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Taxation of Llcs, Llps, Lps


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I.    Background
      A. Fowler v. Penn Tire
            1. Fowler is trustee in bankruptcy and contends that contract was a sales contract, not a
            2. Express language of contract indicated that title remained in Penn tire, but P argues course
            of performance indicates otherwise
            3. Martin failed to segregate tires; was liable for taxes; and paid inventory financing charge.
            4. Court held express language of contract govern
            5. Today under UCC, seller would have to file financing statement with the Secretary of
            State to notify other creditors of security interest
            6. Planning Issues: Sell to retailer, Set up company store, or consign
            7. Selling to retailer is less flexible if mkt conditions change; Contract Issues: Price,
            Quantity, Duration, Svc & Warranty, Indemnification
            8. Company Store requires more investment and active interest; Issues: Locations, Number
            of Stores, Employee incentives and salaries
            9. Consignment has less risk and so higher distribution

II.   Agency and Fiduciary Obligation
      A. An agent is a person who by mutual assent acts on behalf of another and subject to another‟s
      control. (R2 of Agency § 1)
              1. Elements establishing agency:
                       a. manifestation by the principal that the agent shall act for him
                       b. agent‟s acceptance of the undertaking
                       c. understanding of parties that the principal shall be in control
              2. Parties do not have to intend legal consequences of their actions
              3. Master/Servant vs. Independent Contractor
                       a. In M/S, master has control over physical conduct, manner and means; see R2 of
                       Agency § 220, p23.
                       b. In IC relationship, principal has control over objectives; not all IC‟s are agents
                       c. Humble Oil- Ct found M/S relationship b/c the oil company dictated the hours of
                       operation and gave a break on rent for selling Humble pdts
                       d. Hoover- Sunoco had a lot of influence, but agent determined his hours, assume
                       profit or loss risk, hired his employees, and had his name posted as proprietor
      B. Tort Liability
              1. General rule is master is liable for torts of servant committed in scope of employment
              (respondeat superior); frolic doesn‟t count
              2. Principals are generally not liable for torts of Independent Contractors
              3. Exception: if principal holds IC out as his servant, he may be liable in tort see Gizzi v.
      C. Liability of Principal to Third Person
              1. If the harm is not physical but injury to emotions or pocketbook, the principal is liable if
              the agent had actual, apparent, or inherent authority, OR was an agent by estoppel, OR if
              the principal ratified the act or transaction.
                       a. Actual Authority may be either express or implied. Implied actual authority when
                       agent‟s actions are necessary to complete principal‟s objectives.
                       b. Apparent Authority
                                1) Agent can bind principal to contracts with 3rd person when the principal
                                has made manifestations to the 3rd person that the agent has this power.
                                2) Must be reasonable for 3rd person to believe agent has authority

                        3) Lind v Schenley- VP told Lind to ask NY sales manager about salary, thus
                        court found NY manager had apparent authority to grant salary. Salary
                        seemed unreasonably large, but court held for Schenley anyway
               c. Agency by Estoppel
                        1) Principal allows 3rd party to rely/change position by intentionally or
                        carelessly causing such a belief OR by failing to notify 3rd party of mistaken
                        belief when principal has knowledge of such a belief.
                        2) Ratification is very similar but relates to a retroactive approval of the
                        agent‟s actions.
               d. Inherent Authority
                        1) Hu classifies as a miscellaneous grab bag to account for situations where it
                        is unfair to allow the principal to escape liability
                        2) R2 Agency 194- an undisclosed principal is liable for acts of an agent
                        done on his account if usual or necessary in such transactions (even though
                        forbidden by the principal.
                        3) R2 Agency 195- an undisclosed principal who entrusts an agent with the
                        management of his business is subject to liability to 3rd persons with whom
                        the agent enters into transactions usual in such business and on the
                        principal‟s account, although contrary to the principal‟s directions
                        4) Watteau- former pub owner had no actual authority to buy cigars on behalf
                        of the principal, but did so anyway on credit. Creditor sued principal. Court
                        found inherent authority (although transaction was not on principal‟s
                                 a) Policy argument against liability- Creditor could have checked or
                                 asked for cash. Creditor also made sale based on manager‟s credit,
                                 not the credit of the undisclosed principal- therefore windfall
                                 b) Policy for- Creditor was relying on credit of business not
                                 manager‟s personal credit. Seller‟s should not have to check into
                                 every transaction. Creates incentive for Principal‟s to choose good
D. Fiduciary Obligations
       1. Agency Costs
               a. If principal and agent are both utility maximizers, there is reason to believe that
               the agent will not always act in the principal‟s best interests
               b. Monitoring Expenditures- cost of measures taken by principal to ensure that the
               agent is acting in his best interest
               c. Bonding Costs- resources spent by agent to ensure he will not take actions that
               will harm the principal
               d. Monitoring Expenditures, Bonding Costs, and Residual loss make up the Agency
       2. Rules
               a. Unless otherwise agreed, the agent has a duty to act solely for the benefit of the
               principal in all matters connected with his agency (R2 Agency 387)
               b. Unless otherwise agreed, the agent has a duty to give to the principal any profits
               realized in connection with transactions conducted by him for the principal, even if
               the agent did not harm the principal (R2 Agency 388)
               c. Agent has duty not to use confidential information acquired as a result of his
               agency for the principal; even after the agency ends (R2 Agency 395)
               d. Unless otherwise agreed, agent has duty not to compete with principal concerning
               the subject matter of his agency (R2 Agency 393)

                      e. Unless otherwise agreed, while agent can compete with principal after the agency
                      has ended, he can only use general information concerning the method of business
                      and the names of customers retained in memory (R2 Agency 396)
               3. Cases
                      a. Bancroft-Whitney v. Glen- Bender Co. raid on Bancroft-Whitney. D recruited
                      employees from BW before departure. D used sensitive salary information and
                      mislead BW about competitor‟s raid. Court said this was a breach of duty of loyalty.
                      b. Town & Country v. Newberry- D left housecleaning business and started his own,
                      targeting customers of his former employer. Court said breach of duty of loyalty,
                      although does not meet standard of Corroon.
                      c. Corroon & Black-Rutters v. Hosch- D, insurance agent, quit and took client lists.
                      Issue is whether client list was a trade secret. Court held no. Restatement Factors:
                               1) The extent to which the info is known outside of the business
                               2) The extent to which it is known by employees and others involved in the
                               business (files were very accessible in this case)
                               3) The extent of the measures taken to guard the information
                               4) The value of the info to P and his competitors
                               5) The amount of money expended by P developing the information
                               6) The ease or difficulty with which the information could be properly
                               acquired by others.
                               Note: For (4) and (5) court attached significance to the fact that the
                               information was compiled in the normal course of business

III.   Accounting Matters
       A. Basic Equation: Assets = Liabilities + Net Worth
       B. Double Entry Bookkeeping
               1. For every change, there must be a corresponding change to ensure the basic equation
               remains the same
               2. Examples
                       a. Increase in Assets offset with increase in Liabilities OR N.W.
                       b. Increase in Assets offset with a decrease in another Asset
               3. Net income is typically added to Net Worth
       C. Balance Sheet represents a snap shot in time
               1. Current Assets= liquid like cash, securities, inventory
               2. Current Liabilities are due within one year
       D. Income Statement covers a period of time (quarter/year)
       E. Statement of Changes in Financial Position shows changes in working capital

I.     Organizational Issues
       A. Management- who runs the enterprise and makes business decisions
       B. Finance- How will start up costs be financed? Initial v. subsequent contributions. Capital and
       Human Capital
       C. Duration
       D. Risk and Return- how will these be allocated among participants
       E. Ownership
       F. Benefits of Written and Oral Agreement
              1. Written has evidentiary value and imposes discipline to negotiate terms that you might
              forget about in an oral agreement, like departure of partners
              2. Oral may be easier to amend, shows trust, and has lower transaction costs.

II.    Formation and Legal Nature of Partnerships
       A. Partnerships are governed by UPA and RUPA
              1. Aggregate v. Entity (minor issue)
                       a. UPA tends to take more of an aggregate view, while RUPA takes more of an
                       entity view (i.e p/s can be sued as an entity)
                       b. Tax treatment is more like aggregate, as p/s is a pass-through entity
                       c. Most states treat like an entity, allowing p/s to sue or be sued in its name and
                       allowing title to property to be held by p/s
                       d. For diversity purposes, p/s treated like an aggregate, so if a partner is from the
                       same state as a plaintiff, diversity is destroyed.
              2. Despite taking an entity perspective sometimes, most states still use the UPA
              3. UPA/RUPA are default rules, for the most part, that can be contracted around
       B. Formation of Partnerships
              1. Four elements of a partnership (UPA 6; RUPA 202)
                       a. An association (voluntary agreement)
                       b. Of two or more persons (including individuals, partnerships, corporations,etc)
                       c. To carry on as co-owners (share P/L and control)
                       d. A business for profit (charitable organizations and trade associations probably do
                       not count.
              2. A partnership does not require a written agreement. Look at facts and circumstances to
              determine the existence of a p/s.
              3. Profit sharing is prima facie evidence that someone is a partner (UPA 7(4)). However,
              there may be a different result if profits were received in payment
                       a. For a debt by installments or otherwise
                       b. As wages to an employee or rent to a landlord
                       c. As an annuity to a widow or representative of a deceased partner
                       d. As interest on a loan, even if the payments vary in amount with the profits of the
                       business (RUPA exempts present/future ownership of the collateral AND rights to
                       income, proceeds, or increases in value derived from the collateral.
                       e. As consideration for sale of goodwill of a business or other property
              4. After profit sharing, courts look to control to determine whether someone is a partner
                       a. Martin v. Peyton- Defendant lent securities to the p/s on condition that he retains
                       some control over the business, including veto power over speculative endeavors.
                       Court found he was not a partner.
                                 1) veto power and other controls were normal controls that any lender would
                                 want over a borrower
                                 2) Defendant did not share in losses
                                 3) Defendant had a contractual option to become a partner and refused.
                       b. Hu: Given the riskiness of the loan and the amount of control, court could have
                       gone either way.
                       c. Lesson: retaining too much control over borrowers could lead to unwanted
                       liability, although it did not happen in this case.

