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CORPORATIONS Prof. Sachs SPRING 2001
INTRODUCTION TO CORPORATIONS _______________________________________ 4
Approaches .............................................................................................................................................. 4
Introduction to Fiduciary Duty ............................................................................................................. 4
Features of Corporations ....................................................................................................................... 4
Formation of Corporations .................................................................................................................... 5
Procedures ............................................................................................................................................................5
Shares Authorized ................................................................................................................................................5
Efficient Market Hypothesis .................................................................................................................. 6
Shareholder Rights Under State Law ................................................................................................... 6
Voting Rights .......................................................................................................................................................7
Basic Voting Rules...............................................................................................................................................7
Annual Meeting....................................................................................................................................................7
Special Meeting....................................................................................................................................................8
Notice of Annual Meeting ....................................................................................................................................8
Notice of Special Meeting ....................................................................................................................................8
Action w/o a Meeting ...........................................................................................................................................8
Election of Directors ............................................................................................................................................8
Removal of Directors ......................................................................................................................................... 10
Selecting Replacements ..................................................................................................................................... 11
Proxy Regulation .................................................................................................................................. 11
Proxy Statement.................................................................................................................................... 11
Shareholder Proposals: Rule 14a-8 .................................................................................................... 11
Procedural Requirements of Proposal ................................................................................................................ 12
Substantive Requirements of Proposal ............................................................................................................... 12
Fraud/Misleading Statements in Proxies: Rule 14a-9 ...................................................................... 13
Private Cause of Action ..................................................................................................................................... 13
Elements of a 14a-9 Action .................................................................................................................. 13
Materiality .......................................................................................................................................................... 14
State of Mind ...................................................................................................................................................... 14
Causation............................................................................................................................................................ 14
SH Right to Inspect............................................................................................................................... 15
THE BOARD OF DIRECTORS _______________________________________________ 17
Background ........................................................................................................................................... 17
Board Meetings ..................................................................................................................................... 17
Director’s Duty of Care ........................................................................................................................ 17
Decisions ............................................................................................................................................................ 17
Business Judgment Rule ...................................................................................................................... 17
Director’s Duty of Care ........................................................................................................................ 18
Omissions ........................................................................................................................................................... 18
Adequate Process ............................................................................................................................................... 19
Director Exculpation Provisions ......................................................................................................... 20
Delaware §102(b)(7) .......................................................................................................................................... 20
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MBCA 2.02(b)(4)............................................................................................................................................... 20
Duty to Monitor for Illegal Activity .................................................................................................... 20
Notice ................................................................................................................................................................. 20
Compliance ........................................................................................................................................................ 21
Causation............................................................................................................................................................ 21
Corporate Opportunity Doctrine ........................................................................................................ 21
Common Law Approach .................................................................................................................................... 21
ALI Approach .................................................................................................................................................... 22
Interested Director Transactions ........................................................................................................ 22
Definitions.......................................................................................................................................................... 22
Shareholder Sanitization .................................................................................................................................... 22
Director Sanitization .......................................................................................................................................... 22
Fairness to the Corporation ................................................................................................................................ 22
Derivative Actions................................................................................................................................. 23
Delaware ............................................................................................................................................................ 23
Demand Requirement ........................................................................................................................................ 23
Response to Demand .......................................................................................................................................... 23
Special Litigation Committee ............................................................................................................................ 24
Derivative Actions................................................................................................................................. 24
MBCA ................................................................................................................................................................ 24
Demand Requirement ........................................................................................................................................ 24
Dismissal ............................................................................................................................................................ 24
Comparison of Zapata to MBCA 7.44(a) ........................................................................................... 24
OTHER BUSINESS FORMS _________________________________________________ 25
Comparison to the Corporation .......................................................................................................... 25
CLOSE CORPORATIONS ___________________________________________________ 26
Features ................................................................................................................................................. 26
Legislative Response to Protect Shareholders in Close Corporations ............................................. 26
Shareholder Agreements ...................................................................................................................... 26
MBCA 7.32 Shareholder Agreements................................................................................................. 27
BJR in Close Corporations .................................................................................................................. 27
Dissolution in Close Corporations....................................................................................................... 27
Voluntary Dissolution........................................................................................................................... 27
Judicial Dissolution............................................................................................................................... 27
Shareholder Buyout.............................................................................................................................. 28
Share Transfer Restrictions ................................................................................................................. 28
ALLOCATING CREDITOR RISK: PIERCING THE VEIL ______________________ 29
Creditor Protection............................................................................................................................... 29
Delaware ............................................................................................................................................................ 29
MBCA ................................................................................................................................................................ 29
Piercing the Veil .................................................................................................................................... 29
Contract Cases.................................................................................................................................................... 30
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Tort Cases .......................................................................................................................................................... 30
SECURITIES FRAUD AND INSIDER TRADING _______________________________ 31
§ 10(b) and Rule 10b-5 ......................................................................................................................... 31
Securities Fraud .................................................................................................................................... 31
Requirements ..................................................................................................................................................... 31
Purchaser/Seller ................................................................................................................................................. 31
Material Fact ...................................................................................................................................................... 32
State of Mind--Scienter ...................................................................................................................................... 32
Reliance/Transaction Causation ......................................................................................................................... 32
Insider Trading ..................................................................................................................................... 33
Who Must Disclose or Abstain .......................................................................................................................... 33
Elements ............................................................................................................................................................. 34
Misappropriation of Information ........................................................................................................................ 34
Rule 10b5-2 ........................................................................................................................................................ 35
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INTRODUCTION TO CORPORATIONS
Approaches
SH = Owners. BOD and officers = managers
Two ways of thinking about corps:
1. Private property of SH: purpose is to increase SH wealth
2. Social institution: not strictly private but tinged w/social purpose. BOD duties
extend beyond ensuring good return to treating fairly what the corporation affects
Central problem w/corp law: How do you keep mangers accountable?
Approaches for accountability:
1. Law & Economics/Contractarian: Accountability is not a big deal, b/c managers
want what SH want. SH will sell if bad mgmt and new SH won’t buy in. SH can
minimize risk by diversifying.
NB the benefits of NOT diversifying: 1) may have enough shares to control and have
influence; 2) company loyalty; 3) careful monitoring of managers
But role of the law in this approach is MINIMAL.
2. Regulatory/Traditional: Substantial, significant legal intervention needed to protect
SH. Various forms of protection are: 1) giving SH a voice; 2) giving SH procedural
protections; 3) disclosure; 4) imposition of fiduciary duties on managers.
NB that managers can manipulate ALL of these protections.
Introduction to Fiduciary Duty
Central feature of corp law
Reilly: Sales rep who starts own fundraising business while still at his old firm. Former
employer sues for breach of fiduciary duty. Ct. applies principle of fiduciary duty, finding an
obligation to act for the corp and not solicit future business. NB that fiduciary duty becomes
part of the employment contract. Not a separate contract b/c of difficulty of anticipation,
contracting out all contingencies.
Fiduciary duty amounts to an ad hoc notion of fairness. Reg/trad view. L&E approach to
substance of fiduciary duty is what the parties wouild have bargained for if they had
bargained.
Features of Corporations
1. Separation of Ownership & Control: No right to manage as a SH. BOD has ultimate
responsibility of mgmt. Serves function of encouraging investment.
Individual SH: probably not a good mgr., can put up $ w/hope of profit and knowing don’t
have to devote time to it.
Corporate SH: Means greater attn., but only to a fraction of holdings w/in portfolio.
2. Limited Liability: SH will only lose the amt. invested, personal assets are safe. Possible to
become SH w/o worry of risking much, and makes it easier for corp to raise capital.
3. Transferability of Interests: SH can sell shares and end r’ship w/o approval of corp.
Makes willing to invest b/c no feeling of being locked in.
4. Continuity of Existence: relatively permanent entity, hard to dissolve. Makes an attractive,
stable investment.
NB All of these characteristics can be abused by mgrs.
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Formation of Corporations
Procedures
1. Choose a state of incorporation: That state’s law will govern the internal affairs of the corp
(r’ship b/w mgr, SH, and fiduciary duties). Internal Affairs Doctrine.
Does not have to be state in which corp will do business, but if planning to do all business in
one state, should incorp in that state b/c less expensive (taxes).
