Business Organizations I. Agency a. In General: i. Agency Defined: 1. Restatement: a. A manifestation by principal, to the agent, that agent shall act: i. on the principal’s behalf; AND ii. subject to the principal’s control b. Agent consents to so act 2. P and A agree that A will do something for P and that it will be done subject to P’s control. b. Application (Examples of an Agency Relationship) i. Gorton v. Doty 1. Facts: Δ loaned her car to football coach; coach was told he could only borrow the car if he was the one who drove it; coach crashed the car and several kids were killed. 2. Issue: Was coach and agent of Δ? 3. Application: Δ made the agreement conditional upon the coach agreeing that only he would drive the car. Thus, the arrangement was subject to Δ’s control and on her behalf. Consent by the coach was implied by the fact that he took the car. Therefore, the coach was an agent of Δ. 4. Holding: Δ was liable for coach’s negligence. ii. A. Gay Jensen Farm v. Cargill 1. Facts: Δ was a grain seller; A was a grain elevator (storage). A owed Δ money, so to continue in business w/o Δ calling its debts, A agreed to act subject to some control by Δ; they entered into a series of contracts that obligated A to Δ in certain respects. A then owed money to farmers (π) that were selling their grain to A; A couldn’t meet its obligations, so π sued Δ. 2. Issue: Whether an agency relationship existed between Δ and A. 3. Application: a. Δ manifested an intent that A would act on its behalf it would store grain for Δ and sell to it first b. Was subject to Δ’s control A required to consider Δ’s “recommendations” (which were backed by the fact that Δ could call its debts), plus Δ interfered w/ A’s business operations c. A consented to the agreement 4. Holding: Agency established Δ was liable for A’s wrongdoing. iii. Options: 1. Do Nothing risk liability. See Cargill. 2. Reduce Control less influence over the third party, so they may screw up 3. Exert More Control take over every aspect to ensure things are done well (McDonalds) c. Liability of Principal to Third Parties in Contract i. Authority 1. Rule: an agent that has been authorized to act on behalf of the P (actual authority) may bind the P to contracts that the A enters into. a. 2 Kinds of Actual Authority: i. Express – Principal tells A to do something ii. Implied – P assigns A a task and one of the things A does is reasonably necessary to carry out the task. 1. Prior practice and industry custom may also be the basis for implied authority b. Requires that P made a manifestation of consent to A, that A would have authority to act on P’s behalf. 2. Mill Street Church v. Hogan a. Facts: Church (P) hires A to paint church ceiling; A tells church that it’s a 2 person job. P takes out insurance in event of injury to A. A hires his brother (π) to help paint; π gets hurt wants church to help pay for his injury; P argues that π was not an employee b/c A did not have authority to hire π. b. Issue: Whether A had authority to hire π. c. Application: A had told P that it would require 2 people to do the job; P hired A to do the job Thus, it was implied that A had authority to hire another employee. d. Holding: A had authority to hire P liable re: payment ii. Apparent Authority 1. Rule: Where P makes a manifestation of consent to a third party that A has authority to act on P’s behalf, then P will be bound by A’s actions consistent w/ that manifested consent. See Ampex. However, if the third party’s belief that A has authority to act on P’s behalf is unreasonable, then P not bound by A’s actions. a. Defenses: i. Third party’s belief that A had authority to act on P’s behalf was unreasonable. 1. If notice (actual or constructive) that A does not act for P, then the belief is unreasonable as a matter of law. a. Employment manual b. Web site (law firm directory) c. News ad 2. Almost necessary w/ respect to former employees P must put parties it deals w/ on notice that A no longer works for P ii. NO manifestations of consent 1. BUT, failure to act may satisfy manifestation requirement Estoppel. See Hoddeson. 2. Lind v. Schenley a. Facts: π was a salesman for Δ; Δ’s VP, and π’s boss, assigned him to work for A and told π to report to A re: his new position and new salary; A told π that he would get a 1% commission on all sales; π made a sale, but Δ denied him the commission. b. Issue: Did A have apparent authority to bind Δ? c. Application: Δ (through the VP) had led π to believe that A had the authority to set π’s salary and spoke on Δ’s behalf. Although the 1% was high and only state managers had usually received the bonus, π had as much responsibility as many state managers, so his belief that salary + commission were genuine was reasonable. d. Holding: Δ owed π the commission b/c A bound Δ to the terms that he gave to π. 3. Three-Seventy Leasing v. Ampex a. Facts: π negotiated computer leases with one of Δ’s salesmen (A); π submitted an offer to lease the units; Δ never signed the agreement, but A had given π a delivery schedule of when the components would be sent. b. Issue: Did A have apparent authority to bind Δ? c. Application: Δ had manifested consent to π that A had authority b/c A was a salesman, and it’s common practice that salesmen have authority to enter into contracts on behalf of their employers, and Δ never did anything to change that impression in π’s mind. The belief was reasonable (common practice) d. Holding: π bound to the contract b/c A had apparent authority to act on P’s behalf. iii. Inherent Agency Power 1. Rule: a. Usually only arises in two cases: i. Undisclosed Principal (third party is unaware of P) 1. P liable for actions that A takes that would be w/in the usual scope of business by A’s engaged in similar activities. See Fenwick (orders for cigars and food by bar manager). ii. Agent exceeds his/her authority b. Catch-all rule – fills the gaps where other theories would fail 2. Watteau v. Fenwick (Undisclosed Principal) a. Facts: A sold his bar to Δ; Δ only permitted A to buy water and bottled ale; A kept his name on the liquor license and his name remained on the door; A bought cigars and Bovril from π; π did not know that Δ was the true owner, nor that Δ did not have authority to buy; Δ refused to pay π b/c it told A not to buy. b. Issue: Whether Δ was liable on the contract given that A did not have actual authority, nor had Δ made manifestations that would lead to a finding of apparent authority. c. Application: Buying cigars and Bovril was w/in the power of most bartenders Inherent Agency d. Holding: Δ liable for A’s contract iv. Ratification (retroactive grant of authority) 1. Elements of Ratification: a. Acceptance of A’s action w/ intent to ratify; AND i. Affirmation may be express or implied b. Knowledge of the material circumstances. See Botticello. 2. Note: cannot ratify an agreement if it would cause a gross injustice. 3. 2 Key Questions: a. What types of acts constitute an affirmation by the principal? b. What effect will be given to that affirmation? 4. Botticello v. Stefanovicz a. Facts: H and W owned land jointly; π, who was leasing the land, wanted to buy negotiated lease w/ option to buy w/ H; W never was a party to the deal; π moved in and made improvements and W had benefited from the rental payments. When π tried to exercise his purchase option W said no deal π sues to enforce contract. b. Issue: Did W ratify H’s contract of sale by standing by and watching π make improvements and accepting his rental payments? c. Application: Although W arguably accepted the agreement w/ intent to ratify, she was not apprised of the material circumstances of the deal she was not informed and could not ratify something in which she was uninformed. d. Holding: W’s actions did not constitute a ratification of the contract. v. Estoppel (Relies on Apparent Authority Theory NO apparent authority in fact) 1. Rule: a. A Δ may be estopped from denying agency (even where no P-A relationship ever existed) if: i. Δ’s acts or omissions create an appearance of authority in the purported agent; ii. π reasonably relies on the appearance of authority; iii. to π’s detriment (damage) 2. Hoddeson v. Koos Bros. (Negligenceapparent authorityharm to π) a. Facts: π went to Δ’s store to buy furniture; A appeared to sell π the furniture; A was not an employee, but a crook; π never got her furniture and sued. b. Issue: Could π sue Δ under an agency theory c. Application: Since Δ’s negligence led to a veil of authority being cast over A, and π had reasonably and detrimentally relied upon that apparent authority, she had stated a claim. d. Holding: π could sue; Δ could be estopped from denying an agency relationship. vi. Agent’s Liability on the Contract 1. In General a. 2 Scenarios: i. Disclosed Principal 1. Not liable, unless: a. Clear intent of parties that A be bound; OR b. A made contract w/o authority ii. Undisclosed Principal 1. A treated as though a party to the contract. See Curran. a. third party elects who to sue 2. Atlantic Salmon v. Curran a. Facts: Δ did business as a corp X – buying and selling seafood; Δ actually owned corp Y – never get dba as corp X; Δ entered into contracts w/ π; Δ defaulted; π could not sue corp X (didn’t exist) nor corp Y (no money) wanted to sue Δ anyway b/c he was the one w/ the $. b. Issue: Whether Δ was liable for the contract that π athought it was entering into with corp X. c. Application: Since the principal (corp X) was only partially disclosed (not a valid corp b/c Δ never had corp Y dba corp X partially disclosed P), Δ (agent) was liable on the contract. d. Holding: Δ liable for corp X’s contract b/c P was only partially disclosed. d. Liability of Principal to Third Parties in Tort i. Rule: 1. A principal is liable for the torts (or breaches of contract) of an agent that are conducted within the scope of the agent’s employment. See Humble. ii. Test: 1. Is there an agency relationship (act on P’s behalf and subject to P’s control)? a. No: P NOT liable b. Yes: Step 2 2. Is A a servant or independent contractor (almost a subquestion re: control – but it’s a defense any Δ would raise)? a. Independent Contractor: P NOT liable. See Hoover (insufficient control). b. Servant: Step 3 3. Was A acting within the scope of his employment? a. No: P NOT liable b. Yes: P liable Agency. See Humble (sufficient control). iii. Servant v. Independent Contractor 1. General Rule: a Principal is liable for the torts of its servants, not for the torts of an independent contractor. a. Real Key = degree of control. Cf. Hoover (P not liable b/c it only had ability recommend certain practices to A, but A could reject) with Humble (liable b/c P had ability to control the day-to-day activities of A) 2. Humble Oil v. Martin a. Facts: Δ oil company owned gas station and leased it to A; agreement gave Δ the right to give A orders; one of A’s employees left parking-brake off and car rolled down hill and hit someone. b. Issue: Was A an agent of Δ? c. Application: Δ maintained (or had the ability) control over A sufficient that A was considered a servant, not an independent contractor. d. Holding: A = servant; Δ = liable. 3. Hoover v. Sun Oil a. Facts: Similar case involving gas station and a fire started by a cigarette. Difference Δ oil company only had right to make recommendations, did not have control over day-to-day management. b. Issue: Was A an agent of Δ? c. Application: Δ did not have ability to control A, so no master- servant relationship established. d. Holding: Δ NOT liable. 4. Murphy v. Holiday Inn a. Facts: Δ is the corp.; A is a franchisee; π slipped and fell at A’s hotel, sues Δ under an agency theory. b. Issue: Was A an agent of Δ? c. Application: Although the franchise agreement created many obligations between Δ and A, the Δ did NOT have control over the day-to-day operations of the hotel. Thus, no master-servant relationship established. d. Holding: Δ NOT liable. iv. Scope of Employment 1. Liability only attaches to the agent for acts done w/in the scope of employement, not for those outside the scope of employment (frolic) 2. Two Approaches: a. Total Abandonment i. A must totally abandon his duties. See Clover. b. Foreseeability i. If A’s misconduct is foreseeable, then P liable for that misconduct. See Bushey. 3. Ira S. Bushey & Sons v. United States a. Facts: Drunken sailor, returning from shore-leave, damages dock. b. Issue: Was sailor acting w/in the scope of his employment? c. Application: It was foreseeable to the US (Δ) that a sailor would get drunk and do something foolish to the dock while returning to “serve” the master. d. Holding: sailor was acting w/in the scope of his employment b/c the harm was foreseeable. v. Liability for Torts of Independent Contractors 1. General Rule: Principal NOT liable for torts committed by an independent contractor. a. Exceptions: i. Principal retained control over the aspects of the work in which the tort occurred ii. P hired an incompetent IC iii. P hired IC to carry out an activity that is a nuisance per se (inherently dangerous) iv. Nondelegable duty 2. Majestic Realty Associates v. Toti Contracting a. Facts: Δ hired IC to demolish a building; IC goofed and damaged a neighboring building. b. Issue: Was Δ liable for IC’s negligence? c. Application: If the activity contracted for was a nuisance per se or inherently dangerous, than the exception would apply. d. Holding: Remanded for determination re: whether the demolition was a nuisance per se / inherently dangerous. e. Fiduciary Obligation of Agents i. In General 1. Two Duties a. Duty of Care i. Not to do job negligently/recklessly b. Duty of Loyalty i. Examples of Breach of Fiduciary Duty of Loyalty: 1. Kickbacks, bribes or gratuities. See Rst § 388 2. Secret profits. See Regem (had to disgorge $ made through his position despite fact that employer could not have made) 3. Usurped business opportunities. See Singer (had to disgorge profits for repair jobs redirected from his employer although employer could not have done them) 4. “Grabbing and Leaving” (using information gained from agency relationship to former P’s disadvantage). See Town & Country (ex-employees liable for taking customer lists from former employer and then using that list to solicit business to the ex-employer’s detriment) a. Duty to preserve secrets extends beyond the agency relationship customer lists, trade secrets, etc. b. Law Partner Hypo: i. Tell clients you’re leaving + invite them to come breach ii. Leave, then invite clients to come no breach ii. Disclosure 1. If A discloses his breach to P gives P the power to handle (allows P to ratify/sanction A’s actions) ii. Duties During Agency 1. Reading v. Regem (Duty of Loyalty) a. Facts: π (soldier) was approached by smugglers and asked to transport goods across a checkpoint; π was paid for assisting the smugglers; the Crown (Δ) discovered the smuggling and took all the money π had been paid by the smugglers. b. Issue: Whether Δ could take (was the rightful owner) of the money. c. Application: Δ could NOT have made the money on its own since doing so would have been illegal. So, the narrow issue was whether the Δ could take profits from and agent that it could not have made on its own. Court reasoned that since π was only able to make the $ by virtue of his position as Δ’s agent, then the $ should be turned over to Δ public policy: want to deter that kind of conduct. d. Holding: Δ entitled to keep the $ 2. General Automotive Manufacturing v. Singer (Duty of Loyalty) a. Facts: Δ worked for π as a consultant; Δ had contract was supposed to “dedicate” himself completely to work for π (loyalty); π did not have capabilities to do some of the jobs that were referred to them Δ rerouted those jobs to other shops and made $ for every job he rerouted; π sued to have that profit disgorged. b. Issue: Did Δ breach his fiduciary duty of loyalty? c. Application: Δ argued that he did not breach duty of loyalty b/c π was unable/unwilling to do the jobs. However, Ct reasoned that Δ was still required to inform π about the jobs so it could decide whether to take at increased cost (and decreased profit) or whether to expand its business to address the demand. Thus, his actions were disloyal. d. Holding: Δ required to disgorge his profits to π (although those profits were more than π would have made on its own public policy: deterrence) iii. Duties During and After Termination of Agency – Grabbing and Leaving 1. Town & Country v. Newberry a. Facts: Δ worked for π house cleaning business; π had spent time and effort to find clients; Δ quit and started own business in competition w/ π; Δ used π’s customer list to solicit business took clients from π. b. Issue: Did Δ violate his fiduciary duty of loyalty despite the fact that the agency relationship had ended? c. Application: Δ had used information gained from the agency relationship to π’s detriment. d. Holding: Δ breached duty of loyalty liable II. Partnerships a. What is a Partnership? Who are the partners? i. In General 1. Partnership: a. “an association of 2+ persons to carry on as co-owners a business for profit.” See UPA § 6(1) b. Requires an agreement btw the parties. 