Corporations Outline - Master

Corporations Outline AGENCY 1. Agency -- “The fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on behalf and subject to his control and consent by the other so to act.” a. Types: i. Contractual/Commercial 1. Actual a. Express: this could be written such as power of attorney. b. Implied: anything that flows as a natural consequence of the expression i. i.e. I here by empower to sell land for me. This would allow you to advertise, etc. to sell the land. ii. 2. Apparent: This does not flow from the contract but purely from the surrounding factors or representation. a. If it seems that an employee had authority to do something, the C will be estopped from denying it. b. Test: Was it rx to think the person had the authority to do the action? 3. Ratification – agent has no authority but he acts of the agent make it so the principal is liable. a. i.e. C does not object after participating in the K for a year. 4. Adoption – like ratification but the C either signed or accepts liability. ii. Tort 1. Respondeat Superior –if agent does something within scope of employment, C can be liable. a. Is the person an employee or private contractor. 2. An agency relationship is the following (3 or 4 elements): a. Principal must manifest that agent will act for him b. The agent must accept the undertaking and; c. The parties must agree that the principal will be in control of the undertaking 3. Apparent Agency1 (also known as Agency by Estoppel) -- 2 Elements: a. 1) Franchiser acted in a manner that would lead a reasonable person to conclude that the operator or/and employee of the franchise restaurant were employees of the D b. 2) The P actually believed the operator and/or employees of the franchise restaurant were agents or servants of the franchisor; c. 3) The P relied on to his detriment upon the care and skill of the allegedly negligent operator and/or employees of the franchise restaurant. 4. Notes: a. Every partner is the agent of a partnership b. Agents may be regulated in corporations by the bylaws, BOD resolution or through apparent authority. c. Differences Between Tort and Contract 1 2 Butler v. McDonalds – Franchise agency case where 3p cut himself on door of store. So far we have talked about Actual Agency and Apparent Agency i. Tort: agents may bind their employer through their actions. Law may relieve employer where agent departs from his principal duties. 1. Key Question: Is the worker an agent or independent contractor? a. Look at facts around the worker. ii. Contract: in commercial matters an agent with actual or apparent authority representing a fully disclosed principal will bind that principal and the agent is not the contracting party. 1. If the principal is undisclosed at time of K formation, 3P can elect to sue agent instead of principal but not sue both. PARTNERSHIP 1. Fiduciary Duties – Partners only owe care and loyalty to each other. a. Loyalty i. If you get benefits under the partnership you hold them in trust. ii. You cannot do something on behalf of a competitor to negotiate a deal or something else that is adverse to your partnership iii. Refrain from competing with the partnership. iv. Any type of self dealing is suspect is potentially a loyalty problem. b. Duty of Care i. Limited to engaging in grossly negligent or reckless or intentional misconduct. 1. What does this exclude? Simple negligence. Why? We want to encourage people to explore ideas without being sued for a simple mistake. 2. Partnerships Generally a. Elements i. Association with ii. 2 or more people who iii. Co-Own a biz iv. For profit b. Partnership Agreements i. Typically an agreement that describes the relationship in detail ii. Very flexible iii. If something is missing → Uniform Partnership Act fills in gaps 1. Law tends to protect 3 rd parties related to partnerships - But this protection is limited by expecting them to know certain things c. Fiduciary Duty Exists among Partners i. This is a duty that is stricter than the morals of the market place and more of a duty than arms length to your partner ii. Self-Interested behavior that has disinterested behavior to partner not allowed d. Types of Partners i. General Partners 1. GP’s are agents of the partnership – they manage the partnership 2. Liability - Unlimited Liability → can sue a GP for their personal stuff i. Liable for more than just his investment - § 306 – all partners are jointly & severally liable for obligations of the partnership unless otherwise agreed by the claimant or provided by law i. Can sue one of the partners for everything if you want to ii. Limited Partners 1. RULPA (1985) - LP’s are not personally liable for the debts of the co. they are involved in, unless: i. Exercise enough control to make them substantially similar as a GP; or ii. The creditor had actual dealings with the LP - Gateway v. GB – A limited partnership was formed by a GP and an LP. The GP formed a K w/ some Co. and the only reason this happened was b/c the GP said that the LP was financing and managing their co. GP defaulted and that Co. sued the LP claiming that the LP was personally liable b/c of their control in the limited partnership. Ct held that the amount of involvement was a triable issue 2. Safe Harbors (things that LP’s can / can’t do) i. More Modern Version - 303(A) i. Obligation of a LP is not obligation of LP 1. not liable for obligation for LP solely by rx of being LP → even if participates in management & control LIMITED LIABILITY COMPANIES LLC & LLP 2. Private Autonomy – affairs are controlled by people that run the LLC which is detailed in the operating agreement 3. Liability is limited to the LLC’s assets – no personal liability 4. Lawsuits are Derivative a. Suits that are brought by a member of the LLC, suing on behalf of the LLC (representing it) against other members of the LLC (i.e. D & O) b. Unless violating a mandatory law of the state, the LLC has the power to send disputes to arbitration c. Jaffari – derivative suit brought against LLC and the LLC is trying to get the suit arbitrated. The member bringing the suit claims that the arbitration clause wasn’t signed by the LLC as a separate entity in the “agreement”. Ct held this doesn’t matter b/c the members signed it – they are representative and this is t/f sufficient CORPORATION ISSUES RELATED TO FUNDING OR FORMATION 1. Promoter Liability a. Generally: Promoter is someone who takes initiative in starting a C. i. Can act alone or as co-promoter b. Fiducariy Duties i. Co-promoters are treated like partners. ii. May owe FD to future SH 1. Once they form a concrete plan to create a C, they owe FD a. Duty is owned to SH, C, and promoters. 2. Self Dealing a. Need to disclose 3. Inflated Consideration a. Waterstock liability –This is stock given in exchange for property where the property’s true value is less than the par value for the shares. It is not market value. It is an accounting entry. The corporation or other shareholders can come after you for that difference. 