Short-handDr: directorDrs: directorsBd: boardshr: shareholdershrs: shareholderscp: corporationtn: transactiontns: transactionsacr: acquirermgt = management

Table of Contents

01. GEN SUM............................................................................................................................................................................................ 2

02.......................................................................................................................................................................................................................... 3

03. POL QS................................................................................................................................................................................................. 3

04. AGENCY LAW.................................................................................................................................................................................. 4

05. PARTNERSHIP............................................................................................................................................................................... 7

06. PARTNERSHIP............................................................................................................................................................................. 12

07. PARTNERSHIP RELATIONS W/ 3PS........................................................................................................................... 13

08. CORPORATE FORM................................................................................................................................................................. 17

09. CORPORATE FORM: THE BOARD OF DIRECTORS.........................................................................................17

10. CORPORATE FINANCE: METHODS OF FINANCING.....................................................................................19

11. CORPORATE FINANCE: DISCOUNT RATE AND PROJECT VALUATION.........................................19

12. CREDITOR PROTECTION.................................................................................................................................................... 22

13. SHAREHOLDER VOTING: ECONOMICS & CURRENT TRENDS............................................................24

14. SHAREHOLDER VOTING: RULES................................................................................................................................. 24

15. SHAREHOLDER VOTING: REMOVING DIRECTORS......................................................................................25

16. SHAREHOLDER VOTING: SEPARATING CONTROL FROM CASH FLOW RIGHTS.................26

17. SHAREHOLDER VOTING: PROXY FIGHTS............................................................................................................ 27

18. SHAREHOLDER VOTING: PROXY WAR & TOWN HALL PROPOSALS..............................................27

19. DEFEATED PROXY ACCESS RULE.................................................................................................................................................. 28

20. DUTY OF CARE............................................................................................................................................................................ 29

21. DUTY OF CARE: LIABILITY SHIELDS........................................................................................................................ 31

22. DUTY OF LOYALTY................................................................................................................................................................... 32

23. DUTY OF LOYALTY: CAN DIRECTORS LOOK AFTER NON-SHAREHOLDERS’ INTERESTS?............................................................................................................................................................................................. 35

24. EXECUTIVE PAY......................................................................................................................................................................... 36

25. SHAREHOLDER SUITS.......................................................................................................................................................... 37

26. CONTROL TRANSACTIONS: INTRO AND POL................................................................................................... 40

27. CONTROL TRANSACTIONS: SALE OF CONTROL BLOCK.........................................................................40

28. CONTROL TRANSACTIONS: FREEZEOUT & CONTROLLING SHAREHOLDER SELF-DEALING..................................................................................................................................................................................................... 41

29. TENDER OFFER: PROCEDURE & REGULATIONS............................................................................................43

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30. M&A: MASTER RM................................................................................................................................................................... 47

31. M&A: METHODS OF TAKING CONTROL................................................................................................................ 48

32. M&A: PUBLIC CONTESTS FOR CONTROL............................................................................................................ 50

33. M&A Q1: DEFENSES TO HOSTILE TAKEOVER PERMISSIBLE?..........................................................51

34. M&A Q2: WILL REVLON ENHANCED DOC SCRUTINY APPLY?............................................................54

35. M&A Q4: SHAREHOLDER COUNTERMEASURES AVAILABLE?............................................................56

36. M&A Q5: APPRAISAL RIGHTS (APPLY IF (1) THERE’S A FREEZEOUT, OR (2) EF).............57

37. POL ON TAKEOVERS.............................................................................................................................................................. 58

38. INSIDER TRADING................................................................................................................................................................... 60

01. GEN SUM

A. Transactions in control1. Benefits of control

a. Control premiumb. Market rule v. Equal opportunity rulec. [Digex]: Weakening of Controller’s entitlement to control premium

Statuteso [* = Mandatory]o Shareholder voting

DGCL § 141(a) (requiring at least one director)*; § 211(b) (requiring annual meetings)*; § 216(3) (plurality voting is default); § 216(2) (majority vote for everything else); § 141(k) (removal), compare RMBCA § 808(a); DGCL § 242(b)(2), compare RMBCA § 10.04(f) (class voting); DGCL § 160(c)* (circular voting). Rules 14a-1 through 14a-12 (governing solicitations)*; Rule 14a-8* (shareholder proposals); Rule 14a-11* (new proxy access rule); Rule 14a-9* (general antifraud rule).

o Contests for control Section 13(d)* and related definitions* (block disclosure); Rules 14(d)(4-7)* (governing substantive terms of tenders); Rule 14(d)(8)* (pro-ration rule); Rule 14d-10* (best price).

o M&A DGCL 251* (voting rules and exceptions thereto); DGCL 271* (asset acquisitions); RMBCA 11.03 (share exchanges); DGCL 262* (appraisal rights, as modified by market-out exception); DGCL 203* (mandatory waiting period for freeze-outs). Rules 14a-1 through 14a-12* (governing solicitations); Rule 14a-8* (shareholder proposals); Rule 14a-11* (new proxy access rule); Rule 14a-9* (general antifraud rule).

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o Insider trading Section 16(a)* and Section 16(b)* (governing trading by directors, officers, and

10% holders); Section 10(b)* and Rule 10b-5*.

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02. POL: Duty of careA. Are 102(b)(7) waivers good or bad from a policy standpoint?

03. POL: Shareholder-board power allocationA. How much deference should courts afford to disinterested board member and shareholder approval?

B. ARGs CON court intervention1. Parties will price it in ex ante2. Court intervention will increase costs of ex ante bargaining (transaction costs) Higher

cost of capital3. Efficiency is maximized by unfettered market [Chandler in Disney]: Results manifest,

capital will flow

04. POL: Duty of loyaltyA. Does “Say on Pay” do a good job of avoiding duty of loyalty concerns in executive compensation cases

- the classic conflicted transaction?

B. Are different standards of fiduciary duties justified in close corporation settings?

05. POL: Shareholder suitsA. Is there social utility in allowing shareholder lawsuits?

B. Should there be a demand requirement for shareholder lawsuits? Should it be stronger or weaker than it currently is?

06. POL: Control block sales – market rule AOT equal opportunity rule)

A. Under the market rule: Less costly to buy controlling blocks Easier for looters to purchase controlling blocks

1. Looters will be willing to pay more because they can extract more value from the corporation, but that will decrease the value for the minority shareholders

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B. Under equal opportunity rule would increase the cost of purchasing controlling blocks – offering the same price to each shareholder means that the new controller would have to increase the firm value overall for it to be profitable

1. Gets rid of all possible looters but also gets rid of some efficient buyers with less prominent gains

C. Rule choice you choose depends on whether you think most buyers are looters OR efficient buyers

07. POL: Tender offers & Williams ActA. POL PRO regulation of TOs

1. Removes shareholder collection action problem2. Without Williams, Target’s shareholders lack information about Br’s financies or plans for the

company Cant decide if they should tender their shares now or remain invested in Target3. Br could unfairly pressure shareholders by tendering only for part of Target’s shares and buy

shares on first come, first served basis Shareholders will want to tender ASAP or else their shares will be redeemed at a low price in back-end merger

4. [Gilson & Bebchuk]: Disclosure triggers an auction regime, which enhances efficiency of individual takeovers, without decreasing number of efficient tender offers

B. POL CON regulation of TOs1. Heavy handed rules2. [Easterbrook & Fischel]: Buyers can free ride from other buyers; auctioneering discourages

people from searching utility-maximizing opportunities to seize control

08. POL: TakeoversA. POL RAT for requiring shareholder approval

1. RAT1: M&A decisions are too big/important to be left to managementa. But, it probably isn’t just about the size of the corporation because the BJR applies to

decisions that involve the same transactional value2. RAT2: Mergers don’t require expertise to evaluate

a. Probably not true because knowing which firm to buy draws a lot on manager’s expertise

3. RAT3 [Real reason]: M&A decisions pose unique agency problemsa. Last decision the manager will make, so its not likely that they are particularly

interested in making a decision that will get shareholder votesb. Because shareholders’ interests are not necessarily aligned with managements’

interests, even though management has better expertise and more information (which usually justifies BJR) there is not the same amount of deference here

B. POL PRO takeovers1. Remove inefficient managers2. Discipline all managers via deterrence3. [Icahn, Easterbrook & Fischel]: Board should be passive in the face of hostile tender offer. If

shareholders like the deal, they should do so—this represents market forces at work.4. “Just say no” defense entrenches bad directors

a. [Time]: Board can “just say no” so long as they have some basis for arguing that their long-terms strategy will secure more value for shareholders

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5. Economic question: Is the acquisitions may K-H efficient?a. Value increasesb. Economies of scalec. Economies of scoped. Vertical integratione. Management efficienciesf. Often convince managers to agree to mergers by paying them offg. “Smoothing” (project diversification)

i. Not very persuasive; shareholders can diversify on their own

C. POL CON takeovers1. Takeover artists aren’t making robust value propositions to shareholders: They’re coercing,

greenmailing, etc.2. Doesn’t discipline the absolute shittiest managers (whose firms are too fucked up to be

worth buying)3. Necessitates golden parachutes for managers (who otherwise won’t serve as managers b/c

too pussied out by fear of M&A doods).4. Forces managers to focus on short-term value AOT long-term projects5. Managers will rush to burn through retained cash b/c it’s attractive to Brs 6. Increased corporate debt (b/c targets restructure to pay dividends and stave off hostile bids,

and b/c successful Brs often heavily mortgage company).7. Value transfers

a. Tax transfers away from public fisci. Can carry net operating losses (NOLs) of one company to reduce future tax

liability of acquiring companyb. Transfers from creditors

i. Switch equity to debtc. Transfers from consumers

i. Anticompetitive merger leads to pricing powerd. Transfers from minority shareholders

i. Freeze out of minority8. Value destruction

a. Overestimation of benefits

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b. Empire buildingc. Poor incentives for managers

D. REGULATIONS on hostile takeovers1. Regulation at the control block acquisition stage

a. Control share statutes: (e.g., Ohio, Indiana) prevent a bidder from voting its shares beyond a specific threshold (20-50%) unless a majority of disinterested shareholders vote to approve the purchase of the stake.

b. Constituency statutes (e.g. Pennsylvania, Indiana): allow the board to consider non-shareholder constituencies.

c. Disgorgement Statutes (Pennsylvania & Ohio): require bidders to disgorge short-term profits from failed bid attempts.

2. Regulation of second-step freezeouta. Business combination (freeze-out) statutes: (e.g., DGCL §203 (SS 197) prevent a bidder

from merging with the target for either three or five years after gaining a controlling stake unless approved by the target’s board.

b. Fair price statutes: (e.g. Maryland) set procedural criteria to determine a fair price in freeze-outs.

3. Illinois Rule: Found unconstitutional as preempted by the Williams Act (Edgar v. Mite) but what really bothered the court was that the state legislature could sit in judgment of deals

4. State statutes that are permitteda. Control Share statutesb. Regulation of Tender offers c. Constituency Statutes d. Disgorgement statutes e. Combination*/Freeze out statutes f. Fair price statutes

09. POL on defensive measuresA. POL PRO strong defensive measures

1. PP provides directors with ability to bargain on shareholders’ behalf Overcomes CAP2. White knights serve as “stalking horses” and enable shareholders to get most value out of the

hostile bidder (Forstmann in Revlon)

B. POL CON strong defensive measures1. Lipton’s study showing that shareholder value benefits from PP has been discredited2. In any case, we can't measure the economic effect b/c every DE corporation effectively has

the pill3. PP has led to significant decline in of hostile TOs

C. Japanese “middle ground” on PP1. Poison pill may be adopted without a shareholder vote (as in Delaware), but must be

“necessary and reasonable in relation to the threat posed.” 2. However, pills may only be used to maximize shareholder value—they may not be justified by

reference to other corporate constituencies.3. And in order to be “reasonable in relation to the threat posed,” a pill must provide a

mechanism for shareholders to eliminate it, for example by board election or by a “sunset provision”

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D. POL Qs on Shareholder voting 1. What are the pros and cons of staggered boards? 2. What are the costs/benefits of providing shareholders with more rights?3. Is the Froessel rule the right rule for reimbursement of challengers and incumbents?4. Is SEC regulation of Proxies efficient?5. Should we have less stringent rules regarding shareholder proposals?6. Should the DC Circuit have struck down the new proxy access rule? Was that a good rule?

10. Agency Law Agency

o Consent Usually by contract, but not always

o Agent (A) has power to bind principal (P) to a third party (T) Economic value of agency is this power

o Formation/terminationo P’s liability for A’s authorized and unauthorized contracts, and for (some) torts

committed by Ao A’s duties to P

Typeso Scope

Special agent Limited to single transaction

General agento Disclosure

Disclosed Undisclosed

Do not know that A is an agent (e.g., Disney World and M.T. Lot Corp.) Partially disclosed

T does not know identity of Po Control

Employee/servant Detailed control

Independent contractor Less extensive control

Terminationo Cannot enter into agreement not to revoke agency

Always can be terminated, by either party, at any time Uncomfortable with agent’s ability to continue to bind unwilling

principals Jenson Farms Co. v. Cargill, Inc. , Minn. 1981

o Warren buys grain from farmers; Cargill financing Warren and buys 90% of graino Over time, Cargill develops extensive control over Warren

Managerial adviceo [Warren has collapsed and is now judgment-proof]o Even without explicit agency agreement, Warren held to be agent for Cargill

Implied consent through course of dealing of P and A Exercising more control than a bank Conduct is more important than parties’ conceptions

Protecting third partieso However, many of Cargill’s suggestions were never implemented

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Does this undermine court’s holding?

Economic value of agency relationship comes from ability of A to bind P to T Authority

o Actual Reasonable person in the agent’s position would infer authority Derived from P’s instructions/actions

o Apparent Reasonable third party would infer authority Derived from T’s observations

o Inherent Usually accompanies or is incidental to transaction authorized

As long as T is not aware that Based on third party’s beliefs about agent Exists to protect people harmed by dealing with agents

White v. Thomas , Ark. 1991o White (P) had authorized Simpson (A) to buy specific parcel of land at auction, up to

$250k Gave A blank check Buys lands for > agreed-on price

o A agrees with Thomas (T) to sell section of land to make up difference A represents that she has power of attorney and signs contract

She did not, in fact, have POAo Court concludes no actual authority (from A’s perspective)o Court concludes no apparent authority (from T’s perspective)

T did not exercise due diligence after asking about POAo OK that P accepts one agreement, but not other

Creates agency problem for third parties Jackson: This will lead to increased prices, because it will include

premium for uncertainty Gallant Ins. Co. v. Isaac , Ind. 2000

o Thompson-Harris (A) transfers Isaac’s (T) insurance to her new car, on behalf of Gallant (P)

A represents that T’s insurance is bound Upgrade happens over weekend, so T is to come in and sign/pay deposit on

Mondayo Accident before Mondayo No actual authority

Agency agreement requires P’s approval of changeso No apparent authority

Even though A regularly binds insurance before receiving approval from Po Inherent authority

A says insurance was binding Therefore reasonable for T to believe A could be bound

[Third Restatement changes a bit; requires notice to P to protect them]

How do we reconcile White and Gallant?o What is proper sharing of information costs between P and T?

Who is lowest cost-bearer of information? Who should have burden of due diligence?

