Yates tendered payment without demand being made. The pro missory note and pledge agreement did not
contain a termination clause.
Trial court held :
o MO law controlled and pro missory note was not valid consideration under MO law.
o Stock purchase agreement terminated at Trad ing‟s filing of articles of dissolution.
o Tender of payment for pro missory note was ineffective under both state‟s law.
1. What law controls the stock transaction?
2. Does the law validate the stock purchase agreement?
3. What effect does the dissolution have on the stock purchase agreement?
Affirmed decision of trial court.
1. If a choice of law provision makes a K void, then it is not applied because the intent of the parties in entering the
agreement was to have a valid agreement.
2. DE law validates the SPA because consideration is not necessary in the sale of stock.
3. Dissolution terminates the agreement because it was provided for in the K and as a result the intent of the parties
would best be served by termination of the agreement at dissolution.
I. Choice of Law
o Trading = DE Co rp/MO PPB -> Normally DE law would control stock issuance, but the SPA had choice of law
provision selecting MO law as governing.
o MO law makes the SPA void because a promissory note is not money or property and does not const itute valid
consideration for the stock.
o DE law treats the stock issuance as voidable with the absence of valid consideration.
A. The Internal Affairs Doctrine
o Provides that the law of the state of incorporation should be applied to settle disputes affecting the
organic structure or internal ad ministration of a corporation. Only recognized in MO
o Issuance of stock is considered an internal affair requiring the applicat ion of the laws of the state of
o : IA Doctrine bars application of M O law to the issuance of stock by foreign corporation despite choice
of law provision.
o Court: Part ies were free to choose under stock purchase agreement.
o Public policy – “If the corporation‟s sole contact with the state of incorporation is the naked fact of
incorporation and all o r most of its contacts lie within the foru m state, the foru m state can intervene in the
internal affairs of the corporation so long as the shareholders of the corporation are not subjected to
contradictory or inconsistent laws.”
o All of the shareholders in the SPA were affo rded the same choice of law provision and the company had
substantial contacts with the state whose law was selected.
o The internal affairs doctrine does not apply here.
B. Missouri Law Section
o Should be read to apply to only domestic corporations.
o The choice of law provision by the parties was Ok to subject a foreign corporation to the laws it would
not usually be subject to.
C. Restatement Section
o MO has adopted Restatement 2nd of the Conflict of Laws which states that where a choice of law
provision renders a K void, the choice of law provision will not be applied because it is presumed that the
parties enter K that they intend to be valid.
o Court: The application of the choice of law prov ision and allowing this to proceed in MO renders the
SPA void; THE DE law SHOULD BE APPLIED BECA USE MAKING THE SPA VOID WOULD NOT
EFFECTUATE THE PRESUM ED INTENT OF THE PA RTIES TO ENTER A VA LID K.
II. The Delaware Approach
o The issuance of stock without consideration or insufficient consideration does not render the issuance
void, but instead voidable.
o Up until the dissolution of Trading, Yates could have held stock valid ly, but after d issolution, he was
unable to cure the defect in consideration.
IV. The Effect of Dissolution
o 6/87: Trad ing filed art icles of dissolution and 7/87 appellant tried to pay for h is shares.
o : Under DE Law, the corporation had a 3 year winding up period allowing him t ime to pay and redeem.
o Court: The law chosen for the first issue does not have to be the same as other issues under the
Restatements. Despite the law chosen, the terms of the SPA state that upon the dissolution the agreement
terminates. THE INTENT WAS TO END THE A GREEM ENT AT DISSOLUTION.
Brennan v. Ruffner, Florida Court of Appeal (1994) Casebook p. 86 – THE PROB LEM OF THE MULTIPLE CLIENT
In 1976, Brennan (MD) and Martell (MD) hired Ruffner (JD) to incorporate their med ical practice as a P.A. fo r which
Ruffner prepared a shareholder‟s agreement.
In 1982, Mirmelli (MD) joined the corp and each MD became a 1/3 shareholder in the P.A. so Ruffner was to draw up a
new shareholder‟s agreement, which was signed 8 months later including a provision for involuntary termination of any
shareholder by a majo rity vote of the other 2 shareholders.
In 1989, Martell and M irmelli terminated Brennan as shareholder and employee of the corporation who sued them claiming
breach of K and fraud in the inducement. This lawsuit was settled.
Brennan filed suit against Ruffner for legal malpractice, breach of K, breach of fiduciary duty and breach of K as a third -
party beneficiary. Despite denying he had representation in the first suit against the MDs he said that Ruffner represented
him individually and as the corporation in making the agreement. Ruffner denied having represented him individually.
Whether or not a lawyer representing a closely held corporation is also in turn representing the shareholders in an individua l
Affirm su mmary judgment in favor of lawyer because an attorney/client relat ionship did not exist between the shareholder
and the attorney representing the corporation so there is no basis for legal malpract ice
A lawyer representing a closely hel d corporation does not also by that representation represent the sharehol ders
indi vi dually unless by agreement or s pecial circumstances.
Elements of Legal Malpractice Case –
o Attorney was emp loyed
o Attorney neglected reasonable duty
o Negligence of attorney resulted in and was proximate cause of loss to plaintiff
There must be privity of contract between lawyer and the client.
o No priv ity here because the lawyer was only representing the corporation.
o Brennan said that Ruffner represented him too but he admitted he had no attorney in sworn statement in first case.
o Also argues that Ruffner had a duty to him because he was a shareholder of a closely held corporation
o COURT: Where an attorney represents a closely held corporation, the attorney is not in priv ity with and therefore
owes no separate duty of diligence and care to an individual shareholder absent special circu mstances or an
agreement to also represent the individual shareholder.
Third Party Beneficiary
o There are no facts that show that it was the primary intent of the corporation in hiring Ruffner to draft the
shareholder‟s agreement was to directly benefit Brennan.
Breach of Fiduciary Duty
o The facts do not support the contention that the lawyer had a duty to inform h im of conflict of interest.
o Ruffner had told the MDs collectively that he represented the corporation in drafting the shareholder agreement.
Opdyke v. Kent Liquor Mart, Inc., Delaware Supreme Court (1962) Casebook p. 89 – PROB LEM OF THE MULTIPLE
o In 1959, and Smith (defendant) were d iscussing opening a liquor store. They interviewed Rich ter (owner of a
shopping center and defendant) who said there was a place in the shopping center for the store if he could be co -owner
of the business to which they agreed.
o and Smith hired Bro wn (JD) to incorporate the business which was done in 9/ 59. There were 300 shares of capital
stock sold and each man received 100 shares. In the first incorporators and directors meetings, they discussed the
possibility of restricting the sales of stock and Brown advised them of the procedures for doing that but nothing came
o In 6/60, a liquor license was granted. The company borrowed $20K for goods and working capital with the
stockholders and their wives jo ining in the note. There was also debt to Richter and Meyer (Richter‟s company) for
$2600 for construction work.
o In 8/60, the store opened and did not prosper. On 10/9/ 60 and 10/20/60, Richter offered to get out of the venture where
finally gave Richter check for $415 for equity in the corporation.
o On 11/19/60, Smith told he wanted to get out but the result is in dispute. The next day, Smith sold Richter h is shares
for $415 and Richter‟s pro mise to relieve Smith of the Pro missory Note with a new note being executed among
Richter, and their wives as well as Richter‟s nephew and his wife.
o In 2/61, with procedural advice fro m Brown, Richter transferred h is shares to Smith (40) and his nephew (60).
o called Brown later and said that he bought Richter‟s shares and did not assume the debt on the promissory debt.
Bro wn advised that a meeting be held to resolve what was going on.
o In 3/61, the meeting was held and discussed Richter‟s stock where Bro wn stated that he did not represent the
individuals but the corporation. They negotiated about the sale, wh ich was in dispute. The final decision was that
would assume the note and get all of Richter‟s shares. was to have under 3/13 to refinance the loan and the debt to
Richter and Meyer which was extended.
o On 3/ 24/ 61, told Brown that he was going to go through with the deal. On 3/28, Richter and Smith saw Brown and
told him said that the deal was off because Richter and Smith had proposed a sale of the corporation to Behan for
$30K, which wou ldn‟t agree to. Bro wn told them to make a different offer to Behan but also that he might be
interested if not for himself but another client in purchasing the company.
o In the end, Bro wn apparently bought Richter‟s interest and told himself that he had 3 options. Eventually, agreed
to become partners with Bro wn but exp ressed his enmity for Richter and th e fact that he though he was going to buy
the stock fro m h im.
o eventually sought the advice of another attorney and the stock and Brown‟s note were put in escrow.
sued and lost in trial court. His first claim was that he actually bought Richter‟s stock in 10/ 60 because of the acceptance
of his check by Richter and the endorsement. This was decided in favor of Richter and was affirmed by this court. The
second claim was that he was entitled to a money judg ment representing extra co mpensation for working in the store for
which he was paid $50/ week. The court did not decide this question. The third contention was that Brown breached a
fiduciary duty by using confidential information to further an adverse interest. The trial court found in favor of Brown.
Whether or not an attorney who purchases stock in the corporation he represents breaches a fiduciary duty to one of the
Reversed the decision of the trial court on the breach of fiduciary duty.
An attorney may not use information gained through his role as counselor in obtaining an interest in property without
explicit consent of the party‟s whom he was responsible for counseling.
Bro wn‟s argument
o His fiduciary duty was only to the corporation and not to the stockholders.
o He advised at the onset of the argument that he represented the corporation only and therefore was free to buy the
o The original emp loyment of Brown was limited to the organization of the corporation and obtaining the liquor
o The issuance of shares was not within the scope of Brown‟s employ ment.
o Corporation has a separate existence fro m the individual stockholders.
o We must determine what the relationship was between Bro wn and the three shareholders.
o Bro wn was the attorney for all three men at the beginning and he told them at the beginning of problems that he
couldn‟t represent one of them against the others.
o By advising in the settlement, he was acting as a legal adviser.
o WHEN BROWN BOUGHT THE STOCK, HE A CQUIRED A N INTEREST IN THE SUBJECT MATTER OF
THE DISPUTE BETWEEN THE CLIENTS, WHICH WAS NECESSA RILY A DVERSE TO THE INTEREST
OF ONE OF THEM .
o He acquired the knowledge of the sale of the stock while act ing as counselor.
o The only way he could have relieved himself of the obligation was to get exp licit consent of the after a fu ll
explanation of his legal rights and position.
Wartzman v. Hightower Productions, Ltd., Maryland Court of Special Appeals (1983) Casebook p. 99 – S ECURITIES
o Hightower t ried to break the flagpole sitting record. Adler, Billit z and Qu inn formed the co mpany, Hightower
Productions, in 1974 as a pro motional venture. They were going to have someone ride in special flagpole seat
fro m 4/1/ 75 through the New Years where he would descend in Times Square.
o In 11/74, the principals approached an attorney (Kaminko w) of the Wartzman firm to incorporate the venture. He
referred them to Wartzman as he was trial attorney.
o They met with Wart zman and told him they needed to sell stock to the public to make $250K for financing. JD
prepared and filed articles of incorporation and the company came into existence on 11/6/ 74. The articles
authorized 1 million shares at $.10/share for $100K total.
o They put $20K in the bank and found a Woody Hightower. PR events occurred and corporate backers were
o Co mpany raised $43,000 by selling stock. The co mpany was low on funds so 2 weeks before ascension, they met
where JD told them that no further stock could be sold because the corporation was structured wrong and that they
needed a securities attorney to fix it. (JD learned this through casual conversation with a friend).
o JD failed to prepare offering memorandum and assure that the corporation has made the required disclosures to
investors in accordance with MD Securit ies Act. JD advised that the securities attorney would be about $10K-
$15K and the work would take between 6-8 weeks, during which t ime no more stock could be sold.
o Shareholders decided to scrap the project at this point.
Hightower filed suit alleging breach of K and negligence for the law firm‟s failure to create a corporat ion authorized to
raise the necessary capital. The trial court only submitted the claim of the corporation against the law firm (the ind ividual
shareholders suits were dis missed). Jury verd ict was $170K in favor o f Hightower. The law firm appealed. JD argu ments
were: 1) Jury verdict amount was speculative; 2) Lack of nexus/causation between the failure to perform and the loss
claimed – The result will be unjust where a person performing a co llateral service for a new venture will be held liable as
full guarantor for all costs incurred by the enterprise upon failure to fu lly perform the collateral service.
Whether or not an attorney is liable for a failed business venture when he fails to set up the securities properly and the
company can no longer sell stock for operating capital?
Yes, an attorney may be held liab le and they may be liab le fo r the speculative damages of t he company.