4. Secret profits c. d. e. 2. a. 3 iii. Best way to protect is to have transactions approved by disinterested board after full disclsoure Situations: BURDEN is on Promoter to prove he is not liable. i. If the promoter makes a contract without mention of C name, promoter is liable 1. C may relieve promoter by assigning the K. ii. If the P makes a K with 3P without disclosing that the C is not yet formed, P will be liable. 1. P may be relieved of liability if C is later formed and takes over the K, but this is not for sure. iii. If both parties know that K is for not yet formed C, then usually promoter is not liable. 1. Fact dependent – cases vary. Theories that might help promoter drop out i. Continuing Offer – P makes a continuing offer capable of being accepted by the C (P never liable). ii. Novation – allow P to drop out if 3P knows of the later to be formed C. iii. Estoppel – If 3P knows that the P has no intention of being bound and is content to look to the future C, he should be estopped from holding P liable. 3 iv. Agency (Ratification) Theory – later C can ratify K made by P. Relation back doctrine operates. P drops out of liability 1. This is unlike adoption where P would remain liable with the C. Other Notes on Promoters i. Once they form a concrete plan to create a C, they have a FD and cannot without disclosure keep a secret profit from the C. 1. FD is to SH, BOD and C. Defective Incorporation 4 Defacto Corporation O’Rorke v. Geary -- Facts: P is suing for performance on the K for the debt of D to be paid for the building of a bridge. When D made the K with P, he was not a corporation. Why did the D sign the K? He signed the K because he knew that his corporation would be formed in the future. He is claiming that he is acting an agent of a future company. We call D a promoter. Ultimately a corporation did form but did not exist before the completion of the bridge. Did the P know at the time of the K that there was no C? It appeared that he did. It cannot be a standard agent acting for a principal contract. there was no principal. He could have used a novation (a novation is saying that someone will come at the time of K and accept duties). It was not structured this way. The court would not imply one. So why not ratification? Ratification can only happen post-entity formation. Cannot work opposite way. That leaves us with the third pattern which is the guy did take it on and allow the court to indemnify me. But that does nothing to change the relationship between P and D. Why not estop P? You would need detrimental reliance by D. The court is suggesting that since P was happy to deal with D in his representative capacity he should be estopped from going after D. You would need something to intervene and say that D was entitled to rely that P was willing t look only to the C. Lesson to lawyers: this problem could be avoided by putting what the parties intend in abundantly clear terms. A novation is the surest way of the theories that are available for him to drop out. It is less clear when an adoption occurs he drops out. As far as counseling Mr. Geary what would you advise him to keep it simple? Put a novation. OR tell him not to enter into any business until he is incorporated. 4 Cranson v. International Business Machines Corp. -- Facts: D bought type writers from P. When he signed the K for buying the machines he thought that he was incorporated however he was not because of an error by his lawyer. When the K was made there was not a C on paper. P claims that D was liable for the money because when he signed the K there was no C under a contractual theory. Issue: Is D liable for contracts made on behalf of an organization when it was not incorpated do to an error? Decision/Reasoning: A de jure corporation means a C which is in law free form defects. It what capacity did D deal with I.B.M.? He though that he was an officer or an agent for a non-defective C. Court ruled one of two doctrines could protect D: de facto or estoppel. On formation no one ever thought there was no corporation. The court ruled that since P dealt with D as a Corporation relying on that assumption they are estopped from treating them different than form a corporation. The reliance was them dealing with D in a representative capacity. b. c. 3. a. 4. a. i. Saves participants form partner liability if: 1. there was a good faith effort to incorporate 2. there was actual use of corporate powers. a. i.e. have SH meeting, elect BOD, etc. ii. De jure Corporation 1. Used at common 2. If participants of C did had minor defects in directory requirements a de jure C was formed. a. If failed to comply with mandatory requirements no C was formed. Corporation by estoppel i. Requirements 1. False representation of concealment of fact from person ignorant of truth 2. With the intention by the person making the representation of causing reliance and; 3. Actual reliance by the ignorant person based on false representation. ii. Only available when defacto doctrine does not apply. MBCA §2.04 – All persons acting on behalf of a corporation when they new that no corporation existed in the MBCA, are joint and severally liable. Formation and Finance Stock i. Common stock – usually confers the right to vote. Gives percentage of C 1. In the event of sale, they get their share of assets after creditors. 2. they usually get proportional amount of dividends a. dividends are a claim on the earnings of the C. b. Not entitled until board declares them. 3. Corporate charter can give common stock holders different rights (i.e. divided into classes that can vote). ii. Preferred Stock – get preference over common stock holders. 1. given a specified dividend that is paid out before common stock holders get theirs. 2. In the event of liquidation they get paid before CS. 3. Usually note entitled to vote Piercing the Corporate Veil Generally: Creditors or litigate may go beyond C structure and hold SH< directors, officers, etc. personally liable. 5 i. There is a presumption against piecing ii. When C is pierced treat like a LP 1. passive players are protected 5 Minton v. Cavaney -- Facts: P child drowned in D’s public swimming pool. P argued that D was personally liable. D argued that he was protected because the pool was under C. D took the position of secretary, president and treasurer. Some of the paperwork was housed in his office. The pool only had a small amount of insurance. P argued that because the pool was inadequately funded, D should be liable. Decision/Reasoning: D in this case was not even a shareholder; the shares did not go through. In equity the finer points do not matter as much. Did the swimming pool operate? It does not really say. D argues that he was just helping the company in a temporary capacity. What type of liability arises? P has a judgment against the pool which remains unsatisfied. Isn’t the prospect of tort judgment exactly why we have limited liability? The reason in the case book is because it place a strong amount of reliance the lack of adequate funding. The courts of equity intervened and bypassed the LL. Was there any type fraud by D? No. he was just practicing law. The court seems to be comfortable that if the operating capital is too thin to responsibility to meet your