2. Basics: a. Characteristics (Factors in the Test): i. For profit, unincorporated business ii. 2+ owners iii. each owner contributes iv. share in profit/losses (BIG) v. share in control/management (BIG) b. BUT: i. These characteristics may vary b/c the partnership agreement (contract) may alter those characteristics 1. Examples: a. Voting rights + loss obligation is proportional to ownership interest allows one person/group to retain control (Law Firm management committee) 2. BUT: bending the rules too far can be risky 3. Liability: a. partners (individually) are liable for the debts/obligations of the partnership 4. UPA & P’ship Agreements: a. UPA acts as the default rules guiding the partnership and its relations in the absence on a specific agreement, these rules will apply b. However, parties can alter the default rules w/ a P’ship Agreement: i. % of income can be altered ii. loss allocation can be altered iii. duties can be assigned 5. Formation of a Partnership: a. Requires an agreement i. Agreement may be written (formal) or oral (informal) 1. even a written agreement may not de determinative of whether or not a partnership exists. See Fenwick. ii. Partners v. Employees 1. Fenwick v. Unemployment Compensation Comm’n a. Facts: π operated beauty shop; C worked as receptionist; C asked for raise, π could not afford so offered to make her “partner”; Terms of written agreement: C got 20% of profits, π bore all losses, π had all control, severable by either party w/ 10 days notice. i. Note: UPA receipt of profits is prima facie evidence that a partnership exists. b. Issue: Was C a partner? c. Application: Facts favoring partnership C got 20% of profits and held the title of “partner.” Facts against partnership π retained full managerial control and bore all the risk (of losses). Ct reasoned that although the agreement made C a “partner” it was in name only; in fact, π’s sole control and burden of risk made him the only partner (under the default rules). d. Holding: C was not a partner. iii. Partnership by Estoppel 1. Young v. Jones a. Facts: π loans money to bank, who gives money to a SAFIG; SAFIG steals $; PW-Bahamas audited SAFIG and said they were OK; SAFIG and PW-Bahamas are judgment proof; π tries to sue PW-US on the theory that it is a partner w/ PW-Bahamas. The 2 companies are not actual partners, so π has to sue under a p’ship by estoppel theory. b. Issue: Is PW-US a partner by estoppel w/ PW-Bahamas? c. Application: P’ship by estoppel requires some kind of manifestation by PW-US that it was a partner of PW-Bahamas, which π then relied upon. Since PW-US never made any statements/manifestations that π relied upon no p’ship by estoppel d. Holding: Δ was not a partner by estoppel 2. Note: a. PW-Bahamas and PW-US both licensed their names from PW- Worldwide (a holding co.) b. π may have succeeded if he had sued PW-Worldwide under an apparent agency theory. i. BUT, see Murphy (Hotel franchise not liable for the torts of its franchisee lack of control) c. If π had succeeded against PW-Worldwide it may have been able to assert a claim against PW-US reverse veil piercing, or maybe inherent agency power (undisclosed principal and PW-US was principal and PW-Worldwide was the agent). b. Fiduciary Obligations of Partners i. Introduction 1. Duty of Loyalty a. Can’t cheat other partners or take personal advantage of opportunities that one comes upon through his position as partner. See Meinhardt. b. Disclosure i. If a partner discloses a personal opportunity that arose from his position as a partner (p’ship opportunity), then the P’ship may decide whether or not to act on the opportunity. BUT, decision must be made in good faith. ii. Thus, p’ship may ratify (sanction) the partner’s personal acceptance of the p’ship opportunity c. Waiver – RUPA § 103(b)(3) i. Duty of Loyalty may not be discarded by a p’ship agreement, but may specify certain actions that are not considered breaches of duty (prospective waiver), so long as those specified actions are not manifestly unreasonable. 2. Meinhardt v. Salmon (Duty of Loyalty) a. Facts: π and Δ formed partnership to manage a hotel for 20 years; π was somewhat of a silent partner, while Δ was the more visible managing partner. When lease on building expired, the land owner made a deal w/ Δ to develop the land; Δ never informed π of the opportunity; π sued breach of fiduciary duty of loyalty (took a partnership opportunity for himself) b. Issue: Did Δ breach his fiduciary duty of loyalty? c. Application: Δ argued that the p’ship ended at 20 years when the lease expired; π argued that the opportunity came to Δ through his position in the p’ship, and therefore, the opportunity righylt belonged to the p’ship since Δ failed to disclose the opportunity he had breached his FD of loyalty. Ct accepted π’s arg. d. Holding: Δ took advantage of a p’ship opportunity w/o disclosing that opportunity to the p’ship. ii. After Dissolution 1. Bane v. Ferguson (Duty of Care) a. Facts: π retired from law firm, was entitled to a pension; firm merged w/ another firm was a disaster and the merged firm folded; π stopped receiving his pension; π sues mismanagement (breach of duty of care). b. Issue: Did Δ owe π a duty of care since he was no longer a partner? c. Application: π was not a partner; his relationship w/ the firm was contractual. Since he was not a partner (though he still had an interest in the firm’s continued profitability) the firm did not owe him fiduciary duties. Even if it did owe him a duty protected by BJR w/ respect to the merger. d. Holding: Δ did not owe π fiduciary duties not liable. iii. Grabbing and Leaving 1. Meehan v. Shaughnessy (Duty of Loyalty) a. Facts: Δ’s were partners in a law firm, were dissatisfied and planned to leave: Δ’s talked with some employees and asked if they wanted to join; sent out letters, on π firm’s letterhead, inviting clients to join them (did not indicate that clients had choice to stay with π); and, when asked by other partners, denied that they were leaving. b. Issue: Did Δ’s breach their fiduciary duty of loyalty? c. Application: It’s OK to compete, but Δ’s could not use do so while working for π. Since they solicited clients during their employment, on firm letterhead, and w/o indicating that clients had a choice to stay breach. Also, although Δ’s could have kept their plans to leave to themselves, since other partners asked them, and Δ’s lied breach. d. Holding: Δ’s breached their fiduciary duty of loyalty iv. Expulsion 1. UPA a. Any partner may be expelled as long as the expulsion is not carried out in bad faith. 2. Lawlis v. Kightlinger & Gray a. Facts: π was a partner in Δ law firm; π was alcoholic given one last chance alcoholic second chance straightened up + wanted more $ (restored to previous amount) another partner told him he was going to be fired Δ’s executive comm’t fired π π sued (breach of FD of loyalty) b. Issue: Did Δ breach its FD of loyalty by firing π? c. Application: Although the partner told π he would be fired, that was not a wrongful termination b/c that was just an expression of what partner thought executive comm’t would do. Was actually fired when comm’t terminated him by vote, which was permitted w/in the p’ship agreement P’ship had a right to terminate him w/ a vote. d. Holding: No breach of FD Δ not liable. c. Partnership Property i. Rule: 1. A partner has an interest in the p’ship, individual partners do NOT own the assets owned by the p’ship. 2. So, when a partner sells their interest in the p’ship they’re out. See Putnam. ii. Putnam v. Shoaf 1. Facts: π was a partner in a firm; sold her interest to Δ; later discovered that old accountant had embezzled $ from p’ship (while π was still owner); p’ship won judgment against accountant; π sued Δ for the money they received from the judgment against the accountant reasoned that the recovery belonged to her since she was the one cheated (Δ would get a windfall). 2. Issue: Could π recover the judgment from Δ? 3. Application: When π conveyed her interest in the p’ship she conveyed everything she owned the right to receive $. She did not transfer nor retain any interest in a judgment against the accountant b/c she never owned such an interest that rt belonged to the p’ship (which would then distribute the judgment in the form of $ to the partners). 4. Holding: π could not recover from Δ b/c she never had a property interest in the p’ship claim against the accountant. d. Raising Additional Capital i. Couple Approaches: 1. No Agreement a. Problem of free-riding not all partners may decide to invest and free-ride if MP gets the $ 2. Managing P can try to sell additional points a. Incentive to invest; otherwise, partner will have his ownership interest in the firm decreased 3. Penalty Dilution Provision in P’ship Agreement a. Partners obligated to invest additional capital or face dilution if they don’t invest e. Management Rights i. UPA 1. all partners have equal rights in the management of the partnership a. may be varied by p’ship agreement i. Planning: want to have some sort of procedure re: actions w/ respect to a tie vote (tie-breaker or unanimity) ii. Nat’l Biscuit Co. v. Stroud 1. Facts: Δ and F formed a p’ship to run a grocery store; Δ and F disagreed about whether F should be allowed to buy more bread; Δ told π that he would not be liable for any bread π delivered; F ordered more bread from π; p’ship defaulted and π sued Δ. 2. Issue: Was the p’ship bound to the contract, given that there was an even split re: whether F had power to enter into the contract, or was F personally liable (acted outside of authority w/ respect to the contract)? 3. Application: Since the default rules indicate that a majority vote is required to carry out a course of action Δ’s and F’s disagreement did not revoke F’s power to carry out p’ship business. Since Δ failed to remove F’s ability to continue ordering bread, F retained the power to order bread despite Δ’s objections. Since F was an agent of the p’ship p’ship bound Δ personally liable (partners are personally liable for the debts of the p’ship). 4. Holding: Δ personally liable for the bread debt. iii. Day v. Sidley & Austin 1. Facts: Δ had, by a p’ship agreement, vested management control in an executive committee (controlled day-to-day operations); π was a partner and chairman of the Washington office; Δ and another firm decided to merge; π was made co-chairman; Δ decided to close its office and move to the merged firm’s Washington office; π unhappy w/ loss of prestige and the move sues for fraud, breach of K, and Breach of FD. 2. Relevance: Illustrates that partners are free to make contracts to change the dynamics of the p’ship relationship Δ had given all of its managerial control to the executive committee and that was acceptable. f. Dissolution i. Terminology 1. UPA = Dissolution a. When a partner leaves/joins, then old p’ship dissolves and is immediately reformed w/ the current members 2. RUPA = dissociation a. P’ship continues but w/ or w/o the joining/leaving partner ii. Phases of Demise of a P’ship: 1. Dissolution – change in p’ship relationship; partners agree to stop working together 2. Winding Up – process of shutting down; taking care of unfinished business 3. Termination – the end iii. Causes of Dissolution 1. Natural (e.g. permitted expulsion, permitted departure) 2. Wrongful – in violation of p’ship agreement 3. Extraneous (e.g. bankruptcy) iv. Buyout Agreements 1. Major Issues: a. Who may departing partner sell to? b. May departing partner force remaining partner(s) to buy his interest? 2. Planning Issues: a. Provisions to Consider: i. Rt of First Refusal ii. Compulsory buy-out iii. Restrictions on Sale iv. Rt to Purchase on death/dissociation/disability b. Buyout Price: i. Appraisal ii. Formula iii. Book value iv. Pre-arranged price 3. G & S v. Belman a. Facts: π and N are general partners; N becomes a cocaine addict and engages in all kinds of outrageous behavior; π sues N for dissolution of the business; While suit in progress, N dies interest transfers to his heirs/assigns (Δ); π then tries to exercise its buy-out option (which arose when N died); Δ argues that the suit = wrongful dissolution b. Issue: Can π exercise its buyout option or did the filing of the dissolution suit = wrongful dissolution. c. Application: The p’ship agreement did not specify how the p’ship could be terminated UPA governs allows ct to dissolve for cause. Since court had not made a determination, no dissolution had occurred. Also, since π had grounds to file for dissolution its filing of the claim did NOT equal a wrongful dissolution. Thus, since the p’ship was still in existence at N’s death, π was permitted to exercise its contractual right to purchase N’s interest at his death. d. Holding: No wrongful dissolution from filing suit; π could exercise its buyout option. v. Law Firm Dissolution 1. UPA a. $ made while wrapping up firm business belongs to the firm distributed accordingly. See Jewel. i. BUT, p’ship agreement can specify different way to handle distribution of old clients and their business. See Meehan (clients could be taken if departing partner paid a “fair charge”) 2. Jewel v. Boxer a. Facts: 4 partners in law firm; no p’ship agreement; split evenly into 2 firms; π sues Δ for profits earned by Δ on clients (of the joint firm) that Δ continued to work for post-dissolution. b. Issue: Whether π was entitled to profits made by Δ, from clients of the joint firm, that Δ took with them upon dissolution. c. Application: The clients were from the old firm, so the $ made by Δ’s (and vice versa w/ respect to clients π took) belonged to the old firm and was to be distributed accordingly. d. Holding: π was entitled to profits made by Δ in wrapping up old firm business Δ had fiduciary duty to handle competently (not that it was really needed – wants to keep good client relations). 