Reliance Interest –
o If it can be shown that full performance wou ld have resulted in a net loss, the plaintiff cannot escape the
consequences of a bad bargain by falling back on his reliance interest.
o Here, JD should have known or knew that the success of the venture rested upon the ability of Hightower to sell
stock and secure advertising as the adventure accelerated. It was not collateral to the issue – it was what the
company depended upon.
Duty to Mitigate –
o The offer to set them up with securities lawyer is not mitigating device that Hightower was obliged to accept.
o Doctrine of Avoidable Consequences
Sivers v. R &F Capital Corp., Oregon Court of Appeals (1993) Casebook p. 104 – DEFECTIVE INCORPORATION
FACTS and PP:
Both are businessmen. is a shareholder and director of R&F. and entered into commercial leasing agreement
involving warehouse space in Oregon. Lease was signed by and the as chairman of R&F. Lease signed on 1/12 to
begin on 1/17. R&F was incorporated on 2/9/90. R&F failed to pay rent so sued. claimed the was personally liab le
under the law. moved for directed verdict but was denied so he appeals here.
Whether or not
Reversed trial court
In order for a person to be held personally liab le when acting as a corporate agent with faulty incorporation, the person
must have ACTUA L knowledge of the defect in incorporation at the time of acting – acting in bad faith.
The code provides that a person purporting to act as or on behalf of a corporation knowing there was no incorporation is
jointly and severally liable for liabilit ies.
“Knowledge” is key.
Legislat ive intent – to protect those who honestly thought they were incorporated (articles had been filed).
The test is one of actual knowledge and it is the ‟s burden to show the defendant had such knowledge.
: The facts show that he knew.
Court: Disagree ( h ired a leasing agent to negotiate the lease and never dealt with the personally so he even thought he
was only dealing with the corporation and he didn‟t inquire about the corporations status then.
Defendant testimony: No specific experience in incorporating because attorneys handled that. All parties believed the
company was incorporated at the time the lease was signed (saw the articles in 12/89). He shouldn‟t have much reason to
The evi dence does not rise to the level of actual knowledge on behalf of the defendant and that is required by the
statute (di d not state “constructi ve knowledge”) –
: Ju ry could disbelieve the defendant about his knowledge and that was their prerogative but the court states that there had
to be some evidence that the defendant had actual knowledge about the lack of incorporation.
Plaintiff gave no evidence to the contrary so the directed verdict should have been granted.
Equipto Division v. Yarmout h, Washington Supreme Court (1998) Casebook p. 107 – EFFECT OF DISSOLUTION ON
FACTS and PP:
o Yarmouth continued to conduct business after J&R was dissolved in August.
o The COA has interpreted the activities to those necessary to wind up business and that the actions were ultra vires
and the corporation did not have the capacity to form the K that gave rise to the debt.
o The COA brought in common law principle stating – “The persons who purports to contract in the name of a
principal may be liab le if he knew or should have known about the principals‟ lack of capacity and the other party
does not know. Yarmouth should have been aware and court found them personally liab le.
What is the corporate officer‟s liability for conducting business as usual after the corporation has been dissolved? Whether
statutory law resolves the legal question in this case precluding application of co mmon law principles.
o All persons purporting the act as or on behalf of the corporation, knowing there was no incorporation under this
title, are jointly and severally liable for liabilit ies created while so acting except for any liability to any person who
also knew that there was no incorporation.
o Acting before the incorporation is one thing – Usually a pro moter‟s liability for pre -incorporation contracts.
o The urges application of the statute to his situation (where one acts after dissolution).
o The statute imposes liability on only those who act knowing there was no incorporation. The new statute was
intended to address the equitable concern for protecting those who act with good faith and to otherwise abolish the
common law principles of de facto corporations and corporation by estoppel.
Coopers & Lybrand v. Fox, Colorado Court of Appeals (1988) Casebook p. 115 – DEFECTIVE INCORPORATION
Fo x met with , a national accounting firm, in 11/81for a tax opin ion and other accounting help . He to ld that he was
acting on behalf of a corporation he was forming. accepted the engagement knowing that the corporation was not in
existence. Fo x‟s corporation was incorporated on 12/4/ 81 and was billed by for $10K +. The bill was not paid and
sued Fo x individually for breach of K on a pro moter liab ility theory.
appeals trial court judg ment in favor o f the in that the court erred in ru ling that Fo x, pro moter, could not be held liab le
on a pre-incorporation contract in the absence of an agreement that he would be so liable and that had failed to sustain
the burden of proof.
Whether or not a promoter is liab le for the debts incurred in setting up the corporation when there is no proof of express
GENERA L RULE: Pro moters are generally personally liable for the contracts they make, though made on behalf of a
corporation to be formed.
EXCEPTION: If contracting party knows the corporation is not in existence but nevertheless agrees t o look solely to the
corporation and not to the promoter for pay ment then the promoter has no personal liab ility.
o Fo x at trial said that either expressly or imp liedly agreed to look solely to the corporation for payment.
o Of course, said that its client was Fo x and not the corporation.
Findings at Trial Court level:
o No agreement that would obligate Fo x without written findings of fact.
o Court entered judgment on Fo x‟s behalf.
o Fo x was not acting as an agent because there was nothing to act as an agent of.
o Fo x was a pro moter: one who, alone or with others, undertakes to form a corporation and procure for it the rights,
instrumentalit ies and capital to enable it to conduct business.
o GENERA L RULE: Pro moters are generally personally liable for the contracts they make, though made on behalf
of a corporation to be formed.
- EXCEPTION: If contracting party knows the corporation is not in existence but nevertheless agrees to look
solely to the corporation and not to the promoter for payment then the promoter has no personal liability.
- There was no agreement here. So Fo x is liable.
o Trial Court also ruled that the burden to prove there was no agreement was on .
o This court said that the proponent of an alleged agreement has the burden of proving the agreement existed
so it would be Fo x‟s job.
American Vending Services, Inc. v. Morse, Utah Court of Appeals (1994) Casebook p. 117 – DEFECTIVE
FACTS and PP:
- The Morse family built a car wash in 1984 and ran it for 11 months. Then they entered into K with Durbano and
Garn (attorneys) acting as officers of A VSI to buy the car wash.
- The JDs claim that they represented to the Morses that the corporation (AVSI) would buy and run the car wash.
- They contracted on 7/10/95 when JDs had not filed Articles of Incorporation for A VSI although he had reserved
- JDs claimed that their Art icles had been returned twice because of the name but they were continually trying to get
it filed before the sale.
- Articles were filed on 8/19/95 and the exp lanation for not filing was that he was too busy moving offices.
- Morses tried to go after JD personally but the trial court decided that JD was making bona fide effort to
incorporate and dismissed the personal charges.
- AVSI operated the car wash for 3 years, had money problems and failed to make any payments to Morse on the
balance owing under the sales K. The JDs claimed that Morse provided fraudulent projected income figures (both
false and padded). Morse says that the numbers were verified and that the real reason for the failu re was the
inexperience of the JDs in running a car wash.
- AVSI eventually allowed the bank to foreclose on the car wash.
- AVSI alleges that Morse supplied it with incorrect and false inco me pro jections and that it should be able to
rescind the K under a) fraudulent misrepresentation, b) negligent misrepresentation, c) material breach of K, or d)
mutual mistake. The trial court found the evidence on those claims insufficient to allow rescission of the K.
- Important findings of fact by the court: 1) Morses knew that the JDs intended to form a corporation; 2) JDs
attempts to file was bona fide attempt to organize the corporation; 3) Morses admitted the corporations existence
in their in itial answer; 4) Morses intended to K with A VSI and not the JDs individually; 5) A VSI‟s evidence was
insufficient to allow rescission.
- Important Conclusions of Law by the trial court: 1) A VSI was a de facto corporation when it bought the car wash;
2) A VSI was corporation by estoppel when it bought the car wash; 3) Morses are estopped fro m denying the
existence of the corporation; 4) A VSI failed to establish elements for its claims.
- Trial Court damages: Morses - $76.8K plus costs, interest and reasonable attorney‟s fees. This was a hollow
victory because AVSI has no assets from wh ich it can satisfy the judgment so they appeal.
o s appeal the trial court‟s ru ling in their favor?? They asserted that there was error in the trial court‟s legal
conclusions regarding de factor corporations and corporations by estoppel as well as the court‟s decisions
regarding attorney fees.
o s AVSI appeals the trial court‟s ruling against it asserting that the trial court erred in finding that there was
insufficient evidence to support the claims of fraudulent and negligent misrepresentation, breach of K and mutual
Whether the trial court erroneously concluded that AVSI was a de facto corporation? Whether the trial court erred by
concluding as a matter of law that AVSI was a corporation by estoppel, thereby precluding the Morses from denying its
Did the Morse‟s commit fraud in representing the profitability of the car wash? Decided that this was not the case at trial
Reverse in part and affirm in part.
- In some courts, de facto corporations do not exist under the BCA, but others still recognize them because the only
place in the code where it abolishes them is the comment after the section.
De Facto Corporations in Utah:
- Corporations at common law can be de jure, de facto or by estoppel.
- De Jure Corporat ion: one wh ich has been created as the result of comp liance with all of the constitutional or
statutory requirements of a particular govern ment entity.
- De Facto Corporation: one which has been created by a bona fide attempt to create a corporation even though the
efforts at incorporation can be shown to be irregular, informal or even defective.
- Corporation by estoppel: one where the part ies thereto are estopped fro m denying the e xistence of the corporation,
basically – the parties by their agreements or conduct estop themselves from denying the existence of the
- Business Corporation Act governs corporations in Utah
o A corporation‟s existence begins when the state issues the certificate of incorporation.
o All persons who assume to act as a corporation without authority to do so shall be jointly and severally
liab le fo r all debts and liabilities incurred or arising as a result thereof.
- Co mmon Law de facto corporations: Created to protect individuals fro m personal liab ility when they were
conducting legitimate corporate business prior to corporate formalit ies. Corporation was held liab le if several
factors were present: 1) Valid law existed under which such a corporation could be lawfully organized; 2) An
attempt had been made to organize thereunder; 3) the defective corporation was an actual user of the corporate
franchise; 4) (sometimes) good faith in claiming to be and in doing business as a corporation.
- Criticized highly which led to MBCA (Model Business Corporation Act) which codified uniformity.
o A de facto corporation does not exist under the Model Act.
- De Jure incorporation is too simple to have to allo w de facto corporations.
- UTAH‟s ADOPTION OF THE BCA EXTINGUISHED THE DE FACTO CORPORATIONS DOCTRINE.
- The corporate existence was not yet begun.
Corporation by Estoppel in Utah
- AVSI: Morses are estopped from arguing that it was not a corporation because Morses knew that JDs intended to
have AVSI purchase and run the car wash.
- Is the Corporation by estoppel doctrine still good in Utah?
Illinois Controls, Inc. v. Langham, Oh io Supreme Court (1994) Casebook p. 128
invented the cross-slope monitor which is used in highway construction for grading and began to market th rough
Langham Engineering, an un-incorporated business. was formed to market and manufacture the CSM because although
he sold 100 of the devices for John Deere machines he wanted to get them into Caterpillar mach ines as well.
Finding of Facts:
- Parties were aware that certain market ing strategies had to be employed requiring about $225,000 over 2 year
period. On ly 60-80K of this money was co mmitted.
- Balderson prior to the PIA told him that he would invest $250K in IL controls to assure amp ly supply of CSM for
CAT but only 20K was co mmitted.
- No attempts were made to address the importance of proper training of sales force, proper installation,
demonstrations and consignment sales.
- Balderson‟s actions were more than neglect as he sacrificed the exclusive relat ionship between IL Controls with
CAT fo r CAT co mpetitors through Dymax.
- Failure to emp loy reasonable efforts to market the CSM destroyed the potential of IL Controls and doomed a $4
million co mpany.
Appellee contends that the reference in the PIA to the marketing capabilit ies of Clark Balderson and BI created no
market ing obligation. The COA agreed with Appellee but the Supreme Court does not.
What obligations are created by a pre-incorporation agreement (PIA)?
Whether those obligations are breached when…?
Who is liable when obligations under pre-incorporation agreement are breached?
The agreement leaves little doubt that marketing was one of the covenants to which the parties agreed and the obligation
was also backed up by the obligation to exert reasonable efforts to market the CSM.
A contractual provision which gives a party the exclusive right to market a product on behalf of another imposes upon that
party a duty to employ reasonable efforts to generate sales of the product.
Illinois Controls and Balderson are jointly and severally liable to appellants for breach of the PIA. (Corporation and
- A corporation is liable for the breach of an agreement executed on its behalf by promoters where the
corporation expressly adopts it or benefi ts from it wi th knowledge of its terms.
- Promoters of a corporati on who execute a contract on its behal f are personally liable for the breach thererof
irrespecti ve of the later adopti on of the contract by the corporation unless the con tract provi des that
performance thereunder is solely the res ponsibility of the corporation.