obligations given the nature and scope of your business then courts in equity can, in order to avoid injustice, pierce the corporate veil. Context [Tort to Contract] Effect P-C-V P was additional D with partnership like liability D (shareholder or other insider) incurs liability Equitable Subordination P wants D to move to back of l ine or dissolutions D MAY end up with zero despite formal status Relevant Factors: iii. Insolvency of C iv. Lack of adequate capitalization v. Disregard of C formalities 1. Right way to issue stock 2. Failure to keep minutes 3. Failure to hold SH meetings vi. Non-payment of dividends vii. Siphoning off of C profits viii. Non-functioning of directors or officers ix. Surety or personal promise. x. Key: Look for a blurring distinction between the Cs. b. Notes i. Usually for closely held corporation ii. Very difficult in publicly held corporations iii. To find a parent corp. liable, the party seeking relief must show that there is an overt duty owed to the party seeking to invoke the doctrine of piercing the corp veil, AND that the corp. manipulated the legal entities in order to avoid the legal duty iv. Reverse Piercing: occurs when SH asks its corporate benefit to be ignored to qualify for an otherwise non-available benefit. 5. Equitable Subordination (Deep Rock Doctrine) i. Generally: subordinates D to other creditors if justified by facts. 6 ii. Happens a lot when C are liquidating iii. Arises when there has been a commingling, disregard of C formalities, excerise of C control by SH?Officer/Director. iv. Look to equity. Go through factors. CORPORATIONS 1. Parts of the Corporation (structure) a. Shareholders 6 Costello v. Fazio -- Facts: There are three partners. They all put in lots of money but Fazio puts in 40K (much more that the rest). They are being sued by the trustee in a bankruptcy proceeding. D upon corporation got his money back through a promissory note. Upon BR he is trying to assert that claim as a general creditor. P is arguing that that should be part of the partnership capitol. They did not call in the loan and paid off the existing creditors. It was not an existing situation where they were calling in the loaned money. This way they could get the money out of the BR or, if business improved, they could take it out and it would not be income and thus not taxable. The most confusing part of the case is the abstract contribution. The court seemed to think that they had a business model where they stayed one step ahead of their creditors. They did not think this was adequately capitalized. They placed the bar very high. At the end of the day they penalized them by saying that they had to step to the back. They changed the note to shares. i. Generally: Give the C consideration in exchange for shares. Power to elect BOD. ii. They may 1. Elect SH 2. Vote by proxy or silicate proxies a. Must show good faith in soliciting proxies – must be related to investment. 3. remove directors for cause or without cause (in many states) 4. Vote cumulatively (if allowed by state and bylaws) 5. Inspect SH lists a. Requirements: i. Must have good faith and purpose 1. i.e. Any purpose relating to the value of investment. ii. Demand must be proper. b. They do not have a per se right to inspect all C documents. Must have a good faith intent. 6. Call SH meetings 7. Sue on behalf of the C 8. Sue C where specially injured 9. Receive dividends 10. Make SH proposals in publicly traded C. 11. Enter into voting agreements 12. Compete with (unless controlling SH) 13. Sell a control block of shares at a premium but not to a known looter. iii. May Not 1. Acquire shares through deceptive means 2. transfer shares in breach of transfer restrictions iv. SH are owed FD by officer and directors 1. SH owe FD to other SH in closely held C v. SH are entitled to: 1. materially full and accurate information before tendering their proxies; 2. and proper notice before special meeting vi. Meeting 1. Annual Meeting -- There must be an annual SH meeting a. A failure to hold a meeting at the time or place specific in bylaws does not effect a corporate action. b. Notice does not need to include purpose or description unless otherwise stated in the AOI. 2. Special Meeting – this is a separate meeting from the annual meeting. a. It is called by either: i. The BOD or the person authorized to do so by AOI or; ii. A person with a certain percentage of outstanding shares (MBCA says a 10% SH can) b. Only matters described in the notice may be discussed. c. Quorum is made up of majority of outstanding shares (articles or bylaws can reduce or increase this number). i. Majority vote will bind the C. 1. Under MBCA you only need majority of people present as long as there is a quorum. 2. Under MBCA, if a quorum is present an action passes if a majority of votes cast outweighs the votes against (abstentions do not count). ii. Once a quorum is present at the meeting it remains even if a portion leaves the meeting. d. Notice of SM must provide description and purpose of meeting. 3. Notice a. Must give time, place and date for any meeting no fewer than 10 days and no more than 60 days before such meeting. b. Only voting SH are entitled to be notified unless otherwise stated in bylaws or AOI. c. Waiver of Notice i. SH can waive notice of meeting if signed in writing an delivered to C to be included in minutes ii. SH does waive notice if: 1. He shows up to the meeting anyway UNLESS SH object at the beginning of meeting 2. Waives objection to consideration of a particular matter at the meeting not contained in the description of the purpose of the meeting UNLESS he objects when it is presented. 4. Voting a. Procedure i. After fixing a date for meeting, C shall prepare list of all names who are entitled to notice 1. list arranged by voting group and show address and amount of shares. 2. List must be available for inspection by any SH beginning two days after notice of the meeting is given ii. Refusal of list procedures does not affect validity of actions taken at meeting. b. Voting Entitlement i. Every share is entitled to vote. ii. A C2 is not entitled to vote on behalf of the shares of C1 where C1 owns a majority share of C2. c. Proxies i. SH can vote by proxy; directors CANNOT ii. Appointment is revocable unless it states otherwise and coupled with an interest. Interests include 1. A person who purchased or agreed to purchase the shares. 2. a creditor 3. en employee with such specified in his employment K. 4. A party to a voting agreement – see 7.31. iii. It is against public policy to sell or buy proxy votes. d. Voting for Directors (Cumulative) i. No right to cumulative voting unless specified by AOI. 1. Cumulative voting may only be used for election a. CV on merger would not work. ii. IF CV is permitted it can be eliminated by AOI. e. Voting Trusts and Agreements i. Voting trust – confers right to vote in trustee. Must vote according to agreement. Trustee hold shares in trust. 1. 10 year limit. 2. Trustee does not get dividends; equitable holder does 3. Used to satisfy creditors. ii. Voting Agreements -- Less formal; agreement to vote as a block. No title exchanged. 