THE FIRM & THE LAW OF AGENCY

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ISSUE RULE CASEAgency (1) One person (the Principal) consents that

another (the Agent) shall act on P’s behalf & is subject to P’s control, & (2) A consents to the act

Agent’s Fiduciary Duty

Agent has FD to Principal (duty of loyalty) CCS v. Reilly: Employee/agent of CCS can’t solicit own business during employment. (A has FD of loyalty to P).

Hamburger: Employee’s arrangement of financing/lease space for new business is OK-logistical.

BA/Merrill Lynch: D’s lied to SH’s (As breached FD to Ps).

Employment at Will

Foley v. Interactive Data Corp: F had at-will k, which was amended through time/type of relationship (bonuses, promotions) breach of implied-in-fact k’l obligation to discharge for good cause only.

Manifestations of Consent

Actual Authority: when P manifests consent directly to A (express or implied)

Apparent Authority: When A is without actual authority, but P manifests consent directly to third party who is dealing with A (express, implied).E.g., Starbucks

Inherent Authority: Judicially created gap-filling device that tends to arise when equities favor person who suffers loss from agent’s unauthorized actions.Note: Usually, must show benefit to the P. If not, look at economic rationale theory: who should have known better?

Blackburn v. Witter (Farmer’s wife): Farmer’s wife acted in ordinary care; Witter/brokerage house (P) placed Long (A) in position to defraud their customers. B had done business with W before.

Sennott v. Rodman & Renshaw: Court did not recognize agency. Sennott had unclean hands, savvy investigator-should have known better. Lack of reliance on P because S wouldn’t talk about check endorsement with P representative.

PARTNERSHIPS

ISSUE STATUTE/RULE CASEGenerally Partnership = association of >2 to carry on as co-

owners of a business for profit (§101(6)), formed under §202.

Default rules = equal management & control (§401(f); equal profit sharing (§401(b)), equal losses (§401(b)).

Can k around default rules with Partnership Agreement (§202)

Partner is agent of partnership (§301)

Formation P-ship formed when P’s carry on business as co-owners (§202(a))

Intent to form partnership not needed (§202(a)) Saying that you are partners is not enough, need

intent to share profit/losses equally.

Byker v. Mannes: Focus on whether parties intended & actually “carry on business for profit” & not on intent to form p-ship.

Hynasky v. Vietri: Court looks at action after partnership agreement was signed & said that parties did not act as joint owners of business for profit. “Just because you call goose a duck-it is not a duck”.

Fiduciary Duties

FD = legal obligation to act for benefit of another.o Obligation of good faith & fairness in

dealing with one another, & duty to act in furtherance of p-ship

Breach of FD = failure of fiduciary to observe a standard of care exercised by professional of similar education & experience. (Rest. Of Agency §379).

Each partner is an agent of the partnership (§301(1))

Partner owes partnership DUTY OF LOYALTY (§404(a) & (b))

o (1) To account to partnership, (2) to refrain from dealing w/p-ship in conduct or winding up as or on behalf of party having adverse to p-ship (3) refrain from competing with p-ship in conduct of p-ship business before dissolution.

(Note: Broad & can k around parts of it under §103(b)(3)).

Partner owes DUTY OF CARE (§404(c))o Refrain from grossly negligent or

reckless conduct, intentional misconduct, or knowing violation of law.

o Negligence alone is not enough.(Note: Courts don’t ever recognize breach of duty of care because such a high standard).

Meinhard v. Salmon: P’s owe finest duty of loyalty to each other. (“punctilio of an honor most sensitive”) (Treat JV same as P). S had duty of disclosure (S was manager-M would have not known of offer).

Self-Dealing:Vigneau v. Storch Engineers: Should not go around secretly entering relationships with p-ship. V gets salary for work that he did, capital contribution-but profits he made must be paid back to p-ship. Violation of FD of loyalty; no disclosure; may not engage in self-dealing.

Duty of Care/Negligence:Ferguson: Negligence in management of affairs of GP or JV does not create right of action against partner by p-ship.

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Operating/ManagingP-Ship

Each Partner has equal right to manage & control business (§401(f)).

Disagreement in “ordinary course of business” can be decided by majority of partners (§401(j))

Extraordinary matters require unanimous vote (§401(j)).

Right to access to books & records (§403)

Covalt v. High: All partners have equal rights in management & conduct of business of p-ship. If it is an un-resolvable issue, p-ship should dissolve. High values his FD to CSI more than his FD to Real Estate Venture by refusing to raise rent. Ct said they knew about it before & should have k’ed for it ahead of time under §103(b)(3).

Contracting for Absolute Discretion

Can’t k for near-absolute discretion in Partnership Agreement.

Limitations:o §103(b): PA may not (1) vary rights &

duties under §105 except to eliminate duty to provide copies to all Ps (2) unreasonably restrict right of access to books & records under §403; or (3) eliminate duty of loyalty under 404(b) or 603(b)(3) but (I) can id specific types/categories that don’t violate duty of loyalty…(4) unreasonably reduce duty of care (5) eliminate duty of good faith & fair dealing (6) vary power to dissociate as partner & (7)-(10).

Self Dealing/Contracting for Discretion:Starr v. Fordham: When partner has engaged in self-dealing, BoP on partner to prove fairness. Partners breach FD when they make unfair profit distribution (and determine their own) to departing partner. Can’t k around basic requirements of good faith/fair dealings.

Profit Sharing

Profit Sharing: §401(b)

Partner Liability

Partnership = agent of partnership (§301) P-ship liable for loss or injury caused to person as a

result of wrongful act or actionable conduct of partner acting in ordinary course of business (§305(a)).

Partners are jointly & severally liable for all obligations of p-ship unless otherwise agreed upon (§306).

P-ship may sue and be sued in name of p-ship (§307).

Liabilities of purported partner (if person relying on represent enters into txn with actual or purported p-ship) (§308).

PA Properties Inc. v. B.S. Moss: Court recognized inherent authority when a GP JV, who is not named in an agreement b/w a co-venturer & a third party, benefited from the agreement. (Would have been actual authority if not for JV agreement provision.)

Haymond v. Lundy: Absent evidence of contrary, plain language of PA will be relied on in determining whether partner violated agreement.

Dissociation Dissociation occurs: §601-events that causeo Partner leaves (at-will) (601(1))o Some triggering event in PA occurs (601(2)o Expulsion pursuant to PA (601(3))o Expulsion by unanimous vote of other

partners (pursuant to 601(4))o Judicial determination (601(5))o Partner becomes debtor in bankruptcy, etc

(601(6))o Partner’s death (601(7))o (8)-(10)

Effects of dissociation (§603)1

Meehan v. Shaughnessy: by engaging in preemptive tactics like recruiting other attorneys secretly and sending clients secret letters that don’t present all options, partners violated FD. Must dissociate BEFORE competing against partnership. Unclear b/w time of notice and leave, but still have duty of loyalty in this window of winding up affairs; limited under 603 and

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o Remaining partners buy out interest: §701 (fair market value of accounts and any interest)

o Dissolution & winding up process of business: §801

Dissociation partner no longer has right to participate in business except in wind-up §603(b)(1)

Dissociated partner’s FD narrows has FD only w/r/t matters before dissociation §603 (unless partner participates in winding up of partnership business)

Withdrawing partner breaches FD if he acts unfairly towards p-ship, causing p-ship harm. Liable for damages (Meehan).

Partners don’t violate FD for expelling partner in at will p-ship (Bohatch) under 601(3).

404(b)(3): non-compete term terminates when dissociate/give notice.

Bohatch v. Butler & Binion: a law firm doesn’t owe partner a FD not to expel her for reporting unethical conduct (if PA allows for expulsion).

Dissolution

(beginning of winding up process)

Events causing dissolution & winding up of partnership (listed in 801).2

o Disassociation of at-will p-ship notice from P of express will to withdraw (801(1)) (other than 601(2)-(10)).3

o Definite term ends §801(2)o Event triggering in PA §801(3)o Unlawful 801(4)o Judicial determination that impracticable to

continue business §801(5)

Partnership continues during dissolution §802. P-ship terminated when business is wound up

§802(a). Settlement of accounts §807

o Liquidation, pay creditors (a)-like employees and banks, other liabilities paid-like partners get back capital accounts. Anything that is left is profit and split among partners (default rules = 50/50).

Note: Under §401, human capital does not count as value.

Page v. Page: A p-ship may be dissolved by express will of any partner when no definite term or particular undertaking is specified.

Kovakic: K wants R to share in half of loss after dissolution/settling capital accounts. Court: values R’s service capital.

Shamloo: In settling capital accounts; no value for human capital (§401).

McCormick: Judicially dissolved and no longer practical to continue doing business under 801(5). Under 807, must be process of liquidation and full accounting. Must pay off creditors, bid for control.

Wrongful Dissociation

(On test, don’t forget to start with basic rule 601(1)-partner is

Partner’s dissociation is wrongful if:o Breach of express provision of PA 602(b)(1)o Before expiration of term if for definite term

602(b)(2) (if partner withdrew by express will, except w/in 90 days after another partner’s dissociation by death.

Partner who wrongfully disassociates is liable to p-ship and other partners for damages caused by

Drashner v. Sorenson: P-ship for a term. If partner dissociates would be wrongful and may not get any money at all/take time (701(h)). Court held S wrongfully dissociated under 601(5) & not practical to continue doing business.