For corps doing business in many states, Delaware is the favored state of incorporation.
Why? Two views: Race to the bottom (DE has worst corp laws that allow mgrs to do
whatever they want) and Race to the top (DE has best laws b/c most flexible, which is in SH
best interest b/c mgrs want to do the right thing). Mixture of both. DE still favored over
states w/similar corp codes b/c DE has body of case law and judiciary experienced in corp
cases. DE also requires 2/3 majority to change its corp code.
2. Formal procedures required by every state:
a. Charter/Articles of Incorporation: The corp constitution. Must be filed
w/state. Must include corp name, # of shares, address/name of registered
office/agent, name/address of each incorporator
b. Bylaws: Corp statutes. Not on public file. Much easier to amend than A of I.
Shares Authorized
MBCA 2.02(a)(2)
Class of shares = all shares that have identical rights.
Types of stock: common and preferred
1. Common Stock: Not expressly defined in MBCA, but every corp must authorize
shares with: voting rights (mainly for BOD) and liquidation rights. May be in the
same class of shares or a different class.
Also generally receive dividends. Pmt of—when and how much—are w/in discretion
of BOD
2. Preferred Stock: Must also be in charter. Less of a risk, but less of a gain. SH have
some preference against common SH w/respect to 1) dividends; 2) distribution in
liquidation; or 3) both. Dividend pref and liquidation pref means a right to receive
either before the common SH, at a fixed amount.
Do not receive voting rights (unless right reserved in charter if div hasn’t been
received in specified period—for protection).
Do not participate in profits (specified dividend or liquidation amt per share and no
more).
3. Debt Securities: Bond, debentures, etc. Distinction b/w equity and debt: equity
represents an o/ship interest, debt is something that must be repaid.
Rights of debtholders: 1) repayment w/in certain time; 2) entitled to regular pmts of
fixed interest; 3) come before equity SH in liquidation.
In exchange for security, no vote for BOD
SENIOR SECURITIES
EQUITY SECURITIES
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Common Stock Preferred Stock Debt
Income Dividends based on Set amount of Fixed amount at a set
earnings dividends, ahead of c- time—principle at
stock maturity date
Elect Board? Yes No (w/qualifications) No (possible in DE)
Liquidation Excess after senior Set amount ahead of Ahead of equity
securities c-stock securities
HOW TO KEEP MANAGERS ACCOUNTABLE
1. Mkt., EMH
2. Voting rights under state law
3. Federal proxy system
4. Right to inspect
5. BOD duties
Efficient Market Hypothesis
R/ship b/w disclosure of financially significant information and changes in securities mkt.
prices
Semi-strong form: a security’s price reflects ALL publicly available info about stock and
company. Price is a consensus view of value of that stock relative to others.
This occurs due to activities of mkt pros and who they advise. Doesn’t mean you can’t beat
the mkt, just can’t do it consistently.
Paradox is that mkt becomes efficient by effort of analysts/traders to learn all they can to give
good advice—by virtue of people behaving as if mkt is not efficient.
NB that data to support the EMH is based mainly on companies traded on NYSE and
AMEX. These two are distinctive in that the very big companies are traded on them,
companies w/lots of institutional investors—the type of companies followed by analysts.
Plenty of companies are not followed by analysts, and don’t have big investors—so may not
be completely efficient b/c some info not impounded as quickly as other
Importance to corporate law: EMH protects SH—stock price reflects how well a company
is being run. The market exerts a discipline on managers.
Shareholder Rights Under State Law
Corp is managed by BOD w/2 possible limitations: MBCA 8.01(b)
1. Charter can limit BOD’s power
2. Limit power subject to MBCA 7.32 (ONLY APPLIES TO CCs)
Amendments to Charter must be initiated by the BOD MBCA 10.03 SH can only make
recommendations.
Amendment to Bylaws may be initiated by BOD or SH. MBCA 10.20
Auer: SH are allowed to make proposal concerning ousted president. Most cases are attuned
to specific issues.
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Voting Rights
Consist mainly of right to elect directors, but also include:
1. Charter amendment after BOD approves
2. Mergers after BOD approves
3. Dissolution after BOD approves
4. Selling off assets
As entity changes, SH get to vote (19th century view). SH known as rationally apathetic.
Ex: not reading merger proposal accompanied by proxy statement. Why?
1. Not an expert, so won’t find reason to disapprove the merger
2. Wall Street rule—simpler to just sell shares
3. Not enough shares to make a difference
4. Respect for experts
5. Let someone else do the work—free riding on the bigger investors
Not rational for insititutional investors to be apathetic: have bigger block of shares w/more
to lose, easier access to good info, easier time of coordination among themselves.
Basic Voting Rules
1. SH must meet at a regularly scheduled annual meeting. MBCA 7.01
2. Special meetings for particular purposes. MBCA 7.02
3. Record date—only SH of record by a certain date can vote (set by bylaws or BOD) MBCA
7.07
4. SH action at a meeting requires a quorum, majority unless charter says o/wise MBCA
7.25(a)
5. Cannot break quorum by walking out MBCA 7.25
6. To get a matter approved concerning election of directors, a plurality is needed. MBCA
7.28(a)
7. If matter is dissolution, change in charter rules, the positives must exceed the negatives.
MBCA 7.25c
8. Proxy voting—SH can authorize someone else to exercise their voting rights (usually mgmt.)
MBCA 7.22. Regulated by federal law.
9. Vote by written consent instead of meeting must be unanimous. MBCA 7.04
Annual Meeting
Date usually set forth in bylaws MBCA 7.01
If corp wants to change date, must make sure date is set w/in 6 mos. after end of fiscal year
or 15 mos. after last annual meeting. MBCA 7.03(a)
Schnell: Cts. can use equitable power to prevent mgmt from manipulating procedures. Here,
corp moved up annual mtg date and changed to inconvenient location. Allowed to do all of
this, but occurred in the middle of election contest and would disad SH who opposed mgmt
slate. Note a murky line of cases, not a bright line rule
HBO: Ct held inequitable a postponement of mtg announced evening before scheduled day.
Mtg can be postponed if BOD carries burden of persuasion that postponement was in SH best
interests. tried to argue in best interests of SH to be informed, but ct. found had ample
opportunity prior to postponement to inform SH. Permissible to give SH extra time, just not
in this case.
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Stahl: 30% SH wanted mtg held at earlier date than req’d by bylaws or DE code, in order to
facilitate his effort at takeover. Refusal to call mtg when not obligated to do so is not an
impairment of the exercise of franchise.
Special Meeting
Note a special meeting can be called by the BOD (or whoever authorized to under A of I or
bylaws) OR by SH of at least 10% of votes to be cast
Corp can raise or lower the 10% mark (but can’t go higher than 25%)
Notice of Annual Meeting
MBCA 7.05
BOD must give notice of meeting no fewer than 10, no more than 60 days before the mtg
date
Notice of a special mtg requires description of why mtg being called
Record date may be set in bylaws to determine who gets notice MBCA 7.07
Record date can’t be more than 70 days before the mtg
If mtg adjourned more than 120 days after original mtg date, new record date must be set
Notice of Special Meeting
If SH makes demand for special mtg, notice must be given of mtg w/in 30 days of receipt of
demand MBCA 7.02/7.03
All in all BOD can’t schedule mtg later than 90 days after the demand is made. MBCA
7.03/7.05 (notice given w/in 30 days of demand but can’t be given more than 60 days in
advance of mtg).
Action w/o a Meeting
SH can take action by written unanimous consent w/o a mtg. MBCA 7.04
BOD has ability to manipulate the record date w/receipt of consents here MBCA 7.04(b)
Record date is when SH signs first consent. BOD can change this record date under MBCA
7.07(a), just has to be w/in 70 days. Ex: could set 100 days after last consent.
Could invoke Schnell—manuevering w/in statutory limits but designed to entrench the BOD
Election of Directors
A quorum is needed under MBCA 7.25(a)
Proceeds by plurality voting MBCA 7.28(a). Ex: 5 directors to be elected from a slate of
10. Winners are the 5 w/the most votes.
Staggered terms of directors: ensures BOD will always have some directors w/experience.
Also makes takeover less likely b/c won’t be able to put all people on BOD at once.
