B U S I N E S S O R G A N I Z A T I O N S O U T L I N E

Agency

Definition of AgencyAgency results from: (1) the manifestation of consent by one person to another (2) that the other shall act on his behalf and subject to his control, and (3) consent by the other to so act [R. Agency. § 1]

Once P-A relationship is established, it is as if the P has done what the A has done There needs to be some agreement more than passive permission but no contract or

compensation neededo On the other hand, even if there is a contract saying otherwise, e.g. independent

contractor, P-A is a question of fact to be determined from the totality of circumstances [Humble Oil v. Martin]

Question of Control: Critical test is nature and extent of the control agreed upon [Murphy v. Holiday Inn]

Element of continuous subjection to the will of the principalo P-A when Doty told Coach that only he can drive the car [Gorton v.

Doty]o P-A when Humble furnished station location equipment,

advertising media, products, decided operating hours, could terminate A at anytime [Humble Oil v. Martin]

o No P-A when Sun had no control over Barone’s day-to-day operation [Hoover v. Sun Oil]

Security Holders and Debtors: Do not become P by merely exercising veto powero Creditor becomes Principal when he assumes de facto control over the conduct of his

debtor [R. Agency § 14] If he takes over the management of the business and directs what contracts to

enter, he becomes liable as a principal for the obligations incurred in normal course of business. Gay Jenson Farms v. Cargill.

Suppliers and Buyers: Supplier becomes agent only if he agrees that he will act primarily for the benefit of the buyer and not for himself [R. Agency §14k]

o If supplier has an independent business, he is not an agent. Factors include: (1) he receives a fixed price from the buyer regardless of what he paid; (2) he acts in his own name and receives title to the property before he transfers it to buyer; (3) he has an independent business buying and selling similar property. Gay Jenson Farms v. Cargill.

Undisclosed Principal: Agent is liable until Principal is disclosed, then no liability o If Principal is partially disclosed, (third party knows P exists but not his identity,) Agent is

responsible for the contract in that situation

Liability of Principal to Third Parties in Contract Principal is only liable for contracts if Agent manifested one of the following:

Actual Authority: o Principal specifically gives the authority to the agent to act on his behalf

Implied Authority: o Actual authority circumstantially proveno Principal actually intended the agent to possess the authorityo Includes powers that are practically necessary or reasonable to carry out the duties

actually delegatedo Factors to consider [Mill Street Church v. Hogan]

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The agent’s reasonable understanding of his own authority given by P Nature of the task or job, whether it necessitates that authority Specific conduct by the P in the past or present permitting the agent to exercise

similar powers (most important) Apparent Authority:

o Not actual authorityo Principal literally holds out the agent as his agent

Needs to be within the usual and proper conduct of businesso Matter of appearances that third parties reasonably expect/ rely on

Third party cannot know of the lack of P-A relationship [Three-Sventy Leasing v. Ampex]

Inherent Authority:o Principal has acted as to enable the agent to hold himself out to the world as the

proprietor of their business while they were undisclosed principals [Watteau v. Fenwick] P has notice of the agent’s conduct and that it might induce others to change their

positions but did not take reasonable steps to notify them of the facts P places agent in the agency and that in itself signals something to others

o P is liable for contracts A enters into in the normal course of businesso P not liable if third party is on notice of A’s lack of authority

Agency by Estoppel: o When you induce someone (active behavior or involvement) to reasonably rely on you to

their detriment, you are liable for whatever they lost Inducement: Active behavior on the part of the person being charged with the

concept of estoppel, i.e. you induced someone and they reasonably relied on you to their detriment

o When a proprietor derelicts his duty and enables one who is not his agent to transact business with a person of ordinary prudence who believes that P-A exists, the proprietor is liable [Hoddeson v. Koos Bros.]

Employer Liability in Tort P is liable for things that are reasonably foreseeable within the scope of employment

o Conduct of a servant is within the scope of employment only if it is actuated, at least in part, by a purpose to serve the master [R.2d Agency § 228(1)]

Policy: Incentive of principal to prevent torts of agentso P is liable for employee’s assault if the assault was in response to conduct which was

presently interfering with the employee’s ability to perform his duties successfully [Manning v. Grimsley]

The Coase Theorem – Efficiency v. Fairness Where transactions costs are low (where the parties can easily negotiate with each other or

contract out of law) then the efficient arrangement will result irrespective of where the law places entitlement

o Irrelevant from a business and efficient perspective what the legal rule is, who has the legal entitlement to who is or isn’t liable

o However in the real world transactions costs are not low. It is very hard for them to contact each other and to reach an agreement therefore they are likely not to contract out of a wrong legal rule.

Therefore it matters very much what the law says and that we as policy makers should give our attention to that project

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Partnerships

Definition of PartnershipA partnership is an association of two or more people who carry on as co-owners for a business for profit, whether or not they intended to form a partnership [UPA § 202(a)]

Both partners work on behalf of the partnership and each other as an agent of the partnership for the purpose of its business [National Biscuit Company v. Stroud]

One partner is responsible for all torts, contracts, liability and debts that any one partner causes/enters into, as long as partners voluntarily dealt with each other and third parties in a way the law views as partnership

o Same categories of agency authorities apply to partnership law, if a partner has any of those authorities, same legal consequences will follow

Factors in determining a partnership [Fenwick v. Unemployment Commission]o Intention of the Partieso Right to share in Profits

Receipt by a person of a share of profits is prima facie evidence that partnership exists, but this presumption can be overcome by other pertinent facts such as lack of intent or other factors [Southex v. Rhode Island Builders]

o Obligation to Share in Losseso Ownership and Control of the Partnership Property and Business

Ownership includes the rights to occupy, exclude, alienate Control is key: All partners should have equal access to the controlling

instrumentality Joint property does not itself establish a partnership whether or not they

share profits made by use of the property [UPA §7(2)]o Community of Power in Administrationo Language in the Agreemento Conduct of the Parties toward Third Partieso Rights of the Parties on Dissolution and the Result of Dissolution

Partnership by Estoppelo In general, persons who are not partners as to each other are not partners as to third

parties [UPA §7(1)]o However if you induce C to rely on the fact that you are B’s partner, and C relies on the

inducement to C’s detriment, you are estopped from denying that you are B’s partner [UPA § 16(1)]

Consequences of partnership follow if partnership by estoppel established C must reasonably rely on the partnership to be entitled to damages [Young v.

Jones] Partners v. Lenders

o When lenders have the right to inspect the firm books and veto any speculative business, but cannot initiate any transactions themselves, they do not become partners; they are just taking precautions of their loan as lenders. [Martin v. Peyton]

o Policy: Other people should not gamble with your money for their own profit. Lenders may ask for certain information on the financials out of ordinary caution, but this does not imply an association in the business.

