Partnership Agreement Owned by Corporations by pvl12698


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Supplement for Ninth Edition of Casebook

Insert the following as II. E. 1. a. at p. 12, and reletter subsequent paragraph accord-

          a.   Apparent authority of the general partner--

RNR Investments Limited Partnership v. Peoples First Community
Bank, 812 So. 2d 561 (Fla. Dist. Ct. App. 2002).

Facts. RNR (D) was formed as a Florida limited partnership. The partnership agree-
ment provided specific limitations on the authority of the general partner, including
restricting the general partner’s ability to borrow funds of a certain amount without the
prior written consent of the limited partner. The general partner entered into a con-
struction loan agreement, note, and mortgage with Peoples First Community Bank (P)
without proper authority. D defaulted under the terms of the loan, and P sought fore-
closure. D claimed that P had negligently failed to investigate and realize that the
general partner had no authority to enter into the loan. The trial court entered summary
judgment for P, and D appeals.

Issue. Did the general partner have apparent authority to bind the partnership to the
loan agreement?

Held. Yes. Judgment affirmed.

♦      The determination of whether a partner is acting with authority to bind the
       partnership is a two-step analysis. The first issue is whether the partner is car-
       rying on the partnership business in the usual way or the business is of the kind
       typically carried on by the partnership. Here the general partner was clearly
       carrying on D’s business in the usual way.

♦      The second issue is whether the other party knew or had notice that the partner
       lacked authority to bind the partnership. D argues that P had constructive knowl-
       edge of the restrictions on the general partner’s authority and was obligated to
       inquire about the general partner’s authority. We do not agree. P could rely on
       the general partner’s apparent authority unless it had actual knowledge or no-
       tice of the restrictions on that authority. There is no allegation that P had knowl-
       edge or notice of the restrictions on D’s general partner.

                                                                   Corporations Supplement - 1
      Insert the following as II. G. 2. b. 4) at p. 16:

                      4)   No ability to independently add new partners--

      Rapoport v. 55 Perry Co., 376 N.Y.S.2d 147 (N.Y. App. Div. 1975).

      Facts. Simon, Genia, and Ury Rapoport (Ps) entered into a partnership agreement with
      Morton, Jerome, and Burton Parnes (Ds), forming the 55 Perry Company (D). Each
      family owned 50% of the partnership. Simon and Genia later assigned 10% of their
      interest to their adult children, Daniel and Kalia. Ps requested that Ds execute an
      amended partnership agreement to reflect this change. They refused, arguing that the
      partnership agreement did not permit the introduction of new partners without the
      consent of all existing partners. Ps brought an action seeking to have Daniel and Kalia
      declared partners. The lower court denied both parties’ motions for summary judg-
      ment and both parties appeal.

      Issue. Does the introduction of new partners require the consent of all the partners?

      Held. Yes. Summary judgment granted for Ds.

      ♦       The partnership agreement states that no partner has the authority to transfer
              any share in the partnership to another party without the written consent of the
              majority of the partners, except to members of the partner’s immediate family
              who have attained majority. Ps argue that this provision authorizes entry of
              their adult children into the partnership. Ds maintain that this only allows a
              partner to transfer a share of profits in the partnership. We agree with Ds.

      ♦       Partnership law provides that unless the partnership agreement states other-
              wise, no person can become a member of a partnership without the consent of
              all of the partners. Furthermore, an assignee of an interest in a partnership is
              not entitled to “interfere” in the business but is merely entitled to receive the
              profits to which the assigning partners would otherwise be entitled.

      ♦       The partnership agreement at issue here appears to follow these rules. In a
              different section, it specifically provides that in the event of the death of any
              partner, that partner’s heir would succeed to all of the privileges and obliga-
              tions of the partner. This language is missing from the paragraph allowing a
              partner to transfer an interest to an adult child. Thus it appears that that section
              was merely intended to limit the right to assign an interest to the adult children
              of partners.

      Dissent. The partnership agreement as written is ambiguous, and there is a triable
      issue as to intent.

2 - Corporations Supplement
Insert the following as IV. B. 5. at p. 40, and renumber subsequent paragraph accord-

     5.     Shareholders’ Rights Plans--

International Brotherhood of Teamsters v. Fleming Companies, Inc.,
975 P.2d 907 (Okla. 1999).

Facts. The International Brotherhood of Teamsters (P) owned 65 shares of the Fleming
(D) stock. As an anti-takeover mechanism, D’s board of directors implemented a
“shareholder’s rights plan,” also known as a “poison pill.” Such plans give boards of
directors authority to adopt discriminatory shareholder rights, making a takeover diffi-
cult and assisting incumbent management in maintaining control of a company. P was
critical of the plan and mounted an effort to change it. P proposed an amendment to the
company’s bylaws that would require any such rights plan implemented by the board
to be put to the shareholders for a vote. D refused to include the resolution in the proxy
statement. P brought an action to get a vote on the proxy. The court found for P, and D
appealed. The appellate court certified the following question of law to the state su-
preme court.

Issue. Does Oklahoma law (i) restrict the authority to create and implement share-
holder rights plans exclusively to the board of directors, or (ii) allow shareholders to
propose resolutions requiring that shareholder rights plans be submitted to the share-
holders for vote at the succeeding annual meeting?

Held. (i) No. (ii) Yes. There is no exclusive authority granted boards of directors to
create and implement shareholder rights plans.

♦         D maintains that the board of directors has authority to create shareholder rights
          plans, subject only to limits that exist in the corporation’s certification of in-
          corporation, and that shareholders cannot restrict this power through the by-
          laws. P argues that the shareholders of a corporation have the authority to adopt
          bylaws on a broad range of topics. The question is ultimately what degree of
          control shareholders can exact upon the corporation.

♦         Generally, the role of shareholders is indirect. A corporation may create and
          issue rights and options. However, it does not automatically translate that the
          board of directors of that corporation has in itself the same authority. A share-
          holder rights plan is essentially a variety of a stock option plan. There is author-
          ity supporting shareholder ratification of stock option plans.

♦         There is nothing in D’s certificate that speaks to the board’s authority or share-
          holder constraints regarding shareholder rights plans. Furthermore, there is no
          shareholder rights plan endorsement statute in this state.