In White, T

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In Gallant, P Also agency by estoppel or ratification

Tort Liability Respondeat superior liability:

o Rsmt. 3d of Agency, § 2.04 (Supp. p. 23)o Employee (rather than independent contractor)

Test focuses on level of control exercised by P Rsmt. 3d of Agency, § 7.06 (Supp. p. 35)

o Control test for acting within scope of employment Problem with this test is that P knows about this test when deciding level

of monitoring to exerciseo “acting within scope of employment”

Franchise advantageso Lower monitoring costso Lower capital costso Incentivize franchise ownero Brand protection

Humble Oil & Refining Co. v. Martin , Tex. 1949 (p. 30)o Car rolls away from filling station and over pedestrianso Negligence by employee hired by Schneider (station manager)o Based on contract between Humble and Schneider, find that he is an employee,

rather than independent contractor Great deal of control, Humble products sold on consignment Humble could direct Schneider

o Therefore, Humble liable Hoover v. Sun Oil Co. , Del. 1965 (p. 32)

o Negligence by employee hired by Barone (station manager)o Based on contract between Sun and Barone, find that he is an independent

contractor, not an employee Freedom to set hours, sell non-Sun products, took title to goods, ownership

stake Though Sun made suggestions, not same level of control

o Sun not liable If only about monitoring incentives, would want to hold station managers liable

o However, most station managers probably judgment-proof Therefore unlikely to internalize monitoring costs

Distinguish two cases: business modelo Barone, not Sun, held risk of profit and loss, whereas Humble Oil paid most of

Schneider’s operating costs Conclusion that Sun has less control over Barone

Duties in Agency: Fiduciary duty

o Duty of obedience To be obedient to documents/to agreement

o Duty of loyalty “pervasive obligation always to exercise legal power in a manner that . . . is

best to advance the interest of purposes of the principal or beneficiary and not to exercise such power for a personal benefit”

Not to acquire financial benefit for self when following duty of principal

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Agent cannot generally act on behalf of adverse party But, can if

o P consento A acts in good faith and discloseso There is fair dealing

Justifications:o Don’t want to prohibit efficient transaction, when it is best

transaction, just because A is conflicted Mere appearance of unfairness will get you to a jury on duty of loyalty

o Duty of care

Tarnowski v. Resop , Minn. 1952 (p. 36)o Juke box routeo Resop (A) lies to Tarnowski (P)o Deal voidedo Also gets remedy against A

$2000 secret commission + fees

o Importance of duty of loyaltyo P overcompensated

Justified by Holmes’s “bad man” theory of the law Deterrence for A

In re Gleeson , Ill. 1954 (p. 38)o Land in trust; trustee is lessor

After P’s death, leases land for an additional yearo Seem to actually benefit beneficiaries (raises payment)o But courts take duty of loyalty so seriously o Policy:

P is dead, so cannot monitor A; may be more protective of trusts than other agency relationships

Cf. collective action problem of shareholders = like a dead woman

11. CN: Partnership Two principals owe duties of loyalty to each other Characteristics of partnership

o All partners are liable as principalso All general agents of partnershipo Jointly and severally liable for debts of partnership, just like single principalso All partners share equally in control (unless they agree otherwise)

Why have a partnership?o Lower cost of capital (debt)o Human capital, with aligned incentives

Meinhard v. Salmon , N.Y. 1928 (p. 47)o [Justice Cardozo]o M & S are joint venturers in Bristol Hotel

M is passive investor; S holds lease and manages S gets 60% for first 5 years; split 50/50 thereafter

o S enters new venture to redevelop and lease whole block for 80 years Without consulting M

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o Information about opportunity was property of the business S misappropriated information

o Strong language about duty of loyalty “Punctilio” paragraph

o M gets 50% - 1 shareo Other possible solutions

Same terms’ option (close to Cardozo’s remedy) Disclose and compete/renegotiate

Cardozo suggests this is what S’s fiduciary duty required Salmon’s option

Probably most K-H efficient; as manager and full owner, S would work harder

o Problems: disincentivizes managers from seeking out new opportunities, because they do not get full benefit

Cf. Dreamworks exception to this rule in their charter Legal truths:

o If a court cites Meinhard’s language, the Δ loses If a court uses the word “punctilio,” the Δ loses big

All a business is is a successive series of opportunities

Partnership formationo Without more, joint ownership of property (§ 7(2)) or sharing of gross returns (§7(3))

do not establish a partnershipo Sharing of net profits is prima facie evidence of partnership (§ 7(4))

As long as not debt, wages, or as interest on a loano Profits as proxy for control

Vohland v. Sweet , Ind. 1982 (p. 52)o Nurseryo Sweet gets 20% of profits, though no explicit agreement

Called “commission,” but actually profitso Inventory built up over the years built up with S’s moneyo Holding that S & V are partners

Ex ante incentive to build up inventory K-H efficient

o Capital contribution not required for partnership Debts

o General partners are unlimitedly personally liable for debts of partnershipo Jointly and severally liable for partnership torts and contracts

Exhaustion Rule: must exhaust business assets before pursuing personal assets

Who can creditors pursue? When can an ex-partner escape partnership debts? Brudney problems (p. 55--56)

o Ars, Gratia, & Artis (“art for the sake of art”)o Mayer contributes money to Artis and is promised half of promised

Ars & Gratia did not know he existed Not partner, because requires consent

Subpartnership, perhapso [FROM MALAIKA:]o Whom can creditors pursue: Who is a partner?

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o Brudney UPA Problems (AKS 55-56): Three parties: (1) Ars contribute labor and is entitled to $5,000 or 1/3 of profits each year (whichever is greater); (2) Gratia contributes land worth $40K and handles sales; (3) Artis contributes $30K cash and handles purchasing Half the cash comes from Mayer (which others know), half the profits go to Mayer (which others don’t know)

1 (a) If consumer is injured by defective equipment Artis knew was defective, is Ars liable? Is Mayer?

Ars: Yes, he is a partner. Just by contributing “sweat equity” Ars can be held accountable. (See Vohland)

Mayer: Mayer on the other hand (UPA § 18(g)) is not likely to be held a partner, because the other partners don’t even know about him. (Compare this to Agency where parties’ knowledge doesn’t matter). You could, however argue that Mayer and Artis are in a sub-partnership. This is very weird sub theory, however, and is unlikely to be successful.

Gratia: clearly a partner 1 (b) If G failed to respond to a customer causing them to lose considerable

sales? Tort of omission Artis: Under UPA § 13, it would seem that he was. Artis would likely

argue that he was not a partner. Artis and Ars, however, would likely be held liable.

Mayer: Will also be on the hook. Under UPA § 18(b) (SS 48): If ordinary or properly you’d be required to respond to a customer, he can be held accountable.

(2) Low exhibits various elements of control: has veto power of expenses exceeding $10,000, can get his money back whenever he wants (thus, if he took it back when the business was in trouble, he could effectively end the business). Low is probably a partner.

Low, however, would argue that he is just “a bank” (like in the Cargill case). Under UPA § 17, if he’s held accountable, he would only be liable for future partnership debts and not for those existing prior (these can only be taken from partnership property)

Exiting Partners UPA 36(2): “ Partner is discharged from liability on the partnership assets when there is

an agreement to that effect.o Courts work hard to find an agreement to that effecto Rationale: it seems unfair to hold partners liable when they no longer have any

control over the partnership What’s the policy rationale for making it easy for exiting partners to avoid liability?

o Don’t want to hold partner liable when they have no control. Ex ante this might discourage them from joining partnerships.

What are reasons for making it difficult?o Don’t want it easy for partner to load up lots of liability and then leave

Third-Party Claims Against Partnership Property Key is distinguishing partnership property and individuals property

o “tenancy in partnership”

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Partnership Governance and AuthorityUPA 18(h)

Majority = head count, not majority of ownership Nabisco v. Stroud

o Stroud couldn’t restrict the ability of Freedman on an ordinary business matter connected with the partnership because he wasn’t a majority of the partners.

o On an ordinary business matter, less than a majority of the partners can’t stop a partner from taking action.

Here, two partners, so one can never be a majority Gap in UPA! Cuts towards action!

o What could Stroud have done ex ante to protect himself from this? This was a default rule so they could have agreed ahead of time N.B. UPA is merely the default rule. You can opt-out, for example, by creating

a partnership agreement.

Termination: Dissolution and Disassociation: Under the UPA, a partner exiting can lead to a dissolution. Under the RUPA, a partner

exiting is not enough. The UPA is still the law in most jurisdictions. In most states, unless a partnership agreement says otherwise, a partner can usually

windup a partnership at any time.

Accountingo Assets - liabilities = equities and earningo *** PUT IN SLIDES

Dissolutiono UPA/common law

A single partner’s exit leads to a wind-up Still the law in most states

Default rule; can be opted out ofo RUPA

Exit alone is not enough Adams v. Jarvis , Wis. 1964 (p. 65)

o Doctors’ officeo Can contract out of default rules of dissolution

Dreifuerst v. Dreifuerst , Wis. 1979 (p. 69)o Partners cannot agree on how to wind up farmo Holding: unless partnership agrees (ex ante or ex post) to distribution in kind, must

wind up by selling all partnership assets Violates UPA § 38(1) (withdrawing partner entitled to cash)

Under UPA, disincentive for leaving partnership, because incoming partner gets more money than person leaving

o Does not get full buy-out priceo Under RUPA, exiting partner does get full buy-out price

Page v. Page , Cal. 1961 (p. 73)o [Justice Traynor]o Oral partnership agreement to run a laundryo One partner tries to dissolve

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Other partner accuses him of trying to take advantage of new opportunity of new AFB

o Trial court implies term to partnership, until debt is repaid Concerned with being taken advantage of

o Partnerships are presumptively at will Not for a term

o IF, however, proved to be in bad faith, wrongful dissolution, and liable for damageso Duty of loyalty is sufficient protection

Limited liabilityo Creditors of partnership cannot attack assets of individual partners

Liability “shield” Goal of making investor comfortable that they will not

o Types Limited Partnership (LP)

Give up control to one general partner, in exchange for limited liability Complete liability shield Leads to agency costs

o Monitoring, however, is tricky, because cannot monitor too much without breaking down shield

o Solved by paying general partner a percentage of earnings Limited Liability Partnership (LLP)

Structure just like general partnershipso Give all partners control

Because of control, however, liability shield is qualifiedo Usually limited only to torts, malpractice

Limited Liability Company (LLC) Members Control Meaningful limit on liability Pass-through tax treatment

o Income of entity is passed through to individuals, who pay income tax

Rather than two-tiered event, as in corporate form

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12. PartnershipA. Definitional issues & General rules

1. Partners are essentially co-principals and co-agents.2. Partners both have a right to share in business’ profits (but need not share profits to be

partners) 3. All owners are liable as principals4. All partners are general agents5. All general partners are jointly and severally liable for the debts of the partnership (much as

single principals are)6. All partners share equally in control, unless they agree otherwise (as in Meinhard)

B. Why have a partnership?1. Cost of debt of an individual principal may become prohibitively high, such that giving up an

ownership stake is less costly 2. Partner contributes human capital3. Ability to create a separate legal entity

C. Conflicts among owners1. It can be hard to DST good faith conflict b/w owners from the cheating by the controlling

owner seeking to exploit the non-controlling owner2. [Meinhard]: M and S are joint venturers in leasing a hotel for 20 years. M supplies half the

capital for the lease. S gets 60% of profits for first five years, then they split 50-50 for remaining 15 years. As lease is about to run out, S renews lease for 80 years without consulting M. M wants a share.

a. H: S violated duty to M to inform M of the duty to inform him about the opportunity to secure the lease. M is awarded about half of the interest that S obtained by renewing the lease.

i. KF: M learned about this opportunity by virtue of his agency—if not for his work in the JV, he would not have learned of this opportunity

b. Economic arguments in favor of and against M and Si. Core Q: The court here must supply a gap-filling rule that supplies the

agreement the parties would have arrived at ex ante. What contract would the parties have agreed to ex ante?

A. OPT1 [Best for M]: “Same terms’ option,” in which M has the option to participate in any new opportunity on the same terms as in the 20-year joint venture. (Close to court’s remedy: M gets 50% of the new deal, just like the old one”

B. OPT2: “Disclose and compete option,” in which S is bound to inform M of new opportunities, and must compete for, or renegotiate over, any new opportunity

1. Court suggests this is why S’s fiduciary duty required2. BUT this option is best for the seller (not the partners), b/c it

would create an auction that drives up pricesC. OPT3: “Salmon’s option,” in which S can keep the new opportunity OR

offer a piece to M at his pleasure (this is what S actually did)1. Ex ante, M would then have demanded a larger share of the initial

profits2. This rule gives S the best incentive to seek out Kaldor-Hicks

efficiency maximizing transactionsD. PROF: We can use S’s active role in the partnership to arrive at a totally

different conclusion1. For PROF: S’s active role SHOULD lead us to conclude that S

should NOT be burdened with an onerous duty, since we want to incentivize him to seek out efficient transactions.

A. From a Kaldor-Hicks efficiency perspective, the rule arguably does not matter

2. For Cardozo: S’s active role leads court to conclude that S owes a duty to M

D. Partnership formation

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1. Uniform Partnership Act 6(1): A partnership is an association of two or more persons to carry on as co-owners a business for profit

2. UPA 7 provides rules of inference for judging whether a partnership exists (even if the purported partners deny it).

a. UPA 7(1): Without more, joint ownership of property does NOT establish a pshipb. UPA 7(3): Without more, sharing of gross returns does NOT establish a pshipc. UPA 7(4): Sharing of net profits is prima facie evidence of a partnership, BUT NOT IF

by way of:i. Repaying a debtii. As wagesiii. As interest on a loan

3. KFs in whether or not court is likely to infer a partnershipa. Control over the enterpriseb. Profit sharing

i. RAT: UPA assumes, as in Humble Oil, that sharing of profits insinuates a sharing of control. If control is shared, then we have a partnership.

c. Intent of the parties 4. [Vohland v. Sweet]: S apprentices to V the Elder. V the Younger takes over the enterprise and

rename it to V’s nursery. Beginning in 1963, S was paid 20% of net profits of V’s Nursery. No explicit agreement. S’s 20% share is erroneous called commission. In 1979, S sues to dissolve the partnership (i.e., S wants to wind up the business, sell its assets, and distribute proceeds). S is basically running the place

a. Q: Is S a partner?b. H: S is a partner.

i. KF: Sharing of profits. ii. IR that S did not place any capital into the business (since S contributed human

capital)iii. IR that S did not engage with the business in the same way that the other

Partner did c. PROF: This is another case about incentives.

i. S was investing his own money by buying inventory. If S wasn’t getting a partner’s share, it wouldn’t make sense for S to put his money into keeping the inventory stocked and invest his time into running the business.

ii. The H in this case gives Sweet incentive to maintain stock and effectively operate the store

13. Partnership relations w/ 3PsA. RSM provisions on the rights of pship creditors

1. CR1 [UPA 15]: Partners are jointly and severally liable for partnership torts; jointly liable on partnership contracts

2. CR2 [RUPA 306]: Partners are jointly and severally liable on partnership torts AND contracts, BUT

a. Creditors must exhaust business assets before pursuing personal assets

B. Core Qs:1. Q1: Whom can creditors pursue (i.e., who are partners)2. Q2: When can an ex-partner escape pship debts?

C. Q1: Who is a partner?1. Brudney UPA problems [CB at 55]

a. Q1: Ars, Gratia, Artis form a pship to create Argrari. Ars contributes sweat equity, and et $5k, or 1/3 of profits eachyearii. Gratia contributes land worth $40K and handles salesiii. Artis contributes $30K cash and handles purchasing

A. Unknown to Ars and Gratia, half the $30K cash comes from Mayer, to whom Artis is promised half of profits

iv. Q1(a): Consumer is injured by equipment that ARtis knew was liable A. Ars’ liability: Ars should also be liable, as he is a partner

1. KF: Artis’ day-to-day operational control places him in a position to take care

2. KF: Artis gets a share of profits

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3. IR that ArtisB. Mayer’s liability: No, Mayer can NOT be liable as a partner because of

the lack of Ars’ and Gratia’s knowledge of his profit-sharing with Artis 1. KF: Mayer has no control 2. KF: Parties’ consent/conception of who is in the partnership has

controlling importance3. Arguably, Mayer may be a partner of Artis (but not of Ars or

Gratia), and may be liable as partner for Artis’ liabilities on that theory

v. Q1(b): Consumer is injured due to loss of resales b/c of Gratia’s conductA. Artis is liable as partnerB. Mayer’s liability

1. UPA 18(b) may work to force Mayer to indemnify partners for lossb. Q2: Low loans the business $50k for ten years, in return for interest in an amount equal

to 25 percent of profits and a veto on large expenditures. Loan is repayable on demand. Low would advice on financing of transactions

i. ANS: Low likely qualifies as a partner ii. As in [Cargill], this is a “lender” whose control over the enterprise is substantial

enough to qualify him as a partner A. NOTE: Oridnary commercial loans made by banks ordinarily do NOT

confer this level of control iii. Q: Can Low be liable for NEW debts incurred by the pship?

A. ANS: Likely yesB. UPA 17: Incoming partners cannot be liable for EXISTING debts, but CAN

be held personally liable for newly incurred debts after joining the pship

D. Q2: Liability of exiting partners1. UPA 36(2): Exiting partner is discharged from any existing liability upon end of pship by an

agreement to that effect between himself, the creditor, and the person/partnership continuing the business

2. UPA 36(3): Exiting partner is released from liability, IF creditors received notice of departing partner’s exit

3. POL Considerations of imposing exit liability on exiting partnersa. Ex ante incentives to join a partnership b. Ex ante incentives to lend money/enter into contractual agreements with partnerships

4. 3P claims against partnership propertya. Statutory structure

i. UPA 25(1) creates a special vehicle, the tenancy in partnership, in which all pship property is held

A. This gives those who deal with the pship an assurance that, because the pship property is NOT held personally by partners, the pship property cannot be looted by partners for individual gain

ii. UPA 25(2): Partners cannot assign their interest in pship propertiii. UPA 26: What partners DO own is their share of the profits—THAT share

corporation be transferredb. Implications

i. Creditors of the pship have priority of access to pship assets. Creditors of individual partners can go after pship assets, but have lesser priority than pship creditors.

c. RAT i. Otherwise, pship creditors would have high monitoring costs b/c they would

have to be concerned about the credit health of partners in their individual capacity, for fear that they might default on their debts and thus expose pship assets to claims by individual partners

ii. Otherwise, partners would have incentives to engage in highly risky behavior, as they have their pship assets to pay off debts

E. Partnership governance and authority 1. UPA 18(h): Any difference arising as to ordinary matters connected with the pship business

may be decided by a majority of the partners; but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners

a. These are merely default rules: pships uslaly opt out of these rules

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b. A partner who is the minority on major decisions (e.g., to contract with a 3P) is still bound by the decision (and thus, the minority partner is liable despite his objection to the contract).

c. NOTE that 18(h) counts bodies, NOT capital contributioni. IR that the minority partner contributed the majority of capital

2. [Nabisco v. Stroud]: S and F are partners. S refuses to be personally lbe to 3P (Nabisco) for any bread deliveries. F requests continue deliveries from Nabisco. Pship dissolves.

a. H: Court finds S lbe b/c S, by himself, was not, and could not be a majority of the partners, and consequently could not restrict F’s authority to bind the pship on an “ordinary matter connected with the pship business”

i. NOTE that the court seems to side with finding pship authority (and thus binding all the partners) to conduct ordinary pship business (e.g., continuing to receive bread shipments)

ii. PROF: Presumption that ordinary-course-of-business conduct serves Kaldor-Hicks efficiency.

b. Policy RAT: A contrary outcome would enable individual partners to exercise effective veto power over the operations of the pship

c. NOTE that S could have avoided liability by EITHERi. RT1: Ex ante, contracting out of the default UPA ruleii. RT2: Terminating the pship after the disagreement arises

3. Brudney UPA [CB 62]: The 3 partners of Argrar disagree over how extensive alterations to a business should be. Gratia signs a contract with a 3P to build an alteration that costs $50K.

a. Q1: The pship and the partners are likely NOT bound by the agreement to pay $50K.i. UPA 9(2): AN act of a partner which is NOT apparently for the carrying on of the

business of the pship in the usual way does NOT bind the pship, unless authorized by other partners

b. Q2: [missed]i. QQ

c. Q3: If Artis intervenes and tries to stop the agreement, but both Ars and Gratia agree to bind the firm

i. ANS: Agreement is not binding. Per UPA 9(2), if the activity is NOT in the ordinary course of business Minority partners have a veto right

F. Partnership termination1. Balance sheet: Defines, at a moment in time, the firm’s assets and liabilities2. Income statement: Calculates net income based on revenue, less COGS, less operating

earnings, less taxes and interesta. Over time, net income flows through to the value of the firm and lands on the balance

sheet3. Definitions

a. Dissolutioni. UPA 29: Dissolution—any change of pship status/relations (e.g., exit of a partner)ii. RUPA 801: Onset of liquidating pship assets and winding up of its affairs

b. Dissociationi. RUPA 601: Partner leaves the pship

c. TErmiantioni. UPA 30: Pship ceases entirely at the end of winding up

d. Winding upi. UPA 37: Orderly liquidation and settlement of pship affairs

4. CRs on who and when pships may be wound upa. CR1: Under UPA, at-will partnerships may be wound up by any partner, at any timeb. CR2: Not so under RUPA

5. Issues on dissolution or “exit rights”a. Q1: Opting out of UPA

i. [Adams v. Jarvis]: A withdraws from a 3-doctor clinic and contends that his withdrawal constitutes a dissolution that gives him right to require a wind up.

