heather s corp outline

CORPORATIONS C.O.A. SUMMARY #1 Articles of Incorporation- must contain the following 5 provisions: 1. Name 2. Purpose Clause - General- says bus. can be conducted for any lawful purpose. - Specific- Limits the kind of business a corp. can engage in. Cannot expand your purpose clause unless the Articles are amended. 3. Capitalization Provision 4. Agents for Service of Process- Must include the person’s address. 5. Executor/Promoter Signature #2 U.V. C.O.A.- Deals with whether or not you want a general or specific purpose clause. Red Flag: The corp. has a narrow purpose clause. No U.V. C.O.A. if the corp. has a general purpose clause. Parties: S.H.’s, or stockholder derivative suit, or the A.G. (must be one of these 3 to file) v. B of D’s. Elements/Rule: The corp. has a narrow purpose clause, and engages in activity/business outside their purpose clause. Remedies: Enjoin the U.V. activity, damages from the B of D’s (under a derivative suit), A.G. can stop illegal activity. Cross-over Issues: Breach of Due Care, Breach of Loyalty. If the corp. amends, B of D’s/Shareholder meeting valid? Miscellaneous: U.V. C.O.A. does NOT apply to executory K’s. Under C.L. U.V. action would make K’s void. #3 Charitable Contributions C.O.A. - At C.L., the Articles had to specify the corp. could contribute to charities. Red Flag: You see a corp. making a charitable contribution. Parties: S.H.’s v. B of D’s, or a specific director responsible for the contribution. Elements/Rule: Corps. can give to charities regardless of whether they have a general or specific p.c. unless there is specific language in the Articles forbidding charitable contributions. Test: Reasonableness. Is the contribution reasonable? 1. If the contribution is over the reasonable amount, analyze the financial status of the corp. & the effect of the contribution on S.H.’s 2. If the contribution benefits one of the directors = Breach of loyalty C.O.A. (interested director) Remedies: Damages from the Board, enjoin the contribution. Cross-over Issues: Breach of due care, loyalty (interested director transaction). Miscellaneous: Public policy… we want to encourage charitable contributions by corps. Bolsters free enterprise… #4 Promoter Liability C.O.A. Red Flag: You see a K being entered into PRIOR TO the Articles being sent out. Parties: 3rd person trying to hold the promoter personally liable v. the promoter’s name (NOT the corp’s name) Elements/Rule: If a promoter enters a K before the corp. is formed, s/he will be personally liable. 1. To avoid personal liability, place the word “agent” after you sign your name AND, 2. Insert a clause in the K stating the 3 rd party will look to the corp. not the promoter for payment. - Look for co-promoters/silent partners when filing. Assert a C.O.A. in joint & several liability. - If the 3rd party knew the corp. wasn’t in existence, but looked to the corp. anyway for payment = no personal liability on promoter. Remedies: The promoter is personally liable to the 3 rd party on the K. Cross-over Issues: Is the corp. stuck with the K? #5 Contracts Formed Prior to a Corp’s Existence C.O.A.- Corp’s are not automatically obligated to adopt these K’s. Red Flag: You see a promoter enter a K before the corp. is officially formed. Parties: S.H.’s, creditors v. B of D’s. Elements/Rule: Normally the B of D’s must vote and agree to adopt a K. 2 ways to adopt: 1. Express Adoption- Certified resolutions signed by the Secretary. 2. Implied Adoption- Adoption based on acquiescence. 1 3. Note: A corp.’s adopting a K doesn’t automatically release the promoter from liability. S/he must get a novation (must be signed by the corp. promoter, and the 3 rd party) Remedies: Corp. doesn’t have to accept K. Cross-over Issues: Board meeting valid to adopt the K? 3 rd party can file a C.O.A. in quantum meruit to get paid. Defective Incorporation C.O.A.- Only applies to K’s signed AFTER the Articles are sent out. If there is no attempt to file the Articles, you have a promoter liability issue. Only look at active S.H.’s. in M.B.C.A jurisdictions. Anything beyond voting, dividend, liquidation, elevates a passive S.H. to active status. Red Flag: You see an attempt to file the Articles, & they’re sent back with a defect cited by the S.O.S. Parties: 3rd person trying to find the S.H.’s liable (creditors, tort victims) v. the S.H.’s (names or group as a whole – NOT the corp’s name), or directors, or officers. Apply defective incorp. theory to tort victims as well as 3 rd parties who have their K’s breached by the representative of the corp. Elements/Rule: 1. M.B.C.A. Jurisdictions- The S.O.S.’s stamp means everything. If bus. is conducted prior to getting it, the corp. is “too defective” = S.H. liability. Only ACTIVE S.H.’s are liable in MBCA jurisdictions. - If you have a stamp, regardless of defect in the Articles, the corp. is “de jure” = no S.H. liability. 2. Non-M.B.C.A. Jurisdictions- The stamp means nothing. PASSIVE AND ACTIVE S.H.’S are liable in NonMBCA Jurisdictions. a. De Jure- Must find substantial compliance with all mandatory conditions precedent which includes: - All 5 requirements must be in the Articles, Articles must be received by the S.O.S. before bus. is conducted, Fees must be paid. - Effect: No one can touch you, not even the S.O.S. b. De Facto- Requires: Valid incorporation statute, Good-faith attempt to comply, Actual use of corp. powers (separate accounts, B of D meeting minutes, signing K’s in the corp’s name?) - Effect: The S.O.S can still bring a C.O.A. but any C.O.A. by 3 rd parties is barred. c. Estoppel- Requires: Holding out of the corp. name (signing a K in the corp. name, corp. checks, letterhead, S.H.’s meeting, B of D’s meetings?), Reliance by the 3 rd party (there can be no personal guarantees by the promoter or corp. agent.) - Effect: Only denies the particular 3 rd party’s C.O.A. whom you proved estoppel against. It doesn’t prevent other 3rd parties or the State from filing a C.O.A. Remedies: S.H.’s can be held liable on K’s the corp. defaulted on. Cross-over Issues: Start with defective incorporation first, then go to piercing. If you start with piercing, you concede the corp’s existence. #6 Piercing the Corporate Veil C.O.A.