Fiduciary Obligations of Partners Fiduciary obligations are very broad Must act in accordance with the obligation of good faith and fair dealing

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Partners owe expansive duties to each other as long as it is related to the partnership venture, for the lifetime of the partners or the undertaking

o Do not owe everything to each other in their personal lives although the law will determine if the partnership exists outside of the business venture

Duty of Care: Refraining from grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law [§404(c)]

Duty of Loyalty: [§404(b)]o (1) Account to the partnership and hold as trustee for it any property, profit, benefit

derived from partnership or partnership property, including partnership opportunities, Partner must consider other partners’ welfare and refrain from acting for purely

private gain [Meehan v. Shaughnessy] Meinhard breaches duty of loyalty by appropriating an opportunity incidental of

the joint enterprise to himself in secrecy and silenceo (2) Refrain from dealing with the partnership as a party having an adverse interest to the

partnership Partners cannot use their position of trust and confidence to the disadvantage of

the partnership [Meehan v. Shaughnessy]o (3) Refrain from competing with the partnership before dissolution

“Joint adventurers owe to one another, while the enterprise continues, the duty of finest loyalty. Not honestly alone, but the punctilio of an honor the most sensitive, is the standard of behavior.” [Meinhard v. Salmons]

Partners May:o Engage in conduct that furthers his own interest without violating fiduciary dutieso Lend money or transact other business with the partnership, where the rights and

obligations of the partners are same as those of a person who is not a partnero Plan to compete without violating fiduciary duties, including actually competing

Facts that pointed towards breach in Meehan v. Shaughnessy: Unfairly removing properties from the partnership Failure to answer accurately and honestly when directly asked about

leaving Failed to give the clients an option to stay

Rights and Obligations of PartnersThe rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by the following rules [UPA § 18]

Parties may contract out of the implied obligations and rights in law below Sharing of Profits and Losses, Two Approaches:

o Under UPA/Common Law: Irrespective of contribution, you share in profits and losses 50/50 unless specified otherwise

Each partner shall be repaid his contributions and share equally in the profits and surplus remaining after all liabilities, including those to partners; and must contribute towards the losses according to his share in profits [UPA §18(a)]

Ordinarily, the default rule is that partners share in profits but do not receive salary, but lots of partners contract out of this and set up salary

o Under RUPA/CA Law: Each party shares in profits and losses in proportion to his contribution

Each partner is entitled to an equal share of the partnership profits and is chargeable with a share of partnership losses in proportion to the partner’s share of profits [RUPA § 401(a)]

Although each partner shares equally in all debts (jointly and severally liable) with respect to third parties, they share profits and losses among themselves in

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proportion to the partner’s contribution (whether money or service or specified in partnership agreement)

Where one party contributes capital and other his skill and labor, neither party is liable to the other for any loss sustained since each lost his own capital, one cash and the other labor hours [Kovacik v. Reed]

Minority Rule in CA, expressly rejected by RUPA Rights in Management: All partners have equal rights in the management and conduct of the

partnership business [UPA § 18 (e)]o The right of each partner to participate in some way will be an implicit term o Otherwise has equal rights in the management and conduct of the business

Disagreement in Management: o If there is disagreement in ordinary matters connected with the partnership, the decision

is made by a majority of the partners. [UPA §18(h)] In a two-person partnership:

No majority vote to deprive either party the authority to act for partnership.

Where one partner continually voices objections and does not sit idly by and acquiesce in the actions of his partner, he cannot be held liable since the expense was incurred individually for the benefit of one partner and not for the benefit of the partnership [Summers v. Dooley]

o When there is an actual agreement among partners, no act in contravention of the agreement may be done without the consent of all partners [National Biscuit Company v. Stroud]

o What either partner does with a third person is binding on the partnership, unless the acting partner (1) in fact had no authority to act and (2) the third party knew of the lack of authority [National Biscuit Company v. Stroud]

o However if both partners have the authority, no restriction can be placed up on the partner’s power to act and the acting partner binds the partnership even if the third party knew of disagreement [National Biscuit Company v. Stroud]

Partnership must be a going concern Activities should be within the scope of business

Majoritarian Default v. Penalty Default Majoritarian: Choose the rule that most of the parties in the situation would want to have – in the

case of Kovacik, this depends on which partner you are and there is no clear preference as a society

Penalty default: opposite of above approach, this default is something most parties would dislike and never accept on their own, so it forces the parties to speak and make arrangements explicitly

o Introduced in areas where controversy is likely to ariseo In CA, the penalty is on the contributor of financial capital because that partner is more

likely to have access to lawyers and insist on different arrangements

Partnership DissolutionOn dissolution, the partnership is not terminated but continues until the partnership affairs are completed, such as the settling of debts. [UPA § 30-32]

Fiduciary obligations continue until affairs are done Lawful Dissolution (no violation of agreement) is caused by:

o Termination of the definite term or particular undertaking specified in agreement All partnerships hope that they will be profitable but that does not make it a

partnership for a term obligating the partners to continue until all the losses are recovered [Page v. Page]

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Implied Definite Terms: Partner advances sum of money with the understanding that the

contribution was to be repaid as soon as feasibleo Partnership will continue for the term reasonably required to

repay loan Partner may impliedly agree (must be supported by factual evidence) to

continue business until:o Certain amount of money earnedo Partners recoup investmentso Certain debts are paido Certain property could be disposed of

o Express will of any partner when no definite term or undertaking specified Must be exercised in good faith e.g. cannot freeze out a co-partner and appropriate

the business to his own use unless he fully compensates his co-partner for the share of the prospective opportunity [Page v. Page]

If exercised in bad faith wrongful dissolution consequenceso Express will of all partnerso Expulsion of any partner in accordance with a power conferred by agreement

Wrongful Dissolution is caused by:o Express will of partner at any time in contravention of the partnership agreement

This does not necessarily dissolve partnership, see dissociation belowo Event which makes the enterprise illegalo Death or bankruptcy of any partnero Decree of court which will be granted under UPA §32 when:

On application by a partner: If party asking for dissolution is at right, he owes no damages If it is wrongful dissolution, party owes contractual damages Note that the filing of the complaint alone does not constitute dissolution

[G&S v. Belman] Partner has been shown to have unsound mind Partner becomes incapable of performing his part Partner’s conduct prejudicially affects carrying on business Partner willfully or persistently commits a breach of partnership agreement that it

is not reasonably practicable to carry on the business with him any longer Minor differences and grievances insufficient The disagreement needs to be of such a nature and extent that all

confidence and cooperation between the parties have been destroyed or one of the parties materially hinders a proper conduct of the business [Owen v. Cohen]

Business of partnership can only be carried at a loss/economic purpose frustrated Other circumstances which make it equitable Note: Filing of complaint alone does not constitute dissolution. [G&S v. Belman]

Consequences to Dissolution:o Exposure to immense liability that the partnership createso Partners in a partnership are all individually completely liable for the debts of the

partnership, including debts in contract or tort Must first pay creditors other than partners, then what is owed to partners in this

order: (1) other than capital and profits, (2) capital, (3) profits [UPA §40(b)]o When a partner retires, the old partnership is dissolved by the retirement of any partner

and when the remaining partners continue their practice a new partnership is formed.