A. Drafter of the partnership agreement confused the terms “dissolution” and “windup,” and it ends up ambiguous

B. Court ends up ignoring the terms of the agreement and decides to honor it spirit

C. TKY: Where there is a conflict, the pship agreement always trumps UPA

G. Statutory default rules for dissolution and limits thereon

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1. [Dreifuerst v. Dreifuerst]: P and D form partnership to operate feed mill. P serves D with notice of dissolution & windup. Parties could not agree to windup. D requested that pship be sold, and partners would bid on entire property. (This would enable Ps to continue to pship, and D’s pship equity to be satisfied in cash)

a. LC: Denies D’s request for sale, and divides pship assets in-kind according to P’s valuation of assets

b. D ARG: He is entitled to in-cash settlement after judicial salec. H:

i. GEN RULE: In-kind distribution is permissible only in limited circs d. UPA 38(1): When dissolution is caused in any way, except in contravention of the pship

agreement, each parther may have the pship sold off and receive in-cash payment, unless otherwise agreed

i. RAT for UPA 38 favoring in-cash settlementA. In-kind distributions may affect creditor’s right to collect on debt owed

1. Pship assets may be worth (if sold as a single bundle for cash) more than the assets once divided up

2. Brudney PROB (CB 72): Artis wants to resign from the Argrar pship. The pship is worth $700K as a going concern; if liquidated and sold off, it is worth $400K; if sold intact to a related business, it would bring $500K.

a. Q: How much would Artis secure?b. CR1 [UPA]: Artis would receive 1/3 of liquidation value ($400K)

i. NOTE that the remaining partners (and any new entering partner) would receive 1/3 of $700K, so we are effectively giving a windfall to them and punishing the exiting partner

c. CR2 [RUPA]: Artis would receive the GREATER of 1/3 of liquidation value or going-concern value

H. Recourse in equity to keep things fair when a partner exits 1. [Page v. Page]: Partners enter into pship laundry business. Pship has indefinite term. Business

lost money, but then begins to turn profitable. Exiting partner wants to dissolve pship to enter into business of his own.

a. LC: Although pship agreement specified no term, but court implies a term anyway to prevent a Meinhard-type situation in which partners try to take advantage of each other

i. It seems clear that the going-concern value is almost certainly greater than the liquidation value, so the court really doesn’t want to allow this kind of

b. H: Refuses to imply a term. The i. Court simply gives the parties what they bargained for

A. RAT: A rule that allowed courts to imply terms might deter have deterred the parties from entering into the pship in the first place Loss of an efficient transaction

c. BUT the court acknowledges the possibility that exiting partner may be liable for damages if he breached fiduciary duty of loyalty (e.g., by “attempting to appropriate for his own use his the new prosperity of the pship without adequate compensation to his co-partner”).

I. Limited liability modifications of pships1. Limited liability: Creditors of the pship cannot proceed against assets of indiviudla partners 2. OPT1: Limited partnership

a. Limited partners are passive investors—they contribute capital and get profits, BUT have limited control and have limited liability

b. General partners are like the partners of an ordinary partnership c. PROB: Theoretically, this can create agency problems b/c the general partners may not

try hard enough to further the interests of the limited partners i. SOL: PE firms like KKR give general partners a 20% cut of profits and a flat 2%

fee This aligns interests of the general partners with those of the limited partners by ensuring that the general partners will try hard to maximize profits

d. Q [CB 78]: Why might some firms opt to remain GPs (AOT LLPs)?i. Remaining a GP sends a message to clients that each individual partner is

willing to put their personal wealth on the line ii. Remaining a GP indicates that partners are better able to monitor each other

A. Conversely, very large firms with partners that are not able to cross-monitor are more likely to opt for LLP form

3. OPT2: Limited liability companya. Advantages that LLC form gives to each member

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i. Active participation in the entit’y socntorl ii. Limited liability iii. Pass-through tax treatment

b. Q: Does an LLC qualify as pass-through, one-time tax treatment (AOT taxed twice, like a corporation)?

i. [OLD] IRS applied a 4-factor testA. TS1: Limited liability for owners of business?B. TS2: Centralized management?C. TS3: Freely transferable ownership infteret?D. TS4: Continutiy of lifeE. IF an entity fails 2 of these factors Entity is taxed twice, as a

corporationii. [Post-1997 rule]: IRS allows entities to simply check a box and opt for taxation as

partnership or corpc. For most people looking to form a business, this is the ideal form

i. Thus, LLCs have grown dramaticallyii. BUT most wealth continues to be held in corporations iii. Also, many LLCs are prevented from engaging in certain businesses (medical

practice, law, etc.)

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14. Corporate formA. Key move is to separate out liability from control

B. Benefits of limited liability1. Reduces need to monitor agents (managers)2. Reduces need to monitor other shareholders3. Makes shares fungible (which also facilitates takeovers)4. Facilitates diversification (without LL, minimize exposure by holding only one company)5. Enlists creditors in monitoring managers (because they bear risk in LL form)

C. Torts1. Incentivizes shareholders to encourage management to spend too little on preventing

accidents2. Encourages investment in hazardous industries3. In contracts, this is negotiated around

a. Sometimes shareholders waive LL

D. Benefits of transferable shares1. Permits takeovers==>disciplines management (deterrence)2. Allows shareholders to exit without disrupting business3. And because of LL, shares are fungible, facilitates market-driven steering of behavior and

incentives towards returns/efficiency

E. Corporate Governance1. DGCL 141(a):“shall be managed by a board of directors”2. Fiduciary duties in exchange for delegated authority

a. Board is economic agent of shareholders

F. Questions:1. How can law encourage managerial diligence, given rational apathy by shareholders?

a. [rationally apathetic = logical not to spend time on oversight]b. Contra Europe, with larger % shareholders, where should not be rational apathy

2. How can law solve shareholders’ collective action problem?3. How can law encourage decisions that are best for shareholders as a whole (and therefore

society)?4. Potential solutions

a. Shareholder votingb. Disclosure

G. Automatic Self-Cleansing Filter Syndicate Co. v. Cunninghame, Engl. 1906 (p. 103)1. Shareholder with 55% wants to sell firm; must be approved by board

a. corporate bylaws require 75% for extraordinary measures, such as replacing board/selling

b. “supermajority provision”2. Bylaws are contract

a. Board of directors stands between majority and minority in a way that is socially usefulb. Information advantage over individual shareholders

15. Corporate form: The board of directors A. Board Structure

1. Broad powers:a. Declare/pay dividendsb. Amend the corp’s bylawsc. Create committees

i. Required to create some, such as audit and compensation comms.d. Agenda-setting authoritye. Sole power to initiate major corp decisions, such as mergers

2. Generally one-year terms, but sometimes staggereda. Up to 3 classes (DGCL 141(d))

i. Board classification requires shareholder approval

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B. Power of shareholders is held in board, rather than individual directors1. Rules of formality

a. E.g., quorum required by DGCL § 141(b)b. Write resolutions

C. Independent directors vs. Manager-directors1. Over time, increasing number of independent directors2. PRO independent directors

a. Reduce agency costsb. Know less about the corporation More pliable to large institutional investors or

controlling shareholders3. CON independent directors

a. Lots of dispersed, individual shareholders Prefer knowledgeable manager-directorsb. However, they have less expertise about area and managers

D. Fogel v. U.S. Energy Systems, Del. Ch. 2007 (p. 107)1. Informal action (3 of 4 directors met before official meeting)2. “The mere fact that directors are gathered does not a meeting make.”

E. Jennings v. Pittsburgh Mercantile Co., Pa. 1964 (p. 110)1. Sale-and-leaseback 2. Egmore (VP and director), acting for Board of Directors, did not have apparent authority

a. Jennings not entitled to rely solely on agent’s representationsb. Must be Board who makes these decisions

3. KF: Extraordinary transaction, outside the scope of ordinary business

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16. Corporate finance: Methods of financingA. Debt v. Equity

1. Debt righta. Maturity date requires repayment at a specified time. Interest must be paid at specified

times at specified rates.b. Acceleration clauses give creditors rights, including control rights, if a payment is

missed (i.e. debtor is in "default").c. Tax law preference permits corporations to deduct interest payments as an expense.d. Debt is less expensive capital than equity

i. Buyers get a lot of rights so are willing to give capital more easily. ii. You may require higher price for stocks b/c stocks give you fewer rights.

B. Equity rights1. Right to dividends, but these are set in boards discretion2. Right to residual claims on the value of the corporation, but these may be zero, timing of

payout is in the board’s discretion.3. Right to vote for directors and on other matters4. Investors require MORE in exchange for equity capital b/c stocks have fewer rights attached to

them.

C. Preferred stock v. common stock1. Preferred stockholders at least get a liquidation preference-- amount that will be paid to

preferred stock b/f common stock.2. Preferred stock has lots of contractual flexibility (See DGCL S 151 page 182)

a. See example of US Treasury investment in AIG. Government was able to convert its preferred shares to common shares to start selling off the company back to the public.

3. Redeemability--ability of either the holder of the preferred stock or the corporation to cash it in. Gives both sides flexibility.

4. Conversion: Corporation or holder of security has ability to take what I hold and turn it into a different class of stock.

a. Ex: when AIG ready to pay back Treas, they turned preferred stock into common stock. When you have lots of contractual terms in the preferred stock, that makes it less fungible.

17. Corporate finance: Discount rate and project valuationA. Discount rate

1. Opportunity cost of money2. As discount rate rises, the present value lowers3. Formulas

a. FV = PV (1+r)n

b. PV = FV / (1+r) n

c. r = (FV/PV)1/n – 1

B. IF NPV is positive Firm should pursue the project/transaction

C. Expected Value1. Sum of (probabilities * outcomes)

D. Risk premium1. Premium charged because outcome is variable2. Try to reduce by diversifying risk via linking together multiple risks so they cancel out3. Individual investment is risk averse: Do not like investments (or games) with widely varying

outcomesa. Sources of risk aversion

i. Declining marginal utility of wealthii. Endowment effect: Regret losing what we have more than regret not gaining

what we don’t have

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18. Creditor protectionA. RM: Forms of secure creditor protection

1. Ineffective regulations (disclosure, distribution, minimum capitalization, capital maintenance)2. Suit on UFTA: Intent to defraud; OR constructive fraud3. Action for equitable subordination: Subordinate shareholders’ “debt” holdings (that he

converted from equity) 4. Action to pierce veil: (1) No separate identity; AND (2) Injustice to creditor if we don’t pierce

veil

B. RT1: Ineffective methods 1. Disclosure requirements: Meant to protect shareholders, not creditors2. Distribution constraints

a. NY: can only be paid from surplus, UNLESS there is shareholder permissionb. DGCL § 154: defines surplus

i. § 170: “nimble dividend” test: May pay out of surplus or net profitsc. Calif.: modified retained earnings test (AKS p. 138)d. RMBCA: assets > liabilities + preferential claims

i. Loophole: if fair valuation (e.g., from investment bank) can pay out more3. Minimal capitalization requirement: Provides little ongoing protection for creditors4. Capital maintenance: Require mandatory action in the event that capitalization falls below a

particular levela. Investors/creditors can contract for this type of rule.

C. RT2: Contractual methods1. Convertibility2. Security interest3. Protective covenants

D. PROB: As a corporation approaches insolvency, shareholders will prefer non-KH-efficient conduct1. [Credit Lyonnaise]: As the corp approaches insolvency, shareholders will try for riskier

ventures, even if it’s NPV negative, because they know bondholders will be paid first and thus shareholders benefit from the venture that pays off an amount well in excess of the bondholder payout

2. PROP: When corporations approach insolvency, directors should be able to go under a new rule

a. CTR: Unadministrable—how do you know you’re in the insolvency line? If you do know, parties will game that line

b. CTR: Creditors can contract for that ex antei. CTR: There may be a lack of information/excessive transactin costs to ex ante

price the protections into loan agreements (i.e., how does a creditor quantify the value it derives from forcing a corp to maintain a certain level of capital?)

E. RT2: UFTA Sections 4 & 51. SUM: Corporations cannot take money out of the till that should be going to creditors2. T1: Intent to defraud3. T2: Constructive fraud

a. Applies where the capital looks “unreasonably small”i. Debtor was engaged in a transaction for which the debtor’s assets were

“unreasonably small”b. PROB: Judge will exercise hindsight bias, and aren’t good at figuring out what level of

capital is sensiblei. Leveraged buyouts (LBOs) can be attacked as fraudulent conveyanceii. ii. Also, the uncertainty of whether courts will interdict these contracts will

increase cost of equity

F. RT3: Equitable subordination1. Usually applies to the “loan” made by maj shareholder who converts his shares into a loan to

corporation2. [Costello]: Partners replace their equity to loans. Creditors claim that the partners’ loans

should be subordinated. a. H: Court subordinates partners’ loanb. KF: Gross under-capitalization

i. History of the partner suggested more capital was needed to run the corporation properly

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c. KF: Real unfairness to creditors WRT what they relied upon when they signed the loani. CF1: If this had been a brand new firm, with no history of interaction bw

creditors and partners Less substance on which creditors would be relying Harder for creditors to claim unfairness

ii. CF2: If this had been a long-ailing firm and creditors knew it Again, creditors had no reason to rely on beliefs in the validity of their notes

G. RT4: Piercing the corporate veil1. Brings shareholders’ personal assets onto the table2. GEN RULE: No piercing IF ANY

a. Public corporationb. Passive shareholdersc. Minority shareholders d. If all formalities are observed and there is nothing funny with the accounts

3. TS1 : Shareholder and corporation do not have separate identitiesa. KF: No corporate records/formalitiesb. TS [Tinkerbell]: Shareholder must believe in the separationc. [Lowendahl]: Shareholder completely dominates corporate policy

4. TS2 : Is there injustice to the creditors?a. [Van Dorn]: Would “adherence to fiction of separateness would sanction a fraud or

promote injustice”?b. RT1: Shareholders engaged in unequitable conductc. RT2: Actual fraudd. RT3: Shell game: manipulation of corporate assets to defeat creditors’ expectations

i. [Sealand]: Creditors seek reverse veil-piercing (pierce through to person, and then through again to that person’s other corporations)

A. POL PROB with reverse-piecing: It may upset the ex ante bargains of the creditors of Private Owner’s other companies

1. Thus, the prospect of reverse-piercing resurrects the specter of monitoring costs, which the corporate form is designed to resolve

2. This kind of revival of agency costs arises whenever corporate liability is abandoned

3. Also, creates uncertainty in lending5. TS3: Did creditor assume the risk?

a. [Kinney Shoe]: Created two liability shields. Once owned the asset, the other subleased it.

i. H:

H. PROF: Proposal for an efficient piercing rule1. Creditors can generally rely on corp assets, subject to normal wear and tear, as of the date

of creditor’s agreement with the corpa. Future corp transactions must generally preserve this value, again subject to normal

wear and tearb. So long as the first two element are satisfied, the owners’ personal assets will be

shielded from creditors’ claims2. RAT: This seems like a sound rule that small businesses would want

a. Supported by the Bob Thompson study, which indicates that courts are much more willing to pierce where owners engaged in misrepresentation

b. Also, courts are more willing to pierce to help out a contract creditor, AOT a tort creditor

3. Applying this testa. Sea-Land would come out the either way (i.e., in favor of veil piercing) because

Marchese was moving assets aroundb. Kinney would also come out the other way (because there was no moving around)

I. The case for limited liability in tort1. We expect that LL in tort leads to:

a. Too little investment in safety, andb. Too much product at too little cost

2. We expect this to happen much less in contract, since contract creditors can bargain ex ante (and thus, achieve a Kaldor-Hicks efficient result)

3. Potential solutionsa. Regulation of precautions

i. PROB: Requires state regulators to know the optimal precaution

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b. Mandatory insurance REQsi. PROB: Requires state regulators to know how to price riskii. PROB: May cause a race to the bottom

c. Give tort creditors first priority in bankruptcyi. This gives contract creditors to seek precautionsii. This seems best, since it will create a flexible market mechanism by which

contract creditors will bargain with the firm to furnish credit at a lower costsiii. PROB: May not necessarily result in pricing-in of additional costs to contract

creditors

19. Shareholder Voting: Economics & Current TrendsA. Economics

1. Rational apathy: Vote makes little difference; Gets very small percent of any changed effected

B. Collective action problems1. [Easterbrook & Fishel]: IF cost to me of gathering information < (benefit to corp. * percentage

of shares I own I will not bother gathering information 2. [Black]: Financial institutional investors COULD be active monitors, but their hands are tied by

legal rulesa. Legal rules keep financial institutions smaller than they would otherwise be, prevent

them from acquiring large percentage stakes, intervene in companies in trouble, enter the boardroom, suppress cross-holdings and antitrust entanglements

b. CTR [Pozen]:Still expensive for institutional investors to gather information3. [Kahan]:Hedge fund are effective monitors

a. Private pool of capital being invested privatelyb. Take positions designed to hedge risk to general market trendsc. Compensation tied directly to performance of firms, unlike mutual funds

C. Recent shareholder-empowering changes 1. Shareholder rights movement

a. Institutional investors form major blocks of these sharesb. Often advised by ISS

2. Majority vote requirements: Corporate law now facilitates, and many companies have now adopted, a requirement that directors are elected by a majority (not plurality) of the votes cast.