1 §603 Article 7 (not wind up) OR Article 8 (dissolution (p-ship continues during this time), wind-up (p-ship terminated at this time under 802(a)), and then 807 (settlement of accounts). Can’t switch from Track 7 to Track 8.2 In p-ship at will, if 601(1) disassociation happens 801 Dissolution3 Exclusions for dissolution are 601(2)-(1) as stated in 801(1); Death does not lead to dissolution (601(7)(i)).

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dissociated from p-ship upon notice of express will to leave. Then, is it wrongful?)

dissociation, 602(c). Wrongful dissociation owes 701(c) (damages) Partners who wrongfully dissociate are not entitled

to payment of any portion of the buyout price until expiration of term, unless partner shows undue hardship to business of p-ship (701(h)).

McCormick: Note: Sister could have gone with judicial expulsion under 601(5), but forgot to/gave up right. Expulsion brother wrongfully dissociates and she would not have to pay him right away (or go through process of dissolution/liquidation, etc).

Benefits of partnerships:

1. Equal management power2. Ability to share profits/losses3. Ability to force a dissolution4. FD: Duty of loyalty (even during dissolution process)

a. Can exclude certain activities under 103(a).5. No duty of care6. Pass through tax (Partners are taxed), not corporate entity. (What LLC gets so not taxed 2x).

Why do you want to dissolve?

1. bid for control2. determination of actual value of interest3. get back initial capital account

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4. JOINT VENTURES, LIMITED PARTNERSHIPS, AND LIMITED LIABILITY PARTNERSHIPS

ISSUE STATUTE/RULE CASEJV Generally Less permanent and less complete merging

of asses and interests than GP.

Corporate firms unite for single purpose. Limited purpose and limited time.

E.g., If S and J set up joint venture for 2010 Superbowl venture, its business relationship for limited period of time, so if J wants to sell beer for 2010 World Series-no FD to Sharon.

JV Fiduciary Duties Joint Ventures: For limited time, limited purpose (can treat as GP or not depending on if it leads to fair results) still owe finest duty of loyalty to each other (Meinhard).

LP Must file form with the state. Separation of ownership and management

functions (Limited partners cannot manage. General partners must manage.)

Limited liability for limited partners. (General partners have joint and several liability).

Firm’s continuity/adaptability to changed circumstances favored. In short, limited cannot leave at will. General can leave at will. Dissolution is not automatic when general partner leaves.

LLP RUPA 306©: Partner’s liability Designed for professional partnerships. Must register with Secretary of state to

become LLP. 1001: Statement of Qualification. ©-

statement may contain: name, address, statement that partners elect to be LLP

1002: Name (must end with RLLP or LLP.

1003: Annual Report Once created, governed by GP law in all

respects except for special liability and distribution provisions defined by statute.

o 2 categories:o Rules extending limited liability

to LLP’s GP Rule limited the partnership’s ability to

distribute assets to general partners.

Dow v. Jones: Law firm. General rules of GP apply to LLP, but partners don’t have unlimited liability. Here, D was convicted and sued J for malpractice. Partners argue firm dissolved 2 months before trial (but during wind-up still LLP). Got rid of LLP certificate 1 month before trial (Now a GP). Still have duties after dissociation. (306).

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CORPORATIONS

DELAWARE RULES, DGCL

ISSUE STATUTE/RULE CASEBasics Separates ownership/managed into 3: Officers, Directors,

and Shareholders. Corporations governed by state law (including most FD) But Federal law covers disclosure, proxy voting, fraud, etc

(SEC Act of 1934 and SEC Rules).Formation/Incorporation

Formation: how corporation formed, file with Dept of State (§101)

Certificate of Incorporation (name, address, nature of business, class of stock) (§102)o To Amend: §242 requires that board adopts

resolution first, then SH majority vote Bylaws may contain any provision relating to business of

corporation, conduct of its affairs, and rights or powers of SH’s (§109(b)).o To Amend, if corporation hasn’t received $ for

stock, directors can amend bylaws, if have received $, SH vote (§109(a). Can put in articles that directors can amend (so then both can).

Board management powers under §141(a) Officers Directors delegate power to officers who run

corporation (§142) (but SH may be able to put into bylaws an officer position bc of 142(a)).

SHs: provide capital by buying shares; elect directors, vote on fundamental changes.

Classes of Stock: §151 (preferred stock §151© Issuance of stock §151, Consideration for Stock §153 (par

value) Rights/Options respecting Stock: §157

CA v. AFSCME: 109(a) allows SHs to pass certain kinds of bylaws, entitled to vote w/r/t bylaws and propose amendments to bylaws, but (b) says that bylaws can’t be inconsistent with law or with certificate. Proposal to reimburse SH for proxy contest for put up own directors if adopted, could cause directors to violate FD. Proposal would be inconsistent with 141(a) that says D’s have FD to corporation and SH.

Also, Bylaws can’t mandate how board should decide substantive business decisions, but may define process/procedures by which those decisions are made.

SH Voting Default: 1 share = 1 vote (212(a) Default re quorum majority shares needed for quorum

216(1), bc certificate of incorporation can change as long as not less than 1/3 (216).

Election of Dso Straight voting = Default- plurality of votes of

shares present in person or represented by proxy and entitled to vote (§216(3))

o Note: IN CA, default = cumulativeo Cumulative Voting SH cast votes = stock x

number of positions available (§214) [(total shares voting*seats you want to

elect)/(directors to be elected + 1) +1]o Class Each class of stock elects specified # of

D’s (§141(d)) Majority of outstanding shares for class or

series required for quorum (216(4)). Classified with staggered terms ensures

D’s in office because constrains SH from replacing.

Adlerstein advance notice to controlling SH/D required bc SH had right to vote and D have FD to SH (he was controlling so Agency applied). Actions at meeting were bad faith/breach of FD.

Murray (Indiana): but in DE, only shareholders can remove directors under 141(k).

Problem 3-8/way to get around the default rules: If articles of incorporation otherwise provide, the board or shareholders can amend articles to remove

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Removal of Directorso SH can remove Ds w/o cause by majority vote of

outstanding shares that can vote (141(k)) except: Where board is classified/staggered

(141(d)) SH may effect removal for CAUSE ONLY (141(k)(1).

If cumulative voting, no D may be removed w/o cause if there are enough votes to against his removal that could have elected him. (so go through formula).

Approval of Fundamental Changes (Mergers -251©, dissolutions, substantial sale of assets, amendments to articles of incorporation -242(b)- (Majority of outstanding shares that can vote)

Voting trusts & voting agreements:o SH may by agreement in writing, deposit capital

stock to any persons authorized to act as trustee for vesting in persons the right to vote for any period of time determined by agreement. Must register agreement w/state office, fact must be in stock ledger of corporation. Stock may be voted in person or proxy. Trust shall incur no liability except for own individual malfeasance. (218(a). Amendments must be filed with state (218(b)).

director w/o cause or declassify the board.

Meetings Meetings of SH (§211)o Annual meetings (§211(b))o May act by written consent/remove communication

(§211(a)(2))o §228 allows stockholders to take action by written

consent w/o a meeting…(a) unless otherwise provided in certificate of incorporation.

Hoschett v. TSI Software: Election of Ds by written consent didn’t satisfy obligation to hold annual meetings. BUT DGCL 211 overruled this right after.

SH Right to Information

List of SH entitled to vote; penalty for not producing (§219)

Must be made available to SH 10 days before every meeting, alphabetical.

Inspection of books and records §220: SH must establish:

o (1) is SHo (2) complied with form and manner required to

make demando (3) Proper purpose: reasonably related to SH’s

interest (220(b)).

Conservative Caucus v. Chevron: SH’s wants stockholder list under 220(b)(i)-for purpose reasonably related to being a SH. BoP that SH’s purpose is improper (high burden) (220(c)). Court held that warning of economic risks of foreign operations is a proper purpose for the lists.

Benefits of Corporations:

1. Perpetuity: can’t force entity to dissolve2. May want more say and have limited liability.

3. Easier because have certain goals on how to grow business.

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4. CORPORATIONS

SEC RULES

1933 = Securities: Do you have an initial issuance of securities? Must meet registration requirements.1934 Act: Reporting; proxy solicitation; empowers SEC with regulations. Are you a publicly held corporation? Must meet these requirements.

ISSUE STATUTE/RULE CASE

Background of 1933 Act

Securities Act of 1933: Regulates offering and sale of new securities.

Requires that all securities for sale must be registered with the SEC or meet an exemption.

Purpose: Focus on Disclosure

What is a security?

Securities Act §2(a)(1): any note, stock, bond, debenture, investment k, or in general, any interest or instrument commonly known as a “security”.

SEC v. Edwards: broad definition of security, page 193. Buy and lease back phones fixed return could be a security.

E.g., Leasing out timeshare: giving you portion of rent could be a security. (Helping with transactions).

Registration Statement: prospectus and other prepared documents required by the SEC prior to an Initial Public Offering (IPO).