3. Meehan v. Shaughnessy a. Facts: P’ship agreement provided that clients could be taken if old firm paid a “fair charge” no on-going fiduciary duty like in Jewel. b. Issue: What about charge for clients taken unfairly? c. Application: Since π had breached its fiduciary duty in removing some of the clients (not informing them of their option to stay), then allowing the p’ship agreement to govern (fair charge) would be unjust. Thus, the appropriate remedy for clients taken in breach of FD would be disgorgement. g. Limited Partnerships i. Rule 1. A limited partner, unlike a general partner, is not personally liable for the debts of the p’ship. See Holzman. However, if a limited partner 1) exerts control (like a GP), and 2) a party relies on the LP’s conduct LP liable. See Holzman. ii. Holzman v. De Escamilla 1. Facts: 1 GP and 2 LPs; P’ship went BK trustee sued LPs to hold them liable for debts theory = no longer LPs. Key facts: LPs had overruled GP on an occasion, LPs forced GP to resign as manager, and GP could not withdraw $ w/o LP approval 2. Issue: Did the LPs, by their actions, become GPs? 3. Application: Their actions demonstrated that they had exerted enough control to be held GPs. 4. Holding: LPs liable for p’ship debts. III. Preliminary Corporate Issues – Nature of Corporations a. Promoters and the Corporate Entity i. Rules: 1. De Facto Corporation a. An improperly incorporated corp will be treated as a corp if: i. Tried to incorporate in good faith; ii. Had a legal right to do so; AND iii. Acted as if a corporation 2. Corporation by Estoppel a. An entity will be treated as a corp if person dealing with the entity: i. Thought entity was a corp all along; AND ii. Would be unjustly enriched if now allowed to argue that entity was not a corporation 3. Sub-Rule: a. If Ct holds that entity is a corp promoter NOT liable (limited liability) 4. Exception: If rights would be substantially prejudiced. See Camcraft (no prejudice where company incorporated under a different country’s laws than it had represented in the contract) ii. Promoters 1. Defined a. A person that acts as an agent of the business prior to its incorporation b. Issues: i. Once business incorporates, does it become a party to the contract? 1. Yes, but only if it adopts the contract (explicit or implicit accept benefits) ii. Once the business incorporates is the promoter free from liability if corp breaches? 1. Not automatically, requires other party to release promoter from liability iii. If business does not incorporate is promoter liable on the contract? 1. Yes, absent an agreement to the contrary 2. “corp” may still be held liable under partnership law although not a corp, may argue that they were partners liability via agency law 2. Fiduciary Duties a. Promoters owe fiduciary duties (care and loyalty) to the corp they represent iii. Southern-Gulf Marine Co. v. Camcraft 1. Facts: π’s promoter entered into an agreement w/ Δ; π was not yet a corp represented that it would be a corp of one state, but actually incorporated in a foreign country; Δ tried to back out of contract; π sued to enforce the contract. 2. Issue: Could Δ deny the existence of the contract? 3. Application: Δ believed that π was going to be a corp, and would be unjustly enriched if permitted to argue that π was not a corp. Furthermore, no prejudice was shown to stem from the fact that π incorporated in a different country. 4. Holding: contract was enforceable Δ breached b. Limited Liability i. In General 1. The individual owners of a corporation are not liable (individually) for the debts of the corporation. See Walkovszky. a. Piercing the Corporate Veil (See Sea Land) i. A creditor of a corp may reach the assets of the individual shareholders if: 1. Unity of interest and ownership a. Disregard of Corporate Formalities b. Undercapitalization c. Commingling of corp + personal funds d. Treating corp’s assets as one’s own 2. Refusal to hold individual SH liable would sanction fraud or promote injustice a. Fact that π may be unable to collect full judgment is NOT sufficient. See Sea Land. b. But, in the tort context, injustice prong may be automatically satisfied. See In re Silicon Breat Implants. ii. Distinction: Contract Creditor v. Tort Creditor 1. Contract: can negotiate terms and investigate beforehand adjust for risk 2. Tort: cannot negotiate or investigate Ct more likely to PCV in this case b. Enterprise Liability i. Where “sister” corporations are owned by a single source and the owner ignores the formalities btw each of the “sister” corps (i.e. treats all of the corps as one). See Walkovszky. c. Planning i. To avoid PCV problem, owner should make sure that the corporate formalities are observed and avoid undercapitalization. ii. Walkovszky v. Carlton 1. Facts: Δ owned 10 cab corps, each owning two cars and carrying the minimum amount of insurance; each cab corp had little assets; one cab injured π insurance did not cover the judgment nor did the corp’s assets; π sued Δ piercing corp veil and enterprise liability (suit against the other corp’s insurance not valid b/c their insurance only covered their cabs). 2. Issue: Whether Δ was personally liable for cab corp’s debt 3. Application: π had not pled that funds were commingled, nor that formalities were disregarded, nor that Δ had treated the corp’s assets as his own; the fact that Δ had broken his fleet into 10 corps was insufficient to pierce the corp veil. 4. Holding: Δ not personally liable NO veil piercing iii. Sea Land Services, Inc. v. Pepper Source 1. Facts: Δ defaulted on contract w/ π; Δ owned several corps funds were commingled, the corps were undercapitalized, Δ used the corps assets to pay his personal debts, no corp formalities were observed; also owned 1 corp jointly w/ another, but still used assets from that corp to pay personal debts. 2. Issue: Could π pierce the corp veil to reach Δ’s personal assets and the assets in his other corps? 3. Application: Since formalities were disregarded, funds were commingled, Δ treated corp assets as his own, the Ct held that unity of interest prong was met. Also, if π were not allowed to PCV, then Δ would be unjustly enriched and a semi-fraud would be sanctioned by allowing Δ to escape liability. 4. Holding: π could PCV reach Δ’s personal assets and those in the other corps iv. In re Silicon Gel Breast Implants Products Liability Litigation 1. Facts: Δ owns a subsidiary corp that produced silicon breast implants; π class was harmed by the fake boobs try to PCV to reach Δ’s assets; Δ had all kinds of control over subsidiary, including the fact that the subsidiary was basically controlled by Δ’s executives and subsidiary required Δ’s approval to do anything. 2. Issue: Could π PCV? 3. Application: Unity of interest was met due to the control factors Δ treated subsidiary and its assets as its own. Injustice prong met authomatically in the tort context. 4. Holding: π could PCV. c. Role and Purpose of Corporations i. Ultra Vires Doctrine (Waste) 1. Actions taken by officers/directors that are outside of their power or contrary to a business purpose a. Cf. Barlow (donation to Princeton would help recruiting education workers and give corp better reputation w/ community); Wrigley (corp could forego potential higher revenue from night games b/c of the legitimate concerns about the negative impact that lights would have on the neighborhood) with Ford (desire to ensure all people had a job was contrary to the corp’s purpose of making money). ii. A.P. Smith v. Barlow 1. Facts: Δ corp gave $ to Princeton; π sued on the ground that making a donation to a school was beyond the D&O power and contrary to a business purpose to make money!. Δ argued that donation to school was w/ power and helpful to business b/c it would make corp more attractive to graduates and help build a positive image w/ community. 2. Issue: Whether the donation to Princeton was ultra vires 3. Application: Although the purpose of a corp is to make money, how money is made is left to discretion of D&O. Thus, where D&O believe that a small donation to a university will further the corp’s business interests, then that is an acceptable use of power. 4. Holding: Donation was NOT ultra vires iii. Dodge v. Ford 1. Facts: Δ refused to issue dividends one year for two reasons: 1) was saving money to rebuild a plant, and 2) was trying to ensure corp had enough money so that it could provide jobs for as many Americans as possible; π wanted dividends, sued on ground that objectives were ultra vires. 2. Issue: Whether the two reasons for denying dividends were ultra vires 3. Application: The first reason – saving for the plant construction – was a legitimate reason not to pay dividends (at least so far as that cost was concerned) b/c it was legitimate business concern protected by BJR. Second reason, however, was not consistent w/ the corp’s goal of achieving profits for SHs was ultra vires. BJR did not protect. 4. Holding: Goal of trying to make jobs for all people = ultra vires iv. Shlensky v. Wrigley 1. Facts: Cubs were losing $; π argued that loss was due to fact that team did not play night games; Δ refused to do night games b/c he felt: 1) baseball was a sport meant to be played during the day (illegitimate – See Ford), and 2) that the lights that were needed to play night games would be harmful to the neighborhood harmful to the team/business. 2. Issue: Whether the denial to play night games, though perhaps financially unwise, was an ultra vires decision 3. Application: Concern about effect of lights on neighborhood and the potential harmful side-effects upon the team/business were legitimate business concerns BJR protects 4. Holding: Denial to play night games were permissible IV. The Duties of Officers, Directors, and Other Insiders a. Duty of Care i. Business Judgment Rule 1. 2 Conceptions: a. Abstention Doctrine i. Court will NOT review BOD decisions ii. UNLESS: 1. fraud 2. illegality 3. self-dealing (Duty of Loyalty) 4. Gross Negligence/Recklessness (uninformed) iii. Significance if an exception is shown, then still have to show a breach of the duty of care 1. Ex: Fed Ex trucks getting ticketed (illegal), but probably a wise business decision not liable. Whereas, if BJR=std of liability, then liable b/c it’s illegal. b. Standard of Liability i. NO liability for negligence ii. Liability requires: 1. fraud 2. illegality 3. self-dealing (Duty of Loyalty) 4. Gross Negligence/Recklessness (uninformed) 2. BJR protects D&O for simple negligence (imprudent business decisions). See Kamin. 3. BJR does NOT protect if: a. D/O makes a decision that he does not honestly believe is in the corp’s best interest b. D/O makes decision that is uninformed (failure to inform itself of “all material info reasonably available to them”). Protects judgment, so if there is no judgment made, then BJR cannot protect. See Van Gorkom. i. Reports 1. D/Os are entitled to rely on reports. But, if the report does not relay the facts upon which conclusions are being made, the party selected to make the report (e.g. an “expert”) was negligently selected, or is made by someone on a matter in which he lacks competence, then that reliance is unreasonable. c. D/O has a conflict of interest (Duty of Loyalty) ii. Test: 1. Does the BJR shield the Δ’s decision? a. Yes: NOT liable. See Kamin (informed decision); Brehm (same) b. No: Step 2. See Van Gorkom (uninformed); Caremark (illegal) 2. Did Δ (D/O) breach his duty of care? a. No: NOT liable. See Caremark (reasonable efforts taken) b. Yes: Step 3 3. Did BOD cure the defect? a. Yes BOD went back afterwards and fixed: NOT liable b. No: Step 4. See Van Gorkom (ineffective amendments) 4. Did SHs ratify the decision? a. Yes: NOT liable b. No: Step 5. See Van Gorkom (SHs cannot ratify if uninformed) 5. Affirmative Defense: Was the transaction “entirely fair”? a. Yes: NOT liable. See Cinerama (no damages; deal was good) b. No: Liable iii. Kamin v. American Express 1. Facts: Δ took a loss on an investment in another co.; Δ wanted to get rid of loss, so distributed the shares as a dividend; π argues that Δ would have saved money if it sold the shares and wrote off the loss in tax filings; Δ, however, was concerned about the effect π’s plan would have on reported net income and, therefore, the stock price; Δ considered π’s proposal and rejected it; π sued for breach of duty of care imprudent decision 2. Issue: Did Δ breach its duty of care? 3. Application: π did not allege fraud, illegality, nor self-dealing. Rather, π alleged that decision was negligent. Since the Δ carefully considered the proposal, the decision was not hasty nor uninformed. Thus, the BJR rule applied and shielded the Δ from liability. 4. Holding: BJR applies Δ not liable iv. Smith v. Van Gorkom (Uninformed Decision Attacking Process) 1. Facts: T was profitable corp, but had tax credits that it couldn’t use; Δ (BOD) investigated several options re: how to make more $; investigated management buy-out angle CFO thought it could get a loan for MBO at a price of $55/share (that’s the max price Δ would have been able to get a loan for; NOT the value of the corp); CEO went to P and offered to sell him the corp for $55/share, P quickly agreed; Δ asked for rt to try to sell to other bidders for higher price, P agreed but asked for a lock-up of 1M shares (guaranteed at least $17M profit – but would also make it harder for Δ to sell to another bidder total purchase price would go up by $55M+ b/c of the extra 1M shares); window of opportunity to sell to another bidder was short and restricted (not a realistic chance to get another bidder); Δ accepted the terms after a 2 hour meeting later realized terms were bad, tried to modify, but changes were not very helpful and made w/o looking over the new deal; SHs voted to approve deal, but were not told how the $55/share price was determined (i.e. uninformed). 