- Here there is a valid corp., but the 3rd party still wants to hold the S.H.’s liable. Red Flag: A newly formed corp. breaches a K, or is involved in tortuous conduct against a 3 rd party. Parties: 3rd person trying to pierce v. the S.H. names (not the corp.) Elements/Rule: 3 grounds for piercing: 1. Fraud- Must show there was an intent to deceive. Must have a misrepresentation at the beginning of the business relationship between a cred. & corp. 2. Contract Cases- Must show BOTH (1) lack of adequate capitalization (Adequate capital to start? Enough continuing capital?) & (2) lack of adherence to corp. formalities (S.H. / B of D meetings, shares issued, siphoning corp. funds for personal use? 3. Tort Cases- Only need to show (1) lack of adequate capitalization, or (2) lack of adherence to corp. formalities. Remedies: Every S.H. (whether they’re active or passive) is liable if the veil is pierced. Cross-over Issues: Enterprise piercing in parent-sub. merger situations. The sub. must be completely controlled by the parent. Do they share the same books/corp. accounts? Same B of D’s is o.k. Miscellaneous: Protect yourself from piercing by inserting an indemnification provision in your subscription agreement. Piercing C.O.A. are equitable, meaning if you prove the above elements, you still must show piercing is equitable/fair/necessary to pierce. #7 2 #8 Amending the Articles of Incorporation- Extraordinary matter. Red Flag: There is an attempt to amend the Articles. Parties: S.H.’s or B of D’s may want to amend. Elements/Rule: 1. B of D’s must first approve the amendment. 2. Then the S.H.’s must approve the amendment by a majority vote. 3. No substantial harm can be done to the minority by the majority. 4. The amendment must be filed and received by the S.O.S. Remedies: Invalid if the above procedures aren’t followed. Cross-over Issues: Were the B of D’s and S.H.’s meetings valid where they voted on the amendment? Substantial harm to minority S.H.’s by the majority? #9 Shareholder’s Rights- Three basic rights: voting, dividend, and liquidation. Any rights above and beyond these must be stated in the Articles. 1. Example: 100,000 shares authorized par value $100 preferred stock, with a redemption at the S.H.’s option. 2. Example: If you don’t trust the B of D’s and want to insure you get dividends, insert a mandatory dividend clause into the Articles or negotiate a voting shift in the Articles. #10 Adequate Legal Consideration for Stock C.O.A.- Has adequate consideration been paid for newly issued shares? Red Flag: You see a corp. selling stock (original issuance or additional shares) Parties: S.H.’s and/or Creditors v. Directors Elements/Rules: Must pass BOTH tests: 1. Qualitative Test- Was the PROPER TYPE of consideration given? - Cash- o.k. to give some money down, and then a note, provided the note is secured. - Services Rendered- Services must be fully rendered. - Equipment/Property- Must be real/tangible property, or intangible/intellectual property (inventions o.k. provided they’re patented), promissory note is o.k. provided it’s secured. 2. Quantitative Test- Was ENOUGH consideration given? - The consideration must be = to or > the number of shares given x par value. - Example: Giving 10,000 shares at par value $1. You must give at least $10,000 in value. - If capital plus cash is given for the stock, the corp. has to value the consideration. 2 options: 1. Good Faith- If the B of D’s valued in good faith, the quantitative test is passed. 2. True Value- Good faith doesn’t matter. If the B of D’s is off by a cent, the quantitative test is failed. - Exceptions to the quantitative test: financial hardship, reissued treasury stock 3. If BOTH tests are passed = adequate legal consideration. If not, then name the stock: - Bonus stock if the qualitative test was failed. - Discount stock if not enough CASH was given (quantitative test failed). - Watered stock if not enough services/property was given (quantitative test failed). Remedies: - Cancel those shares above which consideration was lacking quantitatively, cancel the whole issuance for qualitatively deficient consideration. - Force payment- The S.H. is forced to pay the extra amount to make up for the inadequate consideration. - Damages from the B of D’s- If the true value or good faith test was failed, they pay damages. Cross-over Issues: Breach of due care against the B of D’s for allowing inadequate legal consideration. Miscellaneous: Public policy of above rules: Protect creditors who rely on the guts of the corp. when extending credit. Protects other investors from dilution of their interests. 3 #11 Investment Contract(s) Federal C.O.A.- Suing under Section 5 of the 1933 Securities Act. Any scheme that sells interests may be classified as a SECURITY. Provides for: more remedies, nationwide service of process, greater potential for recovery. Red Flag: You see a corp. sell anything other than stock. Parties: Scheme victim v. the Person or Entity that sold the investment K. Elements/Rule: 4 elements: 1. An investment of legal consideration. 2. An expectation of profits by the investor. 3. Must have 2 investors, similarly situated. Are the investment terms the same for everyone? 4. Investors must be relying primarily on the managerial efforts of others. Remedies: Rescission of the K. You get your money back. Cross-over Issues: If unsuccessful arguing the scheme as a federal C.O.A., argue it under a state C.O.A. Most states define an investment K as anytime you put capital at risk. Miscellaneous: To avoid the scheme being held as in investment K, give up some control over daily operations. Let the investors decide something (i.e. Mc Donald’s menu example). Public policy concern: S.E.C. Act of 1933 requires the registration of all securities being placed in the hands of the public for the first time. Compliance with this act requires: (1) A prospectus be distributed to potential investors; (2) Additional info. is available to the public. (disclosure). New securities being issued have to be REGISTERED with the S.E.C. or they must be relying on an exception: All offerees have access to the same kind of information that would be available if registration were required. Preemptive Rights C.O.A.