1. No time limit. 2. Governed by K. a. Must be reasonable. iii. Voting Restrictions 1. Right of refusal a. Cannot sell to someone unless we approve b. We have right to buy first. 2. What you are looking for as a red flag is a unilateral right by the C to buy shares when ever they feel like it particularly at a price that is unfair. a. Also outright restrictions that do not seem to be related to business or violations of securities laws. b. Board of Directors i. Meetings 1. Act as unit by majority vote 2. Quorum required by 51% of authorized seats a. Split 1: If director leaves meeting after quorum vote still valid b. Split 2: Vote invalid for no quorum. 3. Interested director may not be counted in quorum a. Modern: may be counted in quorum by majority must be by disinterested voters. 4. Meetings may be held by conference call if they can hear and speak. 5. Thos present will be deemed to assent to actions taken unless the minutes reflect otherwise. a. Dissenters cannot be silent; must state dissent in minutes. 6. A quorum does not have to be present to fill a vacant seat. 7. Notice Requirement a. Notice requiremed for special BOD meetings. i. MBCA says not need top put purposes at a special meeting ii. If notice is required and not given accurately, even if there is a quorum action is not valid unless waiver. ii. Elect officers iii. Meet annually iv. They can remove one of their own if in the bylaws and have cause. v. Declare dividends and other C distributions. vi. Power to initiate law suits. vii. Many states allow BOD to be staggered (not all elected at once) 1. Makes it difficult for minority to elect a director when there is CV. 2. Makes take over attempts more difficult. c. Directors i. Generally: Not agents of the C. They are not puppets. They are more like trustees overseeing operation to which they have a fiduciary duty ii. FD of care and loyalty iii. ONLY for Directors: Liability may be limited by the AOI iv. Split: May be removed without cause by SH vote. v. A director who does not have information is entitled to reasonably rely on persons below. 1. A director may rely on: a. Officers or employees of the C whom they believe to be reasonable and competent. b. legal counsel, public accountants or other retain by the C for their expertise c. a committee of the BOD that the director is not a part of. vi. Removal of Directors 1. By SH a. With Cause i. Must show procedural fairness and cause 1. Must show cause and give directors opportunity to defend themselves. b. Without Cause i. Must opt/in in bylaws 2. By Court 3. By Directors a. If power contained in bylaws. d. Officers i. Generally: They are agents of the C. People with titles supervised by the BOD 1. They have FD of care and loyalty. ii. Authority given by the bylaws. iii. Notice by officer is imputed by officers 1. Look for degree of office (if mail guy knows is it imputed?) iv. Ultra Vires acts by officer may be ratified if lawful v. Hired by BOD vi. May be fired by BOD without cause 1. Could result in damages. vii. Cannot declare dividends or other C distributions viii. Presidents and GM usually have power to initiate law suits, unless disapproved by BOD. ix. May resign at will as long as it is with FD and not a time when it would injure the C. e. 2. Funding the Corporation a. Equity Funding – consideration given in exchange for shares i. If consideration is below stock given some type of watered stock liability can exist. b. Debt Funding – insiders loan money to C in exchange for future return or earnings. i. Under deep rock doctrine, if C is abused to detriment of outside creditors, the equity courts could push insider to back of the line. c. Leverage: outside debt allows entity to use other people’s money this placing less insider money at risk and extending their capacity and productivity so that return on investment is enhanced. i. Debt is a factor looked at when trying to PCV. SCOPE OF CORPORATE POWER 3. Ultra Vires a. Generally: Arises where an injunction or personal liability is sought because certain transactions are alleged to be beyond the entity’s powers or its object or both. i. Modern – Unless badly drafted limiting AOI, MBCA § 3.02 has very wide powers giving legitimacy to “any lawful business”. ii. Exceptions – 1. Waste can be pleaded which would also be a way around BJR. 2. Look for self dealing or disloyalty a. i.e. Charitable gift that would normally be okay but, director has some personal interest. 4. Derivative Action a. Generally: Derivative suit is a remedy brought by one or more SH to remedy or prevent a wrong to the corporation. SH sue in a representative capacity on a cause of action that belongs to the C. b. Three Requirements: i. Standing: 1. Person bringing action must be a SH at the time act was committed (not at time of lawsuit) a. Policy: Prevents lawyers from searching for cases. ii. Reasonableness 1. Person must represent SH adequately and fairly. a. Policy: we want to avoid constant irritants b. Cannot bring suit for political reasons. iii. Demand requirement (2 methods) 1. MBCA § 7.42 – Demand must ALWAYS upon the corporation prior to SH commencing action. a. Result: i. BOD rejects/reaches own Solution  Apply BJR (P has burden) ii. BOD accepts  C handles (not S/H) b. If demand is not made, it will be dismissed and can be refilled with demand. 2. DEL – a. Demand is excused if: i. A majority of the board is interested or cannot make an impartial decision. 1. Note: Aronson holds that directors are not interested simply because they are named in the lawsuit. ii. The wrong is sufficiently egregious that it could not have been the product of reasonable business judgment. 1. In other words act not protected by BJR a. Breach of duty of loyalty, self interested transactions, etc. iii. For acts or omissions not in good faith or which involve intentional misconduct. 1. In other words acts that cannot be ratified by the SH. iv. Note: If not excused the suite drops v. Demand Process: SH make demand; process decision; approve or deny based on BJR; SH sue BOD if decision was not based on BJRA such as conflicting interest. b. If Demand is excused – Zapata 2 Step test i. Step 1:The BOD will make a special litigation panel to consider the suit. Their decision is covered by the BJR 1. If they deny the suit, a reviewing court may look to see if: a. the panel was free from conflict; b. if it meets the standard of the BJR ii. Step 2: Court will see if committee was independent and done in good faith 1. will apply own business judgments. iii. Result  decision will be binding on the C. c. If demand is made – i. There is an automatic admission that demand is needed ii. The BOD may refer to a litigation committee or decide themselves 1. The decision will be protected by BJR. iv. Special Litigation Committee 1. Litigation committees are often forms as a response to: a. A demand to rectify the situation of which the would be P is complaining or; b. The fact that the suite has been filed. 