- Where a corporation, with knowledge of the agreement’s terms, benefits from a pre -incorporation agreement
executed on its behalf by its promoters, the corporation and the promoters are jointly and severally liable for
breach of the agreement unless the agreement provides that performance is solely the responsibility of the
corporation or, subsequent to the formation of the corporation, a novation is executed whereby the corporation is
substituted for the promoters as a party to the original agreement.
Parol Ev idence in OHIO:
- Parol ev idence about the nature of a contractual relationship is admissible where the K is ambiguous and the
evidence is consistent with the written agreement, wh ich forms the basis of the action between the parties.
- Legal relationship between promoter and corporate enterprise he seeks to advance is the same as agent and
principal. Law of agency can help govern this relations hip.
- Where an agent purports to act for a principal without the latter‟s knowledge the princi pal may nevertheless be
liable on obligati ons arising from the transacti on if the pri nci pal l ater adopts or rati fies the agreement
arising from the transaction if the princi pal later adopts or ratifies the agreement arising from the
transaction or recei ves benefi ts form the agreement wi th knowledge of its terms . Th is is true even where the
principal lacked capacity at the time of the transaction giving rise to the obligation if, after obtaining such
capacity, the principal manifests acceptance of the transaction.
- A corporation may adopt an agreement after its incorporation that was made prior to its incorporation.
1. When individuals act prior to the incorporation, the rules governing their conduct and liabilit ies come fro m the law
2. RESTATEM ENT 2nd of A GENCY §326: Unless otherwise agreed, a person who, in dealing with another,
purports to act as agent for a principal whom both know to be non -existent or wholly inco mpetent, becomes a
party to such a contract.
3. Co mment b: ???
Sea-Land Serv ices, Inc. v. Pepper Source, 7th Cir. (1991) Casebook p. 136
FACTS and PP
- Sea Land (SL) was shipping peppers for the Pepper Source (PS) when PS stiffed SL on the shipping bill.
- SL sued in Federal court for d iversity and won in the amount of $86.8K v ia default judg ment.
- SL could not find PS as it had been dissolved for failure to pay taxes and PS, even if it had not been dissolved, had
- Now, in 1988, SL sued the owner of PS – Gerald Marchese and the 5 companies he owns. SL sought to pierce
PS‟s corporate veil and “reverse pierce” the other corporations so that all of them would be on the hook for the
- They alleged that these companies were all alter egos of each other and Marchese and were only there to defraud
creditors. (PS was reinstated after these allegations under IL law).
- SL amended the complaint in 1989 adding another corporation in which Marchese has ½ ownership and stated that
it should also be liable. In 12/89, SL moved for SJ and in 6/90 court granted the motion for SJ.
Whether or not piercing the corporate veil can occur when the principal in a corporation has additional assets in other
corporations but not the one against whom the judg ment is sought?
Remand to district court to require that SL show evidence and argument that would establish the kind of additional wrong
present in other successful piercing cases. Insufficient to show summary judgment.
In order to pierce the corporate veil:
1. There must be unity of interest and ownershi p that the separate personalities of the corporati on and the
indi vi dual no longer exist shown by the followi ng: Failure to maintain adequate business records or compl y with
corporate formalities; Commi ngling of funds or assets; Undercapi talization; One corporati on treating the assets of
another corporati on as its own.
2. Circumstances must be such that adherence to the fiction of separate corporate existence woul d sanction a fra ud
and promote injustice where some wrong beyond a creditor‟s inability to collect woul d result.
Van Dorn test:
- There must be unity of interest and ownership that the separate personalities of the corporation and the individual
no longer exist.
o Failure to maintain adequate business records or comp ly with corporate formalities;
o Co mmingling of funds or assets;
o One corporation treating the assets of another corporation as its own.
- Circu mstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud
and promote injustice.
- The companies are Marchese‟s playthings. None of the companies have ever had a corporate meeting except for
the one he owns ½ of. A lot of co mmingling was going on, no by-law, all out of same office and paying personal
expenses out of the accounts. As a result, the first step of the Van Dorn test is met.
- Second part of Van Dorn test – The court questions the meaning of pro mote injustice: So mething less than an
affirmat ive showing of fraud; will an unsatisfied judgment satisfy it? If so there is only one prong of the test really.
The piercing should occur when injustice is pro moted which mean that “some wrong beyond a creditor‟s inability
to collect would result.” SL believed an unsatisfied judgment was enough.
- What is enough? Used corporate facades to avoid responsibilities to creditors; someone in the corporate system
will be unjustly enriched unless liability is shared by all.
1. Questions; 2. Questions; 3. Questions; 4. Questions
Frigidaire Sales Corp. v. Union Properties, Inc., Washington Supreme Court (1977) Casebook p. 141
Frigidaire entered into K with Co mmercial Investors, a limited partnership, the general partner was Union Propert ies and
the limited partners were Mannon and Baxter (the officers, directors and shareholders of Union). Baxter and Mannon
controlled Union. Co mmercial breached the K with Frig idaire.
Frigidaire sued Co mmerical including Un ion properties, Mannon and Baxter. Trial court decided that Baxter and Mannon
were not generally liable for the obligations because of the their control of Co mmercial. Court of Appeals affirmed.
Frigidaire says that the individuals should incur general liab ility for the limited partnership‟s obligations under the Uniform
Limited Partnership Act provision that removes limited liab ility of a limited partner who takes part in the control of the
business because they exercises day-to-day control and management of the partnership. Ba xter and Mannon argue that
Union controlled Co mmercial and not the individuals in their individual capacities.
Whether limited partners may incur general liability for the limited partnership‟s obligations simply because they are
officers, directors or shareholders of the corporate general partner?
Affirmed decision that they are not generally liable for the limited partnership‟s obligations as corporate shareholders, etc . -
When the shareholders of a corporation, who are also the corporation‟s officers and directors, conscientiously keep the
affairs of the corporation separate from their personal affairs, and no fraud or man ifest injustice is perpetrated on third
persons who deal with the corporation, the corporation‟s separate entity should be respected.
- Taking part of the control of the business is not manifested by the follo wing:
o Possessing or exercising a power to vote upon matters affecting the basic structure of the partnership
Election, removal or substitution of general partners;
Termination of the partnership;
Amend ment of the partnership agreement;
Sale of the assets.
- If a co rporate general partner is inadequately capitalized, the rights of a creditor are adequately protected under the
“piercing the corporate veil” doctrine of corporate law.
- When the shareholders of a corporation, who are also the corporation‟s officers and directors, conscientiously keep
the affairs of the corporation separate from their personal affairs, and no fraud or manifes t injustice is perpetrated
on third persons who deal with the corporation, the corporation‟s separate entity should be respected.
- No general liability where they kept the affairs separate.
1. Limited partnerships
In re Silicone Gel Breast Implants Products Liability Lit igation, No rthern District of Alabama (1995) Casebook p. 144
Bristol is the sole shareholder of Medical Eng ineering Corporation, a major supplier of breast implants but not
manufacturer o r distributor of them.
MEC was incorporated in Wisconsin in 1969 with PPB in Racine. It is a privately held corporation making a variety of
med ical devices including breast implants. After extensive due diligence rev iew o f the gel bleed and other issues, Bristol
(DE Co rporation) bought the stock in M EC. In 1982, M EC became a DE corporat ion, wholly owned by Bristol.
In 1988, Bristol expanded its business by buying Natural Y Surg ical Specialties and Aesthetech Corporation and paid for
through Bristol account though charged to MEC. They also performed a due diligence review of the co mpanies.
MEC has had three directors consisting of Bristol VP, another Bristol executive and MEC p resident. The other two board
members could not outvote the Bristol executive. Resolutions passed by MEC were instigated by Bristol. Bristol required
significant event reports and plans for its review. M EC submitted budgets for approval by Bristol‟s senior management by
filling out Bristol fo rms. Bristol had the authority to modify this budget. Bristol was M EC‟s banker and provided loans to
MEC. Additionally, emp loyment policies and wages were applied to M EC by Bristol. Bristol provided various services to
MEC including distribution, develop ment, auditing and review functions and public relat ions . Bristol also had its name and
logo in the product as well as in pro mot ional co mmunicat ions.
MEC was profitable every year and filed its own taxes but Bristol bought insurance for MEC under its own policy. In
1991, Bristol suspended sale of breast implants by MEC and later that year M EC stopped all of its operations. The sale of
MEC‟s urology division before the cessation of activities was approved by Bristol and the proceeds went to Bristol. At this
point, MEC‟s only assets are a demand note fro m Bris tol for the amount fro m the urology sale and indemnity insurance.
Bristol asserts that the evidence is insufficient for the ‟s claims to proceed against it, whether through piercing the
corporate veil or under theory of direct liability.
CHOICE OF LAW:
Look to the laws of several states – DE here.
Motion for dismissal of claims against Bristol by summary judg ment was denied.
- Corporate Control: p iercing the corporate veil to abrogate limited liability and hold Bristol responsible for
- Direct liability: Strict p roducts liability, negligence, negligent failure to warn, negligence per se for non -
compliance with FDA regulat ions, misrepresentation, fraud and participation.
A. Corporate Control Claims
- Where single shareholder holds corporation, potential fo r abuse of corporate form is greatest.
- When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate
form may be disregarded in the interests of justice.
- WHETHER VEIL-PIERCING MA Y EVER BE RESOLVED IN SUMMARY JUDGM ENT?
o Fact intensive process but if the facts could only result in one conclusion
- All jurisdictions have some requirement of showing substantial do mination.
- Factors in showing substantial domination: 1) Co mmon directors or officers; 2) Co mmon business departments; 3)
Consolidated financial statements and tax returns; 4) Parent finances the subsidiary; 5) Parent caused the
incorporation of the subsidiary; 6) Gross inadequacy of capital; 7) Parent pays salaries and other expenses of
subsidiary; 8) Subsidiaries business comes only fro m parent; 9) Parent uses subsidiaries property as its own; 10)
daily operations are not separate; 11) Subsidiary does not observe basic corporate formalities, such as keeping
separate books and records and holding shareholder and board meetings.
- Many of the factors have been proven here.
- DE courts do not require showing of fraud, injustice or inequity if subsidiary is found to be mere instrumentality or
alter ego of its sole stockholder.
- Many jurisdictions that require that showing in a contract case do not require it in a tort situation.
- Because the evidence available at a trial could support a finding that the corporate veil should be pierced, Bristol is
not entitled to dismissal through summary judgment.
B. Direct Liability Claims
- Bristol held itself out as supporting the product because its name was on the product packaging and
- Additionally, Bristol issued press releases stating that the implants were safe. It h as potential
responsibility under tort law.
1. Shareholder of corporation whose veil is sought to be pierced is another corporation here.
2. Contract vs. Tort cases
3. Unitary test vs. the two part test
Walkovszky v. Carlton, Court of Appeals of New York (1966) Casebook p. 150
FACTS and PP:
Co mplaint alleges that was severely injured 4 years ago in NYC when he was run down by a taxicab o wned by the
defendant Seon Cab Corporation and negligently operated by Marchese. Carlton is claimed to be the stoc kholder of 10
corporations, including Seon, each has only 2 cabs registered in its name and implied that only the minimu m insurance is
carried by each individual cab ($10K). The plaintiff alleges that the corporations are operated as a single entity, unit and
enterprise with regard to financing, supplies, repairs, employees and garaging and therefore all names as defendants.
Plaintiff also alleges that he is entitled to bring suit against the stockholders because the mult iple corporate structure
constitutes an unlawful attempt to defraud members of the general public who might be in jured by the cabs.
Defendant Carlton alleges that the complaint fails to state a cause of action upon which relief can be granted and the trial
court upheld that motion. The appellate court reversed.
No piercing of the corporate veil here.
- Law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability
but the courts will disregard the corporate form (pierce the corporate veil) whenever necessary to prevent fraud or
- Whenever anyone uses control of the corporation to further his own, rather than the corporation‟s business, he will be
liab le fo r the corporation‟s acts upon the principle o f respondeat superior applicable even where the agent is a natural
- The corporate form may not be totally disregarded merely because the assets of the corporation are insufficient to
assure him the recovery sought. If insurance coverage mandated by legislature is inadequate for protection of the
public, the remedy is with the legislature and not the courts.
- The plaintiff has to prove that Carlton and his associates were actually doing business in their individual capacities,
shuttling their personal funds in and out of the corporations without regard to formality and to suit their immed iate
- This case is only to be found under respondeat superior.
- The companies were undercapitalized.
- How long are the courts going to allow the abuse of the system?
Kinney Shoe Corp. v. Polan, 4th Cir (1991) Casebook p. 156
FACTS and PP:
In 1984, Po lan formed Industrial and Polan Industries, Inc. to re-establish an industrial manufacturing business.
