Corporations – OutlineProfessor Milton Regan

Basic Corporate Law ConceptsTwo Basic Kinds of CorporationsClose Corporation

Shares are privately owned by a small group of shareholders o Typically the founders and initial investors

Combination of ownership and controlo Shareholders are officers and directors

Open Corporation Shares are open to the public and listed on an exchange

o Many widely dispersed shareholders Separation of ownership and control

o Board has control of the companyo Shareholders have limited rights – do not own in any meaningful sense

Corporate ActorsStockholders

Contract – Residual financial and basic voting rights in return for capitalo Can only vote on matters specified in statutes, by-laws and articles of

incorporationo Can amend the by-laws or approve amendments to the by-laws

Board of Directors Elected by stockholders to manage or supervise corporation’s business

Officers Elected by the board of directors

Stakeholders Creditors, employees, customers and the community Shlensky v. Wrigley

o Rational business practice to consider stakeholders when making corporate decisions

Corporate SecuritiesDebt

Secured/unsecured bonds, debentures or notes Lowest risk with lowest expected return

o Receive fixed payments of interest over time and return of capital upon maturity

o Priority over equities in the event of liquidation Convertible Debentures

o Allow the bondholder to convert the bond into common stockEquity

Preferred Stock Medium risk with medium expected returnso Receive fixed dividends, with the right to be paid before common stock

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o Priority over common stock in the event of liquidation Common Stock Highest risk with highest expected returns

o Receive dividends at the discretion of the boardo Last in line in the event of liquidation

The Corporation and Society

Two Questions of Basic Corporate Theory (1) For whose benefit should corporations be run? (2) What is the best way to ensure that corporations are run in their benefit?

The Corporation as the Shareholder’s Agent ( Private Property/Contractarian Model ) (1) Corporation’s only social responsibility is to increase profits within the

boundaries of the lawo Private Property

Shareholders are the owners and principles of the corporation Directors are the agents of the shareholders – must operate in the

shareholder’s best interesto Contractarian

Shareholders bear the most risk (2) Must protect the shareholder’s interests

o Private property Increase information in voting Allow the adoption of bylaws to restrain directors Increase fiduciary duties

o Contractarian Allow market forces to control mismanagement (prices, takeovers)

Problems with these theorieso Private Property

Shareholders do not own the corporation – do not have the entire bundle of sticks

Shareholders do not have the interests of the corporation in mindo Contractarian

Shareholders can diversify investments to limit risk Market is not perfect/efficient – will not accurately reflect value of

company Dodge v. Ford Motor Co.

o Ford’s refusal to pay special dividends was a breach of their duty of careo Director’s discretion is to be exercised to attain profit for the stockholders

Cannot reduce profits to decrease cost of buying a car for the public The Corporation as a Societal Entity ( Team Production Theory )

(1) Corporations have an obligation to take into account broader societal interests in corporate decisionmaking

o Should think of consumers, political groups, creditors, employees and communities

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(2) Must give the board considerable discretiono In the best decision to decide how to meet expectations of all partieso Cannot favor one interested party over another

Citizens United v. Federal Election Commissiono The First Amendment prohibits the government from suppressing political

speech on the basis of the speaker’s corporate identity Corporation is an association of individuals – a legal fiction that their

rights extend out ofo Unfair restriction to force corporations to speak only through a PAC –

restricting the corporation’s speech itself Government has no interest in equalizing the relative ability of

individuals and groups to influence elections Theodora Holding Corp. v. Henderson

o Corporation can make a reasonable donation where members of the board do not agree with the specifics of the donation

There is a recognized obligation of corporations towards philanthropic, educational and artistic casuses

Corporate FederalismInternal Affairs Doctrine

The law of the state of incorporation governs the “internal affairs” of the corporation, regardless of the state in which the suit is brought

o Internal affairs are the allocations of authority among directors, officers and shareholders (not other constituencies)

Need for predictability and efficiency of corporate operations and law McDermott Inc. v. Lewis

o The structure of voting rights in a corporation is a matter of internal affairs – the laws of the state of incorporation apply to dispute about voting rights

Panamanian law allows a subsidiary to have a voting share in their parent company

Effectively allows the parent corporation to have a voting share in itself

California Pseudo-Foreign Corporation Statute Certain provisions of California law governing corporate affairs applies to a foreign

corporation if:o (1) More than half of its property, payroll and sales are within California; ando (2) More than half of its voting securities are held by California residents

Wilson v. Louisiana Pacific Resourceso California law can constitutionally govern internal affairs of a corporation

with sufficient contacts in California if incorporated in another state Even though the two states have different voting laws

o No issue of inconsistent regulation or uncertainty – applies to corporations incorporated in California as well

Everyone knows what to expect when they choose to do business here

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Anti-Takeover Statutes If a bidder acquires over a certain threshold of a target’s stock, they are prevented

from voting that stock without the majority approval of remaining shareholderso Often upheld against Commerce Clause claims because of lack of

discrimination and the internal affairs doctrine CTS Corp. v. Dynamics Corp. of America

o Indiana anti-takeover statute does not violate Commerce Clause even if it dampens commerce because it is not discriminatory to out of state bidders

Neutral to inter-state and intra-state commerceo Internal affairs doctrine applies to laws governing voting requirements

Amanda Acquisition Corp. v. Universal Foods Corp.o Wisconsin statute delaying merger after a tender offer does not violate the

Commerce Clause because it is not discriminatory to out of state bidders Neutral to inter-state and intra-state commerce

Forming a CorporationGeneral Partnership ( default assumed by law )

Association of two or more people formed by a partnership agreemento Either at-will or for a defined periodo If at-will, dissolved by any partner withdrawal