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Some Partnership Agreements may contain a continuation agreement, obligating the remaining partners to continue to associate with one another as partners under the existing agreement

o If one partner caused wrongful dissolution, he owes the partnership damages for breach of the agreement but is also owed the value of his interest in the partnership if the business continues, not including the goodwill of the business. He is also released from all liabilities of the partnership. [UPA §38(2)]

Damages for breach of the agreement may include liquidated damages as long as they are not a penalty [Pav-Saver v. Vasso]

In continuing the business, other aspects of the agreement still hold; Vasso may use IP to continue the company since Dale contractually receives his patents back upon expiration but the partnership has not yet expired [Pav-Saver v. Vasso]

Wrongful partner was dissociated so the business may continue Court here privileges the right of the business to continue in dissociation

OVER the partnership agreement stating that Dale gets his IP back when partnership expires

Dissociation Rather than Dissolution Occurs When:o A partner retires pursuant to an appropriate provision in the partnership agreement o A partner willfully or persistently commits a material breach of the partnership or a duty

owed [RUPA § 601(5)]o Consequences to Dissociation:

When one partner is dissociated, the partnership continues as to the remaining partners and they must purchase the interest of the retiring partner [Article 19]

Buy-Out Agreement: Before dissolution, partners may take advantage of any buyout provisions under the agreement allowing the leaving partner to end his relationship and receive a cash payment in return for his interest

o Buy-Out Formula [Article 19(e)(2)]: Capital Account of Partner + average of prior three years’ profits actually paid to partner, or other agreed upon sum. [G&S v. Belman]

Capital Account [§ 401]: Partner’s share of Partnership Profits + Money & Property Partner Contributed – Liabilities Partner Contributed

Limited Partnerships Subspecies of partnership which limits the liability as far as partnership status

o Limited partners don’t have liability to third parties Both general and limited partners are considered “corporations” Every limited partnership has to have a general partner and one or more limited partner

o Formed upon the parties agreeing to the relationshipo Limited partner has less control as to the operations of the business

A limited partner will not be liable as a general partner, unless, in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business [Holzman v. De Escamilla]

o If a limited partner starts actually controlling the business, they lose the limited status and are liable to third parties regardless of the third party’s knowledge of his role. Limited partner may even be liable for exercising less than a general partner’s power if third party knew he acted as more than a limited partner. [Mount Vernon v. Patridge]

CA has adopted the modern rule which alters this rule A limited partner does not participate in control solely by consulting with

and advising a general partner with respect to the business by giving general business guidance [RUPA 303(b)]

o Must distinguish between control of the operation and mere guidance

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Even if the limited partner takes control the instrumentality, they are only liable to third parties that they actually deal with themselves, and only if the third party reasonably relies on their general partner status due to the limited partner’s conduct [RUPA 303(a)]

Corporations

The Certificate of Incorporation This document must contain the corporation’s name, address, and nature of business, number of

shares of stock and par value, and the contact information of the incorporators/directors. [§102(a)]

This document may also contain: (1) any provision for the management of the business, create, define and limit the regulating powers of the corporation, directors and stockholders; (3) any other provisions desired by stockholders and any preemptive rights of security holders; (4) provision for actions requiring corporate action or stockholder vote; (5) provision limiting the duration of the corporation’s existence; (6) provision imposing personal liability for the debts of the corporation on its stockholders under specified conditions; if not stated, stockholders or members will not be held personally liable for the corporate debts unless it was due to their own conduct; (7) a provision limiting or eliminating the personal liability of a director of the corporation or its stockholders for monetary damages for breach of fiduciary duty, but not for breach of the duty of loyalty, good faith, or for any transaction from which the director derived an improper personal benefit. [§102(b)]

o Exculpation Clause (b)(7): No personal liability for the directors’ breach of the duty of due care as long as it is stated in the articles of incorporation

The Corporate Entity and Limited Liability Corporations are run primarily for the good of its shareholders Corporations are run by the board of directors unless otherwise provided [Del. § 141(a)]

o Courts will not interfere with the management of directors unless there is a clear showing of fraud, misappropriation of corporate funds/power, or breach of duty of care or loyalty

The Law permits the incorporation of a business for the very purpose of enabling its proprietors to escape personal liability [Walkovszky v. Carlton]

In determining liability, courts may look to principles of agency [Walkovszky v. Carlton]o Whenever anyone uses control of the corporation to further his own ends rather than the

corporation’s business, he will be personally liable for the corporation’s acts upon the principle of respondeat superior

Liability extends not only to commercial dealings but also to negligent acts Piercing the Corporate Veil:

o The equitable owner of a corporation is liable for actions of the corporation where there is an abuse of the corporate privilege of limited liability

o A corporate entity will be disregarded and the veil of limited liability pierced when BOTH requirements below are met [Sea-Land, Inc. v. Pepper Source]

o (1) Alter Ego: Such unity of interest and ownership that the separate personalities of the corporation and the individual or other corporation no longer exist

Factors for consideration: (1) failure to maintain adequate corporate records or to comply with corporate formalities; (2) commingling of funds or assets; (3) undercapitalization; (4) one corporation treating the assets of another corporation as its own

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Parent-Subsidiary: If corporation is a fragment of a larger corporate combine which actually conducts the business, only the larger entity is held financially liable [Walkovszky v. Carlton]

This set-up is legal as long as it’s not used to further personal ends Requires a showing of substantial domination between Parent and

Subsidiary. [In re Silicone Gel Breast Implants] Factors include:o Common directors/officerso Common business departmentso Consolidated financial statementso Parent finances subsidiaryo P caused incorporation of So S operates with grossly inadequate capitalo P pays the salaries and other expenses of So S receives no business except given to it by Po P uses S’s property as its owno Daily operations of the two are not separateo S does not observe basic corporate formalities such as keeping

separate books and records and holding shareholder and board meetings

However this does not mean that where a parent controls several subsidiaries, each subsidiary then becomes liable for the actions of other subsidiaries, for there is no respondeat superior among sub-agents [Roman Catholic Archbishop of SF v. Sheffield]

o (2) Injustice: Circumstances must be such that adherence to the fiction of separate corporate existence would allow fraud or promote injustice

The wrong must be beyond a creditor’s inability to collect [Sea-Land Inc.] Unfairness is something akin to fraud or deception or the existence of a compelling

public interest, such as using corporate facades to avoid creditors; E.g. one person unjustly enriched; intentional scheme to squirrel assets

Duties of Corporate Directors to the Corporation The Delaware Court of Chancery is a court of Equity, not crunching numbers but deciding fairness

o Decides whether a duty was breached or whether business judgment rule attacheso Settlements are reviewed for reasonableness

Ordinary shareholders do not owe fiduciary duties to other shareholders or to the corporation But if you are a director, officer, controlling or dominant shareholder, than you do owe fiduciary

duties to the corporation and other shareholders The Triad of Fiduciary Duties

o Duty of Care Duty to care for the business, be informed, deliberate, disinterested and lawful

Business Judgment Rule: o Tremendous deference to directors’ decisions, which are accepted

as final. Mere errors in judgment are insufficient for court interference. [Kamin v. American Express]

Judicial review OK when there is fraud, oppression, arbitrary action, breach of trust, self-dealing, destruction of rights or neglect of duties

o Directors will not be held liable for the business consequences of their decisions so long as they were legal, not self-dealing, or fraudulent. [Shlensky v. Wrigley]

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Policy: If directors knew that they would be evaluated on negligence standard or that the substance of their choices would be reviewed, they would be highly conservative. We as a society want corporations to take risks.