2. Why would litigation be dismissed a. They would loose b. Another remedy and bad PR c. Cost too much. c. Dismissal i. MBCA § 7.44 – A derivative proceeding will be dismissed pursuant to: 1. A majority vote of independent directors present at a BOD meeting if a quorum of present based on the independent directors alone or; 2. a majority vote of a committee (w/ at least 2 independent directors) appointed by a group of independent directors at a meeting whether or not a quorum is established or; 3. A court appointed body makes the finding it is not in the best interest of the C. ii. If a derivative action continues after a rejection, the complaint has to allege with particularity that (a) the majority of directors was not disinterested or (2) they did not follow the requirements of making a committee or having an independent vote on the best interests of the C. 1. If majority of BOD does not consists of independent directors they will have burden or proving they acted in best interest of C. 5. Business Judgment Rule a. Test (Factual Determination) – Did the company process the decision i. Key: test the analysis not the decision. 7 b. Elements for BHR to apply: i. D had no personal interest in the transaction in question ii. Decision was in good faith (no charades of due diligence) iii. Decision came after a reasonable investigation or analysis under the circumstances and consideration of facts iv. The decision has colorable business justification (not illegal). c. Attacking BJR (4 ways; really three) i. Breach of Care (Burden is on P to overcome BJR) 1. Affirmative Acts (Van Gorkman) 2. Omissions or failures to act a. * After Van Vorkman Del passed 102(b)(7) which made an “opt in” provision that C’s may take advantage of that took away personal liability for duties of care. Now must show breach of loyalty or bad faith. i. If a director or officer consciously ignores his duties to C, thus causing economic injury to C, this falls outside of waiver in AOI. ii. Breach of Loyalty (BJR does not apply) 1. Self Dealing a. Look for an improper personal benefit. 2. Corporate Opportunity 3. Competing Business 4. Waste a. Generally: an exchange that is so one sided that no person or ordinary judgment could conclude that the C has received adequate consideration. i. High standard to prove. 5. Ultra Vires 6. Acts or omissions not in good faith or intentional misconduct. iii. Illegal 1. i.e. Price fixing iv. Fraud 6. Self dealing: “interest Transactions” a. Types i. Loans to Officers or Directors 1. Modern Trend (DEL § 143) – C may lend money to officers and directors if it is beneficial to C. 7 Shlensky v. Wrigley -- Facts: P a shareholder of the cubs is suing the majority SH (Wrigley) in a derivative action for negligence and mismanagement. A derivative suit is a suite that is saying that the corporation is being hurt. P was complaing that D would not out up lights for night games and thus earn more revenue. P is saying that D should not be allowed to do what he is doing in light of the facts. Decision/Analysis: If we let SH question decisions after the fact, there would be lawsuits all day long. P did not offer any evidence that they would make more money. It is not enough to say that they should have done something else. If you could show that despite what was obvious in terms of questionable business decisions and the old man said that baseball was a day game and that he did not care, at some point you are not processing the decision in light of all the facts available with due car and good faith. We want to encourage risk taking but well informed risk taking. The test is not whether the corporation has lost money. The test is whether the decision has been properly processed. Ask did they perform due diligence. If they did then they are protected to the extent that what we are complaining of is simply breach of care. 2. Strict (Traditional) – Voidable by SH at their election 3. Sarbanes Oxley (public companies only) --- forbidden ii. Interested Director Transaction 1. Generally: Since directors and officers are in a position of control they can force the C to do business with them elsewhere that might not be as beneficial to the C. a. Common Law – Voidable at election of SH or C. b. DEL § 144 --- 3 ways for IDT to not be voidable i. Authorized by directors (must have majority vote of disinterested directors; can be less than a quorum that pass it. Q needs to be at meeting) ii. Authorized by SH (must have “ “”) iii. K of transaction is fair to the C at the time it was completed, ratified OR approved by SH or BOD. 1. Marciano Case8 a. If you go through the right process then the burden shifts to the other party to show that it is not fair. iv. Note: If transaction falls under these, burden shifts to P to show lack of fairness. v. Common or interested directors may be counted to reach a quorum but majority vote must be by disinterested directors. c. MBCA i. All transactions have an interest 1. The interest must be sufficient enough to disclose to BOD and 2. Director knew of interest. 2. Duty of Candor – Directors are not allowed to put the C before themselves a. i.e. Can’t donate money to college just to get your son into the school. b. Result  If self dealing is shown the burden of will shift to the C or P to show intrinsic fairness. 7. Corporate Opportunity a. General Rule (ALI) – Director or senior executive may not take advantage of C opportunity unless: i. Director first offers the opportunity to the C and makes full disclosures or; the CP is rejected by the C and either: 8 Marciano v. Nakash -- Facts: P and D represented to equal groups of share holders. They could not agree upon certain corporate policies concerning the company. D was trying t get a loan from a 3P. P was upset about the way the company was being managed so they were not willing to participate in the loan. In response, D made the loan themselves. The problem with the loan is that they are officers and directors. D clearly has an interest because it is their loan. If C did not go well the venture was supposed to be jointly divided. D’s loan came with a promissory note. -- Reasoning/Analysis: Delaware law governs and no longer the common law. P argued that if you cannot get it ratified or approved then it remains voidable; end of story. Court did not agree. Minority jurisdiction says that getting within the 3 exceptions it is conclusive provided that you followed the correct procedures. The prevailing view says that whether you can comply with the 144 statute dictates whether the burden shifts to the other party. If you process it properly, then the burden shift to attacking party to show lack of fairness. If it is not done through one of these avenues then the burden shifts to the proposing party to show that it is fair. Fair is a high standard that goes to the terms and manor in which transaction occurred. Factors in this case – C needed the money. That was important because without this as a factor, insiders could lend money and get an above-market interest rate. Also, there was no one else offering the money on terms noticeably better than this. Last, P did not contribute and D was trying to save the company. In summary the term was fair, needed, and no alternatives existed. 