3. eProxy makes it cheaper to run an insurgent slate: Reduces costs of distributing proxy materials, and likely gives more power to institutional investors.

4. Delaware Court invites 14a-8 resolutions that require reimbursement of shareholder proxy expenses: AFSCME decision rejects the specific resolution at CA but leaves the door open through better drafting.

5. Delaware legislature makes clear that proxy access procedures and expense reimbursement are a proper matter for bylaws: Newly passed DGCL §§ 112-113

6. Shareholder proxy access (even via private ordering) makes contested director elections more likely: Using Rule 14a-8, shareholders will be able to enact bylaws that will allow them put their own nominees on the company ballot.

20. Shareholder voting: RulesA. Mandatory rules

1. Mandatory board2. Annual shareholders’ meeting, with notice and quorum requirements3. Proxy system

B. Shareholders are entitled to vote on :1. Election/removal of directors2. Fundamental corp. changes (mergers, sales of all assets, dissolutions, charter amends.)3. Shareholder resolution

C. When can shareholders meet to vote ?1. Mandatory annual meeting2. Special meetings (the only way for shareholders to initiate action)

a. [RMBCA]: Special meeting can be called by board OR 10% of shareholders

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b. [DGCL]: Special meeting can be called by board OR shareholders, ONLY IF charter provides for it

c. POL PRO: Easier special meetings More monitoring Less agency costs Lower cost of capital

d. POL CON: Easier special meetings Drain on D/O’s time & resources; Disrupt corporate effectiveness

3. Written Consenta. [DGCL § 228]: In lieu of meeting, shareholders can act on any issue they could act on in

meetings via written consentb. [RMBCA § 7.04] Shareholders may act without meeting, IF there is unanimous

written consent D. Methods of voting

1. Straight voting: One vote for each seat on board2. Cumulative voting

a. A given shareholders’ number of votes = number of shares owned * number of seats to be filled; Board is filled in order of candidates with most aggregate votes. Thus, min shareholder can get a few directors on the board by concentrating their votes on a handful of candidates.

b. Ensures min shareholders will have representation on board roughly equal to their percentage

3. Plurality vs. majority votinga. [DGCL 216] is default for pluralityb. Votes withheld are irrelevant; votes against impossible if uncontestedc. Majority is very high hurdled. Other option = majority of all shares voting

E. Class voting requirement 1. POL

a. Efficiency of class voting terms depends on whether differences between class voting regimes are priced in by shareholders

b. Different classes of stock may have divergent interests2. DGCL § 242(b)(2)

a. Class voting only protects legal rightsi. E.g., does not apply to subordination of shares

b. Does NOT apply in mergers3. RMBCA 10.04(a): Classes have right to vote as class when charter amendments affect

economic interests or legal rightsa. (f)---Requires class voting on mergers

4. NYBCL § 804(a)(3)a. Class voting on charter amendment, IF class's rights would be subordinated by

authorizing senior shares

21. Shareholder voting: Removing directorsA. Removing directors

1. RULE [DEL]: Can be removed with/without cause . . . a. UNLESS staggered board OR cumulative voting Requires cause to remove director b. BUT Board has the right to replace removed directors - § 223(a) (default rule, can be

amended)2. RULE [RMBCA]:

B. STRAT: Removing an Unfireable CEO1. OPT1: Amend charter

a. NO, can only do if Board proposes [DGCL § 242(b)(1)]2. OPT2: Amend bylaws

a. YES, not even charter provision can divest shareholders of right to amend bylaws [DGCL § 109(a)]

3. OPT3: Can expand board size4. OPT4: Can get rid of staggered board

a. NOT an option if staggered board is in charteri. Can only do it if Acquirer removes ENTIRE board, because there’s still

cumulative voting

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5. OPT5: Remove directorsa. NO, with staggered board, can only remove for cause [DGCL § 141(k)(1)]

6. OPT6: Break up companya. NO, requires proposal by board [DGCL § 275]

C. Staggered Board1. Implementing a staggered board

a. Only the board may recommend a change of the corporate charter (mandatory) - § 242 (b)

i. Shareholders always retain the right to amend bylaws (mandatory rule) - § 109(a)

b. Need shareholder vote to implementc. Maximum of 3 classes; Directors are divided into classes and each year only one class is

up for election2. Makes it more difficult for an acquirer to take control

a. Delay problemb. Two-election problemc. Firm offer problem

3. “Effective staggered board”a. Cannot be dismantled by bylaw amendmentb. E.g., if staggered board is in charter

22. Shareholder voting: Separating control from cash flow rights

A. [DGCL 160(c)]: No circular voting structures 1. RULE: Shares can’t vote OR count toward quorum if they are EITHER

a. Treasury stock (owned by corporation)b. Shares held by subsidiary in which corp. has majority of voting stock

2. STD [Speiser]: Judge will fill gaps in corporate law by ferreting out functional equivalents of circular voting

a. Corp1 bought Convertible preferred stock in Corp2, which then bought stock in Corp1i. Scheme to evade § 160(c)

b. Functionally equivalent to prohibited circular voting i. Therefore, votes not permitted

B. RULE: No vote buying1. POL PRO [Easterbrook & Fischel]: There is good reason to limit free market operation here

a. Legal rules tying votes to shares increase corporate efficiencyb. New agency costs would be created by allowing separation of voting rights from

equity interest would create i. If controller of 75% of votes owns only 25% of cash flow Won’t invest as much

in monitoringc. Shareholders will sell their votes for LESS than expected dilution of equity interest (b/c

they don’t think their votes will affect outcomes and so under-value their votes)2. [Schreiber]

a. Loan; court characterizes as vote buyingi. Therefore, voidable

b. Does not void transactioni. Nature of transaction is such not to void

A. Other shareholders were not hurt, because they voted in favor of it1. “Cured” vote buying violation

C. EXs: Controlling minority structures 1. Stock pyramids

a. 50%, 50%, 50% will lead to 12.5% ownership, but voting controlb. Disfavored by tax law

2. Cross ownershipa. Phalanx of corps. own each other

i. Contra pyramid, not clear who is at topb. Never seen in US; disfavored by tax law

3. Dual class structures

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a. Different voting power in different classes of stockb. Generally, dual-class recaps not permitted, but can have multiple classes at IPO

i. Though SEC rule struck down, NYSE has rule banning dual-class recaps

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23. Shareholder voting: Proxy fightsA. Q: Who gets reimbursed for proxies?

1. PROF: Analyze Amount, conditionality, bias2. MAJ [Froessel]

a. Insurgents get full reimbursement ONLY IF they winb. Management gets full reimbursement for proxy expenses

i. STD: Technically, management only gets reimbursed for matters of corporate policy

A. In practice, though, no distinction between corporate policy and personal interest

ii. REQ: Proxy expenses spent in belief that they’re in best interests of shareholders

iii. REQ: Proxy expenses must NOT be spent for personal power3. MIN [Super-Froessel Rule]: Reimburse both sides, no matter who wins

a. Incentivizes proxy fights

24. Shareholder voting: Proxy war & Town hall proposalsA. RM: Options open to insurgents

1. Insurgent can send out own proxy solicitations (but Froessel problem)2. Include proposal on directors’ proxy (town hall proposal)3. Propose a bylaw amendment allowing proxy access4. [Under rejected 14a-11]: For larger shareholders, put candidate directly on directors’ proxy

B. Q1: Must a notice be filed b/c it is a proxy solicitation? 1. RT1 [14a-1(l)]: “Solicitation” is “Any communication reasonably calculated to result in the

procurement of a proxy” a. Must file Schedule under 14a-3 (memo + schedule 14A) (lose element of surprise)b. EXC1: Not seeking power to act as proxy, directly or indirectlyc. EXC2: Soliciting 10 or fewer

2. RT2: BUT Owns more than $5M in stock Even if exempt, must file notice

C. Short slate problem1. Addressed by 14a-4(d)(4), which allows to solicit proxies for management nominees

D. Q2: Will the proposal appear on directors’ proxy?1. Q1 [14a-8]: Town hall rule

a. REQ: Must own certain amount of stock for a year, and propose 120 days in advance, at most 500 words

2. Q2: Can management exclude a proposal from proxy?a. RT: Substantially implemented

i. Carpenters’ Pension Fund case study (p. 214)A. Proposal to move to majority vote; Board tries to implement similar plan

in responseB. H: Not excludable as “substantially implemented”

b. RT: Ordinary businessi. TS1: Is it a task fundamental to management’s ability to run the businessii. TS2: Or does it focus more on significant social policy issues?iii. TS3: Seek to micromanage the corporation on complex matters?iv. NiSource case study (Supp. #2)

A. Proposal to eliminate PAC can be excluded as ordinary businessv. CSR proposals

c. Improper under state law – usually can’t bind the corporation to do things, suggestions only

d. Violates the proxy rules – i.e. materially false informatione. Personal grievancesf. Not Relevant: Accounts for only a very small amount of the companies businessg. Company would lack the power to implement the proposalh. Conflicts with one of the company’s own proposalsi. Already substantially implemented

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j. Requests a specific amount of dividendk. Relates to the election of board members or a procedure for such nomination or

election**3. Q3: Will SEC permit exclusion of proposal?

a. Management will seek no-action letter to ensure SEC will not punish corp. for disallowing a particular shareholder proposal

b. RULE: SEC will apply a case-by-case approach to determine if CSR proposal could be excluded

i. [Medical Committee for Human Rights v. SEC]A. H: Shareholder proposal improperly excluded. Proposal to stop producing

napalm NOT related to “ordinary businessii. [Cracker Barrel letter]

A. Sexual orientation discrimination related to “ordinary business”B. Reversed in 1997; now, a case-by-case approach

E. Antifraud Rule [Rule 14a-9]1. RULE: Prohibits fraudulent obtaining of a proxy2. RULE: Includes private right of action, with following elements:

a. REQ: Materiality—substantial likelihood that a reasonable shareholder would consider the misrepresentation/omission important in deciding how to vote

b. REQ: Culpability—[CRs] Negligence // intentional // gross recklessnessc. REQ: Causation/reliance—presumed if the proxy solicitation was an essential link in

accomplishment of the transaction and the misrepresentation was material i. QQ [Virginia Bank Shares]

25. Defeated proxy access ruleA. RULE [14a-11]: Allows shareholders who owned 3% of corp. shares for 3 years to place nominees on

directors’ proxy for up to ¼ of all board seats1. BUT must not be seeking control2. If staggered: calculated by whole board, not just those up for reelection3. TKY: Under 14a-11, insurgents could skip proxy war (sending proxies to shareholders and

persuading them to give over proxy voting right) and directly put your candidate on the incumbent directors’ proxy card

a. Gave insurgents the ability to get around the [Frossel] problem of non-reimbursement

B. Does NOT allow a control slate

C. Now, if you want to avoid a proxy contest, the only possible way to do it is to use 14a-8 to propose an amendment to the bylaws allowing proxy access

1. Not clear how the SEC will rule on these yet2. If they’re not-excludable, then, you can propose your candidate via a shareholder proposal on

the directors’ proxy

D. [Business Roundtable]1. Stayed by SEC2. Does not apply for this year’s proxy season

E. [DGCL § 112] Allows for a bylaw providing for proxy access1. Passed in response to SEC

F. POL CON proxy access rule: 1. Shifts lots of power into hands of institutional investors, ISS, who may not have firms’ best

interests at hear2. Labor unions may place their directors on board

G. POL PRO proxy access rule: 1. Other countries give shareholders much more control2. No shareholder directors could be elected w/o a majority shareholder vote3. Only if conditions were really dire will a shareholder-nominee would be willing to overcome

arduous triggering conditions, year-long wait, and subsequent shareholder votes 4. Proxy access is much more important in post-PP world, where getting control of board is

prerequisite to buying a majority of shares (because you need to redeem the pill in order to buy the shares)

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26. Duty of CareA. RM

1. Was there knowing criminal action?2. 102(b)(7) waiver applies? (DO acted in GF and was not gross negligence)3. Board was passive, which caused losses?

a. Failure to exert minimal effortb. No monitoring systemc. Failed to implement monitoring systemd. Ignored red flags

4. Board’s bad action caused losses?a. Grossly negligent process Board has burden to show EFb. No self-dealing, reasonable investigation, rational belief that they were helping

shareholders BJR

B. Facets of Duty of Care1. Good faith

a. Honestb. No conflict of interestc. Not approve/condone wrongful/illegal activity

2. No wastea. Rationally further corporation’s interests

3. Reasonable carea. Informed in making decisionsb. Monitor and supervise corporate activities

C. Q1: Reason to immediately knock out BJR?1. D/O’s BJ violated a criminal statute

a. KF: Were the shareholders among the class to be protected the criminal statute?b. [Miller]: Shareholders were among the class to be protected by ban on corporate

spending on political campaignsi. H: No BJR for illegal conduct by DOs

2. D/O pursued broad social/political goals unrelated to corporation’s welfare

D. Q2: Is there a 102(b)(7) waiver that covers DO?1. REQ: Did DO act in good faith?

a. 102(b)(7) prohibits waiver for non-GF conduct2. REQ: DO’s conduct was knowing violation of law?

a. 102(b)(7) prohibits waiver for knowing crime3. REQ: DO’s conduct must NOT be intentional, conscious dereliction of duty

a. [Disney]: Gross negligence is NOT bad faith4. REQ: DO’s conduct was gross negligence?

a. [Cede]: If yes, proceed to EF review, and THEN decide of 102(b)(7) eliminates personal liability

b. RAT: Concern there may be DoL violations mixed in5. IF WAIVER APPLIES, and there are ONLY DoC claims Dismiss (per Emerald Partners)6. IF NO waiver (or there are non-DoC claims) Was there inaction, or malfeasance?

E. Q3: Is the board’s passivity in detecting fraud/crime a breach of DoC?1. RT1: Failure to exert even minimal amount of care

a. [Francis]: Total failure to position oneself to detect red flags is breach of DoCi. Duty at least involved looking at booksii. Duty required more than mere objection/resignation

2. RT2: Director omissions despite red flags of crime/fraud No BJR protectiona. BJR does not apply to director omissionsb. Law & econ analysis does not apply: Purpose of BJR is to discourage risk averse

decisions, but these are not decisions, so no incentive to protecti. Doctrinally, deference to active business decisions, but no reason to defer to

inactionc. Q: Was there a red flag?

i. RULE [Allis-Chalmers]: Directors are entitled to rely on compliance of their employees until a red flag (suspicious circs) emerges

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A. Q: Was Board on notice that would make reasonable person suspect wrongdoing, but still didn’t act?

B. RAT: It would be inefficient to require directors to just ALWAYS monitor, since monitoring is costly and it makes more economic sense to require directors to expend monitoring on costs only when, and only on those areas of their corporation that are showing red flags

ii. RULE [Citigroup]: Generalized market/business conditions are NOT a red flag3. RT3 [Caremark]: Board utterly failed to implement any reporting/information system to

detect wrongdoinga. ART(D) [Citigroup]: Frame the loss-causing risk as a business risk (for which there is

no monitoring duty)4. RT4 [Stone]: Board consciously failed to monitor/oversee control systems to detect

fraud/crimea. Board must know that it’s shirking its fiduciary duty of careb. Grossly negligent failure to detect wrongdoing is NOT enough

5. RT5: Failure to accurately disclose information to shareholders to help them decide how to vote

F. Q4: Is this wrong action covered by Business Judgment Rule?1. STD: BJR presumes directors do not breach DoC2. REQ1 [Cede II]: Gross negligence with respect to process Directors have burden to

show EFa. BUT [Cede III]: Gross negligence doesn’t necessarily mean that the substance was

unfair---you can have gross negligence and still the transaction can be EF3. REQ2: No self-dealing

a. Does D have a financial stake?b. QQ What if there is self-dealing?

4. REQ3: Adequately informed decisiona. D acquired all material information reasonably available to them

i. STD: Courts usually require grossly negligent failure to obtain material information.