Two methods of plurality voting: straight and cumulative.
1. Straight Voting
One share one vote. MBCA 7.21. Note exception about entitlement to vote.
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Ex: 6 directors to be elected from slate of 12. A has 1,000 shares. B has 550 shares. A
puts 1,00 shares on each of his 6 candidates. B puts 550 shares on each of his
candidates. A ends up electing the entire BOD Majority SH takes all.
2. Cumulative Voting
Can only cumulate if A of I provides for it. MBCA 7.28(b).
Some states (12) require it, less than 20% of public corps have it.
A reaction to the one-sidedness of straight voting, allows minority representation.
SH gets as many votes as has shares, times the number of directors to be elected to the
BOD NO cap as to how many votes can be put on one candidate.
Ex: 6 directors to be elected from slate of 12. A has 1,000 shares = 6,000 votes. B has
550 shares = 3,300 votes. B can get 2 candidates on the BOD no matter what.
Formula for c-voting:
x = number of shares needed to do what they want (get someone on the BOD)
s = number of shares total at meeting
d = number of BOD wants to elect
D = number of BOD to be elected
x = ( sd / D + 1) + 1
Example from above:
B wants to get 2 candidates on the BOD Note the 1550 equals A + B shares. Assuming
they are the only 2 SH, those are the total number of shares that can be voted at the mtg.
X = [ (1550) (2) / (6 +1) ] + 1
X = (3100 / 7) + 1
X = 443
So B needs at least 443 SH to put 2 candidates on the BOD
Example:
1,000,000 shares total at mtg. 9 directors to be elected. SH wants to elect 1 BOD
member. How many shares are needed?
X = [ (1,000,000) (1) / (9+1)] + 1
X = (1,000,000 / 10) + 1
X = 100,001
Note that the fewer BOD members to be elected, the more shares are needed to elect
one BOD member.
Advantages of cumulative voting:
1. Minority voice
2. Different viewpoints on the BOD
3. Increase quality of discussion on BOD
4. Keep mgrs accountable by enhancement of monitoring
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Disadvantages of cumulative voting:
1. Inefficient to have different viewpoints
2. Unreasonable criticism
3. BOD should represent everyone, not just a faction
4. Too damn confusing
Protections of cumulative voting are illusory; they can be thwarted by Bd:
1. Mandatory in some states—so a corp wouldn’t incorporate there
2. If already incorporated, can incorporate elsewhere (merge original corp into new one)
3. Permissive cumulative voting in charter can be amended (MBCA 10.01). There’s a
catch to this. B/c of reliance by min SH, any SH unhappy w/such amendment can be
bought out by corp. MBCA 13.02(a)(4)(iv). Can get fair value instead of selling (in
the instance of a close corp, for example)
4. Reduce number of directors on BOD, b/c will need more stock to elect one director.
MBCA 8.03(a)—set in charter or bylaws. MBCA 10.20 BOD/SH can change
bylaws, BOD initiates change in charter
5. Stagger the terms of directors, so there are less directors to be elected at any given
time. MBCA 8.06 requires staggering to be in charter, so harder to change and
requires approval of BOD and SH.
6. Assign min BOD members to trivial committees
7. Classify shares. MBCA 6.01(c). Allows creation of different classes of stock
w/different rights. Ex: Class A is original owner w/exclusive right to elect 6 BOD
members. Class B is new minority SH w/exclusive right to elect 3 Bd members.
Preferred to c-voting b/c: min SH has role but a ltd one and eliminates messy,
confusing c-voting.
Note that charter has to be amended if a corp has issued all authorized shares. MBCA
2.02(a)
Bylaw requiring a supermajority has to be in A of I. MBCA 7.25(c). Charter can increase
number of votes req’d (as long as it’s not for election of director). MBCA 7.27 says charter
must include increase in number of votes. This relates to Prob. 3-7 when Sachs told me I was
wrong but I wasn’t.
Removal of Directors
Directors can be removed w/o cause. MBCA 8.08. Unless charter says only for cause.
Why removal w/o cause? SH are the ownvers so let them do it. Cause is also hard to
establish.
Why limit removal to cause? Gives BOD sense of security.
Cause is serious wrongdoing: fraud, criminal conduct, or serious breach of trust.
Campbell: Cause is strictly interpreted. Conduct must be deliberately obstructive. Also
grants due process rights: Notice of charges and opportunity to respond. Also in Auer.
To remove the number of votes to remove must be MORE than the number of votes not to
remove. MBCA 8.08c.
Note that director to be ousted CAN vote for himself.
A different standard of removal exists for c-voting. If number of votes cast FOR removal
sufficient for election, may NOT be removed. MBCA 8.08c.
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Judicial removal provided for, designed to address when BOD has enough to stay on.
MBCA 8.09. SH w/10% can bring (or DA if less than 10%) or can be brought by corp.
Requirements of judicial removal:
1. Dishonest, fraudulent, or gross abuse of authority
2. In the best interests of the corp
Conservative section, defers to power of SH
Selecting Replacements
SH should remove and fill at same mtg, b/c o/wise BOD can fill before they do. MBCA
8.10.
NO requirement that SH be given info on how to vote—that gap in state law is filled by
federal law. 1934 Act.
Proxy Regulation
§ 14(a) authorizes SEC to adopt rules gov’g solicitation of proxies. Part of 1934 Act, after
the crash, to prevent investors from being in the dark. Congress took advantage of states’
authorization of proxy voting.
SEC has wide authority. 3 aspects of proxy regs:
1. Disclosure of info
2. Rule 14a-9—fraud provision
3. Rule 14a-8—SH proposals
Proxy rules are limited to § 12 companies.
Requirements of § 12 corp:
1. Company has a security listed on a national exchange. Can be either equity or debt
security. 12(a). OR
2. Class of equity security held by 500 SH of record and more than $10 million in total
assets. 12(g)
Proxy Statement
Info conveyed to SH in this way. Type of info req’d depends on matter set forth for vote.
Has to come WITH solicitation or BEFORE. Guarding against SH making up mind w/o
info. Rule 14a3a
If mgmt is soliciting proxy in connection w/election of directors MUST send an annual report
containing info in 14a.
If corp doesn’t need to solicit proxies, still must provide same info to SH as if proxies HAD
been solicited. § 14 (c)
Shareholder Proposals: Rule 14a-8
Allows SH to raise proposals in mgmt proxy solicitation—piggybacking. Must satisfy
procedural and substantive requirements.
If corp thinks reqs not satisfied, must explain why to SEC in writing w/copy to SH. Burden
is on corp to show proposal is improper. SEC rules on it.
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Procedural Requirements of Proposal
1. An eligible SH. Owner of record or beneficial holder (street name) of 1% or $2,000 in
mkt value of securities. Must have held for at least one year. (Effort to eliminate
crackpots or just buying shares to be annoying.)
2. One proposal allowed to be submitted per mtg.
3. Length of proposal can be no more than 500 words. (Note SEC would not allow “For
more info, see my website.”) Mgmt can write as long as they want in opposition.
Substantive Requirements of Proposal
Rule 14a-8(i). Ways mgmt can exclude a proposal.
1. Improper under state law. Proposal not a proper action for SH under corporate laws of
organization. You would look to MBCA.
Ex: Proposal to amend bylaws to prevent citizens of Arab countries to hold position of
director. SH can initiate bylaw amendment. Qualifications of directors may be prescribed in
bylaw or charter. MBCA 8.02
2. Violation of law. If proposal would cause corp to violate any state, federal, or foreign law
it’s subject to.
3. Violation of proxy rules, including 14a-9 (false/misleading statement)
4. Personal grievance/special interest. Relates to redress/claim against corp that will result in
personal benefit to proponent or to further personal interest not shared by other SH.
5. Relevance. Relates to less than 5% of corp’s total assets, and for less than 5% of net
earnings/gross sales, and is o/wise not significantly related to business. SEE LOVENHEIM.
6. Absence of power/authority.
7. Mgmt function. If proposal deals with ordinary business operations. Sometimes if a
significantly strong public policy interest exists, the proposal make be out of the realm of
ordinary business. Ex: GM and no use of products by slave labor.