1. the rejection is fair to the C 2. The board rejects it 3. rejection by SH b. 3 questions: i. Is the person someone whom the CP doctrine applies? 1. If they are a BOD or an officer, then yes. 2. What if they are lower? a. Look past the title and at relevant factors: i. How are they compensated ii. What do they do? iii. How did they get the CO? ii. Is it a CP? 1. Test: Is it n the line of business a. If yes, Is there an interest or expectancy 2. Definition (ALI) – a. Any opportunity to engage in a business activity in which a director or a senior executive becomes aware, either: i. In connection with their performance or under circumstances where the director should reasonably believe the opportunity is being offered to the company. ii. Through use of corporate information or property if it would be an opportunity the company would be interested in iii. Any opportunity to engage in a business activity of which a senior executive becomes aware and knows closely related to a business in which the corporation is engaged or expect to be engaged. iii. What happens if the CO comes to you? 1. Offer it to the C a. If you do not offer it to the C you are precluded from later arguing that they could not afford it. 2. Make full disclosure to C a. Make sure that rejection is in good faith or not on bad faith. c. When may a person take advantage of a CO? i. If the C either expressly or implicitly denies the CO. 1. This is subject to the test of self dealing. a. i.e If director turns down the CO on behalf of the C so that he can make more money by himself is self-dealing. 2. When C may not take advantage of the C? a. i.e. if opportunity was not offered at all to the C. 3. If C cannot do it financially a. If person does not offer CO to C based on financial reason, he is precluded from later arguing that the C could not have done it for financial reasons. b. In order to argue financial incapacity you must present it to the C. 8. Voting a. Control Mechanisms i. Voting Trusts – trustee takes title to shares in order to cast vote for number of SH. Does not retain equitable title. Exchange shares for trust certificates. 1. Policy: limits outside interference, satisfy creditors 2. Limitations: Must be filed with the C (no secret voting trust); trust can only last 10 years. ii. Vote Pooling (vote agreements – SH pool together to make an agreement to vote. Not title is exchanged. Vote controlled by agreement. 1. Policy: takes advantage of cumulative voting. Limits outside interference. 2. Limitations: Does not expire; if it becomes a way to oppress other SH it can be disbanded; contract limitations (subject to fraud or inducement) iii. Share Transfer Restrictions 1. Outright Prohibition – no transfer allowed under any circumstance. a. If absolute may a void because of public policy. 2. Prior Approval – BOD, SH must approve before sale is finalized. 3. Purchase Options a. Option in C for them to buy shares first b. Right of first refusal c. Mandatory sell-buy triggering event. 4. Limitations a. Look for out right restrictions or the C being able to buy shares whenever they want. 9. Closely Held Corporations a. Closely held Corporation generally: i. Shares are not traded and may be subject to share transfer restrictions ii. Looks more like a partnership iii. Have heightened duties for SH in dealings with each other 1. this is a two way street. iv. Management and ownership are often fused because directors are also officers and SH. v. SH are owed duty of care and loyalty by BOD, officers AND other SH. b. Purchasing Stock i. Donahue places fiduciary duty on majority SH to minority SH. 9 1. With this look for the majority controlling the C and creating advantages that only apply to them. 2. Things to look for: a. Creating a buyer for MSH and not giving it to the mSH. b. Not giving mSH all the relevant information needed. i. i.e. MSH wants to buy mSH stock. Does not tell him that X wants to buy the same stock at higher price  duty of care and loyalty. ii. Equal Opportunity Doctrine 1. Ask what were the reasonable expectations of the SH iii. When requiring shares, C must give same opportunity to minority SH 10 1. Policy: Majority SH often makes the decisions to purchase stock as officer; can be oppressive to minority SH a. Only for CHC. c. Remedies Available to Minority SH 9 Donahue is a minority: Look for cases where the majority was acting with good faith but did some bad to minority liked firing them. One thing that we do not want is the majority creating a below market price where they could buy them personally or creating a below FMV price. 10 i. Dissolution 1. AT request of minority SH court can order dissolution a. Situations where court may grant: i. Directors are deadlocked in C affairs and irreparable injury is being suffered or will be suffered ii. Directors in control have or will be acting illegally iii. C assets are being wasted b. These factors usually require a significant showing of relevant factors. ii. Court Ordered By-Outs 1. mSH shares are bought at court ordered price iii. Buy mSH at same price or reasonable price. 10. Protecting Minority Shareholders a. Generally: Controlling MSH have a FD to mSH. i. Controlling MSH will be treated like a director or officer. b. Fairness Test: Because MSH have FD, the burden shifts to them to show transactions with C are fair. i. Always uses this test when: 1) self dealing is present and 2) there is a parent subsidiary relationship. 1. If no self dealing, use BJR. a. Under self dealing look to show where the benefit was not just for the MSH but for the entire C. 2. Ask: Did MSH do something to the specific detriment of mSH. ii. You cannot self deal through your control to harm the C to harm the SH. c. Selling Control i. Generally: Anyone can sell their shares for what every price they can get. ii. Majority Shares – most courts allow MSH to sell shares at premium. 1. Types of Purchases: a. Buying controlling shares b. Buying assets – if C agrees to allow C to buys its assets all that is needed is a majority vote; purchase price will be distributed to all SH. iii. Minority Shares – no right to receive same price as majority shares. iv. Exceptions: 1. Misrepresentation – MSH cannot make misrepresentations to the mSH a. i.e. Offers to buy mSH for 10$ when he knows someone else will buy them for 20$. 2. Looting – MSH will be liable to mSH if they knowingly sell to a looter who does attempt to loot the C. a. Purchasing at a premium is on indication of such activity. 3. Selling of a Corporate Asset – MSH that sells stock at a premium could be liable where the premium was created by some C asset that belong to the entire C. 11 11 Perlman v. Fedlman -- There was demand for steel which went that they could go outside of the normal buyers and try to make deals. They could have used the demand for the steel to deal in a way that they could not ordinarily that would not be fair just because there was a market shortage. We can use that money to expand. He was selling to buyer the C opportunity, gave away opportunity to enjoy profitability all so buyer could enjoy steady price of steel. Court said it was wrongful. You are giving away at a particularly important time a C asset to create steal and a good time to make profit. If what you are selling is the sale of a C office the sale might be voidable. 