- A S.H.’s right to purchase newly issued shares, before they’re issued to the public proportionate to the S.H.’s current holdings in order to prevent dilution of the S.H.’s ownership interest. Red Flag: Look for a corp. issuing more stock. Parties: Existing S.H.’s v. B of D’s OR Minority S.H.’s v. Majority S.H.’s Elements/Rule: Exercising preemptive rights requires: 1. Preemptive rights must be in the Articles or the Certificate of Determination. 2. The purchaser must pay the issuing price/f.m.v. for the shares. S.H.’s must give up the additional issuance price over what they originally paid to exercise their preemptive rights. Remedies: If you prove the 2 factors above, you can exercise your preemptive rights, & prevent dilution of your investment. Miscellaneous: For the corp. to issue additional shares, they cannot exceed the authorized amount in their Articles. Look for this. Preemptive rights are usually only given in closely held corps. No preemptive rights in publicly held corps. because this is impractical. The corp. would have to check will ALL their investors every time it issued new stock. Cross-over Issues: Breach of due care against the directors for selling additional shares which exceeded the authorized amount in the Articles. Preemptive rights do NOT attach where the additional issuance is given in exchange for property or services. If you want someone out, and preemptive rights are in the Articles, verify the new issuance is for property/services. #12 #13 Declaration of Dividends C.O.A.- Analyze based on whether it’s a closely held corp. or a publicly traded corp. Red Flag: A corp. refuses to declare a dividend to its S.H.’s. Parties: Closely held corps. C.O.A. – Minority S.H.’s v. Majority S.H.’s. Publicly held corps. C.O.A. – S.H.’s v. B of D’s Elements/Rule: General Rule: The issuance of a dividend is up to the discretion of the B of D’s. However… 1. In a closely-held corp., the minority S.H.’s must show bad faith/a history of hostility: Look for: - Hostility by the majority towards the minority S.H.’s - Minority S.H.’s being excluded from employment by the majority S.H.’s - Excessive salaries for the majority S.H.’s - The existence of a desire by the majority to acquire the minority stock as cheaply as possible. 2. In a publicly-held corp., S.H.’s must prove there is a lack of business purpose for not declaring dividends. Remedies: S.H.’s win their motion to compel dividends from the corp. 4 Miscellaneous: B of D’s don’t have to declare a dividend if they have an adequate business purpose (R&D, goodwill, reinvesting capital surpluses back into the corp.) Goodwill is an adequate bus. purpose, but directors owe a duty to their S.H.’s first, then the general public. - S.H.’s can protect themselves by: Inserting a mandatory dividend clause into the Articles, or get a voting shift. - Additional C.O.A.- If you can’t prove bad faith, ask for a dissolution of the corp. via your voting rights. #14 Legality of Distributions- 3 different kinds: Dividend, Redemption or Repurchase. Sources: Stated capital- # of shares x par value. Paid-in surplus- Amount paid over par value for the outstanding shares. Earned SurplusRetained earnings. A corp’s accumulated income after dividends have been paid. Re-evaluation Surplus- Surplus gained when assets are reappraised at a higher value. Reduction Surplus- Surplus gained by lowering par value. Red Flag: You see a dividend, redemption or repurchase, determine if the distribution is legal. Parties: S.H.’s, Creditors v. B of D’s. Elements/Rule: 1. Dividends- Cannot be paid out of stated capital (guts) - Proper Source- Paid-in surplus, earned surplus, re-evaluation surplus, reduction surplus. - Solvency Test- Balance sheet test (assets > liabilities) AND Cash-flow test (must be able to pay debts as they become due) 2. Redemptions- The S.H. has the right to sell back their shares. The corp. has no discretion. - First look to see that there are redemption rights in the Articles. Then determine if they’re legal. - Proper Source- Paid-in surplus, earned surplus, or stated capital (but only to reduce arrearages) - Solvency Test- Balance sheet test AND cash flow test. - Use stated capital only if there is a cumulative dividend preference in the Articles, & they’re in arrears. 3. Repurchases- The S.H. is asking the corp. to buy back their shares. The corp. has the discretion here. - Proper Source- Paid-in surplus, or earned surplus. - Solvency Test- Balance sheet test AND cash flow test. Remedies: If money has not been paid out, then cancel the dividends. Other S.H.’s CAN cancel the dividends. If money has been paid out, then obtain damages from the B of D’s who declared dividends when they shouldn’t have. Also obtain damages from S.H.’s who knew the distribution was illegal. Cross-over Issues: Breach of due care C.O.A. against the B of D’s for declaring dividends when the distribution comes from the guts or fails the solvency test. #15 Management – Analyze based on whether you have a C.L. Closely Held Corp. or a Statutory C.H. Corp. 1. Non-Statutory (C.L.) Closely Held Corp.