                                                                      Corporations Supplement - 3
      Insert the following as V. C. 3. a. 3) a) at p. 64:

                           a)   Significant propensity to affect the voting process--

      Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970).

      Facts. Shareholders (Ps) of the Electric Auto-Lite Company (D) brought suit to stop
      voting on a proposed merger of D with Mergenthaler Linotype Company and Ameri-
      can Manufacturing Company. Ps alleged the proxy statement sent out by D’s manage-
      ment to solicit votes in favor of the merger was misleading. Mergenthaler owned over
      50% of the outstanding shares of D and had been in control of D for two years. Further-
      more, American manufacturing owned about one-third of Mergenthaler. The proxy
      statement failed to reveal that all 11 of D’s directors, who were recommending the
      merger, were nominees of Mergenthaler. The lower court found as a matter of law that
      this was a material omission and after a hearing determined that a causal relationship
      had been shown. Ds appealed. The district court agreed that the proxy statement was
      materially deficient but reversed on the issue of causation. The court held that if D
      could show that the merger would have received sufficient votes even if the proxy
      statement had not been misleading, Ps would not be entitled to relief. The Supreme
      Court granted certiorari.

      Issue. Must the plaintiff show that the defect had a decisive effect on voting?

      Held. No. Judgment vacated and case remanded.

      ♦      Fair corporate suffrage is an important right. The rule set forth by the district
             court would subvert this right. Even outrageous misrepresentations in the proxy
             solicitation, if they did not relate to the terms of the transaction, would give rise
             to no cause of action.

      ♦      Use of a solicitation that is materially misleading is a violation of law. When a
             misstatement is shown to be “material,” that in itself shows that the defect
             might have been considered important by a reasonable shareholder in deciding
             how to vote. The requirement is only that the defect has a significant propen-
             sity to affect the voting process. There is no need to prove that the defect actu-
             ally had a decisive effect on the voting.

      Insert the following as VII. A. 4. a. at p. 95:

                a.   Fiduciary duties of directors--

      In re USACafes, L.P. Litigation, 600 A.2d 43 (Del. Ch. 1991).

4 - Corporations Supplement
Facts. Holders of limited partnership units (Ps) of USACafes brought suit against the
partnership, the corporate general partner, and its directors, and Metsa Acquisition
Corp. (Ds). Metsa purchased substantially all of the assets of the partnership. Ps allege
that the sale was at an unfair low price in favor of Metsa in exchange for substantial
side payments to the directors of the general partner. Ds filed a motion to dismiss
under the theory that only the general partner itself owed a duty to the limited partner-

Issue. Do directors of a corporate general partner have a fiduciary duty to the partner-

Held. Yes. Motion to dismiss denied.

♦         Under general principles of fiduciary duty, one who controls property of an-
          other may not, without implied or express agreement, intentionally use that
          property in a way that benefits the holder of the control to the detriment of the
          property or its beneficial owner. Thus, at a minimum, there is a duty not to use
          control over the partnership’s property to advantage the corporate director at
          the expense of the partnership, as is alleged here. It is not necessary to delineate
          the full scope of that duty at this time. The complaint does state a claim upon
          which relief can be granted.

Insert the following as VII. B. 3. at p. 98:

     3.     Fiduciary Duty--

Solar Cells, Inc. v. True North Partners, LLC, 2002 WL 749163 (Del.
Ch. 2002).

Facts. Solar Cells (P) is an Ohio corporation formed to develop and manufacture solar
power technology. P and True North (D), an LLC, together formed First Solar, an
LLC. First Solar’s operating agreement provided that P was to provide patented and
proprietary technology and D was to contribute capital and a loan. Both P and D each
received equal amounts of First Solar’s Class A membership units. P received 100% of
First Solar’s Class B membership units, which had no voting rights. P was unsuccess-
ful in developing a marketable product, and eventually D had to make an additional
loan to First Solar. The new loan agreement allowed D to convert its outstanding loans
into additional Class A units. D did so and used its new majority ownership of the
membership units to approve a merger of First Solar into First Solar Operating, an
LLC wholly owned by D. P has filed for a temporary restraining order to enjoin the
proposed merger.

Issue. Is there a reasonable likelihood that P will be successful on the merits in its

                                                                      Corporations Supplement - 5
      claim of breach of fiduciary duty, and is P threatened by irreparable harm if the merger
      is not stopped?

      Held. Yes. Motion for preliminary injunction granted.

      ♦         D argues that the operating agreement limited any fiduciary duties owed by D
                managers. The agreement only limits liability; it is not a waiver of all fiduciary
                duties. D managers must act in “good faith.” It is undisputed that First Solar
                was in financial trouble for months. When the full board of managers met, D
                managers made no mention of a planned merger, yet the very next day they
                approved the merger. No effort was made to inform P managers until a week
                before the consummation of the merger was to occur. These actions do not
                appear to be those of fiduciaries acting in good faith.

      ♦         D argues that there is nothing inherently unfair about the structure of the merger,
                but as P points out, all of the decisions regarding the merger were made unilat-
                erally by D. P’s voting rights would be diluted from an equal voice to only 5%.

      ♦         In addition to the issue of fair dealing, there is also the issue of fair price. The
                merger is based on a valuation of First Solar that is less than one-third of the
                value of the company as calculated only five months earlier. There is a reason-
                able probability that the latest valuation of the company was not entirely fair.

      ♦         Finally, to show irreparable harm, the injury must be one for which money
                damages will not be an adequate remedy. If the proposed merger occurs, P will
                lose the right to appoint managers of the managing board.

      Insert the following as VIII. A. 8. at p. 107:

           8.     Liability Shields--

      Malpiede v. Townson, 780 A.2d 1075 (Del. 2001).