III.   Operation of Partnerships
       A. Management and Authority
              1. Unless otherwise agreed, partners have equal rights in the management and conduct of the
              partnership business (UPA 18(e); RUPA 401(f)).
              2. Unless otherwise agreed, ordinary matters of the partnership are decided according to
              majority vote, while acts in contravention of any agreement must have a unanimous vote.
              3. Unanimity is also required for any action which would make it impossible to carry on the
              ordinary business of the p/s.
              4. Consent of all partners is required to let a new partner into the p/s

       5. Minorities should try to argue implied agreements or extraordinary matters.
       6. A partner is an agent of the partnership
       7. Cases
               a. Summer v. Dooley- In a trash collecting p/s, one partner wanted to hire an
               additional employee, while the other did not. The objecting partner cannot be held
               liable for expense of additional employee. (no majority)
               b. Nat‟l Biscuit v. Stroud- 1 partner wants to discontinue buying bread for the
               business, the other buys anyway. Bread buyer wins. Court said no majority. Also,
               consider that discontinuing the purchase of bread may make it impossible to carry on
               the ordinary business of the p/s.
               c. Racehorse Case- Trainer wants to rest injured horse, but two investors want to
               race him anyway.
                        1) Trainer should argue implied agreement to vest management authority
                        with him OR that the decision was an extraordinary business decision
                        2) Possible sources of dispute
                                 a) Different investment horizons
                                 b) Different risk profiles
                                 c) Plain wealth difference
                                 d) Trainer has reputation at stake
               d. Burns v. Gonzalez- court held p/s not bound b/c the act was not “apparently
               carrying on” the business of the p/s in a way that other similar firms transact business
B. Capital Accounts, Draws, and Related Matters
       1. Capital Account = Account that tracks the cash/capital contributions of each partner
       2. Draws = Distributions to partners based on expected profits
               a. Draws count against profits to be received at the end of the year
               b. Draws reduce capital accounts by the amount of the draw
       3. Indemnification and Contribution
               a. Indemnification is a partnership liability. A partner is entitled to indemnification
               from the partnership if he pays a partnership obligation in full or pays more than his
               b. Contribution is an obligation of a partner. Partners may be obligated to make
               contribution to the p/s to fund a p/s obligation to indemnify a partner.
       4. Tort and Contractual liability of partners
               a. UPA regime (UPA 15)
                        1) All partners are liable jointly and severally for any obligation chargeable
                        to the p/s under UPA 13 (torts in ordinary course of business) and UPA 14
                        (breach of trust/ misapplication of funds)
                                 a) Injured person can sue one partner or any combination of partners
                                 for the whole amount
                                 b) Sued partners would then have to seek contribution from other
                        2) Partners are liable jointly for all other debts and obligations (contracts)
                                 a) Injured person must sue all partners to recover the whole amount
                                 of the injury for acts not covered by UPA 13/14.
               b. RUPA regime
                        1) Under RUPA 305-307, all liability is joint and several, so you must go
                        after the p/s assets first, then partners individually. This reflects the RUPA‟s
                        entity perspective.
                        2) P/S can sue and be sued in the name of the p/s
                        3) A judgment against the p/s cannot be enforced against an individual
                        partner unless there is also a judgment against him (RUPA 307(c)(d))

C. Partner‟s Duty of Loyalty
       1. UPA
               a. Partner must account to the p/s for profits derived by him without the consent of
               the other partners for transactions connected with the p/s (UPA 21(1))
               b. A partner has a right to sue for an accounting in the following situations. Note:
               suits for accounting are uncommon. They usually indicate distrust, and thus partners
               prefer to sue for dissolution.
                        1) He is wrongfully excluded from the business
                        2) The right to sue is granted in the p/s agreement
                        3) For appropriation of unauthorized benefit
                        4) Other circumstances render it just and reasonable
               c. Meinhard v. Salmon- P and D are in a p/s to lease commercial space from L.
               When the original lease expires, L wants to lease the whole block for development.
               D signs a lease with L without notifying P of the opportunity.
                        1) The court held that D violated his duty of loyalty by not disclosing the
                        2) Cardozo says that partners owe each other “the duty of finest loyalty.”
                        3) The issue is whether the opportunity was a p/s opportunity, and b/c of
                        close nexus b/n p/s and new opportunity the court said yes.
                        4) Court considered following in determining that there was a nexus:
                                 a) Distance/geography
                                 b) The kind of business/subject matter/property of the lease
                                 c) The ability of the other partner to partake of the opportunity
                                 d) Is the new opportunity a direct result of being in p/s?
                                 e) Does the new opportunity have an effect on the existing p/s?
                        5) This case stands for the idea that technicalities don‟t matter. Partners owe
                        each other “honor most sensitive.” If judge starts mentioning Meinhard,
                        you‟re screwed.
       2. RUPA
               a. Very different from the UPA, allowing more freedom to negotiate standards of
               behavior (RUPA 103)
               b. Duties of good faith and fair dealing and loyalty cannot be eliminated, but the
               partners can define these terms by agreement, so long as they are not manifestly
               c. RUPA 404
                        1) Only fiduciary duties are loyalty and care; this retains bulk of case law by
                        using “fiduciary.”
                        2) RUPA 301- partners are still agents
                        3) RUPA 104 case law supplements statute, unless displaced
       3. Joint Ventures
               a. JVs usually used for more defined purpose
               b. Some authorities say JVs generally governed by p/s law
               c. RUPA 202 – JVs are p/s if they otherwise fit the definition.
D. Duration and Transferability
       1. UPA Dissolution and Winding Up
               a. Dissolution Defined (UPA 29)
                        1) Dissolution occurs when a partner ceases to be associated with the p/s
                        2) Relates to the characters involved, not the actual business
               b. Effect of Dissolution
                        1) P/S is not terminated when dissolution occurs (UPA 30)
                        2) The business continues until p/s is wound up (UPA 30)

          3) There is a presumption that the p/s will wind up and terminate, unless all
          of the partners, who have not wrongfully caused dissolution, agree to
          continue the business (UPA 38(2)(b); see below
c.   Causes of Dissolution Not Violating P/S Agreement (UPA 31(1))
          1) Term of p/s specified in agreement expires
          2) By express will of any partner in a p/s at will
          3) By express will of all partners in a p/s for a specified term
          4) By expulsion of a partner in accordance w/ p/s agreement
          5) Death of a partner
d.   Causes of Dissolution in Contravention of P/S Agreement (UPA 31(2))
          1) A partner always has the right to cause dissolution, but he may be
          answerable in damages
          2) This includes causing dissolution before the end of a specified term or
          otherwise causing dissolution in violation of the p/s agreement
e.   Dissolution by Decree of Court (UPA 32)
          1) A partner may apply to a court for dissolution
          2) A court shall decree dissolution when:
                   a) Partner is declared a lunatic
                   b) Partner is incapable of performing his duties to p/s
                   c) Partner has engaged in conduct prejudicially affecting business
                   d) Partner willfully or persistently breaches p/s agreement or makes
                   it not reasonably practicable to carry on business with him
                   e) P/S can only be continued at a loss
                   f) There‟s any other equitable reason.
f.   Winding Up When Dissolution is Not Wrongful
          1) Unless otherwise agreed, each partner has a right to force a liquidation and
          a distribution of the surplus (UPA 38(1))
          2) Presumably, if a partner retires and does not force liquidation but accepts a
          cash payment, the other partners can agree to continue the business. Clearly
          this can be done when wrongful dissolution occurs (See below).
          3) A partner expelled pursuant to a p/s agreement only has a right to a cash
          payment for the value of his interest in the p/s
g.   Winding Up When Dissolution Wrongfully Caused
          1) Innocent partners have right to force liquidation, but may continue the
          business after paying the offending partner his share less damages (UPA
          2) If business is liquidated, offending partner receives his share less damages
          3) If business is continued, goodwill may not be considered in valuing the
          interest of the offending partner (UPA 38(c)II)
h.   Distribution
          1) After liquidation, a partner is entitled to the amount in his capital account
          plus his pro rata share (subj to agmt) of any cash left after the obligations of
          the p/s have been paid
          2) The p/s obligations are paid in the following order:
                   a) Those owing to creditors other than partners
                   b) Those owing to partners other than for capital or profits (if for
                   example a partner has made a loan to the p/s)
                   c) Those owing to partners for capital
                   d) Those owing to partners for profits, if any
          3) Absent an agreement, a partner providing services is not entitled to
          remuneration for those services (UPA 18(f)), and so may owe contribution to
          another partner upon distribution. (See Kovacik below)

      i. Termination- Termination is not defined in UPA, but comments indicated that
      termination is the point at which all affairs are wound up
      j. Cases
               1) Kovacik v. Reed- K sought contribution from R, who had contributed only
               services. K had a capital loss of 8,680. Court found R did not owe the 4340
               b/c his services had contributed to capital.
                        a) This holding directly violates UPA 18(f).
                        b) Better theories:
                                 i) Implied agreement that K would bear all loss
                                 ii) Find no partnership existed in 1st place
               2) Dreifurst v. Dreifurst- Brothers in at-will partnership owning grain silos.
               One causes dissolution and wants liquidation. Other wants distribution of the
               assets in kind. Court held that w/o wrongful dissolution, liquidation may be
               forced. (UPA 38).
                        a) Nicholes v. Hunt had opposite result
               3) Page v. Page- P/S begins to become profitable and P seeks declaration that
               P/S is at will. D argues implied term until his investment is recouped, but
               Court follows UPA scheme that P/S is at will if no term is agreed to. The
               Court notes that P may have violated fiduciary duty, but this is a suit for
               declaratory judgment.
               4) Drashner v. Sorenson- P drinks during working hours and draws more
               than his share of funds. Ct found that P‟s conduct meets UPA 32(c/d). So P
               does not get value of goodwill, when his interest is bought out.
2. RUPA Dissociation, Dissolution, Winding Up
      a. Dissociation
               1) Events Causing Dissociation (RUPA 601)
               2) Partner‟s Power to Dissociate (RUPA 602)
                        a) Partner can always dissociate by express will
                        b) P/S agmt cannot abrogate this power (RUPA 103)
      b. Wrongful Dissociation (RUPA 602(b))
      c. Effect of Dissociation (RUPA 603)
               1) If dissociation causes winding up, Article 8 applies
               2) Otherwise, Article 7 applies
      d. Article 7: Dissociation when Business not Wound Up
               1) Dissociated partner‟s interest must be bought out (RUPA 701)
               2) Price is greater of liquidation value or value as a going concern less
               damages, if dissociation was wrongful. RUPA rejects forfeiture of goodwill
               3) In a p/s for a specified term (i.e. wrongful dissociation), the buyout may be
               postponed until the end of the term, although interest must be paid. The
               dissociated partner may apply to court for earlier payment if no hardship to
      e. Article 8: Winding Up
               1) Events causing dissolution and wind up (RUPA 801)
                        a) Preserves UPA rule that a partner in an at-will p/s may force
                        b) Does not include death of a partner
               2) After dissolution, p/s continues only to wind up (RUPA 802)

