Corporations Fienerman Fall Outline 2008

Outlines for Corporations - Fall 2008Professor James V. Feinerman

CORPORATIONS, Pro. Fienerman, Fall 2008I. Agency, P/ship & Ltd Liability Companies

1. Agency2. Restatement (2nd) of the Law of Agency, §§ 1, 2, 13, 26

a) Terms(1) Agency is a fiduciary r/ship which results from the manifestation of consent by one person to another that the latter shall act on the former behalf & subject to his control, & consent by the latter so to act. E.g. S/holders (principals) – officers (agencies).

(a) Principal: has power to dictate how the agent will perform his duties.(b) Agent: is a fiduciary of the principal – owes duties of loyalty, care, full disclosure, integrity, honesty & obedience. Agent must put interests of the principal above his own.

(i) Agent has legal power to bind the principal in relations w/3rd parties.(ii) Agents aren’t guarantors of the results.(iii) Parallel structures – e.g. independent contractor may not be P/A r/ships. (iv) Agents shall act as fiduciaries. E.g. in master / servant r/ships – master shall control & expect the servant to obey. (v) Fiduciaries – i.e. put the interests of the principal above of its own ones.(vi) There shall be manifest act/inaction by the principal to create general understanding that the agent acts on the behalf of principal(vii) Dual agency – there must be a disclosure of possible conflicts of interest. If the principal is OK - then its OK (authority of ratification).

(2) Respondent superior: Wrongs committed by an agent are attributable to the principal so long as they occur w/in the scope of the agent's authority (e.g. w/in the course of employment). The principal authorizes one or more agents to do the company's business & misconduct that occurs w/in the scope of that agency is what the principal has liability for. E.g. "Scope of authority."

(a) CEO has power to bind the company in transactions entered into during the ordinary course of business. Might be different for an extraordinary transaction, requiring special approval from the board or s/holders.(b) An agent needs to make sure the grant of authority is genuine.

(3) Actual authority: Exists when the principal gives consent. Can be created by written or other conduct that causes the agent to believe he had authority.

(a) Express authority: granted to agent by the board directly in a contract or resolution.(b) Implied authority: reasonable implications out of the general grant of authority.

(4) Apparent authority: Exists when you put an agent in a position where 3rd parties would naturally believe that he had authority, it doesn’t matter whether he had actual authority – the principle is still bound. This is about the impression in the minds of people who deal w/ the agent.

(a) Looks to the r/ship b/w the principal & the 3rd party.(b) If authority is doubtful, 3rd party might have a heightened duty to investigate.

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(5) Authority by Estoppel: Exists when the principal fails to deny the authority of the agent.

(a) Example: You go to T-mobile shop & a lady inside the shop wearing a T-shirt w/ T-Mobile logo provides you w/ information about various plans available & sells one of them. You pay to that lady for exchange of a small paper looking like receipt & promise from her that your plan will activated w/in 2 hours. You (as a 3rd person) have reasonable basis to believe that the lady was an agent (employee) of T-mobile. Therefore, T-mobile is liable to you for activation of the said plan, b/c it failed to estop the lady in question from giving an impression of agency.(b) Inaction can have a binding effect.

(6) Authority by Ratification: Exists when after the agent acts on behalf of the principal w/o apparent or implied authority, & the principal manifests its consent to be bind by these actions. In these cases the principal will be deemed to ratify the agency retrospectively.(7) Inherent Authority: Exists when the 3rd party reasonably believes that the agent acts on behalf of the principal, event if the principal didn’t manifests its consents to such actions. (Has recently been eliminated from 3rd Restatement).(8) Delegation of authority by the agent, then it doesn’t jeopardize the ability of the A. to act on behalf of the P.

b) Types of Principal/Agency r/ships(1) Principal & Agent(2) Master & Servant;(3) Independent Contractors(4) Policy: Intended to protect reasonable expectations of innocent 3rd parties who deal w/the corp. & protect the corp. from unauthorized agents.

c) Proof of Agency(1) Express authority - Best one is written. Then it is oral. (2) Implied authority - As a matter of practicality the implied is used more often. E.g. s/holder / officer r/ships. (3) Delegation of agent’s authority – possible if it doesn’t jeopardize the ability of the A. to act on behalf of the P.

d) Duties of an Agent(1) Fiduciary duties – responsibly to put interest of the P above of its own:

(a) Obedience - (b) Loyalty(c) Disclosure(d) Confidentiality – important to protect of confidentiality;(e) Duty to Account – for A.’s actions / inactions. Not necessarily in economic point of view, but time spent, information, money, etc.;(f) Reasonable Care

(2) Full disclosure – of the conflict of interests;(3) Due care – acting of the P. the way or even better as if you act for yourself; duty of special care.;(4) Loyalty – responsibly to put interest of the P above of its own;(5) Honesty – other side of the loyalty;

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(6) Integrity – no dishonor things on our P.;(7) Obedience – w/in the scope of the agency r/ships & obey instructions of the P.(8) Agent’s duty

3. Croissant v. Watrud:(1) Facts: Croissant filled a suit in equity against co-partners in the firm of CPA’s & the executrix of Mr. Watrud (W.)—also a partner—claming damages for breach of duty by W., who paid her money to himself & her husband.(2) Issue: Can a partner bind the p/ship & other partners by its actions, if such actions weren’t in the scope of ordinary business of the p/ship?(3) Court: Accounting p/ship’s client dealing w/ only 1 partner didn’t act unreasonably in trusting the partner further. Accordingly, client wasn’t estopped from asserting against the p/ship her claim for subsequent breaches of duty by the partner she dealt w/.(4) Rule: Agent can bind the principal to liability for actions done on the principal’s account, which usually accompany or are incidental to transactions which the agent is authorized to conduct if, the 3 rd party reasonably believes that the agent is authorized to do them & has no notice that he isn’t so authorized. Inherent authority!

4. Tarnowski v. Resop(1) Facts: Tarnowski (T.) filled a suit against his agent—Resop (R.)—for damages incurred by T. in the course of the litigation for rescission of the fraudulent sale, originated from R.’s breach of his duty (R. took a “bribe” from sellers to convince T. to buy a chain of coin operated music machines).(2) Issue: Whether T. still has a cause of action against R. after it filled a suit against the sellers & returned his money from the fraudulent sale?(3) Court: Minn. Supr. C, said that election by principal to sue 3rd party for rescission didn’t bar action against agent to recover expenses & losses resulting from agent's wrongful conduct.(4) Rule: All profits made by an agent in course of an agency belong to principal whether they are fruits of performance or of violation of agent's duty, & it is immaterial that principal has suffered no damage. Agent must put the principle before himself.

(a) However, if violation consisted of wrongful disposal of principal's property, principal can’t recover its value & also what agent received in exchange therefor.

5. Directors & officers have a fiduciary duty to the corp. & its s/holders(1) Directors & officers have a fiduciary duty to the corp. & its s/holders. (2) Fiduciary duties result from the nature of the employment, & w/out any stipulation to that effect.(3) The fiduciary duty extends to existing s/holders & pledgees of stock, but not to prospective s/holders, however, maybe extended to persons invited to purchase stock. (4) Both directors & officers do & don’t owe a fiduciary duty to ind-al s/holders, but to the s/holders collectively. If only one s/holder, a decision in the interest of that s/holder is not a breach of the duty to the corp.

6. Duty of Loyalty(1) Directors owe fiduciary duties of care & loyalty to the corp. The duty of loyalty is a broad encompassing & is capable of impressing a special obligation upon a director in any of his or her r/ships w/ the corp.

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(2) The duty of loyalty mandates that the best interest of the corp. & its s/holders take precedence over interest of a director, officer or controlling s/holder (if not shared by the s/holders generally). (3) The officer is held to something stricter than “the morals of the market place”. The duty obtains most directly when the officer is interested personally in a matter affecting the corp. The concept of interest includes cases where the officer has a r/ship w/ a party to the transaction that may reasonably be expected to affect the officer's judgment.

7. Duty of Care(1) In addition to their duty of loyalty, discussed in the previous slide, directors & officers of a corp. are required by law to perform their obligations in accordance w/ a minimum standard of care. Courts apply the duty of care in cases involving alleged negligence, mismgt, or intentional decisions to commit unlawful acts. Cases involving fraud, self-dealing, & conflicts of interest are covered under the duty of loyalty.(2) The standard of care for directors & officers of business corp.s is derived from common law & state business corp.s codes. This standard is tempered by the business judgment rule (BJR), a common-law doctrine under which courts generally refuse to second-guess a business decision, so long as mgt made a reasonable effort to make an informed decision. We will examine many cases adumbrating the BJR, especially in the courts of DE.

B. P/ship1. Martin v. Payton

(1) Facts: Appellant claimed that the respondent became partners in the firm by executing 3 doc’s: loan, security & option agreements. The collateral for the loan were securities of the p/ship. Under these doc’s the respondents were to receive a percentage from the p/ship’s profit & obtain a certain level of control over the p/ship’s business.(2) Issue: Whether the arrangement b/w the parties constituted a p/ship?(3) Court: These 3 doc’s held not to create p/ship.(4) Rule: (i) P/ship is a creature of the contract, express or implied; (ii) If the contract contemplates that association of 2 or more persons’ to conduct business as co-owners for profit – there is p/ship (irrespectively of any statement of opposite nature). Anything less than this won’t create p/ship. Manifestation of partner does not matter.

2. National Biscuit Co., Inc. v. Stroud(1) Facts: Stroud (S.) & Freeman (F.) were partners. F. was going to quite from p/ship. S. therefore requested National Biscuit (NB) (its supplier) not to accept any order from F., NB didn’t comply. Nothing in p/ship agreement contemplated that F. is restricted someway in his actions. S. & F. entered into the dissolution agreement, under which all assets of dissolved p/ship remained w/ S. NB claims money for order given by F. while being a partner. S. refuses to pay, claiming that it instructed NB not to accept any orders from F.(2) Issue: Can a partner in 2-partner p/ship bind another partner by his acts, if the other partner disagrees?(3) Court: Order of bread was ordinary course of p/ship’s business, therefore partner (i.e. S.) & p/ship were liable for such order by copartner (i.e. F.).(4) Rule: Any disagreement arising RE: ordinary course of p/ship’s business should be resolved by the majority of partners in a p/ship – 1 partner in a 2-partner p/ship isn’t a

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majority. Unless otherwise provided in the p/ship agreement, the partner in a p/ship have the same level of authority

(a) However: Otherwise in case employment, 1 partner can veto such hire if he disagrees (see Summers v. Dooley).

3. Mainhard v. Salmon(1) Facts: Mainhard (M.) & Salmon (S.) were co-venturers in very successful property dev-t project (this venture was coming to its end). As S. was more business savvy, the landlord approached him w/ proposal for another property dev-t project involving the current facilities & surrounding area. S. went on to enter into the new project w/out disclosing to M. M. filled a suit against S. claiming its interest in the new venture. S. contended that the venture w/ M. was about to over by the time he entered to the new one.(2) Issue: What level of fiduciary duty a participant in the joint-venture owns to its co-venturer?(3) Court: As long as joint-venture lasts co-venturers owns to each other the same level of fiduciary duties those of partners do.(4) Rule: “Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” Principle / agency r/ship principle. Higher standard of loyalty.

C. Ltd Liability Company (LLC):(1) LLC (“the best of both worlds”) is a very common form for small business. The owners are “members” who have ltd liability. Mgt is specified in an operating agreement.

(a) LLC is either centralized or decentralized (b) Can be taxed as a p/ship(c) Has unltd duration, & can be structured in terms of mgt.(d) Very flexible, everything can be specified in the operating agreement.(e) Fiduciary responsibilities: Default rule is that whoever runs the LLC has the same rules of fiduciary duties as in regular corps. But this can be opt-out by the operating agreement.

2. Elf Atochem North America v. Jaffari and Malek, LLC(1) Facts: Elf (E.) brought purported derivative suit against Malek LLC (M.) (where he was a member) & its manager Jaffari (J.), alleging breach of fiduciary duty. The case was dismissed for lack of subject matter jurisdiction. E. appealed.(2) Issue: Whether LLC Agreement was binding to LLC itself, even though it was party to it b/c it didn’t existed then?(3) Rule: (i) LLC was bound by agreement defining its governance & operation, even though LLC didn’t itself execute agreement. (ii) Contractual provisions RE: disputes to be submitted exclusively to arbitration or court proceedings in CA were valid under LLC Act.

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D. Fiduciary Obligations1. Restatement (2nd) of the Law of Agency, §§ 13, 376-396

a) An agent is a fiduciary w/ respect to matters w/in the scope of his agency.(1) Existence & effect of fiduciary duties. The agreement to act on behalf of the principal causes the agent to be a fiduciary. In other words, a person having a duty to act for the benefit of another in matters relate to his undertaking.(2) Other power holders distinguished. The fact that an agent is subject to these fiduciary duties distinguishes him from other persons who have power to affect the interests of others; & duty to act for the benefit of another is often the determinative feature in distinguishing the agency relation from other relations.(3) The facts in each case must be considered in determining whether or not it is understood that the primary obligation of one party is to act for the benefit of the other. The name which the parties give to the relation isn’t determinative.(4) If the agent has ltd capacity, as where he is an infant, he may not be subject to personal liability for his failure to carry out the contractual duties he has undertaken, but any fruits of such undertaking shall belong to principal.(5) Creation Of Authority; General Rule: Authority to act can be created by written or spoken words or other conduct of the principal which causes the agent to reasonably believe that the principal desires him so to act on his account.(6) Manifestations as the sole requirement. It isn’t essential to the existence of authority that there be a contract b/w the principal & agent or that the agent promise or otherwise undertake to act as agent.