      Facts. Frederick’s of Hollywood (“Frederick’s”) is a retailer of women’s lingerie. The
      founders of Frederick’s (the “Trusts”) held about 41% of the Class A voting shares and
      51% of the Class B non-voting shares. Frederick’s board (D) announced a search for a
      buyer for the company. Knightsbridge Capital Corporations (“Knightsbridge”) initially
      offered to purchase all outstanding shares for between $6.00 and $6.25 per share. D
      then received an unsolicited offer of $7 per share from another bidder, Milton Partners.
      After this offer was made, Knightsbridge entered into an agreement to purchase all of
      the Trusts’ shares for $6.90 per share. Knightsbridge was granted a proxy to vote the
      Trusts’ shares, but the Trusts had a right to terminate the agreement if D rejected
      Knightsbridge’s offer. D then received another unsolicited offer of $7.75 per share
      from Veritas Capital Fund (“Veritas”). Knightsbridge amended its purchase agree-

6 - Corporations Supplement
ment with the Trusts to eliminate the Trusts’ termination right, purchased the Trusts’
shares, and informed D of its intention to vote the shares against any competing third
party bids. Knightsbridge increased its bid to match the $7.75 offer, but included terms
to restrict D from pursuing any other offers. D approved the agreement. Veritas in-
creased its offer to $9.00 per share, but D rejected the bid. The stockholders (Ps) filed
a class action complaint for damages for rejection of the higher offer. Ps allege that D
has breached its fiduciary duties in connection with the sale of the company. The Court
of Chancery granted D’s motion to dismiss under Chancery Rule 12(b)(6), concluding
that the complaint did not support a claim of breach of D’s duty of loyalty, and that
Frederick’s charter precluded money damages against the directors for breach of the
duty of care. Ps appeal.

Issue. Does the exculpatory provision in the corporations’ charter bar any claim for
damages against the directors based solely on the board’s alleged breach of its duty of

Held. Yes. Judgment affirmed.

♦         The merger was approved by a majority of disinterested directors.

♦         Ps claim that the sale constituted a breach of D’s fiduciary obligation to maxi-
          mize shareholder value. Even if we assume that facts exist that show gross
          negligence during the board’s auction process, section 102(b)(7) of the
          corporation’s charter bars Ps’ claim. That provision exempts directors from
          personal liability in damages with certain exceptions that are not applicable

♦         Ps claim that the complaint also alleges breaches of the duty of loyalty. We
          disagree. The pleadings fail to properly invoke loyalty or bad faith claims. This
          case is based solely on the breach of the duty of care.

Insert the following as VIII. B. 2. at p. 108:

     2.     Illegal Acts--

Miller v. American Telephone & Telegraph Co., 507 F.2d 759 (3rd
Cir. 1974).

Facts. Stockholders (Ps) in American Telephone and Telegraph Company (“AT&T”)
brought a stockholders’ derivative action against AT&T and all but one of the direc-
tors (Ds). Ps alleged that the company failed to collect an outstanding debt of $1.5
million owed to it by the Democratic National Committee (“DNC”) for communica-
tions services provided by AT&T during the 1968 Democratic national convention.

                                                                    Corporations Supplement - 7
      The district court dismissed the complaint for failure to state a claim upon which relief
      could be granted. The court held that the collection procedures were properly within
      the discretion of the directors. Ps appeal.

      Issue. Does Ps’ complaint state a claim upon which relief can be granted for breach of
      fiduciary duty?

      Held. Yes. Judgment reversed and case remanded.

      ♦      AT&T is incorporated in New York, so New York law applies.

      ♦      The sound business judgment rule protects corporate decisionmaking from ju-
             dicial intervention, provided it is exercised in good faith. If this were merely a
             case of failure to pursue a corporate claim, the sound business judgment rule
             would apply. Here, however, Ps allege that D’s decision not to collect the debt
             is actually an illegal act in the form of an illegal campaign contribution. As a
             matter of public policy, illegal acts may amount to a breach of fiduciary duty.
             Furthermore, Ps are within the class for whose protection the statute prohibit-
             ing corporate political contributions was enacted to protect. Thus the com-
             plaint does state a claim upon which relief can be granted.

      Insert the following as IX. E. 1. e. at p. 116, and reletter subsequent paragraph ac-

                e.   Undisclosed profits--

      Hawaiian International Finances, Inc. v. Pablo, 488 P.2d 1172 (Haw.

      Facts. Pastor Pablo and his wife Rufina (Ds) were directors of Pablo Realty (D). Pablo
      was also president of Hawaiian International Finances, Inc. (P). Ds advised P of attrac-
      tive real estate investment opportunities in California. P’s board of directors appointed
      a subcommittee, including Pablo, to represent P in purchasing some land. The sellers
      were represented by California real estate brokers, who eventually split their commis-
      sions from the sellers with Pablo. P did not know of the commissions. The trial court
      held that under the particular facts of the case Pablo committed no wrong. P appeals.

      Issue. Can a corporate officer and director, acting for the corporation in the purchase
      of investment real estate, retain a commission received from the real estate brokers
      representing the sellers, absent disclosure and an agreement with the corporation?

      Held. No. Judgment reversed.

8 - Corporations Supplement
♦         It is widely held that a director, while engaged in a transaction for his corpora-
          tion, cannot retain an undisclosed profit. It does not matter if there is no harm
          done to the corporation; any money received is held in constructive trust for
          the corporation.

♦         Ds argue that P could not have lawfully shared in the commission because P
          was not a licensed real estate broker. Even if this is true, it is not determinative.
          Had P known of the commission, P could have negotiated for a price less that

Insert the following as IX. F. 4. at p. 119, and renumber subsequent paragraphs ac-

     4.     Fiduciary Duty of Majority Stockholders--

Zahn v. Transamerica Corporation, 162 F.2d 36 (3rd Cir. 1947).

Facts. Zahn (P) brought suit against Transamerica Corporation (D) on behalf of him-
self and other stockholders of Class A common stock of Axton-Fisher Tobacco Com-
pany (“Axton-Fisher”). Axton-Fisher had three classes of stock: preferred stock, Class
A stock, and Class B stock. Class A stock was entitled to receive $3.20 per share
annual dividend and Class B stock was to receive $1.60 per share. Upon liquidation of
the company, Class A stock was entitled to share with the class B stock in the distribu-
tion of the remaining assets, with Class A stock receiving twice as much per share as
Class B. Class A stock was callable by the board of directors of the corporation for $60
per share with 60 days’ notice to the stockholders. D had virtually all of the Class B
stock and control over the board of directors. Axton-Fisher acquired some leaf to-
bacco, that unbeknownst to the shareholders of Class A stock, but known to D, had
sharply risen in value from just over $6 million to $20 million. The board of directors
called in all of the class A stock at the predetermined value of $60 per share. Then the
company was liquidated, with D retaining most of the profit from the leaf tobacco. P
alleged that D wrongly caused Axton-Fisher to redeem the Class A shares rather than
allowing the Class A stockholders to participate in the subsequent liquidation of the
corporation. The lower court granted D’s motion to dismiss, and P appeals.