2. Issue: Did Δ breach its duty of care? 3. Application: The decision was uninformed b/c there was no basis for the purchase price, decision was made in 2 hours, when a simple glance would have probably warned them about the problems w/ the deal uninformed BJR does not protect. Also, their attempts to cure were not helpful b/c the amendments to the deal were crap and made without really looking them over. Finally, the SHs did not ratify the decision b/c their vote was uninformed. 4. Holding: Δs breached their duty of care. v. Cinerama v. Technicolor 1. Introduces the “Entire Fairness” Defense a. If transaction is “entirely fair” then there are no damages Δ NOT liable vi. Brehm v. Eisner 1. Facts: π brought suit against old board re: Ovitz’s compensation package and against new board re: no-fault termination; Δ argues that BJR protects against claim 1 b/c they relied on an expert (compensation consultant), and against claim 2 b/c, although there were facts supporting termination for cause, that would have required litigation, $, and time was a business decision. 2. Issue: Whether Δ breached its duty of care 3. Application: Ct agrees that Ovitz compensation package was important info that was reasonably available to Δ, but that Δ did not breach its duty b/c it relied upon an expert. There were no allegations that expert was disbelieved nor negligently selected Δ were entitled to rely on his report BJR applies. As to the second claim, Ct agrees that Δ could have pursued termination for cause, but that the decision not to was a business decision b/c of the cost/risk of pursuing litigation. 4. Holding: BJR applies Δ NOT liable vii. Francis v. United Jersey Bank (Failure to Stay Informed) 1. Facts: Δ was Director of corp, along w/ her 2 dishonest sons; Δ drank, was old, and completely abandoned her duty as director; sons embezzled $ (in the form of loans); corp went BK; BK trustee (π) sued Δ, on behalf of creditors, for breach of duty of care; Δ argues that BJR applies to the loans sons took out b/c it was an imprudent business decision. 2. Issue: Did Δ breach her duty of care? 3. Application: BJR did not apply b/c Δ never made any judgments. She completely neglected her responsibility as a Director lack of due care w/ respect to process. As a Director she had a duty to be reasonably informed failed to do so breached duty of care. 4. Holding: No BJR breached duty of care Δ liable viii. In re Caremark 1. Facts: Δ was a healthcare provider, subject to anti-referral payments law; some violations of the law were uncovered Δ settled litigation w/ gov’t; π sued derivatively, alleging harm to the corp Δs failed to monitor what was going on w/ reps. 2. Issue: Did Δ breach its duty of care? 3. Application: BJR did not apply b/c the claim was that Δs failed to monitor what was going on (i.e. no judgment – See Francis). However, no breach of duty of care b/c Δ was not required to monitor day-to-day operations, and there was no evidence that Δ completely failed to exercise oversight. 4. Holding: No breach ix. Planning 1. If you do screw up and breach duty of care, can still fix: a. Get an informed BOD to fix/approve the deal; OR b. Get the SHs (informed) to approve the deal 2. Affirmative Defense a. Could always try to claim that the deal is fair b. Duty of Loyalty i. Test: 1. Is there a conflict of interest? (abuse of power as D/O to benefit self) a. No: transaction valid b. Yes: Step 2 2. Has an informed AND disinterested BOD approved/ratified? a. Yes: transaction valid i. See infra Quorum Issues b. No: Step 3 3. Has the transaction been approved by informed SHs? a. Yes: transaction valid. See Gottlieb. b. No: Step 4 4. Is the transaction intrinsically fair to the corp? a. Yes: transaction valid b. No: transaction INVALID voidable by corp ii. Quorum Issues: 1. DGCL § 141(b): a. Quorum (number of directors required for vote to be valid) requires that a majority of the directors be present at the vote. 2. DGCL § 144(a)(1) a. A valid vote requires that a majority of the disinterested directors approve of the action 3. Thus, there can be a sufficient number of directors present to make a quorum, but if there are an insufficient number of disinterested directors that approve of the action, then the vote is invalid. a. How to solve conference call. See DGCL § 141(i). iii. Planning 1. Where a course of action has been undertaken that involves a conflict of interest, there are several ways to cure the problem: a. Show that the deal is intrinsically fair. See Bayer. b. Get an informed and disinterested BOD to approve/ratify the action. c. Get the action approved by informed SHs. iv. Directors and Management (D/O) 1. Bayer v. Beran a. Facts: Δ (BOD) decided to run a radio ad program; CEO/Director consulted his wife, who made recommendations, ad agency accepted her advice; Wife was also a singer and was offered a job to do some of the radio ads pay was reasonable and she received no special prominence; Δs did not know that CEO’s wife was one of the singers until after it had approved of the radio campaign; π asserts that Δ breached its duty of loyalty b/c the campaign was designed to further the career of the CEO’s wife (i.e. self-dealing). Also claimed that action was ultra vires b/c BOD never approved of the campaign by formal board resolution. b. Issue: Whether Δ breached its duty of loyalty. c. Application: There was a conflict of interest b/c Δs had hired CEO’s wife as part of an advertising campaign. The action was not ratified by an informed BOD b/c they did not learn that the wife had been hired until after they had decided to embark on the ad campaign. Furthermore, the SHs never voted on the matter. However, the deal was fair to the corp wife was not paid excessively, she was only one of several singers hired, the program was carefully selected and successful (i.e. corp got its $ worth). Thus, the deal was intrinsically fair. i. Although BOD never formally adopted, it was agreed upon by a majority informally and, in any case, was arguably ratified by acceptance of the benefits. d. Holding: Δ did not breach duty of loyalty. 2. Lewis v. S.L. & E. a. Facts: Δs were BOD of a SLE (owned real property that it leased to LGT); Δs were also BOD of LGT (tire dealership); Δs entered into agreement w/ other shareholders of SLE, that if they did not own LGT stock, they would have to sell their SLE stock. LGT’s lease expired on the property; Δs never pursued renegotiating a lease b/c that would have cost LGT money and Δs basically viewed SLE as existing for LGT’s benefit. When agreement ripened and non-LGT owning SLE SHs (π) were supposed to sell, π brought derivative action alleging that Δs had harmed the value of SLE stock by failing to renegotiate a lease b/c it was in their personal benefit not to do so. b. Issue: Did Δs breach their duty of loyalty? c. Application: Clearly a conflict of interest b/c Δs had a personal interest in not renegotiating the lease on behalf of SLE. Also, was not ratified by a disinterested board, nor was it ratified by the SHs. Finally, the deal was not fair. d. Holding: Δs breached their duty of loyalty. v. Corporate Opportunities (D/O/Maj SH) 1. Rule a. A D/O/Maj SH breaches his fiduciary duty of loyalty if he misappropriates a corporate opportunity. See Guth; Broz. 2. What is a corporate opportunity? a. Tests: i. Historical (Interest/Expectancy/Necessity) 1. Corp has a real/vested interest in the opportunity (i.e. has a better right than others) 2. Corp has an expectancy that it will receive the opportunity (will come to corp by natural course) 3. Corp needs the opportunity to continue its existence ii. Delaware (See Broz) 1. corp is financially able to take opportunity 2. w/in corp’s line of business 3. corp has an interest or expectancy 4. embracing opp would create conflict btw corp and director’s self-interest iii. Line of Business 1. Capable of pursuing the opportunity; AND 2. its w/in corp’s line of business iv. Fairness 1. Would it be unethical for the D/O/Maj SH to take the opportunity from the corp? v. Hybrid 1. Combine aspects of all the Tests. b. Defenses: i. Source 1. Opportunity came to D/O/Maj SH personally (possibly due to reputation), not through his position w/ corp. See Broz. ii. Incapacity 1. Corp is unable to take advantage of the opportunity (lack of resources). See Broz. iii. Disclosure & Approval 1. informed BOD or SHs can ratify the action 3. Broz v. Cellular a. Facts: Δ was on BOD of π; learned of an opportunity to buy a license in a non-competing area; opp was offered to Δ, not to π; mentions to CEO/D and another D, both agree that π was not interested in the opportunity; π was experiencing financial difficulties and could not have afforded to pursue; Δ pursues license; another corp competes; Δ wins license, other corp buys π, then sues Δ for taking a corp opp. b. Issue: Did Δ misappropriate a corp opp? c. Application: opportunity came to Δ in his individual capacity, not as a Dir of π; π was incapable of taking advantage of the opp (no interest); opp was not offered to π b/c of its financial condition (no expectancy). Thus, this was not a corp opp. d. Holding: Δ did not breach his duty of loyalty by misappropriating a corp opp. vi. Dominant Shareholders (Maj SH) 1. Rules: a. SHs, acting as SHs, owe each other no fiduciary duties b. But, Maj SH can owe fiduciary duty to the Min SHs when it conducts business w/ the corp (since it can control the BOD) and there’s a potential for self-dealing (i.e. using power as Maj SH for personal gain at Min SHs expense). See Sinclair (Δ failed to enforce contractual rights b/c it was also Maj SH in the corp that breached the contract Δ benefits at Min SHs expense); Zahn (redeemed Min SHs stock w/o telling them their plans to liquidate and capitalize on increased value Min SHs redeemed, rather than convert, and Δ received a windfall) i. Maj SH will have to show that the deal is intrinsically fair absolute defense ii. Can also get approval/ratification from disinterested and informed BOD (though usually not helpful unless there are Min Directors); OR iii. Can get approval from the disinterested and informed Min SHs. 1. However, this only shifts burden on π to show that the transaction was intrinsically unfair. 2. Sinclair Oil v. Levein a. Facts: Δ owned 97% of Sinven’s stock; π (Min SH) sues derivately, alleging three causes of action: 1) Δ breached its duty of loyalty by forcing Sinven to pay out excessive dividends (i.e. self-dealing), 2) Δ misappropriated corp opp no expansion policy, and 3) Δ breached its duty of loyalty by refusing to enforce a breached contract between π and another of Δ’s subsidiaries. b. Issue: Did Δ breach its duty of loyalty? c. Application: i. π failed to allege any self-dealing w/ respect to the first claim. Since Δ had paid equal dividends, irrespective of whether the SH was Maj or Min, then all π had really claimed was an imprudent business decision (excess dividends = waste). Thus, this was a duty of care claim, and the BJR applied π failed to overcome BJR. ii. There were no corp opp that Δ usurped π failed to allege that any opps were presented to Sinven that Δ took for its own advantage. Thus, no expansion policy was subject to BJR π failed to overcome BJR. iii. The failure to enforce the breach of contract did allege self- dealing, since Δ would have been harmed by enforcing Sinven’s rights. Action was not intrinsically fair, nor approved by disinterested BOD nor the disinterested SHs. Thus, Δ had breached its fiduciary duty of loyalty. d. Holding: Only the failure to enforce Sinven’s contract rights was a breach of the duty of loyalty. 3. Hypo a. XYZ owns 90% of ABC oil co (Texas) b. XYZ learns of an oil opportunity in Alaska c. XYZ uses it power to liquidate ABC and pays out equal dividends d. XYZ then uses the money used from liquidation to pursue Alaska oil e. NO breach of fiduciary duty of loyalty i. All SHs received equal dividends BJR (no self-dealing) ii. No corp opp usurped from ABC (came to XYZ) 4. Zahn v. Transamerica a. Facts: Δ was Maj SH of Class A and B stock; A = 2x liquidation preference, convertible to B; B’s could redeem at $60/share + unpaid dividends; Δ learned that its tobacco inventory went way up, planned to liquidate and make huge profit, so Δ used its control to redeem the Class A stock (they’re bought out – no longer SHs); π’s take the redemption value and do not elect to convert to B; Δ then liquidates and makes huge profit; π sues for breach of duty of loyalty. b. Issue: Did Δ breach its duty of loyalty? c. Application: Ct holds that Δ, if it were impartial, would have disclosed the info re: increase in tobacco price. This was a conflict of classes case, and the Ct held that the BOD failed to act impartially toward each class; rather, the Δ used its power to its personal benefit. d. Holding: Δ liable breach of duty of loyalty vii. Ratification (i.e. SH approval) 1. Fliegler v. Lawrence a. Facts: Δ was president of corp; bought land and offered to sell to corp, but he and BOD agreed that corp could not afford at the time; Δ and BOD formed another corp and transferred the land to that corp; Δ and BOD then entered into an option agreement between the 2 corps to purchase the land (Δ was on both sides of the transaction = conflict of interest); deal was approved by SHs; when BOD exercised option, π sued. b. Issue: DidΔ breach his duty of loyalty or did the SHs ratify the agreement? c. Application: SHs did not ratify the agreement b/c the majority of the approval was by the interested SHs (i.e. the BOD); there was insufficient evidence to indicate that a majority of the disinterested (i.e. minority) SHs had approved. However, Δ did establish that the deal was intrinsically fair. i. Quirk re: DGCL § 144(2): does not confer immunity on D/O if SHs ratify. It simply provides that a transaction may not be invalidated solely b/c a D/O is involved still subject to fairness inquiry. d. Holding: Δ did not breach duty of loyalty c. Disclosure and Fairness i. Derivative Actions 1. Eisenberg – who suffered the most direct injury? a. Corporation: Derivative b. Shareholder: Individual 2. Standing: a. Must have been SH at time of alleged wrongdoing b. Must be a fair/adequate representative (conflict of interest?) 3. Hurdles: a. Bonding – required to post security for corp’s litigation costs. See Eisenberg. b. Demand – must first demand BOD to pursue suit (usually against itself). Excused if reasonable doubt that: i. BOD is disinterested/independent; AND ii. Transaction was valid exercise of business judgment c. Special Litigation Committees – the untainted BODs Cts may only scrutinize process, not substance (BJR). If SLC denies, then π can pursue in Ct – Ct can look at: i. Whether SLC acted independently, in good faith, and w/ reasonable investigation; AND ii. Whether the dismissal passes the BJR ii. Securities Act of 1933 1. Regulates Primary Market 2. Purpose: a. Disclosure to investors b. Prevent fraud iii. Securities Exchange Act of 1934 1. Regulates Secondary Market 2. Issues: a. Securities Fraud b. Insider Trading c. Short-Swing Profits d. Regulate Proxy Voting e. Regulate tender Offers 3. Section 10(b): Prohibits the use of fraudulent or deceptive practices in the purchase or sale of a security iv. Definition of a Security 1. 