Quasi-Corporate and Corporate Forms
I.   Limited Partnerships, LLPs, LLCs, and the Corporation
     A. Taxation
            1. LPs, LLPs, and LLCs all seek to take advantage of some of the limited liability features of
            the corporation, while maintaining partnership (pass-through) tax treatment
            2. Under the old IRS tax regime, an entity would be taxed as a corporation if it met 3 of the
            following factors:
                    a. Continuity of Life
                    b. Centralization of Management
                    c. Limited Liability
                    d. Free Transferability of Interest
            3. Under the new IRS tax regime, an entity simply opts out of pass-through status (check the
            4. In 1988 IRS issued ruling that LLCs would not be treated as corporations
            5. Subchapter S corporations
                    a. Get pass-through tax treatment
                    b. Can have a maximum of 75 shareholders
                    c. Can have only one class of shares
            6. Master Limited Partnerships are publicly traded, and thus do not get pass-through
            7. State franchise taxes also factor into the choice of business organization
     B. Limited Partnerships
            1. One or more general partners plus one or more limited partners
            2. Formation: must file certificate of limited partnership
            3. Rules for general partners essentially same as normal partnership
            4. Limited Partners are generally not liable for the obligations of the limited partnership,
                    a. The limited partner is also a general partner
                    b. The limited partner participates in control of the enterprise and a 3rd party
                    reasonably believes, based on limited partner‟s conduct, that the limited partner is a
                    general partner
            5. Good form for passive investments
            6. Corporations can be limited partners
            7. Gateway Potato- Ellsworth, president of Sunworth, represented to Gateway that GB
            Investments, his limited partner, was a general partner. Gateway relied on this representation,
            and based on GB‟s substantial participation in control, court found liability. This is
            inconsistent with RUPA 303, as Gateway did not rely based on GB‟s conduct. However,
            GB‟s actions were consistent with general partner status, and law varies state to state.
     C. Limited Liability Companies
            1. Formation
                    a. Filing of Certificate of Formation (Articles of Organization)
                    b. Drafting of an Operating Agreement (like corporate by-laws)
            2. LLCs have a limited term of duration (often 30 years)
            3. LLCs can be used for any lawful purpose
            4. Investors (members) may withdraw at will
            5. Dissolution is caused by the exit of any member, subject to operating agreement
            6. Voting is usually in proportion to contributed capital
            7. Management
                    a. Absent agreement, management is vested in the members
                    b. There are “member-managed” and “manager-managed” LLCs

             8. Financial interests are usually freely transferable, although management rights may only
             be transferable subject to approval by all or some portion of the other members
             9. Advantages of LLCs
                     a. Pass-through taxation
                     b. Limited Liability
                     c. Option of centralized management
                     d. No limit as to number of members, types of interest, and classes of stock
             10. Disadvantages
                     a. Costly to convert existing entities to LLC
                     b. Lack of case law (is PCV available in LLC cases?)
      D. Limited Liability Partnerships
             1. Under RUPA, a p/s may become an LLP by filing a Statement of Qualification (with the
             Secretary of State?). (RUPA 1001)
             2. A partner in an LLP is not personally liable for other partners‟ torts (and contracts,
             depending on jurisdiction) unless:
                     a. The offending partner was under direct supervision or control of that partner OR
                     b. The partner had notice or knowledge and did not take reasonable steps to cure (see
                     TXLLPA § 3.08(a)(2)(B)
             3. LLP status usually requires retention of some minimum amount of liability insurance
             4. Disadvantages
                     a. Discourages partners to assume managerial positions like managing partner or
                     head of the corporate section
                     b. Partners involved in a risky practice have to shoulder all of the increased liability,
                     yet they share the rewards with other partners engaged in less risky practices

II.   Selecting a State of Incorporation
      A. Choice of Law
              1. A business must “qualify to do business” in its state of incorporation
              2. Internal affairs rule- the law of the state of incorporation governs the internal affairs of the
              corporation (like shareholder meetings, board of directors, voting, etc)
              3. External affairs include things like labor laws. So a DE corp doing business in TX, must
              comply with TX labor laws
              4. Pseudo-foreign corporations- NY and CA have developed law allowing them to treat
              foreign corporations doing a lot of business in-state as domestic corporations
              5. Some states offer more lax controls on management, including strong anti-takeover laws
              (see below)
              6. Delaware offers the most established case law for corporations
      B. Fees
              1. Corporations are subject to fees for incorporation (franchise tax) and fees for doing
              business (doing business tax)
              2. Corporations doing business in one state probably should incorporate there to avoid
              paying extra taxes.
      C. Competition Among States
              1. Corporations generate taxes for a state and provide other economic stimulus
              2. Theories of State Competition
                      a. The Race to the Bottom- Cary argued that most fees are generated by public corps
                      and close corps will incorporate in state, leading to competition among states to
                      create the most pro-management law.
                      b. Winter: If Cary is right, then shareholders in DE corps will earn below normal
                      c. Posner/Scott: States have different corporate law products
                      d. Today, law does not vary much, so stability is major factor (DE)

III.   Organizing a Corporation
       A. Certificate of Incorporation/Articles of Incorporation
              1. Must contain (DGCL § 102(a), RMBCA § 2.02(a))
                       a. Name
                       b. Address
                       c. Nature/purpose of business
                       d. Classes of stock authorized and their rights and restrictions
                       e. Incorporator contact info
                       f. In DE, initial directors contact info (if they exist)
              2. May contain (see DGCL § 102(b), RMBCA § 2.02(b))
       B. Organizational Meeting (DGCL § 108, RMBCA § 2.05)
              1. Purpose is to adopt bylaws, elect officers and directors
              2. Minutes should be taken to evidence action
              3. Must be held, unless all incorporators (or initial directors) sign a written consent to the
              actions taken
       C. Bylaws (DGCL § 109, RMBCA § 2.06)
              1. May contain any provision for operating the business, not inconsistent with the law or the
              articles of incorporation
       D. Preincorporation Subscription Agreements (DGCL § 165)
              1. Now generally irrevocable, regardless of consideration, for a specified period

IV.    Preincorporation Transactions by Promoters
       A. Promoter Liability- Promoter is generally liable for preincorporation transactions if he knew that
       no corporation had been formed (RMBCA § 2.04)
       B. Possible arguments against liability (none are sure winners)
              1. Promoter honestly believed corporation had been formed
              2. Third party urges transaction, knowing no corporation has been formed
              3. Plaintiff believes he is dealing with a corporation, and thus he would receive a windfall if
              the promoter were held liable
              4. Contract b/n third party and a corporation to be formed. May mean promoter must use
              best efforts to cause the incorporation to occur.
       C. Subsequent Corporate Liability
              1. Corporation is not automatically liable for the contract
              2. If a corporation adopts or ratifies the contract, it will probably be held liable
              3. If a corporation accepts the benefits of the contract, it may be estopped from arguing no

V.     Consequences of Defective Incorporation
       A. Defective incorporation suits usually occur when the parties think the corporation has been
       formed, when it has not
       B. De Facto Corporations
               1. A bona fide attempt to form a corporation and an actual use of corporate power
               2. The result is that parties are estopped from attacking the existence of the corporation
               3. Cantor v. Sunshine Greenery- Secretary of state delayed filing of certificate of
               incorporation and Sunshine entered a lease prior to official filing. P loses, as D was a de
               facto corporation.
               4. A corporation or a person sued by a corporation cannot assert defective organization as a
               defense to a claim (DGCL § 329)
               5. McChesney- requirements for de facto corporation
                       a. Statute by which corporation was legally possible
                       b. Colorable attempt to comply with the statute

                       c. Actual use or exercise of corporate privilege
      C. De Jure Corporations- complies with mandatory conditions precedent of statute with allowance
      for minor clerical errors.
      D. Corporation by Estoppel
              1. A party that has dealt with an entity as if it were a corporation may be estopped from
              denying entity‟s corporate status
              2. Actually a kind of reverse estoppel, as the third party is relying on someone else‟s
              representations to his detriment
              3. Cranson- third party sues shareholders. Lawyer negligently failed to file articles of
              incorporation. Court found no liability since shareholders were innocent and the third party
              had dealt with the entity as if it were a corporation
              4. Involuntary creditors (tort victims) are much more likely to succeed in arguing defective
              incorporation for liability.