Issue. May directors take corporate actions, such as calling a class of stock, for per-
sonal profit?

Held. No. Judgment reversed.

♦         The majority has a right to control, but it also has a fiduciary relation to the
          minority. When a majority stockholder votes as a stockholder, he has the right
          to vote for his own benefit. When he votes as a director, however, he represents

                                                                       Corporations Supplement - 9
                all the stockholders in the capacity of trustee and cannot use his office as a
                director for his personal benefit at the expense of the other stockholders.

      ♦         It is settled law that directors may not declare or withhold the declaration of
                dividends for the purpose of personal profit, or by analogy, take other corpo-
                rate action such as the calling of a class of stock, for such a purpose. Under the
                allegations of the complaint, there was no reason for the redemption of the
                Class A stock followed by the liquidation of the corporation, except to enable
                the Class B stock to profit at the expense of the Class A stock. If the allegations
                are proven, P can maintain his cause of action to recover the difference be-
                tween the amount received by him for the share and the amount that he would
                have received on liquidation.

      Comment. In a subsequent proceeding, the Third Circuit held that the call of Class A
      stock was rightful.

      Insert the following as IX. F. 7. at p. 121:

           7.     Duty to Minority Shareholders--

      Jones v. H.F. Ahmanson & Co., 460 P.2d 464 (Cal. 1969).

      Facts. Jones (P) is a minority shareholder in United Savings and Loan Association of
      California (“the Association”). The Association was a closely held corporation, and its
      shares were not actively traded. Market interest in savings and loan corporations began
      to grow. Certain majority shareholders (Ds) in the Association came together and formed
      the United Financial Corporation of California (“United Financial”). Ds traded their
      Association stock for stock in United Financial, resulting in United Financial holding
      85% of the Association’s stock. The minority shareholders were not offered an oppor-
      tunity to exchange their shares. Ds controlled the Association through the holding
      company. Ds then marketed United Financial for public trading and made a profit. P
      brought suit on behalf of herself and all similarly situated minority stockholders of the
      Association. She alleged that Ds breached the fiduciary duty owed by majority share-
      holders to minority shareholders. The lower court sustained Ds’ general and special
      demurrers. P appeals.

      Issue. Did Ds violate their fiduciary duties to the Association by forming United Fi-
      nancial and marketing its shares?

      Held. Yes. Judgment reversed.

      ♦         Majority shareholders have a fiduciary responsibility to the minority share-
                holders and to the corporation to control the corporation in a fair, just, and

10 - Corporations Supplement
       equitable manner. A potential for abuse arises when a controlling shareholder
       sells his shares at a premium over investment value. When control of a corpo-
       ration is acquired by purchase of less than all of the shares, the acquired
       company’s existence is not affected legally, but commercially, the acquired
       company becomes in essence a subsidiary of the acquiring company. This may
       leave the minority in an unhappy situation. The parent company will wish to
       operate the subsidiary for the benefit of the group, not necessarily for the ben-
       efit of that particular subsidiary. Furthermore, as the purchasing corporation’s
       interest approaches 100%, the market for stock in the original company disap-

♦      Here, Ds owed a majority of the outstanding stock of the Association during a
       period of unusual investor interest in savings and loans. Stock in the Associa-
       tion was not readily marketable due to its high book value, lack of investor
       information and facilities, and the closely held nature of the Association. How-
       ever, Ds made no effort to create a market for Association stock. It appears that
       the market created by Ds for United Financial shares would have been avail-
       able for Association stock had Ds made that effort.

♦      Instead, Ds formed a new corporation, excluding the minority shareholders.
       This made it certain that no market could or would be created for Association
       stock. Ds used their control to obtain an advantage not made available to all
       stockholders, without regard to the resulting detriment to the minority stock-
       holders, and in the absence of any compelling business purpose. This violates
       the duty of good faith.

Insert the following as IX. G. 3. b. 3) a) at p. 123:

                     a)   Right to resign--

Gerdes v. Reynolds, 28 N.Y.S.2d 622 (N.Y. Sup. Ct. 1941).

Facts. The defendants (Ds) were officers and directors of Reynolds Investing Com-
pany (“Reynolds”). They, along with their families, were also the majority sharehold-
ers of Reynolds. Sartell Prentice set out to purchase Reynolds and offered Ds a premium
for their stock and their immediate resignation as directors and officers. There was no
substantial investigation by Ds into Prentice’s financial situation. Prentice had a re-
puted relationship with the Rockefeller family, but no such relationship ever existed.
Ds agreed to the sale and stepped down. No notice was given to the other shareholders.
The company’s assets were immediately wasted and improperly applied by Prentice.
Trustees of the company appointed in bankruptcy (Ps) now seek to hold Ds account-

Issue. Are directors limited in their right to resign by their fiduciary duties?

                                                                  Corporations Supplement - 11
      Held. Yes. Ds must account to the corporation for damages.

      ♦      Officers and directors have a right to resign, but it is qualified by their fiduciary
             obligations. It would be illegal for the officers and directors to resign and elect
             as their successors persons they knew intended to loot the corporation’s trea-
             sury. Here, while Ds had no actual knowledge of Prentice’s plans, they can be
             charged with notice of such an intention. The price paid was so grossly in ex-
             cess of the value of the stock, it was sufficient to give Ds notice of Prentice’s
             fraudulent intent.

      Insert the following as IX. G. 3. b. 5) a) at p. 125, and reletter subsequent paragraph

                           a)   Premium paid for control--

      Brecher v. Gregg, 392 N.Y.S.2d 776 (N.Y. Sup. Ct. 1975).

      Facts. Lin Broadcasting Corporation (“LIN”) was founded by Frederic Gregg (D), and
      D served as LIN’s president. The Saturday Evening Post Company (“SEPCO”) con-
      tracted with D to purchase his shares at a premium. Brecher (P), a minority shareholder
      of LIN, brought a shareholders’ derivative action, alleging that the premium was ille-
      gally paid in exchange for D’s promise to resign as president of LIN and bring about
      the immediate election of SEPCO’s nominees as directors and president. P contends
      that the corporation is entitled to receive the premium that D received in the sale.