Polan Industries was incorporated under Wes t Virginia law in 11/ 84 and for Industrial in 12/84. Certificates of
incorporation were issued but no organizational meetings were held and no officers were elected.
In 11/84, Polan started negotiating with Kinney about the sublease of a building that Kin ney had leasehold interest in.
Kinney was legally obligated to make pay ments to the owner (Cabell County Co mmission) through 1/1/93 when it had the
right to purchase the building.
Sublease began in 12/84 even though the parties signed the written lease on 4/5/ 85. On 4/15/85, Industrial subleased part of
the building to Polan Industries for 50% o f the rental amount due to Kinney. Polan signed both subleases.
Industrial had no assets, income or bank account, no stock certificates, only inco me was fro m the s ublease to Polan, Polan
personally paid for the sublease for Industrial. After the first rental pay ment, no more pay ments were made.
Kinney filed suit fo r unpaid rent and obtained a judgment in the amount of $166,400 on 6/ 1/87. Po lan Industries had filed
for bankruptcy so Kinney couldn‟t obtain possession for 6 months. Kinney then filed suit against Polan individually to
collect the amount due. The district court held that Kinney had assumed the risk of the undercapitalization and was not
entitled to pierce.
Whether Kinney can pierce the corporate veil and hold Po lan personally liable?
Reversed – Kinney was entitled to pierce the corporate veil.
Two-Pronged Test in West Virg inia
- Is the unity of interest and ownership such that the separate personalities of the corporation and the
individual shareholder no longer exist?
- Would an equitable result occur if the acts were treated as those of the corporation alone?
Factors in making determination
- Co mmingling of funds of corporation with shareholder
- Diversion for personal use of funds
- Failure to maintain corporate formalities
- Individual shareholder says he‟s personally liable
- Failure to maintain adequate corporate records
- Identical equitable o wnership in two entit ies
- Same parties own ing
- Absence of separately held corporate assets
- Use of corporation as mere shell or conduit to operate a single venture or some particular aspect of the
business of an individual or another corporation
- Sole ownership of stock by one individual
- Use of same location
- Emp loy ment of same people
- Concealment or misrepresentation of the identity of the ownership, management or financial interests of
- Disregard of legal formalities and failure to maintain proper arm‟s length relations hips among related
- OTHERS listed on p. 157-8
- No corporate formalities
- When a party enters in a contract with the corporation and an investigation would disclose that the
corporation is grossly undercapitalized, based upon the nature and the magnitude of the corporate
undertaking, such party will be deemed to have assumed the risk of the gross undercapitalizat ion and will
not be permitted to pierce the corporate veil.
- District court applied this prong and said that Kinney assumed the risk and the piercing does not apply.
- This court stated that the third prong is permissive and not compulsory.
1. How much mo re than mere undercapitalization should be required?
3. Is it an abuse of corporate form of doing business for an affluent individual to split up her business operations
among different corporations so as to limit her monetary exposure to a modest amount or is this one of the
legitimate advantages which limited liability is supposed to provide?
United States v. Bestfoods, USSC (1998) Casebook p. 160 – PIERCING THE CORPORATE VEIL
CERCLA – 1980: In response to serious environmental and health risks due to industrial po llution; grants the President
broad power to command government agencies and private parties to clean up hazardous waste sites; US can use
government monies (superfund) to pay for the clean up and then sue the owners and operators of the violating companies;
“person” means corporations and other business entities.
In 1957, Ott Chemical (Ott I) began making chemicals in MI where it polluted the soil and ground water.
In 1965, CPC International (CPC) made a co mpany to buy Ott I‟s assets with CPC stock. The new co mpany was Ott II.
Ott II continued the pollution. CPC kept the same officers of Ott II as in Ott I, but also gave those people positions at CPC
and they performed duties for both.
In 1972, CPC sold Ott II to Stsory chemical that operated Ott II until bankruptcy in 1977.
In 1977, The Mich igan Depart ment of Natural Resources (MDNR) found land full o f pollution and tried to sell the land to
someone who had an established clean-up plan.
So, MDNR got Aerojet to buy the land. Aerojet created Cordova CA to buy the land. Cordova CA created Cordova MI to
exist on the site to manufacture chemicals.
In 1981, the EPA mandated clean up of the site, wh ich cost in the tens of millions of dollars.
US sued for the costs of cleaning up industrial waste generated by a chemical p lant under the CERCLA (Co mprehensive
Environmental Response, Compensation, and Liability Act of 1980). US named 5 defendants to the suit: CPC, Aero jet,
Cordova CA, Cordova MI and Arnold Ott. The part ies and the MDNR filed a bunch of contribution claims, counter claims
and cross claims that were consolidated into three phases: liability, remedy and insurance coverage.
Liability has been decided in bench trial which focused on the issue: Whether CPC and Aerojet, as parents of Ott II and
Cordova, had “owned and operated” under the code. The district court found them both liab le because of the following
test: 1) exertion of power over its subsidiary by actively participating in and exercising control over the subsidiary‟s
business during period of disposal of hazardous waste; 2) parent‟s mere ov ersight of subsidiary‟s business in a manner
appropriate and consistent with investment. COA reversed in part reversed in part stating that a parent can only be held
liab le where it abuses the corporate form in such a way that will warrant piercing the corporate veil and disregarding the
separate corporate entities. COA decided that neither CPC nor Aerojet abused the corporate form in that way since there
were separate personalities and parents did not use the subsidiaries to perpetrate fraud or subvert ju stice.
Whether a parent corporation that actively participated in, and exercised control over, the operations of a subsidiary may,
without mo re, be held liable as an operator of a polluting facility owned or operated by the subsidiary?
Vacate and remand with instructions – Re-evaluate.
A parent corporation cannot be held liable unless the corporate veil may be pierced so a corporate parent that actively
participated in and exercised control over the operations of the facility itself may be held directly liab le in its own right as
an operator of the facility.
ISSUE OF LIA BILITY
- Parent corporation should not be liable for the actions of its subsidiaries.
- Parent corporation is not automatically liable under CERCLA as owner/op erator just because its subsidiary is subject to
- The conduct must show that the corporate form was misused to accomplish certain wrongful purposes.
- Only when the corporate veil may be p ierced may the parent corporation be held liable for the wro ngdoing of its
ISSUE OF OW NERSHIP/OPERATOR
- Defining actions sufficient to constitute direct parental operation.
- Someone who directs the workings of, manages, or conducts the affairs of a facility that have to do with the leakage or
disposal of hazardous waste or decisions about compliance with environ mental regulations.
Donahue v. Rodd Electrotype Co., Supreme Court of Massachusetts (1975) Casebook p. 173 – SHA REHOLDERS
RIGHTS IN CLOSE CORPORATION
In 1935, Rodd began with Royal which had the Rodd Electrotype as a wholly o wned subsidiary. Rodd moved up quickly
and by 1946 he was general manager and treasurer.
In 1936, ‟s husband was hired by the company and became plant superintendent by 1946 and corporate VP by 1955. He
never participated in management of the business.
Royal offered shares of the common stock of Rodd to both Rodd and Donahue and Rodd bought 200 shares and Donahue
(with Rodd‟s encouragement) bought 50. Kelley had the remaining 25 shares. The parent company held 725 o f 1000
In 6/55, the subsidiary bought the rest of the shares from the parent for $135,000 and additionally purchased Kelley‟s
shares. Rodd mortgaged his home to obtain some of the necessary funds. These purchases left Rodd with majority control.
Shortly before the buy-out, Rodd became president of the company and in 6/60, the co mpany was renamed Rodd
Electrotype. Rodd‟s sons began to take spots on the BOD and another son replaced Donahue as superintendent of the plant.
In 1965, Charles Rodd (son) took over as president and GM.
Fro m 1959-67, Rodd distributed his shares among his family members.
In 1970, Rodd resigned due to poor health and the Rodd sons who were in power agreed to buy shares fro m their father for
$36,000. (45 shares at $800/share)
Donahue still owned 50 shares but then later divestments to the family left them all with 51 shares by 3/71.
It was not until 3/ 30/ 71 that Donahue learned that the corporation had purchased Rodd‟s shares and he questioned it. The
trial judge found that the Donahue‟s did not ratify the purchase of the shares. After this, Donahue offered his shares for sale
at the same deal given to Rodd but the corporation refused to buy them.
Donahue is a minority stockholder in REC and is suing its board of directo rs, the controlling stockholder and the
corporation for rescission of their purchase of the controlling shareholder‟s shares and repayment fro m Rodd the purchase
price of the shares ($36,000) because the defendants forced the corporation to purchase the sh ares in violation of a fiduciary
duty to her. She contends that the defendants were diverting assets for the benefit of the Rodd family. She wanted an
injunction and restitution of misappropriated funds. The trial court d ismissed the case and the COA af firmed the dis missal.
Whether or not shareholders in a close corporation are required to offer each stockholder an equal opportunity to sell their
What duty of care is owed to minority shareholders in a close corporation?
Reversed the decision to dismiss plaintiff‟s claim but the holding is limited to closely held corporations
If a stockholder whose shares were purchased was a majority stockholder, the controlling stockholders must cause the
corporation to offer each stockholder an equal opportunity to sell a ratable nu mber o f his shares at an identical price to the
When i t is a close corporation, the purchase is subject to the utmost good faith and l oyalty to other stockhol ders.
Argument: Un lawful d istribution of corporate assets to controlling stockholders which constituted a breach of fiduciary
duty owed by the Rodds because they failed to give her an equal opportunity to sell her shares to the corporation.
Argument: Stock purchase was within the powers of the corporation and met requirements of goods faith and fairness and
that there is no right to equal opportunity in corporate stock purchases.
- Close corporation looks like partnership – Ownership is limited to the original parties or transferees of their stock
to whom the stockholders have agreed, in which ownership and management are in the same hands, and in which
owners are dependent on one another for success of the enterprise.
- The relationship among stockholders must be one of trust, confidence and absolute loyalty.
- The minority shareholders are vulnerable to oppressive devices (freeze-outs)
o Refuse to declare div idends
o Drain off earnings of corporation in form of salaries or leases
o Deprive minority shareholders of offices and emp loyment
o Sales of assets at an inadequate price to majority shareholders
- Minority can sue based on director‟s fiduciary obligation to the corporation. The judiciary has been reluctant to
- This can trap minority shareholder with shares he can‟t get rid of. Th ese schemes are designed to get minority
shareholders to sell at a loss to the corporation.
- Because of the fundamental resembl ance of close corporation to partnership, the trust and confi dence which
are essential to this scale and manner of enterprise, and the inherent danger to mi nority i nterests in the
close corporati ons, WE HOLD THAT S TOCKHOLDERS IN THE CLOS E CORPORATION OWE ONE
ANOTHER S UBSTANTIALLY THE SAME FIDUCIARY DUT Y IN THE OPERATION OF THE
ENTERPRIS E THAT PARTNERS OWN TO ONE ANOTHER WHICH IS UTMOST GOOD FAITH
- In a corporation, the directors are held to good faith and inherent fairness standard of conduct but the paramount
duty is to the corporation.
- In MASS, a corporation has the power to purchase its own shares but must do so in good faith and without
prejudice to creditors and stockholders. When it is a close corporati on, the purchase is subject to the utmost
good faith and loyalty to other stockhol ders.
- If a stockholder whose shares were purchased was a majority stockholder, the co ntrolling stockholders must cause
the corporation to offer each stockholder an equal opportunity to sell a ratable nu mber of h is shares at an identical
price to the corporation.
o Gives a market for the minority shares;
o Access to corporate assts for personal use.
- Relief given to the minority shareholder: 1) remission of the original sale; 2) allowance of a new sale of the
Nixon v. Blackwell, Supreme Court of Delaware (1993) Casebook p. 182 –
Trial court held that defendant directors of a closely held corporation breached their fiduciary duties to the plaintiffs by
maintaining a d iscriminatory policy that unfairly favors employee stockholders over plaintiffs. They found that the
directors allo wed employees to provide liquid ity in selling their stock while there was no comparable deal fo r minority
Whether or not the directors of a close corporation must offer the same deal for minority shareholders as majority
Reverse and remand
Ramos v. Estrada, Californ ia Court of Appeals (1992) Casebook p. 188
Somers v. AAA Temporary Serv ices, Inc., Illinois Court of Appeals (1972) Casebook p. 195 – DEVIATIONS FROM
THE CORPORATE NORM
- AAA was an IL corporation that provided temps. It had 2 shareholders with 25 shares apiece (Raimer and Kay).
Raimer was the president and Kay was the secretary and treasurer.
- The number of directors was to be determined at the first shareholder‟s meeting. At t he first meeting held in May of
1967, they decided on 3 (Kay, Raimer and So mers). Additionally, the by -laws were adopted allowing for the schedule
of shareholder and BOD meet ings annually (second Monday of each year).