Includes: Description of business Description of Security to be offered for sale Information about the company’s Directors and Officers Current financial statements

Purpose: To be given to investors to make sound investment decisions

Exemption from Registration

A lot so that small companies don’t have to incur costs of registration fee

Regulation D provides 3:o Rule 504: Firms who sell up to $1M of securities in

12-month period. Receive restricted securities.o Rule 505: Offer up toe $5M in any 12 month

period. Only to accredited investors and 35 others (should be sophisticated enough to know). Receive restricted securities.

o Rule 506: Safe Harbor under §4(2) of 1933 Act. Raise unlimited amount of capital to accredited investors and 35 others (sophisticated). Ust give non-accredited investors disclosure documents. Financial statements same as Rule 505. Receive restricted securities.

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Background of 1934 Act

1934 Act created SEC: independent agency, enforce securities laws, promulgate rules and regulations to implement those laws more effectively.

TO REGULATE PUBLICLY HELD CORPORATIONSRole of Federal Law for Public Companies

Disclosure Issuing securities (’33 Act, Registration Statement) Periodic reporting: covered by ’34 Act, Required by SEA

of ’34 Act. E.g., 10-K, 10-Q, 8-K Proxy solicitation (e.g., at annual or special meeting)-

required by ’34 Act Tender offers (Person/entity (buyer) goes straight to

target SH of public entity and asks to buy shares. Insider Trading (Info that managers/officers have to

provide to investors.)SEC Power SEA §14(a): It shall be unlawful for any person…as the

Commission may prescribe as necessary or appropriate…for protection of investors…”

Purpose: TO govern securities/prevent management from tricking sH from voting for things when didn’t give enough information.

E.g., BA didn’t disclose to SH before merger vote.

Typical Annual Meeting

Nominating committee of incumbent (current) board nominates slate of directors to be elected at next annual meeting. Id’s other things to vote on.

At company expense: Management prepares proxy statement and card; Management solicits SH votes (usually with proxy solicitor’s help).

Proxy refers to 3 things: Relationship, Document, Person.

Annual report (10-K) gets sent to SHs, proxy statement and card sent to SH, free writing w/o statement to them, then they vote while incumbents are still on the board. The proxy solicitor tries to gather cards/votes far in advance.

Proxy voting SH appoint proxy (proxy agent) to vote shares at meeting.

Appointment effected by means of proxy (proxy card). Revocable (before vote happens, SH can take vote back) Lawyers need to make sure card is done correctly. If SH holds shares at brokerage; broker fills out card and

gives to proxy agent.

SEC Proxy Rules (regulates SH’s access)

Rule 14a-3: Incumbent directors must provide annual report before soliciting proxies for annual meeting.

Rule 14a-4: Form of proxy card requirements.

Proxy statement: 14a-5: form of proxy statement 14a-6: filing obligation. 14a-7: mailing 14a-9: fraud

*Very expensive-must hire lawyers –which is why want to

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include on co’s statement to save funds.

Proxy disclosures(what must directors disclose to SHs?)

Information about the meeting Background info directly related to issues to be voted onIncreased use of “therapeutic disclosure” Executive compensation (how much they make; why

determine salary was proper) Audit Committee reports (how much $ is corporation

making? How involved is the audit committee with the accountants’ work/financial statements-oversight?)

Note: Most boards (public corporations require all) must have at least 3 committees: compensation, nominating, audit. Members of the committees must be officer independent. (CEO can’t be on compensation committee). Corporate governance guidelines and practices (how do

we communicate w/SH why we have this person as CEO, how will global warming will affect our business).

SH are owners and thus should have lots of information.

SEC Proxy Rules Rule 14a-7: solicitation assistance to SHs.that are making an independent NON 14a-8 proposal)

o Company must provide SH list of security holders/mailing list, OR mail soliciting material to them. (CHOICE)

o Expensive so usually only used by institutional investors.

o What is difference b/w this process and state law process? (DGCL 220)? NOTE: State corporate law trumps federa here. State law says you can get list anyways-so most sophisticated SH don’t use 14a-7 to get the list-they just use state law.

o Advantages of doing yourself: Don’t have to go through 14-a8 exclusions; can write more than 500 words, can talk to other SH, control timing.

Rule 14a-8: SH proposals (on company’s proxy statement)

o Allows qualifying SHs to put a proposal before their fellow SHs;

o AND have proxies solicited in favor of them in the company’s proxy statement.

Conservative Caucus v. Chevron: Didn’t use 14a-8 or 14a-7 because 7 gives option of giving list, and 8 limits 500 words. THUS, went with DGCL 220

14a-8 Exclusions(SH Proposals)

page 297 of statute book

Procedural exclusions:o Proponent does not meet ownership/format

guidelines (14a-8b2)-continuously held at least $2,000 in market value or 1% of co’s securities entitled to be voted on the proposal at the mtg for at least 1 year by date you submit the proposal. Must continue to hold those securities through date of meeting.

o No more than 1 (c)o <500 words (d)o Proposal not timelyo Issuer must provide proponent with

Lovenheim: Wants board to form committee to study how supplier produces foie gras. Proposal is precatory/nonbinding phrased because of 14a-8(i)(1) which states that must be action that is proper for SH to initiate-must look to state law to

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opportunity to cure most errors w/in 14 days after submission. (f)(1)

o Must appear to present (h) Substantive exclusions:

o Improper under law of issuer’s domicile (i)(1)-(2)

o Personal grievance/special interest (i)(4)o Management functions: (i)(7) BIGGEST

EXCLUSION. “If proposal deals with a matter relating

to the company’s ordinary business operations”

(Can’t ask for new slate of board)o Relevance: (i)(5)o Substantially implemented (i)(1)

Note: Management trumps relevance. So if you can’t exclude under relevance because significantly related to business, then see if can exclude under management.

decide that question. So look at DGCL 141(a). if SH not allowed to initiate, still ok if phrased as proposal.

Board refuses to include proposal because of 14a-8(i)(5): “Company may exclude proposal if it relates to operations that account for less than 5% of assets and 5% of net earnings AND is not “otherwise significantly related” to the company’s business. Court holds that it IS “otherwise significantly related” because still making some money on its-broad view. It includes ethical/social significance. Thus, includes it.

Examples of What Courts think Ordinary Business Is

Not ordinary business, so include in SH proposal: Disinvestment in South Africa Get out of tobacco business Get out of nuclear power business End/Start affirmative action Non-discrimination on basis of sexual orientation or

veteran status Executive compensation

Ordinary Business, so don’t include in SH proposal: Employee (everyday) compensation

Company Responses to Proposals(5 possible responses)

Attempt to exclude on procedural OR substantive grounds.

Must have specific reason to exclude that is valid under Rule 14a-8

Include with opposing statement. Negotiate with proponent. Adopt proposal as submitted.

Excluding a Proposal Process

STEPS:1. Management files notice of intent to exclude with SEC.

Accompanied by counsel opinion if any of stated reasons rely on legal issues.

2. Under Rule 14a-8(f), management must notify SH-proponent of remediable deficiencies in the proposal and provide opportunity for them to be cured.

3. A copy of the firm’s notice/statement must also be sent

US Bancorp, Request for No Action Letter.

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to proponent, who may (but need not) reply.

SEC Response(3 different possible responses)

Staff determines if can be excluded: issues a no-action letter (won’t fine or take action)

Staff determines should be included: notifies issuer of possible enforcement action if proposal is excluded.

Intermediate position: proposal not includible in present form, but can be cured.

If SH or Management is unhappy, can appeal to Commission or Court.

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CORPORATIONS

FIDUCIARY DUTY OF LOYALTY

Note: D’s and O’s are fiduciaries of the corporation and have Duty of Loyalty and Duty of Care. Duty of Loyalty: Self –dealing, Usurpation of corporate activity (bad faith thrown in)

ISSUE STATUTE/RULE CASEFD to SH 2 Aspects:

(1) FD of Loyalty constrains D & O in their pursuit of self-interest

a. Actionable wrong for O/D to compete with corporation or divert to personal use assets or opportunities belonging to the corporation.

b. D must be fair and candid to SHs in pursuing their personal interest

(2) FD of Care Focus on D’s official conduct in directing and managing business/affairs of the corporation.

FD to 3rd Party Constituencies

Board has FD to SH, but can consider 3rd party interests if there is “some rationally related benefit accruing to the SH” or if it bears some reasonable relation to general SH interests.”

Dodge v. Ford: SH suing D for upgrading facilities and lowering price of cars rather than distributing dividends to SH’s. Court will intervene re dividends if refusal to pay amounts to “such an abuse of discretion would constitute a fraud or breach of good faith.” This is rare that court would second-guess D’s decision. Facts of case are peculiar-closely held entity.

Business Judgment Rule

BJR: “Presumption that in making business decisions,

the Ds 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.”

o Absent abuse of discretion, fraud, illegality, conflict of interest, or gross negligence, the judgment will be respected by the courts.

o Burden on party challenging decision to establish facts rebutting presumption.

§141(a): business and affairs of corporation managed and under discretion of the board.

Aronson v. Lewis: quoted language

Shlensky v. Wrigley: To overcome BJR, SH must rely on fraud, illegality or conflict of interest.

FD of Loyalty: Usurpation of Corporate Opportunity Doctrine (CO)

DELAWARE

D’s must favor corporation’s interest over his own whenever interests conflict.