Each partner has an equal voiceo Majority decisionmaking

Personal liabilityLimited Partnership

Partnership with general and limited partners formed by filing a certificate with the state

o Dissolved by a withdrawal of the general partner General partners manage the partnership and have personal liability

o Limited partners are passive investors without personal liabilityCorporation

Legal entity separate from the shareholders formed by filing articles of incorporation with the state

o Perpetual life Board of directors manage the everyday operation of the corporation with majority

ruleo Common shareholders elect the board and vote on major matters

No shareholder liability Reinecke v. Danforth

o Founder of a corporation is not a present or former client of the corporation’s counsel, the corporation was the client

Thus the founder does not hold the confidentiality privilegeLimited Liability Company

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Legal entity distinct from members formed by an operating agreement and filing articles of organization with the state

o Perpetual life Member-managed with voting rights according to capital contribution

o Can be manager-managed if specified in operating agreement and articles of organization (members still vote on major matters)

No member liability Can choose to be taxed as a corporation or a partnership

o Corporation’s profits are “double-taxed” – at the corporate level and at the shareholder level

o Partnership’s profits “pass-through” – only taxed when the partner receives them

Elf Atochem North American, Inc. v. Jaffario Arbitration provision in an LLC operating agreement is valid even if the LLC

itself did not sign the agreement so long as both members did Law of LLC allows great flexibility and freedom of contract to govern

relationships

Accounting and Financial ReportingValuation Basics

No objective truth when reporting the financial accounting and valuation of a company

o Considerable amount of latitude that people will take advantage of in a manner that suits their interests

CEO and CFO must sign off on the financial statements of a companyo Liable if they had reason to believe that any of the representations were false

Balance SheetSnapshot of the company’s financial position

Assets = Liabilities + Equity Analyzed in two ways

o Current ratio – current assets divided by current liabilities Ability to pay short-term obligations

o Debt/Equity ratio – Long-term debt divided by equity Reliance on debt to run operations

Assets (classified in order of liquidity) Cash Accounts receivable

o Amounts owed for goods and services already provided Notes or loans receivable

o Notes or loans the company has yet to collect Inventory Fixed (long-term) assets Intangible assets

Liabilities

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Current liabilities (must be paid within 1 year)o Accounts payableo Demand notes payableo Accrued expenses payable

Long-term liabilities (due more than one year from date)Equity

Paid in capital Retained earnings

Accounting PrinciplesAccrual Accounting

Matching Principleo Firm must allocate the expenses it incurs to generate revenues to the period

in which it recognizes the revenues Realization principle

o Firm must recognize revenue in the period in which it earns it, even if not paid in that period (either not yet paid or prepaid)

Cash Accounting Record expenses and revenues in the period the cash is distributed/received

Statement of Income Net Sales Operating Expenses

o Cost of goods soldo Depreciationo Administrative expenseso Research and development

Gross Profito Net sales minus costs of goods sold

Net Incomeo Net sales minus all expenses (including tax and interest)

Financial Structure of the CorporationCorporate Capital Structure

Company, if using corporate securities, must raise funds so that investors finds rights embodied in securities attractive enough to justify investment

o Tax considerations Interest paid on bonds is deductible for the investor, dividends paid

are noto Leverage and allocation of risk

More debt means more leverage, which means more profit but also more risk for shareholders

Debt-holders will be paid regardlesso Options

Equity-Linked Investors, L.P. v. Adams

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o Directors have a fiduciary duty to the corporation, not to one specific type of investor

Duty to any one group of investors is determined by the terms of their investments (typically common > preferred)

Only a breach of a fiduciary duty if they act in bad faith DGCL § 157. Rights and Options Respecting Stock

o Every corporation may create and issue rights or options entitling holders to acquire shares of stock of any class

Subject to any provisions in the articles of incorporation MBCA § 6.21. Issuance of Shares

o Issuance of shares (or other securities convertible to shares) requires the approval of shareholders at a meeting in which at least of a majority of the votes entitled to be cast is present, if:

Consideration in return is not cash or its equivalent; and Voting power of shares will comprise more than 20% of the voting

power of the shares outstanding before the transaction

Piercing the Corporation VeilPiercing the Corporate Veil Test

Three prong test to determine when to pierce the corporate veil and impose liability on a shareholder or equitable owner (all must be met)

o (1) Control not mere majority or complete stock control, but complete domination

Not only finances, but of policy and business practice in respect to the transaction attacked so that the corporate entity had no separate mind, will or existence of its own

o (2) Control was used by the defendant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or dishonest and unjust act in contravention of plaintiff’s legal rights

Of which undercapitalization at the outset is evidence ofo (3) Control and breach of duty must proximately cause the injury or unjust

loss complained of Walkovsky v. Carlton

o Cannot pierce the corporate veil without showing that there is a substantial unity of interest between the corporation and its shareholders

Shareholder must be conducting business through the corporation in his personal capacity

o Cab company was undercapitalized but had enough insurance to meet their liabilities

Radaszewski v. Telecom Corp.o Cannot pierce the corporate veil due to bad business judgment, must show

purposeful fraud or wrongdoing Insurance would have been enough to cover the claim had the

insurance company not been insolvent

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Freeman v. Complex Computing Co., Inc.o Can be liable through a piercing of the corporate veil as an equitable owner if

one exercises sufficient control over the corporation and uses it to harm the plaintiff

Even if not a shareholder, can be liable if you control the entire corporation

o However, no showing that defendant used that control to commit fraud or other wrong that harmed the plaintiff

Kinney Shoe Corp. v. Polano Corporate veil pierced when sole shareholder creates a grossly

undercapitalized sham corporation only to obtain limited liability Cannot bestow the benefits of a corporate form that was not properly

maintained Gardemal v. Westin Hotel Co.

o Parent corporation cannot be held liable for the acts of a subsidiary through a piercing of the corporate veil, unless:

Subsidiary is organized as a mere tool or business conduit; or Two corporations are not operated as separate entities

o No evidence that the operations of the two corporations were so integrated or that the subsidiary was a mere conduit

OTR Associates v. IBC Services, Inc.o Parent corporation can be held liable for the acts of a subsidiary corporation

when the corporate form is used merely as a shield behind which fraud or other injustice is sought to be done by those who have control of it