- The corp. is managed by the B of D’s, not S.H.’s. S.H.’s can only vote on extraordinary matters: electing directors, removing directors, mergers, consolidation, dissolution, amending the Articles and by-laws. - S.H.’s cannot vote on ordinary matters/mgmt. functions. Management functions: Setting salaries, declaring dividends, appointing officers, hiring/firing employees, placing orders for inventory, taking out S.T. loans. - RED FLAG: You see S.H.’s voting. Can they vote on this matter? If it’s a CLCHC, and they’re voting on ordinary matters, the voting is void. - Amending Articles: First the B of D’s must agree to amend, then the S.H.’s must approve. - In a CLCH Corp., you must have a B of D’s. S.H.’s cannot manage the corp. and are passive. - Whenever you see one class of S.H.’s doing something to another class, ask if there is substantial harm being done to the other classes. - In a CLCH Corp., directors can be removed by S.H.’s for cause (Breach of Fiduciary Duty) or without cause. - Filling director vacancies- The control over who gets to fill vacancies in between terms is determined according to the bylaws. The relevant code might say either the B of D’s or S.H.’s can fill vacancies. But the bylaws can stipulate which one can actually fill the vacancies. - Amending Bylaws- The S.H.’s can draft and amend the bylaws without B of D approval. But if the amendment will cause substantial harm to other S.H.’s, it will not be allowed. 5 2. Statutory Closely Held Corp.- S.H.’s can vote on all matters and manage the corp. If a SCHC has a B of D’s, then the S.H.’s can vote only for extraordinary matters. Same analysis as under CLCHC’s. - Rule: If you want to be a SCHC, you must state this in your Articles. The Articles must say there are no more than 35 S.H.’s (or up to 50), AND the S.H.’s will manage the corp. - If the SCHC has a B of D’s, then the S.H.’s can only vote on extraordinary matters. Same analysis as CLCHC’s. - You can change from a CLCHC to a SCHC by amending the Articles. However, before you start managing, the Articles must reflect this change or all the transactions voted on are void. 16. Stockholder Meetings Valid C.O.A.- 2 ways stockholders take action: shareholder meeting & by written consent. Red Flag: You see S.H.’s coming together in a meeting and taking a vote. Parties: C.O.A. – is the Shareholder meeting valid? Elements/Rule: For a formal meeting, you must satisfy 4 elements: 1. Notice- 10/60 rule. Notice can be no later than 10 days prior, no earlier than 60 days prior to the meeting. - Notice CAN be waived. 2. Record Date- Only S.H.’s who are record owners as of the record date may vote. 3. Quorum- A majority of the outstanding shares must be present in person or by proxy. 4. Valid Vote- A majority of the voting shares present in person or by proxy. - Written Consent- Circulated through the mail, and you sign off on the action. 1. These are valid by a majority vote. No quorum is necessary. 2. Except, if the written consent is to vote in directors, then the vote must be unanimous. Remedies: If one of the elements for a S.H. meeting is missing, any action taken at the meeting is non-binding/void. Cross-over Issues: If there is a staggered or classified B of D’s, where cumulative voting is taking place, you must have more than one director come up for election each year. If there is only one director, cumulative voting is nullified. 17. B of D’s Meetings Valid C.O.A.- B of D’s can take action either through a meeting or unanimous written consent. Red Flag: You see a directors meeting, or a unanimous written consent. Parties: C.O.A. – is the B of D’s meeting valid? Elements/Rule: For a valid B of D’s meeting, you must satisfy 3 elements: 1. Notice- Must be reasonable, 24-48 hours prior. 2. Quorum- A majority of the authorized directors must be present (ex: Corp. has 9 authorized, 5 must be there) 3. Valid Vote- A majority approval on the issue from those directors present once quorum is established. Remedies: If one of the elements is missing above, the director’s action is void. Miscellaneous: Directors can also take action by unanimous written consent. Must be (1) In writing, and (2) Unanimous. Directors can also take action by teleconferencing: Must satisfy the same 3 elements as a B of D’s meeting. 18. Voting Agreements C.O.A.- 2 kinds of voting agreements: Pooling agreement & Voting trust Red Flag: Is it enforceable? Parties: S.H.’s are suing for specific performance on the pooling agreement or voting trust. Elements/Rule: Pooling Agreement- K’ual arrangement among S.H.’s relating to the voting of their shares. Requirements: 1. Must be voting on a proper matter. Depends on whether the corp. is a statutory closely held corp. or a nonstatutory closely held corp. (S.H.’s can only vote on extraordinary matters) 2. Can be oral or written. Voting Trust- S.H.’s transfer title of their shares to a trustee who is authorized to vote their shares. Requirements: 1. Trustee must be the record owner. The former record owner MUST transfer their stock to the trustee. The Sec. cancels the old certificate and issues a new one in the trustee’s name. 2. Agreement must be in writing. 3. Ten year limit. 4. You can only vote on proper matters- Is the corp. a statutory or non-statutory closely-held corp.? Remedies: If any necessary element is missing in the voting trust, every matter it votes on is void. 6 Miscellaneous: Trustees in V.T.’s owe a fiduciary duty of loyalty to the beneficial S.H.’s in the trust. If the voting trust causes substantial harm to other S.H.’s, it will NOT be enforced. 19. Stock Transfer Restrictions C.O.A.- Only apply to closely held corps. Allows corps to preserve control or comply with code provisions or federal securities laws. Red Flag: Look for someone showing up at a S.H.’s meeting who is not the original S.H. (guardian, creditor) C.O.A.- is the restriction legal/valid? Parties: Corp. v. Tranferor Elements/Rule: 3 requirements: 1. The restriction must be in the Articles of Incorporation. 2. Conspicuous as to form and content (should be on the face of the certificate, different font?) - Must detail the triggering event. 3. Restrictions must be reasonable. Restrictions dealing with death, incapacity, transfer by sale, divorce, are o.k. Remedies: If the restriction fails one of the elements above, it’s invalid, & the transfer is good. 20. Director Activity C.O.A.- Can a rogue director bind the corp.? Only applies to closely held corp’s. Red Flag: You see a lone director enter a K, without holding a director’s meeting or unanimous written consent. Parties: Stockholders, Creditors v. the rogue Director. Elements/Rule: One director can bind the corp. if (Mickshaw Rule): 1. After the fact, the remaining directors acquiesced to the action with FULL knowledge. - Look for a director who only gives partial information. 