Duty breached when directors are disinterested or fail to do what they should have under the circumstances

Standard of breach of duty of care is gross negligence Corporation did not breach duty when it donated to Princeton University

since it was made indiscriminately, not in furtherance of directors’ personal ends, modest in amount, and voluntarily made in the reasonable belief that it would advance the interests of the private corporation in the community. [A.P Smith v. Barlow]

Corporation breached duty when the directors did not adequately inform themselves of material information reasonably available to them related to the transaction and failed to disclose all material information that a reasonable stockholder would believe important in deciding whether to approve the sale. [Smith v. Van Gorkom]

o Duty of Loyalty Duty to serve the interests of the principal and to limit their own interests for the

interest of the company and its shareholders When you have a personal interest or are standing on both sides of the transaction

(not disinterested as required by BJR), then BJR yields to this doctrine The Rule of Undivided Loyalty:

o Rigorous scrutiny applied when directors have a particularized interest in the transaction or are standing on both sides of the transaction

o Director has an affirmative obligation to demonstrate that the deal was entirely fair to the corporation and its shareholders

o Breached when defendants took advantage of a favorable market situation and siphoned off corporate advantages (selling controlling shares) for personal gain [Perlman v. Feldman]

Personal Interest does not automatically make the transaction voidable

o No transaction is voidable solely for this reason if (1) material facts as to the director’s relationship or interest to the transaction are disclosed and known to the board and (2) the board in good faith authorizes the transaction through a majority of disinterested directors. [Del. Corp. Code §144]

If the directors know about the conflict and vote to still allow the transaction, protected by BJR [Benihana v. Benihana]

o If the contract is fair, it is valid even though disinterested directors did not formally ratify the decision [Bayer v. Beran]

Breach of duty of loyalty includes: Refusal to declare a dividend when corporation has a surplus of net profits

and the dividend would not cause detriment to business [Dodge v. Ford] Corporate Opportunity Doctrine:

o Guth Test: If the opportunity is (1) in the line of business of the company you serve, (2) the company can financially undertake that opportunity, and (3) the company has a reasonable expectancy or practical advantage in the opportunity, you have a responsibility to turn that opportunity over to the corporation

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o Presenting the opportunity to the board is not required but creates a “safe harbor” removing the specter that the director improperly usurped a corporate opportunity [Broz v. Cellular]

o If the corporation is first given the opportunity to turn down the opportunity for themselves, directors are not liable [eBay v. Shareholders]

o Obligation of Good Faith Breach of the duties of care and loyalty may directly result in liability, whereas a

failure to act in good faith may only result in indirect liability by breaching the duty of loyalty [Stone v. Ritter]

Without a duty to act, there could be no rise of bad faith conduct [In re Walt Disney Co. v. Deriv Litigation]

Three forms of bad faith conduct: (1) Subjective Bad Faith: Actual intent to do harm or violate applicable law (2) Lack of due care, gross negligence without malevolent intent

o Breaches both the duty of due care and the duty to act in good faith, although gross negligence on its own does not constitute bad faith

o Failure of Oversight will result in director liability [Stone v. Ritter] A sustained or systematic failure to assure that a

reasonable information and reporting system exists will establish lack of good faith [In re Caremark]

(3) Intentional dereliction of duty or conscious disregard of one’s responsibilities to advance best interests of corporation

o In the transactional context, an extreme set of facts is required to sustain a disloyalty claim premised on the notion that directors were intentionally disregarding their duties [Lyondell v. Ryan]

*Don’t need to break down into these three forms: Focus on whether the director is consciously disregarding his duties

The Mechanics of Derivative Actions Burden Shifting Analysis

o P has the burden to rebut the BJR presumption that the directors, in reaching their challenged decision, breached one of the triads of their fiduciary duty

If P fails to meet this evidentiary burden, BJR attaches to corporate officers and directors unless P can prove other claims such as waste or abdication

Waste Claim: P must show that no business person of ordinary, sound judgment could conclude that the corporation received adequate consideration

o Rare case where directors irrationally squander or give away corporate assets

Abdication Claim: The board wrongfully delegates a task or their authority to another [Grimes v. Donald]

o Litigation Committee: When a board is interested, it may delegate its authority to a committee of two disinterested directors. The committee can exercise all of the authority of the board to the extent provided in the resolution of the corporation, including investigating the need for continuation of derivative suit. [Zapata Corp. v. Maldonado]

Two-Step Inquiry: (1) Independence and good faith of the committee

in the basis of supporting it conclusions

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o Independence: whether the director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind [In re Oracle]

Focus on impartiality and objectivity (2) Court’s own judgment on whether MSJ should

be grantedo If P succeeds, burden then shifts to defendant directors to prove the “entire fairness” of

the transaction to the Plaintiff stockholder The Demand Requirement

o § 141 does not speak directly to demand but states that directors have the first instance to decide for the corporation

o Therefore, a shareholder must first demand that the directors act before he is able to file a derivative suit

Derivative Suit: The shareholder brings the suit against director on behalf of the corporation and all other shareholders for monetary damages

Any winnings will get put back into corporate treasury to be divided among millions of shareholders to the corporation

Leads to under-enforcement since shareholder gains no personal wins while bearing the costs of litigation

Therefore attorneys are the ones who truly care about bringing these suits, since they may claim attorney fees from the losing side

Director Indemnification in Incorporation Clauses May state that it will pay for the legal damages of directors as long as they

acted in good faith in the interests of the corporation [§ 145(b)] May also state that it will maintain insurance on behalf of a director against

liability incurred by such person whether or not he can be indemnifiedo Legally possible to insure directors even in cases of bad faith/not

acting in best interests of corporationo In reality, this type of insurance hard to obtain

o Demand Procedure When P makes a demand for director action, he is entitled to know promptly what

action the board has taken in response to the demand [Grimes v. Donald] A stockholder filing derivative suit must allege with particular facts either:

Claim of Wrongful Refusal: o Demand was made and rejectedo Board entitled to BJR

P has burden of showing reasonable doubt that board acted independently or with due care in response to demand

o If demand is refused, P may not go back and claim that demand was excused [Grimes v. Donald]

Claim of Demand Excused:o P claims he was justified in not having made the effort to obtain

board actiono If P fails this burden, he cannot go back and make a demand aftero Futile Demand: Reasonable doubt that board was capable of

making independent decision to assert claim P bears burden of showing directors would not be

independent because: The board has a material financial, familial, control

or personal interest in transaction

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Board would not exercise BJR: make an informed decision or choose the terms of the transaction with due care

If P succeeds, the court substitutes its judgment for that of the directors in the conduct of business it should have chosen if not for fraud or bad faith [Marx v. Akers]

o To establish a claim of Excessive Director Compensation, P must prove that some wrong resulted to the corporation due to: rates excessive on their face, unfair compensation rates, lack of good faith in setting rates, invalid BJR