DE Approach Broz, using Guth factors-D or O may not take a CO for his own if:1) Corp financially able to take CO2) CO is w/in corporation’s lien of business3) Corporation has an interest or expectancy in the CO4) By taking CO for his own, D will violate his FD to corporation.-D or O may take CO if:

Broz v. CIS, Inc: CO doctrine implicated only where D’s seizure of CO results in conflict b/w D duties to corp. and D’s self-interest. Held that he did not usurp CO.

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1) CO is presented to D or O in his individual, not corporate, capacity2) CO is not essential to corporation3) Corporation holds no interest or expectancy in CO4) D has not wrongfully employed resources of Corp in pursuing CO

-Note: Not a checklist-just guidelines-Presentation to board not required. “Of course, presenting to board creates ‘safe harbor’ for D, removes specter of a post hoc judicial determination that D has improperly usurped CO.” IMPORTANCE OF LEAVING PAPER TRAIL/PROCESS

Broz quote

Corporate Waste (CW)

Rejection of CO = CW if CO was of “such obvious important and value to corporation that no person of ordinary sound business judgment would have rejected CO.” Waste = Breach of FD. SH would bring derivative suit.

FD of Loyalty: Conflicting Interest Transactions(CIT)

(Use Entire Fairness, not BJR)

Dual Board Memberships: (E.g., Globe Woolen)Duty to disclose. Silence = betrayal of loyalty too.

Self Dealing-Definition: If 1 person, or set, controls both sides of the txn, and that party receives corporate assets to the EXCLUSION of other SHs.-Test: Intrinsic Fairness Test used when parent entity has received a benefit to exclusion of minority SHs of subsidiary and at expense of minority SH of subsidiary.-Must show 1) Fair price; 2) fair process.-Burden: on party standing on both sides of the txn.(Sinclair)

Globe Woolen Co. v. Utica Gas & Electric: Maynard is GW controlling SH, CEO, and Chairman of the Board. Also Utica’s D and Chair of the Board (but owns no U stock). M is wearing GW hat and wants to give GW good deal. At board meeting, M doesn’t say anything. Court held that can betray through silence. Has a duty to warn if duty of loyalty. He had a duty to disclose. Importance of process: M should have spoken up at meeting, given details, or don’t attend mtg at all if not going to say anything so others can ask Q’s).

Sinclair Oil v. Levien:Note: General rule that SH don’t own FD to one another; erosion of this rule when there is a controlling SH.Rule:-Not self-dealing unless SH is receiving something other SH is not receiving.-S was self-dealing bc S benefited from k bc Sinclair Oil was benefiting and S owned 100% of outstanding stock of Sinclair Oil. At exclusion of other SHs bc SO isn’t actually paying/complying

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DGCL §144: “Cleansing Mechanism”- Interested Directors: No CIT shall be void solely by reason of conflict if CIT:

1) If after full disclosure to the board, is authorized by majority of disinterested directors, or (144(a)(1))

2) Full disclosure to the SHs, is approved in good faith by SH, or (144(a)(2))

3) Is fair to the corporation at time authorized/ratified by Board or SHs (144(a)(3))? (Fair dealing and fair price).

a. Note: If you win under this prong, don’t need disclosure to board or SH.

(Shapiro v. Greenfield)Note: CA follows DE’s modelNote: Important to create the paper trail!

Self-Compensation:-§141(h): D’s have authority to fix D compensation unless Articles of Incorporation provide otherwise.-§157: In absence of fraud, board allowed to issue rights/options in stock

Stock Options Test: Under 157(a)1) Identifiable benefit to the corporation?

(Value Prong)2) Value of options reasonable in relation to

value of benefit passing to corporation? (Benefit Prong)

***157(b) says that directors’ valuation is conclusive, so only first prong has real meaning D’s must only show benefit.

(Bryne)Note: If corporation issues stocks in general, falls under BJR. But if they issue stocks to themselves, then must use the stock options test.

with k.

Shapiro v. GreenfieldCourt: just bc sister, doesn’t mean she is interested director. CIT case uses fairness test (DGCL 144(3)) you can show it is fair to the corporation.

Byrne v. Lord:

Board issues equity stock options (form of compensation). Minority SH’s sued bc board were beneficiaries of the challenged stock option plan. Potential conflict of voting rights because dilutes their rights (so many shares). Court uses DGCL 157(a) analysis-2 prong test. Held: Failed 2-prong test here.

Note: Recipients have right to buy stock at set price (exercise/strike price). Right vests in the future. Can backdate stock options so that you buy at a lower price, so then when you cash out-it’s a lot.

Kind of Issue under Duty of Loyalty Cases Which Test to UseIf Conflict of Interest Txn. 1) Is this a CIT txn?

a. Are there interested directors?b. DGCL 144(a): “k or txn b/w corporation

and 1 or more of its D’s or O’s or b/w a corp and any other corp…or have a financial interest…”

2) If YES, doesn’t matter how much research they have done. The question is: can it be cleansed? (Meaning is it not voidable/still valid).

3) Is it cleansed under 144(a)(1)? Was there disinterested board vote after full disclosure

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presentation?4) Is it cleansed under 144(a)(2)? Was there a SH good

faith approval after full disclosure presentation?5) Is it cleansed under 144(a)(3)? Was the txn fair to

the corporation?a. Fair dealing? (Did they go through process

of fairly?)b. Fair price?

Note: In DE, usually if you can show fair price, courts will say it is FAIR!!

If Self-dealing case…If 1 person, or set, controls both sides of the txn, and that party receives corporate assets to the EXCLUSION of other SHs, then

Use Intrinsic Fairness test: Fair dealing, fair price.

If self-compensation, stock options test Use stock options testIf Corporate Usurpation Case Use Broz/Guth Factors

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CORPORATIONS

DUTY OF CARE

ISSUE STATUTE/RULE CASEFD of Care

Focus on procedure

Definition Ds should act w/the care that a person in a similar position would think is reasonably appropriate under the circumstances.-Breaches of care are rare and reserved for egregious conduct.-Apply BJR but if plaintiffs overcome presumption, apply entire fairness (price/process) test.

Policy for Limiting: Voluntary assumption of the risk, institutional competence, incentives to innovate/take risks.

Ways to Violate: Uninformed decisions Failing to investigate Lax board procedures No expert appraisal No formal market vetting

Breach: breach duty of care, use entire fairness test:(1) Fair Process: when txn was timed, how was it initiated,

structured, negotiated, disclosed to Ds, and how approvals of Ds and SHs were obtained.

(2) Fair Price: economic and financial considerations of proposed action: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of corporation’s stock.

DGCL 141(e) Response to Van Gorkom- Bd protected if relying in good faith on corporation’s records, or on opinions, reports, or statements presented to the corporation by any corporation’s O’s or employers or committees of board of D’s, or by any person as to matters the member reasonably believed are w/in person’s professional competence

FOR TEST: Note case: Brehm v. Eisner: page 321-duty of care violation complaint must show that 1) D didn’t rely on expert 2) reliance wasn’t in good faith 3) didn’t reasonably believe E’s advice was w/in E’s professional competence 4) E not selected w/reasonable care and faulty selection process was attributable to Ds 5) subject matter was material and reasonably available was so obvious that board’s failure to consider it was grossly negligent regardless of E’s advice or lack of advice or 6) decision of board was so unconscionable as to constitute waste or fraud.

Joy v. North: policy reasons for duty of care given.

Van Gorkom: No protection for an uninformed decision. 2 hour meeting for fundamental change (merger). BoD didn’t know how set prices, what price was based on, what control is worth to buyer. Once rebut BJR, Ds can still win if show entire fairness (price/dealing). Held: BoD failed entire fairness test.

Weinberger v. UOP (note case): describes fairness test. (page 322).

FD of Care

Board Defenses Against Litigation

Exculpatory Clauses

Definition: Limits or eliminates director’s liability for breach of FD of care only (not loyalty).

§102(b)(7): Exculpatory Clauses must be included in Articles of incorporation; valid as long as they don’t limit liability for:-breaching duty of loyalty-acts or omissions done in bad faith-any transaction where director gets improper benefit

Malpiede v. Townson: Fredricks case: Breach of FD of care dismissed when corporation has exculpatory clause.

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FD of CareDuty to Monitor

Duty of Care:2 kinds of lapses of care:

1) Liability for decisions (like Van Gorkom); BJR presumption applies (page 337)

a. Focus on the process-even if decision is stupid-court won’t interfere if board went through proper process.

2) Liability for inaction/failure to monitor (page 339)-no business decision.

a. Caremark says duty to monitor.b. If are put on notice and then fail to act, liability

may follow-shouldn’t have to spy on employees, but should have processes in place to figure out illegal activity (Graham)

When is there a breach of duty to monitor?-This is only breached if a ‘sustained or systematic failure of board to exercise oversight.’-‘Such as an utter failure to attempt to assure a reasonable information and reporting system exists-will establish a lack of good faith that is a necessary condition to liability.” (page 342).

Effective monitoring/compliance program:Assess risk, establish, revise policies to address risks, establish procedures to ensure compliance with company policies (training, reporting, monitoring, enforcement) board and management oversight, implement improvements.

Procedures/Programs must be:-closely tailored to co’s particular business and associated legal risks-currently verifiable and effectively understood by employees

In re Caremark Int’l: SH derivative suit. Held: A board of directors has an affirmative duty to attempt in good faith that corporate information and reporting system exists and is accurate.Board has duty to monitor, but not have to spy. Only systematic failure standard.