8. Relates to election for m/ship on BOD Prevents interference w/election of specific director.
Does NOT prohibit general proposals about election like c-voting, staggered terms.
9. Conflicts w/corp’s proposal directly.
Lovenheim: proposal to study whether forcefeeding used to make paté. Note couldn’t
propose to prohibit b/c cannot dictate what BOD does. Interpretation of the “not o/wise
significantly related to business” test. Does NOT have to be related to business in economic
sense. SH has to show either: economic and/or social significance OR connection to the
corp’s business. Note a very modest/weak connection here.
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Establishing social policy significance. See fn.8, p. 224. Numerous law, SCt has addressed
it, frequent subject of news/editorials.
Note the public policy exception to (7). SEC in flux on these issues. Cracker Barrel flip-
flop: A proposal by institutional investor to prohibit discrimination based on sexual
orientation. NAL by SEC said proposal was about employment practices and policies that
fall w/in (7) ordinary business. SEC eventually backed down and said, some employment
issues will raise significant policy issues. Case-by-case business.
Another example: Y2K was ordinary business, but became an issue of significant social
policy.
Approaching an issue like this: 1) Make sure proxy rules apply (§ 12 corp.); 2) Look to see
if excludable under 14a-8; 3) Make sure it’s a request and not dictating what BOD should
do; 4) Remember burden on co. to show it’s excludable.
US Bancorp NAL: proposal to change to annual voting. Corp argues that not w/in corp
power b/c requires SH approval to amend charter. SEC doesn’t buy this argument.
Corp can be required to give SH opportunity to correct proposal. 14a-8(f)
Used to be all SH proposals would fail, but trend has changed w/rise of institutional
investors.
Fraud/Misleading Statements in Proxies: Rule 14a-9
Protects SH who receive fraudulent info in proxy stmt.
Getting into federal court: liberal discovery, national service of process, uncertainty of
burdens in state fraud actions, lower remedies.
Private Cause of Action
Borak: Vote for a merger. Harm to corp and SH. A private action or DA?
Note if only DA, security for expenses statute would have applied. Requires small SH to
post bond to cover ’s expenses if action is unsuccessful. Meant to prevent frivolous DA.
Enforcement: SEC can sue under 14(a) and 14a-9. Can bring injunction actions and money
damages, § 21 (d). DOJ can bring criminal action under § 32(a).
Ct. recognizes private action in Borak b/c:
1. Protection of investors is purpose of 14a-9
2. Remedy authorized by § 27 (this is no longer a good position since this section
doesn’t say jack about suing anybody)
3. Give effect to statutory purpose—to supplement gov’t enforcement.
Borak is good law w/respect to existence of private action under 14a-9 but BAD LAW
w/respect to test of when to imply an action
Now, private action only implied when some affirmative evidence exists that Congress
WANTED a private cause of action.
Elements of a 14a-9 Action
Fraud in misrepresentation or omission of a material fact.
1. Material misrepresentation or omission
2. State of mind
3. Causation
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Materiality
TSC
TSC settled the debate among the circuits.
Adopted standard: substantial likelihood that a r/able SH would have considered the info
important
Alternate standard: disclosure would have been viewed as altering the “total mix” of info
Focus is NOT on actual . Not enough for to believe it was material.
Virginia Bankshares
Wants to acquire 15% not owned by corp. Didn’t have to solicit proxies but did anyway—
publicity reasons, have to give same info under § 14(c).
Proxy said directors approved plan b/c SH could achieve a high value of stock. Claim is that
directors knew $42/share was a low price and went along w/it to stay on BOD
Opinions CAN be actual, says ct., but question is whether they are actionable standing alone.
Ct. decides that must show:
1. Directors did not believe what they said; and
2. Opinion must be objectively misleading (ex: share price was unfair in fact)
Price must be objectively misleading b/c Ct. is afraid of strike suits, also fear of encroaching
on state law.
NB that Ct. says SH cannot get judicial relief when they have evidence that allows SH to
reach a different conclusion. A case-by-case analysis—not every mixture of true/deceptive
will end up neutral. p. 983
Mendell
An omission case, proxy stmt failed to disclose founding family’s financial pressures that
were behind the quick sale. (2 opinions in this case—2d in light of Va Bankshares)
After VB, Ct. has to consider how much stock was really worth before considering what
family did/did not believe.
Valuation is difficult. Mkt price is a factor, but may not be an efficient mkt
State of Mind
Most circuits follow Gerstle (2d Cir). All that is required is negligence.
VB reserved this question in fn.5—as to whether scienter was necessary
Causation
Mills
Before TSC, claimed alleged omission in proxy—conflict of interest not disclosed. Ct finds
omission material.
Must show causation b/c action rooted in c/l of deceit, and ct. wants to rein in the action by
imposing some limits
7th Cir imposed merger fairness test, if terms were fair, it would be understood to be
approved.
SCt rejects this test. No substitute for an informed SH vote, and concerned that all sorts of
fraud exist that’s not ltd to merger terms.
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SCt’s test: If materiality is found, causation is presumed, so long as solicitation of proxies
was an “essential link” in the transaction.
In this case, solicitation was necessary. Ct. leaves open what happens when there is no need
to solicit proxies (but note this case was sympathetic to SH—not the trend now).
Virginia Bankshares
Comes back to fn.7 in Mills—whether cause can be satisfied when proxy solicitation is not
necessary
’s theories of causation: 1) Directors had to insulate merger under state law; 2)
Solicitation was necessary to maintain good SH relations
Note that Souter starts w/what justifies implying a private right of action. The rule is to
focus on Congressional intent in the statute. Souter’s Corollary: once the right is
recognized, it shouldn’t be expanded beyond Congress’ intent.
has an enormous burden in overcoming that corollary
Theory of causation based on practical necessity of solicitation by s is flat out rejected.
Ct rejects both theories of causation. Too hypothetical to speculate about what directors
would have done w/o SH approval. SH also didn’t show what state action/remedy was lost.
Possible state law claims:
1. Fraud lulled SH into believing merger was okay, resulting in running of the
stat of limit
2. Loss of appraisal rights—a SH unhappy w/merger under state law can get
bought out by corp at ct-determined price if certain reqs met (liking having
voted against the merger)
This case is just trying to establish limits to private action when SH votes not necessary.
Wilson
Corp did not have to solicit proxies but did
SH can’t allege proxies solicited for good relations as causation after VB
SH claim loss of appraisal rights—in VB, Ct. determined this right hadn’t been lost, so no
causation.
Here, was lost, so ct grants remedy of a fair exchange ratio
Would SCt ever grant causation on this remedy of loss of appraisal rights—b/c it’s a state
remedy rarely used.
Approach to these problems:
1. Must be a § 12 company for proxy rules to apply
2. Material misrep or omission. TSC
3. Opinion? Director belief and objective fact of issue. VB
4. State of mind? Gerstle
5. Votes of minority SH necessary? If yes, then Mills. If no, then VB and Wilson.
SH Right to Inspect
If SH wants to propose own slate for election, can’t be done under 14a-8 (b/c relates to an
election). SH has to do own proxy solicitation, using 14a-7 (co will mail proxy materials).
Access to corp records mainly a matter of state law.
Categories of records:
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1. SH list before a mtg. MBCA 7.20
2. Readily inspectable w/5 days notice. MBCA 16.01(e), 16.02(a)
3. Inspectable w/5 days notice and showing. MBCA 16.02(b), (c)
To inspect records of 16.02(b), must make showing req’d under (c). Need good faith and a
proper purpose. Proper purpose means r/ably relevant to demanding SH’s interest as a SH.
Showing a financial interest will look stronger even if demanding based on social policy
interest. Ex: Chevron, SH strengthened social policy about Angola by expressing concern
w/exposure to economic risks.
When we say interest of SH, we mean interest of corp as well. May make a difference as to
whether inspection relates to a DA or direct action.
Cannot take away right to inspect in charter. MBCA 16.02(d)
Many states have c/l rights of access that these provisions don’t eliminate. MBCA
16.02(e)(2)
16
THE BOARD OF DIRECTORS
Background
Manages the company. MBCA 8.01(b)
Day to day mgmt is by the officers b/c:
1. Time constraints—BOD only meets 6-12 times/yr for few hrs and can only act at
mtgs.