3 Kinds of Security: a. Stock. See Landreth (stock is always a security). b. Investment Contract: (See Howey; Monsanto) i. Investment of $ ii. In a common enterprise 1. Horizontal Commonality a. Pooling btw investors – share in profit/loss b. Sufficient to satisfy commonality req. 2. Vertical Commonality a. Investor and promoter are in common scheme – investors fortunes linked w/ promoters b. Circuit split as to whether this alone suffices iii. With an expectation of profit iv. Solely from the efforts of others 1. Reality: solely is more like mostly c. Any interest commonly known as a “security” i. Same as investment contract. See Monsanto. 2. Examples: a. Public Corp: quintessential case stock b. Close Corp: stock. See Landreth. c. Partnership (Investment Contract): i. No, P’s have control (NOT solely from effort of others) ii. Might be occasion where some P’s are so deprived of control that it looks like a security p’ship agreement d. LP (Investment Contract): i. Yes, LP has no control (effort of others) ii. No, LP may exercise control – have to look at facts 3. Great Lakes v. Monsanto a. Facts: Δ created an LLC to do some work for it; LLC was basically an independent business (employees and all) w/ ownership being held in “shares” that were owned entirely by Δ; Δ sold the LLC to π; something went wrong w/ LLC and π sued Δ for federal securities fraud (easier to plead/prove than state C/L fraud claim); Δ moved to dismiss on ground that LLC was not a “security” w/in the meaning of Rule 10b-5. b. Issue: Whether an LLC is a “security” c. Application: Not stock b/c it’s not a corp. Had to examine as an investment contract. Ct held that there was no common enterprise b/c π was the only interest-holder (no horizontal commonality) and Δ had sold its entire interest, so no vertical commonality. Also, Ct held that expected profits would not come solely from the efforts of others. Although the LLC had employees that would do all the work, π retained complete control over management and could therefore directly affect the profits it would receive from the LLC. Bottom line: this was the sale of a business, not a security. d. Holding: LLC was not a security fed securities fraud claim dismissed v. Registration Process 1. In General a. Whether you’re dealing w/ a security is important b/c securities must be registered before sold liability otherwise b. Also, registration is costly and delays when investment opp can be sold. c. Exempt Securities v. Exempt Transactions i. Security – never needs to be registered (rare) ii. Transaction – exempt only for this deal 1. Private Placement: a. Number of offerees and their relationship to offeror i. Offerees knowledge/sophistication ii. Offerees access to information b. Number of units offered c. Size of the offering d. Manner of offering i. No general advertising/solicitation 2. Securities Act of 1933 § 11 a. Liability for materially misleading statements in a registration statement b. Materiality: i. Info that would be important for a reasonable person to make an informed judgment ii. One that would effect a person’s decision c. Who’s Liable? i. The Issuer Strictly liable (NO Due Diligence Defense) ii. Anyone that signs the registration statement iii. Directors iv. Experts v. Underwriters d. How to Approach: i. Experts parts of the statement that they prepared ii. Everyone else everything the Experts did NOT work on 3. Due Diligence – § 11(c) a. Directors, underwriters, and signatories are NOT liable for materially misleading statements in a registration statement, if they reasonably investigated the information and reasonably and honestly believed that it was in fact accurate. See Escott. b. Experts: i. No reason to believe statements were false; AND ii. Was reasonable to believe that 1. Unreasonable if no investigation undertaken (e.g. take corp reps at their word). See Escott. 4. Escott v. BarChris a. Facts: Δ issued debentures prior to going BK; there were two sets of debentures, so two sets of registration statements; 1960 statement (audited and unaudited) contained some material misstatements re: balance sheet; 1961 statement (unaudited) had material misstatements throughout; when Δ went BK π sued the issuer, the directors, and the auditor (expert). b. Issue #1: Were there any material misstatements in the registration statement? c. Issue #2: Whether any of the Δs were protected from liability under the Due Diligence defense? d. Application #1: Yes, the difference between the numbers given and the actual figures would have been important for a person to make an informed judgment about whether to purchase the debentures or not. e. Application #2: i. Issuer: Strictly Liable ii. Pres + VP (Directors): claimed that they were uneducated, unsophisticated, and did not know what was going on Ct holds them liable b/c they undertook no investigation nor hired lawyers to investigate for them NO Due Diligence. iii. K (Director): failed to investigate NO Due Diligence iv. B (Director): failed to investigate NO Due Diligence v. G (Director): failed to investigate; atty, so should have known better NO Due Diligence vi. PM (auditor – expert): assigned a young auditor, he took the D’s at their word re: info, failed to reasonably investigate to discover whether the info was accurate, investigation would have revealed truth NO Due Diligence f. Holding: All Δs liable for the material misstatements in the registration statements vi. Rule 10b-5 (Securities Fraud) 1. Elements of Securities Fraud: a. Fraud/Deceit: i. Material misrepresentation 1. Probability-Magnitude Test. See Basic. 2. Material Omission: a. Must be a duty to disclose ii. Scienter (See Pommer) 1. Intent to deceive 2. Recklessness a. Maybe, but PSLRA appears to have heightened the pleading requirement more likely π has to show intent. iii. Reliance 1. Fraud on the Market Doctrine. See Basic (where misstatement are made publicly, then, in an efficient market, the stock price will reflect that info and π is presumed to have relied). a. Requirements: i. Misstatement was public. See West. ii. Efficient market b. Defenses: i. Market was NOT deceived ii. Corrective statements (notice to investorscorrect the stock price) iii. Show individual πs would have sold anyway 2. Omission reliance presumed 3. If reliance is unjustified, then no cause of action. See Pommer (was unjustified for π to rely on statements that an acquisition was imminent b/c the fact that Δ told π that the price range was $50M-$100M indicated that negotiations were in early phase and acquisition was not imminent) iv. Proximate Cause (misstatement caused the damage) b. In connection w/ the purchase/sale of a security i. Only purchasers/sellers have standing to sue. No standing if misstatement caused you to NOT purchase. See Blue Chip Stamps. ii. The misstatement(s) need only “touch and concern” a purchase or sale. See Basic (denial that corp was planning to merge w/ another held to “touch and concern” the purchase/sale of the stock). 2. Planning: a. If no duty to disclose, then can simply say “no comment” or say nothing at all just don’t lie. b. If statements made by employee (e.g. CEO or Pres), then Corp will be liable under Agency Law c. If material misstatements are made affirmative duty to correct those misstatements. 3. Basic v. Levinson (Materialiy & Reliance – Fraud on Market) a. Facts: Δ corp’s agents denied that it was engaged in merger negotiations on three occasions; stock price = $20 after the first denial; merger was ultimately announced price went up to $46; π brings class action on behalf of all SHs that sold in about a 1 yr period. b. Issue #1: Were the merger denials material misstatements? c. Issue #2: Is this a proper class action, given that reliance is an issue (and is usually highly fact-specific)? d. Application #1: Ct held that the statements were material. There was no duty to disclose, but Δ affirmatively misstated the truth. Magnitude = great, b/c having their corp merged into another would greatly impact SHs (nothing could affect them more). Probability = may not have been material at first denial, but probability had to go up as time went on and negotiations developed. Thus, the denial that Δ was not in merger discussions was material e. Application #2: Ct held that where misstatements are made publicly, and the market is efficient, it’s reasonable that those misstatements will be reflected in the stock price. Therefore, πs need not show that they actually heard/read and relied on the misstatements; rather, reliance was presumed due to the probable effect on the stock price. Fraud on the Market Doctrine. However, Δ could try to rebut the presumption. f. Holding: Δs made material misstatements and reliance was presumed under the Fraud on the Market Doctrine. 4. West v. Prudential (Fraud on Market) a. Facts: Δ told his clients that a corp was about to be acquired at a premium was a lie; πs were NOT Δ’s clients, but sued Δ on the ground that his misstatements affected the stock price and they bought at those artificially inflated prices. b. Issue: Whether the Fraud on the Market Doctrine could apply to satisfy the reliance requirement? c. Application: FOM requires that the misstatements be made public; Δ made his misstatements in private. Thus, investors could not have gotten wind and the stock price would not have reflected the false info. Rather, says the Ct, sophisticated investors, operating on all the info available to the public as well as their own special knowledge, would realize that the price was inflated and bring it back in line w/ its actual value. d. Holding: FOM theory inapplicable to misstatements made in private. 5. Pommer v. Medtest a. Facts: W was SH in Δ corp; told πs that: 1) Δ had a patent on a device, and 2) Δ was about to be acquired for between $50M-$100M; both statements were lies; πs bought Δ stock from another SH (Director). b. Issue: Whether Δ had committed securities fraud under Rule 10b-5. c. Application: Both misstatements were material: 1) b/c the ownership of a patent would be important factor for a reasonable investor, and 2) the potential acquisition would be very important for any potential investor. Fact that Δ later did receive patent was irrelevant π would have paid a lower price; may affect calculation of damages though. However, reliance on the second misstatement was unjustified, b/c the fact that W indicated that the price range was between $50M and $100M signaled that there was a lot of negotiating to do before any merger would be completed. Also, since W did not sell his own stock, there was a question about whether he had the requisite scienter required for securities fraud. d. Holding: Materiality established for both statements; reliance unjustified for second statement; remanded for determination on scienter question. 6. Santa Fe v. Green (Misstatement false statement) a. Facts: Δ owned 95% of Kirby stock; decided to merge corp w/ another and pay each SH $150/sh for their stock; in merger prospectus, Δ disclosed that the physical assets alone were worth appx $640/sh; Min SHs (π) sued, alleging that actual share value was around $772/sh and that Δs had committed securities fraud under Rule 10b-5 b. Issue: Whether Δ had made a material misstatement w/ respect to the merger c. Application: The Δs did not make a material misstatement. Rather, they disclosed what the actual value was, but indicated that they were only going to pay the πs a fraction of that value no false statement. However, π would be able to pursue their appraisal rights or a state breach of fiduciary duty claim (Maj SH duty of loyalty). d. Holding: NO misstatement π’s 10b-5 claim was dismissed d. Inside Information i. Rules: 1. Common Law: a. 3 Approaches: i. Majority Rule 1. D/O may trade w/ SHs w/o disclosing material info ii. Special Circumstances Rule 1. Duty to disclose may be imposed if there are special circumstances: a. Highly material info b. Concealment of identity or other active fraud c. Susceptible π iii. Minority Rule 1. D/O have a duty of full disclosure whenever they buy/sell shares from SHs b. Only applied to face-to-face transactions 2. Traditional Insider Trading [Rule 10b-5] a. Premised on an omission of material fact (i.e. silence) must be a duty to disclose (silence ≠ fraud, unless there’s a duty to speak) b. Rule: i. If you are 1) an insider in possession of 2) material, non- public info and 3) knowingly/recklessly 4) buy/sell, then you’re liable. c. Elements: i. Duty (Recall, there must be a duty to disclose; so who will the law impose that duty upon?) 1. Statutory Insiders and “constructive” insiders have a duty NOT to trade while in possession of non-public info “disclose or abstain”. See Cady-Roberts. 