Rationale:1) Increase emphasis in

case law on role of director primacy

2) Van Gorkom requirement that boards make informed decisions

3) Federal sentencing guidelines create incentives for law compliance programs.

BUT…Stone v Ritter

Holding: Changes Caremark standard to one of loyalty and not duty of care.

Director oversight liability:“(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a sx or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.”-Knowing violation standard, rather than negligence standard. SH have to show more for court to find the board liable.

Implications: Depending on how you argue this, can take situation away from a straight breach of duty of care (where corporation’s exculpation clauses can protect them under 102(b)(7)) to breach of FD of loyalty (which corporation can’t have provisions against).

Stone v. Ritter:2 FD:

1) Care2) Loyalty

a. Violations of duty of good faith or acts of bad faith (beyond grossly negligent/reckless in decision) now under loyalty.

b. Usurpation of corporate opportunity

c. Conflict of interest

Turns Caremark from informed decision-you should be doing your work as a director-to a known showing of bad faith standard by

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shareholders (duty of loyalty). It is not a knowing violation standard, rather than a negligence standard.

Audit Committees

Post-Enron RequirementsNew securities laws, eg Sarbanes-Oxley Act of 2002-Requires corps to include compliance procedures in their annual reports-Federal requirement w/re to monitoring

Major focus on Sarbanes-Oaxley and changes in NYSE & NASDAQ. Changes focuses on increasing (1) independence and expertise of audit committee members (2) audit committee’s control over the financial audit process, including selection of outside auditor (3) communication between audit committee and the board and (4) internal communications between AC, CEO, CFO and others

Book

FD of CareMonitoring Duties by CEO

Officer’s Oversight and Reporting Duties

Under Sarbanes Oaxley Act, CEO and CFO are central to integrity of a corporation’s financial reporting sx, yet under state law it is still the BoD’s responsibility to ensure that the corporation has adequate controls and system in place.

Miller v. US Foodservice: Miller CEO sued former Company for failing to provide him w/ post-termination benefits. Company countersued, claiming violation of FDs. Miller overstated revenue accounting fraud. He should have suspected wrongdoing. Liable because he had incentive to overstate revenue because bonuses depended on revenue stated. He acted in bad faith. He knew there were weak controls and he lied and said they were being fixed. Held: company has claims against Miller, not vice versa.

Is Good Faith an independent standard of liability?

Confusing if separate duty because shows up in BJR, 141(e), and 102(b)(7).

BUT NO-no obligation to act in good faith.

Bad faith is put under duty of loyalty.

Walt Disney Case: Allegation that board failed to exercise oversight over contract. Held: actions not enough to constitute violation of bad faith.-Court declined to decide whether there was FD of good faith. Ppl started bringing cases as violation of good faith but court said that you can’t bring these because liability threshold is much higher in good faith cases than in care cases.-No court has found liability under this cause of action.

BJR TEST (1) Is it a business decision? Page 321

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STEPS!! (2) Pl has burden/must overcome/rebut BJR to show that Board didn’t act on informed basis in good faith.

(3) But absent abuse of discretion, fraud, illegality, conflict of interest, or gross negligence, courts will go with the board.

(4) Pl must show:a. Breach of duty of care, ORb. Breach of duty of loyalty (self-dealing,

usurpation of corporate opportunity, bad faith thrown into the mix)

(5) Even if Pl’s are able to overcome the presumption, directors don’t necessarily have liability.

(6) The Directors must now show fairness:a. Fair Priceb. Fair dealing

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CORPORATIONS

DERIVATIVE SUITS

ISSUE RULE/STATUTE CASEWhat is a derivative suit?

If you’re mad as a SH, you can: wait until next cycle and put in new set of D’s, unless it is classified board. Can’t put in SH proposal bc of exclusion (management); would have to put in new slate by own proxy statement; can sell shares, can litigate!

Policy D’s responsible for managing corporation (141(a)) including determining which litigation is in corporation’s best interest. Presents problem when deciding whether or not to pursue lawsuit against Ds.

Definition: Suit where SH commences and manages FD litigation on corporation’s behalf. 2 actions:

1) Action against corporation for failing to bring specified suit, and/or

2) Action on behalf of corporation for harm to it identical to one corporation failed to bring

Requirements PRE-SUIT DEMAND (Del. Chancery Rule 23.1) DE requires SH to make pre-suit demand before the board, explaining claims she wishes investigated and remedied.Up to board to decide how to deal.If board rejects SH may challenge decision as breach of FD because has no right to pursue original claim directly now unless board action was not under BJR.

EXCUSE DEMAND: (Aronson) where making pre-suit demand would be futile. Demand futility: must show that there is a reasonable doubt created that this is not true:

1) Directors are disinterested and independenta. Independence = when D’s decision is

based on corporate merits of subject matter before board rather than extraneous considerations or influence (In re the Limited).

b. Test = “subjective actual person”2) Challenged txn was otherwise product of a valid

business judgmenta. Really hard to show that D’s didn’t

make informed business decision.

What you want to show:(1) Independent/disinterested: show some kind of relationship with person who benefited to create rsbl doubt about loyalty level.(2) Informed business judgment: show CEO had Dementia, payoff, etc.

Aronson v. Lewis: futile demand requirements. If you create reasonable doubt of either one of the two parts, then demand is excused.

In re the Limited: Board trying to complete self-tender via agreement b/w Limited and Wexler Trust. Self-tender would require creating debt for company. P argued that 6/12 Board members making the decision “could be” interested as they were close to Wexler.Holding: Sufficient that there was a reasonable doubt of disinterested/independence, so met demand. Able to show that at least half the board was interested in the txn or lacked independence from Wexner. Std for determining independence: Subjective actual person test.

Re: Breach of FD of Loyalty claim:Not enough of finding of corporate waste/duty of care breach.

What is the Test to tell what kind of suit it is? Tooley Test:1) Who suffered alleged harm, the corporation or

the suing shareholders, individually?

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2) Who would receive the benefit of any recovery or other remedy, the corporation or the SH’s, individually?

Derivative Suits Direct SuitsMost suits are derivative Unless complaining SH have suffered a separate and

distinct harm from that suffered by other SH or is based on k’l right.

Brought on Corporation’s behalf. Brought by SH in his name

Cause of action belongs to corporation as an entity Cause of action belongs to SH in his individual capacity. Examples are claims based on:

1) SH voting rights2) Preemptive rights3) Right to inspect books, etc.

Arises out of injury done to corporation as an entity Arises from injury directly to the SHNote: If Dan is a D, O, and SH. Indicted by government for

antitrust violations in setting A’s product prices. A refuses to advance legal expenses to Dan. Dan sues seeking advancement of expenses under De’s indemnification statute.

This is not direct or derivative suit, because Dan is bringing it as his role as the officer/director (not as SH).

Indemnification, DGCL §§102(b)(1) and 145

1. Today, all states have statutory provisions authorizing director indemnification to some degree. 2. Always keep derivative suit separate from criminal case.

DGCL 145(a) DGCL 145(b) DGCL 145(c)“Corporation shall have the power” “Corporation shall have the power” “Must indemnify…if “has been

successful on the merits or otherwise”.

Suits brought by SH or Third Parties Derivative suits: brought by or on behalf of the corporation

Mandatory vs. Permissive Indemnification.

Gets expenses, attorney’s fees, and all money in settlement.

Gets expenses and attorneys fees incurred (does not get judgments or settlements)

Gets all expenses and attorneys’ fees.

Includes Officer/Director/Employee/Agent of Corporation, OR serving at the REQUEST of the corporation as a D/O/EE/or Agent of ANOTHER corporation.

Thus, if Co. 1 asks Df to serve on Co. 2’s BoD, then Co. 1 may be liable.

Note: If can establish that the Df acted at request of another corporation, then would have to indemnify here too.

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CLOSELY HELD CORPORATIONS

CLOSE CORPORATIONS

ASK:

1) What kind of business is this? (statutory CC?)2) What capacity is the party acting in?3) Is the party violating some kind of k? Sterilizing k, SH voting agreement? Or FD of care or loyalty?4) Should this be a direct or derivative suit?Some courts will allow SH to bring direct suit if if it will not:1) Unfairly expose the corporation to a multiplicity of actions.2) Materially prejudice the interests of creditors3) Interfere with a fair distribution of recovering among all interested partiesRichard v. Bryan note case, page 455-57

ISSUE RULE CASEBasics DE must meet statutory requirements to be CC (§§342, 343) Must fit

101, 102, and 103, in addition to these requirements.o <30 SH (342)o Stock not offered publicly (342)o Not transferable to others unless otherwise contracted for

(transfer restriction) (342)o Certificate of incorp. shall have heading that says is CC (343)o Registered as CC in articles of incorporation with state (§344)

Voluntary Termination by amending certification of incorp. (346)Implications easier to squeeze out minority SH bc no liquidity-No secondary market for shares: not publicly traded.-Stock is held in hands of a few people.-Courts pay special attention to minority SH-If meet CC requirements, can k around default rules (350, 354)

Note: CA requires less than 30 SH also.

CC often restrict share transfers (locked in)-Transfer restrictions: right of first refusal, first option, buy/sell agreement

Note: If you fail to meet the statutory requirements under DE, then you just become regular corporation and default rules apply.