2. Officers control the info to the BOD, BOD often meets w/agenda in advance
Functions:
1. Chooses officers in conjunction w/past president, influential investors
2. Advisors/counselors to officers
3. Keep officers in line
4. Decisionmakers in times of crisis
Board Meetings
Hear reports from officers and committees
Specific business of nonroutine nature that officers bring to BOD
Directors are outside and inside, affiliated and unaffiliated
Most BOD have majority unaffiliated outside directors, presumed to be more independent,
effective monitors
Outside Directors
Pro Con
Independence Already have full time jobs
Look at other BOD forcing out presidents Already serving on other BOD
who are doing a bad job
Have their reputations to consider Dependent on officers for info
Social homogeneity breeds efficiency Deferential—golden rule of bdrm that one
good turn deserves another
Want to be renominated
Not socially independent
Concerns about not being great monitors has led to development of strong fiduciary duties to
keep them in line. Largely product of judge-made law
Director’s Duty of Care
Decisions
Business Judgment Rule
Rebuttable presumption that directors made a good decision.
To overcome this presumption, a plaintiff must show that the decision was made
WITHOUT:
1. Illegality
2. Adequate process
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3. Substantive rationality
4. Conflict of interest
Shlensky
Cubs’ night games. SH proposal to have night games to increase profitability. Tries to claim
decision not to was irrational. (Note that this case glosses over decision aspect—decided not
to do something.
Showing irrationality is HARD. But note courts are more likely to find a decision irrational
when a conflict of interest overshadows it.
Could have possibly argued lack of adequate process here, maybe BOD didn’t investigate
into profitability
Dodge v. Ford Motor Co.
Tho. Ford is very successful, decides to pay modest dividends, reduce prices, and expand
plant
challenge on basis that corp being run like a charity
BJR still protects decision here, even tho Ford on the stand creates impression that co is
doing too well and profits should be shared
Litwin
It is possible to overcome BJR
Conflict of interest in this case overshadowing again.
Guaranty bought bonds from Allegheny. A could repurchase for same price w/in 6 mos, so
G had to hold for 6 mos. Whatever happened would be to A’s benefit.
This decision was also an absolute disaster—making ct. more receptive to finding substantive
irrationality. Also, b/c of subejct matter, business transaction that ct. is more comfortable
with. A combo of factors.
Director’s objection. To avoid liability, the director’s dissent must be in the record. MBCA
8.24(d). Must vote against.
Joy v. North
Rationales for the BJR:
1. SH undertake voluntarily the risk of bad business judgment
2. Difficult to reconstruct after the fact and evaluate corporate decisions b/c courts aren’t
business experts
3. Avoid creating overly cautious directors who are afraid to take a risk.
Must show decision caused losses.
Director’s Duty of Care
Omissions
Duty of care also encompasses when BOD has failed to act
Francis
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Director is an alcoholic, bedridden, and almost incompetent, but all directors have to exercise
some minimum of care
Standard of conduct for directors expressed in MBCA 8.30(b)
Failed to carry out duties, so allowed embezzling to happen. Is director liable for the losses?
Conduct was a substantial factor in causing the loss. Test the court uses:
1. If director had performed duties would misconduct have been discovered?
2. If director had discovered it, could it have been prevented?
When the wrongdoing is really bad, courts are quick to assume it could have been prevented.
Burden of proof of causation is on . MBCA 8.31(b). Typically matter of case law. DE has
different approach.
BJR is irrelevant here b/c a complete failure to act.
Hoye v. Meek
Chairman of BOD and president of co, but lived in VT and didn’t preside at mtgs,
occasionally communicated. Son invested in Ginnie Maes (gov’t investment but with
significant interest risk) w/borrowed money.
Bkrcy trustee makes duty of care argument: failure to monitor, to ask questions, pay attn and
ensure a flow of info.
tries to claim son made decisions, semiretired, 11th hour attempt to help.
Causation remains: Very clear would have discovered if fulfilled duties. Something could
have been done. So causation met.
Adequate Process
Smith v. Van Gorkom
Class action seeking recission of merger and damages. Merger was at $55/share (mkt was
$38/share).
Ct. found decision of merger NOT protected by BJR.
Possible conflict of interest hovered here. But mainly lack of adequate process claim based
on:
1. Lack of price inquiry. $55 was at bottom of range calculated. If it was so
great, why didn’t acquiring co try to knock it down? Some kind of valuation
is needed.
2. No review of documents—relied only on oral presentation, which doesn’t
qualify even as a report. Needed to ask questions. Reliance on report must
also be r/able.
3. Timing—one mtg for 2 hrs. Didn’t try to bargain for more time.
Just not much credible evidence that BOD knew what they were doing.
Ct is more intrusive here b/c a cash out merger—SH just get money. A fundamental
decision.
Also possible lack of rationality. Price is most important here—even tho low, w/in range so
tougher case for .
Note that special knowledge of a director could contribute to finding him liable. Can be
judged more strictly in light of knowledge base.
Remand is to determine fair value and award damages for anything over $55/share.
Cede says burden of proving price fair is on . (DE). MBCA 8.31(b) puts burden on .
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Director Exculpation Provisions
Impact of Van Gorkom: about 40 states created exculpation provisions. DE § 102(b)(7) and
MBCA 2.02(b)(4)
Delaware §102(b)(7)
Doesn’t necessarily make Van Gorkom obsolete.
1. Not self-executing—corp must amend charter to have it.
2. Exceptions
3. Applies only to liability for money damages. Does not affect injunctive relief.
Duty of loyalty is not a term of art in this section. Could include a conflict of interest but
may be even broader such as exceeding carelessness, indulgence of directors. Meaning NO
exculpation.
MBCA 2.02(b)(4)
Drafted w/awareness of ambiguities in DE code. Language is much narrower—duty of
loyalty, good faith are not exceptions to exculpation.
Exculpation Provisions
Pro Con
Don’t want directors to be too Not all mkts are efficient to protect
cautious to act SH.
Make other directors unwilling to Voting rights of SH aren’t often
serve. exercised.
Other mechanisms protect SH from
misconduct: EMH, voting rules.
Duty to Monitor for Illegal Activity
When should directors be liable for illegal activity of employees?
Graham v. Allis Chalmers
DA, claiming antitrust violation. ’s theory of liability: notice based on earlier consent
decrees or obligation to create monitoring program to prevent a violation from EVER
happening.
Ct finds no liability. No actual knowledge, no gross negligence to not have a compliance
program in these circumstances.
Directors don’t have to assume employees are bad unless there’s a red flag.
No BJR here b/c no conscious business decision.
Notice
Of illegal activity can take many forms:
1. Info from w/in corp
2. Society in general
3. Legal context in general
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4. Other firms
Compliance
Can also take different forms: legal lectures, manual of rules, audits.
Caremark
Revisits Graham, failure to monitor for violations of ARPL
More notice here, know that law was unsettled and were pretty close to the line, but not
aware of precise activities.
Did have a compliance program, a minimalist one.
Occasion for liability when utter failure to have r/able system in place—w/ or w/o notice.
How far does this case go? We don’t know, and it’s not even a Del. SCt. Case.
Causation
Would monitoring systems have brought violations to light?
Burden on to show under MBCA 8.31(b)(1).
Del. seems to indicate in Caremark that causation may be an AD (in a BJR situation, the
burden would be on , from Van Gorkom)
Corporate Opportunity Doctrine
Forbids diversion of corp opp from corp to individual
Common Law Approach
Factors in determining if a corp opp exists:
1. Use of corporate facilities: using info, personnel, to develop opp
2. Interest/expectancy test: Does corp have a pre-existing r/shiip w/opp? Ex: K in
negotiation, expressed need for opp, expectation that it’s the sort of opp that would be
pursued.
3. Line of business: an alternative to int/exp test in some jds; some jds use both.
Whether the opp is of same general type as that engaged in by corp
4. By virture of position: did director come upon opp in official/unofficial capacity?
5. Incapacity of corp: legally, financially, or practically capable of the transaction? Ex:
financial—maybe opp would be basis for getting credit that corp wouldn’t normally
get. Practical—if someone refused to sell to corp, only to individual. Legal—can
take different forms, like prohibition in charter, ltd. purpose of corp. Less common
today.