2. The action cannot harm S.H.’s, creditors, or the corp. Remedies: Action is invalid if one of the above elements isn’t satisfied. Miscellaneous: Look for a meeting taking place, or a video conference, and THEN the director goes out and enters a K. Officer Activity C.O.A.- Normally, the corp. is bound if the 3 rd party has resolutions signed, stamped and dated by the Secretary, EXCEPT if the 3 rd party knew the Sec. was crazy. Red Flag: You see a corp. officer enter a K/transaction, then the corp. pulls back. Can they bind the corp.? Parties: C.O.A. – can the officer bind the corp.? Elements/Rule: 2 ways officers can get authority to bind the corp.: 1. Express Authority- Any officer can get express authority. Resolutions passed by the B of D’s, and certified by the Secretary, will NOT be questioned. Other sources of express authority: Articles, bylaws, Statutes. 2. Implied Authority- Absent express authority, only the PRES. has implied authority to enter day-to-day K’s on behalf of the corp. He cannot enter extraordinary K’s. - V.P. can only get implied authority if the Pres. is totally incapacitated. - Sec. can only get implied authority if the Pres. and V.P. are totally incapacitated. Etc… Remedies: The action/K entered into by the officer is void. Miscellaneous: “Officers” include: Pres., V.P., Secretary, and Treasurer. In a C.H.C., all 4 positions must be represented, & the Pres. and Sec. CANNOT be the same person. 1 person CAN be the Pres., V.P. and Treasurer though. Cross-over Issues: Was the board meeting giving express authority valid? All 4 positions represented in a C.H.C.? If not, they’re open to a piercing C.O.A. 21. Proxy Solicitation C.O.A.- 14(a)(9) Federal C.O.A. The purpose of this C.O.A. is disclosure to S.H.’s. 14(a)(9) prohibits FMSO’s made in connection with a proxy solicitation. Red Flag: Look for a merger, or S.H.’s voting on an issue in a publicly held corp. Parties: S.H.’s, S.E.C. v. Directors of the corp. (& Majority S.H.’s if they send out a proxy with a FMSO) Elements/Rule: First make sure you have: a solicitation, use of I.C., and publicly held corp. (the stock is traded over a national exchange [NYSE, American Stock Exchange] OR, the corp. has $5 million in assets AND 500 or more S.H.’s in a SINGLE class. 5 Elements: 1. Standing- S.E.C. and individuals have standing. 2. FMSO- Identify the FMSO, and count as many as possible. The more FMSO’s = more damages. 22. 7 3. Materiality- Substantial likelihood that a reasonable person would find the facts important. - Can include oral statements, opinions, or beliefs, are considered “material facts” for 14(a)(9) purposes. 4. Simple Negligence (Mental element.)- Lower standard due to “grand canyon’’ btwn. S.H.’s and B of D’s. 5. Essential Link Test (Causation)- Was your vote needed to pass the action? The FMSO must have lead to a majority vote approval. - Exception: Did the FMSO cause the P to waive their state remedy? Remedies: 1. Enjoin further solicitations with defective materials. 2. Rescind any action taken through the proxies with FMSO’s. - If a director was voted in based on the defective proxy, remove him, and call for a new vote. 3. Merger Situations- Damages. Too hard to “undo” a merger. 4. Appraisal Remedy- The court will reevaluate the stock price. Miscellaneous: Any communication that will end up as an intention to secure the S.H.’s vote is a “solicitation” for 14(a)(9) purposes (Studebaker v. Gittlin). Shareholder Proposals C.O.A.- 14(a)(8) Federal C.O.A. Allows individual S.H.’s to place proposals in proxy materials. Red Flag: Look for a S.H. giving the B of D’s some proposal, and the B of D’s doesn’t listen. Parties: S.H. v. B of D’s Elements/Rule: 2 requirements: 1. The S.H. must be record or beneficial owner of either 1% or $2 K of the corp’s VOTING stock AND must have owned this amount for at least one year prior to the meeting. 2. There can be no valid grounds for exclusion by mgmt: - The proposal proffers action that is U.V. - The proposal deals with management functions. Can’t deal with issues of ordinary bus. operations. Note: Ordinary matters dealing with social policy issues CANNOT be excluded. - The proposal proffers a new slate of directors. - The proposal runs counter to a mgmt. proposal. Remedies: Compel inclusion of the proposal (get another vote on the issue that should have been included), damages from the B of D’s, or self-help. Miscellaneous: The B of D’s doesn’t have to exclude a proposal because it fits into one of the grounds for exclusion. However, if they don’t exclude it, and it leads to losses, = Breach of Due Care C.O.A. Cross-over Issues: If you see a proposal which was accepted by the B of D’s that could have been excluded but wasn’t, no 14(a)(8) C.O.A., = Breach of Due Care C.O.A. 23. 24. Business Judgment Rule- Presumes the B of D’s acted with (1) Due Care, (2) Loyalty & Good Faith, and within their (3) Proper Authority. 1. Decisions by the B of D’s are usually covered by the BJR. Rationale: (1) Judges don’t like to second guess businessmen, they have no experience, (2) Economy/Corps. need to take some risk to grow, (3) B of D’s would be sued constantly without the BJR. 2. 3 ways to overcome the BJR- Breach of Due Care, Breach of Loyalty, Prove the directors acted outside their authority. 25. Breach of Due Care C.O.A.- Deals with normal business decisions which lead to losses for the corp. Red Flag: The BOARD (not an individual director) makes a decision and losses occur/accrue. Could be any kind of decision (decisions not to fight a takeover, to hire a shoddy sub-contractor, to merge with a crappy corp.) Parties: S.H.’s, Creditors v. B of D’s as a whole. Elements/Rule: S.H.’s have the burden of proof here. The BJR attaches up-front here because it’s a board decision. First, make sure you have a decision which causes losses for the corp. (financial or good will) 1. Standard of Care- Reasonable prudent person in similar circumstances. The B of D’s must be fully informed: - Adequate deliberations- Did they examine all relevant documents? 