Ways Minority SH can Have Say:

Agreement relating to limitation on board’s discretion.

Agreements relating to voting of shares.

1. Sterilizing Agreementsa. Traditional approach: Ds can’t give away FD

because power to manage belongs to corporation.b. Modern approach SH can agree to limit D’s

discretion to prevent abuses.i. DE: Can k to sterilize Ds ONLY if CC is

statutory CC (§350).1. §351: Certificate of incorp of CC

may provide that business shall be managed by SHs.

ii. NC/Others: Ct upholds SH agreement unless it violates laws, exhibits fraud, or oppression to minority SHs, or were made to give 1 party a personal benefit.

McQuade: S promised M through SH agreement that he would retain M as director and officer, but later fires him. Held: SH agreement not enforceable because S couldn’t give away his authority to hire and fire. Directors have FD to SH’s and represent the company. D’s can’t give away FD because power to manage belongs to the corporation.

Clark v. Dodge: Court enforced SH agreement because was in corporation’s best interest and they were the only SHs and had both signed the agreement. Different than McQuade bc

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2. Shareholders’ Voting Agreementsa. §212: voting rights of SH, proxies, limitsb. 2 Kinds:

i. Vote Pooling Agreements: SH can agree to vote in certain ways, seen as enforceable K’s

ii. Voting Trusts + Other Voting Agreements: §218. Copy of trust document must be filed w/corporation’s registered DE office.

only 2 SH here-no oppression.

Zion v Kurtz (NY applying DE law): Doesn’t fall under DE 342 requirements of CC. Court still enforces k-(Minority SH approval of corp activities is enforceable). Contrast with Nixon.

Blount v. Taft (NC): If put SH agreement into bylaws that says SH can amend bylaws by majority, then must follow it. Practice Point: Put agreement into separate agreement instead of bylaws.

Ramos v. Estrada: Bound to SH agreement; if you say you are going to vote shares a certain way, court will hold you to that.

Partnership Analogy

DE: DOES NOT RECOGNIZEo Must be statutory CC and also have agreement to treat CC like

P-ship/duties: §354: Operating as P-ship. (Nixon)

MASS: Allows courts to say expectations of CC similar to p-ships.o Sh have same rights to participate in management of

corporation like partners, have FD to each other, can dissolve at will because CC have trust relationships like P-ship. (Donahue)

Zidell: Illustrates oppression of minority SH; hard for him to overcome BJR.

Donahue v. Rodd: (Mass.) Company bought Rodd’s (majority) shares back at $800/share, but wouldn’t buy Donahues’ at same price. Vague Mass definition of CC: small number of SH, no read market for shares, majority SH has substantial participation in operations o the corporation. Rule: Resembles p-ship so SH owe each other FD.

Nixon v. Blackwell (DE): Not a statutory CC. If you want majority SH to have FD to minority SH, you have to be a 1) statutory CC and 2) k for it. ALL ABOUT K. (Contrast with Zion).

Involuntary Dissolution

CA: CGCL §1800: CA allows SH to petition for dissolution. In CC, if liquidation is reasonably necessary for protection of the rights or interest

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Some states have allowed statutes for this in CC.

2 Responses to illiquidity problem:-legislative grounds for judicial dissolution-direct, individual SH action for breach of FD.

of the complaining SH.CGCL §2000: Avoiding dissolution by purchasing shares.

NY: NYGCL: §1104: allowed if there is fraud, oppression, illegality by majority to minority.-NY has 20% threshold: SH must own more than 20% to do this. (CA doesn’t have one).

Note: Minority SH that push for dissolution can’t vie for control in CC (unlike p-ship). States that allow this allow the corporation or majority to avoid dissolution by purchasing minority shares at fair value.

In re Kemp (NY): Reasonable expectation test: Disappointment is not enough to constitute oppression. Oppression = conduct that substantially defeats rsbl expectations held by minority SH.

Gimpel v. Bolstein (NY): Court held not oppressive because 1) No violation of reasonable expectations bc he inherited his shares and 2) Not issuing him dividends is not burdensome, harsh, and wrongful conduct (they just never issued dividends for 50 years). BUT Court bails him out bc doesn’t want him to be an outcast, so lets him be bought out for a reasonable price.

Note: Reasonable price could be anything, even the lowly book value ((assets-liability)/# of shares)

Note: CA uses buying shares at fair market value. In CA; if Majority/Minority can’t agree on FMV, court decides.

Share Re-purchase agreements

-Specifies in advance conditions/price for corporation to re-purchase stock-look at stock legend to see if corporation has one

Purpose: can provide for orderly liquidation of SH investment after retirement/death; give majority SH ability to exclude a discharged or prematurely withdrawing SH from further participation in corporation’s profitability.

Pros:-prevent deterioration in SH relationships, know what to expect, prevent litigation

Cons:-Ks are costly, human rationality is limited, k may present possibilities for oppression.

Concord Auto Auction: (Mass) “Each price shall be reviewed at annual meeting…” but no annual mtg was held. Example of poor drafting of purchase agreement, but court will hold you to it. Important to draft clearly/fairly (neutral third party decides in good faith).

Gallagher v. Lambert: (NY) Mandatory buyback provision. Court will hold a sophisticated person, esp if has attorney to draft, to

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Reminder: IN DE, can’t push for share repurchasing agreement because no p-ship analogy.

Note: IN p-ship when person dies, other partners can purchase the disassociated partner’s shares; this is like that in CC.

agreement.

Pedro v. Pedro (MN): Brothers embezzlement case: court recognizes p-ship analogy and gives brother FMV of shares and favorable decision on lifetime employment. Prof says court overstepped here: could have sued brothers for FD of loyalty violation; push in new directors; k for rights.

On test: Grapple with facts. What has corporation been doing all along? How have minority SH been treated? Did they have share of corporate earnings or place in management? If court accept p-ship analogy-look at TYPE of conduct going on.

Note: No equities/fairness in DE hard line rule. Also, no equities in RUPA (like human capital).

LLC’s

ISSUE RULE CASEWhat is an LLC? -Business organization with tax advantages of

partnerships (pass-through tax)-Limited liability of corporations; no personal liability for members; members stand to lose capital contributions but personal assets are not part of it.-None of the restrictions of CCs. (#, type of SH)-Members contribute capital-Management

o Member-Managed: (like p-ship): equal rights of management, absent contrary agreement, most matters decided by majority vote, significant matters require unanimous.

o Manager-Managed: (like corp): can be structured as BoD, CEO, or both. Must be specified in articles.

Financial Interests:-Profit and loss sharing: absent contrary agreement, most statutes allocate profits/losses on basis of value of member contributions.-Withdrawal: member may withdraw and demand payment of interest upon giving notice specified in statue or LLC’s operating agreement.

Formation:1. File Articles of Organization in

designated state office: ULLCA §203: Articles of Org.

a. Name (with LLC), address, address of agent, organizer, whether it is member-managed

Gottsacker (Wisconsin): 2 brothers + M formed LLC. 2 took only property and transferred it to a new LLC they created w/o asking M Conflict of Interest. K interpretation 1st “collective” is what parties contemplated. Court: Txn okay so long as M and 1B dealt fairly.Importance of the k, courts will construe ambiguous k as to reject construction that leads to unreasonable/unfair result. Even if you are in LLC, you may have background FD that come into play (like p-ship-good faith)-not like corporation where you must have cleansing (144)).

VGS, Inc.: (Court of Chancery of DE): Managers under LLC agreement must exercise duty of loyalty by acting in good faith to one another (Compared to Adlerstein-acting without giving notice is acting in bad faith). Court-made FD duties to add to LLC agreement.

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or manager-managed, whether members liable for debts and obligations,

2. Operating Agreement ULLCA §103: can regulate affairs of co and conduct of business, govern relations among members, managers, and company.

a. Have articles of incorporation and also this, where internal governance/how money gets paid/winding up is discussed.

DE DE: 6 Del. C. 18-1101(b): “it is the policy of this chapter [LLC ACT] to give maximum effect to the principle of freedom of k and to the enforceability of LLC agreements.

A member’s rights include (operating agreement says this): financial interest (right to distributions and liquidation participation) and management rights.

DE S.Ct: the basic approach of the Del Act is to provide members with broad discretion in drafting agreements and to furnish default provisions when the members’ agreement is silent.

Elf Autochem (note page 496)

Exit and Liquidity Similar problems as CC.

Liquidity is a problem.

Love v. Fleetway: What does dismissal mean? Is it included in withdrawal or in retiring? Court uses dictionary.

Haley v. Talcott: Can an investor force remaining member or enterprise to buyback departing member’s interest? Where co-equal members of an LLC cannot agree on a course of action, and if an exit mechanism in the operating agreement is inequitable, the court may order dissolution.

Note: Corporations get taxed twice: on corporate income and on dividends to its SHs.

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CORPORATIONS

CORPORATION AS A DEVICE TO ALLOCATE RISK

Protects Creditors By (1) Capital Legal Requirements (Equity) or (2) Piercing the Veil

Equity Cushion

Purpose: reduce riskiness of extending credit to corporations.

Formulas:o Equity = assets – liabilitieso Surplus = equity – capitalo Capital = par value * # of shares outstanding (§154)

-Par value = minimum price/share that shares must be issued for in order to be fully paid.-DE requires minimum equity (par value * # of shares) IF corporation’s certificate states a ‘par value’ for stock.