2. Statutory Insiders a. Directors b. Officers c. 10% SHs 3. “Constructive” Insiders a. Tipper Liability: i. Liable if their tippees trade and would be liable under Dirks. b. Tippee Liability: i. Tipper breached a fiduciary duty Personal Benefit Test (tipper sought to benefit himself personally: money, reputation, quid pro quo, gifts). See Dirks (disclosure made out of desire to expose fraud NOT made for personal benefit); Switzer (Δ overheard corp Pres tell his wife of merger, Pres did not tell Δ to personally benefit). ii. Tippee had knowledge of the breach iii. Tippee bought/sold stock ii. Scienter 1. Δ knowingly or recklessly trades when inpossession of such knowledge. iii. Materiality 1. Whether a reasonable investor would attach importance to the info Probability/Magnitude Test 2. Factors to Consider: a. Nature of info b. Company’s response c. Market response d. Conduct of insiders 3. Does the fact that the insider traded on the info demonstrate materiality? iv. In connection w/ purchase/sale of a security d. Planning: i. If you have material, non-public info, then do NOT buy/sell that stock. Abstain! ii. Cannot disclose if you’re an employee b/c you have duty NOT to reveal confidential info obtained through employer. See Rst Agency § 395 iii. Once info is publicly disclosed, must still wait a reasonable amount of time to let info become available to the investing public. See Texas Gulf Sulphur (employee liable b/c he traded a few minutes after announcement, but before info was relayed on NYSE ticker-tape) 3. Misappropriation: a. Breach of fiduciary duty – usually confidentiality – to the principal (not the SHs of the stock being bought/sold). Cf. Chiarella (Δ not liable b/c learned of inside info affecting corp X through his employer, who was agent for Corp Y, the acquiror). i. feigns loyalty while secretly using for personal gain. Thus, disclosure may absolve from liability. See O’Hagan (disclosure to principal and the acquiring corp may have cleansed his purchase no apparent need to get their permission). ii. Info learned from a family member that was supposed to be kept secret is sufficient to impose liability. See SEC Rule 10b5-2. iii. Any fiduciary relationship will suffice – the scope of the duty is irrelevant. See Willis (psychiatrist liable for insider trading from info obtained from a client in therapy) b. Buy/sell a security ii. SEC v. Texas Gulf Sulphur (Statutory Insiders) a. Facts: Corp discovered a promising mineral deposit; Pres swore everyone to secrecy; Δs (insiders who knew of the discovery) started buying the corp’s stock; discovery leaked, but was quickly quelled by some materially misleading statements made by corp officials; truth was later revealed; SEC sues Δs for insider trading. b. Issue: Were the Δs guilty of insider trading? c. Application: The discovery was certainly material info b/c any reasonable investor that was buying/selling the stock would have thought the info was important. Also, Δs had a duty to disclose or abstain b/c they were D/O (statutory insiders). Thus, they were liable b/c they knowingly traded in the corp’s stock. d. Holding: Δs liable for insider trading. iii. Dirks v. SEC (Constructive Insiders Inherited Duty) a. Facts: S, a former officer of corp, tells Δ about fraud going on inside the company; Δ investigates and uncovers tells his clients; clinets sell their stock. b. Issue #1: Did S owe a duty to his former employer? c. Issue #2: Did Δ inherit S’s duty to abstain or disclose? d. Application #1: Yes, as a former statutory insider, S had a duty to keep the information secret. e. Application #2: f. Holding: iv. US v. O’Hagan a. Facts: Δ was law firm partner at law firm; law firm was working for Grand Met, who employed law firm to do legal work in their acquisition of Pillsbury; Δ learned of the deal and bought Pillsbury stock. b. Issue: Was the Δ liable for insider trading? c. Application: No duty under the traditional analysis b/c he was not a tippee nor an insider of Pillsbury. Ct reasoned, however, that Δ was liable under the misappropriation theory Δ had breached his fiduciary duty to his law firm, by utilizing confidential info for his personal gain. Since he breached his duty to his employer, he was liable b/c he bought Pillsbury stock. d. Holding: Δ liable for insider trading. v. Rule 14e-3 1. Regulates insider trading w/ respect to Tender Offers 2. No Breach of Fiduciary Duty required Strict Liability 3. Elements of Liability: a. Material, non-public info about a Tender Offer b. Knowledge that info came from an insider c. Buy/sell stock (offeror or target) d. Offeror has taken substantial steps to consummate the deal e. Short-Swing Profits i. SEA § 16(b): 1. Profits made from buying/selling stock or convertible debt must be turned over to the corp if: a. Insider i. Director or Officer must always account for profits ii. 10% SH b. The purchase and sale are made w/in 6 mos. of each other i. Director or Officer 1. §16(b) applies if a D/O prior to either the purchase or the sale ii. 10% SH 1. have to be 10% SH prior to both the purchase and sale. See Reliance (sold stock to get below 10%, then sold remainder not accountable for the second sell b/c he was no longer a 10% SH) 2. the sale that puts you over the 10% threshold is not matchable for § 16(b) purposes. See Foremost (Δ not accountable for profits b/c the initial acquisition that took it over the 10% threshold could not be considered; no threat of “inside” info) 2. Policy: a. Prevent Insiders from profiting off of inside info b. Thus, § 16(b) inapplicable where no threat of misuse of inside info. See Kern (Δ did not purchase/sell w/in the meaning of § 16(b) when it was forced to accept stock as part of merger agreement and was a hostile party in the deal so unlikely that it had access to inside info). ii. Reliance v. Emerson (10% SH & Prior to Both Transactions) a. Facts: Δ owned 13.2% of stock; π merged the corp into itself; w/in 6 mos. of buying the stock, Δ sells 3.24% (taking him to 9.96%), then later sells the remainder; π sues Δ for the profit he made. b. Issue: Is Δ accountable for the profits he made? c. Application: Δ was 10% SH after initial purchase; Δ was 10% SH when he sold the first group accountable for profit made on that sale. However, Δ was no longer 10% SH when he sold the second group, so § 16(b) did not apply. d. Holding: Δ not accountable for his profits. iii. Foremost v. Provident (10% SH & Prior to Both Transactions) a. Facts: Δ acquired debentures from π that were convertible to stock (over 10%); Δ distributed those debentures to its SHs b/c it was liquidating; π sues Δ for the profits made on the distribution. b. Issue: Is Δ accountable for the profits it made? c. Application: Δ was NOT a 10% SH when it initially acquired the debentures, so that purchase could NOT be matched w/ the subsequent sale for § 16(b) purposes. d. Holding: Δ not accountable for the profits. iv. Kern County Land Co. v. Occidental Petroleum a. Facts: Δ was trying to acquire Kern; Kern worked out a deal w/ Tennoco to merge w/ them instead; T and K merge Δ forced to exchange its K shares for T shares as part of the merger; Δ gives T an option to buy the shares; T exercises option Δ makes profit; K (π) sues to account for the profits. b. Issue: Is Δ accountable for the profits it made from the options? c. Application: Δ was forced to accept T stock as part of the merger; Δ was a hostile party in the transaction (rival bidder), so there was no risk of misuse of inside info. d. Holding: Δ not liable for its profits V. Problems of Control a. Proxy Fights i. In General 1. Proxies a. A SH may appoint someone (a Proxy) to vote his shares at a meeting b. Generally, proxies are solicited by the groups vying for control 2. Regulations a. Must provide a written proxy statement before you solicit a proxy 3. Incumbent Power – Rule: a. The incumbent board may use reasonable corporate funds to contest a proxy fight. See Levin. Corp $ can be used so long as incumbents do not commit waste, fraud, or illegal acts. See Levin. 4. Basic Rules: a. Corp may NOT reimburse any party, unless the dispute concerns questions of policy. b. Only reasonable and proper expenses may be reimbursed. c. Corp may reimburse incumbents irrespective of whether they win or lose. See Rosenfeld. d. Corp may reimburse insurgents only if 1) they win and 2) the SHs ratify the payments. See Rosenfeld. ii. Strategic Use of Proxies 1. Levin v. Metro-Goldwyn Mayer a. Facts: π was a Min SH and was dissatisfied w/ the corp’s direction; staged a proxy fight against incumbent management (Δ); Δ’s used corporate funds to solicit proxies and for events/travel in the solicitation process; Δ’s won the contest; π sues, alleging that Δ’s misused corp assets. b. Issue: Whether Δ was liable for misusing corp assets? c. Application: SHs have a right to be informed of the competing positions. Accordingly, incumbent management may use corp $ to inform the SHs of what’s at stake. Since Δ did not commit waste nor do anything illegal/fraudulent, the expenses it incurred in the proxy fight were permitted. d. Holding: Δ’s expenditures in the proxy fight were acceptable. iii. Reimbursement of Costs 1. Rosenfeld v. Fairchild a. Facts: Δs were successful insurgents; old borad had used corp funds to contest the proxy fight; when Δs appointed to BOD they reimbursed incumbents for additional expenses and put forth a vote for the SHs to ratify the reimbursement of their expenses SHs ratified; π challenged the reimbursement of both the insurgents and the incumbents. b. Issue: Could the Δs reimburse the incumbents for expenses and could they seek approval for reimbursement of their own expenses? c. Application: Δs could reimburse both themselves and the incumbents so long as the expenses were reasonable and the contest was about policy (as opposed to personal power). The incumbents could be reimbursed by the Δs, and the Δs could seek reimbursement for their costs by SH vote/ratification. d. Holding: Yes, Δs could reimburse incumbents and seek reimbursement from the SHs for their own expenses. iv. Shareholder Proposals 1. In General a. SHs can request that BOD place a proposal before fellow SHs i. Can also have proxies solicited in favor of the proposal Corp bears the cost b. Rule 14a-8(i)(5) i. BOD allowed to exclude proposals that: 1. relate to operations that do NOT account for 5% of corp’s assets, earnings, or sales 2. are NOT otherwise significantly related to the firm’s business. See Lovenheim (ethical and social concerns may be included significantly related to firm’s business) c. Other Reasons to Exclude: i. Proposal does not concern a proper subject for action by SHs ii. Proposal is illegal iii. Proposal violates proxy rules iv. Proposal is beyond corp’s power v. Proposal relates to ordinary business matters (e.g. employee compensation) vi. Proposal has been submitted in the past and has not obtained much support d. Precatory Proposals i. “Request” or “hope” ii. Not binding on BOD. If it does not follow BJR 2. Lovenheim v. Iroquois a. Facts: π wanted to include a proposal to form committee to investigate the corp’s pate business b/c he was concerned about the ethical implications of force-feeding geese to yield more pate; Δ (BOD) refused to include the proposal on the proxy b/c pate accounted for such a small portion of corp’s business. b. Issue: Whether Δ could exclude π’s proposal? c. Application: Clearly the Δs could exclude the proposal on the ground that it accounted for less than 5% of the corp’s assets, earnings, and sales. The focus was on whether the ethical practices of force-feeding geese were “significantly related to the corp’s business.” Ct reasoned that the ethical and social concerns of force- feeding geese were significantly related to corp’s business, so Δs could not exclude the proposal. d. Holding: Δs could not exclude the proposal v. Shareholder Inspection Rights 1. Proper Purpose Test: a. SHs have a right to inspect corp records if their inspection is being done for a proper (business) purpose. Compare Crane (informing SHs of π’s tender offer terms was a proper purpose); Sadler (same) with Honeywell (π was corned solely w/ political and social goals, not the economic interests of the corp or its SHs). 2. Crane v. Anaconda a. Facts: π desired the SH list so that it could distribute to them, in a proxy, the terms of its tender offer; Δs refused to give π the SH list; π sued. b. Issue: Could Δ deny π access to the SH list? c. Application: Furnishing the SHs w/ the terms of a tender offer was a proper business purpose, b/c it related to the economic interest of the corp. d. Holding: Δ required to give π the SH list 3. State ex rel. Pillsbury v. Honeywell a. Facts: π learned that Δ was producing anti-personnel frag bombs for Vietnam War; π bought stock in Δ, then asked for the SH list to convince SHs to stop producing the bombs; Δ denied to turn over the SH list π sued. b. Issue: Could Δ deny π access to the SH list? c. Application: π had requested the list solely to pursue his own personal political and social agenda; he disagreed w/ the war and was trying to push his beliefs on the SHs. He was not concerned about the economic interests of stock ownership. d. Holding: Δ did NOT have to turn over the SH list 4. Sadler v. NCR a. Facts: AT&T, acting as agent for π, requested SH list (CEDE and NOBO) so that it could submit its tender offer terms directly to the SHs; Δs refused π sued. b. Issue: Proper Purpose? If so, could π get the NOBO list although it was not presently in existence? c. Application: Yes, purpose was proper. Yes, π could get NOBO list despite fact it was not yet in existence. NOBO list had the actual names on non-objecting (to being disclosed) SHs, which would better allow π to reach SHs. d. Holding: π could get the CEDE and NOBO list. b. Shareholder Voting Control i. Entrenchment: 1. Originators of corp issue 2 classes of stock: one w/ full rts (more expensive) and another w/o rt to dividends (cheaper). 2. The cheaper class is a “control class” only originators own the stock, and b/c its cheaper they usually have a lot of shares. Since 1 vote per share allows originators to maintain control of their corp. 3. When full-incident stock is sold publicly, corp must disclose the stock structure investors buy w/ knowledge of what they’re getting into. ii. Stroh v. Blackhawk a. Facts: Δ created 2 classes of stock: A and B; A = full ownership incidents (vote and dividends), B = voting stock (no dividends). Originally, there were 87K shares of A and 500K shares of B; Δ then sold 500K shares of A to public; π bought some of the A shares; π challenged legality of the B shares (not stock). b. Issue: Were the class B shares valid? c. Application: Although the B shares did not carry a financial property interest, control was still a valid proprietary interest. d. Holding: class B shares were valid. c. Control in Closely Held Corporations i. Close Corp Characteristics: 1. held by a few SHs (usually families) 2. NO secondary market ii. Income Issues: 1. Usually derived from salary as a Director/Officer 2. Rarely do they pay dividends iii. Legal Options for the Transactional Atty: 1. Shareholder Agreements a. Validity? See McQuade (obligation to use Director power re: selection of officers) b. Problem w/ a deadlock. See Ringling (arbitrator) c. Enforceability? See Ringling (none); Ramos (forced/elected sale) d. Constraint on Director Discretion. See McQuade 2. Voting Trusts a. Advantage: i. no chance of deadlock (trustee decides and carries out) b. Disadvantages: i. loss of control ii. limited duration iii. still possible for BOD to oppress 3. Statutory Close Corporations a. Defined by statute b. Management is by SHs NOT the BOD eliminates independent Director problem 4. Employment Contracts a. Way to guarantee status as officer w/o tying it to exercise of power as director b. Terms: i. Duration ii. Compensation iii. Duties iv. Termination 5. Involuntary Dissolution a. When all else fails, Ct may step in and dissolve to protect the Min SH don’t count on this though! SHs (and their attys) should make sure they take steps to ensure their security. iv. Rules: 1. SHs may agree on how they’ll vote as SHs, See Ringling, even if the corporation is public, See Ramos. 