A. [Van Gorkom]: D-CEO failed to commission formal study OR solicit other bids prior to selling company.

1. KF: The CEO, not the buyer, proposed sale price2. KF: Board made no attempts to learn intrinsic value of the

company3. KF: D-Board approved sale based solely on CEO’s oral

presentation4. KF: Board made decision in 2-hour period, with no real crisis5. KF: Court suspected that board acceded to the autocratic CEO6. IR: The merits of the case (whether the sale price was fair, which

it probably was) were trumped by the board’s grossly negligent process

b. Consider surrounding circumstances (time pressure on decision?)5. REQ4: Rational, actual belief that the BJ was in corporation’s best interest

a. STD [Disney]: Court will not use 20/20 hindsight to judge BJsb. REQ: DO’s conduct was unreasonable

i. RT2: No-upside transactionA. [Litwin]: Decision to purchase bonds with an option for seller to buy

bonds back was “so improvident, risky, unusual, unnecessary” D liable for decline in value

ii. RT3: Disguised self-dealingc. REQ: Standard is objective, but does consider DO’s special skillsd. REQ: Consider nature/size of businesse. REQ: Reasonable reliance on officers, employees, lawyers, accountants, other retained

experts, committee of the boardi. Board’s decision to rely on expert is protected under BJR if the board’s

procedures are reasonable 6. POL RAT for BJR

a. Avoid discouraging risk-taking and innovation by D/Osb. Courts are poor judges of business realityc. Shareholders should bear risk of business misjudgment

G. Q5: If BJR is overcome, can Board prove entire fairness?

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1. QQ Insert EF analysis

H. Q: Were P’s damages caused by the breach?1. Q [Emerald Partner]: Did damages result entirely from the breach2. DEL [Cede]: If DO violated DoC IR if P cannot prove causation 3. ART(D): If multiple DOs violated DoC Each can argue that the rest of the board would have

voted that way anyway, so my conduct did not cause the bad outcome

27. Duty of Care: Liability shieldsA. Only 3 cases where directors have had to pay out of pocket:

1. Van Gorkum, Enron, and Worldcom

B. BJR: Presumes DoC was met

C. Waiver: No liability for DoC violations, UNLESS there is a GF violation

D. Indemnification1. RULE [DGCL § 145(a)]: MAY indemnify for any claim, except for act taken in bad faith or had

reasonable cause to believe was unlawful a. Permissive; Corp is not required to indemnify

2. RULE [DGCL § 145(c)]: Mandatory indemnification for legal expenses “actually and reasonably incurred,” if you win

a. Point is to minimize D/Os’ risk aversionb. N.B. Also deductible as corporate expense

3. DGCL § 145(f)a. Suggests you could indemnify more broadlyb. But cannot do anything that conflicts with 145(a)

E. D&O Insurance 1. RULE [DGCL § 145(g)]: Can purchase insurance for DO whether or not they could indemnify

that person

F. Reimbursement of legal expenses1. RULE [DGCL 145(c)]: Even if not in good faith, success in a legal action (e.g., settlement with

no payment) Mandatory indemnification

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28. Duty of Loyalty A. RM

1. Does shareholder owe a duty to other shareholders?a. SH owns a fiduciary duty ONLY IF it owns a majority interest in, or exercises control over

the business affairs of the corporationi. RT1: Shareholder owns > 50% of shares automatic status as controlling

shareholder ii. RT2: Shareholder owns < 50% of shares no automatic status; the plaintiff must

allege domination by a minority SH through actual control of corporate conduct2. Was there self-dealing?3. Was the self-dealing by a majority shareholder, or by board?

a. [Apply master DoL RM]4. Theft of corporate opportunity?5. Breach of “duty” of GF?6. Close corporation7. Is BJR review passed?8. Is EF review passed? (fair dealing; fair price; what happened to the corp after the

transaction)?9. Remedies: Rescission OR restitution

B. DEF [Self-dealing]: Corporation conducted business with DO or family member?1. Core Q [Gleason]: Can the principal monitor the agent’s actions? Or is the trustee

dead/disabled 2. General REQs for self-dealing transaction

a. Disclosure?i. IF YES: Did a majority of disinterested directors approve?

A. YES No breachii. IF NO: Disclosure after the transaction (either before suit or a reasonable time

after suit filed)? b. All material facts disclosed?c. Entire fairness?d. Approval by non-conflicted independent directors, voting in good faith?

3. SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF:a. REQ: Transaction was entirely fair when approved, AND EITHER OF b. Full disclosure to board AND majority of disinterested board members approve; ORc. Full disclosure to shareholders AND majority of shareholders voted to approve in GFd. PROF: Not really a safe harbor

4. RULE [SEC Regulation S-K]: D/Os must disclose what interest they have5. QQ: Is it a DoL breach if director fails to disclose material facts about his interest?

C. Types of conflict transactions1. Director has interests in corporation’s counterparty in the transaction 2. Looting or giving self a discount3. QQ4. Refusals to deal, if directors/ controlling shareholders planned to seize that deal for

themselves later

D. MASTER DOL RM : SELF-DEALING by a MAJORITY SHAREHOLDER?1. IF YES (i.e., majority shareholder is dealing with corp, or with min shareholders)

a. SP1: Even with full disclosure, board approval, and/or shareholder ratification, the transaction will likely be subject to EF review

i. Sinclair: Parent makes sub pay large dividends to itselfii. McMulliniii. Cookies: Main shareholder of business has Corp deal on favorable terms w/ his

other businesses Disclosed, BUT iv. Wheelabrator:

b. SP2: Apply Weinberger roadmapc. [Cookies]: Court suspects that board, even though technically “disinterested,” is under

sway of charismatic CEOd. SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF:

i. REQ: Transaction was entirely fair when approved, AND EITHER OF

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ii. Full disclosure to board AND majority of disinterested board members approve; OR

iii. Full disclosure to shareholders AND majority of shareholders voted to approve in GF

iv. PROF: Not really a safe harbor2. IF NOT maj shareholder self-dealing (i.e., general corporate transaction b/w board and

corporation) Did disinterested board members have full disclosure and approve transaction?a. IF disinterested board approved, pre-transaction

i. CR1 [Cooke]: Court will apply BJR review, if disinterested directors conduced business appropriately (only “irrational” or “egregious” conduct will fail)

ii. CR2: Court will apply EF reviewiii. CR3: Court will defer to Board, unless P shows fraud

b. IF YES, but board approved post-transaction Apply EF reviewc. IF NO disinterested board approval

i. Did a majority of shareholders ratify the transaction?A. IF the transaction was NOT ratified Apply EF reviewB. IF transaction WAS ratified Is the claim for waste?

1. IF claim is for waste Apply EF review [Vogelstein]2. IF claim is NOT for waste Apply BJR

d. SAFE HARBOR STATUTE [DGCL 144]: Can NOT void a transaction for self-dealing IF:i. REQ: Transaction was entirely fair when approved, AND EITHER OF ii. Full disclosure to board AND majority of disinterested board members approve;

ORiii. Full disclosure to shareholders AND majority of shareholders voted to approve in

GFiv. PROF: Not really a safe harbor

E. RT4: Theft of CORPORATE OPPORTUNITY1. Q1: Does charter contain a DGCL 122(17) waiver?

a. [Dreamworks]: Charter eliminated execs’ duties to (1) refrain from engaging in business directly competing w/ Dreamworks; and (2) communicate the opportunity to Dreamworks

i. HIST: Post-IPO performance was abyssmal2. Q2: Was the opportunity a “corporate opportunity”?

a. CR1 [Expectancy of interest test]: opportunity grows out of an existing legal interest of the corporation

b. CR2 [Line of business test]: Any opportunity falling within the corporation’s line of business

i. KF: How the opportunity came to the attention of directorii. KF: Remote from the core economic activities of the corporation?iii. KF: Corporate assets used to find or exploit the opportunity?

c. CR3 [Fairness Test]: Holistic analysis3. Q3: Was there incapacity or disability for corporation to seize the opportunity?

a. IF YES Director can take opportunity, no breach of DoLb. IF NO disability Did Board decide to pass up the opportunity, in good faith, and

with approval of disinterested directors?i. [Broz]: Director need not present opportunity to boardii. IF disinterested board passed up No breach of DoLiii. IF no disinterested approval Was there a 122(17) waiver?

A. [Dreamworks]B. IF NO waiver EF review

F. RT5: “DUTY” OF GOOD FAITH breached?1. [Stone]: Failure to act in GF does not result, ipso facto, in fiduciary liability. BUT failure to act

in GF may indirectly trigger liability. 2. Q1: Where on the malevolent intent--gross negligence spectrum does this lie?

a. [Disney]: Intent to do harm ---- Intentional dereliction; conscious disregard of duties ---- Mere gross negligence

b. There may be a level of negligence so profound as to trigger lack of BF No 102(b)(7) 3. Q2: Does the subjective state of mind of the director INTEND to not serve shareholders?

a. IF NO No breach (Disney)b. IF YES Possible breach

G. RT5: In CLOSE CORPORATIONS, heightened duty owed by shareholders to each other

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1. STD: Balance partnership-based notions of fiduciary duty w/ court’s belief about what parties would have bargained for ex-ante

a. ARG(D) [L&E approach]: Minority shareholders could have contracted for 2. Close corporation characteristics:

a. Small # of shareholders Greater likelihood of controlling shareholder b. No public market in stock Min shareholders cannot liquidate their investment c. Less liquidity in sharesd. Majority shareholder participates in daily management of firm Space for

opportunistic behavior3. TS1: LEGITIMATE BUSINESS REASON test

a. Q1: Did minority shareholder challenge transaction?i. IF YES Can majority shareholder show legitimate business reason?

A. No Minority shareholder winsB. Yes Can Minority shareholder show that majority shareholder could

have accomplished same objectives in a manner that harmed minority shareholders less?

1. Yes Minority shareholder wins2. No Majority shareholder wins.

4. TS2 [Donahue]: EQUAL OPPORTUNITY rulea. [Donahue]: Claim of violation of fiduciary duty because minority shareholder was not

given same chance to sell shares back to corporationi. Invokes partnership jurisprudence, and applies partnership-level duty b/w/

shareholders in a close corporationii. Equal opportunity to have shares bought outiii. Concurrence: Approves of decision in terms of selling shares, but not for other

decisions in running a close corp.5. [Smith v. Atlantic]: 4 shareholders, 25% each. Charter required 80% vote to approve corp.

affairsa. Close corp. never pays dividends/ IRS assesses penalty, then other three shareholders

sueb. H: Court applies reasonableness overlay to determine that Wolfson breached fiduciary

dutyi. Court imposes reasonableness overlayii. Went “beyond the limits of reason,” despite explicit clause in charter that

seemed to permit his conductc. PROF: Majority shareholders could have dissolved corp. with only 40% of the votes, so

this holding is a stretch

H. SUM(Burden of Proof) RMBCA § 8.61/DGCL § 144 ALI Principles of Corporate

Governance § 5.02Neither board nor shareholders approve.

Entire fairness (Δ): But see Siliconix (BJR only, if Controller TOs directly to min shareholders)

Entire fairness (Δ)

Disinterested directors authorize Business judgment rule (Π): Cooke v. Oolie, RMBCA § 8.61(b)(1) & Comment 2

Reasonable belief in fairness (Π): ALI § 5.02(a)(2)(B)

Disinterested directors ratify Business judgment rule (Π): RMBCA § 8.62(a) & Comment 1

Entire fairness (Δ): ALI §§ 5.02(c), 5.02(a)(2)(A), 5.02(b).

Shareholders ratify Waste (Π) Waste (Π)

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I.

29. Duty of Loyalty: Can directors look after non-shareholders’ interests?

A. CR1 [31 states]: 1. EX: PA constituency statute

a. D/Os may consider the effects of their actions on any or all groups affected by such action, including employees, suppliers, customers

2. Under this kind of statute, Ford’s decision would have been approveda. These statutes seem radical and overturned a lot of prior corporate law, but they have

only been invoked twice, both in the context of the

B. CR2 [Delaware]: There is NO constituency statutea. CTR: Friedman

i. The role of corporations is to make moneyii. CTR: Friedman presents a false choice—it’s possible to do good and generate

profits

C. GEN RULE: Virtually every corporate action can be justified on a shareholder value-maximizing theory

1. REQ: When DoL is implicated, benefits rendered to non-shareholder constituencies may violate DoL

a. EX: Ross Johnson’s donations were NOT deferred to i. Arranged for endowment of academic chairs in the directors’ names at

universities of their choiceii. Arranged for “fat donation” to a college where a director’s wife was a trusteeiii. ANS: These donations raise the specter of self-dealing (i.e., personal gain for the

directors) rather than corporate value 2. [Swartz v. Friedman]

a. ARG: Swartz (CEO of Timberland)b. F: Clothing company is well-known for shutting down a week per year so that employees

can go work for charitiesc. Do good things for society, and profit will follow

3. [Barlow]a. Q: Should corps be able to make charitable contributions?b. F: Corp donates ot Princeton. Shareholder challenges, claiming that corporation has no

power to make the contribution.i. 1930 NJ statute allows corps to create and maintain charities. ii. Thus, D/Os can basically always make this argument

c. H: Court defers to directors’ judgment that “purchasing” this affiliation with Princeton was good for shareholder value

4. Q1 [AKS 301]: Can corps contribute to controversial political causes?a. Barlow probably allows this, as indicated by Target case

5. THM: Recall self-dealing concerns from Tarnowski v. Riesopa. Courts get concerned where there is a possibility of self-dealing

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30. Executive payA. RULE

1. Apply DoC analysis2. Traditionally, if compensation is approved in advance by disinterested directors/shareholders

Immunizes it from shareholder attack3. BUT there must be some benefit to corporation, or else it’s waste.

B. PROP: We should allow markets to constrain pay1. PRO

a. [Disney]: Corporate decisions are made, risks are taken, results manifest, capital flows, shareholder value is increased

i. Ps claim gross negligence to negate GF and 102(b)(7), but court refuses to set executive pay by judicial fiat

b. Shareholders’ say-on-pay will lead directors to make compensation decisions based on uninformed shareholder preferences

2. CON a. [Bebchuk]: Directors do not bargain over CEO pay at arms’ length

i. [Bebchuk]: Directors have incentives to be reelected. CEOs have power to benefit directors. Directors want to be loyal to CEO b/c he appointed them. Directors prefer that boardroom is colleegial. Directors internalize few costs of favoring CEO (since they own only fraction of stake), but they reap large benefits

b. [Posner]: c. [Jones v. Harris]: >> FILL IN from lectured. Shareholders’ say-on-pay is good

i. Mitigates rational apathy problemsii. Opt-in or opt-out?

C. STRATs: Shareholder measures to tie CEO pay to performance1. OPT1: Tie CEO pay to revenues, costs, profits2. OPT2: Tie CEO pay to stock price

a. BUT this may exacerbate CEO risk-aversion b/c it means his investment financial/personal capital if less diversified

b. BUT stock options may INCREASE risk-preference b/c further declines in stock value do not hit CEO hard, where as further gains are worth as much to CEOs as to shareholders

D. Federal intervention1. IRC 162(m): Stock options are “performance-based” compensation that can be deducted even

over the $1M cap for top-5 executive compensation.2. SEC-required disclosures in annual proxy statements:

a. Regulation S-K: Compensation of CEO, CFO, and 3 top-paid executivesb. Item 402: Detailed discussion of compensation policies, link bw pay and performance,

and descriptin of how compensation decisions were madec. Item 402: Summary compensation table

3. Sarbanes-Oxleya. 304: CEO & CFO must pay back any bonus, incentives, or stock-based gains paid

within 12 months of any financial statement that is later restated due to misconducti. [CSK Auto]: Exec forced to return bonuses even though he was NOT accused of

wrongdoing4. Limits on compensation for TARP firms

a. [ARRA s. 111]: i. Required clawback of compensation to top 5 execs and next 20 highest-paid

employeesii. Prohibited bonus payments to certain employees, EXCEPT bonuses conditioned

on first repaying TARP funds, had value <1/3 of that employee’s total pay, and was paid in restricted stock (i.e., not an option)

b. Treasury-appointed Special Master for TARP executive compensation empowered to i. Approve all compensation paid to top-5 and next 20 highest-paidii. Approve compensation structures for all executive officers and next 100-highest

paidiii. Interpret s. 111 as to all TARP recipients

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iv. “Easterbrook’s worst nightmare”: An unaccountable bureaucrat overriding market forces

c. HIST: Feinberg cut compensation by an average of 50% for 175 employees at 7 firmsd. HIST: Blue-chip companies NOT subject to TARP voluntarily cut pay

5. [Dodd-Frank 953(b)]a. Disclosures as to (i) executive pay in comparison with financial performance of the

issuer and (ii) the ratio of the CEO’s pay to median pay of all other employees b. PROF: Disclosure reduces agency costs for shareholders to monitor

i. PROB: Disclosure publicizes compensation May actually drive compensation UP during good years

6. [Dodd-Frank 951]: a. At least every 3 years, proxy will give shareholders a chance to pass a nonbinding

resolution to approve executive payb. At least every 6 years, shareholders will give shareholders a chance to decide if say-on-

pay vote should happen every 1, 2, or 3 yearsc. Shareholders also vote to give themselves annual vote

7. DESIGN CHOICES UNDERLYING DFA 951 a. POL Q: When considering default rules that are designed to facilitate shareholder

monitoring, is opt-out or opt-in better?i. PROB: Shareholder opt-in will cause the rule to NOT extend to some

corporations for which it’s efficient; Opt-out will cause the rule to extend to some corporations for which it’s NOT efficient

ii. PROF: For a rule that gives shareholder more power, it’s better to have an opt-out rule

A. We can rely on Board to opt-out of rules that are not efficient for their corporation

B. By contrast, shareholder will probably fail to opt-in to rules that are efficient (b/c of apathy)

C. Opt-in rule is good if we think that shareholders will iii. DFA 951 is an opt-out ruleiv. Favorable, because solve collection action problemv. Shareholders May STILL have rational apathy at point of voting, but at least it

gets past procedural stage and onto ballotvi. Contra Rule 14a-8, which is an opt-IN rule

b. Advantagesi. Solves collection action problemii. Shareholders can make views knowniii. Feel like they have a say, which helps to solve collective action problemiv. Unbundles preferences about pay from preferences about directors

c. Institutional investors want to vote every year on this type of thingd. Nonbinding, because if binding, might cause Board to act contrary to fiduciary duty

i. Must have “fiduciary out”ii. If Congress had made it binding, would have overruled Del. law

e. Implications of DFA 951i. Unclear how this will matter to jodgesii. In 2009, shareholders approved executive pay at every TARP firm anyway

31. Shareholder suitsA. RM of shareholder suits

1. Narrative analysis: Does P make demand?a. IF demand is made Does board refuse?

i. IF board refuses BJR appliesii. IF board does not refuse Corporation brings suit against directors

b. IF no demand is made Is demand excused under Aronson/Levine TS [(RT1): Not disinterested/independent; OR (RT2): Challenged decision not protected by BJR]

i. IF demand is required Suit dismissedii. IF demand is excused Does firm form SLC?