- No meeting was held in 1968 but in 1969 at the meeting Kay and Raimer signed waiver of notice of annual
shareholders meeting which also was held to amend the number of shareholders fro m 3 to 2. They elected themselves
the sole directors.
- Somers says that the meetings for 1969 were ever held and that the actions were not discussed until the end of January.
Additionally, he states if they were held, the resolutions were unlawfu l and not within the power and authority of the
Director whose position was terminated sued the close corporation for the termination of his position in order to declare the
amend ment of the corporate by-laws invalid.
Trial court held that the resolution was invalid and that he should be reinstated. The corporation appeals.
Whether the 2 sole shareholders of a close corporation may validly agree that the by -laws of the corporation be amended to
reduce the number of directors and thereupon elect themselves the sole directors?
Whether the shareholders have the power to amend the by-laws where such power has not been reserved to the shareholders
by the Articles of Incorporation?
Affirmed decision of trial court.
- The BCA may not be disregarded in the case of a close corporation but slight deviations from the corporate norms may
be permitted. Action by a shareholder that is in direct contravention of the statute cannot be allowed.
- Where a plaintiff asserts a valid cause of action, the motive in bringing the action is immaterial.
- IL BCA provides that number of directors can be changed by amendment to by-laws and that the power to amend is
vested in the BOD, unless reserved to the shareholders by articles of incorporation.
- Here, the power to amend was not reserved to the shareholders by the Articles so it would rest with the directors. So
the amend ment was not in comp liance and null.
- Argument: Close corporations should be allowed to act in such a way under Galler.
- Galler v. Galler: There is no reason for preventing those in control of a close corporation to reach any agree ment
concerning the management of the corporation, which is agreeable to all despite violating the BCA.
o Limited to close corporations where no apparent fraud or injury would be worked upon the public,
minority interests or creditors but not violating statutory language.
- The BCA may not be disregarded in the case of a close corporation but slight deviations from the corporate norms may
- Action by a shareholder that is in direct contravention of the statute cannot be allowed.
- Raimer Argu ment: Plaintiff brought suit in order to conspire and oust Raimer.
- Where a plaintiff asserts a valid cause of action, the motive in bringing the action is immaterial.
1. Co mment
Lehrman v. Cohen, Delaware Supreme Court (1966) Casebook p. 198
- Giant Foods (Giant), a DE co rporation, founded by Cohen and ‟s father. Each owned equal amounts of the voting
stock (AC – Cohen/AL – Lehrman). The two classes of stock have cumulative voting rights and each is entitled to
elect 2 members of the BOD (4 members total). There was a dispute among the Lehrman children at the death of the
father but in an arrangement, was allowed to acquire the outstanding AL stock giving him voting power equal to
Cohen family. Additionally, Giant was to repurchase a certain amount of stock fro m Leh rmans and the Cohens. An
essential part of the agreement was the creation of an additional seat on the board to obviate the risk of deadlock in the
- On 12/31/49, Giant‟s incorporation certificate was amended to create a third class of voting stock (AD) entitled to elect
the fifth director. The share was empowered with the same rights but not allowed to get any dividends or assets and it
could be repurchased by the corporation at any time for par value ($10).
- AD was issued to Danzansky who was the corporate attorney for Giant. In 4/50, Dan zansky voted his share to elect
himself the 5th director and served as such until 1964. No deadlock arrived before th is point.
- In 12/59, 200,000 shares of non-voting common stock were sold for $3 million in a public issue stating that AD stock
is only to prevent deadlock in AC and A L stock votes.
- Until 10/1/ 64, Cohen was president. On that date, a resolution was adopted at Giant‟s stockholders‟ meeting giv ing
Danzansky a 15 year executive emp loy ment K at $67.6K and options for 25K of non -voting stock. A C and AD voted
in favor and A L voted against. He was elected President by 3-2. On 12/11/64, he resigned as director and voted his
share to elect West as the 5th Director. The new board ratified Danzansky‟s election and his K was approved in
January with certain modifications.
Lehrman sued on 12/ 11 alleging: the AD stock‟s creation, issuance and voting resulted in an arrangement that was illegal
under the law; the election of Danzansky as president and the employ ment contract violated the 1959 deadlock arrangement
which constituted a breach of K and breach of fiduciary duty. The defendants‟ mot ion for summary judgment was granted.
- Applicability of the DE Vot ing Trust Statute
- Legality of the stock having voting power but not dividend or liquidation rights
- Alleged unlawful delegation of directorial duties and powers.
Class AD stock arrangement is a voting trust and it is illegal because it is not limited to a 10 year period as required by
Vot ing Trust Statute.
- Criteria of voting trust: 1) The voting rights of the stock are separated from other attributes of ownership; 2) the
voting rights granted are intended to be irrevocable for a defin ite period of t ime; 3) the principal purpose of the
grant of voting rights is to acquire voting control of the corporation.
- : Argues that this is the situation.
- Court: The stock arrangement was a capitalization of Giant and although it diluted the voting power of AC and AL
stock, it did not divest and separate the voting rights which remain vested in the other classes of stockholders.
- This is not a trust or a pooling agreement.
Class AD stock is illegal because the creation of a class of stock having voting rights only, and lacking any substantial
participating proprietary interest in the corporation, violates the public policy of the state as declared in §218.
- Court: The public policy that the law has disfavored is the separation of vote from stock not fro m o wnership of
- Court: Nothing in the statute says that all stock must have both voting rights and proprietary interest.
- Under §151(a), non-voting stock is authorized so public policy does not condemn the separation of voting rights
form beneficial stock ownership.
- Stock is legal under §151(a).
If the AD stock arrangement is allowed to stand, the VTS will become a dead letter because it will be possible to evade and
circu mvent its purpose simply by issuing a class of non-participating voting stock.
- Court: Assumes divestiture of voting rights; the main purpose of VTS is to avoid secret, uncontrolled
combinations of stockholders formed to acquire voting control of the corporation to the possible detriment of non -
participating shareholders; the legislature should be responsible for fixing this.
In re Rado m & Nierdorff, NY COA (1954) Casebook p. 204 – DISSOLUTION AND DEADLOCK
FACTS and PP:
- Business of printing music founded by R and N.
- N died and left it to his wife who did not get along with her b rother R.
- They have been the sole equal stockholders of this company.
- R sues for dissolution under §103 of BCA where holders of ½ of the stock entitled to vote at an election of
directors may present a verified petit ion for d issolution of the corporation as prescribed in this article.
- Trial court said that there was a basic and irreconcilable conflict between the stockholders requiring dissolution.
- Appellate court reversed and ordered dissolution
Order denying dissolution is upheld
- The dismissal was with in the discretion of the appellate court.
- “Even when majority stockholders file a petition because of internal corporate conflicts, the order is granted only
when the competing interests „are so discordant as to prevent efficient management‟ and the „object of its
corporate existence cannot be attained‟”
o FACTUA L QUESTION
- IN ORDER TO DETERMINE DISSOLUTION, YOU MUST EVA LUATE W HETHER JUDICIA LLY
IMPOSED DEATH WILL BE BENEFICIAL TO THE STOCKHOLDERS OR M EM BERS AND NOT
INJURIOUS TO THE PUBLIC
- R should be entitled to a hearing to present his proof because he has alleged more than enough.
- The deadlock of which petitioner co mp lains is between the stockholders, not the directors, and when the
stockholders are deadlocked, section 103 calls for dissolution, not arbitration.
- There is no need for corporate insolvency to dissolve.
- Just requires a hearing.
- HOLDING: No basis in the statute or elsewhere for requiring that irreparable in jury must occur before resort may
be had to remedy designed to avert it.
Oceanic Explorat ion Co. v. Grynberg, Delaware Supreme Court (1981) Casebook p. 211 – VOTING TRUS TS
Hanewald v. Bryan‟s Inc., North Dakota Supreme Court (1988) Casebook p. 277 – SHAREHOLDER‟S OBLIGATION TO
PA Y AND PAR VA LUE
- On 7/ 19/ 84, Keith and Joan Bryan incorporated as Bryans to be a retail-clothing store. The corporation‟s officers
were Keith (pres), George (VP) and Joan (Sec-Tres). The corporation was authorized to issue 100 shares of
common stock at $1000 par value. Keith got 50 shares and Joan got 50 shares while no money was paid for the
shares in labor, services or money.
- On 8/ 30/ 84, Hanewald sold his store to Bryans, Inc. for $60K and leased the building for $600/ month for 5 years.
Bryans paid $55K v ia loan fro m bank and $5K via p ro missory note due 8/30/ 85.
- The store only lasted 4 months with operating loss of $4840 and closed in 12/84. The inventory was sent to othe r
Bryans stores and a Notice of Rescission was sent to Hanewald to attempt to avoid the lease.
- In 8/1/ 86, Bryans, Inc. was involuntarily dissolved because of failure to file with SOS. Bryan never paid the $5K
promissory note but paid the rest of the creditors. The $55K loan was paid and a $10K loan fro m Keith and Joan
was paid which was intended to be used for operating costs and expenses supposedly.
Hanewald sued for breach of lease and promissory note seeking to hold Bryans personally liable. Brya ns counterclaimed
alleg ing that Hanewald fraudulently misrepresented the business‟s profitability in negotiating the sale. At bench trial,
Hanewald got judg ment against Bryans for $38.6K but refused to hold defendant‟s personally liab le because the $10K loan
fro m Keith Bryan was enough and lack of bad faith to prevent piercing.
Whether or not the Bryans should be held personally liab le for the judgment against the corporation?
Agreed with Hanewald that Bryan should be held personally liab le because of their failure to pay for shares issued to them.
A SHA REHOLDER IS LIABLE TO CORPORATE CREDITORS TO THE EXTENT HIS STOCK HAS NOT BEEN
- Statute: Only obligation of the shareholder is the obligation to pay to the corporation the full consideration for
which such shares were issued or to be issued. It is a pre-requisite for limited liability.
- Consideration for shares: anything but future services, promissory notes
- Failure to pay for the shares makes them personally liab le under the code.
- A SHA REHOLDER IS LIABLE TO CORPORATE CREDITORS TO THE EXTENT HIS STOCK HAS NOT
BEEN PAID FOR.
- Reasons: violates rights of existing stockholders who do not consent to gratuitous issuance; fraud upon subsequent
- Loan was a debt and not an asset and not considered a capital contribution.
Gottfried v. Gottfried, New York Court of Appeals (1947) Casebook p. 286
- Defendants: The corporation, the directors and Hanscom Baking (subsidiary).
- Plaintiffs: M inority stockholders of the corporation (closely held family corporat ion).
- Gottfried was wholesale bakery products company and Hanscom was retail. Both operate separately.
- At end of 1946, outstanding capitalization of Gottfried consisted of 4500 shares of „A‟ stock without value and
20,862 shares of common stock without par value. The „A‟ stock was entitled to $8/share dividends before
common stock was paid. There was also preferred stock.
- s owned 38% o f each class of stock and the defendants owned 62%.
- Fro m 1931-1945, no dividends had been paid to common stock holders but regularly to preferred and sometimes
to „A‟ stock.
- This action was to compel the declaration of div idends upon the common stock in a fair and adequate amount.
The plaintiffs claim that the BOD is breaching fiduciary duty to stockholders and corporation. Supposedly there is
animosity between BOD and minority stockholders. Additionally, s say that BOD are try ing to force the
Dis missed complaint.
In order to show that fiduciary duty was breached because dividends were not paid, you must show surplus existed and
dividends were appropriate but not paid due to bad faith.
- If adequate corporate surplus is available, dividends may not be withheld in bad faith but the mere existence of
surplus is not enough to compel a dividend.
- Ev idence of bad faith: hostility against the minority; exclusion of minority fro m employ ment; high salaries,
bonuses, loans made to officers in control; high taxes if div idends are paid; desire to obtain minority stock as
cheaply as possible.
- TEST OF BA D FAITH: W HETHER THE POLICY OF THE DIRECTORS IS DICTATED BY THEIR
PERSONA L INTERESTS RATHER THA N THE CORPORATE W ELFA RE?
- Plaintiffs have failed to prove that the surplus is unnecessarily large, or that the defendants recognized the
propriety of paying dividends but refused to do so for personal reasons.
Gabelli & Co. v. Liggett Group, Inc., Delaware Supreme Court (1982) Casebook p. 290 –
- Defendants: Liggett and GM Sub moved to dismiss because the complaint fails to state a claim upon which relief
can be granted.
- Gabelli owned 800 shared of 8.4 million of Liggett before merger in 1980. Gabelli brought class action against
Liggett prior to the merger.