Blimpie subsidiary was created to insulate the parent from liability without any other purpose

Effects of Imposing LiabilityPublic Corporation

o Shareholders must monitor other shareholderso Shareholders must monitor managemento Management will be risk averseo Shares will be less fungible due to uncertaintyo Investment in stock will be less attractive relative to other investments

Close Corporationo No issue of monitoring other shareholders or management (all shareholders are

familiar and are likely management)o All other concerns remain

Corporate AuthorityBoard and Shareholder Authority

DGCL § 141. Board of Directorso Business and affairs of corporation shall be managed by the board of

directors except as otherwise provided here or in articles

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Board Composition and StructureAudit Committee

Responsible for the appointment, compensation and oversight of the corporation’s public accounting firm

Responsible for monitoring the corporation’s financial transactions and financial reports

Compensation Committee Oversees the form and amount of senior executive’s compensation

Nominating Committee Responsible for nominating candidates for the board of directors Responsible for deciding whether current directors should be nominated for

reelectionAgency Law

Many relationships in the corporation are agency relationships, giving rise to fiduciary duties of care and loyalty

o Corporation/Shareholders Boardo Board Managers

Agents may have the power to legally bind the principal in legal relationships with third parties

o Actual authority Express or implied from the principal

o Apparent authority Reasonable that third party believes the principal consented to give

the agent authority based on statements and actions of the agento Inherent authority

Reasonable that third party believes the agent has authority based on the position of the agent (does not depend on representations)

Assumed a CEO has authority to bind a corporation in transactions entered into in the “ordinary course of business”

o Ratification Principal can ratify the act of the agent who at the time did not have

authority to bind Ratification can be inferred from the acts (or non-action),

words or conduct of the principal Counsel will often insist on receiving adequate evidence that individuals acting on

behalf of a corporation have authorityo Statutory law, articles of incorporation, bylaws, resolution of the board, etc.

Summit Properties, Inc. v. New Technology Electrical Contractorso Vice President of Finance had apparent authority to sign lease on behalf of

the corporation because the lessor reasonably relied on the representations the corporation made

Further, by failing to take action against the lease after it was notified, the corporation ratified the authority and thus the lease

Menard, Inc. v. Dage-MTI, Inc.

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o President of a corporation has the inherent power to bind the corporation to a contract so long as the contract is within the ordinary scope of his duties

And the third party has no notice that he lacks authority

Close CorporationsClose Corporations

Courts may look to two things to define a corporation as “close”o Integration of ownership and managemento Number of stockholders and the nature of the market for the stock

Due to the illiquid nature of the investment in a close corporation, courts are more tolerant of deviations from the norm

Hobby Lobby Stores, Inc. v. Burwello Rights of a close corporation are derivative of individual rights – corporation

is a legal fiction Must protect the rights of the underlying stakeholders by inferring

those rights on the corporationAlignment of Shareholder ControlShareholder Voting Arrangements

Straight votingo One share equals one vote for one directoro Directors with most votes are elected

Cumulative Votingo One share equals one vote for every open director positiono May “cumulate” all of your votes for one position

Classified Votingo Divide voting stock into two or more classes, each of which is entitled to elect

one or more directorsLimitation Devices on Shareholder Voting

Voting Trusto Convey legal title of stock to a trustee pursuant to the terms of an agreemento Shareholder becomes a beneficiary of the trust, entitled to receive dividends

Irrevocable Proxyo Shareholder gives proxy to vote shares to someone elseo Cannot be revoked for the specified life of the proxy

Vote Pooling Agreementso Agreement between shareholders to vote together on designated questions

Restrictions on Board DiscretionShareholder agreements

Can modify traditional corporate structure if set forth in the articles of the bylaws Must be approved by all shareholders at the time of the agreement

High Voting Requirements Require percentage of the vote to pass any action so high that any one (or group) of

shareholders effectively retain a veto power Smith v. Atlantic Properties, Inc.

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o Minority shareholder, in a close corporation that requires a unanimous vote for corporate action, may not repeatedly vote against an action for personal reasons if the action would be in the best interest of the corporation

Shareholders, even though expected to vote in self interest, must exercise votes in good faith

Restrictions on TransfersRight of First Refusal

Before selling shares to a third person, must offer to the corporation (or its shareholders) on the same terms

If given to shareholders, it is relative to their stake in the corporationFirst Option Provision

Offer to the corporation at a price and on terms fixed by agreementConsent

Transfers conditioned on the consent of the board of directors or other shareholders

Sale Option Withdrawing shareholder can receive an option to sell her shares to the corporation

or the remaining shareholders upon the condition of a specified eventBuy-Sell Agreement

Corporation or remaining shareholders are compelled to purchase the shares of another shareholder upon the occurrence of specified events

Dissension and Oppression Minority stockholder is “oppressed” if the reasonable expectations of the minority

shareholder’s investment is frustratedo Burden then shifts to the defendant to show that there is a rational and

legitimate business purpose for the “oppression”o If the defendant meets their burden, it shifts to the plaintiff to show that it is

not the least intrusive means of doing so Remedies for Oppression

o Courts often have the statutory power to dissolve the corporation if a shareholder establishes that:

(1) The directors are deadlocked, and the deadlock cannot be broken by shareholders and it is injuring the corporation or impairing the conduct of tis business;

(2) The shareholders are deadlocked and have not been able to elect directors for two years

(3) Corporate assets are being wasted; or (4) Those in control of the corporation are acting “in a manner that is

illegal, oppressive or fraudulent.”o Defendants have the burden of proving that an alternative viable remedy is

available Wilkes v. Springside Nursing Home, Inc.

o Majority shareholders in a close corporation owe minority shareholders a strict duty of the utmost good faith and loyalty

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Unless a legitimate business purpose can be demonstrated to justify a breach of that duty

Minority reserves the right to demonstrate the same objective could be achieved through less oppressive/harmful action

Nixon v. Blackwello Corporate directors owe a fiduciary duty of fair, but not necessarily equal,

treatment to all shareholders Matter of Kemp & Beatley, Inc.

o If majority shareholders take actions that substantially defeat the reasonable expectations of minority shareholders, they have engaged in oppressive conduct and the court may order forced dissolution of the corporation

Burden is then on the defendants to show that an alternative viable remedy is available

Bonavita v. Corboo Even if there is a legitimate business purpose for the majority’s action,

cannot defeat the reasonable expectations of the minority if it is not the least intrusive means of doing so

Dissolution of the Limited Liability Company Courts are more likely to respect the parties’ contractual understandings in an LLC

than in a Corporationo Grounded on principles of freedom of contract

Haley v. Talcotto Court may dissolve an LLC when it is not reasonably practical to carry on the

business in conformity with the LLC agreement So long as the LLC agreement does not otherwise provide a sufficient

exit mechanism

Shareholder AuthorityVotingWhat can shareholders vote on?