8 - Seek independent experts- Did they get an independent expert who rendered a proper opinion? - Fairness opinion- Needed in merger situations. 2. Breach- Gross Negligence. If the breach was just simple neg., no one would want to be a director. 3. Causation- But for test. But for the decision, losses would not have occurred. 4. Losses- Monetary or loss of goodwill equals losses. Defenses: 1. Statutory Protection- Local statutes allow a B of D’s to limit their liability in a due care C.O.A. by inserting a liability limiting provision in their Articles (we will not be liable in due care C.O.A.). 2. Good faith reliance on proper experts. 3. Individual director voted against the action, abstained, or wasn’t present when the Board voted. Remedies: Prospective damages, and even punitives. Miscellaneous: A board can be liable for any non-decision they make as well. If they are aware of a problem and do nothing to fix it, and losses occur because of this = Breach of Due Care C.O.A. Breaches of Loyalty Causes of Action 26. Interested Director Transaction – Self-Dealing C.O.A. Red Flag: You see a director on BOTH sides of a transaction (loans, buying/selling property) Parties: S.H.’s v. the Director who is involved in the conflicted transaction. Elements/Rule: The director has the burden of proof here. No BJR, because no board decision. The conflicted director must prove one of the following exceptions applies: 1. Disinterested board approval- Did the board approve the conflicted transaction with FULL disclosure? - Look for inadequate disclosure. (look for details that indicate this in the wording of the fact pattern) - Only disinterested directors may vote. The interested vote CANNOT count towards approval but can count towards quorum. 2. Disinterested S.H.’er approval- Must be full disclosure by the conflicted director. Conflicted stock ownership doesn’t count towards approval. If the conflicted director is the majority S.H., there can be no disinterested S.H. approval. 3. Intrinsically Fair- Director must prove the transaction is fair to the S.H.’s, creditors & the corp. Remedies: Damages, & the transaction is voidable unless one of the exceptions above is proven. Cross-over Issues: If the board approves the transaction and losses occur/accrue = breach of due care C.O.A. Management Compensation – Self-Dealing C.O.A.- If directors are determining their own salaries, this is an interested director transaction (apply the factors above). If they are deciding the salaries of others and spoliation or waste occurs, it’s a breach of due care C.O.A. (apply “spoliation/waste” as the breach standard if the fact pattern is a publicly held corp., or “unreasonableness” if the fact pattern is a privately-held corp.) Red Flag: You see a director deciding his own salary, or deciding the salaries of others, which is either unreasonable or a waste of the corp’s assets. Parties: S.H.’s v. B of D’s Elements/Rule: 1. Interested Director Compensation C.O.A.- If the directors are deciding their own salary, go to the interested director analysis above (disinterested board approval, disinterested S.H. approval, intrinsically fair?) 27. 2. Breach of Due Care Compensation C.O.A.- If the directors are deciding the salaries of others, you have an breach of due care analysis. Replace the gross negligence breach standard with either spoliation/waste if it’s a public corp., or unreasonableness if it’s a privately held corp. a. Publicly Held Corp.- Must show spoliation or waste. The compensation must be trashing the corp. - S.H.’s have the burden to show waste. - Publicly held corps. should appoint a compensation committee made up of outside directors. b. Closely Held Corp.- Must show unreasonableness. Consider: industry standards, type of position, location of the corp. (cost of living in Seattle compared to L.A.?). 9 Remedies: Damages from the board. Miscellaneous: If it’s a normal business decision, where the directors are NOT deciding their own salaries, but the salaries of others, this is a due care C.O.A. (Standard, Breach, Causation, Losses). Except the breach is not gross negligence, it’s “waste” under the compensation C.O.A. 28. Parent-Subsidiary Non-Merger Situation C.O.A.Red Flag: You have a parent-sub. non-merger situation where the parent is mistreating the sub. Parties: Minority S.H.’s of the sub. v. the Parent B of D’s. Elements/Rule: The parent as a majority S.H. owes a fiduciary duty to the minority S.H.’s (subsidiary). The BJR does NOT attach right away. The minority S.H.’s of the sub. have the initial burden to prove: 1. The parent (majority S.H.) received a benefit to the exclusion and detriment of the minority S.H.’s of the sub. - If the minority S.H.’s received ANY kind of benefit, the C.O.A. is dead. 2. If the minority S.H. of the sub. prove the above, the burden shifts to the parent corp. to prove: 3. The deal was intrinsically fair to the minority sub. S.H.’s. (L.T. benefit?, delayed gratification defense) - The BJR locks on after some kind of benefit is proven by the parent. Remedies: Damages from the parent B of D’s. 29. Parent-Subsidiary Cash-out Merger C.O.A.- The parent attempts to gain 50% or more of the stock of the sub. to gain majority control. Red Flag: You see a cash-out merger taking place between a parent and their sub. corp. Parties: Minority S.H.’s of the sub. corp. v. Directors of the parent. Elements/Rule: 1. Both Corp’s B of D’s (parent and sub.) must approve the merger before it goes to the S.H.’s. A majority of disinterested directors must approve the merger. Interested directors can count towards quorum, but cannot vote for approval of the merger. 2. Both Corp’s S.H.’s (parent and sub.) must approve the merger (it’s an extraordinary matter). Interested S.H.’s (the parent majority), cannot vote on the merger, but their votes count towards quorum. Minority S.H.’s of the subsidiary corp. have the initial burden to prove: 3. S.H.’s of the sub. must prove lack of fair dealing (True negotiations? Full disclosure of material facts? Did the B of D’s obtain a fairness opinion? Negotiation committee made up of impartial directors & experts?). 