VI.   Disregard of the Corporate Entity and Equitable Subordination
      A. Shareholders are generally not liable for obligations of the corporation, unless by reason of their
      own acts or conduct (RMBCA § 6.22)
      B. Piercing the Corporate Veil
              1. PCV is an extreme judicial action that disregards the limited liability nature of the
              corporation when it is equitable to do so. Like defective organization, tort plaintiffs may be
              more likely to win as voluntary creditors have a chance to investigate the creditworthiness of
              the corporation.
              2. Factors
                       a. Electing corporate status for the sole reason of avoiding liability is not, without
                       more, grounds for PCV
                       b. Severe under capitalization (may be offset by insurance)
                       c. Disregard of corporate formalities
                       d. Alter Ego- treating corporate assets as if they are personal assets; unity of interest
                       (or parent treating subsidiary‟s assets as if they are the parent‟s)
                       e. Enterprise Liability (Berle)- brother/sister corporations are artificial division of a
                       single business enterprise (probably requires one or more of the other factors as well)
              3. Walkovsky v. Carlton- P was hit by cab. D owns 10 sister cab companies. P claimed that
              the operation was one enterprise and thus D should be personally liable. This argument
              would only lead to going after assets of sister corporation not D. There was some evidence
              that P was using the assets for his own interests, but P did not argue (although he later
              amended his complaint to this effect, thus stating a claim). Also, each cab company had the
              statutory minimum amount of insurance, so it‟s difficult to argue undercapitalization
              4. Minton v. Cavaney- P‟s daughter drowned in swimming pool and wants to PCV and go
              after Cavaney‟s personal assets. Court found the corporation was severely undercapitalized
              (essentially had no assets) and PCV may be justified.
              5. Radazewski- D admits undercapitalized but points to liability insurance as evidence that
              there was no intent to undercapitalize for the purpose of avoiding liability. Court agreed,
              even though the insurance company was in receivership.
              6. Sealand Svcs v. Pepper Source- PCV on ground that formalities were not observed and D
              engaged in fraudulent/wrongful conduct such as commingling corporate funds with his own
              and using corporate funds to pay child support and alimony (unjust enrichment without
              regard to creditors). The case also indicates that a nexus must exist between the defendant‟s
              conduct and the defendant‟s injuries.
      C. Direct Liability of Parent for Subsidiary
              1. Primary Liability Under CERCLA (Environmental Liability)
                       a. Liability comes from being an owner/operator

                       b. Parent may qualify as operator, although subsidiary is the owner, if parent exerts
                       enough control. (Does not apply to normal monitoring and supervisory role of
              2. United States v. Best Foods
       D. Equitable Subordination
              1. Under this doctrine, a controlling shareholder‟s credit interest is subordinated to other
              creditors and perhaps preferred shareholders
              2. Similar factors as PCV considered
              3. Taylor v. SG&E- Parent‟s credit interest in subsidiary subordinated because of parent‟s
              mismanagement of subsidiary.
              4. Benjamin v. Diamond- three factors before equitable subordination is appropriate
                       a. The claimant must have engaged in inequitable conduct
                       b. The misconduct must have resulted in injury to the creditors
                       c. The subordination of the claim must be in accordance with the Bankruptcy Act
              5. If the inequitable conduct is a fraudulent transfer or obligation according to the
              Bankruptcy Act, the trustee may avoid the obligation or transfer, making subordination
              6. A corporation may have duties to creditors even pre-bankruptcy (clearly if there is intent
              to defraud or the exchange was not fair)

VII.   Classical Ultra Vires Doctrine
       A. UltraVires is essentially dead because of the broad statutory purposes allowed for corporations
       B. Exceptions:
               1. Shareholder may bring action to enjoin an act (like charitable donations or the like)
               2. Attorney general may assert in a dissolution proceeding
       C. Goodman- Ultra Vires cannot be argued by parties that approve the act
       D. 711 King‟s Highway Corp- Third parties cannot use Ultra Vires as a sword to escape contracts,
       which they bargained for.

Corporate Structure
I.     The Theory of the Corporate Objective- A First Cut
       A. General
             1. A basic tenet of corporation law is that a corporation is to be run for the benefit of
             2. Traditional Conception- what is good for the corporation is good for the shareholder
                      a. Largely reflected in statutory schemes. For example, questions of fiduciary duty
                      relate to what is in the best interest of the corporation
                      b. Assumptions of traditional conception
                               1) Accounting-based earnings are good indicators of corporate performance
                               2) The welfare of the shareholder is coincident with the welfare of the
                      c. Accounting earnings do not adequately reflect:
                               1) Risk characteristics of corporate investment
                               2) Extent of investment in working and fixed capital necessary to sustain the
                               3) Dividend policy
                               4) The time value of money
                               5) Corollary: Earnings do not reflect ROIC
             3. Actual Shareholder Wealth Maximization
                      a. Focus on stock price and allocation of capital
                      b. Use of quantitative methods, like NPV, to make investment decisions

                c. No concern for the corporation independent of the welfare of its shareholders
       4. Blissful Shareholder Wealth Maximization (See Second Cut below)
       5. Dodge v. Ford Motor Co.- Ford had long-term plan to reduce price of cars at the expense
       of corporate profit to benefit the country. Court ordered a dividend payment and held that it
       was an improper objective to run the company primarily for the benefit of others, not s/h.
B. Time, Risk and Return
       1. NPV
       2. CAPM: d=rf + (rm - rf)
       3. Systematic vs. Unsystematic risk
                a. Corporate managers should ignore unsystematic risk when choosing projects and
                focus on expected return and systematic risk comparisons
                b. Unsystematic risk is diversifiable, and so investors can account for this risk in
                their portfolio
                c. Managers do not really follow this principle to its logical end, as it means that
                their jobs may be at risk
       4. Example: Project A: E(A) = $1.1M, risk-free; Project B: E(B) = $1.15M = .5($2M) +
       .5($300k); both have payoffs in one year
                a. If you can only invest in one, you must ask how the risk affects the discount rate
                b. In the example, B is a “flip of the coin,” so a corporation should choose this every
                time, and over many such projects the return will essentially be riskless.
                c. In reality, the probabilities over time will be interdependent, reflecting systematic
                risk. So you should do the following:
                         1) PV(A) = $1.1M/(1 + rf)
                         2) PV(B) = $1.15M/(1 + d), d = CAPM rate using  for the project
                                  a) By using CAPM, you only consider the systematic risk‟s effect on
                                  the discount rate
                         3) Choose the project with the higher present value
C. Other Constituencies and Considerations
       1. Managers Risk Incentives
                a. More sensitive to unsystematic risk, as they may have a higher portion of their
                wealth in the company
                b. Desire to keep job discourages risk taking
                c. Stock Options
                         1) More volatility = more value
                         2) If already valuable, may not want to take extra risk, especially in light of
                         the above considerations
       2. AP Smith v. Barlow- Corporation allowed to donate to Princeton. This expanded the rule
       that donations must benefit the corporation, and allowed for a very indirect and expansive
       interpretation of benefit. (need for educated workers)
       3. Most states allow charitable donations by statute. A reasonableness requirement is
       generally read into these provisions.
                a. Can the corporation afford it?
                b. Was it more of a personal gift? A “pet charity” for an officer may be akin to more
       4. Milton Friedman: Corporation should try to make as much money as legally and ethically
       5. Credit Lyonnais- When a corporation is operating in the vicinity of insolvency, it owes a
       duty to the corporate enterprise, which includes creditors
       6. Some statutory schemes allow directors to consider employees and the community when
       deciding whether to accept a takeover bid.
                a. ALI PCG § 6.02: may consider
                b. Conn. § 33-756: shall consider

                       c. Indiana § 23-1-35-1: may consider
                       d. NYBCL § 717: may consider
                       e. Penn § 1715: may consider

II.    Shareholdership in Publicly Held Corporations and Traditional Notions as to Corporate
       Objectives in Practice
       A. Berle-Means Theory: Managers act in their own self-interest and get away with it b/c the diffusion
       of ownership interests make it too hard to force management to change
              1. Exit Mechanism- Instead of challenging management, sell your shares
              2. Voice Mechanism- Stand up and be heard
              3. Berle and Means argued that Exit was always preferable to voice
              4. This is still probably true for an individual investor, but some changes have occurred
                       a. The rise of the institutional investor
                                1) More money at stake
                                2) Cannot always liquidate (index funds)
                                        a) Hu thinks net effect of indexers may be negative
                                        b) Mgrs know they can‟t dump
                                        c) Free rider problem
                                        d) It‟s too expensive to monitor management in every company in an
                                3) New SEC rules allow less than 10 to contact, not a violation of proxy rules
                                4) Better access to board and management
                       b. The market for corporate control
                                1) Bad managers get taken over
                                2) Although, poison pills/staggered boards
                       c. Legal Checks on Management
                                1) Fiduciary duty
                                2) Proxy contests
                                3) SEC disclosure rules
                                4) Appraisal remedy (rare; s/h get cashed out)
                       d. Compensation tied to stock price

III.   Allocation of Legal Power Between Management and Shareholders
       A. The Board
               1. Manages business affairs of the corporation
               2. Provides overall strategy
               3. Delegates day-to-day management to officers and hires/fires
               4. Internal controls
       B. Shareholders
               1. Vote on board membership
               2. Remove board members with or without cause
                       a. DGCL § 141(k)
                                1) Staggered boards can only be removed with cause, unless certificate…
                                2) If less than whole board removed and cumulative voting, a director cannot
                                be removed if the votes against removal would be sufficient to elect him.
                                3) If only one class of shares can elect a particular director, apply rules
                       b. California pretty much the same Cal. CC § 303
                       c. NYBCL § 706 same
               3. Vote on
                       a. Amendment to articles of incorporation
                       b. Mergers
                       c. Disposition of Assets

                         d. Director‟s conflicting interest transactions
                         e. Certain indemnification provisions
                4. Usually one vote per share, but can be altered
                         a. Providence v. Worcester- Each shareholder had one vote per share up to 50, then
                         only one vote per 20 shares, making it difficult to takeover. Court said that is
                         permissible as long as in the articles of incorporation.
       C. Schnell v. Chris-Craft- Board wants to avoid proxy fight, so it amends bylaws to move the annual
       meeting earlier, thus frustrating shareholders attempts to organize. The board did not technically
       violate any laws, but they had an inequitable purpose.
                1. Berle and Means- Corporate power is only exercisable for the ratable benefit of
                shareholders. So use of corporate power is subject to an equitable limitation
       D. Blasius Industries v. Atlas Corp- Blasius was a 9% shareholder of atlas and wanted a
       restructuring. Management did not like the plan. Blasius caused a consent to be sent to shareholders
       proposing an expansion of the board, a restructuring, and the election of pro-Blasius directors.
       Atlas‟s board adopt a resolution expanding the board and filled the spots with pro-Atlas directors,
       thus denying shareholders their right to vote.
                1. Court does not apply business judgment rule (Aronson in DE), because the action did not
                involve ordinary business but a thwarting of the shareholder vote.
                2. Court does not apply Unocal (that good faith action having an entrenchment effect as long
                as in reasonable relation to threat posed) because the primary purpose was interfering with
                the effectiveness of a shareholder vote
                3. Court does not apply per se invalidity because it cannot anticipate all future settings in
                which this scenario might arise.
                4. Intermediate standard: when primary purpose is interference with vote, board must show
                some compelling justification (we don‟t know what that might be)
       E. MM v. Liquid Audio- MM nominated 2 directors for class III spots coming up for election. Also
       proposed an expansion of the board and nomination of 4 people for the additional spots. Liquid
       expanded the board from 5 to 7 and filled two spots.
                1. Because liquid‟s actions affected MM‟s contest for control, Unocal is implicated
                2. Because primary purpose was to thwart shareholder vote, Blasius is implicated.
                3. Apply only Unocal when defensive measures are taken, but primary purpose is not to
                thwart vote. For example, in Unocal the board made a self-tender offer to thwart takeover
                4. Apply only Blasius, when there‟s no contest for control (This seems stupid since Blasius
                “touched on control” in accordance with Gilbert, implying Unocal)
                5. Apply Blasius within Unocal, when primary purpose is to thwart vote AND there is a
                contest for control
                         a. Is there a compelling justification?
                         b. Is the defensive measure reasonable?