2. However, a SH Agreement that constrains a Directors discretion to act independently is invalid. See McQuade. a. But, if all the SHs are included in the agreement, then no party is harmed by the limitation, and the agreement is valid and enforceable. See Clark (the only 2 SHs were both parties to the agreement). b. Also, a SH Agreement that limits director discretion, but only binds some of the SHs, may be valid if: 1) it’s a close corp, 2) no Min SH objects/complains, and 3) the terms are reasonable. See Galler. v. Ringling Bros. v. Ringling a. Facts: π and Δ entered into a vote pooling agreement; agreement provided that in the event of disagreement, arbitrator would decide NO enforcement mechanism; π and Δ disagreed about BOD nominee vote submitted to arbitrator he selected π’s proposed board composition; π voted according to arbitrator, Δ did not π sues to enforce agreement. Lwr Ct forces Δ to vote according to arbitrator π’s BOD elected. b. Issue: Whether Δ was bound to vote according to the arbitrator’s decision? If so, could arbitrator’s decision be enforced? c. Application: The agreement was a valid contract, so Δ was bound by its terms. However, there was no enforcement provision, so arbitrator could not vote Δ’s stock for her (nor could Lwr Ct). Thus, Δ had breached the agreement, so her vote was nullified. d. Holding: Δ bound by agreement lack of enforcement provision meant that arbitrator could not compel Δ to vote according to his decision. vi. McQuade v. Stoneham a. Facts: Δ was Maj SH; π bought an interest in the corp; π and Δ entered into a SH agreement to elect each other Directors and to ensure that, as Directors, they would vote to keep each other as Officers at set salaries; Δ fired π from his position as Officer π sues for specific performance on the agreement. b. Issue: Whether the provision to elect each other as Officers was enforceable? c. Application: Directors are supposed to be able to exercise independent judgment. Since the agreement purported to bind the parties to certain courses of action, in their capacity as Directors, the agreement was invalid. d. Holding: Agreement was invalid vii. Clark v. Dodge\ a. Facts: π and Δ were the only two SHs in a corp; Δ and π entered into SH Agreement Δ would keep π as an officer if π disclosed a trade secret; π disclosed Δ fired π sues for specific performance. b. Issue: Whether the SH agreement was enforceable? c. Application: Although Directors are supposed to be able to exercise independent judgment, where all the SHs are involved in the agreement then there’s nobody harmed agreement is valid and enforceable. d. Holding: SH Agreement was valid and enforceable. viii. Galler v. Galler a. Facts: π and Δ had entered into a SH Agreement: vote pooling component, guaranteed BOD seats, mandatory dividends, and mandatory death benefits; together, they owned 95% of the stock; there was also a 5% SH, though he sold his stock during the suit; Δ refused to abide by the agreement π sues. b. Issue: Was the SH Agreement valid and enforceable? c. Application: SH Agreements that limit Director discretion are generally invalid. But, where all the SHs are involved in the Agreement, then there’s no harm to anyone. In this case, there was a 5% SH that was not included in the Agreement. The Ct reasoned, however, that unanimity is not required when: 1) it’s a close corp (yes), 2) there’s no complaining Min SH (yes), and 3) the terms are reasonable and legal (reasonable duration, dividends only paid if excess income, and death benefits were reasonable). d. Holding: The SH Agreement was valid despite the fact that not all SHs were included in it. ix. Ramos v. Estrada a. Facts: Δ was Maj SH of BG, π was Min SH in BG; BG owned ½ of TV; π and Δ entered into a SH Agreement: vote pooling agreement (would vote according to how the majority determined) + enforcement mechanism (if you failed to vote as majority determined, then you were deemed to have elected to sell your shares); π wanted to defect from agreement used power as Director to vote Δ out as the Pres (officer); Next BG meeting, Δ and his allies, nominated a slate of Directors π was excluded and refused to abide by the vote; Δ claimed that, by failing to abide by the agreement, π had elected to sell his shares π sues to have agreement declared invalid b. Issue: Was the SH Agreement enforceable as written? c. Application: π’s decision to vote Δ out as Pres was OK the Agreement did not constrain their ability to vote as a Director. However, when π failed to abide by the majority’s Director nomination slate, he breached the vote polling portion of the Agreement. Accordingly, the enforcement provisions were triggered and π was deemed to have elected to sell his shares. d. Holding: Agreement was enforceable π elected to sell his shares d. Abuse of Control (FDs btw Maj SH and Min SH in a Close Corp) i. In General 1. SHs in a Close Corp usually rely upon their salary as an Officer/Director for income b/c dividends are rarely paid, and when they are, usually don’t amount to much. 2. Freeze-Out: a. When a controlling block of SHs earns a return at the expense of the others. See Wilkes. 3. Rules: a. SHs in a close corp owe each other fiduciary duties. See Wilkes. i. Maj SH may take actions adverse to the Min SH if those actions are in pursuit of a legitimate business purpose. See Wilkes. 1. If legitimate purpose is being pursued, then Min SH may still prevail if it can show that there is a less harmful alternative. See Wilkes. a. Ct must then balance the legitimate bus purpose against the feasibility of the proposed alternative. See Wilkes. ii. Min SH may owe fiduciary duty to Maj SH, if that Min SH has such power (e.g. veto power) that he could effectively oppress the majority. See Smith (80% required to pass any measure 4 Directors = veto power). If so, then the Min SH has a fiduciary duty to use that power responsibly. See Smith (used veto power b/c he disliked the other SHs, not for any legitimate course of business he was pursuing). iii. Termination of an Employee/SH: 1. If π is SH because of their employment Δ can fire w/o concern about FD. See Jordan. a. But, even if π is an “at will” employee, cannot fire for a bad reason. See Jordan. 2. If π is employee because he is a SH FDs apply. See Wilkes. b. Delaware: i. SHs in a close corp do NOT owe each other special fiduciary duties. See Nixon (only the Bayer/Sinclair standard applies) 1. Forces SHs to enter into protective agreements 4. Planning: a. Buy-Sell Agreement (ex ante) i. Rt of First Refusal 1. Specify what conditions trigger the Rt. See Frandsen (Agreement only applied to sales of stock, did not include a merger) a. Even if Rt NOT triggered, can still try to outbid the competitor. See Frandsen. ii. Buy-Out Agreements (Other party must buy your stock) 1. Compulsory Buy-out. See Jordan. a. Triggered when SH leaves corp 2. “Tag Along”. See Frandsen a. triggered when other SH sells their stock iii. Restrictions on Sale (who can SH sell to?) b. Rely on Fiduciary Duties (ad hoc) i. Extremely unwise borderline malpractice ii. Expense litigation ii. Wilkes v. Springside a. Facts: π and Δs were SHs in a nursing home (4 owners); π and one of the Δs had a falling out; π informs Δs of his intent to sell his interest; Δs vote to eliminate his salary and remove him as an officer and director; Corp did not pay dividends; π stayed on and was willing to continue to work until he sold his interest; Δs then offer to buy out π at a low price; π sues for breach of fiduciary duty. b. Issue: Did Δs breach their fiduciary duty to π? c. Application: π was willing and able to continue working; There was no indication that he was incompetent/negligent Δs apparently fired him out of avarice and not for a legitimate business purpose. d. Holding: Δs terminated π for an illegitimate reason (personal avarice) they breached their fiduciary duty. iii. Smith v. Atlantic Properties a. Facts: πs and Δ owned a close corp 4 SHs; Corp bylaws required that any vote required approval by 80% of the BOD any 1 SH had a veto power; πs wanted to declare dividend to avoid tax penalties; Δ did not want dividend (would hurt his tax status) and wanted corp to reinvest the money for repairs; πs and Δ had a falling out; Δ never really came up w/ a plan for repairs; income continued to accumulate and corp was forced to pay tax penalties; πs sue Δ for breach of fiduciary duty b. Issue: Did Δ, a Min SH, breach his fiduciary duty to the Maj SHs? c. Application: Since the veto power gave Δ the ability to oppress the Maj SHs, he had a fiduciary duty to use that power responsibly. Since he vetoed dividends more out of dislike for the πs than for any real interest in seeing the $ reinvested for repairs (no plan). d. Holding: Δ had a fiduciary duty to use his veto power responsibly and he breached his fiduciary duty by using that power to spite the π iv. Jordan v. Duff & Phelps a. Facts: Δ = analyst firm, π = one of Δ’s analysts; π = an at will employee, and owned some stock in Δ pursuant to a Stock Restriction and Purchase Agreement; π’s wife hated his mother, so he decided to look for employment in another state offered job in TX tells Δ that he’s planning on accepting, but will work through the end of the year (get highest value on his stock pursuant to the Agreement); Δ is in merger negotiations at the time, but does not reveal to π that fact; shortly after π quits, the merger is announced later falls through 2 years afterward, Corp is eventually bought in an employee LBO. b. Issue: Did Δ commit securities fraud or breach it fiduciary duty to π? c. Application: Δ’s principal argument is that there was no duty to disclose the merger to π b/c he was an employee at will it could have fired him at any time, including right before the merger he would not have profited from the merger. However, Ct reasons that Δ could not have fired π for a bad reason (i.e. to deny him from benefiting from the merger), so a duty to disclose did exist d. Holding: Δ did have a duty to disclose the merger to π it breached its fiduciary duty and committed securities fraud by failing to do so. e. Transfer of Control i. Control Premium 1. The price paid for shares over their going market price (the “premium”) b/c the amount of shares acquired will give the purchaser control over the corp 2. Cheaper than a tender offer 3. Benefits of buying control: a. Run the company b. Appoint BOD 4. Subject to special regulation b/c its not an ordinary purchase of stock 5. Two Main Issues: a. Should a SH be allowed to sell stock at a premium? Is that fair to the other SHs? i. Yes. See Zetlin (as long as Controlling SH is only selling control, than it’s OK if he makes a premium on the sale). But see Perlman (Controlling SH sold more than control, also cashed out on a corporate opportunity Feldmann plan) b. The Sale of Corporate Offices: Is the buyer purchasing more than just a controlling block of stock? i. Cannot buy Offices. See Essex. ii. What about BOD? 1. Lumbard: a. If Buyer has bought a “controlling” interest bottom line is that he can control who will be appointed to BOD OK that Directors appoint his nominees (NO B of FD) b. Thus, focus is on whether Buyer bought a “controlling” interest. 2. Clark: a. Should be decided on the facts “jury ?” 3. Friendly: a. Directors owe FD to all SHs when a Director resigns, the other Directors have a duty to appoint the person best for the Corp, NOT just the person the controlling SH wants (breach of FD). ii. Frandsen v. Jensen-Sundquist a. Facts: Δ = Maj SH, π = Min SH; π and Δ had a Buy-Sell provision in their SH Agreement: if Δ planned to sell its stock, then π had the rt of first refusal (chance to buy at same price) or, if he declined to exercise that right, then Δ had to purchase his stock (and sell it w/ their own) “Tag Along” provision; Δ announces that corp is planning to enter into a merger w/ FW π claims that triggers his Rt of First Refusal power; FW changes its position just wants to buy one of the Corp’s assets (bank); deal goes through, π sues argues that his rt of first refusal option was triggered by the merger deal and he should have been allowed to buy. b. Issue: Was π’s Rt of First Refusal triggered by the merger announcement? c. Application: A merger is NOT the same as a sale of stock. Since Δ was not selling his stock, the Buy-out provision, which specified sale, was not triggered. Ct reasoned that π could have specified in the SH Agreement that a merger would also trigger the Rt of First Refusal, but he failed to do so. d. Holding: π’s Rt of First Refusal was not triggered, but he could have still tried to outbid FW. iii. Zetlin v. Hanson a. Facts: Δ owned 44% of stock sold to buyer at double the price; π argues that he too should have the opportunity to sell at a premium. b. Issue: Could Δ sell his stock at a premium? c. Application: Δ sold control that’s OK; π desired that the buyer basically make a tender offer and buy everyone’s stock at a premium NO, tender offer is different and would be contrary to law to force buyer to also buy π’s shares. d. Holding: Δ could sell at premium; π was out of luck. iv. Perlman v. Feldmann (UNIQUE) a. Facts: Δ owned 37% of stock (controlling interest) in a steel maker sells to buyer (end-user of steel) at a premium; π’s argue that they’re entitled to some of the premium b/c Δ sold more than just control; Due to war, steel prices were frozen; Δ had implemented a plan (Feldmann Plan) to get around, by forcing steel buyers to pay in advance for future steel (interest-free loan) very profitable for the Corp; Buyer was planning to end the practice and sell the steel to itself (less $ for the other SHs) b. Issue: Whether Δ had breached his FD as Maj SH to the Min SHs. c. Application: Ct reasons that Δ had sold more than just control he sold a corp opp (made extra money off the sale b/c buyer was planning to end the Feldmann plan). Thus, Ct held that he breached his FD by selling a corp opp. Also, πs probably would have had a hard time suing buyer (after all, buyer is the one ending the profitable plan) b/c there’s some issue over the legality of the Feldmann Plan (quasi-bribe) tough to show BoFD by buyer. d. Holding: Δ had breached FD π’s entitled to share in the premium. v. Essex Universal v. Yates a. Facts: Δ owned 28% of RP (controlling interest), agreed to sell that to π; Δ agreed that he would also ask all the BOD to resign, one at a time, then replace those Directors w/ π’s appointees; RP stock rose and Δ tried to renege on the deal alleged that sale was illegal b/c it conveyed more than just control (conveyed the BOD) b. Issue: Whether the sale was legal? c. Application: i. Lumbard: Because π had effectively bought control, there’s no harm in permitting him demand that his BOD be appointed. True that Directors owe FD to SH, but the reality is that π could select the BOD at the next occasion why elevate form over substance? ii. Clark: summary judgment improper jury question iii. Friendly: Can’t sell BOD control Directors owe FD to SHs to ensure best replacement is brought in Form over substance. BUT, can’t apply retroactively Summ Judgment reversed. VI. Mergers, Acquisitions, and Takeovers a. Mergers and Acquisitions i. In General 1. Merger a. The combining of 2 corporations into 1 i. Merger: both become the acquiror ii. Consolidation: new corp formed b. Requires BOD approval c. Surviving Corp assumes liabilities of both corps d. Merger Consideration: i. Consideration passes to the non-dissenting