Dodd-Frank Act Dodd-frank requires every board to have a compensation committee of independent directors that is

authorized to set compensation for the board and high ranking executives Independent Directors do not work for company Inside directors do and may be motivated to give executives what they want The more independent, the less conflict of interest

Say on Pay: shareholders’ advisory vote on executive compensation every three years However the outcome of vote is binding on board

Limited Liability Companies Members typically contribute capital to start the business

o Contribution may be cash, property, services rendered, a promissory note, or other obligation to contribute cash, property or to perform services

LLC combines corporate-type limited liability with partnership-type flexibility and tax advantageso Members have only limited liability: they may lose their capital contributions but their

personal assets will not attach to debt obligationso LLC generally permits private ordering with substantial freedom of contract to govern

their relationship [Elf Atochem v. Jaffari] Partners have broad discretion in drafting partnership agreements Policy: Give maximum effects to the freedom of contract and enforceability of the

LLC Agreements Member Rights and Obligations

o Profit and loss sharing are based on the value of members’ contributions, similar to partnership agreements

o Member may withdraw and demand payment of his interest upon giving the notice specified in the statute or the LLC’s operating agreement

o Absent contrary agreement, each member has equal rights in the management of the LLC Most matters decided by majority vote Significant matters require unanimous consent

E.g. merger, admission of new member, dissolution, etco Manager-managed LLC option availableo Can be structured as a board of directors, a CEO or botho Must be specified in articles of organization

Fiduciary dutieso All members of a member-managed LLC have a duty of care and loyaltyo The managers of a manager-managed LLC have a duty of care and loyalty

However, members of a manager-managed LLC have no duties to the LLC or other members by reason of being members

o Ability to Compete

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In corporations, direct competition between directors and company breaches fiduciary duty

However, an operating agreement that by its very terms allows members to compete will be upheld under the private order justification [McConnell v. Hunt Sports Enterprises]

However provisions still cannot exculpate duty of good faith or misconduct such as theft

Liability of LLC Directors/Memberso Derivative actions allowed

Member may bring an action on behalf of the LLC to recover a judgment in its favor if the members with authority to bring the action refuse to do so

o Principles of Agency apply to third-party liability [Westec v. Lanham] Principal not fully disclosed: Agent liable for contract Principal partially disclosed: Agent party to the contract Principal’s existence and identity fully disclosed: Only Principal is a party to the

contracto Equitable doctrine of piercing the corporate veil applies to LLC’s

If the members and officers of an LLC fail to treat it as a separate entity and cause harm to third party by reason of his own acts, they are individually liable for the LLC’s acts that cause damage to third parties [Kaycee and Livestock v. Flahive]

The Federal Securities Laws

The Securities Act of 1933 Concerned with the primary market, where the issuer of securities sells them to investors Purpose of Act is to protect investors by promoting full disclosure of the information necessary to

make informed investment decisions Meant to protect passive investors that will not be active in managing their investments Registration Requirement

o § 5 requires in connection with any public sale of a security: (1) Registration statement filed with SEC (2) No sale until the registration statement becomes effective (3) Prospectus (principal disclosure statement) distributed to investors before a

saleo §12(a)(1) Imposes strict liability on sellers in violation of § 5

Main remedy is rescission: buyer can recover price paid plus interest less income received on the security

o §12(a)(2) imposes civil liability if Plaintiff can prove prima facie case elements of: (1) Sale of a security; (2) using instruments of interstate commerce or mail; (3)

through prospectus or oral communication; (4) untrue statement or omission of material fact; (5) D offered or sold security; (6) and knew or should have known of untrue statement

Burden on D to prove that he did not know of the misrepresentation/could not have known even with the exercise of reasonable care

No reliance requirement for P Broader than § 11 since it applies not only to fraudulent registration

statements but also to material misrepresentations in written or oral communications

Liability under this section does not arise in secondary market transactions or private placements [Gustafon v. Alloyd Co, U.S.]

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o Two exemptions to the registration requirement Exempt securities, where the buyer is not an issuer, underwriter (someone with a

view to reselling the security), or dealer, do not need to be registered, either when initially sold or in any subsequent transaction §4(1)

Exempt transactions, where the issuer is not involving any public offering, are one-time exemptions only §4(2)

The Private Offering Exemption [SEC Regulation D]o Issuer cannot widely advertise the securityo Must still provide information essential to investment judgment as

would have been disclosed in a registration statement o Must file notice of sale with SECo Generally exempts only the initial saleo Limits on numbers:

If an issuer raises no more than $1 million through securities, may sell to unlimited number of buyers

If it raises no more than $5 million, may sell to no more than 35 buyers

Limits on number of buyers do not apply to accredited investors such as banks, brokers and other financial institutions/wealthy buyers

o Proving the Affirmative Defense of Exemption [Doran v. Petro Management Corp.]

D has burden of proving that the sale was private not public Factors for consideration:

(1) Number of offerees (not purchasers) and their relationship to each other and issuer

o Most important factoro The more offerees, more likely publico Every single offeree must be provided

with sufficient information o Relationship matters; focus on the

information available (given or effective access/realistic opportunity) to the offeree as a result of the relationship

(2) Number of units offered (3) Size of the offering (4) Manner of the offering

Disclosure and Fairness Requirementso Mandates disclosure of material information to investors and the prevention of fraudo Securities fraud laws are better to sue under than common law fraud

Procedural advantages Easier elements to prove than common law, which requires (1) material

misstatement, (2) scienter (intent), (3) reliance/causation, (4) damages o § 11 is the principal express cause of action for fraud

Cannot sue under this in relation to private offering Material misrepresentation or omission must be in the registration statement

Material: matters an average prudent investor ought reasonably to be informed of before making an intelligent, informed decision on buying the security; facts which would deter an investor from buying security

No reliance or causation requirements D has burden of proving that misconduct did not cause P’s damages

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D may reduce damages if it can prove that reduction in value was caused by some other factor e.g. market factors [§11(e)]

No privity requirement P may sue everyone who signed the registration statement, such as issuer,

executive officers, majority of board of directors, every director at the time registration became effective, every person named in the registration as someone about to become director, every expert having prepared or certified any part of the statement and every underwriter involved in the transaction, regardless of whether they read or understood it before signing

o § 11(b)(3) Affirmative Defense of Due Diligence (if proven no fraud): No person, other than the issuer, shall be liable if he can prove that:

(A) He is a non-expert who had reasonable ground to believe and did believe that the statements were true

(B) He is an expert, who, after reasonable investigation, had reasonable grounds to believe that there was no need to make the statements not misleading or that the registration statement did not fairly represent his statement of valuation as an expert

(C) As regards to the statements made by other experts, he did not believe that the statements were untrue or that there was an omission of a material fact

Reasonableness: the standard is that required of a prudent man in the management of his own property, more than simply asking questions and believing the answers you hear without verification

Even if you fail to detect errors, the question is whether a reasonable effort was made to that end [Escott v. BarChris Construction]