- Liggett, DE corp, makes cigarettes and GM Sub, DE corp, is subsidiary of Grant Met an English Corp. GM sub
was formed in 3/ 80 to buy Liggett for Grand Met by way of tender offer. Init ially, they offered $50/share but then
$69/share to counter Standard Brands. Liggett‟s board approved the latt er offer as fair and reco mmended it to the
shareholders. 85% of the shareholders approved the offer and tendered their shares to GM Sub in spring of 1980.
- Grand Met then proposed plan of merger where Liggett would be merged into either Grand Met or wholly -owned
subsidiary where the minority shareholders would be cashed out at $69/share. The merger date was set for 8/80.
- A dividend was not declared as it usually was in late July and minority shareholders brought suit. They were
cashed out by the merger in 8/80.
- The complaint did not ask for in junction against the merger or adequacy of price o f cashout.
- Co mplaint alleges: Grand Met breached fiduciary duty by eliminating the dividend for Liggett until after the
- Defendants contend that the dividend is within the discretion of the BOD and cannot be interfered with absent
showing of oppressive or fraudulent abuse of discretion which has not been shown.
Dis missed complaint (possible amend ment) without prejudice
Whether a minority stockholder of a subsidiary corporation, faced with being cashed out by a merger orchestrated by the
majority stockholder, may co mpel pay ment of a d ividend where he alleges breach of fiduciary duty by the parent
- BOD has been giving wide latitude in making decision of declaring a dividend enjoying a presumption of sound
business judgment not disturbed by a court in the absence of a disabling factor.
- Statute gives power to BOD as well.
- Plaintiff must allege facts that would overcome the protection of the business judgment rule so that transaction
might be tested against the intrinsic fairness tetst.
- WHETHER THERE ARE A LLEGATIONS IN THE COMPLA INT WHICH WOULD PERMIT THE
TRANSACTION TO BE TESTED A GAINST THE INTRINSIC FAIRNESS TEST?
- Factors must be shown: 1) Control and do mination of the transaction by the parent corporation; 2) self -
Berwald v. Mission Develop ment Co., Delaware Court of Appeals (1962) Casebook p. 296
FACTS and PP:
- : Owned 248 shares of corporation and sued to compel liquidation and distribution of assets to shareholders.
- answered and filed motion for summary judg ment which was granted and plaintiffs appeal.
- is a holding co mpany which o wned a block of 7 million shares of Tidewater Oil Co mpany a large integrated oil
company which is controlled through Mission and Getty Oil Co mpany. Mission was formed in 1948 to invest in
the stock only.
- Fro m 1948-1951, Mission acquired more shares and by 1960 had almost 7 million shares. In 1954, Tidewater
stopped paying cash dividends so that it could expand and modernize.
Whether or not there was a conflict of interest between majority shareholder of corporation that was formed to hold and
acquire shares of another corporation such that the arresting of issuance of dividends would be a breach of fiduciary duty to
the minority shareholders?
- There is an inherent conflict of interest because of the tax purposes
- The plaintiff has a duty to show evidence of genuine is sue of fact
- Plaintiff is seeking to wind up the corporation when it was doing what it was lawfully organized to do.
- The courts usually side with the majo rity where there is some plausible reason to do so.
Auer (president of R. Hoe & Co.) v. Dressel, New Yo rk Court of Appeals (1954) Casebook p. 303
- By-Laws state: it shall be the duty of the President to call a special meeting whenever requested in writing to do
so, by stockholders owning a majority of the capital stock entitled to vote at such meeting.
- On 10/16/53, petitioners submitted to president written request for meeting of class A stockholders signed by more
than 55% of the class A stockholders. The president did not call the meeting and after waiting a week, the
petitioners instituted this action.
- Class A stockholders sued under article 78 of Civil Practice Act for mandamus to compel the president of R. Hoe
& Co. to co mply with duty under the by-laws.
- The answer denied that he had knowledge sufficient enough to form a belief only.
Whether the President has discretion as to when to call a meeting when majo rity of stockholders request one be held?
Allow the special stockholder meetings
- Purposes of the special stockholder meeting: a) vote on resolution reinstating A uer as president; b) voting on
amend ment to by-laws or charter about directors; c) voting about director charges; d) voting about other
amend ment to by-laws.
- The stockholders should be allowed to amend their own by -laws to guarantee a right. If there is a problem then
the director illegally removed can have his day in court.
- Where by-law of corporation provided that it shall be duty of president to call special meeting whenever requested
by stockholders owning majority of capital stock, and written requests, signed in names of holders of record of
slightly more than 55 per cent of p referred stock, were submitted to president requesting special meet ing, and
president failed to call meeting, and, after waiting a week, stockholders brought proceedings to compe l president
to comply with duty to call election, and president denied that he had informat ion sufficient fo r belief as to
adequacy of number of signatures on written requests, Special Term properly disposed of the matters summarily
by entering order requiring president to call special meeting.
- The meet ing was unauthorized as it was.
- Corporation code: “The business of a corporation shall be managed by its board of directors.”
- This meet ing would impair the rights of the common shareholders in participating in filling vacancies upon the
BOD and could not be legally adopted at this meeting demanded by petitioners fro m which the co mmon
stockholders would be excluded.
- Additionally, the BOD has the power to run the corporation and not the shareholders.
Driver v. Driver, Supreme Court of Wisconsin (1984) Casebook p. 317 – CORPORATE GOVERNA NCE
- Prior to 7/ 82, James was President of UTC and sole director. The shares of UTC were owned by James, the
respondents (all members of his family), another me mber of the family and 2 emp loyees as follo ws: 2250, 2000
each of the next and 675 each emp loyee.
- In 2/82, Connie Driver called special meeting of shareholders to amend the bylaws to increase the numbers of
directors and revoke the BOD‟s power to amend the bylaws. James countered with another special meeting to
have no change in BOD for 5 years without majority of shareholders approval. There was a meet ing but no
amend ment passed.
- On 4/ 1/82, James amended the bylaws without notice to the other shareholders. The amend ments involved
making the only member of the BOD the president of the corporation; allowing h im alone to call meetings and that
he has to be present for the meet ings; and that he has to be in the voting party in amend ments.
- On 7/ 6/82, Connie called a special meet ing with notices sent to each shareholder and James came but left before
any voting occurred. The remain ing shareholders voted on 5 person board and elected James and others to be
members of the board.
- James did not attend the first new board meeting. He was removed as president and the amendments he made
were repealed. Connie was elected president. Robert was VP and Connie was also Sec/Treasurer.
James sued alleging that the meet ing on 7/9 was called invalidly because he had not participated in the call. He wanted a
temporary injunction against respondents and to change things back to status quo. Respondents countered stating that the
meet ing was proper and wanted a temporary injunction against appellant. Trial court said tha t respondents got summary
judgment because of the statute that said that “a director, (James), had a fiduciary duty to the other shareholders and could
not use his position to entrench himself and perpetuate his own control. James Driver appeals because s ummary judg ment
was awarded against him. The trial court held that he raised no relevant factual issues, that his attempted amend ments to
the bylaws of UTC were invalid because they were contrary to statute and that the respondents adding themselves to the
BOD and removing him as president were valid.
Affirmed Su mmary judgment
James argu ment – There is a factual issue as to his timely notice of the July 9 meeting.
Court – There was no evidence that he was not served in time.
James argu ment – The call of the meeting was invalid under ¶ 3 of the bylaws because he did not join in the call.
Court – That paragraph conflicts with the statute because it eliminates the shareholders‟ right to call special meetings.
James argu ment – The jo ining in only applies to special meetings called on short notice. Ten days notice is sufficient and
he need not join in the calling of those meetings so he is not actually denying their rights.
Court – This is not what ¶ 3 says and no further methods were contemp lated and appellant even said that the meetings
couldn‟t be called without his joining in.
James argu ment – The amend ment to the bylaws was invalid because he did not vote for it.
Court – Each shareholder is entitled to one vote unless the voting rights are enlarged or limited by articles of incorporation.
James argu ment – The veto power is legitimate necessary to protect his minority interest.
Court – Every shareholder holds a minority interest.
Allen v. Park National Ban k, US COA (7th Cir. 1997) Casebook p. 320 – CUMULATIVE VOTING
Allen filed suit against Bank and then Takiff became intervenor who counterclaimed against Allen. A llen said that bank
violated provisions of National Bank Act in adjourning shareholder‟s meet ing where BOD was to be elected and seating a
board dominated by Takiff. He wanted an injunction commanding the bank to seat a board in accordance with the ballots
he cast at the meeting. Takiff‟s counter alleged that Allen was entitled to no relief because he had cast votes for directors in
such a way to violate an agreement between the two men. Takiff wanted an injunction commanding Allen to co mply with
the agreement. At the bench trial, the judge agreed with Takiff‟s interpretation and ordered Allen to cast v otes in future
elections for directors in accordance with that interpretation.
American Telephone & Telegraph Co. v. Harris Corp., Delaware Superior Court (1993) Casebook p. 326
FACTS and PP:
Harris moved for part ial summary judg ment on ATT suing for unp aid and allegedly due royalties pursuant to a license
agreement fro m and after 7/ 1/83.
argu ment: ATT is barred by SOL fro m recovering any royalties allegedly due before 1/ 3/89 (3 years before the action
argu ment: ATT is only barred fro m 1/3/ 86 because NY statute should apply which is 6 year SOL.
Whether the SOL was a good defense?
Whether NY or DE law applies and also whether the license agreement was a sealed instru ment under NY law?
Because the license agreement is not actually a “sealed” instrument, the DE borro wing statute requires the lesser of the
statute of limitations so they would get the 3 year DE limitations period.
In order to create a “sealed instrument”, mo re than the presence of the word seal and a corporate seal is necessary.
1. THE LICENSE A GREEM ENT
- The SOL depends on whether or not it is considered an instrument under seal.
- Factually, it was signed by both parties, “seal” appears below the signature block of each, corporate seal is on
- Argument: SJ should be denied because there is a material fact issue as to whether the parties intended to create
a sealed instrument
o Affidavits fro m ATT stating that the reason they entered into agreements like that was for them to be
o Affidavits fro m Harris stating that they used seals to show that the signatures were authenticated and not
- Argument: Under Delaware‟s borrowing statute, the Court must apply DE 3 year statute of limitations applicable
to claims for breach of contract not under seal.
- argu ment: Under Delaware‟s borrowing statute, the Court must apply NY 6 year statute of limitations governing
- Where a cause of action arises outside the state, DE‟s borrowing statute mandates that t he shorter period of
limitat ions will control.
o So if it is sealed as ATT contends, NY‟s 6 year is shorter than DE‟s 20 year common law SOL.
o So if it is not sealed as Harris contends, DE‟s 3 year is shorter than NY‟s 6 year SOL.
- CHOICE OF LAW
o Agreement states NY law will govern.
- Factual support for : no intent to make it sealed in the language of the document (signed, sealed, delivered; hands
and seals); far below the signature block.
- Factual support for : contains all of the indicia making it sealed (attesting witnesses, seal, impressions).
- It is not legally impossible to having an instrument under seal but the instrument here is not under seal.
- UNDER NY LAW, the presence of the word seal and a corporate seal on the agreement alone will not suffice to
make the document a sealed instrument. It must also contain an exp ress acknowledgment of the presence of the
seal or there must be other proof that the parties intended to make the document a sealed instrument.
- UNDER DE LAW, a sealed instrument must also contain language in the body of the contract, a recital affixing
the seal, and extrinsic evidence showing the parties‟ intent to conclude a sealed contract.
- Adoption of the act of the printer…MORTGA GES require less proof in requiring less proof than other c ases
because they are traditionally sealed instruments. Intent
Stewart Captial Corp. v. Andrus , Southern District Court of NY (1979) Casebook p. 332
FACTS and PP:
- This is a suit for a declaratory judg ment and injunction against the Secretary of Interior by the highest bidder of an
off-shore oil and gas lease which was awarded to the lower bidders because of a presumed defect of the higher bid
- Stewart submitted a bid for $213K with his enclosed check of 1/5 o f the amount of the bid signed by the
company‟s assistant secretary ($42.6K) as required by the noticed. The bid was signed by the Stewart‟s president.
- The bid was rejected on 3/29/ 70 and awarded to bidders Murphy and Ocean. It was rejected because of a technical
deficiency, namely the signature of the president on the bid was not attested to by the secretary.
Whether or not there was sufficient attestation as to the authority of the president of the corporation to make the bid?
The plaintiff was the highest bidder and should have been granted. High bidder on offshore oil and gas lease which showed
that it submitted a legal bid was entitled to injunctive relief precluding lo wer b idders to whom leases were awarded
asserting the rights under those leases and requiring the Secretary of the Interior to execute a lease in favor of the high
Absent explicit statutory provision to the contrary, attestation of a corporate document is a mere formality of bearing
witness to, or affirming the genuineness of, the execution of the document.
- The ‟s documents completely satisfied the requirements of statute but the memorandum to the concluded that
the bid was deficient and legally unacceptable.