E. Piercing the LLC “Veil”1. Kaycee Land & Livestock v. Flahive

(1) Facts: Kaycee Land (KL) brought an action for damages against Flahive LLC (F.) & its managing member for causing environmental damage to the land while using the surface of the land. The Dst. C. certified a question to the Sup. C.(2) Issue: Whether the LLC “veil” can be pierced in the same manner as that of corp.?(3) Rule: (i) The equitable remedy of piercing the LLC “veil” was an available remedy under the Wyo. LLCA. Nothing in the LLCA’s history indicated a legislative intent to prevent piercing the veil doctrine in the LLC context. (ii) The common law rule will not be overruled unless the legislature expressly indented to do so.

II.Basics of CorporationsA. Choice of Entity

1. Sole Proprietorship:(1) 1 owner;(2) duration is ltd by owner’s life;(3) owner gets all benefits, takes all risks;(4) net proceeds = O’s personal income (i.e. pass through entity);(5) non-transferable interest;(6) unltd. personal liability.

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2. P/ship:a) General P/ship (GP): “an association of two or more persons to carry on as co-owners of a business for profit.” Default rule is equality – equal voice, equal authority to bind, & unltd personal liability (can overwrite by an agreement).

(1) Doesn’t require interaction w/ the state, i.e. no registration, filling, etc. Any time 2 or more people go into business together as co-owners for profit, they form GP.(2) Partners need to trust each other – each of the partners has an equal right of participation in the business & has the ability to bind the p/ship & the other partners.(3) No continuity of existence – anytime a partner dies or w/draws the p/ship dissolves.(4) No transferability of interest. (5) Tax: Is just an aggregation of the partners, i.e. no double taxation.

b) Ltd P/ship (LP): a p/ship having general & ltd partners.(1) Ltd partner: has no voice in mgt. Liability is ltd to the capital they contributed. If LP participates in mgt too actively – loses ltd liability shield.(2) General partner: Personally liable as in GP.(3) LP must be filled w/ the secretary of state, failure to do so will result w/ formation of GP;(4) Requires filling with secretary of state;(5) Taxed as a p/ship – no corp. tax.

c) Ltd Liability P/ship (LLP): in LLP the G. Partners can limit their liability to the amount they have invested.

(1) Accountants, lawyers, doctors cannot limit their personal liability for malpractice by becoming a ltd partner.(2) Requires filling with secretary of state;(3) Partners in LLP are liable only for actions under their personal supervision – not liable for other partner's malpractice. Liability not several.

d) Ltd Liability Ltd. P/ship (LLLP): in LLLP the G. Partners can limit their liability to the amount they have invested.

(1) Accountants, lawyers, doctors cannot limit their personal liability for malpractice by becoming a ltd partner.(2) Partners in LLP are liable only for actions under their personal supervision – not liable for other partner's malpractice.(3) Requires filling with secretary of state;

3. Corp.:(1) General Corp. (Corp.): Distinct legal entity from its owners. Mgt is centralized in a BoD.

(a) Need to file articles of incorp.;(b) Unltd duration;(c) Transferability of interest. (d) Tax: Once you create a corp., you also create the corp. as a taxable person subject to separate taxation. Dividends also taxed – i.e. double taxation.

(2) Ltd Liability Company (LLC): Very common form for small businesses. The owners are “members” who have ltd liability. Mgt is specified in an operating agreement.

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(a) LLC is either centralized or decentralized (b) Can be taxed as a p/ship(c) Has unltd duration, & can be structured in terms of mgt.(d) Very flexible, everything can be specified in the operating agreement.(e) Fiduciary responsibilities: Default rule is that whoever runs the LLC has the same rules of fiduciary duties as in regular corps. But this can be opt-out by the operating agreement.

(3) S Corp.: Certain small, simple corp. can choose subchapter S status & be taxed as if they were p/ships to avoid double taxation.(4) C Corp.:

(a) Ltd liability for s/holders even if they participate in mgt.(b) Taxed at both corp. & s/holder level. This double level taxation can be avoided to some extent by payment of reasonable salaries to s/holders in exchange for services actually rendered.(c) Formation similar to S Corp. except for section S election not filed w/ IRS.(d) Typically required for publicly traded corps., businesses that require venture capital.(e) No limits on type or numbers of s/holders(f) Different classes of stock allowed thus enabling different priority for return of capital:

(i) Common Stock (various classes of common stock)(ii) Preferred Stock

B. A Short History of the Corp.1. Internal affairs doctrine: State of incorp. sets the rules regardless of where the corp. conducts business.

(1) "Race to the bottom": Wouldn’t the founders of corp. find the state w/ the most lax rules? But this doesn’t happen b/c other states do pander more than DE & are a lot more mgt-friendly. An equilibrium has left DE somewhere in the middle, not the bottom. DE law is predictable & therefore somehow attractive jurisdiction for corps.(2) Might actually be a race to the top: As long as the choice of incorp. is made before you can sell your shares to the public, investors will not become s/holders of a corp. in a state that doesn’t provide them w/ a reasonable level of investor protection. Ultimately they find a balance.(3) Market forces not legal doctrine align the interests of s/holders & mgt. (4) Corp. law is a set of default rules unless the parties agree otherwise.

C. The Purpose of the Corp. 1. Economic & Legal Framework

a) Should corp. be run for benefit of s/holders or society?(1) Corps. usually have adequate incentives to constrain their profit goals w/in reasonable bounds, i.e. public sentiment. (2) Corps. must take ethical considerations into account. May devote reasonable amount of resources to philanthropic purposes.(3) Economic objectives: short-term profits can be subordinated to responsible corp. behavior that will result in long-term gains.

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2. Dodge v. Ford Motor:(1) Facts: Dodge (D.) & Ford (F.) were s/holders of the same corp. F. was the chair of the board & the controlling s/holder. D. didn’t have as many votes as F. D. claimed that F. breached his fiduciary duties by trying to hold back payment of special dividends. F. contended that he didn’t want to give out dividends for re-investing into the plant. It appears that D. basically wanted dividends for their own factories.(2) Issue: Whether corp. could be forced to pay dividends? Special?(3) Court: Sustained the special dividend portion, but reversed the injunction against building new plant. The C. said that it is not in a position to 2nd guess F.’s decision on the plant’s issue.(4) Rule: A business corp. is organized & carried on primarily for the profit of the s/holders. Company can't do an action that explicitly dismisses s/holder wealth. No BoD decision can ever be taken that goes against this. Only BoD has the power to declare a dividend for s/holders, unless BoD is guilty of fraud or misappropriation of the corp. funds.

(a) F. was outside the zone of behavior b/c he basically said that the s/holders had enough.(b) However: An incidental humanitarian expenditure of corp. funds is permissible. So the discretion to engage in activity that isn’t profit-maximizing is ltd by the requirement that such activity be incidental to the primary purpose of the corp.

3. A.P. Smith Manufacturing Co. v. Barlow(1) Facts: A.P. Smith Manufacturing Co. (AP) made a donation to Princeton Uni. ($1.5K). Action was brought by s/holder asking for judgment declaring the contribution to be a misappropriation of corp. funds & an ultra vires.(2) Issue: Whether a corp. has a right under the statute to make charitable donations?(3) Rule: (i) Corporate power to make reasonable charitable contributions exists, under modern conditions, even apart from express statutory provision (up to 1% of capital) w/in the scope of the purposes of the corp. (ii) Any statutes applies retrospectively.

D. Note on DE Incorporation1. Why is DE Important?

a) In U.S. incorp. statues are state based;b) DE Corp. L. has a long tradition of being chosen by corp.’s in US;c) DE’s Corp. Registry

(1) More than half a million business entities have their legal home in DE including more than 50% of all U.S. publicly-traded companies & 58% of the Fortune 500.

2. Federalisma) Fed. government regulates stock offerings, protects investors, & sets standards for fin. disclosures;b) State governments regulate corp. actions under civil & common L. regimes;c) State of incorp. is very important.

3. Why DE?

a) First mover advantageb) History lesson on incorp.’s

(1) Primary corp. market has been in NY as comm. capital of US;Page 9 of 45


(2) In late 19th century states began to experiment w/ corp. law to become more flexible in regulating incorps. & rules governing the separation of ownership & mgt;(3) NJ was the 1st successful state to move into corp. charter business;(4) DE entered into the market after NJ enacted a series of antitrust laws & become a leading state. This has never changes since then.

4. DE Law Featuresa) Allows flexibility of drafting corp. chartersb) Law sets basic structure

(1) Respecting the right to free contract;(2) S/holder franchise;(3) BoD initiation.

c) Basic Principles(1) Duty of due care to s/holders;(2) Duty of loyalty;(3) Duty of good faith.

5. DE – Who decides?a) DE Court of Chancery

(1) DE's court of original & exclusive equity jurisdiction, & adjudicates a wide variety of cases involving trusts, real property, guardianships, civil rights, & com-al litigation.

b) DE Supreme Court(1) DE's court of final appeal to which appeals from the DE Court of Chancery immediately proceed. There are no further proceedings in DE.

6. Institutions are important!(1) Courts & regulators have played an important role to ensure that corp. governances mechanisms are effective & efficient;(2) Mgt, General Directors, CEOs, Individual directors & the board as a whole need to be held to their duties of care & loyalty to the firm & to apply business judgment in their decisions;(3) The strength of a joint stock company in a market system is the underlying principles of rule of law & fairness to the interest of all s/holders.

E. Players in the Corp.: S/holders, Directors & Officers1. Campbell v. Loew’s Inc.:

(1) Facts: Suit by a s/holder against a corp., requesting a preliminary injunction restraining the holding of a s/holders' meeting, or, restraining the meeting from considering certain matters, or voting certain proxies.(2) Issue: Whether president of the BoD had a right to call s/holders meeting, where the corp. bylaws allowed it to both the president & BoD?(3) Court: The DE Ch. C. declined to enjoin the s/holders' meeting, but preclude the corp. from counting proxy votes & from using corp. personnel & facilities to solicit proxy votes.(4) Rule: (i) the president of the BoD was authorized by the bylaws to call a s/holders' meeting for any reason; (ii) s/holders weren’t restricted when they could vote on directorships, & thus they could replace a director at any time; (iii) directors could be

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removed for good cause, & allegations made by defendants supported the proposed removal of plaintiffs; but (iv) plaintiffs had not been afforded sufficient opportunity to respond to the allegations in the proxy solicitations, & thus the votes tendered by the proxies couldn’t be counted unless & until plaintiffs were given such an opportunity. BoD is in charge of the management, and the President is in charge of executing of the BoD’s policies.

III. Piercing the Corporate VeilA. State Law

1. PCV may happen if the corp. lacks sufficient assets to satisfy the claims, however is an exception rather than a rule. PCV is an equitable remedy to avoid injustice.2. Generally the following factors will be considered by the court for PCV:

(1) Inadequate capitalization(2) Non-functioning of officers & directors;(3) Siphoning of funds from corp.(4) Absence of corp. records(5) Corp. acts as a façade for owners/s/holders(6) Elements of injustice or fundamental unfairness

(a) Subsidiaries: courts accept them as long as the sub. is funded w/ sufficient assets. Corps. should be able to externalize risk through thinly-capitalized subs.

3. Court may disregard the corp. entity if:(1) There is fraud; or(2) Alter Ego doctrine*

(a) *Unity of Interest / Another Me: there is such a unity of interest & ownership such that the separate personalities of the corp. & the individual no longer exist the company is "a mere instrumentality” or “alter ego” of its owner, and(b) Injustice: Allowing s/holder to avoid liability would promote an injustice.

4. Tort v. Contract creditors:a) Tort creditor can’t easily self-protect its (involuntary relations w/ corp.). However, courts pierce corp. veil most often in contract actions.

5. Minnie B. Berkey v. 3rd Avenue Railway Company(1) Facts: Minnie Berkey (MB) was hurt getting out of a street car. MB claimed that b/c (i) the franchise to operate the street railroad belonged to 3rd Avenue Railway Company’s (TARC) parent company (in violation of statute); (ii) subsidiary & parent have their board consisting of almost same set of people; (iii) parents’ legal & accounting departments were in charge of respective tasks of subsidiaries; (iv) employees of parent & other subsidiaries participated in tone centralized pension plan, corp. veil of subsidiary should be pierced to allow her to collect damages from the parent company.(2) Issue: Whether parent company was liable for negligence of its subsidiary, i.e. should the court pierce the corp. veil?(3) Rule: (i) stock ownership alone is insufficient to charge dominant railroad w/ liability for torts of the subsidiary; (ii) The law permits incorp. of a business for very purpose of escaping personal liability.