The Securities Exchange Act of 1934 Concerned with secondary market transactions in which investors trade securities among

themselves without significant participant by the issuero Regulates insider trading, securities fraud, short-swing profits by corporate insiders,

shareholder voting via proxy solicitations, tender offers Recognizes that there may be a difference between what is good for the public v. shareholders Registered Corporations must file:

o Form 10 (once)o Form 10-K (annual)o Form 10-Q (quarterly)o Form 8-K (episodic)

Exchange Act § 10 confers powers to SEC to promulgate rules on securities fraud SEC Rule 10b-5 is a really broad rule prohibiting fraud, the making of untrue statement or

omission of material fact, in connection with the purchase or sale of securitieso Policy: Justifiable expectation of the securities marketplace that all investors trading on

impersonal exchanges have relatively equal access to material informationo Unclear whether there is a private cause of actiono Protection only applies to actual not potential purchasers and sellers of a corporation’s

securities [Blue Stamps v. Manor Drug Stores, U.S.]o Materiality Requirement: substantial likelihood that the disclosure of the omitted fact

would have been viewed by the reasonable investor has having significantly altered the “total mix” of information made available

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Liability for issuance of a false or misleading statement requires proof of scienter – intent to deceive, manipulate, or defraud. Later opinions also count recklessness as sufficient. [Ernst v. Hochfelder, U.S.]

Policy: A fundamental purpose of the securities act was to substitute a philosophy of full disclosure for the philosophy of caveat emptor (buyer beware) and thus to achieve a high standard of business ethics in the securities industry

Materiality in preliminary merger negotiations [Basic v. Levinson]: Materiality depends on balancing (1) indicated probability that the event

will occur and (2) anticipated magnitude of the event in total company activity

o Facts pointing towards materiality: board resolutions, instructions to investment bankers, actual negotiation between principals

Since a merger is one of the most important events that could occur in a small company’s life, inside information regarding a merger can become material at an earlier stage than would lesser transactions

o Rebuttable Presumption of Reliance Reliance is an element of a Rule 10b-5 cause of action Fraud-on-the-Market Theory

Reliance is different in an open and developed securities market than in face-to-face transactions since the market performs a substantial part of the valuation process performed by an investor in f-t-f transaction

Market is the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock = fair market price

Therefore, where a materially misleading statement has been disseminated into an impersonal, well-developed market, D must rebut the presumption by showing facts that sever the link between the alleged misrepresentation and P’s decision to purchase [Basic v. Levinson]

E.g. misrepresentation did not in fact distort the market price, or individual would have purchased despite knowing the statement was false

Where the misleading statements were made to a few clients in private rather than disseminated in the market, the efficient market hypothesis does not apply because there was no way the securities buyer could have heard of the lies; no presumption of reliance. [West v. Prudential Securities]

Definition of a Security The term “security” includes stock, notes, bonds, evidence of indebtedness, investment contracts,

or, in general, any interest or instrument commonly known as “security,” unless the context otherwise requires. [§2(a)(1)]

Litigation often turns on what constitutes “investment contract.” SCOTUS defines it as a contract or transaction where a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party

o Requirement of “solely” now loosened Policy: Requiring investors to rely wholly on the efforts of others excludes the

protection of the securities laws whenever investors make the slightest effortso Look to the economic reality of the investment contract: f the investor is unable to exercise

meaningful control over the investment, it is a security In Robinson v. Glynn, Robinson’s interest was not a security but an ordinary

commercial venture since he was an active and knowledgeable executive, not a passive investor, in the company

Characteristics typically associated with common stock in company:

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Right to receive dividends contingent on profits; negotiability; voting rights proportionate to shares owned; capacity to appreciate in value

Note: The underlying risk and return on stock does not change regardless of the sale of stock price

Insider Trading Insiders may not trade by reliance on material, nonpublic information intended for corporate

purposes only and not for the personal benefit of anyone [SEC v. Texas Gulf]o Insiders include the officers, directors, permanent insiders of a corporation, as well as the

attorneys, accountants, consultants and others who temporarily become fiduciaries of a corporation [Dirks v. SEC, U.S.]

o Material facts include: Any fact which might affect the value of the corporation’s securities Facts disclosing earnings and distributions of company Fact that affect the desire of investors to buy, sell, or hold securities

If those who knew the information trade on it, it compels the inference that other investors would be influenced by the information too

o Insider has duty to disclose information or abstain from trading or recommending securities concerned while information is undisclosed [SEC v. Texas Gulf]

However the insider is not always foreclosed from investing in his own company, the duty to disclose or abstain rises only in those situations where disclosure is reasonably certain to have a substantial effect on the market price of the security

Reasonableness standard Insider will always know a bit more than the outsider because of implicit

knowledge in the strengths, weaknesses and operations of the business Reiterating the point that insider duties only attach to material information

o Once information is disclosed, insiders should wait until the news could reasonably circulate widely [SEC v. Texas Gulf]

o Policy: Insider-trading benefits are a form of secret corporate compensation derived at

the expense of the uninformed investing public and not at the expense of the corporation, which receives the sole benefit from insider incentives

All investors should have equal access to the risks and rewards of participating in securities transactions

Classical Theory o Liability under §10(b) and Rule 10b-5 when corporate insider trades in the securities of

his corporation on the basis of material, nonpublic information Deceptive device since a relationship of trust and confidence exists between the

shareholders of a corporation and those insiders who obtained the confidential information in their capacities as corporate officers [Chiarella v. United States, U.S.]

There is a manipulation or deception element of breaches of fiduciary duty in connection with a securities transaction [Dirks v. SEC]

The manipulation derives from the inherent unfairness involved where one takes advantage of information intended to be available only for a corporate purpose and not for the personal benefit of anyone

Tipper/Tippee Liabilityo A tippee assumes fiduciary duty to the shareholders of a corporation not to trade on

material nonpublic information when the tippee knows or should know that the insider has breached his fiduciary duty to the shareholders by disclosing to tippee [Dirks v. SEC]

o Test is whether the insider will benefit, directly or indirectly, from his disclosure Absent some personal gain, there has been no breach of duty to stockholders Absent breach by the insider, there is no derivative breach by the tippee

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In SEC v. Switzer, the eavesdropper trading on inside information was not guilty of insider trading because the director whom he overheard did not personally benefit from passing along this information

Piggyback tradingo Not on the basis of information but on following someone else’s tradeso Would most likely liable only if piggy backer knew that the other person was trading on

insider information Misappropriation Theory

o Person violates §10(b) and Rule 10b-5 when he misappropriates confidential information for securities trading purpose in breach of a duty owed to the source of the information

Liability of corporate outsider premised on the deception of those who entrusted him with the information [United States v. O’Hagan]

If the trader discloses to the source that he plans to trade on the nonpublic info, there is no deceptive device and thus no violation

o In practice, you wouldn’t disclose because you are still breaching a fiduciary duty to the discloser

Policy: protects the integrity of the securities markets against abuses by outsiders who have access to confidential information that will affect the securities price when revealed but who owe no fiduciary or other duty to that corporation’s shareholders