A. IF no SLC formed Suit continuesB. IF SLC is formed SLC recommends dismissal or settles?

1. IF SLC recommends dismissal

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A. TS [Zapata] : (REQ1) Corporation proves GF, independence, reasonable investigation; OR (REQ2) Court’s exercise of BJ validates dismissal

2. IF SLC recommends settlement A. Are the attorneys’ fees appropriate?B. Is settlement approved?

B. Background1. Same conduct that supports a derivative suit can usually support a direct action (usually class

action). a. P can bring BOTH actions.

2. Derivative suit technically represents 2 suits in one: One by shareholder charging directors with failure to sue on the corporation claim (usually b/c their alleged wrongdoing is the source of the corporation claim), one by the corporation actually suing directors on that corporation claim

3. Recovery from derivative suit goes directly to corporation

C. Q1: Direct or derivative? 1. Q [Tooley]: Who suffered the alleged harm (corporation or shareholders?)2. Q [Tooley]: Who would receive benefit of recovery/remedy?3. Q [Grimes]: Direct suits vindicate individual shareholders’ structural, financial, voting,

transferability rightsa. Compel payment of declared dividends, compel inspection of listsb. Challenge fraud on shareholdersc. Challenge sale of corporation in a merger where directors failed to be

informed/structure fair transaction d. Challenge restrictions on share transferability, e. Challenge denial/dilution of voting rights, compel holding of shareholders’ meetings,

D. Q2: Shareholder has standing? 1. REQ: Shareholder-P must have owned shares at time of injury2. REQ: Shareholder-P must own shares for duration of the suit

E. Q3 [DE]: Demand requirement satisfied, by EITHER 1. RT1: Shareholder-P brought potential suit to the board, OR2. RT2: Demand requirement waived under 23.1 b/c it would be futile

a. TS [Levine gloss on Aronson]: Demand is excused as futile IF EITHER:i. STD [Levin]: Very favorable to directors. Levine had lots of bad KFs that seemed

to favor P.ii. RT1: Directors are NOT disinterested & independentiii. RT2 [Levine]: Show particularized facts that create “reasonable doubt” of the

soundness of the challenged transaction?3. POL on Demand Requirement

a. DE rule effectively creates rule of universal non-demand. If shareholder-P does not claim demand futility, he concedes that Directors are disinterested & independent

b. ALT PROP [ALI]: Shareholder-P must ALWAYS make demand, and can sue only if not satisfied by board’s response to demand

c. ALT demand rulesi. RMBCA: Must make demand and wait 90 days, unless irreparable injury If

demand is refused, shareholder may continue by alleging that Board is interested, or did not act in GF

ii. ALI: Must make demand and unless irreparable injury If demand is refused, court will review board motion to dismiss derivative suit using one of 3 standards:

A. No dismissal if alleged undisclosed self-dealingB. BJR for alleged DoC vibrationsC. Reasonable belief in fairness for DoL violations

F. Q4 [DE]: Special litigation committee 1. Background & Purpose

a. [DGCL 141] Generally authorizes board-created committees (but no clear statutory authorization for SLCs)

b. When SLC is used: If demand is excused, and some directors are interested Board may convene SLC to move separately for dismissal on merits

i. SLC is usually composed of independent directors chosen for disinterestedness.

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ii. If SLC determines suit is not in corp’s interests SLC files MTD on behalf of corporation

c. SLC is NOT mandatoryd. CR1 [DE/Zapata]: If SLC is independent & informed Court applies its OWN BJe. CR2 [NY]: If SLC is independent & informed BJR deference applies

2. TS [Zapata]: Should court accept SLC’s recommendations and MTD?a. Q1: Corporation bears burden to prove independence, good faith, and reasonable

investigationi. Failure to bear burden MTD is dismissed and shareholders’ suit proceedsii. [Oracle]: Oracle board appointed two Stanford profs (also board members) to

SLC. SLC recommends refusing to sue Oracle.A. STD: SLC is likely to be bound by norms of human conduct. Causing a

corp to sue a generous patron to SLC’s university is “just not done”B. H: SLC is NOT independent, DESPITE

1. CTR-KF: SLC produces 1,110-page report concluding Oracle should NOT pursue P’s claims against D-Directors

2. CTR-KF: Extensive scope of SLC’s investigation 3. CTR-KF: SLC members did extensive due diligence before even

joining SLC4. KF: Director-Ds were big direct donators to Stanford and created

research foundations5. KF: Ellison’s stature in Silicon Valley is so large that the

impartiality of ANYONE in that community WRT a suit against Ellison is suspect

b. Q2: Court applies its own BJ to determine if MTD should be grantedi. POL CTR: “I have no business judgment. If I did, I wouldn’t be a judge.”

G. Q5: IF there is a settlement, did it meet REQs? 1. STD [Carlton]: Court will exercise own BJ, but approve a settlement so long as it’s “not badly

off the mark”2. PROB: We should suspect settlements b/c of CAPs and incentive misalignments

a. Attorneys want to settle, b/c costs of suit increase while attorney’s fees and risk of zero recovery do NOT get more favorable over time

b. Directors want to settle, b/c D&O coverage will pay costs of settlementi. But a finding of fraud/self-dealing at trial Personal liability

H. Q6: Are attorney’s fees appropriate? 1. TS [Fletcher]: Substantial benefit?

a. KF: If the derivative suit produced a common fund, fees may be paid from that fundb. RT: Suit “maintained health of the corporation”c. RT: Suit “prevented abuse” that would harm corporation’s/shareholders’ interestsd. RT: Raised standards of corporate governance policies

i. ART (Dell settlement): Corporation adopts governance policies (rule that 60% of board be independent, new accounting code, improved ethics/reporting functions)

e. ART (Attorneys): Avoidance of litigation costs is a “substantial benefit” to the corporation

f. Codified in RMBCA 7.46

I. POL on social utility of shareholders suits & attorneys’ fees1. PRO

a. Solves collective action problem, which would stop individual shareholders from bringing derivative suit

b. Increases corporate value: Deterrence, recovery, governance changesc. “Substantial benefit” rule is good (over and on top of “common fund” rule). We want

to reward value enhancing arrangements, whether or not they are qualitative or quantitative.

i. Attorneys incentives aren't the same as shareholders, so maybe we want to be especially sure there's a benefit to the corporation (which we'll show by money).

2. CONa. Lost value through D&O premiums and litigation costsb. Recovered funds are merely cycled back out of the corp through D&P premiums.c. Attorney’s fees supply motive for P’s counsel to bring suit (and are awarded in 90%

of settled cases)

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i. Are fees calibrated with desirable levels of monitoring/deterrence?d. Problem of scope if we treat avoidance of litigation costs as a "substantial benefit"--

every settlement could prevent future legal fees Too much litigation if we treated that as substantial benefit.

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32. Control transactions: Intro and POLA. Why pay a control premium?

1. POL on market rulea. PRO market rule [Easterbrook & Fischel]

i. Sale of control blocs promotes dynamism, whose benefits include new plans, new management, reduced agency costs

ii. Unequal distribution of gains reduce costs to buyers of control and increase incentive for inefficient controllers to relinquish position

iii. Control premium already prices in most value-increasing opportunities (e.g., Feldman plan)

b. PRO forced sharing of control premium (or equal opportunity rule) [Berle]i. Control is a corporate asset

B. Controlled mergers are highly problematic b/c they present maximum agency costs: It’s a fundamental transaction, AND there is a controlling shareholder

C. Ways to acquire control1. STRAT1: Purchase control block from Old Controller2. STRAT2: Purchase shares of numerous small shareholders 3. STRAT3: Once you are Controller, freeze out small shareholders

33. Control transactions: Sale of Control BlockA. GEN RULE [Zetlin]: Market rule applies, subject to 3 CONSTRAINTS ON SELLER OF CONTROL

BLOCK1. EXC0 [Exchange Act regulations]

a. RULE [14d-10]: Tenders offers in public corporations must be open to ALL shareholders

b. RULE [14d-10]: Each shareholder must best price offered to any shareholder 2. EXC1: Seller-of-control-block cannot take for himself an opportunity that belongs to all

shareholders a. RT1 [Perlman]: Opportunity to extract premium for corporate asset/opportunity

(i.e., having access to steel when other manufacturers don’t)i. [Perlman]: Premium extracted for goodwill / unique market position

A. H: Minority shareholders were entitled to share of premium paid to Old Controller

B. NON-KF: Acquirer did not loot or harm the corporation in any way C. KF: Wartime, fixed prices on steel. Acquirer decided to buy the steel

supplier so they can sell steel to themselves.b. RT2 [Digex]: Opportunity to extract compensation for waiver of DGCL 203

i. Board did not extract compensation from Acquirer for waiver of 203 violate board’s burden to show entire fairness

A. [203]: Prevents party who purchases control of Target to cash-out within 3 years, UNLESS Target’s board approves ex ante

ii. Board has duty to benefit all shareholders, including minorityiii. Weakens market rule

3. EXC2: No sale of corporate offices (AOT capture of control premium)a. ART(D): “The premium didn’t reflect the agreement to sell my office!”b. STD: Smaller the control block & higher premiums More suspicionc. [Muscat]: Control block is 10%; slightly above-market premium, new Directors

reelected by shareholders Upheldd. [Brecher]: Control block is 4%, 35% premium; CEO fired by board Disgorgement of

control premium4. EXC3: Seller-of-control-block must screen out looters

a. RULE [Harris]: Duty to make inquiry that reasonably cautious person would makei. “Cursory investigation” by Board would have revealed Acquirer’s suspicious

financial statements to be worthlessb. POL CTR [Fischel]: It’s too hard to detect looters ex ante.

i. Most refusals to sell on this basis would be false positives.

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ii. Better to ex post punish/imprison looters (accounting for undetected looting)

34. Control transactions: Freezeout & Controlling shareholder self-dealing

A. RM1. TS1: Does the shareholder owe a duty to other shareholders?2. TS2: Was Weinberger roadmap followed?

a. Independent negotiating committee that exerts bargaining power and deliberate carefully

b. Transaction is subject to majority-of-minority condition3. TS3: Apply judicial scrutiny

a. If roadmap not followed Controller bears burden of showing EF 4. TS4: Remedy is appraisal, UNLESS Controller committed fraud

a. Appraisal is pro rate claim on going-concern value of shares

B. Background 1. [DGCL 251]: Enables controlling shareholders to freeze out minority shareholders, e.g., by

arranging a merger b/w/ Corp and a Dummy Corp owned by controlling shareholders, in which Dummy Corp buys minority shareholders’ shares with cash.

2. Draws intense scrutiny b/c agency problems for minority shareholders 3. 1970s: Stock prices fell and freeze-outs surged, suggesting opportunistic freeze-out activity

C. How a controlled merger + freezeout works1. Freeze Outs

a. SP1: Controlling shareholder forms a new corporation and funds it with cashb. SP2: Controlling shareholder forces merger between new corporation and the

corporation of which it is the controlling shareholderc. SP3: In shareholder vote, controlling shareholder dominates and votes yes. d. SP4: New merged corporation pays dissenting minority shareholders cash and cancels

their shares.2. Controller might offer a smaller percentage (20% or so) in IPO, see how the corporation is

going and once it is going well, freeze out the minority shareholders and take the investment value for itself

3. Especially problematic because they couple both fundamental transactions with controlling shareholder – maximum agency costs

D. REQ [SEC 13e-3]: Required SEC DISCLOSURES/FILINGS for going-private transactions

E. TS2 [Weinberger]: Parent/Controller-sub FREEZEOUT ROADMAP1. TRAD [Singer, overruled by Weinberger]: Freezeout w/o a colorable business purpose is per

se a breach of DoL as a matter of EF2. RULE [DGCL 203] prevents a bidder from merging with the target for either three or five years

after gaining a controlling stake, UNLESS EITHER:a. Takeover is approved by target board before the bid occurs; OR b. Acquirer gains more than 85% of shares in a single offer (i.e., moves from below 15% to

above 85%), excluding inside directors’ shares; ORc. Acquirer gets board approval and 2/3 vote of approval from disinterested shareholders

(i.e., minority who remain after the takeover).i. NOTE that this provision makes Acquirer want FEWER shareholders to tender

into first-stage offer3. SUM: Freezeout roadmap

a. RT1: Majority shareholder attempts freezeout via merger EF review, maybe w/ deference to board

i. Board will receive deference IFb. RT2: Majority shareholder TOs directly to min shareholders BJR review, IF ALL

i. Not coercive; independent directors have a role; i-banker analyses are disclosed4. RT1: IF the majority shareholder is attempting a FREEZEOUT VIA MERGER EF fairness in

dealing AND fairness in price…a. REQ: Fairness in price

i. Q1: Controller bears burden to show EF, but can shift burden IF EITHERA. RT1: Special committee is used (by Sub), and has true negotiating

power and is truly independent; OR

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B. RT2: A majority-of the-minority condition is usedii. Q2: How should price be assessed?

A. CR1 [262 & post-Weinberger cases]: Value of the merger does NOT get built into appraisal

B. CR2 [Weinberger]: Valuation includes ALL economic and financial considerations such as assets, market value, earnings, future prospects, etc. (note the expansion beyond appraisal statute valuation)

b. REQ: Target creates independent negotiating committee of non-overlapping directors

i. [Kahn]: Possibility that a not-quite-independent committee will NOT shift burden (but read this narrowly)

c. REQ: Transaction is subject to majority-of-minority conditiond. REQ: Did Acquirer and Target exert bargaining power at arms’ length?e. REQ: Evidence of genuine deliberation/negotiation b/w Sub’s directors and Controller

i. KF: Was there an IB analysis?ii. KF: Was the transaction concluded very speedily?

f. REQ: Shareholders must get full disclosurei. [Pure]

g. [Weinberger]: Signal owns 51% of Target and 6/13 of Target’s board seats. Overlapping directors develop report that $24 is a good price, but do not share report with Target.

i. Signal’s offer: 55% premium; conditioned on majority-minority approvalA. KF: Target approves minimal negotiation and w/ only a hastily-drafted IB

proposalB. KF: Overlapping directors were involved in negotiations and persuaded

non-overlapping directors (but abstained from final vote)5. RT2 [Siliconix]: If Controller TENDERS DIRECTLY TO MINORITY SHAREHOLDERS No EF

review; just BJR, IF ALL OF:a. GEN RULE [Siliconix]: Controlling shareholder has NO DUTY to offer a “fair” price UNLESS

actual coercion/disclosure failures are showni. RAT: As long as TO is pursued properly, free choice of min shareholders to

reject TO is sufficient protectionb. REQ1: Disclosure of I-bankers’ analyses/valuation opinions to shareholders c. REQ2: Offer is not coercive, as fulfilled by ALL OF:

i. Majority-of-minority condition (and the minority excludes all insiders), ANDii. Controlling shareholder promises to consummate a 253 (short-form) merger at

the same price at where the first-stage offer was made, if it obtains 90% of shares, AND

iii. Controlling shareholder has made no retributive threatsd. REQ3: Target board’s independent directors must be permitted a role, by:

i. Having free rein & adequate time to react to TO;ii. Hiring own advisors;iii. Providing minority shareholders with recommendation as to Controller’s offer

F. SUM of judicial scrutiny of TO and SC freezeouts1. STD: If BOTH

a. KF: Feisty special committee, bargaining hard, court will likely accord deference b. KF: Evidence in the deal that the minority got something (standstill, MoM provision)

2. [Lynch]: a. KF: Disinterested IC approved the freezeout, but on threat of a hostile bidb. H: IC appropriately simulated 3P transaction, where negotiations are conducted at

arms’ length and there is no compulsion to reach agreement i. TKY: The Acr dominated the Lynch board (“we’re a 43% owner, you need to do

what we tell you”) ii. On remand, burden remains with

c. TKY: 3. BUT don’t read Lynch too broadly

a. [In re Western National]: Use of a truly independent committee, together with a standstill agreement Board decision gets BJR

4. [In re Siliconix]: Majority shareholder has NO duty to secure best price if he TOs directly to minority shareholder

a. Strategic implicationsi. If Controller dealing with a board can’t get a deal they like, they can just TO

directly to the min shareholders

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ii. In a settlemtn, the settlemtn will be less since everyone knows that it will be scrutinized under BJR as opposed to EF review.

iii. TO is a risky move, since is shareholders reject it, it’ll be hard to go back to the board b/c there is now proof that the price is not adequate

b. Conditions upon going down the Siliconix routei. [Pure]: TO to min shareholders with a MoM. Pure forms an independent

committee and recommends accepting the offer.A. H: MoM provision is inadequate b/c the minority includes managementB. H: Controlling shareholders did not disclose I-banker analysis about the

value of the firm to ii. Three general rules for a rule to succeed under Pure/Siliconix

A. REQ1: Offer can NOT be coercive1. REQ1“Real MoM” condition (AOT a fake one in which the managers

own a lot of stock)2. REQ2: Promies to conduct 253 merger at same price3. REQ3: Controller can not make retributive threats

B. REQ2: Target board’s independent directors MUST be involved somehow---you can’t totally go around them

1. Hire advisors, present to shareholders, be able ot disclose information

C. REQ3: Details developed by i-bankers must be presented to iii. SUM: Two approaches to freezeouts:

A. RT1: Merger, subject to EF reviewB. RT2: TO, subject to Pure/Siliconix REQs

iv. POL: Shareholders seem to receive less value when they go the Pure/SIliconix route. But dose this matter?