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(a) However: If dominion is so complete, interference is so obtrusive, that the general rules of agency the parent will be a principal & the subsidiary an agent. If the merger b/w parent & subsidiary might beget more abuses that it stifled the court may ignore separate existence & treat them as a one.

6. Bartle v. Home Owners Cooperative, Inc.(1) Facts: Bartle (a bankruptcy trustee) (B) filled a suit against a parent company for debts of its subsidiary (a co-operative corp.). The trial court found that there was no fraud, misrepresentation or illegality in this case.(2) Issue: Whether the corp. veil can be pierced in the absence of fraud, misrepresentation or illegality?(3) Court: Affirmed dismissal of the claim.(4) Rule: (i) law permitted the incorp. of the wholly owned subsidiary for the very purpose of escaping personal liability; (ii) the doctrine of piercing the corp. veil was invoked to prevent fraud or to achieve equity.

7. Walkovsky v. Carlton: (1) Facts: Walkovsky (W.) was injured in taxi accident. Carlton (C) was a s/holder of 10 small corp.’s, each has 2 cabs w/ only min. car liability insurance ($10K). W. claimed PCV to held C. liable for injury caused by corp. where C. is a s/holder.(2) Issue: Can corp. veil be pierced to allow W. to collect damages from s/holder solely b/c C. organized, managed, dominates & controlled the corps.(3) Rule: The corp. form may not be disregarded merely b/c the assets of the corp. are insufficient to assure a recovery. If the insur. coverage set my the statute is inadequate, the legislature, not the court, has a burden of correcting this.

(a) However: The court will allow PCV whenever (i) it is necessary “to prevent fraud or to achieve equity,” & (ii) if anyone uses ctrl. of corp. to further it’s own interests rather than corp. bus. (here respondent superior principle will apply).

(4) Dissent: The corps. were intentionally undercapitalized. It was an abuse of the separate entity. If capital is illusory or trifling compared w/ the bus. to be done & the risks of loss, this is grounds for PCV. By setting the min. liability insur. coverage requirement, legislature intended to have a coverage able to cover any liability…

8. Morris v. NY Department of Taxation & Finance(1) Facts: A DE corp., w/ offices in NJ, purchased a cruiser. Morris (M.) is the corp.’s pres-t. M. is NJ resident having leased an apt. in NY. He wasn’t a s/holder of corp. The cruiser was used in NY waters. The NY tax depart. (TD) wanted to PCV from another side – i.e. not from individual to corp. TD claimed that as NY resident ctrl-ed a NJ corp., thus a NJ corp. was subject to NY taxation.(2) Issue: Whether or not to PCV in such circumstances?(3) Court: Reserved by the Sup. C. in favor of M., b/c TD failed to demonstrate that NJ corp. was formed solely for purposes of tax evasion in NY.(4) Rule: Party seeking to pierce corp. veil must establish that owners, through their domination, abused privilege of doing business in corp. form to perpetrate wrong or injustice against that party.

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B. Federal Law1. United States v. Bestfoods et al.

(1) Facts: A chemical plant (CH) generated industrial waste for many years. The CH polluted the soil & ground water. Respondents, succeeding parent corp., purchased the chemical plant's assets. EPA, sued to recover funds for the clean the site. The Dist. C. found respondents directly liable to pay for clean up. The App. C. reversed.(2) Court: US Sup. C. vacated & remanded, b/c a participation-&-ctrl test looking to the parent corp.'s supervision over a subsidiary couldn’t be used to identify direct parental liability.(3) Rule: (i) The parent can’t be derivatively liable under CERCLA if the corp. veil isn’t pierced. However, parent maybe liable if it’s ctrl. over the sub. resulted w/ direct pollution of the facility; and (ii) when, but only when, the corporate veil may be pierced, a parent corporation may be charged with derivative CERCLA liability for its subsidiary's actions.

IV. State Law on Fiduciary Duty of Directors & OfficersA. Nonfeasance

1. Overview

a) Duty of Care: The duty of care requires that directors make decisions based upon reasonably adequate information & deliberation. Directors shall:

(1) Discharge duties w/ the care that an ordinarily prudent person in a like position would exercise under similar circumstances;(2) Discharge duties in a manner they reasonably believe is in the best interest of the corp.(3) Duty of Care requires the directors to attend board meetings; obtain & review adequate info. concerning actions taken by the board; & generally supervise the corp.’s business & its major policies.

b) Fiduciary duties: When you are the director/officer of a corp., you have a legal obligation to act w/ loyalty & care in carrying out your responsibilities.

(1) The board manages the corp., not courts. There should be enough judicial scrutiny to prevent cheating, but not so much that it interferes w/ legitimate business activity.

2. Francis v. United Jersey Bank(1) Facts: Action was brought by trustees in bankruptcy of corp. (re-insurer) to recover funds paid by corp. to principal s/holder for benefit of his estate, & to members of his family. Mrs Francis (F.) was a Director in bankrupt corp.(2) Court: The Sup. C. held that F. was negligent in not noticing & trying to prevent misappropriation of funds held by corp. in an implied trust & her negligence was proximate cause of trustees' losses.(3) Rule: A corp. director should acquire at least a rudimentary understanding of bus. of corp., b/c directors are bound to exercise ordinary care, they can’t set up as a defense lack of knowledge or bus. experience – she should either acquire the knowledge by inquiry, or refuse to act. Directors of corp. have a continuing obligation to keep informed about activities of corp.

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B. Business Judgment Rule (BJR)1. Overview:

a) The BJR is a presumption of the courts that in making a business decision the directors fulfill their fiduciary duties of care & loyalty to the corp. by:

(1) Acting on an informed basis (due diligence);(2) In good faith; and(3) In the honest belief that the decision was in the best interest of the corp. (loyalty to corp.)

b) Application of BJR: The BJR protects only informed decisions by the board.(1) To come under the rules of protection, directors must inform themselves of all information reasonably available to them & relevant to their decision;(2) The proper standard for determining whether a business judgment was an informed one is gross negligence as opposed to mere negligence.

c) The BJR won’t protect director if they either abdicated their functions or failed to act.

2. DE General Corp. Law §§ 141, 251, 271a) Subchapter IV: Directors & Officers

(1) § 141. BoD’s; powers; number, qualifications, terms & quorum; committees; classes of directors; nonprofit corps.; reliance upon books; action w/o meeting; removal;

(a) The business & affairs of every corp. organized under this chapter shall be managed by or under the direction of a BoD’s, except as may be otherwise provided in this chapter or in its certificate of incorp. If any such provision is made in the certificate of incorp., the powers & duties conferred or imposed upon the BoD’s by this chapter shall be exercised or performed to such extent & by such person or persons as shall be provided in the certificate of incorp.

3. Federal Rules of Civil Procedure 23.1.a) Derivative action by s/holders

(1) Fed. R. Civ. Proc. 23.1(b)(3)(A) – plaintiff shall state w/ peculiarity any effort by the plaintiff to obtain the desired action from the directors or comparable authority and, if necessary, from the s/holders or members.

b) Contemporary Ownership Rule(1) This rule requires that the plaintiff in the derivative litigation be a s/holder when the cause of actions arose and continuously since that time.(2) Some state permits a s/holder to serve as a plaintiff even though not a s/holder when the cause of action arose if the s/holder acquired the shares in ignorance of the existence of the claim.

c) Derivative actions are brought by a s/holder on behalf of the corp. b/c the board has failed to do so, i.e. stepping in the “shoes of corp.”

(1) Any amounts recovered belong to corp., not plaintiff.(2) Virtually all derivative actions are brought against directors or controlling s/holders who have breached duties to the corp. (3) Plaintiff represents the corp. on behalf of the other s/holders.

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(4) Sometimes possible to have multiple s/holder suits. Derivative litigation operates as res judicata1 w/ respect to the disposition of the claims involved in the lawsuit.

d) Direct v. Derivative action:(1) Wherever there is injury to corp. the suit is derivative, in contrary where injury is to the s/holder(s) the suit is direct. (2) Characterizing it is as derivative may allow the board to take over or seek dismissal of case if demand & security requirement haven’t been met. (3) Examples of direct actions:

(a) Protection of fin’l rights: i.e., compel dividends (b) Protection of voting rights(c) Protection of governance rights(d) Protection of minority rights: i.e., challenge improper mergers, prevent oppression. (e) Protection of informational rights: i.e., right to inspection.

4. Nursing Home Building Corp. v. DeHart(1) Facts: The corp. sought review of a judg-t that awarded little damages in a suit RE: fraudulent misappropriation of corp. funds against former s/holders. During the s/holders' mgt of the corp., it had serious cash flow problems, resulting in the sellers' forfeiture of the stock purchase contract. (2) Issue: Were former s/holders of corp. protected by the BJR?(3) Court: Ruled that there wasn’t misappropriation of corp. funds as decisions were approved by all s/holders of corp. BJR applied.(4) Rule: (i) BJR immunizes mgt from liability in corp. transaction undertaken w/in both power of corp. & authority of mgt where there is reasonable basis to indicate that transaction was made in a good faith. (ii) Where actions of director were ratified by all s/holders, former sole s/holders were not liable to corp. for such actions.

C. Nonfeasance or the Business Judgment Rule?1. Smith v. Van Gorkom:

(1) Facts: Van Gorkom (VG) was CEO of Trans-Union (TU), which experienced problems w/ tax credit. VG, based on his state of mind, thought that the corp. was worth $55/share in a buy-out. CFO under VG’s request prepared a cash-flow analysis based on the assumption that the corp. will be bought-out for $55/share. VG then approached a Pritzker w/ offer to but-out the corp. for $55/share. Market price was $38/share. Pritzker agreed. BoD didn’t like this idea, but under time pressure & following VG’s 15min presentation approved the but-out (w/ very little discussion/debate). S/holders also approved it relying on proxy statement.(2) Issue: Could the BoD rely on BJR protection?(3) Court: BoD didn’t reach an informed business judgment. BoD was grossly negligent in approving the buy-out 2hour consideration, w/o proper price evaluation of the value of the corp. S/holder approval didn’t provide a shield as the proxy statement was misleading (as if BoD conducted an evaluation & proposal was profitable).

(a) Directors should use good faith not blind reliance . Court didn’t like the fact that BoD blindly relied in VGs presentation w/o further inquiry, despite of being experienced businessmen.

1 Means no longer subject to appeal.Page 15 of 45


(b) The fact of a premium alone doesn’t provide an adequate basis upon which to assess the fairness of the offering price. Market price doesn’t always show the correct value of the company.(c) The presumption that the directors acted in good faith is irrelevant in determining the threshold issue of whether the board exercised an informed business judgment.

(i) E.g. of the BoD being grossly negligence could be the faulty process they used. Court may use this as grounds for rebutting BJR b/c BoD has to have made bus. judg-t, which implies threshold level of process/deliberation. If such level of process can’t be demonstrated, then acts are beyond gross negligence threshold, i.e. no BJR protection.

(a) Policy: Judges aren’t business experts, but they’re good at assessing procedures employed.

(4) Rule: Test I - whether the BoD have informed themselves prior to making a business decision of all material information reasonably available to them. Test II - gross negligence is the standard to determine whether a business decision was an informed one.

(a) There is no protection under BJR for BoD has made an unadvised judgment.(b) Fulfillment of fiduciary role requires more than there mere absence of bad faith or fraud.

(5) Critique:(a) Critiques believe that VG case was wrong on the facts but right on the law, i.e. this didn’t meet the gross negligence standard. (b) B/c of VG case, directors didn’t want to be held personally liable. Thus DE passed §102b7 rule. It allows companies to provide that directors shall not be personally liable for damages UNLESS BoD acted disloyally, in bad faith, criminally, or intentionally to harm the corp.

2. Note on Settlements & Attorney's Feesa) Overview:

(1) Lawyers paid on contingent fee basis (no award for plaintiff – no fee to attorney). This provides an incentive for attorneys to settle for big amount. (2) Strike suits: have little prospect of success on the merits, but could impose litigation costs forcing defendants to settle.

b) Why would s/holders bother to bring derivative claim when there is nothing personally in it for them?