Control Issues among Shareholders Short-Swing Prohibition: The Exchange Act states that when a 10% owner, director, or officer

gains profit or avoids loss in connection with the sale of a security, the issuer can recover that profit within six months [§ 16(b)]

o Purchase of stock falls under this when the purchaser becomes 10% by virtue of the purchase; likewise, when someone becomes less than a 10% owner by virtue of sale, 16(b) no longer applies [Reliance Electric v. Emerson Electric]

Shareholder Democracy/Proxy Fights: o Shareholders have a right to vote on corporate matters or may appoint an agent to vote on

their behalf Agent is the proxy-holder, the document which appoints the agent The incumbent managers of a large firm will solicit proxies from shareholders

directly by asking them to sign and return the proxy card authorizing the management representative to vote on their behalf

It is lawful for present management to utilize corporate funds to solicit proxies from shareholders [Levin v. MGM] when informing stockholders of management’s views on policy questions related to reelection [Cheff v. Mathes]

o Policy: The right of an independent stockholder to be fully informed before making the decision on the continuation of present management is of supreme importance

It is unlawful to use corporate funds to advance the selfish desires of directors to perpetuate themselves in office [Cheff v. Mathes]

o Shareholder Proposals: If any security holder notifies the issuer of his intention to present a proposal for action at the next meeting, issuer must set forth the proposal in its proxy statement and allow the security holder to present a 500-word statement in support of the proposal in the proxy [SEC Rule]

Exception: Issuer may omit a proposal if the proposal: Relates to less than 5% of the issuer’s total assets or net earnings and gross

sales at the end of its most recent fiscal year

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Is not otherwise significantly related to the issuer’s businesso Moral, social and ethical questions can be included in the proposal

mechanism even if it doesn’t narrowly relate to the profitability and operations of the company [Lovenheim v. Iroquois Brands]

o Shareholder Inspection of Corporate Records: A shareholder has the right to inspect business records upon written demand if the shareholder can state a proper purpose reasonably related to such person’s interest as a stockholder [Del. § 220]

Policy: Inspecting a corporation’s shareholder ledger and business records is merely the act of a concerned owner checking on what is in part his property

The statute must be liberally construed in favor of the stockholder since his welfare as a stockholder or the corporation’s welfare may be affected [Crane v. Anaconda]

A qualified stockholder may inspect the corporation’s stock register to directly inform other shareholders on its exchange offer and soliciting tenders of stock [Crane v. Anaconda]

A stockholder who buys stock for the sole purpose of using shareholder democracy to impress his social opinions upon management does not prove that this is a proper purpose germane to his economic interests as a shareholder [Pillsbury v. Honeywell]

o Shareholder Agreements: When the directors are the sole stockholders, they may limit their respective rights and powers by agreement even where there is a conflicting statutory standard, in this case the selection of officers [Clark v. Dodge]

Policy: If the enforcement of a contract damages no one, there is no reason to hold

it unlawful even though it slightly impinges upon a broad statutory provision stating that the directors of a corporation must manage the corporation

Shareholder-Director agreements that technically violate statutes are still upheld in light of circumstances such as [Galler v. Galler]

o No apparent public injuryo Absence of complaining minority interesto No apparent prejudice to creditorso No fraudo No clearly prohibitory statutory language

Policy in the context of close corporations: The agreement is the result of careful deliberation by all initial investors in order to protect those financially interested in the close corporation [Galler v. Galler]

Different from a large corporate setting where stockholders’ agreement is not consciously agreed to by the investors; there, investors have no voice in the formulation and very few ever read the certificate of incorporation

Control in Closely Held Firms In a close corporation, only a few people or families hold stock and the stock is rarely bought or

sold. Shareholders in a close corporation are often also the directors and officers thereof. [Galler v. Galler]

o A stockholder who bargains for stock in a close corporation can contract and bargain into his minority position using business judgment [Nixon v. Blackwell]

o A minority shareholder in a close corporation who contractually agrees to the corporation repurchasing his shares upon at-will termination is an at-will employee, only with the rights and duties of stockholders, not partners [Ingle v. Glamore Motor Sales]

Policy: Certainty, predictability and reliability

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Stockholders in close corporations owe each other substantially the same fiduciary duty that partners owe to one another – one of utmost good faith and loyalty [Wilkes v. Springside]

o Freeze-Outs: When a majority freezes out a minority shareholder:

Majority must articulate a legitimate business purpose Minority is entitled to some value since majority has frustrated his purpose

in entering the corporate venture, denying him return on investment [Wilkes]

Policy: A guarantee of employment with the corporation is one of the basic reasons why a minority owner invests capital in a close corporation

A person such as a lawyer who knowingly aids another in the breach of a fiduciary duty aided and abetted a tort and is liable for the losses suffered by the harmed [Granewich v. Harding]

The Transfer of Control Right of First Refusal: Contractual right that gives the option to enter a business transaction

before the owner can enter into the same transaction with a third partyo Should be interpreted narrowly

In Frandsen, when First Wisconsin acquired J-S, Frandsen did not have the right of first refusal because First Wisconsin was not interested in becoming a shareholder of J-S, and the shares of J-S were not bought but extinguished

o Enforceable only if the contract confers it

Sale of Controlling Shares: o It is illegal to sell corporate office or management control by itself [Del. § 141]

However it is lawful to give and receive payment for the immediate transfer of management control to one who achieved majority share control, even if he cannot convert that into operating control for some time [Essex Universal v. Yates]

o A controlling stockholder may sell his controlling interest at a premium price as long as he acts in good faith

Policy: Control shares can have a premium price because the investor is paying extra for the privilege of directly influencing the corporation’s affairs [Zetlin v. Hanson Holdings]

o When the sale of a controlling premium results in a sacrifice of corporate good will and consequent unusually large premium to the fiduciary, he may not appropriate himself the value of the premium and must account for the corporation [Perlman v. Feldman]

Mergers and Acquisitions Conventional Statutory Merger

o Boards and shareholders of both companies must approve the mergero Lawyers create the new company, usually named after the larger companyo Both companies convey all of its assets to the new company in exchange for stock in the

new company, which goes to the shareholders of the old companies Bigger company with more assets will have dominant stock in company

o Old companies dissolveo Shareholders who did not want to be a part o the new company are entitled to turn in

their shares for cash and receive the appraisal value for stock The De Facto Merger Doctrine - Overturned

o A merger takes place when the sale of corporate assets (no shareholder rights) have the effect of a merger (statutory shareholder rights)

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Look to the “reorganization” document to see if the transaction so fundamentally changes the corporate character of the smaller company that its shareholder in reality is forced to give up stock in the smaller company and accept shares in another [Farris v. Glen Alden Corp.]

Shareholders should be notified as if merger and should be advised of their statutory rights of dissent and appraisal

Policy: Unacceptable since the shareholder would be projected against his will into a new enterprise under terms not of his own choosing

o However the legislature overturns Farris and the De Facto Merger doctrine The reorganization accomplished through § 271 and a mandatory plan of

dissolution and distribution is legal because the sale-of-assets statute and the merger statute are independent of each other [Hariton v. Arco, Del.]