SHs ii. Appraisal Rights: 1. Most states have dissenters’ rights statutes 2. If lots of SHs dissent, then it may threaten the merger deal (non-dissenting SHs may not make much $) 3. Allow a Min SH that disapproves of a merger to sell his shares at “fair value” appraisal proceeding determines “fair value” a. Both Target SHs and Acquiror SHs may exercise dissenters’ rights to a merger 4. Delaware: a. Eliminates dissenters’ rights if target is a publicly traded company and the consideration is stock in the acquiror. e. Triangular Transaction: i. A sets up a new corp capitalizes the new corp w/ the consideration that will be paid to T ii. NC and T merge 1. T SHs have dissenters rts 2. Since NC (subsidiary) is owned by A (parent), A’s BOD control how NC’s shares will be voted NO dissenters iii. T’s SHs get paid the consideration (cash, debt, or A stock) iv. NC becomes a wholly-owned subsidiary of A 2. Acquisition (Asset Purchase) a. The purchase of a specific asset(s) from a corp i. Both corps survive after the sale (at least for a little while anyway) b. requires BOD approval to sell c. Subject to emerging tort doctrine, the purchasing corp does NOT take the liabilities of the selling corp unless there is a written assumption of liabilities d. Consideration for the Sale: i. Can be distributed to the SHs in the form of dividends ii. More often, target liquidates and all the assets are distributed to the SHs 3. Tender Offer a. A public offer (usually to all SHs) in which a buyer offers to purchase the target corp’s shares b. NO BOD approval required c. If buyer gets 50.1% or more of the shares control 4. Proxy Contest a. NO BOD approval required b. BUT, requires approval by SHs 5. Stock Purchase a. Similar to tender offer, but shares are bought over time NOT a single offer to all. ii. Planning: 1. When do you want to bypass the BOD? a. If it refuses to sell at any price b. BOD is holding out for a higher price than you want to pay c. BOD is holding out for side-payments (i.e. kickbacks) 2. What are the tax consequences of a plan of action? iii. De Facto Merger Doctrine (substance-over-form) 1. Rule: a. “If it has the same effect as a merger, then we’ll treat it like one” i. Thus, Dissenters’ Rights and Appraisal Rights available b. When the transaction so fundamentally changes the nature of the corp as in effect to cause the SH to give up his shares in one corp and, against his will, accept shares in another. i. Factors to Consider: 1. Change in BOD composition 2. change in SH composition 3. significant changes in SH value 4. significant changes in corp’s line of business c. Has fallen out of favor 2. Modern Rule (Equal Dignity): a. The statutes governing asset sales and mergers are separate must give equal dignity to each allows flexibility and predictability when structuring. See Hariton (Delaware). 3. Farris v. Glen Alden a. Facts: L corp owned 38.5% of Δ wanted to merge L and GA; Structured deal as an asset sale: L would sell all of its assets to GA, GA would issue stock and give that to L as consideration for the assets; Result: L ended up owning 76.5% of GA stock liquidates and gives its SHs the GA stock; π (a GA SH) sues, claiming that the transaction was basically a merger and, therefore, he’s entitled to dissenters’ rights appraisal. b. Issue: Was the deal a de facto merger? c. Application: BOD was changed, SH composition was changed, changes to SH value, and changes to corp’s line of business de facto merger. d. Holding: Yes, was a de facto merger. iv. Freeze-Out Mergers 1. In General a. Freeze-Out Merger Defined i. When the Maj SH causes the corp to merge (usually w/ a shell that Maj SH owns), thereby eliminating the Min SHs entirely. See Weinberger. 1. mergers usually require approval of both BOD and SHs Since Maj SH is motivating the merger, approval is usually a non-issue. b. Why freeze-out the minority? i. Eliminate costs associated w/ a public corp. ii. More flexibility w/ respect to moving around assets iii. Eliminate Fid Duties to Min SHs c. What about objecting minority? i. Sole remedy is usually appraisal, unless there’s fraud, self- dealing, or waste. See Weinberger. 1. If self-dealing is alleged, then Min SH may bring a class action. See Coggins. To avoid liability for B of FD, Maj SH will have to show that the transaction was entirely fair. See Rabkin. 2. Entire Fairness: a. Fair dealing; AND b. Fair price d. Test (for Breach of FD Claim in Freeze-Out Merger Context): i. Is there fraud, self-dealing, or waste? But see Rabkin (appears to broaden this standard appraisal only the remedy when price paid is unfairly low) 1. No: Appraisal is remedy 2. Yes: Step 2. But see Coggins (business pupose?) ii. Was the merger approved by a majority of the Min SHs? 1. Yes: Step 3 2. No: Step 4 iii. Can the π prove that the transaction is unfair? 1. Yes: Breach of FD 2. No: Step 4 iv. Can the Δ prove that the transaction was entirely fair? 1. Yes: Appraisal is remedy 2. No: Breach of FD e. Equitable Remedies i. Why would a Min SH pursue a class action, rather than “fair value” from an appraisal proceeding? 1. Due to time between suit and trial, π may be able to free-ride on Δs improvements to the corp 2. If π can get injunction/rescission, then its worth FAR more than “fair value” 3. Atty Fees and advantages of Class Action over appraisal (i.e. settlement) 2. Coggins v. New England Patriots a. Facts: Δ used to be Pres of Patriots Football Team lost control and was voted out eventually got control back; to get control, Δ had to get loan from bank, bank wanted Δ to use corp’s income to repay loan (security); Δ, realizing that such an arrangement would be a B of FD, elects to merge the corp into another “shell” that he created; merger is approved, but π, a dissenter, sues to stop the merger. b. Issue: Did the Δ, by undertaking a freeze-out merger, violate his FD? c. Rule: Same as above, but includes the “business purpose” prong before the “fairness” prong. d. Application: Ct recognized that there was self-dealing in the case b/c Δ was pursuing the merger to satisfy his personal debts. Furthermore, it found that this reason was not a legitimate business purpose Breach of FD e. Holding: d breached his FD by freezing-out the Min SHs w/o a legitimate business purpose v. De Facto Non-Merger Doctrine 1. Equal Dignity Rule: a. An asset purchase is an asset purchase, and a merger is a merger form over substance. See Rauch. 2. Rauch v. RCA a. Facts: GE wanted to buy Δ’s assets; Δ had both common and preferred SHs (π); π had liquidation preference = $100/sh if Δ sold assets, then liquidated, it would have had to redeem the preferred stock (i.e. less merger consideration for the common SHs); Δ and GE instead agreed to merge Δ’s SHs would get cash as the merger consideration; merger went through πs got $40/sh, while common SHs got $66/sh, pursuant to the merger agreement; πs sue alleging that the merger was a de facto asset sale. b. Issue: Was the merger a de facto asset sale? c. Application: Equal Dignity to the statutes it was a merger. d. Holding: Merger No liquidation. Appraisal??? b. Takeovers i. Intro 1. Tender Offer a. Most potent weapon in Corporate Raider’s arsenal b. Can bypass BOD and go straight to SHs c. Until 1960’s, almost no regulations i. Williams Act (1968) regulations 1. Key required disclosures: a. Identity b. Plans and intention c. Any contracts, arrangements, understandings, or relationships w/ the issuer 2. §§ 14(d)-(e) triggered when anyone commences a tender offer for more than 5% of the stock d. Types of Defensive Tactics: i. Greenmail 1. Pay the potential acquiror to go away. See Cheff. 2. BUT, there are concerns about Directors using their power to perpetuate their control. See Cheff (use of defensive tactics may be a B of FD). ii. Competition (“White Knight”) 1. Find a friendly “white knight” to take over the firm iii. Scorched Earth 1. Poison Pills a. Rts that attach to stock that make acquisition very unattractive 2. Poison Debt a. Make target incur debt unattractive target 3. Share repurchases at a premium iv. Turn the Tables (“Pac Man” Defense) 1. Original target attempts to take over the original bidder e. SHs attitude toward resistance i. want BOD to drive up price, but do NOT want BOD to be looking out for its own interests f. Judicial Ambivalence Toward Defensive Tactics: i. Reasons For Deference: 1. BOD is supposed to make day-to-day decisions and look out for long-term prosperity 2. Do not want to be the reason that corps are broken up 3. BOD is supposed to drive up price ii. Reasons For Scrutiny: 1. BOD’s self-preservation incentive 2. If corp is trying to take over, than it’s likely b/c BOD is doing a poor job 2. Rule: a. When a takeover attempt is made (usually by a SH), and the BOD resists the takeover, then concerns about Breach of the Duty of Loyalty arise. See Cheff; Unocal. The concern is that the BOD may be trying to perpetuate its own control at the expense of the acquiror/SH or at the expense of other SHs. See Cheff (greenmail); Unocal (self-tender offer, financed at corp’s expense). However, the BOD may act adversely to the acquiror/SH if it acts in good faith after reasonable investigation, and the defensive measures are proportional to the perceived threat. See Unocal. b. Inside Directors v. Outside Directors: i. Outside Directors (weaker incentive to preserve control) 1. Threat Prong a. Did they perceive a threat after reasonable investigation? i. No: Duty of Loyalty Test ii. Yes: Step 2 b. Did they act in good faith based upon that investigation? i. No: Duty of Loyalty Test ii. Yes: Go to Proportionality Prong 2. Proportionality Prong a. Was the action reasonable in relation to the perceived threat? i. No: Duty of Loyalty Test ii. Yes: BJR applies π must try to show actual self-dealing/fraud, or that they were uninformed. See Unocal. ii. Inside Directors (stronger incentive to preserve control) 1. Standard Duty of Loyalty Test: a. Approved by Informed + Disinterested BOD (importance of Outside Directors). See Unocal. b. Approved by informed SHs c. Deal is intrinsically fair to the corp c. Changing Duties: i. BOD may take protective measures against a takeover when the interests of the SHs would be harmed. See Unocal. However, once bidding reaches a point that it becomes clear the corp will be sold, then BOD’s only duty is to maximize SH return – consideration of Corp’s responsibilities no longer applicable, unless it affects SH return. See Revlon (BOD breached FD b/c it impermissibly considered Corp obligations, which they faced personal liability for, rather than solely focusing on SH return) 3. Cheff v. Mathes a. Facts: M was trying to take over H corp; Δs, H’s BOD, were trying to prevent the takeover b/c they believed that M would liquidate; H employees had already become unsettled by M’s actions; Δs elected to buy M’s shares w/ corporate assets and at a premium, in order to make him M away (i.e. greenmail); M accepted the deal; π (SH) sued on the ground that Δs had violated their FD by wasting corporate assets to perpetuate their own control. b. Issue: Did the Δs violate their FD? c. Application: There was some concern that the Δs used breached their FD by looking only to perpetuate their own control, rather than looking toward the interests of the SHs. For the inside directors (directors + officers), they had a stronger incentive to try to preserve their control ($$$). So, the inside directors actions had to show that their actions satisfied the traditional duty of loyalty test (cleansed or fair). For the outside directors (non-officers), the incentive to preserve control was weaker they had to show that they perceived a threat to the corp after reasonable investigation, and that they acted in good faith pursuant to that info. Ct reasoned that the outside directors had taken reasonable investigations into the effect M was having on the corp (long-term and short-term) and that they’re decision to buy him out was taken in good faith. Thus, the outside directors were cleared, so if the greenmail was approved by a majority of the outside directors, then that would cleanse the action for the inside directors. d. Holding: Δs did not violate their FD. ii. Development 1. Unocal v. Mesa a. Facts: π owned 13% of U stock made two-tiered front end loaded tender offer at $54/sh; Δ (U’s BOD) investigated the offer reports from experts concluded that the deal was low; Δ was advised that a self-tender might ward off the coercive tender by π; Δ made self- tender at $72/sh (per advice), which π was excluded from and only kicked in if π got a controlling interest gave incentive for people to hold their shares and not sell to π (would get the higher price instead); self-tender was to be funded by corp and π was excluded from participating; Δs approved the plan approved by majority of the outside directors; π sued Δ on ground that they violated their FD to him self-dealing to preserve their power. b. Issue: Whether Δs had violated their FD to π? c. Application: If the outside directors were cleared, then that would cleanse the deal for the inside directors. i. Threat: 1. Δs had conducted a reasonable investigation (reports by experts) and perceived a threat th SHs interests (low price and bad deal on the back-end), and they acted in good faith to protect the SHs (the self-tender prevent the takeover or ensure the back-end people would not be harmed). ii. Proportionality: 1. the self-tender was proportional to the perceived threat would ward off π (who was offering a low- ball price) or ensure that those on the back-end would not get cheated w/ junk bonds. d. Holding: Δs actions were proportional to the perceived threat defensive measure was protected by the BJR. Also, the interested directors were absolved b/c the action was approved by a majority of the informed and disinterested BOD. 2. Revlon v. MacAndrews & Forbes a. Facts: Δ resisted a low-ball tender offer by π poison pill, self- tender, and “lock-up”; π eventually realized that defensive tactics had worked forced to up its offer into a reasonable range; π continued to up its tender offer Δ got “white knight” – which it gave all kinds of inside info that was denied to π – and the WK agreed to a price; the deal contained a lock-up (no more bidding), and also a guarantee by WK that it would cover some outstanding notes issued by Δs that were potentially litigious. b. Issue: Did Δs breach their FD to SHs? c. Application: The poison pill and self-tender were valid defenses aimed to prevent harm to SHs by low-ball bid. However, once it became apparent that π was going to up bid (and that Δ was going to be bought out), then Δs duty changed duty was to get highest price for SHs. Since Δs were more concerned about avoiding personal liability for the notes entered into a lock-up deal w/ WK, which ended the bidding denying SHs of maximum value. d. Holding: Δs breached their FD of loyalty.
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