A. ARG that it does NOT matter: Shareholders can price it in ex anteB. CTR: Shareholders don’t understand thatthey might be frozen uot in this

way, so maybe they can’t price it in ex ante 5. [Technicolor]: Br completed first-step TO of Target. Br proceeds to second-step freezeout

a. H: Br satisfied his DoL to minority shareholders, as there was arms’ length bargaining and no new information that went unshared with minority shareholders.

6. Synthesisa.

G. Minority SHAREHOLDERS’ REMEDY1. Shareholders may want to bring FD claim, since appraisal is onerous/costly; DoL claims can be

brought as class actions; class actions allow P’s counsel to aggregate claims and, thus, fees2. Appraisal is exclusive remedy, UNLESS there is either

a. RT1 [Weinberger]: Fraudb. RT2 [Rabkin]: Potentially, other factors may also trigger non-appraisal remedies

i. KFs: Misrepresentation, self-dealing, deliberate waste, gross & palpable overreaching

ii. [Rabkin]: Controller promised to not cash out within 12 months except at the price that it purchased control block at. Cashed out at 12 months and a bit

A. H: Shareholders may sue for breach of DoL3. Appraisal does NOT include value of post-merger entity

H. POL/STRAT considerations on Siliconix1. TO is a risk strategy for an Acr, since if shareholders don’t accept it, that is compelling evidence

in the hands of the special committee to turn down the offer that the offer is not enough

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35. Tender Offer: Procedure & RegulationsA. Background: How a Tender works

1. Select target (usually, undervalued company whose real value is not reflected in stock)2. Secretly purchase small percentage (no more than 5%)

a. RAT: This saves money on purchasing once price goes up, and recoups costs if Target mounts a a white knight/share repurchase defense

3. Arrange financinga. Usually, finance via bank loans and junk bondsb. Optionally, form a ShellCorp that will buy all the tendered shares using junk

bonds/loans statutory-merge itself into Target Target corp now takes on obligations of ShellCorp Junk bonds/loans are now secured by Target’s assets

4. Publicly announce TO, stating number of shares sought after, offered price, stated minimum of shares

a. Exert pressure to tender i. RT1: Implicit threat of back-end merger

5. Target’s management mounts defensesa. Seek white knight, self-restructure, pay one-time dividend, institute poison pill, share

repurchase, crown jewels, etc.6. Outcome:

a. OPT1: Bidder can’t get enough shareholders to tenderb. OPT2: Other bidder wins c. OPT3: Initial bidder wins

B. Williams & Hart-Scott Rodino Act 1. Q1: Did group/person acquire +5% BENEFICIAL OWNERSHIP of a public company?

a. 13(d)(1): Any person who directly/indirectly acquires more than 5% of any class of stock in a public corp must file a Schedule 13D with the SEC

b. REQ1: Beneficial owner of a +5% stake must file. Beneficial owner is anyone who…i. RT1: Has the power to vote of shares, ORii. RT2: Has power to acquire shares within 60 daysiii. RT3: Has power to sell of shares iv. RT4 [13d3]: Attempt to evade

A. Elements1. Use of contract/ arrangement2. Purpose/effect is to prevent vesting of beneficial ownership3. Part of scheme to evade reporting requirements

B. [CSX]: Acquirer buys 14% of Target’s stock in the form of TRSs, which are sold by i-banks. Acquirer could demand shares be delivered immediately.

1. H: Imputes beneficial ownership, as this is a scheme that violates 13(d)-3b

2. KF: TCI owned just under 5% of the stock (4.5%) 3. KF: TCI emails discussed the need to ensure that counterparties

controlled less than 5%4. KF: Testimony that the purpose of the plan was to not pay a

higher price for the stockc. REQ2: Duty arises for individuals OR to persons acting in concert who acquire +5%

stakei. Written agreement is NOT necessary

d. Effects of triggering disclosure obligationi. RULE: Filing with SEC is due within 10 days of acquisitionii. RULE: Disclosure must contain:

A. Exact number of shares purchased by person/group making the filingB. Source + amount of funds used to make purchaseC. Purpose of buying shares (plans to seek control? Cause merger? Sell

assets?)D. Plans to take company private

2. Q2: Does HART-SCOTT-RODINO apply and require a waiting period?a. REQ: One party has assets of +100M; other party has assets of +10Mb. REQ: Bidder would end up with +15% of target’s stock

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c. IF YES HSR Act applies to the acquisition:i. RULE: Bidder must notify FTC and DOJ Antitrust about proposed acquisitionii. RULE: Bidder must wait 15 days before buying any more shares for cash, and 30

more days before buying any more shares for securities A. Agency may obtain extension of 10/20 days

3. Q3: Apply SEC’S 8-FACTOR TEST to determine whether there was a tender offera. STD: Court is looking for factors to indicate that CAP may be especially active (and

compel shareholders to tender)b. Active & widespread solicitation of target’s public shareholdersc. Solicitation is for substantial percentage of Target’s stockd. Offer to purchase is at substantial premium over market pricee. Non-negotiable terms of offer f. Offer is contingent on tender of a fixed number of sharesg. Offer has limited timeh. Offerees pressured to selli. Br publicly announces acquisition j. STD: Coordinated offers are VERY LIKELY to be deemed tender offers

i. Only contrary case [Brascsan]: Private calls made to 50 large investors out of 50K total; less than 0.5% premium for most blocks purchased; no stated time window; offer was negotiable (and was more like a statement of interest in buying); solicitees were sophisticated professional investors

A. Only the “substantial percentage” prong is metB. H: Not a tender offer

k. Things that do NOT qualify as TOsi. Mere purchase of large quantity of stock, without moreii. Privately-negotiated purchaseiii. Open-market purchase, IF purchaser keeps secret his intent to acquire

significant stake in target (obv, this isn’t possible 10 days after Br crosses 5% threshold)

4. Q4: IF it’s a tender offer, apply REGULATIONS APPLICABLE TO TOSa. CF1: IF it was NOT a tender offer Br need only make the 13(d) disclosure after

acquiring +5% of sharesb. CF2: IF there was a tender offer Regulations of Tender Offers

i. RULE [14(d)(1)]: If TO would result in Bidder owning +5% of shares A. REQ: Bidder must disclose identity, financing, plans for company in a

Schedule 14D-1B. REQ: Bidder must make reasonable attempt to notify all of Target’s

shareholders ii. RULE: Communications by ANY party advocating shareholders to accept/reject

TO are must make Schedule 14D-9 disclosuresiii. RULE: Traffic rules

A. Shareholders may withdraw stock from TO at any time that TO remains open

B. Bidder must buy from each tendering shareholder pro rata (if TO is over-subscribed)

C. Each tendering shareholder must receive best price given to ANY shareholder

D. TO must be kept open for 20 daysiv. RULE: Limitations on the form of TOs

c. Antifraud rules [14(e)]: Unlawful to make untrue statements/omissions/deceptive or manipulative practices in connection with TO or solicitation

i. Does NOT bar substantive unfairnessii. 14(e) creates implied private right of action giving rise to damages/injunction, if

P SHOWS:A. REQ: Misrepresnetaion/nondisclosure was materialB. REQ: D had intent to defraud/misleadC. REQ: P relied on misrepresentation/omission D. REQ: P must have standing (bidder, non-tendering shareholder,

shareholder who bought/sold shares in reliance on information/omissions)iii. Remedies

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A. OPT1: Injunction (e.g., against bidder from consummating TO, against one party from misleading shareholders as to the opposing side, from proceeding without disclosure)

B. OPT2: Recover damages (available to tendering & non-tendering shareholders, but NOT bidders)

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36. M&A: Master RM A. Master RM

1. Method of acquisition2. Is it a tender offer? If so, apply Williams Act3. DoC issues

a. Board didn’t scrutinize offer closely and allowed a suspected-self-dealing transaction? (Van Gorkom)

b. Board didn’t pursue highest price (Revlon) Waivable as to monetary relief, but NOT waivable if P is seeking to enjoin a measure/transaction

4. Theft of corporate opportunity issues?a. Perelman

5. DoL issues b/c board may be self-dealing?a. Van Gorkom

6. “Duty” of faith?7. Board’s defensive measures permissible (in the case of hostile takeover)?8. Can Acquirer wage a successful proxy fight (to seize the board and redeem pill)?9. Shareholder suit 10. Shareholder can sue for appraisal after freezeout11. Freezeouts

a. RT1: Merger proposed by Controlled shareholder is subject to EF reviewb. RT2: Pure/Siliconix directly to min shareholders

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37. M&A: Methods of taking controlA. TRAD: Either proxy contest (running insurgent directors and convincing other shareholders to vote

for them), or tender offer (acquire majority shares and vote your own directors in)1. MOD: Proxy contest and TO merged into single hybrid form of hostile takeover

B. STRAT1: STATUTORY MERGER1. Boards of each corporation meet and negotiate terms of the merger

a. Independent board committees should be used as early as possible to avoid Eisenberg problems)

2. The two boards draft and agreement that usually provides for a transfer of the target’s stock for stock of the acquirer

3. TS: Proxy materials are sent to the shareholders if neededa. RULE: The vote is NOT a class vote, unless specified in the mergerb. SP1: Target’s shareholders votec. SP2: Do Acquirer’s shareholders get a vote?

i. TS1: [251(f)]: IF Acquirer’s stock will be increased by more than 20% the acquirer’s shareholders are entitled to a vote § 251(f)

A. 50% of ALL outstanding shareholders must vote yes to get a majorityB. RAT:

ii. TS2: [NYSE] Whenever there is an increase of stock of more than 20%, there needs to be a shareholder vote and 50% of stockholders who are actually voting need to approve

iii. TS3: EXC: No vote is required for Acquirer if:A. The agreement doesn’t require an amendment of the charterB. Each share of stock of will be identical to the stock in the surviving

corporationC. There will be less than 20% of the acquirers stock added because of the

merger4. If majority of shares approve, the target’s assets merge with the acquirer and the target’s

shareholders receive acquirer’s stock5. Certificate of merger is filed with the secretary of state6. Dissenting shareholders may bring appraisal rights

C. STRAT2: ACQUISITION OF ASSETS1. How it works

a. Boards of the two firms negotiate a dealb. Boards present the negotiated agreement to the shareholders of the target corporation

only c. Only the target shareholders get to vote (§ 271(a))

i. [RMBCA]: Shareholders are only entitled to a vote if the sale leaves nothing behind (12.02)

d. If shareholders approve, title for each of the actual physical assets is transferred to the acquirer

i. Transaction costs are highere. After the sale of substantially all of its assets, the target corporation distributes the

consideration received to its shareholders2. Q1: Why use this method instead of a merger?3. Q2: What constitutes a sale of “substantially all” assets requiring a vote?

a. KF: Size of the saleb. KF [Thorpe]: Not just size of the sale, but also what the qualitative effect on

corporation’s character & purpose will bec. KF [Thorpe]: Is the transaction far out of the ordinary course of the corporation’s

business?

D. STRAT3: COMPULSORY SHARE EXCHANGE (ONLY in RMBCA jurisdiction)1. How it works

a. Boards negotiateb. Target company presents offer to the shareholders who vote c. If majority vote is achieved, the target’s shares are exchanged for the acquirer’s sharesd. Shareholders of target and acquirer both own shares in the acquirer and the target

becomes a wholly owned subsidiary of the acquirer

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2. Q1: Why use this approach?a. Benefit of wholly owned subsidiary is that there is a liability shield – liabilities of the

target don’t transfer directly to the acquirer

E. STRAT4: TRIANGULAR MERGER1. How it works

a. Acquirer forms a subsidiaryb. Acquirer transfers all the consideration that it will give to the target for the merger in

exchange for all of the stock in the subsidiaryc. Target merges with subsidiary (Subsidiary survives) (statutory merger)d. Merger consideration is distributed to shareholders of the target and the target’s

shares are cancellede. Acquirer then owns a subsidiary filled with the assets of the target and the target

shareholders own shares of the acquirer2. Voting procedure

a. Target always gets a voteb. Acquirer only gets a vote IF more than 20% of new stock is issued under NYSE rules

i. No vote under DE law because the acquirer is not a “constituent” of the merger

F. STRAT5: Reverse triangular merger1. Same as regular triangular except when the target merges with the subsidiary, the target

survives2. Voting procedure

a. Target shareholders always gets a voteb. Acquirer’s shareholders only gets a vote if more than 20% of new stock is issued under

NYSE rulesi. No vote under DE law because the acquirer is not a “constituent” of the merger

c. Merger consideration is distributed to shareholders of the target and the target’s shares are cancelled

d. Target gets a vote because the shareholders will trade in their own stock in the target for stock in the acquirer so it will not be the same shares – 251(f)(2) requirement is not met, so no exception from voting under DE law

G. STRAT6: Tender offer + Triangular merger1. Create a subsidiary of Acquirer’s corporation2. Subsidiary makes tender offer to Target3. If Acquirer gets more than threshold percentage of shares Reverse triangular merger

a. Target survives as a wholly owned subsidiary of Acquirerb. Remaining shareholders get the same payout as given in tender offer.

4. Target’s shares (that were purchased by acquirer) are cancelled. New target shares are converted

5. STRAT Q: Why do a tender coupled with a triangular merger instead of just doing a merger?

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38. M&A: Public contests for control

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39. M&A Q1: Defenses to hostile takeover – Intro & Types A. RM

1. Q: Will takeover defense receive BJR protection (DE law)?a. IF YES BJR protectionb. IF NO Defense must satisfy EF and show fair dealing/price (per normal self-dealing

transaction rules)2. Review of defensive measures

a. Unocal: Legitimate threat; Reasonable fear; Not coercive; Not preclusive; Proportional to threat; Within reasonable range

b. Blasius: Any franchise-tinkering?3. Will enhanced scrutiny apply? IF YES No more defensive measures4. Do deal protection measures pass Unocal review?5. Shareholder countermeasures?6. Freezeout by a controlling shareholder

a. IF freezeout via merger Weinberger analysisb. IF freezeout via TO Siliconix

B. Types of Anti-takeover defenses 1. Pre-offer structural defenses

a. REQ: Shark repellant usually require charter amendments (and thus, shareholder approval )

b. OPT1: Supermajority of shareholders required to approve merger/major salec. OPT2: Majority of minority approval requirementd. OPT3: Staggered boarde. OPT4: Anti-greenmail amendmentf. OPT5: New class of stockg. OPT6: Poison pill

i. Valid under DGCL 157, BUT that’s only a default rule and it can be opted outA. BUT no corporation has ever opted out of the freedom to adopt a PP

ii. Calliii. Flip iniv. Put

2. Post-offer tactical defenses (SEE EM p. 482)a. Defensive lawsuitb. White knight

i. Give white knight a lock-up (e.g., option to buy crown jewels)ii. Give an option to buy stock at favorable price

c. Defensive acquisition (e.g., to create antitrust problems, to jack up debt)d. Corporate restructuring (e.g., take out big debt/sell assets to pay one-time dividend)e. One-time dividendf. Greenmail (buy back Br’s partial stake at above-market price)g. Sale to friendly party who can be trusted not to sell to hostile bidder (white squire)h. Public share repurchasei. Exclusionary share repurchase

i. NOT valid under 14d-10 (TO must be open to all holders)ii. Validated in Unocal

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40. M&A Q1: Does TAKEOVER DEFENSE qualify for MODIFIED BJR?

A. Outliers & potentially overruled by DE courts [Pillsbury/Interco]: If board puts forth its own offer It must redeem the PP and let shareholders decide b/w offers

B. STD: DE courts apply modified BJR, because of higher-than-usual probability that DOs will be acting out of self-interest when they enact defensive measures

1. Under modified BJR, DOs must make special showings to be qualify for BJR protection2. Unitrin gets us very sloe

C. REQ0: The measure represents an ACTUAL BUSINESS JUDGMENT1. POL PROB: Do hidden poison pills qualify for BJR?

a. DEF: A PP that is wrapped up in business judgments (e.g., pill with a built-in provision that says, if the pill is redeemed, it triggers a massive payout to some 3rd party?)

i. [Oracle v. Peoplesoft]: Oracle (Br) bids on Peoplesoft (Cp). Cp responds by launching “Customer Assurance Program” that triggers a massive payout to customers if Oracle acquires.

A. Peoplesoft claims this is a business measure1. “Program is designed to assure that we’re providing proper care to

our customers, and those customers specifically want Peoplesoft service and will be unhappy if they don’t get that (or get compensated appropriately)”

B. Oracle claims this is a takeover defense1. “The program only triggers IF Oracle is acquired!”

ii. NOTE that DE courts have NOT yet decided on hidden poison pills

D. REQ1: Is the THREAT LEGITIMATE?1. IF NO reasonable legimtate threat Enjoin defensive measures2. STD: To find a reasonable fear is quite lenient to Board3. REQ: DOs acted to protect shareholder value, NOT just their own jobs4. RT: Threat need not be real, but merely, reasonably perceived (Cheff)5. RT: Threat to corporate culture (Cheff; Paramount) 6. RT: Threat to long-term strategy unless there is clearly no basis (Time)7. RT: Br would change business practices in a way that would destroy value8. RT: Tender offer will leave corp with unreasonably high levels of debt (e.g., b/c Br will finance

the acquisition with junk bonds)9. RT: Hostile offer would cause shareholders to suffer opportunity loss (to hear Board’s better

offer)10. RT: Structural coercion of shareholders

a. STD: Cases forcing PP redemption usually involve all-cash, all-shares TOs (Interco; Pillsbury)

11. RT: Substantive coercion of shareholders (fear that shareholders will tender into offer b/c of ignorance about true value of the company)

a. Insufficient bid alone is sufficient to constitute substantive coercion (Unitrin)b. Shareholder confusionc. ART (D): “Our shareholders are rationally apathetic. It’s inevitable that they’ll be

underinformed about the deal and confused.”12. EXs of legitimate threats

a. [Moran]: Threat that someday a hostile takeover attempt might emerge Legitimate threat validating a PP. BUT use of a PP/plan will be evaluated when the issue arises.