4. Selling of Corporate Office – Cannot sell shares at a premium in exchange for a C office. a. i.e. X sells 3% of shares and elects new board to Y. b. Control may only be traded as part of actual stock. 11. Proxy Regulation a. Proxy = the act or practice of a person serving as an authorized agent or substitute for another b. Proxy Process i. In order to silicate proxy votes you need to file a proxy statement. ii. “The question for every case is whether the challenged communication seen in the totality of circumstances is reasonably calculated to influence the SH votes” iii. Key: Look for what might be a proxy solicitation 1. if someone says what they are going to vote and that is it – no PS 2. If someone says I am going to vote this way and you should too – PS needed. iv. Proxy Statement 1. Generally: form that must accompany proxy solicitation according to SEC that includes relevant information to SH about source of solicitation. a. Solicitations by management need to include detailed information about the C (i.e. financial reports, reasons for vote, bios, etc.) i. If the solicitation relates to an annual meeting by management, they must provide annual reports. b. If the C plans on voting without soliciting proxies, the 14c still requires management to all the same information to be given to SH. c. Must send to SH unless it is routine like election of BOD. 2. Where to SH proposals fit in? a. SH may soliate proxies for their proposals i. If the SH proposals qualify, C includes them in their proxy statement proposals along with sufficient information. (C pays the postage). 1. If C chooses to say no to the SH proposal they have to alert the SEC. SEC would then enter a no action letter. ii. Management may include their recommendations in the proxy proposals. v. Proxy Form 1. SEC regulates form of proxy. 2. Must indicate who is soliciting the proxy and what specifically the proxy if for. 3. Must include a yes or no box. No blank checks. c. Share Holder Proposals i. A proposal is a recommendation for a company to take action ii. To submit a proposal you must have: 1. Continuously held 2000$ in the C or; 2. 1% of the C. iii. if you are a registered SH, C can verify you status iv. If not you can verify you status when you submit your proposal in a couple ways: 1. Submit letter from record holder of the securities (usually a broker or bank) 2. Show that you have filed a13d form v. Each SH may only submit 1 proposal per SH meeting vi. If you fail to meet requirement C may exclude your proposal after they have notified you of the problem and you have failed to correct it. 1. Burden is on C to show your proposal can be excluded. 2. *Under What other ways may a C exclude my proposal? a. Improper under state law i. i.e. not a proper proposal for the actions of a SH b. Violate a State Law c. Violation of proxy rules i. Can’t use materially false or misleading statements in soliciting proxies d. If the proposal relates to a personal claim or grievance or only for your personal interest or benefit e. Relevance – If it relates to less than 5% of C total assets or earnings and gross sales and not otherwise significant 12 f. If it duplicates another proposal g. If it is a resubmission h. If it relates to a specific amount of cash dividends d. False or Misleading Statements i. Cannot send a proxy solicitation that is false, misleading, or omits material information. ii. SEC gives private cause of action for such a violation iii. Elements 1. Materiality – misstatement or omission must be material a. Materiality test: SH would consider it important in deciding how to vote. b. Bespeaks cautionary doctrine: if omission or misstatement is included in a document that sufficient cautionary language it could be ruled immaterial. i. Fact sensitive analysis. 2. Causation – prove that your vote was necessary for the transaction to go through. a. Do not need to show SH would have relied. ONLY need to show that the solicitation was a an essential step in the transaction at hand. b. It has to cause loss for the damages P suffered. 3. Degree of Fault – Scientor and Negligence a. Scientor is required. 12. Insider Trading, Transaction, and Securities a. 10B-5 i. Generally: used as an alternative to state fraud actions involving private transactions of shares and/or actions involving misrepresentations or fraud relating to information about publicly traded shares. ii. There are two types: Insider trading and Employing Manipulative Deceptive devices. iii. Types 12 Lovenheim v. Iroquois Brands Ltd. P was suing to enforce the proxy materials to include a proposal about a proposed resolution about the caring for geese. He was trying to propose a committee to investigate to see if the bad treatment of geese was going on. Management did not want to because it was expensive and it goes out on the company dime. Issue: Whether they have to include the proposal if it does not relate to economics of C? It centers around the last part of 14(a)(5) which says “and is not otherwise significantly related to the C business”. The court concludes that the proposal because it is a social issue and the exception does not preclude its inclusion. Policy: They want to encourage SH involvement. They say good luck because there is 13 ways in 14(a) for the C to blow it out of the water. 1. Classic – Insider trades in his company’s stock based upon material non-public information. a. D has a fiduciary duty to C/SH. 2. Constructive (Misappropriation) – D has not FD to C/SH but breaches a trust with a person that does have such a duty. This is anyone with a duty of trust with the Corp. Those with access to confidential non-public information by way of their job come under this category. a. Who has duty of trust under 10b5-2? i. A person who agrees to maintain confidence ii. Relationship that has a pattern of confidence iii. Information from spouse, child, parent, etc. 1. *Not a complete list. b. Fraud on the Source: This person breaches a duty owed to the source of the information. c. Possible Defendants: i. Self trader –1) Must be an insider (classic or constructive) and 2) must receive a benefit ii. Tipper --1) Must be an insider (classic or constructive and 2) must receive a benefit 1. do not have to trade on it but someone else does. iii. Tippee – 1) tipper must have been an insider 2) tipper must benefit 3) tippee knows or should have known about breach of duty. iv. Tipper/Tippee Liability 1. Tipper = person given the tip (insider); Tippee = person receiving the tip. 2. A tippee only violates 10b5 if the insider/tipper breaches a FD to his C and a. Receives a direct or indirect benefit and; b. Tippee knew or should have known about that tip was in breach of tipper’s FD. 3. Notes a. The tippee creates liability by either telling others or buying or selling stock. i. If tippee does not know about duty and buys/sell shares, he is not liable and can tell others. Tipper will still be liable. b. For the tipper to be liable shares have to bought or