(1) If you get a judgment or settlement of that action, the law firms have a quasi contractual right to be compensated by the s/holders from the amount created by the judgment.(2) No case can be settled unless a judge determines that the settlement is fair to the corp. & its s/holders.

c) Courts are split as to which method of compensation is appropriate:(1) Lodestar approach: ask how many hours went into litigation multiplied by reasonable hourly rate, then adjust up or down to reflect quality of work. Judge makes independent evaluation after settlement as to what efforts were worthwhile - holistic, subjective approach.(2) Percentage of recovery: instead of quantifying effort, just say 30% should go to lawyers (usually 20-30);

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(3) Incentives for lawyers: lawyers might behave strategically based on which rule is adopted. I.e., if you bring strike suit litigation or nuisance litigation – you try to get them to settle even if you think you can't win.

d) Class Actions & Their Abuse(1) Class actions were conceived as an expeditious way for people w/ similar grievances to join in a common suit & get compensated for injuries, however, they have become a tool for trial lawyers to launch litigations against large bus-es. Plaintiffs sometimes don’t even know they are on trial.(2) Despite of lacking cause of action, these bus-es forced to settle rather go for expensive trials as they may face K/M of plaintiffs.(3) Mostly only trial lawyer benefit (an aver. fee is $1K/hour). Plaintiffs get tiny awards. E.g. in insur. sum-up case in TX, lawyers got $11m; plaintiff’s only $5.5.

e) Market in Securities(1) Lawyers even sue when there is a drop in a corp.’s stock price—often w/o any proof of corp.’s wrong. Corp. forced to settle, 1/3 of sett-t goes to lawyers.(2) The figures show that securities class actions don’t prevent corp. wrong.(3) Securities class action filings rose 31% in 2002. In a recent sett-t a law firm negotiated $300m in fees.

f) “Magnet” Courts(1) Class actions tend to involve plaintiffs from multiple jurisdictions. Thus, trial lawyers are able to make “a forum shopping”. The best forum should be known for favor of class action (magnet courts). (2) E.g. Madison County, Illinois —made a $10.1b verdict against Philip Morris in a “light cigarettes are safer” case. After that the # of class actions filled there increased over 1,800%.

g) Oversight of Class Action Settlements(1) The Sup. C. in Campbell v. State Farm case ltd jury’s ability to set punitive damages at an extreme multiple of actual damages. NY judge Nicholas Figueroa recently threw out as an excessive a $1.3 b claim by the Castano group for work on the California tobacco settlement.

D. Duty of Loyalty & Derivative Actions: Demand & Security Requirements1. Overview:

a) Duties of Agent to Principal, agent shall:(1) act for the benefit of the P.(2) not receive outside benefits w/o approval of the P.(3) can neither disclose nor use for her own benefit any confidential info.(4) not be allowed to compete w/ his P. w/in the scope of the agency bus.(5) not act for 2 P.’s whose interests conflict.(6) not become a party to a transaction w/t the P.’s permission.(7) not engage in inappropriate behavior that reflects badly on the P.

b) Principal’s Remedies When the Agent Breaches a Duty(1) The P. can recover damages caused by the agent’s breach.

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(2) The A. must refund any profits made from the agency, if he breaches his duty of loyalty.(3) The P. may rescind a transaction w/ a disloyal agent.

c) Fiduciary Duties of Directors - Duty of Loyalty(1) Questions about board members’ duty of loyalty most often arise where:

(a) There is a conflict of interest; or(b) Board member takes advantage of a corp. opportunity of the comp.

d) Duty of Loyalty Analysis(1) Is there any conflict of interest?

(a) Direct

(i) Transaction b/w corp. & fiduciary(b) Indirect

(i) Transaction b/w corp. & another corp. in which fiduciary has [substantial?] fin’l interest.(ii) Family transactions.

(c) If “yes”, transaction is voidable by corp.

e) DE GCL §144, §251, §277(1) Sets mere fin’l interest as basis for conflict of interest.(2) Three alternative ways to cleanse:

(a) Disclosure to BoD & approval

(i) No quorum requirement; but majority of minority requirement (b) Disclosure to s/holders & approval

(i) No apparent quorum requirement (c) Transaction fair at time of approval

(i) Burden of proof shifts…

2. The Demand Requirement:(1) Before a s/holder files a derivative suit the s/holder is required to make a demand on the BoD to take an action or explain why demand is excused as futile.(2) Policy:

(a) Corp. is run by the BoD, so decision to bring a lawsuit is a bus. decision. S/holder must 1st ask the BoD to bring the lawsuit itself. Demand is excused if suit is against actions of the BoD.(b) Ensures that intra-corp. remedies are exhausted before going to the courts.(c) Protects against strike suits.

(3) Failure to establish that demand is the futile: usually results in the end of derivative suit. Where demand has been made & refused, BJR applies to the board’s refusal.

3. Security Requirement:(1) In around 1/3 of states (not DE), a derivative claimant w/ “low stakes” must post security for corp.’s legal expenses.(2) This requirement exists to prevent frivolous suits from being made, if plaintiff loses the security deposit cover corp.’s expenses on defense.

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4. Holden v. Construction Machinery Co.:(1) Facts: Herle Holden (HH) brought a s/holder's derivative & direct actions against Warren Holden (WH) (s/holder/director & his brother) & corp. - Construction Machinery Co. (CM) He alleged fraud in the sale of corp. shares by WH & breach of his employment contract w. corp.(2) Court: The trial court found for HH, decreed that the shares of the corp.'s stock were held in trust by WH & that HH was entitled to a conditional annual judgment based on the employment contract. No exemplary damages. Appel. C. reversed in part (WH & CM are liable for exemplary damages); remanded for the amount due to the corp. & for reasonable attorneys fees & expenses that HH & WH incurred.(3) Rule: (i) Equity holds officers & directors of corp. entity, particularly mgt-ctrl-ing directors of closely held corps. strictly accountable as trustees. (ii) Majority s/holder of corp. who was also president & general manager was strictly accountable to corp. for another company's stock purchased w/ check from corp., or for fair market value of such stock, & for all increases, income, proceeds or dividends realized.

5. Eisenberg v. Flying Tiger Line, Inc.(1) Facts: Eisenberg (E.) initially filled a direct suit on behalf of himself & other minority s/holders of corp. to enjoin its reorg-on & merger against Flying Tiger-Line (FTL). FTL moved to dismiss on the ground that security requirement wasn’t complied w/. E. didn’t post a security & the trial court dismissed the case. E. appealed, claming that the action to be personal & not derivative. Higher court reversed. (2) Court: The court determined that b/c E. claimed the reorg-on deprived him & other minority s/holders of any voice in the affairs of the corp., the injury suffered was personal & not derivative.(3) Rule: (i) If the gravamen of the complaint is injury to the corp. the suit is derivative, but "if the injury is one to the plaintiff as a s/holder & to him individually & not to the corp.," the suit is individual in nature & may take the form of a representative class action. (ii) The law of forum law will apply RE: demand and security requirements in derivative suits.

6. Marx v. Akers (NY)(1) Facts: The Marx (M.) alleged that the BoD of IBM wasted corp. assets by increasing their compen. while corp. bus. wasn’t at its best shape (self-dealing).(2) Issue: Whether (i) demand requirement was excused; (ii) BoDs’ wasted corp. assets by increasing their comp-on?(3) Court: (i) The demand was excused b/c a majority of the BoD was self-interested in this matter. (ii) The claim was dismissed, b/c the M. failed to state a cause of action.(4) Rule: An allegation that BoD has voted them compensation doesn’t give rise to a cause of action, as BoD is statutorily entitled to set those levels. M. must have alleged compen. rates be excessive or other facts questioning whether the compen. was fair to the corp. when approved, the good faith of the BoD setting those rates, or that the decision to set the comp-on couldn’t have been a product of valid BJ. (DE Futility test –if one must show a “reasonable doubt” either (i) that the BoD is self-interested or (ii) the BoD breached their duty of loyalty) (NY Futility test – one must prove to the court the BoD is interested in the transaction).

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E. Directive Actions: Role of Special Litigation Committees (SLC)1. SLCs: were formed mainly in response to derivatives suits.

(1) Structural bias: SLC’s might be influenced by other directors. i.e., they all serve as colleagues on the same board.(2) BoD may act as a whole in reviewing a s/holder's demand or it may choose to appoint a committee to investigate the facts underlying a demand & make a report & recommend. RE: the suit. (3) Cases that have rejected the decisions of SLC’s have largely focused on the independence or good faith of the SLC’s members & the reasonableness of the investigations. (4) SLC may also be appointed to review & make a binding determination w/ respect to a pending derivative action where a demand has been excused.

2. In evaluating a SLC:(1) If demand was required (there is a majority of directors that aren’t tainted) that board may create SLC & that committee will be given BJR defense.

(a) If there is no material dispute as to their independence, quality of analysis & the reasonableness of their recommendation (Oracle case).

(2) If demand was excused (a majority of the board has a problem) then even though the SLC is made up of independent directors, it will get a harder look.

3. Decision by the SLC:(1) is binding on the plaintiff s/holder; BUT(2) s/holder may litigate issues such as:

(a) the independence & lack of involvement of the SLC members(b) the adequacy of the underlying investigation.

4. Auerbach v. Bennett (NY): (1) If SLC isn’t “independent,” its recommendations are meaningless:

(a) Independence Factors: Non-defendants; no nomination by named directors; full delegation of authority to SLC.(b) Note: Once above factors established plaintiff bears burden of proof that BoD didn’t acted in a good faith.

(2) If SLC is independent:(a) Procedures used by SLC scrutinized under gross negligence standard.(b) Substantive decision of SLC gets protection of the BJR:

“the substantive aspects of a decision made by a committee of disinterested directors appointed by the corp's BoD is beyond judicial inquiry under the BJR, the court may inquire as to the disinterested independence of the members of that committee & as to the appropriateness & sufficiency of the investigative procedures chosen & pursued by the committee.”

(3) Critique:(a) The above rule ignores problems of “structural bias” in the BoD.

b) Zapata v. Maldonado: two-part test for looking at SLC’s decision to dismiss derivative suit.

(1) 1st inquire into independence & good faith of SLC & the bases for its conclusions. (a) Corp. has burden of proof.

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(2) 2nd, if 1st step is met, court should apply its own “independent business judgment” as to whether the motion should be granted – intrinsic fairness standard. HOWEVER

c) Aronson v. Lewis:(1) Zapata Test applies only to “demand excused” cases. In all “demand required” cases BJR should be applied, no court’s “independent business judgment” is applicable. (2) In a “demand required” case, must make a demand on the BoD or his case will be dismiss for failure to exhaust hi remedies. If s/holder demand on the BoD, this means that the case was “demand required.”

(a) Result: Almost in all cases in DE, demand is not made today.

d) Demand in DE

e) Demand Excused in DE

5. In Re Oracle Corp. Derivative Litigation (1) Facts: Oracle was successful, publicly held, & in the computer software business. The directors sold shares prior to publication of the quarterly corp.'s earnings, which were lower than expected by analysts. The sales were w/in the time limit established for insider's sales. SLC was formed, which prepared a report, & as a result moved to terminate the claim.

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Demand ExcusedAronson StandardBurden on Board

Independent Good Faith Reasonable investigation

If not Case not Dismissed If not Case not Dismissed If not Case not Dismissed

good faith, independence & reasonable investigation

Court applies ITS Bus. Judgment --- YES / NO--- Derivative Case not Dismissed

Zapata TEST

Demand Required -- Demand Excused

Board or Committee Upheld, Unless

Wrongful

Special Committee

Aronson Futility Standard

Independence

Good Faith

Reasonable Basis


(2) Issue: Whether or not the two-member SLC was independent, given that both have substantial ties w/ Stanford University as the defendants did.(3) Rule: The independence test was whether the individual SLC member was incapable of making a decision w/ only the best interests of the corp. in mind, or, as a result, w/out considering any way in which his decision would impact him.

(a) In order to prevail on its motion to terminate the s/holder derivative action, the SLC was required to persuade superior court that:

(i) Its members were independent; (ii) It acted in good faith; & (iii) It had reasonable basis for their recommendations

6. Subsequent Developments(1) Once resolved a derivative suit on the merits is res judicata & precludes other derivative suits on the same theory that the suit is brought on behalf of corp.

F. Dominant S/holders Problems & a Primer on Corporate Finance1. Overview

a) Duties of Controlling S/holder (1) A controlling s/holder has duties similar an officer or director, similar to the duties of due care & loyalty. (2) The duty arises when the controlling s/holder:

(a) Exercises control over the corp.(b) Engages in self-dealing transactions(c) Sells control

b) Exercise of Control(1) A controlling s/holder has the right to use his or her majority or controlling interest to exercise control over the corp.(2) But the exercise of control is subject to a ltd fiduciary duty make full disclosure of all facts “germane” to the transaction (or “material” facts).

c) Intrinsic Fairness Test(1) Example: Sinclair Oil Corp. v. Levien

(a) Sinclair Oil causes its subsidiary to pay dividends rather than invest profits in growth.(b) Court said the dividend policy was completely fair b/c the dividends were paid proportionally.(c) But, Sinclair did engage in self-dealing b/c Sinclair’s other subsidiaries paid its bills late & Sinclair caused Sinven not to enforce the contract.

2. Sinclair Oil Corp. v. Levien (1) Facts: This involved transactions b/w a parent corp. & 98% owned sub. The minority s/holders of the sub attacked several transactions b/w parent & the sub. They included decisions (1) to pay large dividends by the sub solely to meet cash need of the parent; (2) to limit oil development in other countries to different sub’s; & (3) to cause the sub not to pursue claims for breach of contract against the parent.(2) Issue: “Intrinsic fairness” or “BJR” doctrines to be applied?