- Secretary of Stewart submitted several certificates to the documents that accompanied the bid and the certified
check which she signed for the required deposit to be made by the corporation.
- The effect of attestation upon the authority of a corporate officer to make an offer which binds the corporation
depends upon state law and as is incorporated in DE, the law o f that state is controlling in this controversy.
- The presence or absence of attestation has no effect whatsoever on the validity of plaintiff‟s bid as a bind ing offer.
- The determination that the bid was legally insufficient and deficient was erroneous. There was sufficient
Fradkin v. Ernst, Northern District Court of Ohio (1983) Casebook p. 336
Challenge to the 1983 stock option plan for the senior executives of Mohawk Rubber Co mpany which was approved by
directors on 1/4/83 and presented and allegedly approved by the stockholders at the annual meeting.
Shareholder brought derivative action against board of directors seeking declaration that stock option plan had not been
approved at shareholder's meet ing and that proxy solicitation statement had been materially false and misleading.
- Mohawk is Ohio corporation with PPB in Oh io. It manufactures tires sold in replacement market for tires. It has
experienced recent substantial financial success.
- Stock is traded on NYSE – as of 1983, over 2 million shares of common stock were divided among 2600
shareholders. During 1982, the prices for shares ranged from $15 ¼ to $25 1/8. But during 1983, the shares sold
for about $32/share. Because of Mohawk‟s success and relatively s mall portion of stock controlled by
management, the investment commun ity has viewed Mohawk as an ideal takeover candidate.
- ‟s Fawcett and Ernst are the principal executives of Mowhawk. They developed stock option plan because th ey
had been with Mowhawk for so long and owned very little stock. Since 1978, F & E‟s compensation has also
included a stock option plan both earned profits upon cancellation of stock appreciation rights (SAR‟s). In 1982,
there was an additional grant of stock options to F & E. (SARs are a recent development that serve as a substitute
for the grant and exercise of stock option rights. SA Rs allo w a single payment by the corporation of the amount of
appreciation on the stock to the grantee with no purchase or sale of the stock yet the grantee receives the value of
the appreciation of the stock).
- In 1983, the BOD decided that the compensation available to them was inadequate so Ernst was directed to give
this subject further consideration. The terms of that plan were option and SARs with options on 200K shares of
stock. (9.25% of Mohawk‟s outstanding shares). The value of the options was tied to the market price of the shares
on the day of the grant and the increased market price in 1983 dimin ished the value o f options to Fawcett and
- Under the terms of the Plan, any options would be invalidated if the Plan failed to receive approval by the holders
of the majority of the co mmon stock present or represented and entitled to vote at 1983 stockholder‟s meetin g
which was designed to qualify the Plan for exemption to the short swing profit rules of the Securities Exchange
- On 12/17/82, some large shareholders of Mohawk filed amended schedule indicating intent to seek out other
investors who might be interested in acquiring Mohawk.
- On 1/ 4/83, 16 days prior to the BOD meet ing where the Plan was to be presented, Ernst called the directors
individually to obtain approval for the Plan. He sent no written notice and Plan was not before them in written
form prior to the telephone call. Each d irector orally approved the plan as it was presented to him (in parts) but the
Plan presented to the shareholders was not in final form after 1/ 4/83 phone calls. Three of the directors agreed to
be on an “Option Co mmittee”. M inutes of the BOD meeting and option committee meeting were prepared
outlining events of January 4, 1983 as if they had taken place in formal meetings (the minutes were basically
- Option agreements were prepared and signed by Fawcett, Ernst and members of the Option Co mmittee at 1/20/ 83
BOD meeting (It was not discussed at same meeting).
- On 3/ 7/83, a notice and pro xy statement was sent to shareholders for annual meeting to be on 4/12/83 indicating
that the two principal items were proposal to re-elect directors and proposal to adopt the Plan. In a letter with the
proxy, Fawcett and Ernst urged the shareholders to give prompt attention to the proxy and indicated that the BOD
unanimously reco mmended a vote for the plan.
- On 3/ 17/ 83, Independence met with F & E to discuss the Plan and proxy statement and their efforts to get a seat on
the BOD. Independence told F & E that the statement was misleading because it didn‟t fully disclose the benefits.
(Independence was a majority stockholder). Independence send amend ment to schedule stating that it wouldn‟t
intend to support the adoption of the Plan because it was excessive and not in the best interest of the corporation.
- On 5/ 19/ 83, the BOD signed document designed to cure failure of not holding formal BOD meeting.
- filed the co mplaint on 3/25/83 asking to enjoin the vote on the plan at the shareholder‟s meeting wh ich was
denied but enjoining implementation of the Plan until a trial on the merits. An amended comp laint was filed on
4/18/83 raising derivative and class action claims which are the subject of the law suit. Count I alleges violations
of Securities Exchange Act, Count II alleges common law corporate waste, and Counts III and IV allege that the
Plan was not approved according to terms of the Plan or code of regulations.
- says that a proxy statement issued to shareholders describing the Plan prior to the annual meeting vio lated
federal securit ies laws.
- also says that the Plan constitutes corporate waste and was not approved by the requisite number of shareholders
at the annual meeting.
- After denying motion to dis miss and granting class certification, the District Court, held that: (1) stock option plan
had not gotten the required majority vote at shareholder's meet ing, and (2) pro xy solicitat ion statement was
materially mislead ing in a nu mber of respects.
The representations to the shareholders were materially false and misleading because they stated that the BOD had taken
formal action and given deliberate consideration to the Plan so as a result, they violated rules.
The shareholders did not approve plan and that the proxy statement was materially false and misleading with respect to the
actions of the board of directors and the option committee.
I. Approval of the Plan
- Court must consider whether the Plan was approved by the shareholder‟s vote at the annual meeting.
- Court decided that the shareholders did not approve the Plan.
II. Vio lations of the Exchange Act
- Pro xy Rules
o “An omitted fact is material if there is a substantial likelihood that a reasonable investor would consider it
important in decid ing how to vote”
o Mixed question of law and fact – “reasonable shareholder” fro m the given set of facts.
- The facts in this case
o The Misstatement: “The BOD, at its meeting of January 4, 1983, adopted, and directed to be submitted to
the shareholders of the Company for their approval, the 1983 Non -Qualified Stock Option Plan.”
o : That disclosure is materially false or misleading
o : Disclosure, although not precise
Shlensky v. Wrig ley, Illinois Court of Appeals (1968) Casebook p. 387 – DIRECTOR‟S DUTY OF CA RE TO
FACTS and PP:
- appeals dismissal of their amended co mplaint in stockholder derivative act ion against directors for negligence
and mismanagement seeking damages and order forcing s to install lights in Wrig ley field and schedule night
- is minority stockholder of Chicago National League Ball Club (defendant corporation) which is a DE
corporation with PPB in Chicago and it operates the Cubs and Wrigley Field, its concessions, TV and radio
broadcasts of the games. Along with the corporation, also sued directors of the Cubs and Wrigley is president
of the corporation.
- says that night games have been scheduled by most every other team in the league in order to maximize revenue
and income. Du ring 1961-65, Cubs operated at a loss because of inadequate attendance at the home games
according to the and therefore concludes that if they continue to refuse to install lights at the field they will
continue to lose attendance. alleges that the funding for the lights could be obtained by financing and it would
be easily recaptured. He says that Wrigley won‟t allow it because he thinks that baseball is a daytime sport and
that play at night would deteriorate the surrounding neighborhood. The directors supposedly acquiesced to the
policy of Wrigley though the concern was not good faith motive for the corporation.
- alleges that directors are acting contrary and wholly unrelated to the business interest of the corp oration.
Arbitrary and capricious acts constitute mis management and waste of corporate assets. Additionally, alleges that
the directors have been negligent in failing to exercise reasonable care and prudence in the management of the
Whether the complaint states a cause of action when it does not allege fraud, illegality or conflict of interest in
mis management suit?
Affirmed dis missal of comp laint
- Argument – Courts should not step in absent a showing of fraud, illegality or conflict o f interest.
- Argument – That list is not exhaustive.
o Wheeler v. Pu llman: The majo rity shareholders must be permitted to control the business of the
corporation in their d iscretion, when not in vio lation of its charter or some public law or corruptly and
fraudulently subversive of the rights and interests of the corporation or of a shareholder.
o Davis v. Louisville Gas: The judgment of the directors of a corporation enjoys the benefit of a
presumption that it was formed in good faith and was designed to promote the best interest of the
corporation they serve – unless shown to be tainted with fraud.
- Argument – Dodge v. Ford Motor Co stated that there must be fraud or breach of good faith in order to justify
courts entering into the internal affairs of corporations.
- Court – It is not satisfied that the motives assigned to Wrigley and the other directors are contrary to the best
interest of the corporation and the stockholders. The decision is best left to the direc tors without any showing of
fraud, illegality or conflict of interest.
- Court – No actual damage to the corporation
- Argument – Failure to fo llo w the examp le of other major league clubs in scheduling night games constitutes
- Court – Nope – There must be a clear showing of derelict ion of duty on the part of the directors.
Smith v. Van Go rko m, Delaware Court of Chancery (1984) Casebook p. 392 – Director‟s duty of care
Francis v. United Jersey Bank, Supreme Court of New Jersey (1981) Casebook p. 412 – Director‟s Duty of Care
- Parties: The s are trustees in bankruptcy of Pritchard & Baird Intermediaries Corp. a reinsurance broker.
Overcash () is daughter of Pritchard and executrix of her estate. Pritchard was the largest single s hareholder and
she died after suit and before trial.
- The lit igation focuses on payments made by Pritchard to her 2 sons who were officers, d irectors and shareholders.
Trial court found Pritchard liable for negligence in losses caused by the sons. The appellate court affirmed.
Whether a corporate director is personally liable in negligence for the failure to prevent the misappropriation of trust fund s
by other directors who were also officers and shareholders of the corporation?
Affirmed decision of trial and appellate courts
1. Was Mrs. Pritchard negligence in not noticing and trying to prevent the misappropriation of funds held by the
corporation in an imp lied trust?
2. Whether her negligence was the pro ximate cause of the plaintiff‟s losses?
Graham v. Allis-Chalmers Manufacturing Co., Delaware Trial Court (1963) Casebook p. 426 – DIRECTOR‟S DUTY OF
FACTS and PP:
- (derivative action) against directors and four non-director employees because of guilty pleas based on
indict ments charging violations of Federal anti-trust laws. They want to recover damages, wh ich Allis -Chalmers
is claimed to have suffered due to the violations.
- Allis-Chalmers makes electrical equip ment with lots of employees. BOD meets once a month and has 4 officers on
it. The charges that were made against the defendants were that they conspired with other manufacturers and their
emp loyees to fix prices and use rig bids to private electric utilities and governmental agencies in v iolation of anti-
trust laws of the US.
- There was no evidence fro m the Federal Govern ment against the Defendant Directors in this case.
Whether or not a corporation‟s directors can be held liab le for the action of the employees?
Affirmed holding of lo wer court = the indiv idual director defendants are not liab le as a matter of law merely because,
unknown to them, some employees of Allis -Chalmers violated the anti-trust laws subjecting the corporation to loss.
Argument – The Defendants had actual knowledge of the anti-trust conduct upon which the indictments were based or in
the alternative knowledge of the facts which should have put them on notice of such conduct.
- Court: No evidence of actual knowledge during hearing or depositions.
- Failed to establish actual knowledge of imputed knowledge on the part of the BOD
New Argu ment – The Defendants are liable as a matter of law because they failed to take action designed to learn of and
prevent anti-trust activity on the part of any employees of Allis-Chalmers.
- The defendants are liab le for losses suffered by their corporation by reason of their gross inattention to the
common law duty of actively supervising and managing the corporate affairs.
- Rests on idea that the duty of care depends on the circu mstances and facts of the particular case.
Court: The directors were entitled to rely on the honesty and integrity of their subordinates until something occurs to put
them on notice that something is wrong.
Marciano v. Nasash – Delaware Court of Chancery (1987) Casebook p. 433 – Duty of Loyalty (General Princip les)
FACTS and PP:
- Defendants appeal validation of claim in liquidation of Gasoline Ltd. (corporation placed in custodial status
pursuant to DE business law because of deadlock among the BOD).
- 50% of Gasoline is owned by Joe and Nakash and the other 50% by Marciano
- Vice Chancellor ruled that §2.5 million in loans made by the Nakashes faction to Gasoline were valid and
enforceable debts of the corporation despite their origin in self-dealing transactions.
- This company was formed as a joint venture to market designer jeans (Guess jeans). Nakash owned Jordache and
decided to go in on this with the Marcianos.
- Prior to 3/ 86, Gasoline secured the necessary financing fro m Israel Discount Bank in N Y at 1% above prime
secured by Gasoline‟s accounts receivable and Nakashes‟ personal guarantee.