IV.   Legal Structure of Management
      A. Management Directors
      B. Non-Management Directors
              1. Affiliated
              2. Unaffiliated
ALI PCG § 3.01: Management of the Corporation‟s Business                                 1295
ALI PCG § 3.02: Functions and Powers of the Board of Directors                           1295
ALI PCG § 3.03: Director‟s Informational Rights                                          1296
ALI PCG § 3.05: Audit Committee in Large Publicly Held Corporations                      1297
ALI PCG § 3A.01: Composition of the Board in Publicly Held Corporations                  1298
ALI PCG § 3A.02: Audit Committee in Small Publicly Held Corporations                     1298
ALI PCG § 3A.03: Functions and Powers of Audit Committees                                1299
ALI PCG § 3A.04: Nominating Committee in Public Corps: Compositions, Powers              1300

ALI PCG § 3A.05: Compensation Committee in Large Public Corporation                        1300

V.      Formalities Required by Board Action
        A. Boards do not have to act through meetings as long as all board members agree
        B. Teleconferencing permitted
        C. Consequences of Noncompliance
               1. Action may be held ineffective
               2. Courts may apply different standard for closely held corporation
        D. Quorum
        E. Notice of Meeting

VII.    Authority of Corporate Officers
        A. The president of a corporation has apparent authority to bind his corporation to contracts in the
        usual and regular course of business, but not extraordinary contracts
                1. Economic magnitude of contract
                2. Extent of the risk
                3. Timespan of the action‟s effect
                4. Cost of reversing
        B. The secretary has apparent authority to certify the records of the corporation, and third party can
        usually rely on such a certification

VIII.   Formalities Required for Shareholder Action
        A. Meeting and Notice
        B. Quorum
               1. Usually a majority of the shares (or class of shares) entitled to vote
               2. Can be changed by articles of incorporation, but most statutes say not less than a third
        C. Voting
               1. Record owners v. beneficial owners
                       a. Only record owners are entitled to vote
               2. Bylaws fix the record date for the upcoming meeting
               3. For ordinary matters, a majority of shares represented usually wins. RMBCA § 7.25 only
               requires the affirmative vote of a majority of those voting, which may not be a majority due
               to abstentions
               4. For election of directors, usually only a plurality is required (see cumulative voting)
               5. Some extraordinary matters like merger or sale of assets may require approval by a
               majority (or more) of outstanding stock (rather than stock represented at the meeting)
               6. The articles of incorporation can alter the number of votes necessary for action. To amend
               such a provision, the amendment must be approved by the old or new voting standard,
               whichever is higher
               7. Straight voting
               8. Cumulative voting for directors may be provided for in the articles of incorporation
                       a. Cumulative voting allows minorities to get board representation
                       b. Not much power, but allows access to information
                       c. Can be frustrated by lowering number of board members or staggering board
                       d. Also majority can refuse to put minority member on important committees
                       e. Formulas
                                 1) X = SN/(D+1) + 1
                                         a) X = minimum number of shares needed
                                         b) S = total shares that will be voted
                                         c) N = number of directors desired to elect
                                         d) D = total number of directors to be elected
                                 2) N = X(D+1)/S

                                       a) N = number of directors that can be elected
                                       b) X = number of shares controlled
                                       c) D = total number of directors to be elected
                                       d) S = total shares that will be voted

Disclosure and Voting
I.    Shareholder Informational Rights Under State Law
      A. Any stockholder has the right to inspect the corporation‟s stock ledger, list of stockholders, and
      other books and records for a proper purpose (reasonably related to interest as stockholder) DGCL §
              1. When the corporation refuses, the burden of proof is on the stockholder for books and
              2. When the corporation refuses, the burden of proof is on the corporation for stock ledger
              and list of stockholders
      B. Proper Purposes can include
              1. To determine the financial condition of the corporation
              2. To ascertain the value of petitioner‟s shares
              3. To solicit proxies for contest for control Credit Bureau Reports
      C. Security First v. U.S. Die
              1. A stockholder may demonstrate a proper purpose on a showing by a preponderance of the
              evidence that there is a credible basis for probable corporate wrongdoing
              2. The plaintiff must justify each category of requested production
              3. Neither res judicata nor the principle of the law of the case preclude a plaintiff from
              making a later request.
      D. Saito v. McKesson HBOC
              1. Saito requests documents to explore possible wrongdoing
              2. Access limited to books and records that are necessary and essential to accomplish stated
              3. Once a stockholder establishes a proper purpose under DGCL § 220, any secondary
              improper purpose is irrelevant
              4. DGCL § 220 cannot be read narrowly to deprive a stockholder of necessary documents
              solely because they predate his first investment or were prepared by third parties
              5. Saito is a shareholder of McKesson HBOC, the parent of HBOC. He is not entitled to
              inspect books and records of the subsidiary, as separate corporate existence must be observed.
              However he may be able to access documents that HBOC gave to McKesson prior to the
              merger or gave to McKesson HBOC after the merger (same rationale as 3d party docs)

II.   Federal Securities Disclosure and Stock Exchange Rules
      A. Federal Securities laws have goal of transparency, i.e. disclosing material aspects of the business
      B. The ‟33 Act covers disclosure in primary offerings, and the ‟34 Act covers secondary markets
      C. Considerations in going public
             1. Disclosure gives competitors insights. Example: Item 16 in Form S-1 (Registration
             Statement) requires disclosure of all material contracts
             2. Costs associated with going public
                      a. Lawyers, bankers, accountants
                      b. Financial printer
             3. Potential increase in civil liability
      D. „33 Act
             1. § 5 is most important and deals with registration
             2. Exemptions (arguing something is not a security rarely works because of the broad
             statutory definition § 2(a)(1)

                      a. Exempted Securities § 3 (Municipal Bonds, e.g.)
                      b. Exempted Transactions § 4 (Private Placements)
                      c. Rule 506 of Regulation D- Safe Harbor
              3. Civil liability for False Registration Statement § 11
                      a. Can sue anyone who signed
                      b. Due diligence defense available for underwriters, directors
       E. ‟34 Act
              1. Continuous reporting system for operations
              2. Who is subject to disclosure requirements
                      a. Basically public companies and broker-dealers involved in trading on exchanges
                      see § 12
                      b. A company with 500 shareholders and $10M in assets is subject to the Act
              3. Disclosure § 13
                      a. Any person acquiring 5% stake § 13(d), Schedule 13D
                      b. Issuer Reports § 13(a)
                                a. Rule 13a-1: Annual Reports
                                b. Rule 13a-11: Current Reports on Form 8-K
                                         1) Buy/Sell Assets
                                         2) Merger/Acquisition
                                         3) Change in Control
                                c. Rule 13a-13: Quarterly Reports on Form 10-Q
              4. Rule 10b-5 and implied right of action
                      a. Primary means by which derivative suits are brought
                      b. Liability for material misrepresentations or omissions; device to defraud; course
                      of business, which operates as a fraud

III.   Proxy Rules
       A. Regulated by § 14 of ‟34 Act
                1. Rule 14a-2: the rules apply to every solicitation of a proxy w.r.t. securities registered
                under § 12
                2. Rule 14a-1(l)(1): lists what “solicitation” means
                3. Rule 14a-1(l)(2): lists exceptions
                4. Studebaker v. Gittlin- A letter soliciting authorization to inspect a stockholder list was
                held to be a solicitation, even though no plan to solicit proxies.
                5. Rule 14a-3: Information to Be Furnished to Security Holders
                6. Schedule 14A: Information Required in Proxy Statement
                7. If management does not solicit proxies, an information statement must be delivered to
                shareholders prior to a meeting § 14(c)
                8. Schedule 14C: Information Required in Information Statement
       B. J.I. Case Co. v Borak- Supreme Court held that there was an implied private right of action for
       violation of the proxy rules.
                1. These are brought under Rule 14a-9: False or Misleading Statements
       C. Mills v. Electric Auto-Lite- Involved a proxy statement with material false/misleading statement.
       Management sent out proxy solicitation, but did not disclose that the acquiring company already
       owned 50% of Auto-Lite. The merger probably would have gone through without proxy solicitation,
       but that does not matter.
                1. It is not appropriate to focus on the fairness of the merger
                         a. B/c that assumes how voters will behave
                         b. B/c that would substitute court‟s judgment for what is fair
                         c. B/c misrepresentation not concerning deal pts would be insulated from action
                2. Major issue was causation