Harris case applied.
If corp opp does exist, director must offer to the corp. If BOD rejects, then director can
pursue it.
Rejection must be done w/full disclosure and w/o manipulation.
Few jds say that director cannot pursue it even if BOD does give approval. Concern that
BOD will accommodate directors rather than acting in corp’s best interests.
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ALI Approach
Casebook p. 340
ALI gives definition of corp opp depending on whether person in senior exec
Gives more clarity to c/l factors, and harsher.
See also Broz. Analyze problem under both these approaches.
Interested Director Transactions
MBCA §§ 8.60-8.63
At one time all transactions were banned, but that was too harsh.
Three ways of sanitizing these transactions have developed:
1. Approval by disinterested directors
2. Approval by SH
3. Litigating fairness of it
Definitions
MBCA 8.60
If transaction falls outside definition of coflicting interest transaction, it is NOT
ATTACKABLE.
Definition of ci transaction:
1. Need a transaction. Not applicable if corp REFRAINS from action
2. Transaction involves:
i. a director or related person.
ii. Involves entities w/economic ties to director and must be of enough
significance to be brought before BOD.
Often won’t know if def applies, so it’s best to sanitize
Related person (see definition) test: must be a party to the transaction, has a beneficial
interest in transaction, and r/ably expected to exert an influence on director’s vote.
Shareholder Sanitization
MBCA 8.63(b)
Majority of qualified shares must be cast in favor of transaction.
Director Sanitization
MBCA 8.62
Need approval of majority—but no fewer than 2—of qualified directors.
Comments say even if we have qualified directors, they may vote as an accommodation,
which means no sanitization.
BOD action must comply w/MBCA 8.30(a)—good faith and best interests of corp. Section
doesn’t mention BJR, so not sure we presume in director’s favor.
Fairness to the Corporation
MBCA 8.61(b)(3)
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has to establish that transaction was fair to corp.
Fair defined as what could be achieved by arm’s-length bargaining out on the mkt.
Derivative Actions
Why make it hard to bring one?
1. Usually atty wanting a fee who motivates the SH
2. Whether to sue or not is a mgmt decision
DA law focuses on trying to separate bad suits from good suits:
1. Demand requirement
2. Use of special litigation committee (SLC)
Delaware
Demand Requirement
Aronson (DE)
Demand Futility doctrine—Demand is futile when:
1. Reasonable doubt that directors are disinterested OR
2. Reasonable doubt that transaction prohibited by BJR
Prong 1 looks at whether BOD is sufficiently impartial, prong 2 looks at whether BOD in
making decision to go through w/transaction is entitled to BJR protection
In DE, demand is required UNLESS demand would be futile
cannot make conclusory allegations, must plead w/particularity
tries to claim demand is futile b/c directors don’t want suit where they’ll be s. Ct rejects
this as a bootstrap argument. Generally the fact they’ll be s is irrelevant unless transaction
is so egregious (p. 403)
Majority of the BOD must have a financial interest in the transaction or be beholden to
someone w/financial interest
Directors have a presumption of independence
Prong 2—look to see if BOD decision is not protected by BJR
Rales
Prong 2 doesn’t apply in two situations:
1. Since time of challenged transaction, a majority of the BOD has been replaced
2. Subject of DA is not a business decision by BOD (so of course BJR doesn’t apply).
Ex: inaction (Francis, Allis-Chalmers), corp opp.
Response to Demand
Corporation can:
1. Agree and take over the litigation
2. Use an internal solution that exists
3. Reject lawsuit and try to terminate
If BOD rejects demand, SH can challenge but has to show decision not to sue is outside
protections of BJR
Hard to succeed once demand is rejected, so should SH always fight futility?
1. It’s expensive
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2. Possible dismissal w/prejudice
3. Could end up bearing costs if not r/able
Ex: 11th Cir case—demand rejected and argues no protection under BJR for decision to
terminate. Ct agreed b/c BOD hired law firm who had represented wrongdoers in criminal
proceedings for same transaction to investigate. Lack of adequate info.
Special Litigation Committee
Zapata
Demand excused based on futility. NB before Aronson, so futility was easier to establish.
Original BOD members gone, and 2 new directors appointed to SLC. Problematic b/c
interested directors chose the 2 who are going to pass judgment.
SLC said lawsuit should be dismissed. This happens almost 100% of the time.
2 step process of examining decision of SLC:
1. Ct inquires into good faith, independence, and r/able investigation of SLC. Burden
on corp to show. Worried about structural bias.
If this step not satisfied, corp loses and litigation continues.
If it is satisfied, ct. has discretion to move onto step 2.
2. Ct applies its own business judgment, focusing on corp’s interests and public policy.
Only applies in cases where demand has been excused b/c it would be futile. If demand is
not excused, decision to terminate would be reviewed under BJR standards
.
Tough demand standard, but laxer at SLC stage
Derivative Actions
MBCA
Demand Requirement
MBCA 7.42
Has universal demand requirement—no such thing as demand futility
Can bring lawsuit if corp doesn’t respond to demand w/in 90 days.
Dismissal
MBCA 7.44(e)
Motion for dismissal—the burden of proof depends on whether a majority of directors were
independent at time committee acted
If BOD found to be independent, has burden to show didn’t meet MBCA 7.44(a)
If BOD found not independent, has burden of proof showing MBCA 7.44(a) was met
Comparison of Zapata to MBCA 7.44(a)
Zapata MBCA 7.44
SLC has to do investigation and Requires only r/able inquiry
written record
24
Zapata MBCA 7.44
Ct. looks at r/ableness of conclusions Ct. looks at whether conclusions follow
from inquiry
Ct. can consider public policy in step Only addresses best interests of corp.
2 of test.
has limited right to discovery does NOT have right to discovery.
OTHER BUSINESS FORMS
Comparison to the Corporation
Partnership Limited Partnership Limited Liability Co.
Formation No formalities, just 2 or 1 general partner and at Formed by filing
more people who share least one limited partner. w/state.
the profits and control Has formal requirements
like corp.
Management Treats all partners as Cannot control business. Members manage unless
owners and mgrs. All o/wise provided.
have equal rights to
manage, act on behalf,
incur obligations. No
formal requirements.
Liability Personal liability for Limited liability for Limited liability like
debts of p/ship limited partners. corp. Fiduciary duties,
piercing the veil apply.
Transferability Cannot sell interest. To Limited partner can sell
admit new partners, interest.
others must agree
Continuity Can be abruptly and
easily dissolved
Tax Not a separate taxable Favorable tax trmt of the
entity, partner’s income p/ship.
tax rate is used.
25
CLOSE CORPORATIONS
Features
1. Small number of SH. No precise number representing a cut-off. Some statutes cap, but no
cap in general.
2. SH actively involved in mgmt. No separation of o/ship and control. Well-informed about
business, so less concern over monitoring. But also so involved that they have most of their
$ tied up in it. Very vulnerable to what other SH might do.
3. No public mkt for shares. No discipline exerted over directors/officers by mkt. Makes it
very difficult to sell.
Legislative Response to Protect Shareholders in Close Corporations
1. No special treatment, just make it more liberal for everyone.
2. Add few provisions that apply to CCs only (MBCA 7.32 is an example).
3. Provide special CCs statutes that can be incorporated under (Del §341 is an example.)
Shareholder Agreements
1. Voting agmts under MBCA 7.31. Not ltd to CCs, but has to be in writing.
2. 8.01(b)—applicable to any corp, limit on BOD authority in charter. 7.32 limited to CCs,
must be unanimous, limit on BOD authority.
3. C/L may also apply where MBCA doesn’t.
McQuade
Agmt that min SH would be directors and officers at specific salaries.
Ct has no problem w/promise to get elected as directors b/c doesn’t upset a corp norm, but
impinges on BOD authority to guarantee them as officers.
MBCA 7.31 authorizes agmts like this
Clark
Guarantee of ¼ of net income, named as general mgr
This agmt was unanimous, all SH agreed. Ct also relied on language that req’d director to be
faithful, efficient and competent.
Much more deferential.
When not unanimous agmt and significant change from corp norm—invalid agmt. McQuade.
When unanimous, slight impingement, little variation from norm—valid agmt. Clark.