Elect/remove directorso With or without cause – unless articles say otherwiseo Directors must be given notice and opportunity to meet accusation

Approve proposed amendments to the articles of incorporationo But cannot propose

DGCL § 109 – Propose and approve amendments to the by-lawso Articles may allow the directors to adopt, amend or repeal bylaws, but this

does not take it away from the stockholders Approve significant transactions Approve conflicted transactions

When can shareholders vote? Annual meetings

o Date specified in the by-laws Special meetings

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o DGCL § 211. Meetings of Stockholders Special meetings of stockholders may be called by the board or by any

person authorized in the articles or the bylawso MBCA § 7.02

Called by an member of the board, owners of 10% of stock or anyone authorized in the articles

Meeting requirementso Shareholders must be given notice of all meetings in which they are entitle to

voteo “Record date” is set – only shareholders “of record” on that date can voteo MBCA 7.04. Action without meeting

Action requiring a meeting can be taken without one if written consent by all shareholders entitled to vote on the action

Articles can allow for consent by minimum number of votes requiredHow can shareholders vote?

In person at the meeting Vote by proxy

o Give consent for someone else to vote on your behalfShareholder Voting Dynamics

Costs of shareholder informing themselves is typically outweighed by the expected returns from informed voting

o Collective action problemStructuring Corporate Combinations

“Market Exception” to appraisal rightso No need for appraisal rights if the market will serve the same purposeo Requires the stock to be traded publicly

(1) Statutory Mergero Target is merged into Purchaser – all of T shares are converted into P shareso MBCA

Voting Requirements Majority of T’s outstanding shares required P’s shareholders only vote if there is a dilutive share issuance

Appraisal Rights T’s shareholders have appraisal rights unless “market

exception” P’s shareholders do not have appraisal rights unless entitled to

vote on mergero DGCL

Voting Requirements (§ 251) Majority of both T and P’s outstanding shares must approve

the merger (unless short-term merger) P’s shareholder approval not required if P’s outstanding voting

stock is not increased by 20% Appraisal Rights (§ 262)

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T’s shareholders have appraisal rights if the “market out exception” does not apply

P’s shareholders have appraisal rights if they were entitled to vote on the merger and the “market out exception” does not apply

(2) Triangular Mergero Target is merged into a newly created subsidiary of Purchaser – to shield P

from liabilityo MBCA

Voting Requirements Majority of T’s outstanding shares must approve the merger P’s shareholders vote only if there is a dilutive share issuance

Appraisal rights T’s shareholders have appraisal rights unless “market

exception” applies P’s shareholders have appraisal rights only if they were

entitled to vote on the mergero DGCL

Voting Requirements Majority of T’s outstanding shares must approve the merger Only P’s board must approve the merger (P’s shareholders do

not own shares in the subsidiary) Appraisal Rights

T’s shareholders have appraisal rights if the “market out exception” does not apply

P’s shareholders do not have appraisal rights (3) Statutory Share Exchange

o Target shareholders receive Purchaser’s shares in exchange for their stock – T becomes a subsidiary of P

o MBCA Voting Requirements

Majority of T’s outstanding shares must approve P shareholders only vote if there is a dilutive share issuance

Appraisal rights T’s shareholders may seek appraisal unless the “market

exception” applies P’s shareholders do not have appraisal rights

o DGCL Does not recognize the statutory share exchange

(4) Sale of Assetso Target sells assets to Purchaser in exchange for P stock or other

considerationo MBCA

Voting Requirements Majority of T’s outstanding shares must approve the sale

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P shareholders only vote if there is a dilutive share issuance Appraisal Rights

T’s shareholders have appraisal rights if there is no “market exception”

P shareholders do not have appraisal rightso DGCL

Voting Requirements Majority of T’s outstanding shares must approve the

transaction Appraisal Rights

No appraisal rights (5) Tender Offers

o Purchaser offers to purchase Target shares directly from T shareholderso DGCL § 251. Merger of Consolidation of Domestic Corporations

(h) After a tender offer, shareholders of the target corporation that have not tendered do not need to vote for a merger if:

Market exception applies; and Consideration paid in merger is the same paid in the tender

offerInitiating ActionScope of Board/Shareholder Power

DGCL § 109(b)o By-laws may contain any provision relating to the business of the

corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officer and employees

DGCL § 141o Authority of the board of directors is plenary

Unless otherwise stated elsewhere in the articles of incorporation or the DGCL

o Directors may be removed with or without cause by the holders of a majority of shares entitled to vote

Auer v. Dresselo Stockholders have inherent power to remove directors for cause, regardless

of by-laws giving that power to the board Thus the board must call a meeting to remove directors at the

shareholder’s request Blasius Industries v. Atlas Corp.

o Board cannot undertake action with the primary purpose of interfering with shareholder voting, even if in the good faith pursuit of the corporation’s best interest

Business Judgment Rule is for everyday management of the corporation, not the shareholder/board power structure

Cannot have the agent define the authority granted by the principalProxy Solicitation

DGCL § 112. Access to Proxy Materials

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o Bylaws may provide that corporation is required to include in its proxy materials individuals nominated by a stockholder, subject to procedures and conditions