Note: Can have negative equity.Note: Capital & surplus are not liabilities.Note: Surplus is not profits.

Problem 6-1 (handout)

Types of distributions (ways corporation distributes $ to SH)

1) Dividends,(2) Redemption of shares-corp has right to redeem shares –agreement with SH-, and(3) Repurchase of shares-go out and ask SH to repurchase shares, like Limited case.

Limits on Distributions to Shareholders

Dividends

Minimum Initial Capitalization Requirements DGCL §154: permits a corp’s D to specify by resolution what

amt of the consider paid for shares shall constitute capital. Only limit is that capital can’t be less than amount equal to aggregate par value of issued shares having par value.

§153: requires shares w/par value be sold for at least that amount.

Quality & Valuation of Consideration paid for Shareso §152: Consideration selected left to discretion of directors:

“consisting of cash, any tangible or intangible property, or any benefit to the corporation…”

Limits on Distributions to SHo §154: Determination of amount of capital (Capital = par value *

shares outstanding)o §244: Reduction of Capital (244(a)(4) permits d’s, acting by

resolution, to transfer to surplus some or all of the capital represented by outstanding shares, which is in excess of the aggregate par value of such shares) can change par value to something lower so that your capital is lower and surplus is higher.

o §170: Dividends & Payments: must be paid out of the surplus, OR if entity has no surplus, must be paid out of net profits that the fiscal year dividend is declared or the year before. (If capital is less than aggregate amt of capital represented by stock, D may not declare/pay dividends.)

Klang v. Smith’s Food & Drug Centers: Ds can use FMV as appropriate reference point; deference to d’s method of calcuating surplus unless Pls can show D’s used “unacceptable data”, bad faith, or fraud in evaluating value of assets. Corp’s balance sheet not conclusive of whether DE statute forbidding impairment of capital has been violated.

Note: Problem 6-1: Under §152, board has discretion to determine what consideration is worth; and doesn’t’ matter if later deemed

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o §173: Declaration and payments: no corp shall issue dividends other than in accordance with this chapter (§170).

o §174: Liability of D for unlawful payment of dividend or stock purchase. (a): willful or negligent violation of §173, d’s shall be jointly and severally liable w/in 6 years after paying such unlawful dividend to the corp and to its creditors in the event of its dissolution or insolvency to the full amt of the dividend unlawfully paid. (So if d’s paid $100,000 out of $20,000 surplus, must pay extra $80,000 themselves).

*Note the willful/negligent provision.

worthless Ds will argue it was informed decision at the time it valued it.

Note: Problem 6-1: board can revalue fixed assets, using FMV, before declaring dividend, so that corporation has a lot more surplus.

2 Approaches to Limitations on Distributions

1) Legal Capital Test (DE)a. Idea of separate account of collateral to protect

creditors.b. Problem: small amount of money/capital: doesn’t do

much to protect creditors. We care more about fair market price (capital is so minimal bc of par value).

2) Insolvency Test (most states)a. No distribution may be made if immediately

afterwards corporation would be insolvent.Piercing the Corporate Veil

o Removing legal fiction of corporation/limited liability and reaching to SH sitting behind veil.

o Creditors sue to make SH liable for corporate debts.o Very fact specific.

Black Letter Lawo Veil Piercing “rule: a court will pierce the veil when Pl proves

that:o SH had COMPLETE domination and controlo SH used control of corporate form in unjust,

fraudulent, or wrongful way; ando SH ‘s unjust use of control caused actual harm to the

Pl.o What is the use of the test?

o Equitable testo Really about working through the facts/Application

important.K Cases:

o Courts more reluctant to pierce veil since they assumed third parties can negotiate and adjust terms accordingly. Power to avoid it. Pre-existing relationship before the loss. Voluntary decision to become a creditor, so creditors may have bargained for the risk.

o Exercising control is not enough, must show injustice caused

o Look at whether there is a complete lack of formalities

o Look at whether SH leads 3rd parties to believe he is operating corporation legitimately.

Tort Cases:o Courts more willing to pierce veil when person/corporation is

directly involved in causing tort to occur.

Consumer’s Co-Op: Application of the test. Ct didn’t pierce veil bc no unjust reason (undercapitalization alone is not unjust)

Western Rock Co.: Ct pierced veil bc controlling SH used corp’s existence to perpetrate tortuous conduct. Passed 3-part test.

Baatz v. Arrow Bar: Tort case: go through 3-part test. Arrow Bar served drinks to person who hit someone in car. Are SH’s liable? Ct didn’t pierce veil. Did not use control in a fraudulent way.

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o Who should bear the risk? Who is in a better position to prevent the costs? No ability to avoid. Sue everyone.

Parent/Subsidiary Relationships: court will pierce veil if:1) Parent dominated subsidiary so that s had no separate

existence, AND2) Parent abused relationship with S to commit fraud or cused

harm.

Craig v. Asbestos: Potential control over subsidiary not enough to pierce. Likely, OK if can show separate boards, financials, books, records, elections. To pierce parent, must show that through policy/business practices, that parent/subsidiary are working as 1 enterprise. *Importance of formalities.

US v. Bestfoods: Did the parent own/operate the subsidiary? Must show total domination and control. Unless veil pierced, parent corporation not liable.

Piercing in LLC Cases

Page 587-88 Kaycee (Wyoming): SH’s argument is an exception to the veil piercing. If LLCs are not like corporations, then should not apply corporate veil piercing doctrine in LLCS and should allow full limited liability in the LLC context. Court: Want to encourage same equitable doctrine and use the same 3-part test.

BALANCE SHEET

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CORPORATIONS

MERGERS & ACQUISTIONS

FRIENDLY

Basics Process:o Board adopts a resolution approving agreement of merger

in favor of merger (251(b))o Agreement shall state (1) Terms & Conditions of merger

(2) mode of carrying the same into effect (3) if merger: amendments or changes in certificate of incorporation of surviving corporation (4) if consideration (5) manner of converting shares (6) other details.

o Board submits resolution and agreement of SH to vote at annual or special meeting if vote is required.

o Vote required: Acquiring/Target companies generally (251(c)). Need a majority of outstanding share entitled to vote.

o Not required, Acquiring:o De minimis merger: 251(f): if no dilution (Paid in

cash), or if minimal dilution (shares acquired don’t exceed 20%)

o Merger of parent & subsidiary: Short-form: 253(a): If parents owns 90%+ of shares, no vote needed.

Who votes? §251: Both constituent corporations ratify:o Boardo SH, Majority requiredo What needs to be sent to SHs?

o Public co-proxy statemento Private company-documents as required by state

corporate law.

Hewlett v. HP: Importance of Process (contrast to Van Gorkom). Need SH vote to increase authorized stock for merger/amend certificate of incorporation. Claim of vote buying and claim of disclosure: Court said both were fine: not enough evidence for 1st and estimates are fine for 2nd (not material fact that needed to be disclosed).

Types: Merger: Acquired entity disappears and acquiring entity inherits liabilities by law.

Consolidation: new company is the surviving entity.

§259: Legal effects of merger.Voting & Appraisal Rights

If SH voted no on a merger, SH can exercise appraisal rights:o If, vote was needed to approve §262(b)(1) gets appraisal.o Given to dissenting SH the right to demand that

corporation buy shares at judicially determined FMV.o Given to selling firm SH, buying firm SH; UNLESS:

o Market out exception (262(b): Io Bought-out shareholders: No appraisal rights

if stock was publicly traded/listed on National Securities Exchange (or held by > 2000 shareholders) at time of merger and shareholders were offered as consideration for their shares either stock in the survivor or stock that is publicly traded (or held by > 2000 shareholders)

o Continuing shareholders: No appraisal rights

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if stock was publicly traded/listed on National Securities Exchange (or held by > 2000 shareholders) at time of merger Exception to market out: if target

received cash as consideration (§262), or stock in private company gets appraisal

o If vote was not needed to approve 262(b)(1)-NO appraisal.

o Perfecting Appraisal: 262(d)

HOSTILE

Basics Normal process:1. Acquirer buys shares of Target on public

market, less than 5%.2. A expresses intent to take over T.3. T rejects.4. A gives bear hug letter.5. T uses defensive tactics.6. T’s SH (including A) sue T for breach of FD,

and/or7. Tender Offer, and/or8. Proxy fight

If T’s directors refuse to open gate to acquirer, what can A do? (usually do both).

o 2 Tier Tender Offer: Cash deals-sometimes stock. Bidder offers a lot of money to target SH’s. Acquire enough shares to control board through tender offer and then acquire remaining shares through merger.

o Proxy Fight: launch a proxy fight/send out proxy statement to other SH convincing them to vote out old board (expensive since must sent out own statements).

Note: Federal Securities Laws that apply here:

o SH voting in public companies: federal proxy regulations: §14(a) of ’34 Act, SEC Regulation 14A.

o Tender offers for shares of public companies: Williams Act: 3rd party tender offer: §14(d), (e), SEC Rules.