4. S.H.’s of the sub. must show lack of fair price (Negotiations over the P to be paid minority S.H.’s?) Once minority S.H.’s prove lack of fair dealing & price, the burden shifts to the board to prove… 5. B of D’s of the parent must prove the deal was fair. Were they serving themselves or the minority S.H.’s? - Fair? Arms-length negotiations, final P paid to the minority S.H.’s was within the original fairness report range? - After the directors prove the deal was fair, then the BJR attaches. Remedies: Appraisal Remedy- Minority S.H.’s are paid the diff. between what they were paid, and what they should have been paid if there hadn’t been a breach of loyalty. Cross-over Issues: Two 14(a)(9) C.O.A., one against the each corp’s B of D’s for disseminating proxy statements with FMSO’s. Breach of due care by the minority sub’s S.H.’s against their own B of D’s for not negotiating. Breach of due care C.O.A. by the parent S.H.’s against their own B of D’s for entering a merger which caused losses?? 10(b)(5) by future S.H.’s of the minority sub. against its B of D’s. 30. Usurpation of Corp. Opportunity C.O.A.Red Flag: A director takes an opportunity from the corp. for their own benefit. Parties: S.H.’s of the corp., Creditors v. the Director who usurped the opportunity. Elements/Rule: The BJR doesn’t attach here because only one director is taking action (no board action) 1. Test: Is the opportunity within the current plan of the corp. or the future plan of the corp.? - Line of Business Test: Is the acquired asset or business within the general line of the corp’s business? 10 2. Defenses the director can argue in this C.O.A.: - The opportunity was offered “just to you”. The person offering the opportunity stated that they refused to deal with the corp. - The opportunity was U.V. - The opportunity was illegal. - Estoppel- The B of D’s knew about the opportunity but did nothing about it. 3. Bad Defenses: Corp. couldn’t afford the opportunity (they can always borrow $), corp. lacked the manpower (corp. can always hire), “I didn’t know it was a corp. opportunity” (Directors have a duty to be informed). Remedies: Constructive Trust- Takes the property/opportunity from the director, and gives it to the corp. If the property/opportunity has been sold in the meantime, the profits go back to the corp. Damages- Awarded only if you can prove bad faith. Insider Trading- Federal C.O.A. 10(b)(5)- Insider trading is an “omission” because of the failure to disclose material inside information. Applies to both publicly traded and closely held corporations. Red Flag: You see someone trading on material, non-public, inside information. Elements/Rule: 2 kinds of insiders- Traditional and Constructive. 1. Traditional- Directors, executive officers, and majority or controlling S.H.’s. 2. Constructive- Anyone in a position of trust or confidence with the corp. You must have a fiduciary relationship with the corp. to be considered a constructive insider. Examples: lawyers, accountants, engineers. Can include blue collar employees: janitors, etc… (must come across confidential info. in the normal scope of their work) - Those with access to confidential, non-public information by way of their position are considered insiders. 31. Rule: Anyone considered an “insider” (traditional or constructive) has a duty to disclose or abstain from trading on inside information. Prima Facie Case for 10(b)(5) Insider Trading: 1. Interstate Commerce- There must be some use of I.C. This element is a given. 2. Standing- Identify a proper P and proper D. - Proper P- S.E.C. or Private P (must be an actual purchaser or seller of the stock at issue, or someone who received the stock through a merger) Not adequate to say “I would have bought or sold”. - Proper D- A person who has a duty to disclose the insider info. or abstain from trading. 1. Self-trader- An insider who personally benefits. A self-trader doesn’t pass on the info., he just trades for himself. Requirements: (1) must be a traditional or constructive insider; (2) must derive a financial or nonfinancial benefit. 2. Tipper- An insider who tips information, but doesn’t necessarily trade on it. They DON’T have to trade to be liable under 10(b)(5). Requirements: (1) must be a traditional or constructive insider; (2) must derive a financial or non-financial benefit (reputation, revenge, “made me feel good”) 3. Tippee- A person who receives info. from a tipper, and trades on it. Tippees do NOT have to be insiders. The tippee’s tipper must have intentionally given the info. to the tippee. No liability for eaves-dropping… Requirements: (1) Tippee’s tipper must be an insider, (2) Tippee’s tipper must personally benefit either financially or non-financially (axe to grind, enhancing self-esteem), (3) Tippee, knows, or should have known, the tipper breached a fiduciary relationship in tipping the info. - A person can fall into more than one defendant category. Look for the “pivot”. 3. FMSO- Identify the inside information the insider failed to disclose. 4. Materiality- There must be a substantial likelihood that a reasonable person would find the fact(s) important. - Material information CAN be speculative (Texas Gulf Sulphur Case). 5. Reliance- There is a rebuttable presumption the P relied since insider trading is so bad. There must be proof the P relied on the non-disclosure of info. - If the P would have traded anyway, there is NO reliance. 6. Scienter- The D has to know that what they’re doing is wrong. 11 - If you’re a traditional insider, ignorance is not bliss. Must have adequate disclosure. - An annual S.H. meeting is NOT adequate disclosure. 7. Causation- But for the non-disclosure, damages would not have occurred. Defenses: Disclosure. Adequate disclosure requires: 1. Disclosure to a national media source (N.Y. Times, L.A. Times, National T.V. network), AND 2. Give the stock market time to react- at least 15 minutes. Remedies: Private P = damages, S.E.C. = treble damages, Injunctions, Rescission or Specific Performance. 