                        a. Court held that causation is shown if the proxy solicitation itself, not the
                        misrepresentation, was an essential link in the accomplishment of the transaction
                        b. The acquirer had 54% and needed 2/3 thus minority vote was essential
               3. Court discussed possible remedies in dictum
                        a. Unwinding- Is it in best interest of shareholders
                        b. Damages- Only if merger reduced earnings/earnings potential of holdings
                        c. Equitable Relief- too late
                        d. Attorney‟s fees- promote deterrence
      D. TSC Industries v. Northway- Court addressed materiality. Held that an omitted fact is material if
      there is a substantial likelihood that a reasonable shareholder would consider it important in deciding
      how to vote.
      E. Virginia Bankshares v. Sandberg- Two questions: whether statement of opinion can be a material
      fact for Rule 14a-9 liability; whether a minority whose vote was unnecessary to approve transaction
      can claim damages.
               1. A statement of opinion or belief is factual in two senses
                        a. Does the speaker truly believe the statement
                        b. Is it objectively true
               2. Both must be false for liability to attach
               3. A minority cannot show damages if the transaction would have occurred with or without
               their vote
      F. If a stockholder does not rely on the representation, there‟s no cause of action (no standing)
      G. 2nd Circuit says negligence is sufficient for culpability under 14a-9. The Supreme Court has
      repeatedly declined to address the issue of scienter
      H. Shareholder Proposals
               1. Rule 14a-8: Shareholder Proposals (Q&A)
               2. When can a company exclude shareholder proposals from its proxy statements
               3. Roosevelt v. Du Pont- Supreme Court held that a one year difference in the timetable for
               phasing out CFCs was an ordinary business decision exception Rule 14a-8(c)(7)

IV.   Proxy Contests
      A. Why don‟t we seem them more often?
             1. In smaller corporations, management may own a high percentage of shares
             2. Outsider‟s expenses are generally not paid by corporation, and often expensive experts
             have to be hired to carry out the contest
             3. Insiders can use employees and other company resources to fight
      B. Rules for Reimbursement of Expenses (Rosenfeld)
             1. Incumbent Management
                     a. The expenses must be reasonable
                     b. Must be a contest over policy (almost anything qualifies)
             2. Insurgents
                     a. The expenses must be reasonable
                     b. Must be a contest over policy
                     c. They must win
             3. How are Tender offers different?
                     a. Still very expensive (bankers, lawyers)
                     b. But if you fail, the offer probably moved the shares you own, especially if
                     someone else comes in, which may offset your sunk costs

Capital Structure
I.    Traditional Financial Products
      A. Equity
             1. Common Stock
                     a. Control
                     b. Residual Interest
                     c. Terms
                             1) Issued
                             2) Outstanding
                             3) Par Value (DGCL § 153)
                             4) Stated Capital = Outstanding * Par Value
                             5) Watered Stock- stock sold or exchanged for less than it‟s worth, thus
                             diluting existing shareholders interest
                     d. Proper Consideration (DGCL § 153)
                     e. Non-assessable- simply means shareholder is only liable for the consideration he
                     owes for his stock
             2. Preferred Stock
                     a. Control- usually cannot vote, unless a number of dividends have been missed
                     b. Dividends
                             1) First right to dividends, but that does not mean the corporation must pay
                             them a dividend
                             2) Dividends are usually cumulative- missed dividends must be paid before
                             common stock can be paid
                             3) Higher interest in bankruptcy than common, but subordinated to debt
                     c. Problem Set p 93:
                             1) Dividends are not cumulative, not uncommon in VC setting
                             2) Voting: VC has 55k votes compared to 1.1M in fright corp. This is
                             meaningless for control. When/if they convert, they will have 1.1M votes, so
                             it makes sense to have each pfd share have 20 votes
                             3) Redemption
                                       a) Redemption for par + accrued dividends implies cumulative
                                       dividends, but see above
                                       b) Amounts to a risk free loan, unless VC converts before Fright can
             3. Debt
                     a. Credit facility
                     b. Commercial paper
                     c. Corporate bonds
                     d. Interest is tax deductible
                     e. Converts and others

II.   Derivatives and New Financial Products
      A. Visions
             1. Science run amok
             2. Order made possible by derivatives
      B. Considerations
             1. The process by which they are invented, marketed and diffused
             2. The products themselves
      C. Types of Risk
             1. Market risk
             2. Credit risk

            3.   Model risk
     D. Uses
            1.  Risk management
            2.  Arbitrage
            3.  Speculation
            4.  Lower cost of borrowing
            5.  Avoidance of regulatory barriers
                     a. Tax considerations
                     b. Investment in countries that are illegal
     E. Legal Roles
            1. Help innovators understand contract principles
            2. Help management understand
            3. Help develop internal control systems
     F. Four stages of the production side
            1. No way to value derivatives, huge transaction costs
            2. Small market, banks synthetically create counter parties to transactions with a basket of
            3. Market increases, banks involved on all sides, need to look at net exposure
            4. Net exposure model does not account for run-of-the-mill loans, banks are starting to do
     G. Risk Analysis
            1. VaR
            2. Stress testing- what happens if a certain improbable event occurs
            3. Models tend to work until they fail (usually in a disastrous way)
     H. Products
            1. Options
            2. Forwards- agreement to buy/sell an asset in future; asset usually delivered
            3. Futures- similar to forward except:
                     a. Marked to market
                     b. Standardized contracts
                     c. Asset usually not delivered
            4. Swaps
                     a. Interest rate swaps
                     b. Currency swaps
            5. Black-Scholes Variables
                     a. S
                     b. K
                     c. T
                     d. rf (need domestic and foreign for currency swap)
                     e. 2
     I. Damages
            1. Value of future payments in a swap (difficult to value)
            2. Cost of cover (may overstate in exotics)

The Corporate Objective in Theory and Practice- A Second Cut
I.   Should corporations hedge?
     A. Legal Side (Errors)
            1. Lawyers will say hedging is good management and may be necessary to comply with
            fiduciary duty
            2. Brane v. Roth- Directors of grain coop breached fiduciary duty by not hedging.

                      a. This does not make as much sense in a public company setting, because the
                      assumption is that shareholders are diversified
                      b. Seems to fit with close corporations
             3. Some companies hedge against accounting losses (Kamin v. AMEX). This really makes
             no sense for shareholders.
      B. Finance Side (Errors)
             1. Economists focus on how hedging effects shareholder wealth. They assume, however,
             that actual price = intrinsic value.
                      a. Derivative induced panics will make the price of the hedge vastly different from
                      its intrinsic value
                      b. Disclosure of Derivatives is not good
             2. Shareholder wealth and Shareholder Welfare may not be correlated in terms of derivative
                      a. Hedging can interfere with shareholders portfolio decisions
                      b. Hedging can frustrate shareholder attempts to make a “pure play”
                      c. In any decisions about corporate objective, how does a corporation know the
                      identity or its shareholders?
                                1) Should they assume long-term goals?
             3. Costs of internal controls should be considered in assessing the value of derivative activity
      C. Berkshire Hathaway
             1. Max(after-tax cashflow), essentially focuses on blissful share price
             2. Assumes undiversified shareholders
             3. Has made public statements that price of shares are too high
             4. Advantages of focusing on blissful share price
                      a. Takes the emphasis off accounting measures
                      b. Ignores preservation of the entity
             5. Disadvantages of focusing on blissful share price
                      a. Market may not recognize your effort (EMH is after all b.s.)
                      b. Is disclosure to investors about relation to actual price necessary?

II.   Sarbanes-Oxley
      A. Different in nature from other legislation
              1. Congress ignored barriers that have historically separated state corporate law from federal
              securities law
                       a. Regulates audit committee
                       b. Cannot lend to Execs
              2. Imposes regulations that have usually been the domain of bar associations and state
              supreme courts
                       a. Whistleblower
              3. Accounting profession lost self-regulation
      B. How the Act operates in terms of legislative drafting:
              1. X shall (not) do…
              2. SEC shall come up with rules subject to these parameters
              3. Creates organizations such as public accounting board
              4. Postponement of issues with instructions to SEC to investigate
      C. Internal Corporate Governance
              1. Audit Committee (SOX § 301, ‟34 Act § 10A(m)
                       a. All must be independent
                       b. Directly responsible for hiring/overseeing outside auditor
                       c. Accounting firm reports directly to the committee
                       d. Note: this strays from state law by taking power from the board and treating the
                       committee as a separate powerful entity

            2. Executive Certification (SOX § 302, § 906)
                    a. CEO and CFO must certify that the financial statements fairly present, in all
                    material respects, the financial condition of the company
                    b. § 906 raises criminal penalties
            3. SEC shall make rules regarding disclosure of internal controls (§ 404)
            4. Disgorgement of Profits in event of restatement of financials (§ 304)
            5. Officer/Director Bars & Penalties (§ 305, ‟34 Act § 20(3) & § 21(d))
            6. Protection for Whistleblowers (§ 1107)
     D. External Controls
            1. Changes to the Accounting Profession
                    a. Public Accounting Oversight Board (§ 101)
                            1) Not an establishment of the U.S. government
                            2) Minority of members are accountants
                            3) Board can make substantive rules and has some enforcement powers
                    b. § 103
                            1) Retention of audit papers
                            2) 2nd partner review
                            3) Description of test of internal controls
                    c. Auditor Independence
                            1) Preapproval of nonaudit services by audit committee (§ 202, ‟34 § 10A(h))
                            2) Prohibited non-audit services (§ 201)
                            3) Conflicts of Interest of auditors (§ 206, ‟34 Act § 10A(l))
                            4) Audit Partner Rotation (§ 203, ‟34 Act § 10A(j))
            2. Improved Information to Capital Markets
                    a. Real time disclosure (§ 409)
                    b. Off-balance sheet financing, tailor and avoid boiler plate
                            1) S-K 303(a)(4)(A) Business purpose
                            2) S-K 303(a)(4)(B) Exposure/Effect on liquidity, capital resources, market
                            risk, credit risk
                    c. Disclosure of transactions involving management and principal s/h (§ 403)
                    d. Code of Ethics (§ 406)
                    e. Insider trading during pension fund blackout (§ 306)
                    f. Security Analyst Conflicts of Interest (§ 501)
            3. Attorneys (§ 307)
            4. Increase in Criminal Sanctions & Increase in Statute of Limitations

The Special Problems of Close Corporations
I.   Introduction
     A. Donahue v. Rodd-Electrotype- Donahue owned 50 shares; Rodd owned 200 (1000 total). Rodd
     was allowed to sell 45 shares for $800/share. Donahue repeatedly tried to sell her shares, but the
     corporation would only offer between $40-$200 per share.
             1. Court holds that shareholders in a close corporation owe one another substantially the
             same fiduciary duty as partners. (Think Meinhard)
             2. The Court discusses two possible solutions
                     a. Dodd must remit the money he received for his shares, with interest, in exchange
                     for 45 shares of the corporation
                     b. The corporation allow Dodd an equal opportunity to sell a ratable amount of
                     shares (45, not all 50)
                              1) Problem with this option is that it may put a strain on corporate assets
                              2) Does this mean majority shareholders must offer minorities employment
                              in the corporation?