Defensive Tactics 1. Director-related provisions, like staggered board, no cumulative voting, limits on removal

2. Board discretion over capital structure; authorize/unissued stock, blank check preferred stock.

3. SH restrictions: limits on ability to call special mtg, no action by written consent, advance notice.

4. Supermajority voting requirements5. Super-voting stock6. Greemail7. White Knight8. Change of control employment k’s (golden

parachutes)9. Pac-man defense10. Poison pills11. Litigation (sue for FD breach-sue board of

hostile bidder for wasting $)

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12. Acquisitions of asset that hostile bidder doesn’t want

13. Regulatory protective measuresAre defensive tactics OK?

Unocal Test

The Unocal test begins with burden of proof on Directors.

1. Was action w/in power or authority of the board?

a. Does the statute authorize this defense and

b. If it is okay, does the firm’s charter impose any restriction on defense use?

2. Reasonableness: Did the board have reasonable grounds for believing that a danger to corporate policy and effectiveness existed? (Burden on board to show good faith and reasonable investigation-process important). [rare to prove not reasonable]

3. Proportionality: Was the defense proportional/reasonable in relation to the threat posed?

a. Factors to consider: Will it make the co so unattractive that nobody would want it? Inadequacy of price offered, nature and timing of takeover, illegality, impact on constituencies other than SH, risk of non-consummation, quality of securities being offered in exchange.

4. If the directors pass the 2-pronged test, then kicks back to the BJR rule (BoP on Pl)

5. If the directors do NOT pass, they will be able to have the chance to go through the fair process and price test to escape liability.

Unocal v. Mesa

Poison Pills Aka SH Rights Plan, signed by company.Rights become exercisable upon some triggering event such as: acquisition of specified percentage of target shares, or announcement of tender offer for some specified percentage of shares.

Flip in Provision: Target’s SH’s have right to buy additional Target company stock at discount: company has more stock outstanding so that co is more expensive but it is getting little cash for amount of stock it is selling.

Flip-Over Provision: Gives SH right to receive Buyer stock in a 2nd stage freeze-out merger (buy stock in merged entity): stops buyer from being able to control entity because can’t squeeze out the minority SH, bc then they have right to buy stock at discount.

Note: Company has redemption features: gives board option of redeeming rights at nominal cost to allow desirable acquisitions to go forward.

Moran v. Household: No explicit provision in DGCL that says directors can adopt poison bills, but Court holds that 157 gives d’s ability to grant rights and options for whatever reason they want. Court holds that BoD can make Poison Pills. Then goes through Unocal test and finds for Board. Power under § 151(a), § 151(g) and § 157 to do these devices.

Revlon Rule: When board puts up company for sale or there is a

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change in corporate control, board has duty to maximize company’s value by selling to the highest bidder.

“Directors’ role changed from defenders of the corporate bastion to auctioneers charged with getting best price for SH at a sale of the company”.

DE Rule: When board decides to sell, duty to maximize the co’s value by selling to highest bidder. But if they don’t’ decide to sell, has FD to the corporation-so can’t do whatever you want as a director to make the stock prices go up.

Note: Revlon only applies in change of control transactions-not just txns where board has decided to find a white night. “I am selling my co to him. SH rights are being converted to $5 a share”- this is a txn.

Are you in Unocal Land? (Defense tactics)-then use 2-prong test.

Are you in Revlong Land? Has the board made a decision to sell the company? If yes, it is ALL about maximizing SH profits.

Note: May be facts where both standards apply (e.g., Revlon). Put up initial defenses. Then once found white knight, role changes to auctioneer.

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FEDERAL LAW AFFECTING CORPORATE TRANSACTIONS

DISCLOSURE

Remember to first ask: Is alleged misconduct connected to purchase or sale of a security? (Merger counts too-money for shares)

Why important? o Provide information for SH to make informed voting decision. Helps d’s do better job, used by investors, enhances monitoring by accountants, facilitates enforcement actions by gov’t.

Mandatory Disclosure In the Matter of Informix: Violations: false, misleading books, records, accounts, insufficient internal accounting controls. Civil punishment/remedy: C & D order (stopping future violations).

Rule 10b-5 Section 10(b)It shall be unlawful for any person to use or employ, in connection with 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

Rule 10(b)-5-It shall be unlawful for any person:A. to employ any device, scheme, or artifice to defraudB. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, orC. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person-In connection with the purchase or sale of any security

Blue Chip Stamps: Private cause of action: no clear Congressional intent for private cause of action, so take it as OK. (Judicial oak out of legislative acorn).

Santa Fe: Short-term merger: didn’t get to vote. SH argue no chance to vote (but merger process is state process-federal rules don’t apply here), as long as you comply with state corporate statutes, process of DGCL 253 satisfied. If don’t like it, can bring FD claim in state court-CAN’T bring a 10b5 claim over a state law. The evaluation/appraisal action statement remedy covered by state law-being forced to sell securities. UNFAIRNESS IS NOT FRAUD.

Limits the reach of 10b-5: should not create federal cause of action for conduct traditionally covered by state law.

Who may bring a 10b-5 action?

SEC, Dept of Justice (criminal), Private parties (no express private remedy under §10, private cause of action implied under R10b-5

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INSIDER TRADING

Rule 10(b)-5-It shall be unlawful for any person:(a) To employ any device, scheme, or artifice to defraud(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, or(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person-In connection with the purchase or sale of any securitySEC Definition of Insider Trading

Refers generally to buying or selling a security in breach of FD to other relationship of trust and confidence while in possession of material, non-public information about the security.

Violates SEC Rule 10-b

“Material”:Modern definition: Whether there is a substantial likelihood that a reasonable investor would consider the omitted fact important in deciding whether to buy or sell securities.

TGS court: whether a reasonable man would attach importance to the information.

“Insider” Defined

§16b of SEC Act of 1934:-prohibits insiders (directors, officers, and owners of 10% or more) from making short swing profits-By prohibiting insiders from purchasing and selling stock within 6 months (hard line)

OVERINCLUSIVECorporation can sue the insiders and make them return profits.

Tests for Insider Trading

Texas Gulf Sulphur:o ANYONE in possession of material non-public information

musto Disclose it, oro Abstain from buying or selling (while information

remains undisclosed)

Materiality factors:1. Nature of information2. Company response3. Market response4. Conduct of insiders

Note: Rule 10b-5 definition of insider includes: TGS director, secretary, geologist, janitor (FD to corporation).

Compare to §16b of SEC Act of 1934: Officers, directors, 10% SH

Texas Gulf Sulphur:FN 12: not saying that corporation has to disclose the information. Timing is based on BJR. But either disclose or abstain.

Non-Insiders No 10b liability where purchaser of stock who has no duty to a prospective seller because he is neither an insider nor a fiduciary. Has no obligation to disclose material information he has acquired, and his failure to disclose information does not constitute a violation of 10b.

Chiarella v. US: mark-up guy found out corp will launch takeover and shares will go up so bought shares and sold post

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takeover. He made $30K in 14-month period. He had material-nonpublic info. SCOTUS said no liability because no FD to SH of target entity. Not every financial unfairness is a violation of 10b-5. 10b-5 is not based on equal access to information.

Constructive Insiders

1. Where they obtained material, non-public information from issuer with

2. An expectation on the part of the corporation that the outside will keep disclosed information confidential, and

3. Relationship at least implies such a duty (some relationship of trust).

Note: If you are a janitor who gets info at a law firm, you have a k with the firm, thus you may be considered a constructive insider.Examples: Someone who has a duty for a period of time (lawyers, accountants).

Dirks, FN 14

Tippees Liable when:1. Insider/tipper breached his FD by disclosing material non-

public information for personal gain (objective standard); AND

2. The tippee knows or has reason to know of the breach of duty

Tippee’s liability is derivative of the tipper’s; arising from role as participant after fact in insider’s breach of FD.

Note: Dirks adds benefit layer: Tipper must get a benefit, which could be anything: $, reputation, gift, etc.

Dirks

Misappropriation Theory

Definition:A fiduciary’s use of undisclosed information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5 (page 1088).

*If person tells principal before trading on the information, can’t get them under 10b-5.

Rule 10b5-1: Trading on Basis of Material Nonpublic Info (after O-Hagan, added this).Purchase or sale of security "on basis of awareness of" material non-public information anytime there is a breach of trust, confidence directly, indirectly to the issuer or the shareholders of that issuer or to any other person who is the source of the material non-public information. (captures classic, constructive, and tippers, or anyone who gave you material nonpublic information –even w/o relationship…)

10b-5(2): Non-exclusive list of 3 situations in which person has a duty of trust or confidence for purpose of misappropriation theory.

O’Hagan

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1. Agreement to maintain confidence exists2. History or pattern of sharing confident info, such that recipient

knows/should know that communicator expects confidentialitya. Captures romantic relationships/sharing, etc.

3. Info is obtained from spouse, parent, child or siblinga. UNLESS recipient shows history w/ no expectation

of confidentiality

Unlawful Tender Offer Purchases 14e-3

Prohibits ANYONE connected with the tender offer from tipping material, non-public information about it. (not insider or otherwise).

Chiarella and Dirks: 10b-5 liability for insider trading is now premised on a duty to disclose arising from a relationship of trust and confidence b/w parties to the transaction.

Classic Trading: Insider has FD to corporation and investors/SHs. Insider uses information himself.

Tipping (Dirks): Insider has FD to corporation and gives tip to another person. That other person who doesn’t have FD with corporation actually trades on information. Tippee buys shares from SHs.

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