In re Wheelabrator Technologies, Inc. Shareholders Lit igation , Delaware Court of Chancery (1995) Casebook p. 438 –
MANAGEM ENT‟S DUTIES TO THE CORPORATION AND SHA REHOLDER RATIFICATION
FACTS and PP:
Whether or not shareholder ratification should operate to ext inguish a duty of loyalty claim against a director?
What are the legal consequences of a fully-in formed shareholder approval of a challenged transaction?
The court dealt with ‟s MSJ in fo llo wing way: 1) granted for disclosure claim; 2) g ranted for duty of care claim; 3) denied
as to duty of loyalty claim.
- Acts of directors can be void or voidable.
o Vo idable acts are those that are performed in the interest of the corporation but beyond authority and are
curable by shareholder approval.
o Vo id acts are those that are ultra vires, fraudulent or involve corporate waste and are not curable by
- Shareholder rat ification of voidable d irector conduct has extinguished claims against the director when:
o Director acted in good faith, but exceeded the board‟s de jure authority.
o Directors failed to reach an informed business judgment in approving a transaction.
- Ratificat ion decisions that involve duty of loyalty claims include:
o Interested transactions between a corporation and its directors;
This will not be voidable if it is approved in good faith by a majority of the disinterested
shareholders because it invokes the business judgment rule and limits judicial review to issues of
gift or waste.
o Cases involving a transaction between the corporation and its controlling shareholder.
These involve primarily parent-subsidiary mergers conditioned upon getting majo rity of the
minority stockholder approval.
In parent-subsidiary merger, standard of review is entire fairness and BOD has to prove that the
merger was entirely fair.
Where merger is conditioned upon majority of the minority approval, the burden shifts to the
- A FULLY-INFORM ED SHA REHOLDER VOTE OPERATES TO EXTINGUISH A CLA IM:
o Where the BOD takes action that is claimed to exceed the board‟s authority; or
o Where the BOD failed to exercise due care to adequately inform itself before co mmitt ing the corporation
to a transaction.
- SHA REHOLDER RATIFICATION DOES NOT AUTOMATICA LLY EXTINGUISH A CLAIM FOR BREA CH
OF DIRECTOR‟S DUTY OF LOYA LTY.
- THE EFFECT OF SHA REHOLDER RATIFICATION IN DUTY OF LOYA LTY CASES HAS BEEN:
o Change the standard of review to the business judgment rule with burd en of proof resting on the plaintiff;
o Leave entire fairness as standard of review but shifting burden of proof to the plaintiff.
1. Notes about Marciano and this case.
2. New section in the MBCA
Sinclair Oil Corp. v. Levien, Delaware Supreme Court (1971) Casebook p. 442 – PARENT-S UBS IDIARY DEALINGS
FACTS and PP:
Sinclair is a holding company primarily in the oil business. It owned 97% of Sinven stock.
The Plaintiff (Levien) o wned 300 of the 120,000 shares of Sinven.
Sinven was incorporated in 1922 and has been oil co mpany mainly in Venezuela.
Sinclair is responsible for no minating all members of Sinven‟s BOD and the trial court found that the directors were not
independent from Sinclair because they were in so me way related to Sinclair. The t rial co urt found that and this court
determined that: because of Sinclair‟s domination, it is clear that Sinclair owed Sinven a fi duciary duty.
- says that from 1960-66 Sinclair caused Sinven to pay out excessive dividends and causing industrial
development to be prevented.
- Fro m 1960-66, Sinven paid out $108 million $38 million more than earnings. Sinclair could not prove that these
transactions were intrinsically fair to the minority shareholders of Sinven.
This action was a derivative action requiring Sinclair to account for damages sustained by its subsidiary Sinven because of
dividends, denial of industrial development and breach of contract. Sinclair appeals the requirement.
The trial court held that because of the fiduciary duty and control over Sinven, th e relationship with Sinven must meet the
intrinsic fairness test – where Sinclair had to prove that its transactions with Sinven were objectively fair.
1. Were the dividends self-dealing and therefore subject to the intrinsic fairness test?
2. If not, did they deny Sinven of industrial develop ment and which test should be applied to this?
- Argument: The transactions between it and Sinven should be tested by the business judgment rule where the
court will not interfere unless there is a showing of gross and palpable overreaching.
- Court: Where it is a parent-subsidiary relationship, the business judgment rule is not applied but the intrinsic
fairness test is used. The basic situation for the application for the rule is one in wh ich the parent has received a
benefit to the exclusion and the expense of the subsidiary.
- Precedent: As long as the parent does not receive any benefit, the business judgment rule is properly applied.
- A parent owes fiduciary duty to subsidiary in dealings between the two.
- Self-dealing occurs when the parent causes the subsidiary to act in such a way that the parent receives something
fro m the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary.
- If a can meet h is burden of proving that a dividend cannot be grounded on any reasonable business objective,
then the courts can and will interfere with the board‟s decision to pay the dividend.
- Argument: It is imp roper to apply the intrinsic fairness standard to dividend paymen ts.
- Court: If such a dividend is in essence self-dealing by the parent, then the intrinsic fairness standard is the proper
- ISSUE: Were the div idend payments by Sinven self-dealing by Sinclair?
o The minority shareholders of Sinven got a proportionate share of money.
o As a result the dividends were not self-dealing.
o The business judgment standard should have been applied.
- ISSUE: Did Sinclair h inder the industrial develop ment in such a way to be self-dealing?
Carpenter v. United States, USSC (1987) Casebook p. 530
- In 1981, Winans was reporter for Wall Street Journal and in 1982 became one of 2 writers of daily colu mn –
“Heard on the Street” wh ich discussed stocks with info rmation about them. To do this he interviewed corporate
- Because of what was said in this colu mn and its perceived quality and integrity, it had the potential to affect the
price of stocks that were examined in it.
- Prior to publication, the contents of the columns were the Journal‟s confidential info rmation. Despite that rule,
Winans entered into a scheme in 10/ 83 with Brant and Felis (both with Peabody brokerage firm in NY) to give
them advance informat ion about the Heard column. Brant and Felis then allo wed Clark (a client of theirs) to buy
or sell based on the probable impact of the colu mn on the market. They shared the profits. They made about
- In 11/93, Peabody noticed the correlations and inquiries began. Then SEC got involved and eventually Winans
and Carpenter went to SEC and told them the whole scheme.
- The District Court found that Winans had knowingly breached a duty of confidentiality by misappropriating
prepublication information regarding the timing and contents of the Heard colu mn – and although the Journal was
not a party to the trading in was nevertheless considered to be in connection with a purchase or sale of securities
within the mean ing of the statute and the rule.
o The scheme‟s sole purpose was to buy and sell securities at a profit based on advance information of the
contents of the column.
- Felis and Winans were convicted of violating 10(b ), 10b-5 and additional other federal vio lations.
- Carpenter was convicted for aiding and abetting.
- COA affirmed the trial court holding.
United States v. O‟Hagan, USSC (1997) Casebook p. 534 – THE SCOPE OF DUTY TO DISCLOSE OR ABSTAIN
- O‟Hagan was partner in law firm in Minnesota.
- In 1988, Grand Met (an English corporation) retained his firm as counsel to represent them in a potential tender
offer for the co mmon stock of Pillsbury Co. (a M innesota company).
- Both GM and law firm made efforts to protect the confidentiality of the tender offer plans.
- O‟Hagan did no work on the deal.
- In 9/88, the law firm withdrew as counsel and less than 1 month later, GM announced the tender offer publicly.
- On 8/ 18/ 88, while the firm was still representing GM , O‟Hagan began buying call options for Pillsbury stock
which gave him the right to but 100 shares of Pillsbury stock by specified date in September of that year.
Additionally he kept on buying options and common stock until the tender offer was announced.
- When GM made the offer on 10/ 4, O‟Hagan made $4.3 million on the stock he bought.
- SEC began investigating O‟Hagan which led to 57 count indict ment allegin g that he:
o Defrauded his law firm and their client by using non-public information for his own personal gain;
o Used the money to cover embezzlement and conversion of trust accounts;
o Co mmitted mail fraud, securities fraud, fraudulent trading in connection with tender offer and violated
money laundering statutes.
- At jury trial he was convicted of all counts and sentenced to about 3 ½ years in imp risonment.
- COA reversed all of the convictions by a divided court holding the following:
o Liability under 10b-5 may not be grounded on the misappropriation theory of securities fraud.
o Rule 14e-3(a) (which p rohibits trading while in possession of material, non -public information relating to
a tender offer) exceeds the SEC‟s rulemaking authority because it didn‟t require a breach of fiduciary
o The other convictions rested on the violation of the securities laws and therefore could not stand once the
other convictions were reversed.
- First issue relates to the misappropriation of material, nonpublic information for securit ies tradition
o Is a person who trades in securities for personal profit, using confidential informat ion misappropriated in
breach of a fiduciary duty to the source of the information, guilty of v iolating 10b -5?
- Second issue relates to fraudulent practices in the tender offer setting.
o Did the SEC exceed its rulemaking authority by adopting Rule 14e -3(a), wh ich proscribes trading on
undisclosed information in the tender offer setting, even in the absence of a duty to disclose.
Issue One: A person who trades in securities for personal profit is guilty of v iolating 10b -5 when they use confidential
informat ion misappropriated in breach of fiduciary duty.
Issue Two: The SEC did not exceed its authority in rulemaking that trading on undisclosed informat ion in the tender offer
setting is prohibited under Rule 14e-3(a).
1. The 10b -5 convictions may be predicated on the misappropriation theory
- §10b prohib its using any deceptive devices in connection with the purchase or sale of securit ies in contravention of
rules made by the Co mmission.
- The statute reaches to any deceptive devices used in connection with the purchase or sale of any security.
- Rule 10b-5 and hence §10b are violated (under trad itional or classical theory of insider tradin g liab ility) when a
corporate insider trades in the securities of his corporation on the basis of material, nonpublic info rmation because
it qualifies as a deceptive device under 10b because a relat ionship of trust and confidence exists between
shareholders of corporation and insiders who have obtained the informat ion because of their position inside the
o The classical theory applies to officers, d irectors and other permanent insiders of a corporation AND to
others who temporarily become fiduciaries of a corporation.
- The “misappropriation” theory, as opposed to the classical theory holds that: “a person commits fraud in
connection with a securities transaction and thereby violates 10b -5 when he misappropriates confidential
information for securities trading purposes, in breach of a duty owed to the source of the information.
o Liability is premised on a fiduciary-turned-trader‟s deception of those who entrusted him with access to
confidential informat ion.
- The two theories, classical and misappropriation complement each other because one deals with the duty to the
shareholders and the other with duty to fiduciaries of the shareholders.
o Deception: required that he feigns fidelity to the source of the information.
o Connection with purchase or sale of security: fraud is consummated when he uses the informat ion to get
- Theory behind the theory: A misappropriator who trades on the basis of material nonpublic in formation, in short,
gains his advantageous market position through deception; he deceives the source of the information and then
harms members of the investing public.
o It catches fraudulent means of capitalizing on confidential information through securities transactions.
o The theory gels with the purpose of the act: to insure honest securities markets and promote investor
- This case: Proper to use misappropriation theory because it met the statutory requirement that there was “deceptive
conduct in connection with securities transactions.”
- Problem with the COA argu ment: They said there needed to be a breach of duty to parties in a securities
transaction or to other market part icipants. This court said that the statute does not require that.
2. Fraudulent trading in connection with a tender offer in vio lation of 14e -3(a): Did the SEC exceed its rulemaking
authority in its adoption of 14e-3(a) without requiring a showing that the trading at issue entailed a breach of
- The authority comes fro m the second section of §14(e) which delegates definitional and prophylactic rulemaking
- The Act was designed to make d isclosure rather than court-imposed principles of fairness or artificiality the
preferred method of market regulation.
- 14e-3(a): Disclose and abstain fro m t rading requirement which is violated when one trades on the basis of material
non-public informat ion concerning a pending tender offer that he knows or has reason to know has been acquired
directly or indirectly fro m an insider or someone working on their behalf. A duty is created to disclos e or abstain
fro m using the informat ion without regard to whether the trader owes a pre-existing fiduciary duty to respect
- USSC states that SEC may prohib it acts that aren‟t fraudulent under common law if it is reasonably designed to
prevent acts and practices that are fraudulent.
Scalia‟s DISSENT/ CONCURRENCE:
Dissents to the 10b-5 d iscussion: Must construe 10b-5 to require the manipulat ion or deception of a party to a securities
1. Misappropriation theory fails to provide a coherent and consistent interpretation of the requirement of use or
emp loyment of the deceptive device in connection with the purchase or sale of any security.
2. There was no relevant or underlying fraud against which 14e-3(a) reasonably provides prophylaxis.