Zion v. Kurtz
Any business decision requires Zion’s consent, impinges on BOD authority. Kurtz violates
agmt.
Under Del law, could have provided in charter for this, or could have incorporated under CCs
statute
Compliance w/statutory requirements may not be insisted upon when no one’s hurt, agmt
is unanimous.
Under the MBCA 7.32(b)(1)(B), would have to have a writing to which ALL SH agree
26
MBCA 7.32 Shareholder Agreements
Can run roughshod over other MBCA provisions—can override them. Gives flexibility to
CCs.
Outer limits—subject to public policy limitations
Must be in writing and signed.
Blount
Need to draft agmts carefully. Agmt ends up being included as bylaw.
Ct says it’s a bylaw and subject to § 4 of charter—need unanimity.
When in doubt, SH agmts read in a way that allow for change.
BJR in Close Corporations
Zidell
wants a higher dividend
BJR protects decision regarding dividend amt.
Ct not concerned w/a failure to inform here b/c a CCs and all directors involved in day to day
operations.
Plausible evidence of future need for cash that cut in favor of
Wilkes
Business run as p/ship but incorporated over concern for unlimited liability
Fired Wilkes—no salary and did not pay dividends, so got no return on investment.
Other SH obviously interested in forcing Wilkes to sell his shares at substantially reduced
price
Ct announces new standard to make it easier for SH to challenge BOD conduct:
1. must show (majority) that there’s a legit business objective
2. can win by showing a less harmful alternative that could have been adopted.
Recovery ordered: salary would have received if stayed w/corp. Money comes from other
SH on theory of unjust enrichment.
How could this be avoided? Good employment K, SH agmt setting forth salary, dividend,
r/ship b/w them, a buy/sell repurchase agmt.
Not every jd accepts this case. This case differs from Zidell in terms of egregiousness.
Dissolution in Close Corporations
Voluntary Dissolution
MBCA 14.02
For any corporation
Requires vote by BOD and SH. Majority.
Judicial Dissolution
MBCA 14.30(2)
SH petitions for dissolution based on:
1. Director deadlock
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2. SH deadlock
3. Oppression. Defined by cts in 3 ways: burdensome, harsh, wrongful conduct; breach
of fiduciary duty of good faith and fair dealing (Wilkes); frustration of r/able
expectations of SH.
4. Waste
Ct instructed to limit this remedy to situations of genuine abuse. Ct may dissolve, in its
discretion.
Only remedy provided is dissolution. Some cts don’t feel bound by this language and will
order a buyout instead. Even w/o MBCA 14.34 on the books
Shareholder Buyout
MBCA 14.34
Buyout of SH who petitions for dissolution
Filing requirements:
1. Close corporation
2. Already petitioned under MBCA 14.30(2)
3. Filing under 14.34 CANNOT be by same SH who filed petition under 14.30(2) or by
corp itself
Intended effect is to prevent SH from using 14.30(2) as a threat
NB a minority SH who has veto power under SH agmt owes a fiduciary duty to other SH
NOT to use veto power for oppressive purposes.
Das treated as direct action in CCs context.
Share Transfer Restrictions
MBCA 6.27 upholds r/able restrictions
Concord
Agmt to repurchase shares at SH’s death
Admin of estate refuses to tender shares b/c price is too low. Set by agmt. Estate claims
parties intended to review and adjust set price each year. Failure to do so is breach.
Ct enforces K as written, strict view of its role.
Parties could have vetoed any change, also, purchase price would be funded by life ins
policies—would create an unfunded obligation if ct upped purchase price.
Gallagher
Fired w/agmt buyback—upon terminaton will buy shares back. Two different values—book
before certain date, tied to earnings after date. Fired before date so book value.
claims bad faith termination.
Ct would be unwilling to apply Wilkes here, different facts.
Pedro
Resembles Wilkes, a pattern of abuses. Fired.
K kicks in upon death or desire to sell.
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NB that Ks are not read more widely than necessary especially since already contravening a
corp norm.
Withdrawing SH—suggests voluntariness. Look for this language—what if it appeared in a
termination claim?
If K doesn’t apply, try to see if more like Wilkes or Gallagher?
ALLOCATING CREDITOR RISK: PIERCING THE VEIL
Creditor Protection
Delaware
Par value in charter was once to indicate at what price shares would be sold
Today’s function of par value:
1. Floor set forth in charter below which issuing price CANNOT fall (typically set very
low)
2. Determining amt of money available to pay out dividends.
Capital account: combined par value of all shares issued
Surplus account: anything above that.
Example: 10 shares set in charter @ par of $10 = $100. 10 shares sold @ par of $100 =
$1,000. Means $900 in surplus.
Capital CANNOT be distributed except on dissolution.
Surplus is issued to SH.
Dividends come from surplus or recent profits. § 170.
MBCA
Doesn’t really protect creditors.
Directors can set price however they want. MBCA 6.21
Dividends can be issued as long as doing so doesn’t put corp in either of 2 situations under
MBCA 6.40:
1. Equity insolvency: judgment call that corp, if issued dividend, could not pay its bills.
2. Balance sheet insolvency: liabilities exceed the assets.
If BOD violates 6.40, cause of action can be brought against directors under MBCA 8.33.
Directors have BJR protection. Not a great remedy b/c :
1. Action belongs to the corp (could bring a DA w/difficulty)
2. Nothing gives creditor any standing
Creditors can protect themselves: get a letter of credit, higher interest rate, guaranty.
Piercing the Veil
Normally only SH risk the money they invest, but limited liability can give way
Lots of case law in this area b/c corp codes don’t do a lot to protect creditors
Ability to predict outcomes is limited
Potentially can apply to any corp, but no public corporation has ever been pierced.
29
Contract Cases
Where creditor had contract w/corp
Olsen
Factor ct looks at in piercing is failure to comply w/corp formalities. Most were followed
here.
Formalities a ct will look at:
1. Commingling of funds? Can mislead creditor into thinking all money belongs to
corp. Shows not treating as a separate entity.
2. Issuance of stock? Worry about undercap.
3. Holding meetings? Possible evidence of a sham corp, suggestive of bad faith.
4. Undercapitalization? Measured from the formation of the corp. O/wise might be
holding SH responsible for plain old bad luck. Undercap from the start looks like bad
faith in formation.
No undercap here--$7,000 sufficient consdering ltd scope of business. Has to be pretty
extreme.
Here, there was an opp to investigate, and a continuing loan of money even tho knew about
delinquent bills.
No question of illegal dividends here—look for that.
Piercing can be a shortcut for righting wrongful action (like illegal dividend w/the not so
great remedy under 8.33)
KC Roofing
Two types of fraud involved:
1. Intent not to pay debt to unsecured creditors.
2. Reincorporation w/virtually same business.
Veil is only pierced here to the SH responsible for wrongdoing—the one in control.
Tort Cases
Western Rock
Piercing here reaches Strouds and another corp. Ct also pierces that corp.
Willing to pierce here b/c intentionally created damage that KNEW corp could not pay.
Knew about damage, knew insurance didn’t apply, knew no property could be attached b/c
none owned by corp.
Resembles On Top Roofing
Piercing in tort cases is often analogous to a fiduciary duty—strengthens the case for
piercing.
Assume that corp was bankrupt and trustee is appointed to bring the claims for corp for the
benefit of creditors.
Trustee could bring fiduciary duty claim against two s here—an egregious substantive
decision to continue to cause damage. Overcomes BJR.
Piercing here can be a shortcut to enforcing fiduciary duties.
If a trustee could bring a claim then piercing is likely.
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Baatz
injured by judgment proof drunk who was drinking at Arrow Bar—who continued to serve
him. Misdemeanor to serve obviously drunk person. A private right of action implied.
No insurance for bar here b/c statute was retroactive. Did not know at time of formation of
this kind of liability or at time of accident.
Pay attn to degrees of intentional misuse of the corporate form
Possible fiduciary duty claims: failure to monitor employees(Allis-Chalmers). Need to have
notice of a problem—some red flags to ensure a compliance program.
Craig
English corp involved here, but looking at state law b/c that’s where tort took place. Cts split
on whether to apply where tortious act took place or internal affairs doctrine.