      Issue. May a premium be paid for stock in exchange for a promise of control of the

      Held. No.

      ♦      As a matter of law, the agreement, insofar as it provided a premium in ex-
             change for a promise of control of the company, was contrary to public policy
             and illegal. Clearly, D must forfeit to the company any illegal profit derived
             from his sale of stock.

      Insert the following as X. C. 2. c. 8) d) at p. 149:

                           d)   Deception required--

      Santa Fe Industries, Inc. v. Green, 430 U.S. 462 (1977).

12 - Corporations Supplement
Facts. Santa Fe Industries (D) acquired control of 60% of the stock of Kirby Lumber
Corporation (“Kirby”). Through a series of purchases, D later increased its control to
95% of the corporation. D then invoked section 253 of Delaware Corporation Law,
which permits a parent corporation owning at least 90% of the stock of a subsidiary to
merge with that subsidiary upon approval by the parent’s board of directors and upon
making a cash payment for the shares of the minority stockholders. The consent of the
minority stockholders is not required. D obtained an appraisal of Kirby’s assets and
submitted this, along with other financial information, to Morgan Stanley & Co. (“Mor-
gan Stanley”), an investment banking firm, to appraise the fair market value of the
Kirby stock. Based on Morgan Stanley’s findings, the minority stockholders (Ps) were
offered $150 per share. Ps filed suit in federal court, claiming that the stock was worth
at least $772 per share and that the appraisal from Morgan Stanley was fraudulent. The
district court dismissed Ps’ complaint for failure to state a claim. The court of appeals
reversed, and the Supreme Court granted certiorari.

Issue. Does a breach of fiduciary duty, without any deception, misrepresentation, or
nondisclosure, violate Rule 10b-5?

Held. No. Judgment reversed and case remanded.

♦         Section 10(b) and Rule 10b-5 prohibit conduct involving manipulation or de-
          ception. Congress has repeatedly described the purpose of the Act as imple-
          menting a philosophy of full disclosure. The fairness of the terms of the
          transaction is at most a tangential concern of the statute.

♦         The transaction here was neither deceptive nor manipulative. Under state law,
          the minority shareholders could either accept the price offered or reject it and
          seek an appraisal in the Delaware Court of Chancery. There was no federal
          cause of action under Rule 10b-5.

Concurrence (Stevens, J.). The controlling stockholders did not breach any duty to
the minority shareholders because there was complete disclosure and the minority share-
holders are entitled to receive the fair value of their shares.

Insert the following as X. D. 7. at p. 155:

     7.     Interpretation of Section 16(b)--

Kern County Land Co. v. Occidental Petroleum Corp., 411 U.S. 582

Facts. After Occidental Petroleum Corp. (D) unsuccessfully sought to merge with Kern
County Land Co. (“Old Kern”), D offered to purchase shares from Old Kern share-

                                                                  Corporations Supplement - 13
      holders in an attempt to gain control. Old Kern management sought to frustrate D’s
      takeover attempt by entering into merger discussions with Tenneco, Inc. (“Tenneco”)
      instead. Under the terms of the merger, Tenneco would acquire Old Kern, and a new
      corporation, also named Kern County Land Co. (P), would be formed. Shareholders of
      Old Kern would receive a share of Tenneco stock in exchange for their shares of Old
      Kern. D realized that if the merger occurred, D would be forced to exchange its Old
      Kern shares for Tenneco stock and thus be locked into a minority position in Tenneco.
      Thus, before the merger closed, D entered into a negotiation with Tenneco whereby D
      granted Tenneco an option to purchase all of the Tenneco preference stock to which D
      would be entitled in exchange for its Old Kern stock if the merger closed. The merger
      took place, and the Old Kern shareholders received Tenneco preference stock in ex-
      change for their Old Kern stock. Old Kern was dissolved. D exercised its option and
      received a profit on its shares of Old Kern stock. P instituted suit under section 16(b)
      against D to recover the profits that D received from its dealings in the Old Kern stock.
      P alleged that the option and the exchange of Old Kern shares for shares of Tenneco
      were both “sales” within the coverage of section 16(b). Both acts took place within six
      months of the date on which D became the owner of more than 10% of the stock of Old
      Kern. The district court granted summary judgment in favor of P. The court of appeals
      reversed and ordered summary judgment in favor of D. The Supreme Court granted

      Issue. Is it a section 16(b) “sale” when the target of a tender offer defends itself by
      merging into a third company and the tender offeror then exchanges its stock for the
      stock of the surviving company and also grants an option to purchase the latter stock
      that is not exercisable within the statutory six-month period?

      Held. No. Judgment affirmed.

      ♦      Section 16(b) provides that a statutory insider must surrender to the issuing
             corporation any profit realized by him for any purchase and sale of any equity
             security within a period of less than six months. The purpose of this act is to
             prevent the unfair use of insider information and to maintain fair and honest
             markets. When applied to nontraditional transactions beyond a purchase and
             sale, the courts ask whether the particular type of transaction involved is one
             that gives rise to speculative abuse.

      ♦      In this case, D was clearly a “beneficial owner” within the terms of section
             16(b) when it purchased more than 10% of the shares of Old Kern. The issue
             then is whether a “sale” took place when D became bound to exchange its
             shares of Old Kern for shares in Tenneco pursuant to the merger agreement or
             when D gave an option to Tenneco to purchase the shares so acquired.

      ♦      First, under these facts, D cannot be seen as an insider. To the contrary, D was
             a tender offeror trying to seize control of Old Kern. Old Kern’s management
             was vigorously opposing D. Furthermore, D did not participate in negotiating
             the merger between Old Kern and Tenneco. Once the merger was formed, it
             was out of D’s hands. Old Kern had the necessary stockholder votes without
             the approval of D. The involuntary nature of D’s exchange, when coupled with

14 - Corporations Supplement
       the absence of the possibility of speculative abuse of insider information, con-
       vinces us that section 16(b) should not apply to this case.