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(3) Court: The Court concluded that the issue involving the excessive dividends & limiting business opportunities should be evaluated under BJR. However, refusal to enforce the contract claim should be evaluated under “intrinsic fairness” test.(4) Rule: (1) A parent owes a fiduciary duty to its subsidiary when there are parent-sub dealings. However, this alone doesn’t evoke the intrinsic fairness standard. This standard will be applied only when the fiduciary duty is accompanied by self-dealing—the situation when a parent is on both sides of a transaction w/ its sub. Self-dealing occurs when the parent . . . causes the sub to act in such a way that the parent receives something from the sub to the exclusion of, & detriment to, the minority s/holders of the sub.”

b) Can a s/holder attack a transaction if there is no self-dealing?(1) Yes if, “the motives for causing the declaration of dividends are immaterial unless the plaintiff can show that the dividend payments resulted from improper motives & amounted to waste.”

(a) Definition of Waste: “an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade.”(b) Does Waste = Fraud? If so, then s/holders cannot approve the transaction & it is not protected by the BJR

c) Burden of Proof(1) Once the plaintiff raises the issue of fairness, the burden is on the defendant to prove fairness;(2) The defendant can shift the burden to plaintiff if the transaction was:

(a) Fully Disclosed(b) Approved by independent, disinterested special committee

3. Zahn v. Transamerica Corp. (1) Facts: Zahn (Z) held Class A stock in a corp. Transamerica (T) owned almost all of the same corp.'s Class B stock & dominated the mgt, business, & affairs of the corp. Z filed a class action suit alleging that T caused the corp. to redeem its Class A stock & then liquidated the corp. so that T could acquire most of the value of the corp. for itself.(2) Court: On appeal reversed b/c T, as the BoD of the copr & as controlling s/holder, had a fiduciary duty to minority Class A s/holders that was violated if the allegations of Z were true.(3) Rule: (i) The law imposes upon the directors of a corp. or upon those who are in charge of its affairs by virtue of majority stock ownership or otherwise the same fiduciary relationship in respect to the corp. & to its s/holders. (ii) The majority has the right to ctrl, but when it does so, it occupies a fiduciary relation toward the minority, as much so as the corp. itself or its officers & directors. (iii) Duty only mandates that the board acts as if it were independent, i.e. inform Class A s/holders of their stock value & then redeem for Class B.

(4) AXTON FISHER Shares Structure(a) Class A S/holders

– Annual (Cum.) Dividend: $3.20– Convertible To B; 1:1– Contingent Voting Rights

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– Liquidation Rights -- 2:1– Callable: $60 + Acc. Div.

(b) Class B S/holders

– Annual Dividend: $1.60– Voting Rights– Liquidation Rights -- 1:2class

(c) Pref. Shares Par Value: $100

– Annual (Cum.) Dividend: $6– Liquidation Value: $105+Cum. Div.– No Voting Rights

(d) Debt

b) Dominant S/holders’ Duties(1) A s/holder can be “dominant” w/ <50% of shares

(a) Courts usually presume dominance at 25%.

(2) Virtually all successful suits against dominant s/holders are for duty-of-loyalty: i.e., causing BoD to effect a non-pro-rata distribution of corp. assets.

(a) Duty of Care/BJR tends to protect otherwise;

(3) As w/ interested directors, once plaintiff makes this showing, burden shifts to the defendant s/holder to “cleanse”, which is often harder for a dominant s/holder to demonstrate.

c) Self Dealing Transactions(1) When the exercise of control involves engaging in a self-dealing transaction w/ the corp., the controlling s/holder has the duty to prove that the transaction is intrinsically fair to the minority s/holders.

d) Intrinsic Fairness Test(1) Consider two factors:

(a) Fair Dealing: Procedural aspects: How was the transaction was timed, initiated, structured, negotiated, disclosed & approved? Was it rushed by the controlling s/holder?(b) Fair Price: Considering all relevant factors, was the price fair?

G. Ratification by S/holders1. Overview

a) Ratification(1) Ratification by disinterested corp. participants creates a “safe harbor” that “sanitize” self-dealing transactions w/out the necessity of a judicial inquiry into the fairness of the transactions. HOWEVER(2) Ratification under old 8.31 (a)(1) or (a)(2) doesn’t validate transactions that involve waste, fraud or actions in excess of authority. BUT if sanitized under the said rules the burden of proving waste & fraud is on the attacking person.

b) Duties of Controlling S/holder (1) A controlling s/holder has duties similar an officer or director, similar to the duties of due care & loyalty. (2) The duty arises when the controlling s/holder:

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(a) Exercises control over the corp.(b) Engages in self-dealing transactions(c) Sells control

2. Flieger v. Lawrence (1) Facts: Lawrence (L)–the president of Agua–acquires some antimony. He proposes it to Agau, but the latter can’t accept b/c of lack of fin’l resources. So L gives it to USAC. USAC later acquires 800K shares of Agau stock in an approved merger by s/holders. L & other D’s argued that sec 144(a)(2) should protect them from any claim of voidability due to self-dealing, b/c the transaction was approved by s/holders.(2) Court: The court held that the burden was upon D’s to demonstrate the intrinsic fairness of the transaction. L & other D’s didn’t wrongfully usurp an opportunity belonging to Agua. & that they & close corp., didn’t wrongfully profit by causing Agua to exercise an option to purchase that opportunity.(3) Rule: (i) Where certain individuals stood on both sides of transaction b/w 2nd corp.’s in negotiating the terms of option agreement by which 1st corp. acquired the other, the burden was on those Ds to demonstrate its intrinsic fairness to the acquiring corp. & its s/holders. (ii) Since a majority of the shares of corp. voted in favor of exercising option to purchase a 2nd corp. were cast by D’s, ratification by the s/holders didn’t affect the burden of showing that the transaction was intrinsically fair. (iii) In determining intrinsic fairness of 1st corp.'s option to acquire a 2nd corp. in light of the fact that the D’s owned stock & held positions in both corp.’s, court would examine the transaction as of the date on which s/holder approval was given. (MAJORITY OF MINORITY should ratify being fully informed and such MAJORITY OF MINORITY must be disinterested).

3. In re Wheelabrator Technologies, Inc. S/holders Litigation (1) Facts: The class alleged a breach of fiduciary obligations (1) to disclose to the class material info RE: the merger; as well as breach the duties of (2) due care & (3) loyalty. Defendants moved for summary judgment.(2) Issue: Can informed s/holder ratification extinguish claims for breach of duties to disclose, duty care & loyalty? (3) Rule: In only 2 circumstances has the DE Supreme Court held that a fully-informed s/holder vote operates to extinguish claim:

(a) Where the BoD takes actions claimed to be in exceed the BoD’s authority (but not ultra vires, fraud or waste); & (b) Where it is claimed that the directors failed to exercise due care to adequately inform them before committing the corp. to a transaction.

The effect of s/holder ratification in duty of loyalty case has been either to change the standard of review, w/ the burden of proof resting upon the plaintiff, or to “entire fairness” as the review standard, but shift the burden of proof to the plaintiff. BUT in this case (b/c the merger did not involved a dominant s/holder) the standard of review of BJR, not an “entire fairness”. The burden of proof shifted to the plaintiff.

H. Note on “The Duty to Act in Good Faith”1. The Disney Case

(1) Facts: The litigation involved a derivative suit against Disney’s directors & officers for damages allegedly arising out of the 1995 hiring & the 1996 firing of Michael Ovitz. The termination resulted in a non-fault termination payment to Ovitz under the terms of

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his employment agreement valued at roughly $140 million. The s/holder plaintiffs alleged that the Disney’s directors had breached their fiduciary duties both in approving Ovitz’s employment agreement & in later allowing the payment of the non-fault termination benefits.(2) Rule:

- the contours of the duty of good faith remained “relatively uncharted” & were not well developed;

- any definition of bad faith that would cause a violation of due care (i.e., gross negligence) to become a de facto act or omission not in good faith would eviscerate the protections afforded by Sections 102(b)(7) & 145 of the DGCL.

- 2 categories of fiduciary behavior that constitutes bad faith:o The 1st is so-called “subjective bad faith,” evidenced by “fiduciary

conduct motivated by an actual intent to do harm” to the corp. or its s/holders, referred as “quintessential bad faith.”

o The 2nd category–“intentional dereliction of duty, a conscious disregard for one’s responsibilities.”

“[T]he universe of fiduciary misconduct is not ltd to either disloyalty in the classic sense…or gross negligence. Cases have arisen where corp. directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision. To protect the interests of the corp. & its s/holders, fiduciary conduct of this kind, which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed. A vehicle is needed to address such violations doctrinally, & that doctrinal vehicle is the duty to act in good faith.”

V. Federal Law Regarding Duties to S/holdersA. Regulation by the Securities & Exchange Commission

1. Note on Definition of a Securitya) Section 2(1) of the 1933 Securities Act

(1) The term equity security is hereby defined to include any stock or similar security, certificate of interest or participation in any profit sharing agreement, pre-organization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, ltd p/ship interest, interest in a joint venture, or certificate of interest in a business trust; any security future on any such security; or any security convertible, w/ or w/out consideration into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another w/out being bound to do so.

b) SEC v. Howey provides for 4 step test:(1) An investment of money or other valuable property;(2) In a common enterprise:

(a) horizontal commonality

(i) a pooling of investors’ contributions & distribution of profits & losses on a pro-rata basis among investors(ii) investors are similar

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(b) vertical commonality (less strict)

(i) (less stringent) requires that an investor & promoter be engaged in a common enterprise, w/ the “fortunes of the investor linked w/ those of the promoters”(ii) portion of investors linked to those of promoters

(3) W/ an expectation of profits;(4) Coming primarily from the efforts of others:

(i) An agreement among the parties leaves so little power in the hands of the partner or venturer that the arrangement in fact distributes power as would a ltd p/ship, or (ii) The partner or venturer is so inexperienced & unknowledgeable in business affairs that he is incapable of intelligently exercising his p/ship or venture powers; or (iii) The partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful p/ship or venture powers. Koch v Hankins

2. Federal Securities Law(1) The Fed Securities Laws are comprised of a series of statutes, which in turn authorize a series of regulations promulgated by the SEC(2) The 2 main statutes involved in the Fed Sec laws are the Securities Act of 1933 (governs the issuance of securities by companies) & the Securities Exchange Act of 1934 (governs the trading, purchase & sale of those securities)(3) Each has a wealth of regulations promulgated by the SEC, as well as regulations adopted by the National Association of Securities Dealers, Inc. & the various stock exchanges

3. State Securities Laws (Blue Sky Laws)(1) While the SEC directly, & through its oversight of the NASD & the various Exchanges, is the main enforcer of the nation's securities laws, each individual state has its own securities regulatory body, typically known as the state Securities Commissioner. (2) Most states have left the anti-fraud regulations to the SEC & the various SROs, but do in fact have the power & authority to bring actions against securities violators pursuant to state law. Further, each state has its own securities act, which governs, at least, the registration & reporting requirements for broker-dealers & stock brokers doing business, sometimes even indirectly, in the state. (3) The various state securities regulators have most of their impact in the area of registration of securities brokers & dealers, & in the registration of securities transactions.

4. Common Law & the Securities Markets(1) In addition to the varied securities rules & regulations enacted by statute, there is a large body of case law, decisions by judges, which impact severely on the securities industry.

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(2) Briefly, there is the concept of common law fraud, & in theory, if perchance a particular act did not fall w/in the scope of the federal securities laws, the actor may still be subject to a fraud claim under the common law. (3) In some states & in certain circumstances stock brokers may be considered to be fiduciaries to their customers. That is, they are expected to conduct themselves w/ a higher degree of care than would the ordinary person. (4) Additionally, the common law notions of contract & negligence also find their way into the securities laws, for each purchase & sale of a security is in reality a contract, & each transaction b/w market participants, whether in the financing of an IPO, or in the customary stock purchase w/ a broker, can involve issues of negligence law.

5. Note on SEC Registration Processa) Purpose of registration

(1) The ’33 Act aimed to increase the public trust in American markets. It accomplishes this goal through disclosure of important fin’l info in the registration statement, & in the prospectus. The info in the prospectus enables investors to make informed judgments about whether to purchase a company's securities.

b) Registration process(1) In general, securities sold in the U.S. must be registered. The registration forms call for:

(a) a description of the company's properties & business;(b) a description of the security to be offered for sale;(c) information about the mgt of the company; and(d) financial statements certified by independent accountants.

(2) All companies must file their registration statements electronically. These statements become public shortly after filing & accessible through EDGAR system.

6. Note on Other Exemptions [under the Securities Act of 1933](1) Issue of the following doesn’t require registration w/ the SEC:

(a) private offerings to a ltd number of persons or institutions;(b) offerings of ltd size;(c) intrastate offerings; and(d) securities of municipal, state, & federal governments.

(2) Regardless of whether securities must be registered, the 1933 Act makes it illegal to commit fraud in conjunction w/ the sale of securities. A defrauded investor can sue for recovery under the 1933 Act.