       B. Characteristics of Close Corporation that Support Higher Duty
               1. Unlike public context, minority cannot easily sell shares (locked in)
                       a. No market for shares
                       b. Valuation difficult
               2. No disclosure documents in close corporation setting
               3. Shareholders are usually not well diversified
               4. Shareholder‟s salary may depend upon the corporation‟s success
       C. Statutory Close Corporations
               1. Allow shareholders to operate more like a partnership
               2. Relatively new, so not much case law
               3. Danger of growing out of this election
               4. Shareholder agreements can accomplish a lot of the same effects

II.    Special Voting Arrangements at the Shareholder Level
       A. Voting Trusts
               a. Transfer shares to a trustee
               b. Trustee is shown as the owner on the books
               c. Usually limited to a 10 year term
       B. Voting Agreements
               a. An agreement between shareholders to vote a certain way
               b. Often provide for ADR
               c. Specifically enforceable (depending on jurisdiction)
               d. Courts, in the past, have characterized voting agreements as voting trusts and then
               invalidated them on the ground that they do not meet all the statutory requirements. This may
               not be as likely these days.
       C. Ringling Bros. v. Ringling- 2 minority shareholders (of 3 total shareholders) had an agreement to
       vote their shares together and submit to arbitration if they do not agree. The court decided to
       invalidate the breaching party‟s vote, but the majority shareholder‟s votes were still sufficient to deny
       adjournment of the meeting. In response, RMBCA § 7.31 provides that such agreements are
       specifically enforceable. This would lead to a different result in this case. Court also could have
       found an implied proxy or left the results and allowed damages.
               a. Agreement should have granted express proxy to arbitrator
               b. And expressed that the proxy was irrevocable and coupled with an interest

III.   Agreements Controlling Matters Within the Board’s Discretion
       A. McQuade v. Stoneham- McQuade bought 70 shares for cash and an agreement that the three
       shareholders would use best efforts to keep each other as directors and maintain their respective
       offices (McQuade as treasurer).
                a. Court said this violated the rule that directors should run the company (not shareholders),
                which includes setting salaries and appointing officers.
                b. The clause about directorships may be more akin to a voting agreement.
                c. Theory is to protect minorities (Court notes that no other minorities are objecting to the
                new treasurer)
                d. How could have McQuade accomplished his goals?
                        1) Amend articles of incorporation (RMBCA § 8.01(b))
                        2) Shareholder agreement between all shareholders (RMBCA § 7.32)
                        3) Create a class of shares, only these owners eligible to be treasurer
                        4) Execute an employment contract
       B. Shareholder agreements do not hurt potential shareholders, because their lawyers should
       investigate (they must be noted on certificate RMBCA § 7.32(c))
       C. Clark v. Dodge- Two years after McQuade, also in NY. Characterized McQuade analysis as
       dicta, and court establishes new standard for valid shareholder agreements:

             a. Invasion of board‟s power is so slight as to be negligible
             b. No damage suffered by or threatened to anyone (like creditors)
      D. Galler v. Galler- Shareholder agreement attempting to assure each family had split control.
      Provided for election of directors and payment of dividends. Court said okay if:
             a. There is no objecting minority interest
             b. No injury to anyone (public, creditors)
             c. No clearly prohibitory statutory language

IV.   Supermajority Voting and Quorum Requirements at the Shareholder and Board Levels
      Sutton v. Sutton- Plaintiffs want to amend a provision in the articles of incorporation that requires
      unanimity to conduct any business. He has 70% of the vote. Statute says two-thirds necessary to
      amend a super-majority voting provision unless articles of corporation specify higher. Court said
      company‟s articles specify unanimity sufficiently to require unanimity to amend the super-majority

V.    Fiduciary Obligations of Shareholders in Close Corporations; Implied Understandings
      A. Rosenthal v. Rosenthal- Fiduciary duties owed by business associates in a close corporation to
      one another:
               1. Act with diligence, care and skill of ordinary prudent person in similar circumstances
               2. Discharge duties in good faith with a view to furthering each other‟s interests
               3. Disclose (and not withhold) relevant information affecting the relationship
               4. Not use position to gain special advantage over another associate
      B. Wilkes v. Springside Nursing Home- 3 shareholders ganged up on the 4th, fired him, and did not
      reelect him as director. His salary as an employee represented his only return on his investment in the
      company. Also, he was fired for bad blood not poor performance. Court held that the 3 in control
      breached a fiduciary duty to the fourth.
               1. Test:
                        a. Was there a legitimate business purpose?
                        b. Could the objective be achieved with less harm to shareholders?
                        c. Was “strict good faith” upheld?
               2. This tempers the Donahue standard of partnership-type fiduciary duty
               3. Court could have resolved under normal corporate fiduciary duty (Hu)
               4. Lowering the duty from partnership level gives business people a choice of legal product
      C. Smith v. Atlantic Properties- 4 shareholders and 80% vote required for any action. Wolfson
      continuously vetoes dividend payment causing the corporation to incur IRS penalties for retaining too
      much cash. He did not want to have to pay taxes on dividends (rate back then was like 90% for
      highest bracket).
               1. Minorities also owe fiduciary duties to majority
               2. Note that if they would have followed Wolfson‟s plan of reinvestment, there would not
               have been tax penalties. (But Wolfson had no real plan)
               3. Organizational Options
                        a. Advance agreement about dividends
                        b. Expressly limit the duration of the corporation
                        c. Have buyout provision
                        d. Arbitration provision
                        e. Have majority hold preferred voting stock (or bonds?)

VI.   Restrictions on the Transferability of Shares and Mandatory-Sale Provisions
      A. In close corporations, often corporation doesn‟t want free transferability
              1. Often shareholders are involved in the enterprise
              2. Care a lot about interpersonal relationships
              3. Want to avoid frequent changes in control

                4. Restrictions on # of shareholders in S corp.
                5. Don‟t want to cross the line to public company subject to ‟34 act
                6. Don‟t want a shareholder to sell to a competitor
                7. Don‟t want to endanger statutory close corporation status
       B. Types of Restrictions
                1. First Refusal- Right to match a 3rd party offer
                2. First Option- Must first offer to corporation at a predetermined price (or formula)
                3. Absolute Prohibitions- probably not enforceable
                4. Limit to certain classes of persons (family)
                5. Consent Restraint- transfer must be approved by the other shareholders
                6. Buy/Sell Agreements- Stockholder has right to sell his shares under certain circumstances
                or at will when exiting. They can be in a number of different forms.
                         a. Formula specified in agreement and other shareholders can either purchase or
                         liquidate the company
                         b. Shareholder specifies a price and others can either buy his shares or sell their
                         shares to him at that price.
                7. Mandatory Sale Provisions- A type of first option that kicks on the occurrence of some
                contingency such as termination of employment or death.
       C. Factors affecting reasonableness
                1. Corporation‟s size
                2. Extent of restraint
                3. Length of time
                4. Does it promote the corporation‟s interests
       D. Allen v. Biltmore Tissue- Corporation had mandatory sale provision in case of death requiring the
       shareholder to give the corporation the option to buy his shares for the price he paid for them. Court
       upheld, despite the inadequate price, b/c of the 90 day limit and b/c of the bylaws represented the
       parties‟ wishes.
       E. Arguments for Enforceability
                1. That‟s the deal they made
                2. Consistent enforcement reduces litigation
                3. The difficulty of valuation
                4. People counting on legal precedent
       F. Jordan v. Duff & Phelps- P is forced to leave his job and must sell his shares back to Duff &
       Phelps under a mandatory sale provision. D&P does not disclose that they are about to be acquired
       and P‟s shares will be worth a helluva lot more. Merger was announced 10 days after he quit. P
       would have had $452k instead of $23k for his shares. This is a 10b-5 action and was decided on
       D&P‟s failure to disclose a material fact (Decision to leave involved the sale of securities, implicating
       ‟34 Act). Also based on fiduciary duty owed to another shareholder (Easterbrook says D&P is a close
       corporation, how are they subject to ‟34 Act?).
                1. This is a tough case because D&P had an obligation to keep quiet
                2. Also there‟s an argument that the literal terms of the contract should have been upheld.

VII.   Dissolution for Deadlock and Provisional Directors and Custodians
       A. Wollman v. Littman- 2 factions each own 50% and are deadlocked. Court declines to dissolve the
       corporation (partly because it would effectively accomplish one faction‟s desire to the detriment of
       the other) and appoints a receiver to help run the business until trial.
       B. Solutions to Deadlock
               1. Tie-breaking director
               2. Buy-sell agreement
               3. Dissolution mechanism in case of deadlock
               4. Arbitration

                5. RMBCA § 14.34 allows shareholders to buy out any shareholder seeking dissolution in a
                judicial proceeding and provides a process for reaching an appropriate price
        C. Voluntary Dissolution is available under RMBCA § 14.02(e)
        D. Court may appoint a custodian or receiver (if company is insolvent)
        E. Under some statutes a provisional director may be appointed. This differs from a custodian in that
        a custodian normally has complete authority, while a provisional director is a deciding vote.