♦      The mere execution of an option to sell is not generally regarded as a “sale.” It
       is clear that D wanted to avoid the position of a minority stockholder with a
       huge investment in a company over which it had no control and in which it had
       not chosen to invest. Tenneco did not want a potentially troublesome minority
       stockholder. These motivations do not smack of insider trading. D wanted to
       get out at a date more than six months later. Tenneco had a right to buy after six
       months, but D could not force Tenneco to buy. Also, even if D had insider
       information about Old Kern, it certainly had no insights into Tenneco.

Dissent (Douglas, Brennan, Stewart, JJ.). The court applies an “ad hoc” analysis to
section 16(b) when it should apply a bright-line rule. The term “sale” in the Securities
and Exchange Act includes “any contract to sell or otherwise dispose of.” Clearly D
“disposed of” its Old Kern shares within the statutory period.

Insert the following as XI. J. 2. a. 1) at p. 175:

               1)    Plaintiff must account to corporation--

Clarke v. Greenberg, 71 N.E.2d 443 (N.Y. 1947).

Facts. Greenberg (D) commenced a stockholders’ derivative action on behalf of the
Associated Gas & Electric Company (“AGECO”) against its officers and directors. D
alleged that the officers and directors had mismanaged AGECO, and D asked the court
for an accounting. Before trial, D discontinued the action and transferred his stock,
having a market value of $51.88, to the defendant directors for a sum of $9,000.
AGECO’s trustee, Clarke (P), brought suit against D to recover the difference. The
lower court dismissed and the appellate division affirmed. P appeals.

Issue. May a plaintiff in a stockholder’s derivative action be required to account to the
corporation for moneys received in private settlement for discontinuance of the ac-

Held. Yes. Judgment reversed.

♦      When a plaintiff brings a derivative suit, the action belongs primarily to the
       corporation, the real party in interest. Thus any judgment so obtained, as well
       as proceeds of any settlement, belongs to the corporation and not the individual
       stockholder plaintiff. Regardless of the method in which the suit was termi-
       nated, the plaintiff must account to the corporation.

                                                                 Corporations Supplement - 15
      Insert the following as XII. B. 4. a. at p. 180:

                a.   Defining “substantially all”--

      Hollinger, Inc. v. Hollinger International, Inc., 858 A.2d 342 (Del. Ch.

      Facts. Hollinger, Inc. (P) is a stockholder in Hollinger International, Inc. (D). P seeks
      a preliminary injunction preventing D from selling one of its subsidiaries, the Tele-
      graph Group. The Telegraph is a leading newspaper in the United Kingdom.

      Issue. Must D’s stockholders be provided with the opportunity to vote on the sale of
      the Telegraph Group because that sale involves “substantially all” of the assets of D?

      Held. No. Motion denied.

      ♦      Section 271 of the Delaware General Corporation Law authorizes the board of
             directors of a corporation to sell “all or substantially all of its property and
             assets . . . only with the approval of a stockholder vote.”

      ♦      D first argues that the Telegraph Group belongs to a subsidiary and not to D,
             and thus this rule does not apply. It is clear that the sale was directed and con-
             trolled by D. Wholly owned subsidiaries do the bidding of their sole owners.

      ♦      The test in determining whether an asset comprises “substantially all” of a
             corporation’s assets has two parts. First, are the assets to be sold quantitatively
             vital to the operation of the corporation? Second, does the sale substantially
             affect the existence and the purpose of the corporation?

      ♦      Here, the Telegraph Group is not quantitatively vital to the operations of D.
             Even after the sale, D will retain other significant assets, including the Chicago
             Group, which owns, among other things, the Chicago Sun-Times and the Jerusa-
             lem Post. As to the second component of the test, P argues that the Telegraph
             Group is vital to the corporation because of its journalistic superiority over the
             Sun-Times. The economic value, not the social importance, of the assets is
             controlling. After the sale, D’s stockholders will remain investors in a profit-
             able publication company with valuable assets.

      Insert the following as XII. B. 6. f. 1) at p. 183:

                     1)    No de facto merger--

      Terry v. Penn Central Corp., 668 F.2d 188 (3rd Cir. 1981).

16 - Corporations Supplement
Facts. Penn Central Corp. (D) is the successor to the Penn Central Transportation
Company, a railroad company, which underwent a reorganization under bankruptcy. D
had a large loss carry-forward, and to put that loss carry-forward to its best use, D
began to acquire corporations whose profits could be sheltered. D created a wholly-
owned subsidiary, PCC Holdings, Inc. (“Holdings”) to acquire the businesses. First
Holdings acquired Marathon Manufacturing Company (“ Marathon”). Marathon stock-
holders (Ps) were granted a class of preferred D stock. D then sought to acquire Colt
Industries, Inc. (“Colt”). Ps sought to enjoin Holdings from proceeding with the pro-
posed merger. The lower court denied the request, and Ps appealed. D subsequently
abandoned the Colt merger. However, the court determined that the case could pro-
ceed because D planned to continue with its acquisitions, and thus the same dispute
was likely to recur in the future.

Issue. Was the transaction is this case a de facto merger sufficient to entitle the share-
holders to dissent and appraisal right?

Held. No. Judgment for D.

♦      Ps argue that the proposed merger between Holdings and Colt constitutes a de
       facto merger between Colt and D and therefore D’s shareholders are entitled to
       the protections for dissenting shareholders provided by state law. First, it must
       be noted that the shares of D to be issued in the Colt transaction do not exceed
       the number of shares already existing. Next, the parties of a merger are those
       entities that are actually combined. If the merger proposed here occurred, both
       Holdings and D would survive as separate entities. Finally, there is no fraud or
       fundamental unfairness present here.

Insert the following as XII. C. 9. a. at p. 192:

          a.   Business judgment rule applies--

Moran v. Household International, Inc., 500 A.2d 1346 (Del. 1985).