DGCL § 113. Proxy Expense Reimbursemento Bylaws may provide for the reimbursement by the corporation of expenses

incurred by a stockholder in soliciting proxies in connection with the election of directors, subject to procedures and conditions

SEC Shareholder Proposal Rule 14(a)-8o The board can omit a shareholder’s proposal on a proxy statement that:

Is not proper under state law Is misleading or false Does not meet a minimum economic test (5% of sales, assets or

earnings) and is not otherwise significantly related to the company’s business

Involves “ordinary business operations” (DGCL § 141) Relates to an election for membership of the board

Lovenheim v. Iroquois Brandso A proposal’s significant relation to the company’s business is not related to

economic significance Includes policy questions important enough to be significantly related to

the issuers businessOrdinary Business Decisions vs. Process and Procedure

DGCL § 102(b)(1)o Articles of incorporation may contain:

Any provision for the management of the business and for the conduct of the affairs of the corporation

Any provision creating, defining, limiting and regulating the powers of the corporation, directors and the stockholders

DGCL § 109(b)o By-laws may contain any provision relating to the business of the

corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officer and employees

CA, Inc. v. AFSCME Employees Pension Plano Shareholders can amend the by-laws to dictate the process and procedures

by which the board acts But cannot adopt by-laws that mandate the decision itself

Disclosure Duties to ShareholdersSecurities and Exchange Act § 14(a)Two Requirements for Challenging a Misleading Proxy Statement

(1) Proxy statements are prohibited if they contain a material misstatement or omission

o Material if there is a substantial likelihood that the disclosure of the omitted fact would have “altered the total mix of information available to a reasonable investor”

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Can include a belief (Basic) or opinion (Virginia Bankshares)o TSC Industries, Inc. v. Northway, Inc.

A fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote

Must have a significant propensity to affect the voting process, but not necessarily change to vote itself

o Basic, Inc. v. Levinson Misstatements about merger negotiations can be material statements

of fact depending on probability that event would occur and the anticipated magnitude of the event

Probability indicia of interest in the transaction at high corporate levels

Magnitude size of the entities and the potential premiums over market value

o Virginia Bankshares v. Sandberg A statement of belief (opinion) by a board of directors can be a

material misstatement if the statement of belief is false (not what they actually believed)

Must show (1) they lied about what they believed and (2) that the stated belief was not the true state of the world

o Gantler v. Stephens If statement would not be material, but it is disclosed and it is

misleading, it may become material Statement that board carefully considered a merger offer prior

to privatization, while not necessary, becomes material once disclosed

(2) Plaintiff must show that the misstatement or omission caused a losso (a) Must show that the proxy solicitation was an “essential link” in the

transaction – that the shareholder’s vote was required for the transaction; oro (b) Must show that you were mislead into voting for the transaction which

led to a loss in appraisal rightso Virginia Bankshares v. Sandberg

Proxy statement must be required for the transaction to go through for there to be an injury to the shareholders

No injury if the transaction would have gone through anywayo Mills v. Electric Auto-Lite Co.

If proxy solicitation was required for transaction, omission or misstatement not required to have caused shareholders to vote the way they did

Only need to show that proxy solicitation was an “essential link”

Duty of CareBoard Decisionmaking

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Duty of Care Board of Directors owes a fiduciary duty of care to the corporation and, through the

corporation, the shareholderso Must act in the corporation’s best interestso Must exercise reasonable care in making decisions and in overseeing the

corporations affairsBusiness Judgment Rule

Presumption that in making a business decision, the directors of a corporation acted:

o (1) On an informed basiso (2) With a rational business purpose

In order to rebut these presumptions, the plaintiff must show (respectively):o (1) Gross negligence

Want to protect incentive to take riskso (2) Waste

Must show the transaction wholly lacks consideration If the plaintiff rebuts either, the board cannot show entire fairness because (1)

shows lack of fair process and (2) shows lack of fair outcomeo However, board can show that the transaction caused no harm

Smith v. Van Gorkomo Rebuttable presumption that a board’s business decision is fully

informed, made in good faith and in the best interests of the corporationStatutory Exculpation of Directors

Provision in the articles of incorporation can reduce director’s personal liability for violations of the duty of care (not loyalty)

o Want to preserve incentive for directors to take riskso Want to fairly limit damages relative to the director’s culpability

DGCL 102. Contents of Certificate of Incorporationo (b)(7) Articles may contain provision eliminating or limiting personal

liability of a director to the corporation/stockholders for breach of fiduciary duty, but may not eliminate liability for:

Breach of duty of loyalty Acts or omissions in bad faith Intentional misconduct or violation of law Improper personal benefits

Indemnification State corporate statutes allow for the articles, by-laws, or private contracts to

provide for indemnification of the directors by the corporationo State statutes are either permissive, mandatory or comprehensive (both)

Insurance D&O policies what two separate but integral parts

o (1) Reimbursement to the corporation for its lawful expenses in connection with indemnification of the director/officer

o (2) Coverage of claims against corporate directors/officers in their corporate capacity

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Duty of Good FaithBoard Oversight

Duty of good faith is an extension of the duty of loyaltyo Breached by a conscious disregard of duty to take action to fulfill a fiduciary

duty (Stone) Board of Directors has a duty to the corporation to make good faith efforts to ensure

that adequate corporation information and reporting systems existo Level of detail of the system’s oversight is a question of business judgmento Only applicable to the monitoring of employee conduct, not business risk

Lack of good faith can be shown by:o Sustained or systemic failure to establish a reasonable information and

reporting systemo Failure to investigate or respond reasonably and adequately to a “red flag”

DGCL § 141. Board of Directorso (e) Director (or committee designated by board) is protected in relying in

good faith upon the records of the corporation, or upon such information presented to the corporation by any of its officers, employees, committees, or any professional or expert