E. REQ2: Is the FEAR REASONABLE?1. IF no reasonable fear enjoin the defensive measure2. KF: Good faith & conducted a reasonable investigation coming to the threat conclusion.3. KF: Time spent discussing measure4. KF: Extent of analysis5. KF: Outside experts’ valuations

F. REQ3: Defense is NOT PRECLUSIVE/COERCIVE 1. REQ: Not preclusive (makes it totally impossible for hostile takeover to succeed)

a. IF preclusive Court will enjoin defense

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b. EX: A PP “call” plan that gives each shareholder the right to buy a share of Br’s stock at 1/10th market value

c. EX: PP “put” plan that gives each shareholder right to sell back stock at 10x market value

d. EX [Omnicare]: Absolute lockup that makes it inevitable a favored bidder will acquire company

e. STD [Toys ‘R Us]: Some mathematical probability that other bidders may still find the deal viable Defensive measure is reasonable.

2. REQ: Not coercive (does not cram down on shareholders DO’s plan)a. [Selectica]: Defense that would merely continue status quo ante business strategy is

NOT coerciveb. EX [Unocal]: Discriminatory self-tender offer is banned under Williams Actc. EX: D/Os waste corp’s assets in the course of mounting defense (e.g., extravagant

price paid to buy back shares in greenmail; selling off crown jewel at below-market price)

G. REQ4: Defense is REASONABLE IN RELATION to the threat posed1. IF NOT reasonable in relation to threat EF review2. REQ: The measure must somehow benefit stockholders

a. [Revlon]: If the measure clearly deprives shareholders of the highest price for their shares no BJR

3. KFs that Board should consider to mount a reasonable defensea. Inadequacy of price offeredb. Nature and timing of offerc. Questions of illegalityd. Impact on constituenciese. Risk of nonconsummation f. Quality of securities being offered

H. REQ5: Defense is PROPORTIONAL in relation to threat1. IF NOT proportional EF review2. Courts are unclear as to what work this prong does3. [Mentor]: Board puts in place a 6-month slow hand pill that prevents future board from

redeeming the pill. a. H: Slow hand pill is disproportionate under Unocal/Citrin

i. Board did not give a good enough reason for needing the defense (besides “we need 6 months to respond to a hostile offer).

b. H: Delaware SC asserts that “current board cannot bind future boards.” This seems to prove so much—current boards can and do bind future boards.

I. REQ6: IF Board’s defensive measure TINKERS WITH SHAREHOLDER FRANCHISE … 1. RAT: As Delaware courts have moved closer to “just say no” Greater reliance on preserving

proxy contests as means of shareholder exercise of choice & avenue to Acquirer taking control 2. Franchise tinkering = no BJR UNLESS

a. RT0 [Hilton]: If there is a mixed bag of defenses, including some franchise-tinkering Review Unocal+, but Blasius-lite

i. Courts face an issue of severability ii. Courts will try to get into the minds of directors to assess whether if they had

known certain things would be invalidated, they would still have undertaken other measures

b. RT1: Rebut Blasius by showing shareholders voted for the transaction (Gantler)c. RT2: Make a showing of ALL OF

i. REQ5.a: Threat to corporate policy (Unocal) ii. REQ5.b: Compelling justification for the measure (Blasius)iii. REQ5.c: Measure was proportional to the perceived threat (Unocal) per

Liquid Auto.A. [Carmody]: Dead hand provision for poison pill

1. Serious disenfranchising effect because shareholders are powerless to elect board that can redeem

2. Measure is preclusive, and thus disproportionate and unreasonable3. EXS of shareholder franchise tinkering

a. CF1: Board takes action on specific votes, timing of specific votesi. Change the date of the SH meeting (Schnell)ii. Adding more Board members in response to proxy contest (Blasius & Liquid Auto)

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b. CF2: By contrast, structural measures are more likely to be reviewed under Unocal STD

i. Issue more shares to allied shareholdersii. Buy back stock at market price selectively from a large shareholder who would

likely vote for insurgentsiii. Issue additional stock at market price to allied shareholders (does not run afoul of

Liquid auto)

J. REQ6: “DUTY” OF GOOD FAITH breached?1. RT1: If board acts to entrench itself, or…2. RT2: Acts in bad faith, or…3. RT3: Is intentionally derelict in its duties to collect information4. [Stone]: Failure to act in GF does not result, ipso facto, in fiduciary liability. BUT failure to act in

GF may indirectly trigger liability. 5. Q1: Where on the spectrum from malevolent intent--gross negligence does this lie?

a. [Disney]: Intent to do harm ---- Intentional dereliction; conscious disregard of duties ---- Mere gross negligence

b. There may be a level of negligence so profound as to trigger lack of BF No 102(b)(7) 6. Q2: Does the subjective state of mind of the director INTEND to not serve shareholders?

a. IF NO No breach (Disney)b. IF YES Possible breach

K. Quasi-REQ5: Majority of board is independent directors1. STD [Revlon]: Strict view of who qualifies as “independent.”

a. [Revlon]: Directors who were also significant shareholders, or had business ties to corporation, were NOT independent

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41. M&A Q2: Revlon enhanced DoC scrutiny applies?A. CLR: Revlon claim is a DoC claim, but non-waivable b/c it Revlon claims seek injunctive relief

B. Revlon applies where EITHER1. Entire company is up for cash sale; OR2. Control of company would pass to a single individual/group

C. Q1: ENHANCED SCRUTINY WILL NOT APPLY where:1. RT1: Target’s challenged transaction a merger another public company that’s NOT

controlled by single individual/small entity2. RT2: Board is “just saying no” to lift a PP in response to a tender offer (even if all-cash and

high-premium)a. If Br’s tender offer is conditional on some act by the board (e.g., redemption of PP),

Board may refuse to do sob. BUT the decision to “say no” (e.g., to keep a PP in place) must satisfy Unocal

(reasonable fear, proportional) and Revlon (if level playing field was triggered)

D. Q2: Ways to TRIGGER REVLON duties1. RT0: Other KFs about a challenged merger that push toward Revlon mode

a. All-cash, or all-nonvoting-stock (AOT all-stock): Because court is equipped to judge cash consideration, whereas board should have deference to judge value of stock; and because nonvoting stock will not enable Target’s shareholders to exercise control over company

b. Acquirer is a whale, Target is a minnow: Because merger of equals implies a business strategy of synergy

c. Acquirer is a controlling shareholder of Target: Because this looks like a sale of control, and court wants to ensure shareholders of Target capture control premium

2. RT1: Target initiated an active bidding process for itself, OR3. RT2: Seek a transaction involving a breakup of the company (usually in response to hostile

bid)? 4. RT3 [Viacom; QVC]: Control will pass to a single individual/small group?

a. IF YES Revlon scrutiny kicks inb. EX [QVC]: Board’s preferred transaction would shift control from “fluid aggregation

of unaffiliated shareholders” to cohesive new controlling shareholder i. Paramount and Viacom are in merger talks. QVC jumps in with hostile TO to

Paramount. Paramount puts up defenses. ii. Br and Target embed special provisions into merger agreement to ensure that

Target wouldn’t simply be put “in play” for another Br to snap up (no-shop, cancellation fee, lock-up stock option) Merger agreement fails enhanced scrutiny

A. KF: Target board gave insufficient attention to features of the deal that impeded maximizing shareholder value

B. KF: Target board had a competing offer on the table for a much higher price, but it was uninformed and didn’t take that offer seriously

C. H: On Revlon review, strikes down no-shop, termination fee, and stock options b/c they were designed to limit a competitive offer

c. NON-EX [Time]: Board’s preferred transaction is a stock-for-stock exchange that keeps control of Target in public shareholders’ hands

i. Time and Warner were already in merger talks. Paramount hostile TOs to Time. Time puts up defenses. Time shareholders make Unocal and Revlon claims.

A. H: No Revlon duties, because the merger would NOT result in breakup and ownership of Time would remain with public shareholders

d. RAT: Control premium is costly, and compensates the minority shareholders for their lost voting power. But once current shareholders of Target sell of their shares and give up control premium, they’ll never be able to recapture it. So the current sale of control must make most of opportunity to realize for shareholders the best value reasonably available.

5. POL on Revlon dutiesa. Revlon imposes a tax on Acquirersb. PROF: It doesn’t make sense to

E. Q3: IF YES LEVEL PLAYING FIELD rules kick in, else Board’s approval of transaction is QQ (void?)

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1. STD: If management is one of the bidders and/or has seats on board, court will scrutinize corporation’s negotiations very closely

a. Target should form a special committee to handle negotiations2. RULE: Once management offers company for sale NO MORE defensive measures3. RULE: DOs have duty to obtain highest price for shareholders

a. NO auction-ending lockups unless further bidding is unlikely4. RULE: DOs must perform market check for higher bidders

a. EXC: No market check needed if directors have reliable evidence with which to evaluate the fairness of transaction

5. RULE: DOs must treat equally all would-be bidders (no favorable treatment for white knights)a. ART(D): The defensive measures were merely meant to maximize bidding! (by leveling

out the playing field by boosting the underdog and stoking a bidding war (to shareholders’ benefit)

b. CTR-ART(P): The purpose of the measure is shut down the auction and give win to white knigth

c. [Revlon]: Board gave white knight crown jewels option, no-shop option , private financial information, and promised $25M cancellation fee. Prime reason was b/c white knight’s offer would better protect corp’s creditors, who might sue Board

i. CF1: Board’s initial defensive measures (PP, share repurchase plan) were OK b/c of board’s reasonable fear that buyer would impair corporation’s effectiveness by using junk bonds and selling assets to pay debt

ii. CF2: BUT as soon as board authorized management to negotiate a merger/buyout DOs duty is to maximize shareholder value (auctioneer), NOT to defend the bastion of corporate value OR defend intersts of any other constituency

iii. KF: Board’s favoring of white knight was primarily motivated by fear of personal liability from creditors

F. Q4: Are the DEAL PROTECTIONS subject to BJR, or will they cause transaction to be enjoined?1. STD: Unocal is the appropriate standard in evaluating the reasonableness of deal protections

where SH franchise is not implicated (Omnicare). 2. TS: Board bears burden of passing Unocal & including fiduciary out, to receive BJR (else,

injunction & damages)a. REQ0: Deal protection contract must contain a fiduciary out, in the case of lockups

issued while in Revlon-modeb. REQ: Reasonable grounds for believing that a corporate policy existed and was

affected by the person’s stock ownership (Cheff) i. Threat to corporate policy : threat of non-consummation of the deal is typically a

viable threat (OmniCare TRU) c. REQ: That the defensive mechanisms were reasonable in light of threat posed

i. Per se categoriesA. No fiduciary out in the deal protection provisions (Omnicare)B. Precludes any additional bids because so coercive and severe

ii. Where a measure is not coercive/preclusive, it is likely that the court will determine that the measure was reasonable.

A. Toys ‘R Us -- some mathematical probability that other bidders may still find the deal viable, the protection measure will be ground to be reasonable.

3. If Unocal duties are met BJR. a. If not, the transaction may be enjoined and the BOD liable for FD damages.

4. Does there have to be a fiduciary out in DE law? a. Omnicare Decision: DE S.Ct. held 3-2 that a fiduciary out was required in these instancesb. RJ: This decision is likely to be reversed and we are not responsible for this case, but note this outcome and its

ambiguitiesc. Under Unocal, this a grey area outcome with arguments on both sides

i. For transactions subject to Revlon, the court requires a fiduciary out (implicitly; so that directors can gain the best value)

ii. Why might directors pay a termination fee even when the court didn’t require them? A. Directors want to be Odysseus (“tied to the mast”) to encourage

purchasers to emergeB. In some ways DE courts are grappling with exactly the issue that Odysseus

struggled with about being tied or following the sirens 5. POL on deal protection

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a. PRO Deal Protections: Without them, ex ante buyers may not emerge knowing that their deal could be jumped by a later buyer

i. Deal protections are the way that directors latch themselves to the initial offerb. CON Deal protections: There is a cost that accompanies this since they won’t enlist in

later offers so we must weight the costs of this against its benefits: i. Practically, Fiduciary Out provisions amount to handing Odysseus a pocket knife

where they can explore other deals if appropriate under fiduciary obligation A. This may be destructive to the value that hostile offers bring to the table

c. Our policy choice depends on our analysis of the benefits or cons and the degree to which fiduciary outs prevent offers from arising

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42. M&A Q4: Shareholder countermeasures available?A. Competing visions of the corporation

1. 109(b): Bylaws [which shareholders may pass] may contain ANY provision relating to business of the corporation, conduct of its affairs, rights/powers of directors, shareholders, etc.

2. 141(a): Corporation’s business and affairs are managed by board of directorsa. GEN STD: 141(a) trumps, so a shareholder bylaw to mandate redemption of the PP

would likely FAIL

B. STRAT: Shareholders can AMEND BYLAWS to limit use of pill1. PROP: Bebchuk proposes to CA to amend its bylaws to say that pill can be adopted only by a

unanimous board vote, and pill expires automatically after one year unless ratified by shareholders

a. SEC refuses to grant no-action letter allowing CA to omit it from its proxy2. NOTE that, if adopted, this proposal would enable Br to take over a firm w/ a staggered board

in just one election (since the Br can establish a foothold in the board Poison pill will expire in at most a year and won't be ratified)

C. RULE: BOARD CAN TIE ITS HANDS in a way that shifts more power TO shareholders, but it can NOT tie its hands in a way that deprives shareholders of power (b/c of fiduciary duty)

1. [Unisuper]: News Corp (Cp) agrees with large shareholders to a “board policy” that any PP put in place would expire after 1 year, unless extended by shareholders. Br bids. Cp’s board extends pill in contravention of the earlier policy.

a. Note that board is basically tying the hands of future boardsb. H: The agreement to not extend PP is binding upon the board and future boards

2. Court’s analysis seems to suggest that Board is merely an agent of shareholders, and must act as shareholders wish

a. PROF: But as DGCL 141(a) suggests, directors CAN deviate from shareholders’ express wishes

i. The entire reason that PPs are upheld is that the board is free to NOT follow shareholder instruction

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43. M&A Q5: Appraisal rights (Apply if (1) there’s a freezeout, or (2) EF)

A. Process of obtaining appraisal (DGCL 262)1. Shareholder gets notice of appraisal right at least 20 days before meeting Submits written

demand for appraisal BEFORE vote Votes against/abstains merger Within 120 days after merger is effective, file petition in Chancer Court

2. Court holds valuation proceeding to determine shares’ fair value, exclusive of any value arising from accomplishment/expectation of merger

B. Q: D Does shareholder have APPRAISAL RIGHT?1. Statutory merger [DGCL 251]: Yes, if T shareholders vote, UNLESS stock market EXC (262)

a. EXC [262(b)(1)]: Market-out Exception DENIES appraisal rights IF ANYi. RT: Shares are market-traded, ORii. RT: Corporation has +2K shareholdersiii. RT: Shareholders are not required to vote on the merger

b. CTR-EXC [262(b)(2)]: Appraisal right is restored IF ANYi. Merger consideration is NOT in the form of EITHER

A. Shares in surviving corporationB. Shares in a third corporation that is exchange-traded, or has +2K

shareholders C. Cash, BUT ONLY IF it’s provided in place of fractional shares

2. Asset acquisition [DGCL 271]: No, UNLESS provided in charter3. Share exchange

a. [DEL 262]: Nob. [RMBCA 13.02(a)]: Yes, UNLESS stock market EXC

4. SUM CHART: Voting rights and appraisal rightsa. Merger: Shareholders of BOTH constituent parties have BOTH rights (MBCA & DE)b. Triangular merger: Target’s shareholders have voting rights AND appraisal rights

(subject to market-out exception)c. Sale of assets: Target’s shareholders have voting rights ONLY; no appraisal rights

C. Q: WHAT VALUE is received under appraisal right?1. Value as minority share: Apply a “minority discount” to the share block2. Value as pro rata claim on going-concern value: Not discounted 3. Value as pro rate concern including benefits of deal: Count additional value from the

transaction

D. Q: HOW TO VALUE?1. MOD: DCF

a. CR1 [Weinberger]: Valuation may include post-merger earning potentials, so long as it has proof and is not speculative

i. BUT Weinberger court probably did this only because he was trying to make the appraisal remedy look more like EF remedy, and in doing so stretched 262(h)]

ii. EX [Cede]: New business strategy implemented after a mergerb. CR2 [DGCL 262(h)]: Shareholders in an appraisal action are NTO entitled to gains from

that transaction 2. TRAD measures:

a. Market value of sharesb. Earnings value based on previous 3 years of earningsc. Value of liquidated assets, less liabilities d. DE’s old block method, which combines the above 3 measures

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44. Insider tradingA. Efficient Capital Markets Hypothesis

1. Weak form: 2. Semi-strong form:3. Strong form:

B. SUM1. We get closer to true prices b/c investors are always on the lookout for mispriced assets.2. For many assets, there are straightforward methods of ascertaining their value. All that is

needed is info and math.3. Information is plentiful, and investors have good reason to invest in its production.4. Market prices should reflect well-informed estimates, based on all available information, of the

discounted value of the expected future payouts of corporate stocks and bonds.

C. PRO Why believe ECMH?1. Unless ECMH is approximately correct, there would be big arbitrage opportunities (we could

all jump into the market and make big profits).2. Ockham's razor: Holding all else equal, the simplest solution is probably the right one. SEC

and DE courts tend to use this hypothesis.3. EX: Oracle acquisition of Peoplesoft. Testimony in court of CEO led immediately to market

shifts.

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