32. Takeovers – Bidding Corp.- Breach of Due Care C.O.A. Red Flag: You see a corp. decide to take over another corp. Parties: S.H.’s of the BIDDING corp. v. their own B of D’s. Elements/Rule: A B of D’s of a bidding corp. owes a fiduciary duty of due care to their OWN S.H.’s (not the takeover corp’s S.H.’s) when making a decision to take over another corp. 1. The BJR attaches upfront here because this is a decision by the B of D’s. 2. They must be fully informed when they decide to takeover another corp. (adequate deliberations, sought independent experts, fairness opinion) 3. If they merge with another corp. and losses result, breach of due care C.O.A. results. 4. Apply normal breach of due care analysis- Standard, Breach, Causation, Losses. Remedies: Damages from the B of D’s. Takeovers – Decisions to Defend – Is The Defense Mechanism Valid C.O.A.?- Target corp. has 2 options: #1 Do nothing (due care C.O.A.); or #2 They decide to defend (loyalty C.O.A.) Option #1 - Target takes NO defensive action (Due Care C.O.A.)- Since the B of D’s took no defensive action, there is a presumption they didn’t act in their own self-interest. Red Flag: You see a corp. take no action to defend against a takeover. Parties: S.H.’s of the target corp. v. their own B of D’s. Elements: The BJR applies up front since it’s a board decision. 1. Apply the 4 elements of a due care C.O.A. (standard, breach, causation, loss) - Look for actual or potential losses (the tender offeror takes over and guts the corp., they take the corp’s cash) 2. The B of D’s decision to do nothing by itself could lead to losses for the corp. 33. Option #2 – Target corp. DEFENDS (Loyalty C.O.A.)- If the B of D’s adopts defensive mechanisms, they owe a fiduciary duty of loyalty to their own stockholders to act in their interest. Red Flag: The target corp’s B of D’s takes defensive steps to fight off a takeover. Parties: S.H.’s of the target corp. (for their lost premiums) AND the B of D’s of the bidding corp. v. Target B of D’s. Elements/Rule: The BJR does not apply upfront. Since the board adopts defensive mechanisms, we presume they’re acting in their own self-interest. The TARGET B of D’s must prove (Moran Test): 1. There was an actual or perceived threat to corporate policy or effectiveness. - There must be a reasonable, good-faith investigation to see if the threat is real. Before going to the second step in the Moran test, MAKE SURE THERE WAS AN ACTUAL OR PERCEIVED THREAT, AND THERE WAS A GOOD-FAITH INVESTIGATION. - Actual threat - Someone tells you they’re going to take over your corp. (still investigate this) - Perceived threat- Look for a surplus of cash lying around the target. Does the target have a patented invention the bidding corp. wants? Crown jewel? 2. The defense mechanism has to be reasonable in relation to the threat posed. Will it work? a. Poison Pill- The option to buy more stock is given to current S.H.’s. Makes a takeover more expensive for the bidder. - Reasonable unless the pill kicks in at less than 10%. b. Golden Parachutes- Lucrative pension packages to be paid if the target corp. is taken over. - Reasonable unless the package is so lucrative that it pushes tender offerors away. c. Porcupine Provisions- Provisions a corp. adopts into its Articles/By-laws to make it more difficult to be 12 taken over. These are only effective if the board has proposed to amend the Articles, and the S.H.’s approved the amendment to include these provisions. - Supermajority Vote- Reasonable on both S.H. and director levels unless the majority percentage is > 80%. - Staggered Board- Is always reasonable. - Eliminate Cumulative Voting- Whether it’s reasonable depends on which state you’re in. If it’s a mandatory cumulative voting state, you couldn’t eliminate cumulative voting as a porcupine provision. d. Shark Repellant- Target goes into state court seeking protection from a takeover based on a state statute. - Always reasonable. e. White Knight- Target solicits competing bidders who are friendly (won’t bust up the corp.) to the target to bid against the raider. - Reasonable unless their price is too low compared to the raider. f. Pac-man- The target corp. turns around and makes a tender offer for the tender offeror. - Reasonable unless it’s too expensive for the corp., or is not in the best interests of the S.H.’s. - Look to factors like the target’s capitalization to determine whether it’s reasonable. g. Issue Additional Stock and Place It In Friendly Hands- Issue new stock and give it so someone you trust. - Reasonable unless you can’t issue more stock (exceeds original authorization), or if the target puts the stock in the wrong hands and they turn on them. h. Self-Tender Offer- The target redeems some of its outstanding shares from existing S.H.’s. A publicly held corp. will privatize and transform into a closely-held corp. to remove stock from the raider. - Reasonable provided they pay a reasonable price to their S.H.’s, and the redemption is legal. i. Declaring Dividends so a Friendly Majority S.H. Can Make a Tender Offer - Reasonable unless the declaration of the dividend was illegal. j. Selling Off the Crowned Jewel- The target sells off its most prized asset. - Unreasonable unless the target is facing a certain bust-up merger unless they sell it. k. Scorched Earth- The target sells off all its assets to deter a takeover. The board wastes the corp. - Never reasonable. l. Tin Parachutes- Lucrative compensation packages for low-level employees. - Never reasonable. 3. If the B of D’s of the target proves the 2-pronged test above, the defense mechanism stands. - The BJR attaches only after the Board proves the test above. After this, the S.H.’s cannot challenge the B of D’s decision to implement the defensive mechanisms. Remedies: 1. If the defense mechanism is unreasonable, strike the defense mechanism. 2. Damages against the B of D’s if the defense mechanism is unreasonable. 13