7. Note on Securities Act Civil Liabilities(1) When a registration contains either an untrue statement or omission to state a material fact, required being stated or necessary to make the statement therein no misleading, then the following is liable:

(a) Directors, accountants, named directors, underwriters (b) Experts: Accountants, Lawyers

(i) Expert Portion (a) Defense: Reasonable Investigation, Reasonable Grounds

(ii) Non-expert Potion (a) Defense: Non-liable (b)(3)(A)

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(iii) Non-Experts: Underwriters (iv)Expert Portion

(a) Defense: Non-liable (b)(3)(A) (v) Non Expert Portion

(a) Defense: Reasonable Investigation & Reasonable grounds (c) The Firm faces strict liability (d) Outside Directors have a far less obligation than do inside directors, effectively stating that they may rely on the advice of experts on solely expert testimony, but for the unexpertized portions, they cannot just say that they consulted experts

B. Insider Trading1. The basic rule of insider trading

(1) Under Rule 10b-5 insiders (or those who step into their shoes) must either disclose material, non-public information or not trade – Disclose or Abstain

2. Four Categories (1) Classical Insider Trading: A person who has access to material, nonpublic info has a relationship of trust & confidence w/ the party to sale must either disclose or abstain from trading

(a) Basic harm is a fraud on the other party to sale of securities (b) A fiduciary nexus is required for liability (c) Applies only when a relationship of trust exists b/w the insider who trades based on material, nonpublic info & the party on the other side of the transaction (d) Classical insiders are officers, directors, controlling s/holders & any employee (e) Rule for liability is that: A person who has a relationship of trust & confidence w/ the corp. must disclose material, non-public info prior to trading or abstain from trading based on the info.

(2) Constructive Insider Trading (extension of the classical theory): A version of classical insider trading that involves a person who becomes temporary fiduciary of the corp. (e.g. lawyers, bankers)

(a) Constructive insiders is:

(i) any person in a temporary relationship of trust & confidence w/ the corp.(ii) Lawyers, accountants, bankers, consultants

(b) Rule for liability: A person who has a relationship of trust & confidence w/ the corp. must disclose material, nonpublic info prior to trading or abstain from trading based on the info

(3) Outsider Trading (Misappropriation): A person who appropriates material, non-public information in violation of a duty of trust & confidence w/ the source of the information

(a) Basic harm is a fraud on the source of the inside info (b) Requires relationship of trust or confidence w/ the source of the material, non-public info (c) Applies to outsiders who have no fiduciary relationship to the company in which the securities are traded (e.g. a banker for the bidder in a tender offer who considers trading the company’s stock)

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(d) Examples of when people owe trust & confidence to the source are employee/employer relationships or other fiduciary relationships - lawyers, accountants, investment bankers, consultants

(4) Tipper/Tippee Insider Trading: A tipper or tippee faces liability for trading based on material, non-public information upon satisfaction of the personal benefits & breach of fiduciary duty tests

(a) Applies to both classical theory & misappropriation theory (b) For tippers :

(i) 10b-5 liability extends to insiders & outsiders w/ a duty of confidentiality who improperly "tip" others regarding material, non-public info (ii) Impropriety governed by "personal benefits" test

(a) Money, enhanced reputation (c) For tippees:

(i) 10b-5 liability extends to tippees who trade based on the receipt of material, nonpublic info from insiders or outsiders w/ a duty of confidentiality (ii) Tippee must know or have reason to know that the tipper breached a fiduciary duty

(d) Chain of liability:

(i) Liability attaches to entire claim of tippees (ii) At some point, connection might seem too tenuous to satisfy requirement that tippees know or should have known about the breach of duty of confidence by tipper (iii) Some cases have held entire chain liable, however, if there is conscious indifference to source of information

(e) No eavesdropping liability

(i) You are not required to abstain from trading based on material, non-public info if you hear that info from someone w/ who you have no relationship of trust or confidence

3. Rule 10(b)5-2b: A relationship of trust & confidence exists when:(1) the recipient agreed to keep the info confidential, (2) the persons involved in the communication have a history or pattern of sharing confidences (so that recipient should have known the communicator expected the info to be kept confidential) or (3) the person who provided the information was a spouse, parent, child, or sibling of the recipients, unless the recipient could show that there was no reasonable expectation of confidentiality (4) the rule for liability:

(a) Must disclose or abstain from trading (b) Disclosure to source insulates trader from liability

4. Insider Trading Penalties (1) SEC Enforcement

(a) Civil & Criminal Penalties (b) Disgorgement of Profits

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(c) Treble Damages (d) Private Causes of Action

(2) Private Causes of Action

5. "Material inside information" – standard of materiality(1) Basic test in determining whether information of insider is "material inside information" is whether

(a) reasonable man would attach importance to information in determining his choice of action in transaction in question, & that (b) encompasses any fact which in reasonable & objective contemplation might affect value of corp.'s stock or securities.

(2) "Material inside information" includes not only info disclosing earnings & distributions of corp. but also those facts which affect probable future of corp. & those which may affect desire of investors to buy, sell, or hold corp.'s securities. (3) Whether facts in possession of insider are material inside info, when facts known to insider relate to particular event & are undisclosed will depend at any given time on balancing of both, indicated probability that event will occur & anticipated magnitude of event in light of totality of corp.'s activity

6. United States v. O’Hagan(1) Facts: The case involves a tender offer by Grand Met to Purchase Pillsbury Company. Grant Met was represented by Dorsey & Whitney, a law firm where O’Hagan was a partner. O’Hagan didn’t work on this matter directly. However, he learned of the proposed tender offer from conversations w/in the firm, & he made huge purchases of Pillsbury stock & options before the takeover attempt was announced. He profited more than $4.3m from this transaction.(2) Issue: Misappropriation theory.(3) Rule: The U.S. Supreme Court approved decision of the district court, which was reversed by the 8th Circuit court, holding by a majority vote that insider trading violation occurs when a person misappropriates confidential information for the securities trading purposes in breach of duty owed to the source of the information.(4) CONTRARY TO THE CLASSICAL THEORY OF INSIDER TRADING: which applies not only to officers, directors, & other permanent insiders of corp., but also to attorneys, accountants, consultants, & others who temporarily become fiduciaries of corp.

7. SEC v. Texas Gulf Sulphur(1) Facts: 14 employees (D.) of Texas Gulf (TGS) discovered large deposit of ores. Some D.’s purchased stock in the TGS. TGS released an ambiguous statement about drilling, then released a detailed statement a few days later, after which the price of TGS’s stock increased substantially. The SEC commenced action alleging violations Sec. 10(b) & Rule 10b-5. The below court found that 2 of the individual D’s, Clayton & Crawford had violated Sec. 10(b) & Rule 10b-5.(2) Rule: The court held that not only are directors or mgt officers of corp. 'insiders' w/in meaning of Sec 10b-5 of ’34 Act, to be precluded from dealing in stock of corp., but Sec. is also applicable to one possessing information, though he may not be strictly termed an 'insider' w/in meaning of ’34 Act. Thus anyone in possession of material inside info is an 'insider' & must either disclose it to investing public, or, must abstain

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from trading in or recommending securities concerned while such inside info remains undisclosed.(3) Duty of insider to disclose info or abstain from dealing in corp.'s securities arises only in essentially extraordinary situations, which if disclosed are reasonably certain to have substantial effect on market price of security;(4) Insider is not obligated by the SEC rule to grant on outside investors benefit of his superior fin’l expertise by disclosing his educated forecasts, but objective rather requires nothing more than disclosure of basic facts so that outsiders may draw on their own evaluative expertise w/ knowledge equal to that of insiders. (5) "Material inside information" – is whether reasonable man would attach importance to info in determining his choice of action in transaction in question, & that encompasses any fact which in reasonable & objective contemplation might affect value of corp.'s stock.

C. Rule 10b-51. Overview

a) Sec 10b-5 & Rule 10b-5(1) Rule 10b-5, & Section 10b are known as the Anti-Fraud provisions of the 34 Act, & most regulations flow from this rule. The rule has been the subject of extensive litigation, & later revisions to this article will address some of the significant aspects of those matters, including insider trading, market manipulation, fraud in connection w/ public offerings & takeovers, & fraud in connection w/ dealings w/ customers.(2) A private cause of action exists under 10b-5(3) Only persons who are purchaser or sellers of securities can be plaintiffs under 10b-5(4) Defendants maybe liable even if they themselves neither purchased nor sold securities(5) The plaintiff must establish that defendants acted w/ “scienter”, i.e. “intentional wrongdoing” or a “mental state embracing intent to deceive, manipulate or defraud” (recklessness in some circumstances can satisfy “sceinter”)(6) Triggered by use of interstate commerce (mail, telephone, etc.)(7) Prohibits deception, not unfairness.

“ Sec. 78j. Manipulative & deceptive devices

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange -

(a) To effect a short sale, or to use or employ any stop-loss order in connection w/ the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules & regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

(b) To use or employ, in connection w/ the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules & regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

2. Efficient Capital Markets Hypothesis (ECMH)(1) Basic Assumption: Prices of publicly traded assets match the value that asset pricing theory says they should have

(a) Strong ECMH - Market prices are an unbiased estimate of future cash flows fully reflecting all information

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(b) Semi-strong ECMH Market prices are based on an unbiased forecast of future cash flows that fully reflects all publicly available information(c) Weak ECMH - Market prices reflect all information contained in the record of past prices

3. Basic Inc. v. Levinson(1) Facts: The Supreme Court granted certiorari to resolve a split among the courts of appeals as to the standard of materiality applicable to pre-merger discussions, & to determine whether the courts properly imposed a presumption of reliance in certifying class members in an action alleging violations of Sec 10(b) of the ’34 Act & Rule 10b-5.(2) Rule: The court held that an omitted fact is material if a reasonable s/holder would consider it important in making their vote, & this standard should be applied to all Sec 10(b) & Rule 10b-5 actions. The court also held that materiality requires a case by case review of the facts, & a rebuttable presumption exists that s/holders relied on available info when buying or selling securities. The judgment of the court of appeals was accordingly reversed & remanded.(3) Fraud on the market theory is based on the hypothesis that, in an open & developed securities market, the price of a corp.'s stock is determined by the available material info regarding the corp. & its business. Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. The causal connection b/w the defendants' fraud & the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations.

b) Traditional requirements of a 10b-5 action:(1) Materiality - a reasonable investor would have considered the misstatement or omission important (magnitude and probability (reasonable likelihood)).(2) Scienter - defendant acted w/ intent to deceive, manipulate or defraud.(3) Reliance - plaintiff must show s/he relied on the misrepresentation; or, if omission, rebuttable presumption absent contrary proof by defendant that the plaintiff relied. HOWEVER: under ECMH theory showing of reliance not required.(4) Causation - the misstatement or omission caused the plaintiff’s damage.

4. Note on Judicial Limitations on Actions Under Rule 10b-5(1) First, both District Courts & Courts of Appeal appeared to be more willing to dismiss the cases;(2) Second, rule 9(b) requires allegation to be plead “w/ particularity.” Case law in 2nd Circuit required not only that the plaintiff state facts w/ particularity, but also these facts must give rise to a “strong inference” that the defendant’s intent was fraudulent.(3) Third, circuits adopted a “bespeaks caution” principle that prevents reliance on forward looking statements (e.g. forecast, projection, or statements regarding expectations of future performance)

D. The Federal Proxy Rules1. Problems of Control

a) Note on Proxy Fights(1) Proxy fights occur when minority owners are trying to get enough votes to obtain seats on the Board or affect other important issues that are coming up for the vote.

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(2) Mgt has several advantages in a traditional proxy fight:(a) it has current list of s/holder, while the insurgents may have to go court to het it;(b) Mgt may finance its solicitation from the assets of the corp., while insurgents may not;(c) S/holders unhappy w/ mgt tend to sell rather than fight;

(3) Can be used in hostile takeovers, e.g. an aggressor may acquire a substantial minority position in the target by purchase & then use proxy contest to obtain sufficient additional votes to replace incumbent mgt.(4) Proxy fights are subject to SEC regulation, which requires:

(a) a participant in a proxy contest to file specified info w/ the SEC & the securities exchanges at least 5 days before the solicitation begins. The info to be disclosed relates:

(i) the identity & background of the participants;(b) their interests in securities of the corp., when they are acquired’

(i) financing arrangements;(ii) participation in other proxy contests;(iii) understandings w/ respect to future employment w/ the corp.

b) Sample of a Proxy Card(1) Proxies – s/holders voting mechanism (their right to control). It is a solicitation to s/holders to allow people to vote for them.

(a) Must have an annual meeting(b) Sometimes special meetings for unusual events(c) Must have a quorum amount & notice

(i) Proxies help to get quorum amount & make it possible for them to show up(d) Director, officers, controlling s/holders may call special meetings(e) Date of citizenship is record date

(2) Soliciting proxies requires that you give the person you are soliciting a proxy statement, if there are any false or misleading statements made negligently you face liability 14(a)

(a) Proxies can be used by s/holders to get at social policies of the corp. not business policy though you entrust that to your board.

c) SEC proxy rules:(1) Requirements to disclosure of full info to s/holders relating to:

(a) proposals for s/holder action presented by mgt through the proxy solicitation machinery;(b) to a lesser extent, general info about the operation of the corp.