Graham v. Allis-Chalmers Manufacturing Co.o Absent cause for suspicion (“red flag”), there is no duty upon directors to

install and operate a corporate system of espionage to ferret out wrongdoing Directors are entitled to rely on the honesty and integrity of their

subordinates until something puts them on suspicion In re Caremark International Inc. Derivative Litigation

o Board has a duty to make good faith efforts to ensure that adequate internal corporate information and reporting system exists

Level and detail of system’s oversight is a question of business judgment

o Lack of good faith shown by a sustained or systemic failure to establish a reasonable information and reporting system

Or by a failure to investigate/respond reasonably and adequately to a “red flag”

Stone v. Rittnero Duty of good faith is an extension of the duty of loyalty, not the duty of care

Conscious disregard of responsibilities by failing to put in place an adequate compliance system is an act of bad faith – breach of loyalty

ATR-Kim Engineering Financial Corp. Aranetao Directors who fail to act as an independent and impartial fiduciary, and fail to

monitor another director, are acting in bad faith Thus are liable as if they were the director wronging the corporation

In re Citigroup Inc. Shareholder Derivative Litigationo Directors violate their duty to the corporation by failing to properly monitor

employee conduct, not business risk

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Business decisions, like the assumption of risk, are analyzed under the business judgment rule

Duty of LoyaltyIn General

Managers must put the Corporation’s interests before personal interestso It is presumed by courts that managers are:

Disinterested Independent

To allege breach of Duty of Loyalty, must show:o (1) Interested Party (Manager, Director, Officer); oro (2) Must show that party is incapable of making an independent judgment

Cleansing Interested Director Transactions DGCL § 144. Interested Directors

o An interested director transaction will not automatically be void solely because of the interest if either:

There has been informed, disinterested (and independent) board approval or informed shareholder approval (majority of minority); or

The transaction is fair to the corporation MBCA §§ 8.61-63. Judicial/Director/Shareholder Action

o Director’s conflicting interest transaction is not judiciable if: Authorized by the affirmative vote of a majority of disinterested

directors (no less than two), so long as: Disinterested directors were informed (of interest) Disinterested directors deliberated alone

Authorized by the affirmative vote of a majority of disinterested shareholders, so long as:

Disinterested shareholders were informed (of interest) It was fair to the corporation

When making a decision, Board can “cleanse” the transaction to protect themselves against breach of duty of loyalty claims

o Once cleansed, the challenger is only left with a duty of care claim – thus the Business Judgment Rule applies

Transaction can be “cleansed” in two wayso Majority of independent, disinterested, and informed board members

approve the transaction; oro Transaction is submitted to the shareholders and approved by an informed

and uncoerced majority of the minority (of disinterested and independent shareholders)

If not cleansed, board has the opportunity to prove that the transaction was nonetheless “fair” to the corporation – must show:

o Substantive Fairness fair in consideration and other terms of the transaction

o Procedural Fairness Process of decision and director’s conduct

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Cleansed by an Approval of Disinterested and Independent Directors Interested Director transaction can be valid and subject to BJR if:

o A majority of the disinterested and independent directors approve the transaction; and

o Material facts as to director’s interest are disclosed or known to that majority Benihana of Tokyo, Inc. v. Benihana

o Transaction involving an interested director obtains the benefit of the BJR if the transaction is approved by a vote of the independent and disinterested directors

So long as the material facts as to the director’s relationship/interest are disclosed or known to the remainder of the board

In re eBay, Inc. Shareholders Litigationo Remaining directors are not independent and disinterested when the

interested directors are controlling shareholders Remaining directors’ have stock options that are dependent upon the

controlling shareholders continuing to vote them in In re Walt Disney Company Derivative Litigation

o In order to show that remaining directors are not disinterested or independent, must show that they are beholden to the interested party

Cannot exercise business judgment independent of the interested party

Cleansed by Majority of Minority Shareholders Interested director transaction can be valid and subject to BJR if approved or

subsequently ratified by shareholders, so long as:o Majority of disinterested and independent shareholders approve the

transaction;o Material facts as to the transaction and the director’s interest were disclosed

to the shareholders; ando There is no coercion present

Lewis v. Vogelsteino Shareholder ratification shifts the burden to shareholders to overcome the

business judgment rule – must show “waste” So long as the approval was validly obtained – must be informed of all

relevant terms and conditions and non-coercive Harbor Finance Partners v. Huizenga

o Once disinterested and independent shareholders ratify a self-dealing transaction with an informed and non-coerced vote, a “waste” challenge serves little purpose

Corporate Opportunity Doctrine Director, officer or managerial employee cannot divert to themselves any business

opportunity that “belongs” to the corporation if:o It is one the corporation can financially undertake;o Is within the line of the corporation’s business and is advantageous to the

corporation; ando Is one in which the corporation has an interest or a reasonably expectancy

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Director, officer or managerial employee can take the corporate opportunity if presented to the corporation and the corporation rejects it

o Rejecting corporate decision-makers must be informed, disinterested and independent

Duties of Controlling ShareholdersStandard of Review for Cash-Out Transactions

Controlling shareholder will use a cash-out merger to terminate other shareholders’ equity interest in the corporation by forcing them to accept cash for their stock

o Merges the partially owned target into a completely owned subsidiary, with the completely owned subsidiary paying cash for the target stock

o As controlling shareholder, can force the target to accept the offerSelf-Dealing Transactions

If a controlling shareholder engages in “self-dealing,” the court will review the transaction under “intrinsic/entire fairness” instead of the BJR

o Self-Dealing: Controlling shareholder is on both sides of the transaction; and Controlling shareholder receives a benefit to the exclusion and at the

expense of the subsidiaryo Intrinsic/Entire Fairness:

Burden of proof shifts to the controlling shareholder to show that the transaction was fair to the corporation

Must show: Substantive Fairness fair in consideration and other terms

of the transaction Procedural Fairness Process of decision (informed) and

director’s conduct Sinclair Oil Corp. v. Levien

o A parent corporation must pass the intrinsic fairness test only when its transaction with its subsidiary constitutes self-dealing

Transaction is self-dealing when the subsidiary does not share in the benefit of the transaction, and the transaction is to its detriment

Weinberger v. UOP, Inc.o In order for there to be procedural fairness, minority shareholders must be

informed of all material information regarding the merger When information is gathered from target to determine purchase

price, must disclose the purchase price to the target’s shareholdersIndependent Committees

If an independent committee is used in the negotiation process, the burden of “entire fairness” shifts to the plaintiffs if:

o The committee has genuine bargaining power that it can exercise with the controlling shareholder at arms length; and

o The controlling shareholder did not dictate terms of transaction (coercion) Kahn v. Lynch Communications Sys., Inc.