VIII.   Dissolution for Oppression, Mandatory Buy-Out, and Arbitration
        A. Hetherington & Dooley
                 1. Exploitation is uniquely related to liquidity
                 2. In a close corporation, mandatory buyout should be an available remedy in the case of
        B. Matter of Kemp & Beatley- Circumstances that give rise to dissolution include mistreatment of
        complaining shareholders and misappropriation of corporate assets. Existence of oppression should
        be evaluated in light of shareholders “reasonable expectations.” In this case, the shareholders had
        reasonable expectations of participation in management and a reasonable return on their investment.
        Plaintiffs established grounds for dissolution, but court ordered a period of time for corporation to
        buy them out.
        C. Problems with Reasonable Expectations standard
                 1. Test can be applied to non-monetary issues
                 2. Outcomes could be unpredictable
        D. Arbitration

The Duty of Care and the Duty to Act Lawfully
I.      The Duty of Care; Limits on Liability and D&O Liability Insurance
        A. Francis v. United Jersey Bank- Brothers in a reinsurance company were misapplying customers
        funds for their own benefit. Their mother, a director, failed to understand how business works, keep
        herself apprised of the financial statements, or make the slightest effort to discharge any of her
        responsibilities as a director. Trustee in bankruptcy sued.
                 1. D was held liable for breach of her duty of care.
                 2. Directors cannot set up a defense of lack of knowledge needed to exercise the requisite
                 degree of care.
                 3. Directors should maintain familiarity with the financial status of the company by regular
                 review of financial statements.
                 4. Her duties extended to third parties b/c of nature of reinsurance business
                 5. Causation was satisfied because a facial examination of the balance sheet would have
                 revealed the illegal activity.
        B. Aronson v. Lewis- Directors have duty to inform themselves, prior to a decision, of all material
        information reasonably available to them. Business judgment rule is predicated on gross negligence.
        C. Barnes v. Andrews- Learned Hand addresses some causation issues. The case may stand for the
        proposition that an inattentive director will not be liable if full attentiveness by all the directors would
        not have saved the situation; no cause-in-fact.
        D. Kamin v. AMEX- AMEX owned shares in DLJ and shares lost significant amount of value.
        AMEX can either liquidate at a loss or distribute shares as a special dividend. The former is much
        better for shareholders ($8M in tax savings), while the latter is better for accounting earnings. Court
        said accounting considerations fell under the BJR. Hu: A board would never make such a decision
        E. Standard of conduct outlined in ALI PCG § 4.01(a) gives rise to several duties:
                 1. The duty to monitor
                 2. The duty of inquiry
                 3. The duty to make prudent or reasonable decisions

         4. The duty to employ a reasonable process to make decisions
F. The standard of review applied to these duties, the BJR, is less stringent, and it requires four
conditions precedent:
         1. The director have made an actual decision (failure to inquire does not count, although a
         deliberate decision not to act does)
         2. The director must have informed himself to the extent he reasonably believed appropriate
         under the circumstances (duty to employ a reasonable process)
         3. The decision must have been made in good faith
         4. The director may not have a financial interest in the subject matter of the decision (What
         happens in a takeover when director owns shares?)
G. Cede & Co. v. Technicolor- Directors failed to reach an informed decision, so no protection of
BJR. They then have the burden of establishing that the transaction was fair.
H. Policy Reasons for the BJR
         1. Courts are not business experts and should limit substantive review of business decisions
         2. Hindsight bias
         3. Don‟t want to discourage good risk-taking
         4. May impose too much liability (Shareholder wins by showing bad outcome)
I. The Rule in DE (Aronson): The rule is “a presumption that in making a business decision, the
directors of a corporation acted on an informed basis, in good faith and in the honest belief that the
action taken was in the best interest of the company. Absent an abuse of discretion, that judgment
will be respected by the court. The burden is on the party challenging the decision to establish facts
rebutting that presumption.
J. Smith v. Van Gorkom- Trans Union was a company generating a lot of cash but low net income
due to lots of depreciation. TU had accumulated ITCs that it could not use, and the board believed
that the share price did not reflect TU‟s real value. Board considered MBO, but Van Gorkom (VG),
the Chm/CEO did not want to because of conflicts of interest (supposedly). Roman (CFO) did some
preliminary calculations on what price could service the debt. VG approaches Pritzker and suggest
$55/share, unsolicited. VG agrees to sell Pritzker 1M shares at $38. Bd meets for 2 hours and
approves merger sight unseen. Later approves amendments sight unseen.
         1. Merger Price
                 a. Last 5 yrs price has been b/n 24 ½-39 ½, so $55 represents a substantial premium
                 b. Ct says trading price does not factor in control premium
                 c. Managers clearly thought the market was valuing too low
                 d. We don‟t know what the board could have received if they did a good job
                 e. Company did no assessment of intrinsic value (Roman‟s was a feasibility study)
                 f. Van Gorkom suggested the price and Pritzker jumped on it.
                 g. No I-Banker (although Bd members were highly qualified to assess value)
         2. Procedure
                 a. Van Gorkom was a one-man show. He did not discuss with other board members
                 before approaching Pritzker
                 b. VG did not disclose that he suggested the price, how he arrived at the price, or the
                 purpose of the 9/20 meeting
                 c. No recess in the meeting
         3. Merger Documents
                 a. Delivered too late for review
                 b. Not even a written summary provided to board
                 c. Was not read
                 d. Amendments approved sight unseen
         4. This case shocked legal community
                 a. No conflict of interest to indicate self-dealing
                 b. There was a substantial premium over the trading price
                 c. The directors were very experienced and knew the company inside-out

                       d. The shareholders approved the transaction
              5. The case may not be all good for shareholders
                       a. May encourage board to spend too much time/money on diligence
                       b. Encourages long meetings
                       c. Bid shopping may preclude some early bids
                       d. Gives board more discretion to take advantage of need for deliberation to delay
                       transactions if they don‟t like the suitors
                       e. Cynical view: Another DE tool to help management entrench themselves
                       f. Could discourage competent directors OR cause director pay to rise
                       g. Fallacy of conservatism- more time = higher price. Sometimes deals come along
                       that are very attractive but will be broken if you take too much time.
              6. Court cites Aronson, but are they really applying BJR?
                       a. Aronson says decision will be respected absent an abuse of discretion and that
                       burden is on party challenging to establish facts rebutting the presumption.
                       b. VG did not satisfy the element of an informed decision (duty to employ a
                       reasonable process). Plaintiff established this. So, VG not entitled to protection of
                       the business judgment rule.
      K. Substance and Process in the duty of care- if the process of the decision (4 elements to come
      under protection of BJR) are satisfied in a reasonable way, then the substance of the decision should
      be reviewed under the looser standard of rationality.
      L. Emerald Partners v. Berlin- Burden is on defendant to show that they acted in good faith.
      M. D&O Insurance
      N. Indemnification
              1. Depends on statute
              2. Usually not available when there‟s a judgment against a director. For settlement it
              depends on the statute
              3. Directors are usually entitled to indemnification if they win on the merits.
              4. Certificate of Incorporation can eliminate liability for monetary damages for breach of the
              duty of care (DGCL § 102(b)(7))
      O. In Re Caremark- Directors‟ obligation includes a duty to judge in good faith that the corporate
      information and reporting systems are adequate in design and concept.
              1. Causation must be proven, as good compliance systems are not fail-safe
              2. Plaintiff must show
                       a. Directors knew or should have know of internal control problem
                       b. Directors took no steps in good faith to remedy the problem
                       c. Such failure proximately caused the loss
              3. See SOX §§ 302, 404, 406
      P. Corporate Criminal Liability (CB 581)
      Q. D&O liability to third persons: Generally protected by the corporate veil, but if the conduct
      complained of is tortious, like tortious interference with contract, D&O may be personally liable
      R. A director is only liable for decisions in which he acquiesced. Directors should take care to
      ensure that there dissent is in the minutes or file written dissent after meeting.

II.   The Duty to Act Lawfully
      A. Miller v. ATT- ATT provided services to the Democratic National Convention and never pursued
      the debt. P alleged breach of fiduciary duty and that the action constituted a violation of federal law
      against corporate campaign contribution. If P only alleged failure to pursue a claim, BJR would have
      applied. When violation of criminal law is alleged, especially when it is a law to protect
      shareholders, directors are not entitled to protection of the BJR. (In NY, there must be a net loss to
      the corporation to state a cause of action. This encourages law breaking when it makes economic
      B. Note on Criminal Liability of D&O (CB 596)

The Duty of Loyalty
I.    Self-Interested Transactions
      A. Assumptions
              1. Human nature leads to advancing self-interest
              2. Group dynamics lead uninterested directors to help out the interested directors
      B. Early courts allowed corporation to automatically void the transaction
      C. When does this come into play? (RMBCA § 8.60)
              1. Director or related person is a party to a transaction OR has a financial interest
              2. Director sits on the board of another entity involved
      D. Statutory Approaches
              1. Substantive fairness plus approval of disinterested directors
              2. Substantive fairness
              3. Approval of disinterested directors
              4. Shareholder ratification
              5. Note: Self-dealer must fully disclose for these approaches to be meaningful
      E. Lewis v. SLE- LGT & SLE were corporations owned by different members of the same family.
      LGT leased premises from SLE at unreasonably low rate. Pursuant to a shareholder agreement
      family member in SLE were compelled to sell their shares to unify operations. Brother complained
      that book value (price which he was receiving) had been distorted by the lease. The burden was on
      the defendants to show transaction was fair and reasonable. They failed.

II.   Takeover Context
      A. Devices to thwart takeover
             1. Shark-repellent
             2. Staggered Boards
             3. Poison Pills
      B. Arguments for such devices
             1. Even with a premium, offers may be too low
             2. Preservation of some special corporate control (?)
             3. When public shareholders remain, risk of minority abuse
      C. Argument against
             1. On the whole, mkt for corporate control is good
             2. Ousts bad management
             3. Unlocks value
      D. Law in DE
             1. Unocal- Good faith measure in reasonable relation to threat
             2. Revlon- When board has decided to sell, board has duty to conduct an auction or by other
             means achieve the highest price. Hard part is determining when in “Revlon Mode”
             3. Statute (DGCL § 144) regarding interested directors can‟t be read literally (the “or”
             between the scenarios is not set in stone, will be fact specific). These safe harbors may be
             illusory as courts may review anyway. Some courts view as shifting the burden of proof.


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