(2) Prohibitions against fraud or deceptive non-disclosure in proxy solicitation material;(3) Requirements that appropriate proposals submitted by the s/holders be included in the proxy solicitation materials prepared by mgt & s/holders be given an opportunity to consider them.(4) Special requirements applicable only to proxy fights.

d) SEC Rule 14a-3, Disclosure requirements(1) If mgt is making solicitation, info must be furnished about the corp.’s affairs; about the backgroung of directors & nominees, about their remunerations; about other

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transactions w/ mgt & w/ other, & about any matter on which the vote of s/holder is sought.(2) The proxy statement defined to include newspaper ads & informal communications among s/holders w/ respect to voting plans;(3) Provides that if a solicitation is made on behalf of mgt relating to an annual meeting of s/holders are which directors are to be elected, the proxy statement must be accompanied by an annual report of corp.(4) Corp. under sec 12 of ’34 Act that plan to conduct a s/holders’ meeting w/out 1st making a proxy statement must supply s/holders w/ the same info as if they were make a proxy statements;

e) SEC Rule 14a-9, False or Misleading Statements [in Proxy Materials](1) No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time & in the light of the circumstances under which it is made, is false or misleading w/ respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication w/ respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.(2) The fact that a proxy statement (or any similar form) has been filed w/ or examined by the SEC shall not be deemed as a “safe harbor.”(3) The following are some examples of what, depending upon particular facts & circumstances, may be misleading w/in the meaning of this section.

(a) Predictions as to specific future market values.(b) Material which directly or indirectly impugns character, integrity or personal reputation, or makes charges concerning improper, illegal or immoral conduct or associations, w/out factual foundation.(c) Failure to so identify a proxy statement, form of proxy & other soliciting material as to clearly distinguish it from the soliciting material of any other person or persons soliciting for the same meeting or subject matter.(d) Claims made prior to a meeting regarding the results of a solicitation.

2. Gaudiosi v. Mellon(1) Facts: The Court of Appeals held that candidate-s/holder's “unclean hands” would require denial of equitable relief in connection w/ proxy contest even though other s/holder-plaintiffs had not participated in his acts.(2) Rule: In action for equitable relief RE: proxy contest, evidence sustained finding that one of plaintiffs had "unclean hands" by reason of his attempts to intimidate s/holders. One who comes into equity must come w/ clean hands & keep those hands clean throughout pendency of litigation, even to time of ultimate disposition by appellate court.

3. J.I. Case Co. v. Borak(1) Facts: Plaintiff was a s/h in J.I. Case Co., which was merged into American Tractor Co. Plaintiff alleged that the merger was effected through the use of a false & misleading proxy statement. The sole question here is whether a violation of the proxy rules gives rise to a private cause of action for damages or rescission.

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(2) Issue: Whether §27 of ’34 Act authorizes a fed cause of action for rescission or damages to a corp. s/holder w/ respect to a consummated merger which was authorized pursuant to the use of a proxy statement alleged to contain false & misleading statements violative of §14(a) of ’34 Act?(3) Rule: The “private enforcement of the proxy rules provides a necessary supplement to SEC action. As in antitrust treble damage litigation, the possibility of civil damages or injunctive relief serves as a most effective weapon in the enforcement of the proxy requirements.” The court can shape any remedy, if the statute does not provide for any specific remedy.

E. State Law Regarding Inspection of Books & Records1. Thomas & Betts Corp. v. Leviton Mfg. Co., Inc.

(1) Facts: Minority s/holder (T&B), which had purchased its interest in closely held corp. w/ the goal of ultimately acquiring the entire corp., requested inspection of corp.'s books & records. The Court of Chancery granted ltd inspection so that s/holder could value its shares, & s/holder appealed. (2) Issue: Whether T&B have stated “proper purpose” under Sec 220 DGCL for inspection of corp.’s books & records? (3) Rule: (1) s/holder failed to satisfy appropriate standard for inspection of books & records w/ regard to claim of waste & mismgt; (2) facilitating its own use of equity method of accounting for its investment was not proper purpose for s/holder's requested inspection; & (3) trial court did not abuse its discretion in lmt’ing scope of inspection to those doc’s which were essential & sufficient to s/holder's purpose of valuing its shares. (4) While s/holder seeking inspection of corp.'s books & records in order to investigate waste & mismgt has burden of coming forward w/ specific & credible allegation sufficient to warrant suspicion of waste & mismgt, s/holder doesn’t bear "greater-than-normal evidentiary burden," but rather has a normal burden. (5) The s/holder's primary purpose for inspecting books & records of closely held corp. was to acquire corp., this interest was contrary to those of corp., but that unwillingness of corp.'s principal to negotiate change-of-control transaction put s/holder in unenviable position of "locked-in" minority s/holder, trial court properly ltd s/holder's inspection to those doc’s which were essential & sufficient to its purpose of valuing its shares.Damages

F. Sarbanes-Oxley1. Note on Sarbanes-Oxley Act (SOA)

(1) Fast pace of SOA’s approval likely to result in need for numerous interpretations & explanations & there is a potential for far reaching impact on Corp. Gov. & Conduct, Fin’l Reporting & the Public Accounting Profession & also affects legal community & investment banking analysts(2) Consistent w/ President Bush's "Ten Point Plan" & guided by the core principles of providing better info to investors, making corp. officers more accountable, & dev’ing a stronger, more independent audit system, Sarbanes-Oxley contained a requirement that corp.’s disclose rapidly & in plain English any info that materially affects the corp.'s fin’l condition. Corp.’s also have to include in their annual & quarterly fin’l reports info on "off-balance-sheet" transactions.

2. Welch v. Cardinal Bankshares Corp.

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(1) Facts: Corp. Exe., who was terminated for engaging in activities protected by SOA's whistleblower protection provision, filed petition seeking enforcement of an ALJ's order of reinstatement. Employer filed motion to dismiss.(2) Issue: Whether or not court can enforce a preliminary order of ALJ?(3) Rule: (1) ALJ's order was a preliminary order, & (2) court did not have subject matter jurisdiction to enforce ALJ's preliminary order.

(a) Due to the jurisdiction-conferring nature of statute governing enforcement of Department of Labor rulings, inconsistent agency interpretations could not inform the court's interpretation of the statute. (b) Filing of an enforcement action w/ the district court under Sarbanes-Oxley Act's whistleblower protection provision vests jurisdiction in the district court.

VI. Close CorporationsA. Fiduciary Obligations in the Close Corp.

1. MBCA §§ 7.22, 7.30, 7.31, 7.32

a) § 7.22. PROXIES(a) A s/holder may vote his shares in person or by proxy.(b) A s/holder may appoint a proxy to vote for the s/holder by signing an appointment form, or by an electronic transmission.(c) An appointment of a proxy is effective when a signed appointment form or an electronic transmission of the appointment is received by the inspector of election or the officer or agent of the corp. An appointment is valid for 11 months unless otherwise is provided in the appointment form.(d) An appointment of a proxy is revocable unless stated otherwise in the appointment form & the appointment is coupled w/ an interest. Appointments coupled w/ an interest include the appointment of:

(1) a pledgee; (2) a person who purchased or agreed to purchase the shares; (3) a creditor of the corp. who extended it credit under terms requiring the appointment; (4) an employee of the corp. whose employment contract requires the appointment; or (5) a party to a voting agreement created under section 7.31.

(e) The death or incapacity of the s/holder appointing a proxy doesn’t affect the right of the corp. to accept the proxy’s authority unless notice of the death or incapacity is received by the officer before the proxy exercises his authority under the appointment.(f) An appointment made irrevocable under subsection (d) is revoked when the interest w/ which it is coupled is extinguished.(g) A transferee for value of shares subject to an irrevocable appointment may revoke the appointment if he didn’t know of its existence when he acquired the shares & the existence of the irrevocable appointment wasn’t noted conspicuously on the certificate representing the shares.(h) Subject to section 7.24 & to any express lmt’on on the proxy’s authority stated in the appointment form or electronic transmission, a corp. is entitled to accept the proxy’s vote or other action as that of the s/holder making the appointment.

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b) § 7.30. VOTING TRUSTS(a) One or more s/holders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them, by signing an agreement setting out the provisions of the trust & transferring their shares to the trustee. When a voting trust agreement is signed, the trustee shall prepare a list of the names & addresses of all owners of beneficial interests in the trust, together w/ the number & class of shares each transferred to the trust, & deliver copies of the list & agreement to the corp.’s principal office.(b) A voting trust agreements may not extend beyond 10 years. (c) The agreement must be in writing & signed by one or more s/holders who transfer their shares to the voting trustee on the books of the corp.(c) A voting trust agreement can be extended at any time during its life for a period of 10 years running from the date the 1st s/holder signs extension of a voting trust.

c) 7.31. VOTING AGREEMENTS (Pooling agreements)(a) Two or more s/holders may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this section is not subject to the provisions of section 7.30.(b) A voting agreement created under this section is specifically enforceable

d) § 7.32. S/HOLDER AGREEMENTS(a) An agreement among the s/holders of a corp. that complies w/ this section is effective among the s/holders & the corp. even though it is inconsistent w/ one or more other provisions of this Act in that it:

(1) eliminates the BoD or restricts the discretion or powers of the BoD;(2) governs the authorization or making of distributions whether or not in proportion to ownership of shares, subject to the limitations in section 6.40;(3) establishes who shall be directors or officers of the corp., or their terms of office or manner of selection or removal; (4) governs the exercise or division of voting power by or b/w the s/holders & directors or by or among any of them, including use of weighted voting rights or director proxies;(5) establishes the T&C of any agreement for the transfer or use of property or the provision of services b/w the corp. & any s/holder, director, officer or employee of the corp. or among any of them;(6) transfers to one or more s/holders or other persons all or part of the authority to exercise the corp. powers or to manage the business & affairs of the corp., including the resolution of any issue about which there exists a deadlock among directors or s/holders;(7) requires dissolution of the corp. at the request of one or more of the s/holders or upon the occurrence of a specified event or contingency; or (8) otherwise governs the exercise of the corporate powers or the mgt of the business & affairs of the corp. or the relationship among the s/holders, the directors & the corp., or among any of them, & is not contrary to public policy.

2. Euphemia Donahue v. Rodd Electrotype Company of New England, Inc.(1) Facts: This case involved a non-pro rata distribution to a ctrl’ing s/holder, a distribution in which minority s/holders were not permitted to share.(2) Issue: What level of fiduciary duties a ctrl’ing s/holder owes, if at all, to a minority s/holder in a close copr.?

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(3) Rule: This case created a duty similar to the duty of partners in a partnership, which they owe to each other. The court created a general principle of “equal opportunity” for minority s/holders in such cases.

(a) Just as in a p/ship, relationship among s/holders of close corp. must be one of trust, confidence and absolute loyalty if enterprise is to succeed;(b) Although corp. form provides advantages for s/holders such as ltd liability, perpetuity, etc., the close corp. provides an opportunity for majority s/holders to oppress or disadvantage minority s/holders who are subject to a variety of oppressive devices termed "freeze-outs" which majority may employ. (c) To secure dissolution of ordinary close corp., s/holder in absence of corp. deadlock must own at least 50% of the shares or have advantage of favorable position in articles of organization.

3. Definition of the Close Corp.(1) A close corp. to be typified by:

(a) a small number of s/holders;(b) no ready market for corp. stock;(c) substantial majority s/holder participation in the mgt, direction and operations of the corp.

B. S/holder Agreements in the Close Corp.1. Note on S/holder Agreements, Voting Trusts, Statutory Close Corp.s, & Involuntary Dissolution.

See above 2. Galler v. Galler

(1) Facts: Action for specific performance of s/holders' agreement and for accounting. The court entered a decree adverse to defendants, and they appealed. The Appellate Court for the First District reversed in part and affirmed in part and remanded. (2) Rule: The Illinois Supreme Court held that where the agreement wasn’t a voting trust but a straight contractual voting control agreement which did not divorce voting rights from ownership of stock in a close corp., the duration of the agreement, which was interpreted as continuing so long as one of the 2 majority s/holders lived, didn’t offend public policy and did not render the agreement unenforceable.

(a) It also concluded “any arrangement concerning the mgt of the corp. which are agreeable to all” should be enforced if:

(i) no complaining minority interest appears;(ii) no fraud or apparent injury to the public interest appears; and (iii) no clearly prohibitory statutory language is violated.

C. Oppression in the Close Corp.1. Baker v. Commercial Body Builders, Inc. (Oregon)

(1) Facts: Owners of 49% of stock in a close corp. filed action against owners of remaining stock and directors of corp. to compel dissolution of corp. for alleged oppressive and fraudulent conduct of ctrl’ing s/holder. The court dismissed the complaint and the plaintiffs appealed. (2) Rule: The Oregon Supreme Court held that though some of ctrl’ing s/holder’s conduct, inc’ing preventing plaintiffs from examining corp. records and failing to notify plaintiffs of certain corp. meetings, was 'oppressive' conduct w/in statute authorizing liquidation of assets and business of a corp., trial judge was not in error in finding that

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such conduct was not so serious as to require dissolution of corp. or any other equitable relief in view of fact that most of conduct complained of occurred during one year and did not continue after that year.