Facts. Household International, Inc. (D) is a diversified holding company. D’s man-
agement was concerned about the company’s vulnerability as a takeover target and
adopted a preferred share purchase rights plan to ward off future advances. Under the
plan, common stockholders are entitled to the issue of one right per common share
under certain triggering conditions. The first is the announcement of a tender offer for
30% of D’s shares, and the second is the acquisition of 20% of D’s shares by any single
entity or group. If an announcement of a tender offer for 30% of D’s shares is made, the
rights are issued and are immediately exercisable to purchase 1/100 share of new pre-
ferred stock for $100 and are redeemable by the board of directors for $.50 per right. If

                                                                 Corporations Supplement - 17
      20% of D’s shares are acquired by anyone, the rights are issued and become non-
      redeemable and are exercisable to purchase 1/100 of a share of preferred stock. If a
      right is not exercised for preferred stock, and thereafter a merger or consolidation oc-
      curs, the rights holder can exercise each right to purchase $200 of the common stock of
      the tender offer for $100. Moran, one of D’s directors and the chairman of the Dyson-
      Kissner-Moran Corporation, D’s largest single stockholder, began discussions con-
      cerning a possible leveraged buy-out of D. Moran and his company (Ps) filed suit
      challenging the plan. The Court of Chancery upheld the rights plan as a legitimate
      exercise of business judgment by D. Ps appeal.

      Issue. Should the business judgment rule be the standard by which the adoption of a
      rights plan is reviewed?

      Held. Yes. Judgment affirmed.

      ♦      In Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), we held
             that the business judgment rule applied to a board’s actions regarding a pend-
             ing takeover bid. Here we are dealing with a defensive mechanism to ward off
             possible future advances. It seems even more appropriate to apply the business
             judgment rule to reviewing a pre-planned defensive mechanism. But before the
             business judgment rule can be applied, it must be determined whether the di-
             rectors were authorized to adopt the rights plan.

      ♦      Ps contend that no Delaware law authorizes the rights plan. Corporate law is
             not static and must grow to meet new concepts. Merely because the law is
             silent as to the matter does not mean that it is prohibited. The directors adopted
             the plan pursuant to statutory authority in 8 Del.C. sections 141, 151, and 157.
             In addition, the inherent powers of the board concerning the management of
             the corporation’s business and affairs also provide the board with authority
             upon which to enact the rights plan.

      ♦      The rights plan does not prevent stockholders from receiving tender offers.
             There are still numerous methods available to successfully launch a hostile
             tender offer. Also, the rights plan will result in no more of a structural change
             than any other defensive mechanism adopted by a board of directors. In fact, it
             could do less harm than other mechanisms, which can result in increased debt.

      ♦      Ps also claim that the plan restricts stockholders’ rights to conduct a proxy
             contest. However, the receipt of a proxy does not make the recipient the “ben-
             eficial owner” of the shares involved, which would trigger the rights. Any ef-
             fect the plan may have upon proxy contests will be minimal. Many proxy
             contests are won with an insurgent ownership of less than 20%.

      ♦      The adoption of the plan was within the authority of the directors. Thus, the
             next step is to determine if the directors have met their burden under the busi-
             ness judgment rule. Under the rule, the directors must show that they had rea-
             sonable grounds for believing that a danger to corporate policy and effectiveness

18 - Corporations Supplement
       existed and that the defensive mechanism adopted was reasonable in relation
       to that threat. The burden then shifts to the plaintiffs to show a breach of the
       directors’ fiduciary duties. There are no allegations of bad faith on the part of
       the directors here in the adoption of the rights plan. Ps claim that the board was
       uninformed. The standard to be applied is whether the directors were grossly
       negligent. We conclude that the directors were not grossly negligent. The di-
       rectors reasonably believed that D was vulnerable to coercive acquisition tech-
       niques and adopted a reasonable defensive mechanism to protect itself.

Insert the following as XII. C. 12. at p. 195, and renumber subsequent paragraph

     12. Shareholder franchise--

Hilton Hotels Corporation v. ITT Corporation, 978 F. Supp. 1342 (D.
Nev. 1997).

Facts. Hilton Hotels Corporation (P) announced a $55 per share tender offer for the
stock of ITT Corporation (D) and plans for a proxy contest at D’s 1997 annual meet-
ing. D rejected P’s offer and decided not to conduct its annual meeting. P filed a mo-
tion for a mandatory injunction to compel D to conduct the meeting as originally
scheduled. The court denied P’s motion, finding that D had 18 months within which to
hold its meeting. D then announced a comprehensive plan to split D into three new
entities, the largest of which would be ITT Destinations. The board for ITT Destina-
tions would be comprised of members of D’s current board, but staggered into three
classes, with each class of directors serving for a term of three years, with one class to
be elected each year. The comprehensive plan also contained a “poison pill” resulting
in a $1.4 billion tax liability, which would be triggered if P successfully acquired more
than 50% of ITT Destinations. D sought to implement the plan prior to its annual
meeting and without obtaining shareholder approval. P filed for a motion seeking an
injunction enjoining D from proceeding with the plan, declaring that D’s directors had
breached their fiduciary duties, declaring that D could not implement the plan without
obtaining a shareholder vote, and requiring D to conduct its annual meeting by a cer-
tain date.

Issue. May D enact a change in the structure of the board of directors without obtain-
ing a shareholder vote?

Held. No. Motion granted. D is enjoined from implementing the plan, and D must hold
its annual meeting by the designated date.

♦      There is no Nevada law on this matter, but we find Delaware law persuasive.

                                                                 Corporations Supplement - 19
      ♦         There is no legal basis for mandating a shareholder vote on the adoption of D’s
                plan. However, the plan would violate the power relationship between D’s board
                and shareholders by impermissibly infringing on the shareholders’ right to vote
                on members of the board of directors. Thus the plan must be enjoined on that

      ♦         In analyzing the plan itself, under the Unocal test, we must consider (i) whether
                D had reasonable grounds for believing a danger to corporate policy and effec-
                tiveness existed, and (ii) whether D’s response was reasonable in relation to
                the threat. D has failed to demonstrate such a threat. There is no showing that P
                will pursue a different corporate policy than the current directors. D has not
                even met with P to discuss P’s offer. Even if P’s offer constituted a cognizable
                threat, D’s response was preclusive and unreasonable. It would deny share-
                holders from exercising a right they currently possess—determining the mem-
                bership of the board of D.

      ♦         If the plan purposely disenfranchises D’s shareholders, it is not a reasonable
                response unless a “compelling justification” exists. Here the collective facts
                demonstrate that the primary purpose of the plan was to disenfranchise the
                shareholders. First, the timing of the plan was formulated in response to P’s
                offer and the plan was to take place before the annual meeting. Next, the plan is
                primarily designed to entrench the incumbent board. There is no credible justi-
                fication for not seeking shareholder approval of the plan. In a prior split, the
                board did seek shareholder approval. Finally, D did not seek an Internal Rev-
                enue Service opinion on the tax consequences of the plan. Serious questions
                remain as to whether the plan was reasonable in relationship to P’s offer.