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o A minority shareholder can still be a controlling shareholder if they dominate corporate affairs

Effective veto power can make a minority shareholder a controlling shareholder

o Independent committee will not shift the burden to the plaintiffs when the committee does not have genuine bargaining power

Without the real power to say “no,” committee will not be found to have genuine bargaining power

Independent Committees Coupled With Majority of the Minority Business Judgment Rule applies when, from the controlling shareholder’s first

overture, the merger has been subject to both:o Negotiation and approval by an independent committee of directors with

genuine bargaining power; ando Approval by an un-coerced, fully informed vote of a majority of the minority

of investors In re MFW Shareholders Litigation

o Once a transaction is subject to both procedural protections, the limited benefits of “entire fairness” review are not worth the added costs

Closer to an arms length transaction – can protect themselves with an informed vote, and gain bargaining power with a committee

o Benefit of BJR gives directors incentives to employ maximum procedural safeguards

Standard of Review for Alternatives to Cash-Out MergersShort-Form Merger – DGCL § 253

If parent corporation owns at least 90% of the subsidiary’s outstanding shares, can engage in a short-form merger

o Must file a certificate setting forward its ownerships and the terms of the merger

o Must inform the subsidiary’s minority shareholders of the terms and advise them of their appraisal rights

Does not require any action by the board or shareholders of the subsidiaryo Thus, they are not given the right to judicial review of the transaction

Tender Offers and Short-Term Mergers Often, a corporation will commence a tender offer conditional on receiving 90% of

the target’s stocko Once they obtain this threshold, they can commence a short-term merger

without any opposition or judicial review Tender Offers will be subject to a process-based “voluntariness” review

o (1) Offer has to be subject to a non-waivable requirement that is approved by a majority of the minority

o (2) Controlling shareholder must promise to effectuate immediately a short-form merger at the same price as the tender offer

o (3) Controlling shareholder must made no retributive threats (coercion)

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o (4) Controlling shareholder must permit the independent directors on the board time and authority to react to the tender offer, hire their own advisors, and make a recommendation

In re Pure Resources Inc. Shareholders Litigationo Tender offers are subject to a “voluntariness” review - requires full

disclosure and lack of coercion Must still give deference to shareholder decisions that are voluntary

and informedo Shareholders ability to decline tender offers does not remove all threats of

structural coercion Prisoner’s dilemma, informational advantages, etc.

Shareholder LitigationDirect and Derivative Actions

Direct actionso Action brought in the name or right of a holder to redress an injury sustained

by, or enforce a duty owed to, the holder Likely in the form of a class action

Derivative actionso Action brought in the name or right of a corporation by a holder to redress an

injury sustained by, or enforce a duty owed to, a corporation Shareholder represents the corporation (fiduciary in character) to

vindicate interest of all shareholders Tooley v. Donaldson, Lufkin & Kenrette, Inc.

o Two questions to ask to determine if injury is derivative: Who suffered the harm – the corporation or the shareholders as

individuals? Who would receive the benefit of any recover or other remedy – the

corporation or the shareholders as individuals?The Demand RequirementExcusal of Demand

Three requirements of derivative litigation – stockholder must:o Retain ownership of the shares throughout the litigation;o Make pre-suit demand on the board; ando Obtain court approval of any settlement

When is demand excused?o Board’s decision whether or not to carry forward with litigation after

shareholder demand is entitled to the BJRo Thus, in order to avoid demand, must create a reasonable doubt that:

(1) Majority of directors are disinterested and independent (2) The challenged transaction was otherwise the product of a valid

exercise of business judgment (Duty of care/duty of loyalty not breached)

o Temporal point of view

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If board that would be demanded is the one who made the challenged action:

Must apply review to the time of the challenged action Where they disinterested and independent then?

If board that would be demanded is not the one who made the challenged action:

Must apply review to the time of the decision not to review Are they disinterested and independent now?

Aronson v. Lewiso Demand will only be excused where facts are alleged with particularity which

create a reasonable doubt that the director’s action was entitled to BJR Not enough to show interest that board would be defendants in the

lawsuit requested Rales v. Blasband

o If seeking to avoid demand to a board that did not make the challenged business decision, the BJR cannot apply to that decision with respect to them

Must examine if they can impartially consider the merits of the challenge without influence by improper considerations

Special Litigation Committees Corporations often form a Special Litigation Committee (SLC) to consider whether

or not to move forward with a demanded lawsuito Thought to insulate the board from any interest that would invalidate BJR

Two step analysis for reviewing SLC recommendationo (1) The court should inquire into the independence and good faith of the

committee and the bases supporting its conclusionso (2) The court should determine, applying its own independent business

judgment, whether the motion should be granted Includes considering constituencies the board/SLC could consider

Zapata Corp. v. Maldonadoo When reviewing an SLC’s recommendation to the board, but be weary of the

inherent structural biasDefinition of “Director Independence”

Cleansing Contexto To prove a director is not independent, must show that he is “more willing to

risk his reputation than his relationship” with the interested director he is beholden to

Highest burden to meet – least skeptical Demand Futility Context

o To prove a director is not independent, must show reasonable doubt that he is “more willing to risk his reputation than his relationship” with the interested director he is beholden to

Medium burden to meet – less skeptical SLC Context

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o Independence turns on whether a director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind

Lower burden to meet – more skeptical

Protecting and Selling ControlBasics of Acquiring Control

Mergerso Bidder gives an offer to the target company’s board

If approved by the board, will be submitted to the shareholders for approval

If rejected by the board, will never be sent to the shareholders for approval

Tender Offerso Bidder gives an offer directly to the shareholders to purchase their stock at a

premium If successful, will vote in a new board to approve a merger

o Common features of a tender offer Conditioned on receiving a certain percentage of shares Conditioned on the redemption of a poison pill Opportunistically timed for when directors are up for election

o Proxy Contests Bidder will often engage in a preemptive proxy contest to replace the

board and redeem a pill before shareholders tender to the bidder Proxy rules apply

Takeover Defenseso Poison Pill (“Shareholder Rights Plan”)

Upon the occurrence of a triggering event, shareholders have the pro rata right to purchase a new series of stock at a discount

Except the bidder – thus dilutes their interest and increases costs of obtaining control

o Staggered Board In bylaws or articles, corporations can divide board into classes that

are voted in at different times Increases the time required for a successful bidder to take

control of the target boardo DGCL § 203. Business Combinations with Interested Stockholders

(a) Corporation shall not engage in any business combination with an interested stockholder (15%) for 3 years following time they became interested stockholder, unless:

Combination was approved before they became interested; Interested shareholder owns 85% of stock; or Approved by at least 2/3 of the outstanding voting stock not

owned by interested stockholder (b) Subsection (a) does not apply if articles say otherwise

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“Structural Coercion” as a threato Board believes that the structure of the tender offer creates a risk that

shareholders will tender at an inadequate price If offer is front loaded (for 50%), shareholders will tender so that they

are not left out to dry “Substantive Coercion” as a threat

o Board believes company’s strategic plan will deliver more value than the premium offer, but stock market has not reflected that

Thus, risk that stockholders might tender in ignorance or upon a mistaken belief

Judicial Review of Takeover DefensesProactive Defensive Measures

Defensive measures taken by the board prior to any threat are subject to the business judgment rule

Defensive Measures in Response to a Threat When defensive measures are taken in response to a threat to corporate control, the

board must meet the two-prong Unocal analysis to receive BJR protectionso (1) They had reasonable grounds to believe that a danger to corporate policy

and effectiveness existed (and it was not in their own self interest to remain in power); and

o (2) The defensive measure adopted was proportionate to the threat posed Directors may only take into account non-shareholder interests if doing so provides

some rationally related benefits for the shareholderso If substantive coercion, defensive measures may only be utilized for a limited

time sufficient to ensure shareholders receive information necessary to make an informed decision

Unocal Corp. v. Mesa Petroleumo Board may consider any relevant constituency to the corporation when

determining if there is a threat to the corporation Reasonable to repurchase stock from shareholders to defeat a

perceived threat to the corporation Paramount Communications, Inc. v. Time, Inc.

o Unocal does not apply to defensive measures taken proactively when entering the entertainment business

However, Unocal does apply to the maintenance of those defensive measures once the threat appeared

o Can take intangible factors into account to determine if there was a reasonable fear of threat

Air Products and Chemicals, Inc. v. Airgas, Inc.o Threat of arbitragers selling at a price that the board reasonably believes is

inadequate is reasonable Staggered board and poison pill are a proportionate response to that

threato Significant amount of deference to the board in determining what is a

reasonable response to a threat

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Defensive Measures when the Corporation is “Up For Sale” Once the sale of a corporation is inevitable, the interests of anyone other than the

shareholder may not be taken into accounto Regardless of presence of threat to corporate controlo Can only implement defensive measures designed to get shareholders a

higher price Will be judged under a reasonableness standard

Corporation is “up for sale” when:o There will be a break-up of the corporate entityo There will be a change in control

Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.o When corporation is “up for sale,” directors duty changes from maintaining

the company as a viable corporate entity to maximizing shareholder benefit Lyondell Chemical Co. v. Ryan

o Board is not “up for sale” unless the board itself takes action to transfer control

Mere presence of bidders is not sufficient Paramount Communications, Inc. v. Time, Inc.

o Revlon does not apply without evidence that the board would lose control of the corporation

Paramount v. QVCo Once competitive bidding begins that would cause a change in corporate

control, the target board must maximize shareholder value Cannot fail to critically examine the competing transactions and

negotiate with both biddersDefensive Measures that Frustrate Shareholder Voting

There must be a “compelling justification” if defensive measure adopted either: o (1) With the primary purpose of impeding the effectiveness of a shareholder

vote for The election of directors; or A change in control

o (2) With the effect of precluding an effective shareholder vote Is an effective shareholder vote realistically attainable?

Carmody v. Toll Brotherso “Dead hand provision” accompanying a poison pill is preclusive

Compels shareholders who want fully functioning board to vote for incumbent directors Makes proxy contest realistically unattainable

Blasius Industries, Inc. v. Atlas Corp.o Board needs a “compelling justification” to take measures impeding the

effective exercise of the shareholder vote Unitrin Inc. v. American General

o Defensive measures giving the board an effective veto percentage of shares upon the purchase of 15% by any bidder was not preclusive

Bidder could wage a proxy war with 14.9% to get the approval of remaining shareholders – still realistically attainable

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Chesapeake Corporation v. Shoreo Defensive measure requiring supermajority vote (giving board a veto) was

preclusive, and there was no compelling justification Clearly intended to impede the effectiveness of the shareholder vote “Substantive coercion” is not a compelling enough justification

Mercier v. Inter-Tel, Inc.o Suggestion Unocal is a better standard that Blasius when reviewing

defensive measures effecting the shareholder vote on the election of directors or changes in corporate control

o Applying Law The defensive responses postponing date of vote are not preclusive or coercive, thus Unocal

“Substantive coercion” is a reasonable threat Defensive measures postponing date of vote are proportionate

Air Products and Chemicals, Inc. v. Airgas, Inc.o Defensive measure is not preclusive if it is not reasonably attainable to gain

control in the short-term but is within two years

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