Differs here b/c trying to treat 2 corps as one before trying to pierce to get to SH. Enterprise
liability.
A public corp here
Some cts more comfortable w/treating parent and sub as one than piercing corp to reach SH.
For enterprise liability, need:
1. Widespread intertwining b/w 2 corps—overlap
2. A wrong
Can’t be the typical kind of intertwining b/w parent and sub.
SECURITIES FRAUD AND INSIDER TRADING
§ 10(b) and Rule 10b-5
Most widely litigated provisions in securities law
When drafted thought to only apply to gov’t actions (SEC or DOJ)
In 1940s, cts began recognizing implied rights of action.
Bankers Life, accepted implied private right of action in 10(b)
Applies universally—NOT ltd to § 12 companies.
Two basic uses:
1. A fraud in connection w/purchase or sale of securities
2. Remedy for insider trading
Securities Fraud
Requirements
1. Need a purchaser or seller
2. Need omission or misrepresentation of a material fact.
3. Scienter
4. Loss causation
5. Reliance/transaction causation
Purchaser/Seller
Blue Chip Stamps
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s claim prospectus was overly pessimistic, in a deliberate attempt to discourage purchase
Issue is standing. If they did not purchase, can they sue for fraud?
Analysis here anchored in policies thought important at adoption of 1934 Act—
discouragement of strike suits, frivolous litigation.
Ct institutes a Purchaser/Seller Requirement. Upholds a much earlier case, Birnbaum.
Why require to be a p/s?
1. Anyone could say they would have bought/sold if hadn’t been defrauded
2. Effect on business
Chose this case b/c facts are very sympathetic to the s—making clear that no one should be
quick to make an exception to the p/s requirement.
Before, used to be an exception if was only seeking injunctive relief. Now, cases go both
ways.
Material Fact
10(b) encompasses “manipulative” or “deceptive” devices—so that presupposes that fact
must be material.
Basic
Denied involvement in merger negotiations when it was
Adopts for purposes of 10b-5 the same standard in 14a-9: substantial likelihood that
r/able SH would find info important. TSC. Also the alternate significant alteration of the
“total mix” of info.
Note also the special status of mergers—need for add’l guidance in finding materiality. Ct
adopts probability that event will occur and magnitude of event.
Rejects agmt in principle test—and s prefer the prob/mag test b/c can find materiality
before agmt in principle would ever be reached.
Prob/mag test only applicable in mergers or in all contingent events? Ct reserves question in
fn.9. potentially applicable to 14a-9 too.
State of Mind--Scienter
Ernst & Ernst
Induced to invest based on representation of high rate of return. Corp went bkrpt. Sue
accountants for aiding and abetting fraud by failing to discover the “Mail Rule” (president
was the ONLY one allowed to open mail).
Didn’t decide here if cause of action for aiding and abetting exists. In Central Bank, there is
NO aiding and abetting liability under 10b-5.
Decided negligence is not enough under 10b-5—relying on language and history of statute.
A result-oriented opinion here.
Language of opinion suggests actual intent required. Fn.12 holds open possibility that
recklessness MAY be enough.
Virtually every circuit has said recklessness IS enough.
Reliance/Transaction Causation
Only relevant as to private actions—comes from c/l as means of restraint on private action.
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Did fraud cause the transaction? Distinguish from loss causation—did fraud cause ’s
loss of money?
Ex: Joe invests in corp that owns a boat, relying on capacity boat had. (That was a lie.)
Told boat had insurance. (That was true.) The boat sinks. No loss causation b/c fraud not
related to boat’s insurance.
MUST prove loss causation—b/c could just be the mkt, economy. Need a link b/w ’s
conduct and loss of money.
Link b/w ’s fraud and ’s decision to buy or sell. Cts are forgiving about this—have
established presumptions that aid in the showing.
Affiliated Ute
Presumption of reliance when an omission is the basis of fraud.
When fraud is nondisclosure, presumed relied on nondisclosure in making trade.
Too hard to show relied on something not there.
Basic
“Not involved w/merger negotiations.” A misrepresentation, so Affiliate Ute doesn’t apply.
Ct recognizes fraud on the market theory. Facilitates class actions (each doesn’t have to
show reliance) and in accord w/EMH.
Justification of presumption of reliance—investor invests assuming price of stock is fairly set
and not contaminated by fraud.
Rebuttal options for :
1. Market makers were privy to the truth, so market price wasn’t affected. The market
wasn’t fooled.
2. News credibly entered that dissipated the effect of misrepresentations.
Here, fraud was cured by news of merger—market fooled but got its bearings quickly
When is this presumption available? Cts are split:
1. If publicly traded, assumed to be an efficient mkt
2. must show that mkt is efficient
A battle of the experts on this will occur
Possible application of VB—opinions and motives under 14-9 may also apply in 10b-5.
Insider Trading
Primary source of regulation of insider trading is 10(b)—cts have read into a prohibition that
really isn’t there. Only other option was § 16(b) which was wholly inadequate.
Cts developed the disclose or abstain rule—and insider msut disclose the info to everyone
in the whole world OR refrain from tipping or trading on it.
Question becomes who is subject to the DOA rule?
1. Insiders
2. Tippees
3. Temporary insiders
Who Must Disclose or Abstain
Chiarella
Financial printer figured out who was being taken over
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Had material info and did benefit from it, but NO liability b/c:
1. Not an insider in corp so no fiduciary duty
2. Mere possession of inside info doesn’t make him liable
Dirks
Analyst who finds out about and investigates fraud after being told about it by former VP.
Tells clients of investigation and they trade on this info
Not an insider so NOT subject to DOA rule. SEC tries to claim b/c had inside info he
inherits the DOA requirements.
SCt ruled out that kind of liability in Chiarella, decides some tippees are free to trade on info
and some are not
For a tippee to be liable:
1. Need a breach of fiduciary duty by TIPPER
2. Tippee must know or constructively know of breach by tipper.
Liability is derivative of the tipper
What is a breach of fiduciary duty for this to work? Tip for cash, for gift, for quid pro quo.
NO LIABILITY for duty of care violation—as in a tipper who is just careless in
conversation.
Breach that counts is one that is for personal benefit. Policy behind this is the need for
efficient markets—if afraid of liability, won’t talk to analysts, so market gets no info and
isn’t efficient
not found liable here b/c the tipper (Secrist) did not get a personal benefit from giving
info—only a possible reputational benefit, but no evidence in record here.
An additional basis of liability recognized in fn.14—Temporary Insiders: outside lawyers,
accountants, etc. given confidential info for corporate purposes.
Elements
1. Info must be material (same definition as TSC)
2. must act w/scienter
3. must be a purchaser/seller for private action
4. Reliance/transaction causation—if had acted legally, would still have bought or sold? If
yes, no reliance. If no, reliance. But hard to think about what would have done when
has 2 legal options (disclose or abstain). Cts came up w/new requirement:
Contemporaneous traders—who traded at the same time the insiders traded but in the
other direction.
Misappropriation of Information
First put forward in Chiarella, but not adequately presented
O’Hagan
A partner in firm representing a bidder in a takeover. Buys stock in target of takeover and
profits around $4 million.
Not liable as insider b/c NOT an insider of company he traded in, not a temporary insider b/c
didn’t represent the company he traded in. Not liable as a tippee b/c learned of info w/o a
breach by insider of target company.
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Note if he had worked for firm representing target, would have been liable under temporary
insider.
Misappropriation theory closes the gap here.
Liability for misappropriation when
1. R/ship of trust and confidence exists
2. Theft of info from that r/ship
Securities laws now protecting r/ships wholly outside the trading context
New SEC rule10b5-2 clarifies the definition of r/ship of trust and confidence
Rule 10b5-2
Clarifies when a r/ship of trust and confidence exists:
1. When an express agmt exists to maintain the info in confidence
2. A history, pattern, practice of sharing confidences. This one is ambiguous b/c think
of the psychiatrist/patient example. Revealing info relating to trading may be very
different from other info revealed in confidence.
3. Rebuttable presumption of confidence when confiding in spouse, parent, child,
sibling
Sub-tippees in a chain—need to have enough infor to arouse suspicions that a wrong was
committed somewhere. Like Prob. 11-7, p. 1172. Case law is not well developed on this.
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