      ♦         Interference with the shareholders’ franchise is serious and not to be left to the
                board’s business judgment. D argues that its plan is better than P’s offer. This
                argument should be directed to the shareholders, not the court.

      Insert the following as XIV. E. 7. at p. 262:

           7.     Due Diligence Defense--

      Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y.

      Facts. During the late 1950s, BarChris Construction Corp. (“BarChris”) built elabo-
      rate bowling alleys, with attached bar and restaurant facilities. BarChris offered its
      customers an alternative method of financing, which was essentially a sale and lease-
      back arrangement. Thus BarChris had to expend considerable sums up front before it
      received reimbursement and found itself in financial trouble. To raise money, BarChris

20 - Corporations Supplement
sold stock to the public. BarChris also sold some debentures to raise additional work-
ing capital. These debentures are the subject of this litigation. The registration state-
ment of the debentures was filed with the Securities and Exchange Commission.
BarChris continued to have financial difficulties and eventually filed for bankruptcy
and defaulted on the debentures. Various purchasers of the debentures (Ps) filed suit
against the persons who signed the debentures’ registration statement, the underwrit-
ers (“Drexel”), and BarChris’s auditors (“Peat, Marwick”) (Ds). Ds filed a motion to


(i)       Did the registration statement contain false statements of fact or omit facts that
          should have been stated to prevent it from being misleading?

(ii)      If so, were those facts “material” within the meaning of the Act?

(iii)     If so, have Ds established their affirmative defenses?

Held. (i) Yes. (ii) Yes. (iii) No. Motion to dismiss denied.

♦         There were various falsities and omissions in the debenture registration state-
          ment, and the court finds that several are material within the meaning of the

♦         Each defendant claims that he had no reasonable grounds to believe, and did
          not believe, that there were any untrue statements or material omissions in the
          registration statements. Each defendant also claims that he made a reasonable
          investigation. Each defendant’s defense must be considered separately.

♦         Russo, the chief executive officer of BarChris, was personally involved in fi-
          nancial negotiations and knew BarChris’s financial condition. Russo knew all
          of the relevant facts and has no due diligence defense.

♦         The founders of the business were Vitolo and Pugliese. Both men were of lim-
          ited education and were primarily involved in the actual construction work.
          Nonetheless, both men were members of BarChris’s executive committee and
          certainly knew of the company’s money problems. They have not proven their
          due diligence defenses.

♦         Kircher was the treasurer of BarChris and its chief financial officer. Kircher is
          a certified public accountant, and he was thoroughly familiar with BarChris’s
          financial affairs. Kircher contends that he had never dealt with a registration
          statement before and thus the blame should lie with BarChris’s attorneys for
          not properly advising him. This is not a good defense. He must have known
          parts of the statement were not true. He has not proven his due diligence de-

                                                                   Corporations Supplement - 21
      ♦      Auslander was an “outside” director. He was the chairman of the board of a
             bank and only became a director of BarChris on the eve of the financing in
             question. He had little opportunity to familiarize himself with the company’s
             affairs, and the facts indicate that he relied on the assurances of Vitolo and
             Russo and had no actual knowledge of the problems. Nonetheless, a director is
             responsible to use reasonable care to investigate the facts, not rely solely upon
             the word of others. Auslander has not established a due diligence defense.

      ♦      Grant was a director of BarChris, and his law firm was counsel to BarChris. He
             drafted the registration statement for the debentures, but this is not an action
             against him for malpractice in his capacity as a lawyer. Grant honestly believed
             the registration statement was true. To a certain extent, a lawyer is entitled to
             rely on the statements of his client. However, it is not unreasonable to require a
             check of matters easily verifiable. There were many areas where Grant failed to
             make an inquiry that he could easily have made, and which, if pursued, would
             have put him on his guard. Grant has not established a due diligence defense.

      ♦      The underwriters, other than Drexel, made no investigation and relied upon
             Drexel as the “lead” underwriter. Drexel worked with director Coleman for
             information. No attempt at verification beyond this was made. Underwriters
             are just as responsible as a company if a prospectus is false. They cannot es-
             cape responsibility by taking at face value representations made to them by the
             company’s management. Although the underwriters believed the information
             to be true, they did not establish the defense of due diligence.

      ♦      The auditors, Peat, Marwick, were the “experts” on the figures in the registra-
             tion. Most of the audit was done by a senior accountant, Berardi. Berardi made
             numerous material errors. In essence, Berardi asked questions but did nothing
             to verify the answers provided to him. There were enough danger signals in the
             materials to require further investigation on his part. Peat, Marwick has also
             not established its due diligence defense.

22 - Corporations Supplement
                                TABLE OF CASES
                        (Page numbers of briefed cases in bold)

Brecher v. Gregg - 12                          Malpiede v. Townson - 6
                                               Miller v. American Telephone & Tele-
Clarke v. Greenberg - 15                        graph Co. - 7
                                               Mills v. Electric Auto-Lite Co. - 4
Escott v. BarChris Construction Corp. - 20     Moran v. Household International,
                                                Inc. - 17
Gerdes v. Reynolds 11
                                               Rapoport v. 55 Perry Co. - 2
Hawaiian International Finances, Inc. v.       RNR Investments Limited Partnership
  Pablo                                          v. Peoples Fir - 1
Hilton Hotels Corporation v. ITT Cor-
  poration - 19                                Santa Fe Industries, Inc. v. Green - 12
Hollinger, Inc. v. Hollinger Interna-          Solar Cells, Inc. v. True North Partners,
  tional, Inc. - 16                              LLC - 5

International Brotherhood of Teamsters         Terry v. Penn Central Corp. 16
   v. Fleming - 3
                                               Unocal Corp. v. Mesa Petroleum Co. - 18
Jones v. H.F. Ahmanson & Co. - 10
                                               Zahn v. Transamerica Corporation - 9
Kern County Land Co. v. Occidental
  Petroleum Corp. - 13

                                                               Corporations Supplement - 23

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