(a) A "close corporation" is not like a partnership and a minority stockholder does not have the right to demand dissolution of a corporation upon substantially the same showing as might be sufficient for dissolution of a partnership.(b) An “oppressive” conduct defined:

(i) an abuse of corp. position for private gain at the expense of the s/holders;(ii) plundering of a “close” corp. by the siphoning off of profits by excessive salaries or bonus payments and the operation of the business for the sole benefit of the majority s/holders, to the detriment of the minority s/holders, would constitute an “oppressive” conduct as to authorize a dissolution of the corp.

D. Special Statutory Treatment of the Close Corp.1. DE Statute & Notes & Questions

a) Of particular interest:(1) Recognizing that close corporations will operate like partnerships;(2) Remedies for deadlock:

(a) Custodian(b) Provisional director(s)

(3) DE takes a cautious approach to fiduciary duties(4) Does NOT impose partnership-like duties on close corporation shareholders(5) May limit remedies practically available to dissatisfied participants in DE LLCs

b) Other factors to consider:(1) Similar to partners carrying out a joint business for profit.(2) The corporation may be their only source of income.(3) Their investment in the business may also represent the majority of their personal assets.

c) Allocation of Control Issues(1) Courts allow shareholders in close corporations to modify the allocation of corporate control(2) shareholder voting agreements(3) voting trusts(4) classified stock(5) super-majority voting or quorum(6) restrictions on share transfer

d) Fiduciary Obligations in Close Corporation -- Shareholders in a close corporation have the following duties:

(1) a duty of reasonable care(2) a duty to further the interests of each other w/in the scope of the relationship(3) a duty not to w/hold relevant information regarding the affairs of the relationship

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(4) a duty not to use their positions to gain special advantage over the other people involved

(a) These are all judicially created, not statutory.

e) Public Policy Considerations(1) Shareholders depend upon the corporation for their livelihood.(2) Minority vulnerable to "freeze-outs" - controlling shareholder prevents minority from realizing the economic benefits of the corporation.(3) Controlling shareholder can exercise economic coercion to get the minority shareholders to relinquish their shares at unfairly low prices

f) Reasonable Expectations(1) A shareholder in a close corporation may reasonably expect ownership will entitle him or her to a job, a place in management, a regular dividend, or some other form of security.(2) The expectations of the shareholder must be:

(a) Reasonable under the circumstances(b) Central to the decision to join the corporation

(3) Reasonable expectations may change over time

g) Proper Purpose(1) If acts defeat reasonable expectations, majority still has opportunity to show that they took action for a proper business purpose.(2) The injured shareholder then has the right to show that there were alternative methods to achieve the business purposes that were less harmful to the minority.

h) Public Policy Considerations(1) Nature of the relationship in close corporation where shareholders are similar to partners.(2) Risk that majority shareholders are using economic duress to oppress, disadvantage or freeze-out a minority shareholder.(3) Control of Publicly Traded Corp.’s

E. A. S/holder Proposals1. SEC Rule 14a-8, S/holder Proposals

(1) Rule 14a-8 establishes a procedure by which s/holders may submit proposals for inclusion in the registrant’s proxy solicitations material. If the proposal is an appropriate one for s/holder action, and is timely, the issue must include the proposal even if opposed to it. S/holder’s proposal may address levels of executive compensation, discrimination, affirmative action, the treatment of minority groups, the use of nuclear power, and environmental concerns.(2) SEC may issue a “no action letter” stating that it will not pursue a claim if the corp. will exclude the particular s/holder proposal from agenda. This letter is not binding for it.(3) Eligibility – s/holder must own shares for the value at least $2K, or 1% of company’s securities entitled to be voted, and for at least 1 year by the date (s)he submit its proposal. S/holder must continue to hold the securities through the meeting.(4) The proposing s/holder may include no more than 500 words in support of its proposal;

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(5) The s/holders’ proposals may be decline for following purposes:(a) 14a-8(i)(1) proposal does not concern a proper subject for action by s/holder (b) 14a-8(i)(2) proposal is illegal(c) 14a-8(i)(3) proposal violates the proxy rules (e.g.: 14a-9 prohibits misleading proxy material)(d) 14a-8(i)(4) proposal concerns a personal grievance or benefit(e) 14a-8(i)(6) proposal concerns a matter beyond the power of the firm to effectuate (f) 14a-8(i)(7) proposal related the firm’s ordinary business operations(g) 14a-8(i)(12) proposal has been submitted in the past 5 years and has not obtained much support (series of percentage votes ranging from 3% - 10%, rising for each re-submittal of the proposal)

2. Lovenheim v. Iroquois Brand, Ltd.(1) Facts: Shareholder filed suit seeking to bar corporation from excluding from proxy materials being sent to all shareholders in preparation for an upcoming shareholder meeting information concerning a proposed resolution (pâté) he intended to offer at meeting.(2) Rule: Rule 14a-8(i)(5) provides that if a shareholder’s proposal relates to operations which account for less than 5% of the firm’s assets, earnings or sales, and is not otherwise significantly related to the firm’s business, the proposal may be omitted from the proxy statement. But what kinds of proposals are “significantly related” to the firm’s business?

(a) The term “otherwise significantly related” is not limited to economic significance; matters of ethical and social significance can be included because

(i) the rule itself is ambiguous; (ii) the SEC had earlier required inclusion of important policy questions when even less than one percent of a firm’s assets or earnings were implicated; (iii) adoption of the 5% rule by SEC still allowed significant proposals – significant on their face – to be included; and (iv)an older decision, Medical Committee, implied proposals involving general political and social concerns were acceptable.

(b) On s/holder's motion for preliminary injunction, the District Court held that s/holder demonstrated likelihood of prevailing on merits w/ regard to issue of whether his proposed addition to proxy materials being sent to all s/holders in preparation for an upcoming s/holder meeting was "otherwise significantly related" to corp.'s business w/in meaning of s/holder proposal rule, thus entitling s/holder to preliminary injunction to bar corp. from excluding from proxy materials his proposed resolution (RE pate) despite fact that none of corp.'s net earnings and less than 0.05% of its assets were implicated by proposal; ethical and social significance of s/holder's proposal warranted inclusion in materials.

F. Separating Economic Rights from Voting Rights1. Stroh v. Blackhawk Holding Corp.

(1) Facts: Company issued two types of stock:(a) Class A had one vote and a par value of $1; 3M shares issued(b) Class B had one vote w/out a par value; 500K shares issued

Directors bought the Class B stock for $.0025 a share. They were able then to hold a quarter of the vote for $1,250 where the other stock was around 2M. Action by class A

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s/holders' protective association for decree cancelling class B stock certificates and restraining holders thereof from voting them at any s/holders' meeting. (2) Rule: - A corp. may prescribe whatever restrictions or lmt’s it deems necessary in regard to the issuance of stock, provided that it not limit or negate the voting power of any share.- Cor.'s class B stock, holders of which were entitled to vote, were valid shares of stock notw/standing stock was not entitled to any dividends on voluntary or involuntary liquidation or otherwise, and right to vote which they possessed was not separation of voting rights from ownership of corp. shares.- The constitution (Illinois) requires only that the right to vote be proportionate to the number of shares owned, not to the investment made in a corp. In Illinois to classify shares of stock such that one may invest less than another in a corp., and yet have ctrl. In this case the parties went one step further than is customary. The stock which could be bought cheaper, and yet carry the same voting power per share, was not permitted to share at all in the dividends or assets of the corp. This additional step did not invalidate the stock.- The s/holders (P) and Blackhawk Holding Corp. (D) differed on the definition of the term “proprietary” in respect to the statutory definition of shares. S/holders (P) defined this as a property right, necessarily encompassing a correlating economic interest in the corp. However, the court adopted Blackhawl’s (D) definition as the right to mgt or ctrl.

G. Duties related to Transfer of Control1. Zeitlin v. Hanson Holdings, Inc.

(1) Facts: Minority s/holder sued owners of effective ctrl’ing interest complaining of sale of their interest for a premium price. The NY Supreme Court rendered partial summary judgment for defendants and denied plaintiff's motion to substitute a party and file further amended complaint and to compel depositions. The Supreme Court, Appellate Division, affirmed, and appeal was taken.(2) Rule: The Court of Appeals held that:

(a) absent looting of corp. assets, conversion of a corp. opportunity, fraud or other acts of bad faith, a ctrl’ing s/holder is free to sell and the purchaser is free to buy that ctrl’ing interest at a premium price, and (b) adoption of rule that a ctrl’ing interest may be transferred only by means of a tender offer would be contrary to existing law and so radical a change that it is to be best effectuated by the legislature;(c) Although minority s/holders are entitled to protection against abuse by ctrl’ing s/holders, they are not entitled to inhibit the legitimate interests of the other s/holders.

H. The Discretion of the Board in an “Endgame” Situation - Hostile Takeover Attempts & Mgt Defensive Tactics

1. Omnicare, Inc. V. NCS Healthcare, Inc.(1) Facts: After partial dismissal of another offeror's claims challenging target corp.'s proposed merger w/ acquiring corp., the Chancery granted summary judgment to Def. directors-s/holders of target corp., as to offeror's challenge to s/holder voting agreements, and denied minority s/holders' motion, in their class action, for preliminary injunction based on alleged breach of fiduciary duties by target corp.'s directors. Offeror and minority s/holders appealed.

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(2) Rule: - Lock-up deal protection devices, which when operating in concert are coercive and preclusive, are invalid and unenforceable in the absence of a fiduciary out clause. - The directors of a DE corp. have a continuing obligation to discharge their fiduciary responsibilities, as future circumstances develop, after a merger agreement is announced. The s/holders of a DE corp. are entitled to rely upon the board to discharge its fiduciary duties at all times.- Conflicts of interest arise when a BoD acts to prevent s/holders from effectively exercising their right to vote contrary to the will of the board.- The latitude a BoD will have in either maintaining or using defensive devices it has adopted to protect the merger it approved will vary according to the degree of benefit or detriment to the s/holders' interests that is presented by the value or terms of the subsequent competing transaction.- Decision of target corp.'s BoD to adopt defensive devices to completely "lock up" the proposed merger w/ acquirer warranted heightened judicial scrutiny under Unocal, to determine whether BoD acted in good faith after conducting reasonable investigation and whether defensive response was reasonable in relation to the threat posed.UNOCAL TEST: At first stage of Unocal enhanced judicial scrutiny of defensive devices designed to protect a corp.'s merger agreement, target corp.’s BoD must demonstrate they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed.- At 2nd stage of Unocal enhanced judicial scrutiny of defensive devices designed to protect a corp.'s merger agreement, a court must 1st determine that those measures are not preclusive or coercive, and then the focus must shift to the "range of reasonableness" determination as to whether the defensive devices are proportionate to the perceived threat to the corp. and its s/holders if the merger transaction is not consummated.- When a BoD decides to enter into a merger transaction that will result in a change of ctrl, enhanced judicial scrutiny under Revlon is the standard of review.- Unless the procedural presumption of the BJR, that the directors of a corp. acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company, is rebutted, a court will not substitute its judgment for that of the BoD, if the board's decision can be attributed to any rational business purpose.- Under Unocal the Court says that the Board’s decision to resist a tender-offer would be subject to enhanced scrutiny because the BJR was not enough. If the decision of incumbent managers is challenged they have to demonstrate that they perceived a threat to the corp. or its constituencies.- There are situations in which incumbent managers are no longer free to erect or employ defensive measures and their role is only to make sure that the s/holder receive the highest possible price for their shares. (Revlon mode). This happens in 2 situations: i) a corp. bust-up is inevitable or ii) the corp. is on the auction block (there are multiple bidders). HOWEVER: In a Unocal mode the corp. can resist, in Revlon mode it cannot.- Any time majority ctrl changes to REVLON rather than to UNOCAL.

I. Valuation 1. Piemonte v. New Boston Garden Corp.

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(1) Facts:(2) Issue:(3) Rule: DE Block Valuation…

J. Freeze-Out Mergers1. Del. Gen. Corp. Law § 262 2. Weinberger v. UOP, Inc.

(1) Facts: Corp. which was majority s/holder of sub sought, and acquired, remaining shares of sub by merger transaction incl’ing payment of cash to minority s/holders of sub for their minority shares. Minority s/holder, on behalf of class of all sub s/holders who had not exchanged their shares for merger price, attacked validity of merger transaction and sought to set merger aside or, in the alternative, an award of monetary damages against sub, majority s/holder of corp., and investment banking firm which provided fairness opinion prior to merger.(2) Rule: (1) merger did not meet test of fairness, where feasibility study prepared by two of sub's directors, who were also directors of parent, indicating that a price in excess of what parent ultimately offered for sub's outstanding shares would have been a good investment for parent, was not disclosed to sub's outside directors, and (2) on remand, minority s/holders would be entitled to damages based on the fair value of their shares as determined by taking into account all relevant factors, including the elements of rescissory damages if susceptible to proof and appropriate to the issue of fairness.Overhauled the DE law on freeze-outs; clarified duty owed minority s/holders of sub by ctrl’ing parent, required informed vote of minority, rejected business purpose test, created requirements of "fair dealing" and "fair price" and re-emphasized the near-exclusivity of the appraisal remedyDamages ???

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