sold from someone. v. Private Cause of Action 1. Applies to any company or entity that issues a security 2. Elements of 10b-5 a. Interstate Commerce i. If someone walks over to their neighbors yard and tries to defraud them, this is not a 10b5 action because IC is not invoked. b. Right Court and federal (NOT STATE CT) c. P is a buyer or seller i. Birnbaum Rule: in private action under 10b-5 P must be a buyer or seller. ii. Contemporaneous requirement -- Usually there is a 5 day window with the misrepresentation. d. Misrepresentation or Omission i. It must be material 1. Would a person trading want the facts that the insider traded on or; 2. Would a reasonable investor deem this to be important (not necessarily determinative but an important element in the overall mix of the information a. Anything capable of changing the share is material 3. Measured in quantitative terms a. 10 million dollar asset purchase is not material in multi-billion dollar deal. ii. Kinds of Misrepresentations can include: 1. Silence when there is a duty to speak 2. Affirmative statement 3. Half or partial truths e. Reliance i. If it is material, reliance is presumed. ii. Rebuttal by showing the insider or person did not rely on the information. iii. Misstatement 1. Open market  “Fraud On the Market” presumed a. This would be where you are buying shares anonymously. 2. Face to face (prove it) a. This is the cleanest that is the most like a tort rule where the P has the burden of showing the reliance f. Causation i. Can some external event show that it caused the share to go south ii. But for the non-disclosure the damage would not have occurred. g. Sceintor i. Willful deception ii. Deliberate Reckless disregard 1. With recklessness error on the side of requiring more iii. Fraud must involve deceit or concealment of material information iv. Note: negligence is not enough for private cause of action 3. Duties of Trust or Confidence in Misappropriation Insider Trading Cases (10b5-2) a. Scope of Rule – Any purchase or sale of security on the basis of or the misappropriation of material non-public info. b. Who has duty of trust under 10b5-2? i. A person who agrees to maintain confidence ii. Relationship that has a pattern of confidence iii. Information from spouse, child, parent, etc. 1. *Not a complete list. 4. Other Rules a. There is no private cause of action for abiders and abettors under 10b-5 but the SEC does have a COA. i. Elements: Any person that supplies substantial aid b. P has to be a purchaser or seller. D does not 5. Tipper/Tippee a. Dirks  A tippee will be liable only if the tipper breached a fiduciary duty in giving the information to the tippee. vi. Insider Trading 1. General Test: a. Did tipper receive a benefit from the tipping (Dirks) b. Is the person breaching a duty of trust that is owed directly or indirectly to the issuer of that security or the SH of that inuser or any other person who is the source of the information (O’Hagan) i. Defenses: 1. The person was already going to buy or sell the shares 2. Did not use information b. 14e-3 Transactions on the Basis of Tender Offers i. Any person that receives information of tender offer that they know is non-public material information and trade on the basis of that information they are liable 1. Does not apply if: a. the person making the transaction did not know the information b. the person can show that they were already going to purchase or sell. i. i.e. policy, routine buys, etc. ii. It is illegal to pass on information relating to a tip if it is foreseeable that such a communication is likely to result in a violation. iii. Key: Look for substantial step for a tender offer 1. just saying I want to buy your shares does not work. c. § 16(b) of Securities Exchange Act i. Generally: designed to prevent specified persons from trading on an in and out basis on the strength of inside information. 1. Only applies to C registered under § 12 of Securities Exchange Act a. C must register if they have over 10M in assets and 500 SH or; b. They trade on a national securities exchange 2. Only applies to: a. Officer b. Directors c. SH with more than 10% of shares ii. Requirements for Insiders 1. Have to report trading to the SEC if you are an insider a. Only for your C though 2. Make an initial disclosure of your share holdings 3. Indicate the price that you sold them or bought them at. 4. No defenses for D. iii. Standing: 1. Officer/Directors – status at time of transaction is sufficient. 2. 10% SH – must have 10% shares before matching purchase and sale a. if below 10% and then a SH buys above that mark it will not work. 3. It can be any SH and they do not have to be a SH at time of wrong. iv. Notes: 1. Must have an off setting purchase-sale of shares within six months 2. Actual use of inside info is not needed 3. Profits are payable to the C a. Profits are computed by comparing the highest sale price with the lowest purchase price and so on. 4. All actions are derivative a. SH can bring suit and do not need to own shares at time of transaction. v. Persons subject to § 16 must report holdings and changes in holdings to the SEC. vi. No finding of fraud or misconduct is needed (no scientor requirement) 10b-5 Applies to all entities capable of having security D can be anyone P sue on own account (not derivatively) Liability comes from avoiding losses or making gains (single transaction) Need possession of material non public info or scientor Defenses available § 16(b) Applies to § 12 C only D must be officer, director, or own 10% Always derivative or Corporation itself Always need purchase and sale inside 6 months. No showing of scientor or non-public info needed. No defense available Tipping not relevant or actionable BOTH APPLY IF: Statutory insider trades on basis of material non-public info after making reciprocal purchase within 6 months. 13. Shareholder Appraisal Rights a. Generally: State Statutes give SH the ability to dissent from certain types of transactions and receive the appraised value of their shares. i. In most jurisdiction only SH that vote on the transaction can receive AR. b. When is it available? i. Mergers, ii. Compulsory share exchanges iii. Sale of C assets iv. Fundamental change to AOI. v. If AOI or bylaws say so vi. KEY: look for fundamental character change to C’s stock. c. Process i. C must give notice to SH if they think AR may be invoked. ii. SH sends notice of intent to dissent 1. Cannot waive this right by then voting in approval. iii. C then sends confirmation notice of intent to dissent. 1. If SH continues to intend to dissent, C offers AR at fair price. d. What is fair value or the price? i. SH states request price; C either agrees or states their requested price; if these fail a court proceeding will set the price. e. Notes: i. Because AR can be an excessive drain on C, most mergers have an opt out provision if too many SH seek AR. ii. Understand that if the C follows the procedure by giving notice and you do not comply strictly by giving notice and responding when you are supposed to (like on vacation or give a proxy) that is it and you are done for better or worse.