New Policy: The Transfer of Control is desirable The Practical Merger

o List offers its shares or cash to the individual shareholders of Glen Alden in return for their Glen Alden shares

Transaction is with individual shareholders, requiring no votes of Glen Alden directors or shareholders

No appraisal rights for other shareholderso Once List has enough shares to gain control (usually 90%), List uses a special procedure

called Short-Form Merger to merge Glen Alden into List The Cash Out Merger

o Old Acme and Blue Building create a new company called New Acmeo Both companies convey all their assets to New Acme. As consideration, New Acme gives:

Cash payment to Blue Building All of its stock to Old Acme

o New Acme ends up with assets of Blue Building but all the shareholders from BB have been cashed out; new company consists entirely of Old Acme shareholders

The Freeze-Out Mergero A concerning twist to the cash out merger

Difference is dealing between two companies v. one company and minority stockholders

o Existing Company Pyramid owns 60% of Acme, minority shareholders own 40%o Pyramid holds a vote in Acme to merge Pyramid and Acme into PyrAcme

Will obviously win majority vote since it owns 60%o Pyramid and Acme convey all assets to PyrAcme. As consideration, PyrAcme gives:

Cash payment to minority shareholders All of its stock to Pyramid

o Considered legal as long as the minority shareholders receive a fair price Challenging the merger: Burden-Shifting

P must allege specific acts of fraud, misrepresentation or other misconduct to demonstrate unfairness of the merger terms to the minority

Majority shareholder must show by preponderance of the evidence that the transaction was fair

If the corporate action was approved by an informed vote of majority of the minority shareholders:

o Burden shifts to P to show that transaction was unfairo However those relying on the vote carries the burden of proving

disclosure of all relevant material facts

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Fairness has two aspects, fair dealing and fair price, to be looked at as a whole [Weinberger v. UOP]

Fair Dealing: timing of transaction, who initiated, structured, negotiated, disclosed to the directors, how the approvals of the directors and the stockholders were obtained

o Whether defendants disclosed all information in their possession germane (that a reasonable stockholder would consider important) to the transaction

Fair Price: economic considerations of all relevant factors such as assets, market value, earnings, future prospects and any other elements that affect the inherent value of a company’s stock

Takeovers Stock Options

o Call Option: right to buy at a certain price on a specified day $1 for an option to buy Acme from you at $20 on or before April 10 On April 10 if Acme is $30, exercise option On April 10, if Acme is $15, do not exercise option Want to own if you believe stock will increase in value over long term

o Put Option: right to sell sock at a specified price on or before a specified day $1 for the right to sell you Acme at $20 on or before April 10 On April 10 if Acme is $15, put it On April 10 if acme is $25, then put is useless Want to own if you believe stock will decrease in value

o Short-sale Pay $1 to borrow Acme today (trading at $20) return it to you on April 10 Sell acme today, pocket the $20 Hope that Acme is $15 on April 10 Hope that Acme is not $25 of April 10

Tender Offers: A public, open offer by a prospective acquirer made directly to all stockholders tender their stock for sale at a specified price during a specified time, subject to the tendering of a minimum and maximum number of shares

o Unlawful to engage in fraudulent, deceptive, or manipulative acts in connection with any tender offer. SEC will prescribe means reasonably designed to prevent such acts and practices. [§ 14(e) of Exchange Act]

o Liability for fraud in connection with a tender offer under SEC Rule 14e-3(a) if: Someone takes substantial step to commence a tender offer D has insider info and knows that the information comes from (a) the tender

offeror, (b) the issuer of securities, or (c) an agent of either and engages in a transaction related to the tender offer without public disclosure

Must wait a reasonable time after disclosure to engage in tradingo A corporation may purchase and sell shares of its own stock [Del. § 160 (a)]

If the Board buys out a dissident stockholder in good faith to maintain proper business practices, board will not be held liable [Cheff v. Mathes]

Board may self-tender for its own shares excluding the participation of a stockholder making a hostile two-tier tender [Unocal v. Mesa]

Duty of care extends to protecting the corporation and shareholders whether the threat originates from third parties or other shareholders

Heightened Scrutiny of BJR in the context of Control Issues: Board will not be penalized for an honest mistake of judgment if it

appeared reasonable at the time decision was made [Cheff v. Mathes]

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However there is an enhanced duty upon the board due to the potential conflict of interest since they will stay in office [Unocal]

o Requirements to satisfy Unocal Duty: Directors have burden of proof Good faith investigation

Leading to reasonable grounds for believing danger to corporate policy and effectiveness

No dominant motive of self entrenchment or interest Proportionality: Decision must be reasonable in relation

to threat posed [Unocal]o Helps if board is comprised of independent directors

After Unocal, SEC amends rules to prohibit issuer tender offers unless they’re made to all shareholders - This particular defense from Unocal is now outlawed

o Lock-up provision is an option granted to a buyer of a corporation’s stock as a prelude to a takeover; the major or controlling shareholder is effectively “locked up” and may not sell its stock to anyone else without paying an agreed upon “option” $ to the buyer

Permitted when there is no director interest or other breaches of fiduciary duty Policy: Lock-ups entice other bidders to enter a contest for control,

creating an auction and maximizing shareholder profit since the rest of the market now finds out the value of the company from all the work and money the buyer put into it, and just needs to bid $1 higher and creating an auction and maximizing shareholder profit

Poison Pills: Shareholders receive the right to be bought out by the corporation for a substantial premium on the occurrence of a specified triggering event

The Poison Pill from Revlon is a pill that the directors distribute a right to all the shareholders; the right allows the shareholders to exchange their share for a debt instrument with a high value requiring the firm to pay them a high figure by a specified date. Since it will be difficult for the firm to pay those off, they promise to use assets in a certain way

Purpose of the pill: threaten to burden the corporation with a heavy debt to repel buyers

o You hope you never have to swallow the pill; you threaten to burn the company down

Concern for various corporate constituents are proper when addressing a takeover threat, as long as it is rationally related to the benefit accruing to stockholders; No longer proper once the company is no longer a going concern [Revlon v. MacAndrews]

Just rearticulating the rule from Unocal/Fordo Revlon Duty: Once the company is for sale, the duty of the board changes from defenders

of the corporate entity to the maximization of the company’s sale value for the benefit of the shareholders [Revlon v. MacAndrews]

Two situations implicate Revlon duties [Paramount v. Time] When a corporation initiates an active bidding process seeking to sell or

reorganize itself, involving a clear break up of the company When a corporation abandons its long-term strategy seeking to break up

the company in response to a bidder’s offer *Focus on whether or not the shareholders will be sticking around:

o If there is no tomorrow for the shareholders and they are just being cashed out, the only question left for them is the price

o If there is a tomorrow for the shareholders, the continuing viability of the business plan is relevant

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If board’s reaction is a defensive response and not an abandonment of the corporation’s continued existence, Revlon duties are not triggered although Unocal duties attach [Paramount v. Time]

Directors are not obligated to abandon long-term plans for short-term shareholder profit unless there is clearly no basis to sustain the corporate strategy

There are no legally prescribed steps that directors must follow to satisfy their Revlon duties [Lyondell v. Ryan]

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